International Trade Committee
Oral evidence: UK investment policy, HC 998
Wednesday 23 January 2019
Ordered by the House of Commons to be published on 23 January 2019.
Watch the meeting
Members present: Angus Brendan MacNeil (Chair); Mr Marcus Fysh; Sir Mark Hendrick; Mr Ranil Jayawardena; Emma Little Pengelly; Julia Lopez; Faisal Rashid; Catherine West.
Questions 1 - 59
Witnesses
I: Dr Lukas Linsi, Political Economist, Amsterdam University, Professor Richard Kneller, Professor of Economics, Nottingham University and Courtney Fingar, Editor-in-Chief, fDi Magazine.
II: Dr Ilona Serwicka, Research Fellow, UK Trade Policy Observatory, Jonathan Athow, Deputy National Statistician and Director General, Economic Statistics, Office for National Statistics and Dr Henry Loewendahl, Group CEO, WAVTEQ.
Witnesses: Dr Lukas Linsi, Professor Richard Kneller and Courtney Fingar.
Q1 Chair: Good morning. Thank you to the panel for coming here this morning. Please think of yourselves as educators. This is the first session in the inquiry into UK investment policy for the Committee, so we will be probing perhaps at the foothills. Hopefully by the end of our inquiry we will reach the summit and become experts, but we will only do so with your help. Can I ask you to introduce yourselves, please?
Dr Linsi: I am Dr Lukas Linsi. I am a Political Economist at the University of Amsterdam in the Netherlands.
Prof Kneller: I am Professor Richard Kneller. I am Professor of Economics at the University of Nottingham.
Courtney Fingar: I am Courtney Fingar. I am Editor-in-Chief of fDi Magazine from the Financial Times.
Q2 Chair: Thank you all for coming. Professor Kneller, the International Monetary Fund, the Organisation for Economic Co-operation and Development and the World Trade Organization all make a distinction between foreign direct investment—FDI—and foreign portfolio investment, also known as indirect investment. How does one differ from the other and why does this distinction matter?
Prof Kneller: Both are investments made by either residents or businesses from one country into assets in a different country. Portfolio investments tend to be in stocks and bonds whereas foreign direct investment tends to be into a particular business. A simple way of characterising the difference would be to think about the motivations behind those.
For portfolio investment it would be in order to gain some sort of short-term financial gain from that, whereas we normally think of FDI as trying to acquire assets that allow for managerial control and ownership of the firm. It is much more of a longer-term investment compared to portfolio investment. Another difference associated with that would be to think about the ability to sell on those assets. The liquidity of the markets would typically be much deeper for portfolio investment stocks and bonds and so on than it would be for when you acquire the assets, the buildings, the machinery and the equipment.
Q3 Chair: One is presumably more stable than the other. Once you have tied up your money in assets as opposed to stocks and bonds, it is a bit more difficult to take the money out, I presume?
Prof Kneller: Yes. It is much more difficult to find a buyer. You have to find a buyer for those assets, so it is much easier to return your money back to your home country when the markets are liquid, when there are lots of buyers and sellers in those markets.
Q4 Emma Little Pengelly: Dr Linsi, you have argued that the distinction between FDI and portfolio investment is somewhat arbitrary. Can you elaborate on that?
Dr Linsi: As Professor Kneller just pointed out, the distinction between FDI and portfolio investment is quite clear conceptually. FDI is a long-term investment where the investor seeks to have managerial influence over the company, while portfolio investment is more of a short-term investment in which the goal is just to hold the shares, hoping that the price will increase to resell. Conceptually the distinction is quite straightforward.
The problem is that it is very difficult to make this distinction statistically. One way that it could be done—which would probably be the safe way—is to analyse each foreign investment transaction on a case-by-case basis and try to evaluate whether the motivation of the investor is to operate the company and have a long-term investment or whether it is just to hold the shares and resell them. From a practical perspective, that is not really feasible because of the huge number of investment decisions that are being made each and every day.
What statisticians decided to do instead was to introduce what is called the 10% rule. That is a statistical convention—and it is really nothing more than a convention—to classify any foreign investment transaction that involves 10% or more of a company as FDI and, if it is less, then as portfolio investment. While this might be efficient from a practical perspective, because it provides a neat classification scheme, I think it creates serious conceptual issues.
The 10% rule was probably never perfect, because it is inherently arbitrary to some extent, but what is even worse is that, because of the globalisation of capital markets and finance and economic production regimes, this 10% rule has become less and less appropriate to make a clear distinction between these two types of flows.
One example is that in today’s global financial markets there are a lot of very large investment funds, like private equity funds and hedge funds, and, because they are so large, when they invest especially in medium-sized and smaller companies often their investments will be above this 10% threshold. The intention often is not to operate the company, but it is much more of a portfolio investment. They want to buy low and sell high. In this sense, a lot of portfolio investments can get classified as FDI, and that starts blurring the distinction.
An even bigger problem is that the 10% rule, and also in some sense the conduct of FDI itself, is rooted in very much a textbook image of the world economy where you have country A and country B and the investor in country A sends the money directly to country B. That is not really how things work and less and less so in today’s global economy, because a lot of indirect investment flows are channelled through various investment vehicles. Today, if there is a US investor who seeks to acquire a British company, it is quite unlikely that the investor will send his money directly from Wall Street to the City of London. Usually it will go to a holding company in a place like Bermuda or the British Virgin Islands, then it will go on to Luxembourg, the Netherlands, Jersey or Guernsey, and end up finally in the UK.
