Understanding foreign direct investment (FDI)

Introduction

This guide provides an explanation of what foreign direct investment (FDI) entails and why it is so important to the UK. It explains how FDI is measured and the key terms used in this context.

Intended as essential reference material for anyone wishing to learn the basics of FDI, it avoids economic jargon and points readers toward industry sources if they want to find out more.

The guide also gives a brief description of the role of UK Trade & Investment as the UK’s inward investment agency.

Brian Shaw Managing Director, Business UK Trade & Investment

What is FDI?

FDI is the international movement of capital for specific investment purposes where the foreign investor gains control over the investment asset. FDI occurs when overseas companies set-up or purchase operations in another country. FDI encompasses new projects, expansions of existing projects, or mergers and acquisitions activity.

Why do companies engage in FDI?

There are a number of reasons:

• To access new overseas markets or better serve existing markets (eg investing in the UK in order to reach customers in Europe)
• To take advantage of lower manufacturing and wage costs (eg outsourcing)
• To access new technology and skills – particularly in R&D
• To locate a business function near clusters of similar or related companies (eg headquarters in the City of London, or R&D functions near the pharmaceutical cluster in the East of England).

Why is it important for modern economies to attract FDI?

Foreign companies bring new technologies, ideas and skills, as well as new investment to an economy – and there can be significant benefits for indigenous companies as suppliers and for local economies. A high level of inward investment is a sign that a country is a good place in which to do business. It also signals that a business culture is open to new ideas, skills and cutting-edge practices. Likewise, acquisitions by overseas firms are a vote of confidence in the business environment and the quality of a country's businesses.

Is encouraging FDI an admission that a country can't compete internationally?

Not at all – the reality of an increasingly globalised marketplace is that companies will base operations in whatever country provides the best opportunities for growth. This means that the most successful economies are those that can compete on an international level. This may mean that certain types of operation, such as low-value manufacturing, migrate away from the UK towards lower-wage economies, but the UK can play to its strengths and attract investment in high-value, knowledge-based industries.

What is it that attracts foreign companies to invest in a country like the UK?

Foreign investors are attracted by the UK's general business environment; availability of skilled labour; the strength of the R&D base; the position of English as the international language of business and the wide range of other languages spoken in this country; economic stability; the tax and regulatory regime; and ‘softer' factors such as a diverse cultural mix, lifestyle and education system. While the UK cannot necessarily compete with emerging economies on cost, the UK is not only an important and valuable market in its own right but also provides a platform for reaching markets in Europe. It provides a skilled and adaptable workforce and unrivalled R&D capabilities for international businesses looking to grow. Investing companies also recognise the importance of operating in a market in which it is easy to set-up and do business.

What benefits does FDI bring?

Foreign investment is essential for the long-term health of the UK economy because of its contribution to creating and underpinning British jobs, as well as boosting local and regional economies.

International investors are some of our biggest and most innovative manufacturers, and service providers, bringing enormous benefits to the UK. These include not only job and wealth creation, but also an injection of innovation to process, product and organisational structure, adding to UK capacity in output, R&D and exports.

International investment allows companies to achieve growth and economies of scale that domestic markets alone would not allow. This makes them more productive and profitable with greater capacity for job and wealth creation. The expansion of high productivity businesses helps strengthen competition within the economy as companies are exposed to new ideas and practices.

How does the UK attract FDI?

The UK's inward investment promotional effort combines both national and regional agencies in a co-ordinated network. This consists of staff based overseas in the principal markets from which FDI is sourced; UK Trade & Investment's HQ in London; and the English regional development agencies (RDAs) and the devolved administrations (DAs) in Scotland, Wales and Northern Ireland. UK Trade & Investment has a key role in managing this network and co-ordinating the efforts of both the public and private sector partners around the UK to make the best case for ‘UK plc'. This ensures that potential investors have access to all the available help and advice they need to make the best commercial decisions. UK Trade & Investment's principal objectives in the area of FDI are to attract, retain and add value to UK investment.

How is FDI measured and compared between countries?

There is no one simple method of measuring inward investment, but most methods of measuring it either focus on the number of projects or jobs, or the financial value. Financial measurements are either of stocks or flows.

FDI stocks

FDI stocks measure the level of cumulative FDI stock of capital investment by foreign enterprises at a single point of time that takes account of both new investment and disinvestment. The United Nations Conference on Trade and Development (UNCTAD) produces annual statistics of global stock movements in their World Investment Report. This is available on the UNCTAD website: www.unctad.org/wir

FDI flows

FDI flows are new investments by foreign enterprises made during a period of time – either by calendar or tax year. While much inward investment is included in FDI flow statistics, not all of it will be. For example, if an inward investor decided to expand its facilities in the UK but used local finance, this would not appear in FDI flow statistics as it involves no inflow of money to the country.

Sources of statistics on FDI

There are a number of organisations that produce figures and statistics, each giving a slightly different picture or analysis (see table on pages 10 and 11 in the PDF). Some, for example, include merger and acquisition activity, while others count only publicly announced information.

