UK is top destination for inward investment, but investors predict a decline in its future appeal

Posted On: 
25th May 2017

UK retains its position as the leading destination for foreign direct investment in Europe, but with Germany ‘hot on its heels’, warns EY. 

Mixed picture - while investor sentiment in the short-term remains buoyant, significant concerns have been expressed about the UK’s medium to long-term attractiveness

The UK secured its highest ever level of inward investment in 2016 and retained its title as Europe’s most attractive location for international investment, ahead of Germany, France and Spain, according to EY’s latest annual Attractiveness Report.

The UK attracted 1,144 foreign direct investment (FDI) projects last year, an increase of 7% on 2015, compared to the European market, which saw a 15% rise and enjoyed the best year for international investment since the Eurozone crisis, securing 5,845 projects.

After the UK’s stellar performance in 2015, which saw a 20% increase in the number of FDI projects, a 172% surge in HQ’s locating, and an influx of investment into the regions outside of London, the UK’s market share of European FDI in 2016 fell from 21% to 19%.

Steve Varley, EY UK Chairman, commented: “Although the UK’s relative FDI performance in 2016 was not as strong as in recent years, there were no signs of any immediate collapse in investment as a result of the outcome of the EU Referendum.”

Short-term plans are in line with historic trends and are especially positive among Asian investors, 30% of whom say they intend to invest in the UK in the next 12 months, followed by Western Europe (24%) and North America (21%). In addition, 37% of investors that are already established in the UK plan to invest further in the next 12 months.

Varley continues: “However, the relatively positive perceptions of the UK’s attractiveness in the short term, are offset by a significant and worrying deterioration in investors’ longer-term expectations of the UK’s future evolution as an FDI location.

“Most notably there has been a sharp decline in how global investors rank the UK on key attractiveness criteria such as: quality of life; educational standards; stability and transparency of the political, legal and regulatory environment; transport and logistics infrastructure; and local labour skills, which have all been the major sources of strength for the UK’s FDI proposition in recent years.”

Brexit impact

Global investors had mixed views when asked about the future attractiveness of the UK. 32% of respondents, surveyed between March and April 2017, say they expect the UK’s attractiveness to FDI to improve over the coming three years, while 31% expect it to decline. Both figures are significantly worse than recorded long-term averages of 53% and 8% respectively. In fact, since March 2016 the share of investors with a negative view of the UK’s medium term prospects for FDI have almost doubled.

Mark Gregory, EY’s chief economist says: “The research suggests that the EU Referendum vote and its aftermath may be having an influence on global perceptions of the UK’s medium to long-term attractiveness. Western European investors are twice as negative as Asian and North American investors.

“Decisions on the majority of investments made in 2016 would have been made up to three years ago, which helps to explain the UK’s solid performance last year, but signs of a slowdown are on the horizon.”

9% of investors surveyed said leaving the European Single Market will prompt them to change their investment plans or re-locate from the UK to Europe in the next three years.

Germany ‘hot on UK heels’

Germany, which saw a 12% increase in FDI projects in 2016, extended its lead in attracting ‘new’ or ‘first time investments’, a position it has held since 2012 when it overtook the UK. In 2016 Germany marginally increased (0.5%) its share of all new FDI projects coming into Europe, compared to the UK which saw a fall of 2%.

The UK did see a 30% increase in the number of logistics projects, double the European-wide growth rate, but the number of research and development (R&D) projects fell in the UK to a low of 16% (since 2011) from 26% in 2015. Headquarters locating in the UK also fell by 32%.

Mark comments: “This slow-down for the UK compared to a growing R&D project flow across Europe, may raise concerns over the UK’s influence and access to EU research funds and skills to fuel future innovation.”

The success of the ‘super regions’

London remained the UK’s dominant location for FDI, followed by Scotland, which maintained its second place. The ‘super regions’, the Northern Powerhouse and the Midlands Engine, continued to do well attracting roughly double the number of projects they secured at the beginning of the last decade.

Mark Gregory commented: “Taken together, the regional FDI figures for 2016 do suggest that the strong ‘super regions’ are thriving whilst more geographically peripheral regions – for instance Wales, the East, North East and South West of England – are slipping behind. Finding ways to share the benefits of FDI more evenly across the country is a critical challenge that future policy needs to address.”

UK’s e-commerce strength

In the top ten sectors for FDI in Europe, the UK is the leading destination for: software; business services; automotive assembly; financial services; and food. Germany leads in machinery and equipment; chemical; electrical; electronics; and plastics and rubber.

In 2016, the UK saw a very positive performance from both business services – with projects increasing by 38%, fuelling London’s success. Software FDI held up well, along with manufacturing, which saw a 5% increase in the number of projects, driven by a growth in logistics investment.

Notably, food manufacturing projects rose by 59% and online retail by 24%, underlying the strength of e-commerce in the UK. International investors expect financial services, IT and business services to lead the way for the UK economy in the coming years. The information, communication technologies, IT (ICT) sector is seen as Europe’s fastest growing, which the UK shows clear strength in. “This could be an opportunity for the UK to reposition itself, drawing on its strength in this sector and helping to future proof the UK’s FDI performance,” added Mark.

Europe the dominant source of investment in the UK

The proportion of UK FDI projects generated from the European Economic Area (EEA) was the highest ever at 39% last year, up from 32% in 2007, whilst the proportion of investment in 2016 from the US – historically the UKs most important FDI origin - fell to its lowest level in the past decade.

The UK’s top ten origins of FDI were from: Ireland (+79%), France (+37%), Germany (+31%), and Australia (+29%). Conversely significant declines were recorded in the number of projects from China (-13%), the Netherlands (-21%) and India (-30%).

The proportion of investment recorded into the UK from the Asian economic area has generally remained static over the past ten years – unlike Europe as a whole, where FDI projects originating from China now outstrips those from India by almost 3:1.

The UK secured 40% of all Indian projects compared to 20% of Chinese projects. “Chinese investments into Europe are increasing, but the UK is securing only half of many as them as Germany. The UK will need to chase down Chinese investment to keep ahead,” added Mark.

Time to act

The UK economy has performed well after the EU Referendum vote and the outlook for FDI remains strong in the short-term. However, there are a number of indicators suggesting that the outlook for the UK is likely to be challenging and the UK needs to move quickly to position for future success.

“What is clear, is that the UK has a short window to act. On a positive note, the UK has a solid base to build from, with globally renowned strengths. A rapid response and clear strategy can help the UK to protect its leading position for inward investment in Europe and capitalise on future opportunities," said Mark.

In the view of global investors, the priorities for the UK are clear: Infrastructure, cited by 31% of investors; negotiating trade deals with new countries (32%) – US, China and India identified as most important; skills (28%); retaining existing EU trading arrangements (28%); the approach to migration (22%); and creating incentives for foreign investors (21%).

“Once defined, the strategy will need to be communicated effectively to investors to ensure their concerns over the medium-term can be understood and addressed as far as possible,” Mark concluded.