There is a very opaque, complex structure through which these financial flows are channelled, which makes it very hard to track them. It also means that a lot of things that are being measured as FDI—they are technically FDI because they are above this 10% threshold—are just pass-through funds. They are funds being shifted through offshore jurisdictions, which can create severe distortions for global FDI statistics.
Q5 Emma Little Pengelly: Although it does not show up in official figures, is there any unofficial measuring of that? What percentage of what is currently going as FDI do you suspect may fall into that category of just notional or paper FDI?
Dr Linsi: Yes, there are some estimates. I believe the UK Office for National Statistics has started to do some experimental statistics where they try to capture what is called special-purpose entity FDI, financial FDI. The US Bureau of Economic Analysis has tracked this for a long time and for US outward FDI, financial FDI going through special-purpose entities was about 10% in the 1980s, but today it is up to 50%. It is a very large amount of what is measured as FDI flows.
Q6 Chair: There are references in FDI to the particular terms of stocks and flows. Can you briefly explain the difference between those terms and what is meant by them?
Dr Linsi: A flow is what is happening within one year, usually, and the stock is the accumulation of flows over the years. I think there are some accounting complications with how to value the past flows, but we can leave that for later if necessary.
Q7 Julia Lopez: A question for Ms Fingar. FDI data can be presented on the basis of asset/liability presentation or directional presentation. I would be grateful if you could summarise for us what the difference is.
Courtney Fingar: The main feature of directional presentation is that reverse investment is removed from it. Reverse investment is when an affiliate or subsidiary invests in its parent. Because of that, directional presentation tends to be smaller than the asset/liability basis. With directional you are looking at the money fully that came in. It is more actual direct investment, for example, and you remove any money that went in the opposite direction from the subsidiary, say the UK office to the parent. It allows a truer look at the source of investment, for example. For that reason, countries reporting their FDI statistics, if they want to look just at FDI, would usually use the directional basis because you can see where the money has come from and the direction of it, which is why it is called directional presentation.
With asset/liability you tend to get larger numbers because it takes into account a much wider pool of potential money. You would look at all the assets and all the liabilities that that country and the companies that exist there could claim. You are adding assets and deducting liabilities, but this is a much broader term. You would look at all assets, all liabilities, not specifically just the direct money that has flowed in from another country. I hope that makes sense.
The OECD recommends that the asset/liability basis is used to calculate capital flows that would be fed into the wider balance of payment issues. That is purely for a consistency basis because asset/liability matches more the mechanism that is used to quantify other macroeconomic indicators. For consistency sake, it recommends using that, but, if you are reporting the individual country’s FDI, it is usually better to use directional. I believe that the UK uses a directional basis when announcing its FDI figures.
Q8 Mr Ranil Jayawardena: Professor Kneller, a paper for the European Central Bank notes advantages that can make host countries more attractive to firms and sources of FDI, including tax benefits, low tax rates, high-quality infrastructure and high trade openness. With the greater flexibility that we will have after Brexit, are there any steps that you think the UK might wish to take to attract more investment, such as investing in free ports or unilaterally reducing tariffs or key infrastructure that would enable that greater investment?
Professor Kneller: There is a lot in that question.
Mr Ranil Jayawardena: First question.
Chair: There always is with Mr Jayawardena’s questions.
Prof Kneller: It is probably worth beginning with an answer to that by thinking about the different motives there are behind FDI. Broadly, we might classify those as horizontal motives. That would be an example of just replicating abroad the production that you have in your home country. What Uber does is a good example of that. It takes what it does in the US and replicates that in the UK.
A different motive would be what we would call vertical FDI motives. That is when you take the production method and you split it up into chunks and you have different stages of production hosted within different countries. A good example there would be what happens in the car industry. The production of engines, wheels, steering wheels and so on happens in different locations and the assembly happens in a final location.
A third characterisation of FDI would be export platform FDI, and that is where you have FDI in a particular location such as the UK, in order to use the UK as a wider base to sell into the European market currently.
That is a neat way of thinking about the different motives for FDI although, in reality, the FDI that we observe tends to combine lots of different motives together. They will have a horizontal, a vertical and an export platform FDI motive. That is partly because FDI has tended to increasingly concentrate itself on a regional basis over time. Then if we try to unpick that and think about what the determinants of FDI are and, therefore, how those different types of FDI may respond to those. You have already mentioned infrastructure and taxation and corporate taxes but also tariffs, labour costs, human capital and so on. The other key determinants of FDI would be the size of the markets and how wealthy firms and businesses in those markets are.
In a post-Brexit world—assuming that it is a form of Brexit where there are tariffs potentially between the UK and the European Union—you can see that those export platforms as well as those vertical FDI motives are going to be affected by that. In particular, the ability to move the different components, the different intermediate inputs across national borders is an important part of what multinationals do. Something like a third of all exports that happen globally is intrafirm trade with multinational firms.
Q9 Mr Ranil Jayawardena: Sorry to push you, but could I unpick it a bit further with your assistance to understand better? You talked about infrastructure. What sort of infrastructure do you mean? From your analysis, your work that you have done—you have referenced tariffs—what is your consideration of the concept of free ports? Do you believe that unilaterally reducing tariffs is of advantage to FDI or potential FDI?