The table lists some of the key sources of inward investment statistics. There is no direct comparison between these statistics but all in their own terms provide an indication of trends. Some eg UNCTAD provide comparisons between countries, others eg UK Trade & Investment focus on the UK only.

What has the UK’s performance on FDI been in recent years?

As mentioned previously there is no single method of measuring and comparing inward investment performance. To demonstrate this, there are a selection of graphs showing how the UK has performed over the past five years in the PDF.

Do mergers and acquisitions (M&A) count as FDI?

Mergers and acquisitions by foreign companies obviously involve existing operations. However they often pave the way for significant new investment into the UK that can lead to more jobs being created.

Sometimes a merger or acquisition will protect jobs that would otherwise have been lost. Foreign investors target UK companies for acquisition because they see long-term growth potential for their business and are willing to invest to achieve that growth.

As mentioned in the table on pages 10 and 11, the European Investment Monitor does not count M&As as inward investments, whereas UNCTAD stock figures include companies involved in M&A activity, and UK Trade & Investment's figures include M&As with over 50 per cent controlling interest.

Is the UK losing out to the new members of the EU in attracting FDI?

With the expansion of the EU with ten new members in 2004, and more set to join in 2007, foreign investors have a much broader selection of lower-wage markets and skill sets from which to choose. The UK has positioned itself as a mature market, producing higher-value goods and services and with a highlyskilled workforce, and continues to be the leading investment location in Europe, according to the UNCTAD World Investment Report 2006.

In line with its positioning as a high-value market, the UK attracts more European headquarters and R&D projects than any other European country1. The UK's focus is to attract hi-tech companies, and exploit the wider aspects of innovation in a variety of knowledgedriven industries.

What about offshoring? What impact has the trend for moving facilities to low- cost economies had on FDI in the UK?

The UK cannot compete on costs, nor should we try to. Instead, we focus on adding value to the services we offer. While some types of operation will migrate to lower-wage economies, companies want to gain access to a skilled and flexible workforce, and unrivalled R&D capabilities.

Offshoring is not a one-way street. Foreign companies are tapping into the sophisticated skills and expertise offered in the UK's services sector. This area accounts for almost 21 million jobs and 70 per cent of the UK's economy. Importantly, emerging economies, such as India and China, are choosing to invest in the UK and are providing excellent trading opportunities as they grow.

Have we seen the end of investment in manufacturing in the UK?

According to the European Investment Monitor Report 2005, investment in manufacturing in the UK is the strongest for eight years. Export orders have shown their strongest rise in a decade2. According to a survey by the Engineering Employers Federation (EEF) in the past four quarters UK exports by UK manufacturers have seen the best-sustained growth since 1995. UK manufacturing accounts for a sixth of the economy, with the sector employing around four million people with a further two million employed in related services. The sector now accounts for about 75 per cent of UK R&D spending and two thirds of the nation's exports. Importantly, most of these exports are the high technology sectors of pharmaceuticals, aerospace and automotive3.

Does the UK pay grants and subsidies to investors to encourage them to set up, expand or stay in the UK?

The main form of support is the Selective Finance for Investment scheme in England, which aims to encourage significant investment in projects that lead to long-term improvements in productivity, skills and employment. It is a discretionary grant that may be offered to overseas companies (and UK owned companies) opening a new operation, or expanding/ modernising an existing operation in an Assisted Area. It is available to both manufacturing and service projects meeting certain criteria.

See www.dti.gov.uk/files/file31813.png for more information. Scotland, Wales and Northern Ireland also offer a set of grants and incentives. Assistance and funding are also available for recruitment and training.

• Scottish Development International
• International Business Wales
• Invest Northern Ireland

Companies also benefit from R&D tax relief, with small and medium-sized enterprises able to deduct 150 per cent of qualifying expenditure on R&D activities when calculating their profit for tax purposes and large companies 125 per cent. The government intends to extend additional R&D tax credit support to companies with 250-500 employees, subject to the outcome of state aids discussions with the European Commission.

Are there quotas or restrictions on investment or investors in the UK?

Generally no. The UK government is clear that we should not adopt protectionist measures in the UK.

Generally the UK does not discriminate between nationals and foreign individuals in the formation and operation of private companies and no screening regime exists.

UK Trade & Investment

UK Trade & Investment is the government organisation that supports companies in the UK doing business internationally and overseas enterprises seeking to set up or expand in the UK.

Our global network of offices work in close partnership with the English regional development agencies and devolved administrations in Scotland, Wales and Northern Ireland.

We can provide businesses with:

• introductions to sector networks – industry leaders, universities, other centres of excellence and collaborative partnerships;
• bespoke information on key commercial considerations – company formation, financial incentives, labour, real estate, transport, utilities and regulatory issues;
• thorough regional analysis and informed advice to help choose the right location; and
• a pipeline into central government to help safeguard business interests.

For further information on Inward Investment and the role of UK Trade & Investment, please contact:Alasdair Crewe, UK Trade & Investment Press Office Tel: +44 (0)20 7215 4218 alasdair.crewe@uktradeinvest.gov.uk