Hamish McRae: Why education is paramount in wooing foreign investment

Something big has been happening in the march towards an ever more global world economy that some will find disturbing, others quite comforting and still others inevitable. It is that foreign direct investment flows have now fallen for three years on the trot. If you take world trade as a rough and ready measure of globalisation, it is still racing forwards. If you take cross-border investment flows as your measure, it is in trouble.

Something big has been happening in the march towards an ever more global world economy that some will find disturbing, others quite comforting and still others inevitable. It is that foreign direct investment flows have now fallen for three years on the trot. If you take world trade as a rough and ready measure of globalisation, it is still racing forwards. If you take cross-border investment flows as your measure, it is in trouble.

But something else is happening too. The focus of international investment is shifting away from goods to services. Indeed cross-border investment in services is now much larger than investment in goods. Welcome to the global service world.

Every year UNCTAD (the United Nations Conference on Trade and Development) produces its World Investment Report, the best source for international trends in investment, and the new one came out last night.

Some of the key messages are picked up in the charts. The first graph shows the extraordinary surge in foreign direct investment - typically where a company from one country builds a plant in another - during the late 1990s. Then came the plunge, which continued last year. The numbers are still large in absolute terms - FDI flows were still $560bn last year - but the flow to developed countries was down 25 per cent to $367bn. The fall in the flow into the US was particularly marked, while there were also sharp falls in investment in Germany and the UK.

However, investment in developing countries actually rose last year by 9 per cent, reaching $172bn - nearly one-third of the total.

For those of us who find the overall decline disturbing, there may be better news in the pipeline. UNCTAD thinks that this year a recovery is under way. It also notes that what matters for long-term growth is total investment, not just the cross-border element of it. But since FDI also brings technology transfer, any decline is surely a concern.

Fortunately, as the second graph shows, FDI flows to the developing world are strong. Total resource flows to the developing world have fallen since the Asian financial crisis of 1997/8, but most of the fall has been in portfolio investment and bank lending, which have been negative and is now negligible. Given that official flows have also come down, the main source of cross-border money for the developing world is FDI. This is a real contrast to the early 1990s, when the main flow was official funds.

Well, that is the big picture. The report is a mine of information about the detail of where the money is coming from and going to, the different types of investment, the importance of the giant transnational companies, the ranking of different countries in terms of their potential to attract inward FDI (the US, Norway and the UK are top) and so on. There are also some new figures on China and India, both as recipients of investment and, most interestingly, as sources of it. But arguably the most interesting shift of all is the one towards services, something that has until recently attracted much less attention than it deserves.

We still think of trade and investment as shipping goods around, whereas it is increasingly one of shipping ideas around. Even when there is a product involved - take Coca-Cola for example - the main trade is the idea of how to make it, bottle it and sell it, rather than ship the stuff round the globe. So the UNCTAD study is helpful in explaining the nature of this shift.

The starting point is that services are now the largest part of money economies, much bigger than manufacturing. They are also a critical competitive element in modern economies: to be competitive you have to have good financial markets, good telecommunications and so on. And as a result of the information revolution, IT-type services are now traded internationally in much the same way that manufacturing goods have been traded for many years.

We can see this in our daily lives. Five years ago, when you rang a UK company with a query you would be talking to someone in the UK, maybe Ireland. Now you may well be talking to someone in India. Service industries that were, a few years ago, national ones are now transnational. FDI is a key way of transferring what was a national service to an international one.

From a British perspective this is all to the good. We seem to have a comparative advantage in trade in services that we don't really have to any extent in trade in goods. In fact we get a larger proportion of our foreign earnings from services than any other large economy. But like any other seismic global economic shift, it is troubling too.

To take a simple example, call centres tended to replace factories as a major source of jobs in areas of high unemployment. But if those jobs go too, perhaps to India, what will there be left for us to do? Here in the UK we have managed to maintain high levels of employment but in the US the exodus of jobs - many of them service jobs to lower wage countries has meant there has been no net job creation during the past four years. "Off-shoring" has become a dirty word in the US politicians' lexicon.

From the developing countries' point of view there are many benefits to service trade as opposed to goods trade. It is, by and large, non-polluting. It means that cities far from the sea or lacking general infrastructure can still get into the export game. It is much easier and cheaper to put in good telecommunications than it is to build roads, railways and airports. But it puts an onus on education - having well-educated people with language as well as computer skills. Some countries can manage to achieve this; others have been slower at doing so. Cheap labour is not enough; it has to be well-educated labour too.

So while it is wonderful to see what has happened in, most obviously, Bangalore, it is disturbing that relatively little similar service development is happening in Africa, a continent with the advantage of being in the same time zone as Europe. FDI can help, because it brings training as well as money. But basic education is a basic necessity for economic progress.