Prof Kneller: Anything that improves infrastructure is going to reduce frictions—trade costs, as we call them. Would it allow firms to move the components that they need more easily across national borders? Similarly, a reduction in tariff is going to lower those costs. But trade costs are not just simply made up of how easy it is to move between ports or within a port or are not just made up of tariff rates. They are also made up of non-tariff barriers. There is potentially a change in non-tariff barriers as well.
Q10 Mr Ranil Jayawardena: Sorry to push you on this, but free ports?
Prof Kneller: I don’t have any specific evidence on free ports, so I am a bit reluctant to say.
Q11 Mr Ranil Jayawardena: On reflection after the Committee, if you wish to write to us that would be really useful but, in that respect, fine.
Could I push you on tax? Any analysis you have done on tax rates in a jurisdiction and the effect that lowering tax rates has on FDI? It would seem to me that there is a pretty clear connection. That if you have lower taxes companies are more likely to want to invest, but do you have data on that? What is the best analysis you have done on that?
Prof Kneller: I have not done any analysis on that question. There is evidence that lower corporate tax rates are positively associated with increased FDI flows into a country.
Mr Ranil Jayawardena: Again, please write to the Committee afterwards if there is anything that comes to mind. That goes for everyone. Thank you.
Chair: You are going to be busy writing to us.
Q12 Faisal Rashid: Following on from the point that my colleague made about the lower taxes—and you mentioned there could be other reasons as well and not just lower tariffs—when you produce a product or move a product from one country to the other, tariff does matter, doesn’t it? It reduces the cost and it becomes more productive. At the moment the UK has one of the lowest corporation taxes, but nine years ago it was around 28%. Do you have any analysis about the FDI at that time and the FDI now? Are there any figures on that?
Chair: Foreign direct investment when the corporation tax was higher in the UK.
Faisal Rashid: I believe that FDI at the time was higher than now. I don’t have any figures, but do you have any figures? I believe economic development and economic activity and demand also makes it more favourable than just the lower the tariffs and the lower the corporation tax.
Courtney Fingar: We have a data business in our division of the Financial Times that is tracking and analysing greenfield FDI. That is companies setting up new physical facilities or expanding existing facilities. This means a new presence, a physical office and a headcount. I think it is important, when looking at FDI on the subject of flows, to look at greenfield in isolation because this is the type of FDI that is driven by these motives, by the attractiveness of the country, be that the corporate tax rate, the infrastructure or the connectivity. It is not just about getting a bargain on an asset.
The UK has been pretty steady, as was mentioned by the Chairman. This greenfield FDI, real FDI, is not very volatile because these are long-term decisions and the UK has been a strong performer throughout the years, regardless of the corporation tax. Taxes can be attractive, but mainly if you are looking for a headquarters operation, for example. The corporation tax is important but not crucial. If you want to set up an R&D facility you care much more about the skills than tax and tax is related to credits, protection of intellectual property and so on.
The only thing that has dented or had any significant impact on the UK’s attraction of greenfield investment has been the referendum to leave the European Union, where we saw a sudden and very notable decline in greenfield FDI. I would argue that the corporation tax has been less significant.
Q13 Chair: I want to widen out the question on this. I think Dr Linsi in particular has written that there is greenfield investment, mergers and acquisitions and special-purpose entity types of FDI. Perhaps Dr Linsi or Courtney Fingar would like to expand on those.
Dr Linsi: I can say a bit more about these three different types of flows, maybe linking back to the question about taxation and how to attract these kinds of firms. Broadly speaking, it is useful to break down global FDI into three categories: greenfield, mergers and acquisitions and special-purpose entity FDI. Of course there is year-on-year fluctuation, but they correspond more or less to about one-third of global FDI flows, globally and probably also in the UK, but very roughly.
The first type—greenfield FDI—is probably the kind of transaction that we typically have in mind when we think about FDI, as Courtney just said: a company from abroad building a new factory from scratch. We can think of Huawei from China buying a piece of land in Scotland or somewhere else and building a new semiconductor plant. That is a typical case of greenfield FDI. Mergers and acquisitions FDI is the takeover by a foreign investor of an already existing company. That is not building a new firm but buying an already existing local firm. A classic example—and a case that I think raised the blood pressure of some of your colleagues a few years ago—was when Kraft from the US took over Cadbury. There was a very heated debate about that.
Chair: Everybody can relate to chocolate.
Dr Linsi: Yes. That is a mergers and acquisitions FDI. The third type, the special-purpose entity FDI—which is what I talked a little bit about before—is holding company structures, which is very different from the other two. Special-purpose entity FDI is a very technical term. I think a less technical term would be letterbox companies or shell companies, which are very different because they are not really doing any industrial production or activity. They are just holding shares in companies elsewhere for tax reasons. It is usually to minimise their tax bill.
A typical case here would be Amazon. If you have ordered a book from Amazon recently you may have noticed that the invoice will have been to Luxembourg and not to the UK even though you bought it from Amazon UK, because Amazon is very eager to shift as much of its products as possible through Luxembourg because then it has to pay less tax. This is a very different kind of transaction.
Broadly, there are these three types. I think it is important to distinguish between those from a policy perspective.
Chair: That is why the GDP per capita of Luxembourg is so high.
Dr Linsi: Yes, and Ireland had strange revisions of their GDP figures. It depends on how you account for these kinds of things, exactly.
