A value based UK trade policy for an attractive Brexit

Brexit is a risk…

The UK has been the most successful country in Europe in attracting Foreign Direct Investment (FDI) for more than a decade, consistently attracting around one fifth of all investment projects into the region according to EY’s Global Investment Monitor research. Our latest report highlights the risks Brexit may pose to future UK performance.

…because trade and labour mobility matter to investors…

Investors are concerned about the UK’s terms of the UK’s exit from the EU. If the UK’s terms of departure were to be at the “softer” end of the spectrum, with trading arrangements with the EU after Brexit on slightly less favourable terms than today, only 12% of all investors say this would make the UK more attractive, compared to 51% who say less attractive. The negative sentiment is strongest among investors based in Europe — of whom just 2% say this would make the UK more attractive, compared to 64% who said it would make the UK less attractive. The responses on the impact of a more restrictive approach to labour mobility provide the same message.

…but the UK has a window of opportunity to respond…

When international investors were asked how they expect the UK’s attractiveness for FDI to change in the next three years in autumn 2016, the proportion of investors expecting the UK’s attractiveness to improve was 29%, while the percentage expecting it to get worse has more than doubled from 16% in Spring 2016 to 34%. However, 25% of the investors we surveyed intend to invest in the UK in the next 12 months. This is a slight increase since our survey in the spring and suggests that Brexit may not yet have impacted investor sentiment to a significant degree. Hence the UK has a window of opportunity to act to ensure the impact of Brexit is mitigated.

…and hence a new trade strategy is required…

We have commented in our previous EY UK Attractiveness reports that the UK needs more alignment and integration in its trade strategy. Alignment across all Government policy and especially to wider industrial strategy, and integration across all the components of trade, FDI, exports and overseas investment.

Starting with sector priorities, the role of exports, FDI and overseas investment can be defined and policy aligned to support this. Germany provides an example of such an approach. While the UK has performed strongly in attracting manufacturing FDI in recent years compared to Germany, German export performance continues to outstrip the UK. Over the last five years, Germany has invested in approximately five times as many manufacturing projects across Europe than the UK. This provides more supply chain control and flexibility but also proximity to market and soft power. The UK has tended to view the elements of trade as silos.

A more strategic approach to trade is required and the promise of a UK industrial strategy will be a very helpful starting point. Once the role for trade in industrial policy is defined, specific actions can be developed, tailored to the characteristics of individual sectors. Our analysis has identified the following themes that should be considered in developing future trade and FDI policy:

• Not all FDI is of equal value. We have previously questioned the benefits of sales and marketing investments. Our most recent analysis shows that many of these investments are beneficial as they support the inflow of software skills and also provide a basis for exports to Europe. However, there exists a need to continue to ensure that too many resources are not allocated to chasing volumes rather than value in FDI – the focus should be on understanding the wider benefit of investments.
• Brexit will not impact the UK’s attractiveness equally across activities. It is likely that Brexit will lead to changes in the UK’s trade, migration and regulatory arrangements with the EU and this will impact certain investments more than others. Headquarters investment is a good example. Over 50% of UK FDI in this area in the last 10 years has been for “European” HQs and it seems unlikely this hit rate will continue and so resources may need to be reallocated to other areas. A targeted approach is required and a realistic view of the benefits and prospects of data and call centres is needed.
• Manufacturing should be a priority. Over half of all FDI projects in Europe originate from manufacturers and each project in production in the UK is matched by an investment elsewhere in the value chain over time, with logistics having a very close linkage. We have previously identified the scope for reshoring in a changing world economy. Now with digital technology impacting the sector and a weaker pound, the potential is increasing. Success will require the appropriate response to skills, support for R&D, infrastructure investment in facilities that support the movement of goods, trade agreements with key export and import destinations and targeted incentives.
• Software. The UK has been very successful in attracting software FDI. This may become harder in future if access to the EU market is restricted and skilled labour is harder to attract to the UK. There will be a need to work hard to reassure investors from the USA and to ensure UK policy prioritises the needs of this sector. There should also be more focus on seeking to attract the highest value investments, this is likely to be those which help to build the UK’s digital platform such as AI, Robotics and analytics capabilities.
• R&D. This has been an area of strong performance in recent years with the UK leading Europe in key sectors such as biotechnology. Skills, incentives and access to the UK’s universities all matter and policy must look to ensure that any adverse effects of Brexit are compensated for in future.

The 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.