Economics: Inward bound

Dennis Turner

Over 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.