Distinguishing between these three flows for policy is important for three reasons. First, it is important because these different kinds of FDI can have different kinds of economic effect. Politicians usually like FDI because it is supposed to create employment and create new jobs, but, whether it creates new jobs or not, it depends a little on what kind of FDI it is. With greenfield FDIs—the building of a new factory—it is very likely that it will create new jobs in that plant, but for mergers and acquisitions it is less clear because it is a takeover of an existing firm. The jobs are already there so it does not need to create more jobs. It can if the foreign takeover makes the firm more profitable or it expands later, so it can create additional jobs, but it can create fewer jobs if the new owners decide to downsize and cut some jobs. Lastly, with special-purpose entity FDI the employment creation effect is really minimal. Maybe it creates some new opportunities for shrewd tax advisers and maybe for the postman delivering the letters to the letterboxes, but otherwise it does not really create many jobs.
When politicians agree that they want to attract FDI, it is important to think what kind of FDI they want to attract. It also matters how you attract these different kinds of FDI, and that comes back to taxation. If a country wants to attract special-purpose entity FDI, tax laws are very important. As the Netherlands has been very successful in doing, you can create some special provisions and you can create SPE FDI through that. But for greenfield FDI, tax seems to be much less salient as an issue. They care more about the business environment, having an educated workforce and this kind of thing. Then you need to invest much more in education to provide the skilled workers that they are looking for and so on.
Q14 Chair: Courtney Fingar, you said that there has been a tapering off of greenfield FDI post the Brexit referendum of 2016. Has there been an increase in other areas?
Courtney Fingar: The noticeable change happened, as I said. The UK had been one of the best and most reliable performers for greenfield FDI over the years, even after the financial crisis managed to record an increase. What we tracked with our service—which is looking at just greenfield investment—in the year 2016, with the vote happening midway in between, was a 38% decrease in greenfield FDI coming into the UK. I think a lot of that was the shock of the vote and certainty matters a lot in greenfield investment because, as we have discussed, these are long-term decisions. You don’t just pull the money out right away. It is not a speculative investment. Therefore, greenfield investors are very sensitive to instability and uncertainty, so we are definitely seeing that.
In 2017 there was a 10% further decline in greenfield FDI in the UK. What we are seeing is a noticeable and continued decline in greenfield figures into the UK after the vote, largely down to the uncertainty with the relationship and access to the European market, but of course wider trade agreements. There is also uncertainty regarding talent and immigration. That is a big question mark that companies have.
What we are finding is that the UK has many attractions for greenfield investment that will outlast this decision and this event. However, one of the strongest hands the UK always had to play for greenfield is that it had a lot of solid criteria but the stability that the country exhibited has now been cast into doubt. As to how much of a recovery we will see, that will be determined by what kind of deal is struck, what kind of arrangements and how much of a stable footing can be found.
In relation to your question, at the same time that we have seen a decrease in the UK we have seen increases in greenfield investment in many European countries. That suggests that there has been a shifting effect.
Q15 Chair: With the pound being cheaper—I have heard anecdotally, and it is probably in more the mergers and acquisitions area—are you seeing any increased activity elsewhere? Have people taken advantage of that?
Courtney Fingar: Yes, and that is the case with M&A. With the pound being weaker and with prices being cheaper, many companies will see that as an opportunity, especially in M&A investing in property and so on. That is why I would stress that it is very important to look at these quite separately because they mean two very different things. Portfolio investors, real estate investors—and even drivers of M&A—are driven by completely different motives from greenfield investors.
Q16 Mr Marcus Fysh: I want to drill into what you were saying about the uncertainty and the possibility for rates of greenfield investment to snap back similar to what they were before. Do you have any sense as to how much pent-up investment there might be for that type of investment? You talked about the uncertainty. How much of the uncertainty you have described would be uncertainty about the politics rather than about, for example, the actual trading framework? How important is political stability to that greenfield investment?
Courtney Fingar: To answer your second question first: the political uncertainty is impacting the faith in the other arrangements and how these trading arrangements will be sought and, ultimately, what kind of arrangement will be reached with the EU and how soon that could happen and, therefore, how soon the UK could begin negotiating other trade agreements and putting other things in place. I think that the political uncertainty definitely creates the uncertainty about policy and the wider business environment.
There certainly will be some pent-up investment. It is very likely that a lot of companies are just in a wait-and-see mode. They will have interest in the UK market still and will have some plans, but why not wait a year if you are going to make a significant investment, especially a bricks and mortar investment? There likely is some pent-up demand and probably we will only know when it will be released again when there is much more certainty about the eventual framework of the wider UK investment environment. Of course, right now, that is being largely dictated by the negotiations with the EU.
Q17 Chair: You did indicate earlier that some of the pent-up might be becoming displacement. Eventually this pent-up pressure gets released and—
Courtney Fingar: It might go somewhere else.
Chair: Yes.
Courtney Fingar: What we are seeing is that, regardless of what happens, the UK will continue to be an important investment destination. It still leads Europe. Despite the decline in its FDI flows, it is still the leading destination in Europe. This has been affected by the decline. There will be attributes of the UK that will remain unchanged and will continue to make it an attractive environment.
To the extent that policy could make it even more attractive, that would help. Those would largely be investments looking for a certain talent pool that exists here. The English language is very valuable still—especially for American companies, for example—and the US is still the largest outbound investor in the world for greenfield investment. American companies will continue to favour the UK, although American investment has declined as well because of the uncertainty.
