RSS feedsOver the last few years, inflation has become the number on which economic analysts and commentators tend to focus. But not so long ago the balance of payments was the statistic dominating the headlines. A current account deficit of the order of magnitude that is common today would have sparked ‘a run on the pound’ and put pressure on the UK’s ‘gold and dollar reserves’, generating panic among policymakers. Today, it barely registers on the economic Richter scale.
This is partly because we no longer have fixed exchange rates and so there is no requirement for government to try to defend a specific value of sterling. But it is also because we can manage deficits with minimal disruption. This is thanks to a robust balance of payments capital account, in particular the willingness of many foreign companies to invest in the UK.
The desire to attract inward investment is one of the few industrial policies pursued consistently by successive UK governments over the past 25 to 30 years, and the implications of capital inflows stretch beyond just propping up the balance of payments. Either in terms of direct investment or portfolio investment, the UK has punched above its weight. An estimate by the National Institute put the UK’s share of the global stock of inward investment at 8% compared with a 3% share of world GDP.
For the longer-term impact on the UK economy, foreign direct investment (FDI) is of the most interest. Foreign investments by multinational companies can offer a way of transferring new ideas, technologies and working practices to the host country, thereby raising output and performance. The presence of foreign competitors in their own backyard, moreover, could encourage local businesses to raise their game and adopt best practice. Over time, therefore, the structure of the UK’s industrial base will be strengthened and competitiveness improved, eventually benefiting the current account of the balance of payments.
The initial wave of direct investment in the 1970s was largely in manufacturing and took advantage of all sorts of incentives offered by governments anxious to shore up employment in under-performing parts of the UK economy. These investment flows have frequently been encouraged by national government or regional agencies, which offered incentives such as tax breaks, grants and subsidies to attract new businesses. From the mid-1990s, the motives have become more complex, the sectoral coverage much wider and the process has been facilitated by increasingly integrated capital markets.
Admittedly, perceptions of the benefits of inward investment became tarnished when downturns in the foreign parents’ home base led to UK subsidiaries closing down. There were also accusations that some of the transplants were footloose, taking financial support from public funds and then moving on when opportunities emerged elsewhere. Yet there have been some striking successes. The Nissan plant in Sunderland, for example, is the most efficient of the Japanese giant’s international operations, while HSBC’s acquisition of Midland Bank has created a British-based global banking heavyweight.
Where some previous Labour governments have been suspicious of foreign ownership of local businesses, the present administration is well aware of the benefits it can bring. Relative to turnover, many of these companies invest and export more and, with higher levels of productivity, pay higher wages. In many sectors, the transplants set the performance standards.
Gordon Brown and his colleagues recognise that it is location rather than ownership that matters. Any British-based enterprise selling globally creates jobs here, pays taxes to HM Treasury and contributes to the UK’s balance of payments. These are substantial pluses for the UK; the fact that some of the dividends and profits may go elsewhere is a small price to pay. Many of the transplants could as easily be located in other European or Asian countries, in which the UK would miss out on all the benefits.
Creating an investment-friendly environment to attract these businesses has long been an objective of the Chancellor and numbers published towards the end of 2006 suggest he is having some success. A United Nations report ranked the UK’s £89bn of FDI in 2005 in top place, ahead even of the US and China. The DTI’s figures showed that around 1,220 projects were recorded in 2005-06, an increase of 14% in a year. Other European companies, however, are now aware of the potential offered by inward investment and are framing policies accordingly. There is no room for complacency in maintaining the UK’s competitive advantage.
Portfolio investment has been equally buoyant (foreign buyers bought a record number of British companies in 2006 in deals estimated at £170bn) across a range of industrial activities. And the amount that British companies invest abroad dwarfs the value of investment into the UK.
All of which shows that, like the movement of goods and people, the movement of capital is a global game and national boundaries matter less and less.
