Has the EU’s Single Market been a magnet for foreign investors?
EU enthusiasts still make confident claims about foreign investors’ post-Brexit decisions, despite their mistaken predictions about the euro, despite the European Commission’s findings, despite contrary indications and evidence, and despite the known uncertainty of such predictions
One of the more common arguments in favour of continued EU membership is that foreign investors prefer to locate in the UK because it is a member of the EU and will only continue to invest if the UK remains a member. A number of foreign investors in the UK who prefer that it remain an EU member have lent support to this idea by saying publicly that they might reconsider their investment here if the UK decided to leave.
The argument is a long-running one. It was first mentioned in the government pamphlet sent to every household before the 1975 referendum. It re-emerged in the debate about joining the euro, briefly revived in 2012, when the prime minister vetoed a new treaty to help the stricken euro. It was sometimes used by those who opposed the coming referendum, on the grounds that the referendum itself would create uncertainty and frighten foreign investors.
In the cases when we can check, predictions or warnings against subsequent events proved to be correct. After the decision to stay out of the euro, the UK’s share of inward Foreign Direct Investment (FDI) flows to 15 European countries declined very slightly, but it is difficult to attribute this to the new currency since some eurozone countries fell still more. The real winners in the growth of FDI stock over the post-euro years were three non-euro and non-EU countries, Switzerland, Norway and Iceland. After the prime minister’s veto in 2011, FDI in the UK rose quite sharply while that to Germany and France plummeted.
In 2007, the European Commission itself had given up the claim that the Internal Market is a magnet for foreign investors. It admitted that, ‘…the Internal Market has not been able to deliver in terms of promoting further the role of the EU with respect to global investment flows.’ It also noted that ‘the Internal Market is also losing its attractiveness for international R&D investment.’ In 2012, the European Competitiveness Report, acknowledged that ‘the EUʼs share of global inward FDI has declined significantly’ which it attributed to ‘the crisis’ and to ‘the attractiveness of emerging markets.’
Even though the European Commission has long acknowledged the evidence, Sir John Major is among those who still think this is a useful argument to persuade the British people to vote to remain in the EU. We must, I suppose, expect their warnings, and expect those foreign investors who can be persuaded to say they may reconsider their investment post-Brexit, to be heard until referendum day. Though some on that side of the argument, like the chairman of the Remain campaign, have dismissed their argument:
Stuart Rose, chairman of Britain Stronger in Europe, dismissed fears that leaving the EU would lead to companies leaving the UK as ‘a red herring’ and ‘scaremongering”. He said: ‘I think it’s ridiculous to suggest that everybody is going to suddenly go offshore, I don’t believe that for one moment.’
The most relevant evidence on FDI is given in the figure below. It shows the FDI stock per capita across Europe and a few other developed societies in 2014. At first glance, it does not suggest that either the EU itself or the euro, or the Single Market have been especially attractive to foreign investors. First, because neither EU nor eurozone countries are distinguished from others by their high FDI stock holdings. Second, because EU members differ greatly among themselves, and there happen to be good reasons to explain those with the highest holdings, having nothing to do with the EU or the Single Market. However, before drawing any conclusions from these figures, two caveats must be given about any interpretation of FDI data.
Caveat one – no-one knows
Almost everyone thinks they know why investors locate in one country rather than another, but those who have studied the evidence are not so sure. UNCTAD has been documenting and analyzing FDI flows since 1970 but has always been wary of offering explanations of their decisions on the grounds that they are influenced by a ‘host of nearly unquantifiable social, political and institutional factors’. In 1993, they nonetheless sought to quantify the nearly quantifiable producing their FDI Potential Index and eight factors that encourage investment. In 2003 added four more, none of which related to EU membership or the Single Market.
A few researchers have preferred to ask investors directly about their decisions. An Ernst & Young survey in 2005, for instance, included follow-up interviews with key decision-makers in 98 of the 787 multinational firms which had invested in six European countries over the years 1997-2003. The interviews were non-directive and open-ended, the informants being asked to identify any of the things that might have affected their company’s decision to invest in a particular country. The proportions of items mentioned in their answers are presented in the pie chart below.
As may be seen, ‘proximity to clients’ rated number one, and several of the other answers
also have a geographical dimension such as ‘centrality’, or ‘proximity to major airports’, and even perhaps ‘proximity to similar businesses’. Although these company decision-makers could say whatever they wished, none of them ever mentioned either ‘the world’s largest Single Market’, or the euro, or the absence of tariff barriers. These things did not even rate a word in the ‘other’ category, details of which were given in an appendix of the report.
Sir John Major seems to be among those who think that they know intuitively why foreign investors choose a particular country. He declined to commission research on the subject when in office but has spoken confidently about it with complete indifference to the research that is now available. Perhaps he thinks his conversations with a few investors are sufficient.
