Can rebalancing sustain the UK’s leadership of European FDI?

A very positive performance…

EY’s 2016 UK Attractiveness Survey (UKAS) shows the UK’s performance last year in attracting Foreign Direct Investment (FDI) was outstanding. The UK attracted a record number of 1,065 FDI projects and created over 42,000 jobs, the most in any year since we launched ourUKAS programme in 1997. The 20% growth in projects achieved in a European market that grew by 14% means the UK increased its market share from 19.9% to 20.9%. 

…driven by the emerging regional powerhouses…

But the national numbers only tell part of the story: 2015 was the year of the UK’s regions and cities as rebalancing started to become a reality. Almost 90% of the UK’s total growth came from the regions outside of London and the South East. The North West led the way with an increase in projects of 118%, Yorkshire achieved 66% growth, Scotland 51% and the West Midlands 46%. The “Northern Powerhouse” has recorded growth of 127% in the two years since the term was first coined.

…with solid progress across the board

The UK also made progress in several other important areas:

• Attracting key strategic investments such as Headquarters, which increased by 172% giving the UK a 53% share of the European market, and R&D facilities, project numbers for which grew by 37% in 2015.
• Manufacturing continued to do well with the UK attracting more manufacturing FDI projects than Germany for the second year running. This success underpinned the strong performance of the North and Midlands.
• There was a good balance across sectors with Software, Financial Services and Business Services posting healthy growth.
• Investment from target fast growth markets also increased with a rise of 79% in projects from China and 58% growth in projects originating in India.
• The UK was the European leader in the two sectors identified by investors as most likely to drive Europe’s growth, ICT, and Financial Services.

But worrying signs for the future…

Against this positive backdrop, the strong signs in our investor survey that the UK’s attractiveness may not be as strong in future as in recent years took us by surprise:

• When asked about their likelihood to invest in the UK in the next year only 23% of investors responded positively compared to 27% last year, the lowest UK figure since 2010.
• When asked how the UK’s attractiveness for FDI will change in the next three
  years, only 36% of investors expect it will improve compared to 54% last year. This is the lowest UK score since 2010.
• The UK’s ranking as Europe’s most attractive location for FDI also fell relative
  to Germany with the UK now two percentage points further behind.

…that is not fully explained by investor perceptions of the UK’s key attributes…

This shift in both relative and absolute terms is unprecedented in our experience. In search of an explanation we reviewed the ranking given by investors on the UK’s attractiveness on 15 key attributes. While there was a very slight decline in the UK’s ranking on its top 10 attributes and larger decline on the weakest five, the shifts in total do not appear to be of the scale to explain the fall in future perceptions, especially as the UK still scores highly in several of these areas relative to its European competitors.

The EU referendum may be influencing investor views of the UK’s future attractiveness…

Since our survey in 2015, the UK Government has decided to hold a referendum on the UK’s membership of the EU. Some 78% of all respondents to our perception survey were aware of the upcoming referendum on the UK’s membership of the EU when asked in early 2016, compared to only 55% of investors who were aware of the possibility in 2015.

Access to the European Single Market (ESM) has consistently been identified by as an important element of the UK’s overall attractiveness by foreign investors in our surveys since 2014. In 2016, 79% of investors cited access to the ESM as a key feature of the UK’s attractiveness, up from 72% last year and 63% the year before.

When asked about how either a significant or substantial decline in the terms of access to the ESM would impact the UK’s attractiveness over 50% of investors in both cases said it would have a negative effect whereas only 7% viewed it positively. It seems clear therefore that a risk of change in the terms of access to the ESM is a significant concern for investors. Interestingly, the degree of change is less important, any reduction in the terms of access currently enjoyed has a significant negative impact on perceptions of the UK’s attractiveness for FDI. It does appear that a change in market access is an important issue for the majority of investors.

…and this seems to be feeding through into lower investor perceptions of future attractiveness.

The scale of change in future perceptions of the UK goes beyond what we would expect from the decline in the UK’s score on its key attributes. As the UK’s ranking has fallen in relative as well as absolute terms, there appears to be a UK specific effect related in part at least to the upcoming EU referendum. It seems reasonable to conclude that, without any future actions taken by the UK Government to mitigate any adverse effects of the UK leaving the EU, a poorer level of access to the ESM would reduce UK FDI in future. There may be scope for increased FDI from investors attracted by changes to the UK investment regime but the UK’s relatively highly attractiveness ranking on most attributes suggests the scope for additional stimulation of FDI may be limited.

Action needs to be taken now to secure the UK’s leadership position.

Whatever the outcome of the EU referendum vote, our analysis has identified a number of areas for action to strengthen the UK’s attractiveness a as destination for FDI. These recommendations assume, in line with official UK Government policy, that the UK will vote to remain in the EU on June 23rd. (Should the UK vote to leave, a review of these recommendations would obviously be required).

The priorities for action are:

• Re-engage with investors after the June 23rd vote;
• Develop an integrated trade strategy covering exports and FDI and the linkages across Government at both the national and regional level;
• Make investors aware of the devolution story, only 38% of foreign investors have heard of the policy but those who have are very positive about it;
• Deliver on promised skills and infrastructure improvements such as digital skills, roads and London airports. This will require national and regional co-ordination of activity.
• Be more ambitious on manufacturing, geographic rebalancing will only succeed in the UK if manufacturing prospers.

I will return to explore the thinking behind these themes in more detail in subsequent blogs. In the meantime here is a link to our UK report.

@MarkGregoryEY

markgregoryeconomics.ey.com

EY UK Attractiveness Survey is part of our Economics for Business programme which provides knowledge, analysis and insight to help businesses understand the economic environments in which they operate.