There will always be investments that are targeted just for this market. However, companies that may in the past have felt wholly comfortable putting investments into the UK, with which to serve the entire EU, may now find that they need to hedge. We are seeing a lot of that. In the past, where there may not have been a need for an office or a significant presence in Frankfurt or Paris, we will now find that there is. That might mean a smaller presence still in the UK and an additional presence elsewhere in Europe.
Q18 Catherine West: I have a separate question. It is more about the impact on a country or a region of large lumps of FDI; how much this might lead to exposure to security concerns and to high-risk individuals and some of the genuine feeling that there is a whole lot of money sitting there. I know that in what were previously very small domestic economies, like Malta and Cyprus, suddenly the impact of a lot of cash potentially sitting there has exposed domestic populations to high levels of crime. What is your view on that?
Courtney Fingar: This probably points to what Dr Linsi was saying about the different types of FDI. With the special-purpose vehicle and other types of investment of that nature that you see flowing into countries—especially those that have a very favourable tax rate—you get these distortions in the economy. With the greenfield FDI it is less so, because the nature of it means that it is bringing something tangible in the way of jobs, facilities and so on. It is another aspect of the importance of that distinction and deciding which type of FDI will be prioritised and then making the policy to try to attract that real ground-level FDI rather than this more distorting type.
There is a debate going on in most countries about controls. The US has cracked down quite a lot. As you will know, there are policies in the EU to vet investments for national security concerns and also to vet individuals who are investors. With the individuals, this is important to look at with schemes like citizenship by investment, which have been very controversial in many countries and can bring in proper investors but also bring in less savoury individuals and exposure to crime. It is important to have vetting procedures not just for the companies bringing in investment but for individuals as well.
Q19 Catherine West: I am sure that the panel will agree that, once you get organised crime embedded and at the same time you cut back on your enforcement, you can end up with really significant problems. It also has a knock-on effect on community cohesion.
Courtney Fingar: Yes, it can.
Chair: This has been very interesting so far and we have probably opened a lot of avenues in our minds, but we are going to have to try to gallop on because of time. There is no better example of that than Faisal Rashid who can really crack the pace here. No pressure, Faisal, but on you go.
Q20 Faisal Rashid: That type of FDI discussion was quite useful. We can also emphasise how important it is to have figures about the type of FDI and the impact in the country that it has created. For example, if somebody is coming and bringing £20,000 only, buying an existing franchise of Subway and borrowing £80,000 from the bank, but has not created any jobs or anything, that is not good quality FDI.
Dr Linsi: Exactly, and I think very often in political debates and discussions FDI inflows are taken as a sign of how well the economy is doing. Having more FDI means the economy is competitive, but we should take it into account that the global aggregate FDI statistics are a very mixed bag that includes all kinds of transactions.
There are certainly some kinds of FDI, like greenfield FDI, in high value-adding industries that are related to competitiveness; a lot of the other things that are measured in these global FDI statistics are not. FDI statistics can go up because you have a lot of foreign takeovers that are not necessarily a sign that your economy is doing particularly well. I think FDI is not a symbol of the competitiveness of an economy and it should not be used as that.
Q21 Faisal Rashid: Do you agree that the Government should have some kind of statistics focused on the type of FDI and the impact assessment of that as part of our policy?
Dr Linsi: Absolutely. That is really crucial. Statistical offices are under a lot of strain. They have to collect these balance of payments statistics, which were defined in the 1950s. There are all kinds of other priorities for why it is collected as it is, but it does not really give you a very good picture of what is going on. We need more disaggregated, micro-level data, which is starting to be done.
Prof Kneller: To add some detail about the effects of M&A activity, there are really good data in the UK and other countries on the ownership structure of firms, which allows us to see when they are domestically or foreign owned, but also to see what happens to those companies once they are acquired by foreign firms, for example.
What we tend to find there is that, on average, multinational firms from whatever country are typically bigger, much more productive, more R&D intensive, more skill intensive and so on. They are better on almost every dimension compared to domestic firms. The domestic firms that they tend to acquire through M&A activity are typically better firms. They are cherry-picking the best domestic firms to acquire.
You might be concerned by that, but when we trace what happens to those individual firms after they have been acquired, once they have become foreign owned, on average at least—I am sure there are exceptions to this that you can think about—we find that the employment levels, the productivity and the profitability of those acquired firms goes up.
The underlying mechanism is likely to be that the foreign multinational firms are sharing some of the knowledge and the technologies that they have with the domestic firms, which is causing them to improve. There are concerns to be had about M&As and the fact that they are cherry picking the better domestic firms but, alongside that, there is evidence that they improve those firms.
People have also looked at what happens when the multinational firms, the foreign firms, withdraw their investments. There is evidence that the performance of those acquired affiliates worsens again, consistent with that idea that the multinational firm is withdrawing some of the knowledge and the technology that made the firm better in the first place.
Q22 Faisal Rashid: A question to Ms Fingar. Definitions of investment for the purposes of international agreements are usually categorised as enterprise-based or asset-based. Can you explain this distinction and why it is significant?
Courtney Fingar: With the caveat that I am not a lawyer, so I will not get too much into the legal technicalities, in broad terms, as you mentioned, for the purposes of international investment agreements, bilateral investment treaties and so on you tend to classify an investment as either enterprise-based or asset-based.
Enterprise-based is closer to our traditional concept of direct investment, which we have been speaking about, and excludes things like portfolio investment, real estate and so on. It really relates to an investment that involves an actual enterprise incorporated in the host state. India, for example, uses this definition for their bilateral investment treaties, sometimes controversially. That means that India would only extend these protections that could be found under the investment treaties to companies that have set up an enterprise and registered something—a proper company or business in India.