Caveat two – FDI data is suspect
The second thing to be said is that there is still not sufficient data about FDI flows and stocks over time that distinguishes between FDI, in the sense of investment requiring permanent presence, commitment and managerial control over time in the country in which they invest, and so-called special purposes entities (SPEs) in which capital may be nominally invested for tax purposes, or parked while awaiting real investment in some other ultimate investment country (UIC). Data that distinguishes between authentic investment and SPEs is only just beginning to be regularly collected.
There are some clues that indicate whether foreign investments are authentic or simply hosting SPEs. One is the ratio between the FDI flows into a country and its gross fixed capital formation (GFCF) in the same year, or the FDI stock as a proportion of GDP. If FDI flows or stocks exceed 100 per cent of GFCF or GDP, as they routinely do many times over in offshore financial centres (OFC), we may reasonably infer that the investment is a purely financial arrangement. A second clue is when the FDI inward flow does not merely decline, but suddenly becomes sharply negative. This suggests that investors are withdrawing or moving funds rather than closing factories and offices.
Using one or more of these clues, there is good reason to think that Luxembourg is no different, in this as in other respects, from an OFC, and for that reason it has been omitted from the figures altogether. There are also strong grounds for omitting, or at any rate sharply reducing the figures for Belgium and the Netherlands, and there must be some suspicion about the figure for Ireland. These happen to be the top three FDI stock holders in the EU, and if their real FDI stock figures were reduced, the weighted EU mean would, of course, have been still lower than it is.
A final piece of evidence
The 2015 A.T. Kearney Foreign Direct Investment Confidence Index seeks to assess and measure how political, economic and regulatory changes will ‘likely affect countries FDI inflows in the coming years’, and annually ranks the 25 most attractive countries for foreign investors.
The data is collected by ‘a proprietary survey administered to senior executives of the world’s leading corporations… The 300 participating companies represent 26 countries and span all industry sectors. All companies report global revenue of at least $1 billion.’ Respondents do not rate the investments prospects of their own country.
The rankings in the table are the arithmetic means of the rankings of each country in 15 reports, whose results are reported on the website, though Italy, Spain and the Netherlands were among the top 25 in less than 15 rankings. The wide difference in the ratings of EU member countries suggests that these corporate informants do not look on them as a Single Market or investment location. It seldom figures in the commentaries that accompany the assessments, though the promised EU referendum in the UK was mentioned in the 2013 and 2014 reports.
However, in 2015 respondents were asked what the most important factors were to their company when choosing to make foreign investments. 25 per cent of respondents said domestic market size, which was the most popular single answer; 11 per cent mentioned ‘participation in regional or bilateral trade agreements’, which was the fourteenth most popular response. Other factors mentioned included tax rates, transparency, corruption, labour costs, legal and regulatory processes, property rights, transport and telecom infrastructure and security.
- It is unwise to confidently predict what will happen to FDI flows or FDI stock, and those who have previously done so to make a case for EU membership have been shown to be mistaken.
- The publicly available evidence, like that available to the European Commission, does not suggest that the EU, the eurozone, or the Single Market have been distinctively appealing to foreign investors. One should remember that a large proportion of the investors in the non-EU countries are themselves from EU countries, and are presumably therefore well-informed about the benefits of the Single Market.
 Robert Peston explained on BBC TV that if multinationals ‘begin to see the UK as an isolated island, they will not wish to stay [so] businesses are now desperate to hear a positive statement from Mr Cameron about how the UK’s position in the Single Market can somehow be buttressed.’ An enlarged version of his report appeared on his website. ‘Big Business Deeply Troubled By Cameron’s Veto’, Robert Peston, December 11th 2011.
 Fabienne Ilzkovitz et al, European Economy, Economic Papers, N° 271 January 2007, Steps towards a deeper economic integration: the Internal Market in the 21st century, A contribution to the Single Market Review European Commission, Dir-Gen for Economic and Financial Affairs, ISSN 1725-3187 http://ec.europa.eu/economy_finance/index_en.htm
 European Competitiveness Report 2012, Reaping the benefits of globalization, European Commission (2012) pp.9,10,119: http://ec.europa.eu/enterprise/policies/industrial-competitiveness/competitiveness-analysis/european-competitiveness-report/ index_en.htm
 Sky, Dermot Murnaghan Interview with Lord Rose, 19th April 2015: <https://corporate.sky.com/media-centre/media-packs/2015/murnaghan-interview-with-lord-levy,-labour-peer-and-lord-rose,-conservative-peer-190415>
 European headquarters: Location decisions and establishing sequential company activities, Final report, Ernst & Young, Utrecht, 2005.
 Figure 11, A.T. Kearney, Connected Risks: Investing in a Divergent World