ATTRACTING FOREIGN DIRECT INVESTMENT TO THE UK: FLEXIBLE LABOUR MARKETS GOOD; OVERVALUED POUND BAD
Flexible labour markets help attract inward investment to the UK, and that investment has a very positive effect on the economy. Since 1985, for example, foreign investment in UK manufacturing has raised productivity growth by 1% a year. But the current overvaluation of sterling will reduce future direct investment from abroad, which will in turn reduce the level of UK exports. These are some of the conclusions of Ray Barrell and Nigel Pain of the National Institute of Economic and Social Research, writing in the November issue of the Economic Journal.

Barrell and Pain note that multinational enterprises now have a significant impact on the distribution of employment and output across Europe. European integration is changing the nature of production: the reduction of barriers to trade and capital flows is making it easier for firms to relocate. And their foreign investment can have a powerful impact on the potential growth rate of host economies and the level of employment they can sustain. Barrell and Pain address two sets of questions:

Why do Firms Invest Abroad?

Firms can take new products and processes to markets that they would not have otherwise penetrated. This raises the income of both home and host.
Firms look for low costs when they want to produce for export from the host. The UK’s overvalued exchange rate will reduce inward investment. The flexible labour market is an advantage, but it cannot offset the overvaluation.
Firms look for technology gaps that they can fill and advantages they can exploit. Manufacturers come to the UK because they are more productive than UK firms. The City makes the UK attractive for banks because of the scale of its activities. Manufacturing firms find Germany attractive because of its skilled workforce.
What does Foreign Investment do?

Foreign investment in UK manufacturing since 1985 has raised productivity growth by 1% a year. The effects of foreign investment will have spilled over into UK firms as they copy new management techniques.
Investment in services has been taking advantage of the structure of the UK’s service sector. It has not raised productivity growth. Monetary Union could make the City less attractive if the UK stays out.
Inward investment raises exports, but outward investment reduces them. The UK has been a large outward investor as well as a recipient of foreign investment. UK exports may be reduced by the net outward investment over the last ten years.
Barrell and Pain conclude that European integration and the single market programme have made capital more mobile. Flexible labour markets help attract inward investment to the UK. But competition from highly skilled workforces in continental Europe reduces UK exports in the single market.

Note: ‘Foreign Direct Investment, Technological Change and Economic Growth Within Europe’ by Ray Barrell and Nigel Pain is published in the November 1997 issue of the Economic Journal. Barrell and Pain are both researchers at the National Institute of Economic and Social Research (NIESR), 2 Dean Trench Street, London SW1P 3HE. Their research was supported by the Economic and Social Research Council (ESRC).

For Further information: contact Ray Barrell or Nigel Pain on 0171-222-7665 (email: R.Barrell@niesr.ac.uk or n.pain@niesr.ac.uk); or RES/ESRC Media Consultant for Economics Romesh Vaitilingam on 0171-878-2919, 0117-983-9770 or mobile 0468-661095.