This is a narrower definition and, because of that, this fell out of favour over the years where investment exporting countries—like the US, whose companies are operating in most countries around the world and were feeling that American companies were exposed, not properly protected—sought to have a wider definition.
This is where asset-based came in. This meant that the protection found in a bilateral investment treaty was not just related to; you have a company set up there. You have put in a physical office. It means that you have an asset, either movable or immovable, in that country, so this is much broader. It could include not just portfolio and real estate but also even intellectual property. It means that a company could make a claim for protection under a BIT for a violation of something that impacted an asset that they hold in the country. This has become more the norm and the way things are going.
It fits with an increase in international investment disputes, because with the more types of investment that are covered under these agreements, you tend to have more claims and more disputes. But that has become—for good or evil—the international norm.
Q23 Chair: Building on that understanding of definitions, with respect to investors, can you give us the distinction between natural persons and legal persons and the issues it poses in respect of cross-border investors?
Courtney Fingar: These are also terms that you find in these disputes with host countries and investor companies. In basic terms, the natural person is an actual person, an individual. I would be considered a natural person, a living, breathing human being. A legal person can be an entity, a company, an NGO, some kind of organisation. For example, I might be a natural person under international law, but if I created a company, if I incorporated myself, that entity would be a legal person. Even giant companies could be classed as a legal person in international law. This becomes significant in bilateral investment treaties because you need to classify what is an actual investor. In some cases it could be a natural person because shareholders can make claims under bilateral investment treaties. I might want to sue a country as a shareholder and as a natural person.
For a natural person, it is fairly straightforward: what is the nationality of that person? The nationality dictates whether I can claim protection. This becomes complicated if you are a dual national. It happens in this example that I am a dual national of the US and the UK. That means, as a natural person, if I were engaged in business I could claim protection under the investment protection treaties that the United States has signed and also those that the UK has signed. However, with a legal person, an entity, a company, there is not a straight-up nationality.
Citizenship is very easy to prove for a natural person; I either have this passport or I don’t. For a legal person—and this is more common in these international investment disputes because usually you have a company suing a country for a breach—you have to get into issues of what the nationality of that actual company is, which is not always straightforward.
This has led to a problem called treaty shopping where a company could look and say, “I have my headquarters here, but we have a huge presence in this place and maybe it is better that I claim I am a Dutch company because Holland has stronger protections in its investment treaty” and so on.
Q24 Chair: Do you see companies moving headquarters to take advantage of that?
Courtney Fingar: Not necessarily moving the headquarters, but claiming jurisdiction in order to get a better protection. The way to avoid this, when going forward and thinking about how to craft bilateral investment treaties to protect the country from unfair claims from investors, is to very clearly define which companies can claim protection. A lot these days are thinking of saying, “If you want to claim protection, as a company or a legal person under this treaty, you might need to prove that there is a place of incorporation”.
A company that wants to claim protection through the UK’s treaty with somewhere else might need to prove it is incorporated here and is headquartered here and also has significant business activity here, not just a headquarters. The challenge is to make these criteria as clear as possible in order to avoid the treaty shopping.
Q25 Julia Lopez: I have been asked by the Chairman to be quick fire, but I do have a supplementary. It is another definition question, but it is for Dr Linsi. Political economists often distinguish between productive and speculative investment. Could you explain this distinction and say how relevant it is in relation to cross-border investment?
Dr Linsi: The distinction between speculative and productive investment essentially boils down to the distinction between portfolio and foreign direct investments. There is a very good distinction, but it is not always so clear because speculation can also lead to productive activities. If you have a real estate boom that is driven by speculation, it will lead to productive outcomes of new houses and new buildings.
They may not be the best terms, but academics often use these labels to distinguish between portfolio and FDI, the notion being that FDI is more a long-term investment. It is productive in the sense that you are going to operate the company; have industrial activity where you are located. For portfolio investment, the more speculative investment, the motivation is the strategy of buy low, sell high, so investors buy a share in a company because they anticipate that the share price will increase and they want to resell. They do not have an interest in staying with the company for a very long time or influencing its management, but really just to benefit from changes in market prices.
Q26 Julia Lopez: Going on from Faisal’s and Marcus’s questions and whether FDI can be deemed as something that is a positive in an economy, one of the trends that has been talked about is that we have a very strong tech sector but Britain does not produce the Amazons, the Googles and so on. It has been suggested that it is often because our IT firms get to a certain size and then they are snapped up by larger American IT firms. How detailed can investment data go? Can you look at the size of the firm that is being bought, what kind of sector it is in and by country, so that you can see a trend like that where our SME tech firms are being bought up by larger international investors?
Dr Linsi: I don’t have specific data on that, but what you describe sounds very plausible. The amount of capital that a fund or a conglomerate has plays an important role here. But the bigger question that your question raises is: what is really a British company? That is often not so clear. What is a UK company? What is a British company? In the global economy that we are living in, it is very hard to tell.
Yesterday we had the announcement that Dyson is moving its headquarters to Singapore. Does that mean it is not a British company any more? It is a tricky question because it says—and I think there is some truth—that it is a global company. It is not attached to any one nationality. I think that is true, that corporations are not really national constructs any more because they have global value chains, they produce all over the world, assemble, put it together. They have complex legal structures and with intellectual property they are able to move their assets around. It is very mobile.
