Why does inward investment matter for productivity?

Inward investors in the UK are reported to have a productivity advantage and pay higher wages compared with the average level of the UK firms and can help play an important role in improving the UK’s productivity.

Nigel Driffield, Professor of International Business at Warwick Business School, is leading research exploring how Foreign Direct Investment (FDI) can be used for generating productivity and growth in lagging locations.

There are two mechanisms through which inward investment can generate productivity growth in a local economy:

• Batting average effect How the presence of higher productivity level of (new) inward investors, more than the average level of the region, will increase the average productivity.
• FDI spillovers How the presence of FDI creates productivity growth within the wider economy. This covers data that is not always met by official statistics, including why a firm chooses a given location, the financial performance of the parent company, its sector and its subsidiaries, the nature of the investment and the ownership share.

Nigel, Research Associate Xiaocan Yuan, and Fernando Gutierrez Barragan, Head of Trade and Investment at statistical and analytics firm Moody’s Analytics, have written four reports focusing on FDI flows into the UK and what that means for productivity. These examine both greenfield investment and Merger and Acquisitions (M&As).

Greenfield investment

Greenfield investment is where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up. Most parent companies also create new long-term jobs in the foreign country by hiring new employees. It is recognised that FDI from other developed countries, particularly in the form of greenfield FDI, contributes the most to productivity, both directly and indirectly.

Mergers & Acquisitions

The contribution that foreign M&As make to UK productivity are more indirect, depending on the extent to which changes of ownership lead to higher levels of investment, innovation, or knowledge transfer from the parent company. Equally, the effects also vary by the motive for the investment. 22 They are often “technology-sourcing FDI” – where companies acquire the knowledge or intellectual property of the target firm, or to enter new markets. Typically, these are associated with lower levels of subsequent productivity growth than, for example, FDI motivated by the desire to lever its existing technology into new markets.

Brexit effects

The four reports focus on the changing patterns of FDI before the Brexit referendum, through a regional lens, and by the changes in makeup of FDI that has entered the UK since the referendum.

They find an increase in the proportion of FDI coming into the UK focused on the local market, rather than using the UK as an export platform, while also showing that re-investment by existing investors, which declined dramatically after Brexit, is starting to recover. With inward FDI to the UK now more likely to become embedded in local ecosystems, there is scope for increased spillovers of knowledge and productivity.

Skills and location matter

The research is a proxy or lens for understanding how the UK can get more from foreign investment and how to move the dial to better jobs. The team is working on a model that can be adopted by government, emphasising that FDI should not be thought of in insolation and that skills and location matter.

The Productivity Institute was asked by the Office for Investment and The Department for Business and Trade to aid their developing strategy on how inward investment promotion can contribute to levelling up. The purpose of the paper is to explore the potential for inward investment into the UK to contribute to reducing regional inequality.  The research emphasises the need to evaluate a location’s capacity to attract investments and subsequently maximise the benefits of such investments, particularly regarding spillovers to the wider economy.

This was also explored in a report co-authored with Dr Irina Surdu-Nardella, Where best to invest? Insights from manufacturing multinationals and the risks of lost investment in the UK, with CBI Economics.

Through 43 interviews with business leaders from multinational manufacturers, the report builds a picture of the investment process within foreign-owned and domestic firms and confirms that the UK does compete with other markets for investment funding in most cases. This report compares the perceived strengths and weaknesses of the UK macroeconomic and political environment.

Nigel’s work on inward investment

The report was part of Nigel’s work with the Midlands Productivity Forum, where he is the academic lead. Nigel is also a member of the Midlands Engine and the West Midlands Innovation Zone board and has presented to the West Midlands Combined Authority. His expertise in the area of FDI was recognised with a case study on the benefits of inward investment to the West Midlands in REF 2021.

Other acknowledgements and collaborations include:

• Being thanked in the foreword to the report The role of universities in driving overseas investment into UK Research and Development by the higher education independent think tank HEPI.
• Being a witness for the Inward Investment panel session for the UK Trade & Business Commission report Trading our way to prosperity: A blueprint for policymakers.
• Working with the National Centre for Universities and Business.
• Giving oral evidence in the Productivity Commission session on public investment.
• Citation of his work in the report An industrial strategy for the everyday economy by the CIPD, the professional body for HR and people development.
• Liaising with the Office for Investment and the Department for Levelling Up, Housing and Communities (now the Ministry of Housing, Communities & Local Government).
• Providing written evidence to the Inward Foreign Investment inquiry by the House of Commons.
• Contributing to the Harrington Review of Foreign Direct Investment published in November 2023, which offered a series of recommendations to reorganise the government in a more investment-friendly way, which has led to future collaborations with Lord Harrington, now a member of the House of Lords.