The economics of inward investment: Paying foreign investors to build factories here doesn't make sense

Hamish Mcrae

Should we really be giving all that money to the Koreans to come and build factories here? The question has been given a hard edge in the last few days with the evident retreat from Europe by Korea in the face of mounting troubles back home. And of course it is not just Korea about which we should be asking the tough question.

Does it make sense now - whatever the arguments in the past - to subsidise inward foreign investment at all? After all, the economy is generating plenty of jobs. Any money given to some foreign firm has to be taken from British taxpayers, including British companies, and so reduces their ability to compete in the world. And many companies are perfectly happy to invest in the UK without large subsidies to bribe them to do so.

This last point is the best starting place because nothing here should be taken as an argument against inward foreign investment, which should be welcomed. Indeed cross-border investment is one of the main ways in which technology management know-how is transferred around the world, and therefore an absolutely crucial element in the wealth-creation process. The argument is against excessive subsidies to encourage investment, and maybe all subsidies which favour incomers rather than existing corporations.

First, to put the importance of inward investment in perspective, glance at the graphs. On the left you can see the way in which outward investment has soared since 1990, but inward investment has not risen much. We should not think of ourselves as particularly relying on inward investment; it is merely one side of the balance sheet and currently the smaller side.

Next, look where the money is coming from. We think of inward investment as being principally from Japan and more recently Korea, for these are the countries building the big car and electronics plants. Actually the lion's share of inward investment comes from North America. In 1996 (see middle graph) it was almost double the flow from the entire European Union. The flow from other developed nations, countries like Japan and Australia, was quite small, while the rest of the world, which includes Korea, is tiny.

If you look at the total stock of foreign investment, rather than the flow in any one year, North America and the EU again dominate (right-hand graph). Actually the largest single set of investments, by country, were those of the US, which accounted for 39 per cent of the total, while the Netherlands was second at 15 per cent, ahead of Switzerland, Germany, Australia and France. Only then came Japan, the seventh biggest.

Why then do East Asian investors gather so much publicity? Why is it regarded as a disaster if some Japanese company decides to build a factory in France instead of coming here? Why do prime ministers trudge down to South Wales to open Korean factories?

I think it is partly because of the sums of public money involved. If taxpayers' money is being given to a foreign company, from a country with a record of dubious financial disclosure, politicians have to make a big play of it or they would be accused of wasting taxpayers' money.

It is also a story, in the sense that it is culturally interesting to have East Asian work practices applied in the UK, to see how well we adapt to them. And the very foreigness of an Asian investor is more obvious than that of a European or North American one - particularly since much of the European and North American investment is by acquisition rather than by building a greenfield factory.

We all know that Toyota is Japanese. How many people outside the financial community know that Rowntree is now Swiss? (For that matter how many people know that Burger King is British, not American?)

At first sight there seems a vast difference between acquiring an existing enterprise and building a new factory, but the difference is more apparent than real. Toyota, Nissan and Honda build factories, while BMW bought Rover. But if you look at the actual sums expended, most of BMW's investment has not been the actual purchase but the funds it has pumped into improving the product range and the factories. We get the funds and the technology transfer in just the same way as we would had BMW built on a new site. We just don't have to pay so much in "incentives".

The case for paying these incentives surely turns on three main things: that jobs are created in places where they are most needed; that new skills are developed; and that if we didn't have these incentives the business would go somewhere else.

The first argument has seemed particularly powerful recently. During the 1980s, with high unemployment generally and very high unemployment in "old" industrial areas, there seems a powerful need to create jobs in places like South Wales, the middle belt of Scotland and the North of England. These are the main regions which have recently been fighting each other to get new investment.

Now, while great disparities of job opportunity still exist, the pockets of unemployment are just that: small (but sadly deep) areas of very high unemployment quite close to areas of strong job growth. Overall unemployment, of course, is still falling to levels which would have seemed extremely optimistic a decade ago. The jobs argument, therefore, is much weaker than it used to be.

New skills? Well, yes, to some extent. But we should ask ourselves whether the skills to work on an electronic factory production line are really appropriate. Are these exploiting our comparative advantage as a nation? The attention to training by foreign-owned firms may be generally better than that of UK-owned ones (though that is not proven), but if the jobs are not secure then all the training in the world is pointless. The jobs in Korean companies here are self-evidently not secure.

Finally, what if the jobs went elsewhere? It is a tough question because the loss of jobs is visible, whereas the costs of getting those jobs is invisible. But at some price you are surely better to save the money, have the jobs go to France or Spain, and cut taxes on British companies instead. Remember, Korea and Japan do not pay UK companies large sums to come into their market, and for very good reason.

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