This still national economy is much more the workforce, which is immobile, but we should not really think of corporations as being attached to or having a certain nationality.
Chair: There is certainly a vacuum of definition there, isn’t there? Apologies.
Courtney Fingar: But you can get data of that type in order to study the trend.
Q27 Faisal Rashid: What is the distinction between tangible and intangible investment? This is mostly referred to by economists. How does it apply particularly to cross-border investments?
Prof Kneller: The obvious difference is that intangible assets simply lack physical substance. They would include things like patents and copyrights and software that a firm has developed—and data in more recent times—but management and organisation as well. The intangible nature of those assets means that they behave very differently to physical investment.
We have already mentioned Uber. The intangible asset of Uber is embodied in its software, and it means that that asset is scalable in a way that a physical asset would not be. It is the idea that Uber’s software can be replicated in lots of different markets. They also tend to have the property of spillovers. What I mean by that is that, when lots of people use that intangible asset, everyone benefits from it. In Uber’s case, the more customers that Uber has, the easier it is to match customers with the drivers.
It does not tend to be a property that you associate with physical assets, like a desk. It also means that the investments in those assets tend to be sunk so they are very difficult to recover if the firm closes down. How do you price an intangible asset, such as the way that the firm is managed and organised? They also have properties that are very difficult to price. You can put a price on a desk or a piece of ICT but how do you put a price on an idea or the way that the—
Q28 Faisal Rashid: Won’t that be intangible then?
Prof: Yes. That is a property of an intangible asset. The final property would be that they tend to have synergies. These intangible assets tend to go hand in hand with more skilled labour. They tend to benefit the more skilled workers that they have. Multinational firms tend to be very rich in those intangible assets.
If you went round a factory that was owned by a multinational firm, you might not observe many differences in the equipment compared to a domestically owned firm, as the object gaps are not very big, although they may still be present. A much bigger factor would be the ideas gap. The intangible assets of those multinational firms would be much greater when compared to the average domestic firm. The fact that they are difficult to price means that their values can be moved into different tax jurisdictions to move profits between locations.
Q29 Chair: Thank you very much. Panel, the last hour has just flown past. Thank you for unpacking an awful lot of that. It was a very interesting session indeed. We are greatly in your debt. We will probably see you again sometime perhaps. It would certainly be nice. As I said in the beginning, consider yourselves as educators. I think you have achieved that this morning. We will take a two-minute comfort break and then we will be back with the second panel. Thank you.
Witnesses: Dr Ilona Serwicka, Jonathan Athow and Dr Henry Loewendahl.
Q30 Chair: I welcome our second panel. Please introduce yourselves for the record—name, rank and serial number.
Dr Serwicka: My name is Ilona Serwicka. I am a research fellow at the UK Trade Policy Observatory, University of Sussex.
Chair: The very famous University of Sussex. Since Brexit, the knowledge of the University of Sussex has become stratospheric.
Dr Loewendahl: Hello, everyone. My name is Henry Loewendahl. I am CEO of WAVTEQ, which is a consulting, data and technology company, probably considered a special-purpose vehicle in Hong Kong, not intentionally. Our main operational base is in the UK.
Jonathan Athow: I am Jonathan Athow. I am Deputy National Statistician for Economic Statistics for the Office for National Statistics. We are responsible for the official statistics on foreign direct investment.
Chair: Good to see you again.
Q31 Emma Little Pengelly: Data sources concerning FDI include the ONS’s UK FDI survey, FDI statistics published by the United Nations Conference on Trade and Development and the fDi Markets database. Can you summarise for the Committee how these are compiled and how they relate to each other?
Jonathan Athow: We are responsible for official FDI statistics in the UK and we do that by surveying companies. We use a business register to identify companies that have foreign parents or foreign subsidiaries, and that is how we target our surveys. We then go out and survey them. One of the challenges with these surveys is getting all the data together and properly understanding it.
When we are talking about, particularly, mergers and acquisitions, data can be very complex. Some of our data does take a while to feed through. For the UNCTAD data—the UN data you referred to—it tends to take an early version of our data, our initial estimates. They are broadly on the same basis, but sometimes they will not have the most up-to-date numbers. In particular, I think the 2017 numbers that it had were our very first estimates, which were much lower than our subsequent estimates. That is the main difference between those sorts of official data sources.
Q32 Emma Little Pengelly: If I recall correctly, when Greg Hands came before the Committee he referenced the Department and how they measure and publish activity. One of the things that he mentioned was that previously they identified a number of FDIs, but that there could be a number of much smaller ones, which did not necessarily represent the amount of work or the value of the FDI, and that they had indicated that there was going to be a shift within the Department to looking at the value of FDI. Is that something that has happened here? Is that comparable to the way that other countries measure FDI?
Jonathan Athow: Let me come back to that and get at this another way. I think this will be relevant when some of the other witnesses speak. We compile our FDI statistics because we are interested in balance of payments: how much money is flowing in and out of the UK. We are interested in that top-down figure. We then break it down into whether it is foreign direct investment, portfolio investment or other flows. We are interested in the top-down, and that is where our strengths are. We know we are comprehensive, but we do not often have the level of detail.
One of the things we would like to do is offer more detail and work with the Department for International Trade to have a much more granular understanding of what is going on. People want to know: what is greenfield investment versus different forms of investment? All those sorts of terms you have probably heard. You cannot distinguish that from our statistics at the moment, and we would like to do more. The Department for International Trade has some of those bottom-up numbers. They go project by project, but it is not always clear they will know exactly how much money is in some of those transactions.
It is a challenge for us, as statisticians, to think about how we bridge that gap. Having a top-down number is useful, but if you are trying to understand what is driving that, what sort of activity it is, we do not really have that at the moment. That is something we would like to work on with the Department for International Trade, but we do not have the information at the moment.
That said, there are probably lots of other organisations out there who do collect that data as a business advisory service and try to understand it in a bit more detail, but you will not necessarily be able to reconcile that with the top-down numbers that we produce.
Dr Loewendahl: The previous panel was very interesting. When you look at the top-level numbers in most developed economies, basically what you are seeing is who has been most successful in selling their corporate assets to other foreign companies, because most of it is M&A.
As mentioned, there is not a breakdown of greenfield versus M&A. As we have seen, that distinction is extremely important in understanding the motives, determinants and impact of FDI. The fDi Markets database is from the Financial Times. I was the original patent applicant for that, and we developed it in 2003 exactly for this reason. The dataset did not exist on greenfield investment or productive investment, new capital investment and new jobs in economies around the world. We launched it in 2003, the Financial Times acquired it in 2008 and we still work very closely with the FT on that.
The greenfield FDI is tracking the same as DIT is tracking, which is new companies establishing new operations in the UK, existing companies in the UK expanding their operations, which is creating jobs and new capital investment in machinery, equipment and so on. That is what we are tracking in real time, worldwide, every country as far as we can; every company. That gives you a dataset of greenfield FDI.
Just for transparency, it is not just fDi Markets that do this. Moody’s now has a database. IBM has an internal database. I also developed that for them when I was at IBM. They also have database tracking there, so there are now three databases basically tracking exactly the same stuff, as will be the same for M&A.
In M&A you have Dealogic, Thomson Reuters, Bureau van Dijk, owned by Moody’s now, which provide M&A databases, so there are at least three major sources of M&A data going down to the project level. The data are available, and you can see what is going on.
Chair: Marcus Fysh might have a good question in this area.
Q33 Mr Marcus Fysh: Yes. I was going to ask about how the split-out of greenfield can happen. You have mentioned some of the existing data sources that are there. Are there any particular challenges to Government Departments accessing that? You were saying that you wanted to work more with the DIT. What are the limitations that you see in terms of trying to construct a valid dataset that we as a Committee, for example, might have confidence in?
Jonathan Athow: It is a bit early to say because we have been working elsewhere with many of the organisations to try to get better data on other aspects of financial flows. The challenges we find are that many companies want to work with us and there is a benefit in having a set of statistics that add up to the total.
Q34 Mr Marcus Fysh: Reconciliation?
Jonathan Athow: Reconciliation is very important because it encourages people to believe there is a consistent story being told. The challenge sometimes is taking the accounting and business concepts that are used and translating them into something that is meaningful in terms of the overall economy and statistics. It is sometimes bridging that gap. This is how a business will look at something, but, when we are trying to produce an overall set of national accounts, we are interested in a set of concepts that are slightly different. We are interested, for example, not necessarily in legal ownership but in where the economic ownership of something is. You end up with those sorts of concepts being very challenging.
The other issue is that we want to provide long-run economic data. We would like 30 or 40 years’ data. Trying to get data that is consistent from the private sector—realising that different players have been in at different times—getting a consistency of data over 30 to 40 years is very, very challenging. Often it is the practical issues that are the barriers.
Q35 Mr Marcus Fysh: Just as a supplementary, my understanding is that, for example, in the employment statistical series that ONS has, they are based on surveys of companies, effectively, who say how many people are employed in particular locations?
Jonathan Athow: Yes.
Q36 Mr Marcus Fysh: In theory, it would be quite useful to reconcile those sorts of numbers to the FDI data, wouldn’t it?
Jonathan Athow: Indeed, and we have already started some of that reconciliation. I was before this Committee talking about how we had put trade data together with VAT data. VAT data tells us something about business turnover, what sector it is in, and then we could look and see how they were trading. We were looking particularly at Northern Ireland.
When you can match these datasets together, it does bring out some very interesting issues. These are exactly the sorts of things we would like to be able to do more of, but it is very, very complex to knit together many different data sources, to make certain that the results are genuinely what are going on on the ground and not just because of the method a statistician chose to link different datasets.
Dr Loewendahl: The US does this. The Bureau of Economic Analysis in the US in 2017 published its first ever dataset, the first country in the world and the only country in the world that publishes their official data with a breakdown of M&A versus greenfield. It is all available to the public. You get the exact distinction. You also see the new investment versus the expansion of existing investors, and you get the data by the FDI amount and also by the employment. They are the first in the world to be able to do that. You can download it and you see exactly what is going on.
If you look at their 2016 data—just to give a good stat—97% of the FDI was M&A, only 3% greenfield, so it shows you the role of M&A in the US in particular when you are looking at the headline numbers. The UK would be lower than that but still probably high.
Q37 Chair: What would you say the UK numbers are for greenfield versus M&A?
Jonathan Athow: We do not have any at the moment.
Q38 Mr Marcus Fysh: In the UK context, we often hear about the UK being one of the largest investors in the US. Much of that would be M&A, presumably, would it?
Dr Loewendahl: Yes, and vice versa.
Jonathan Athow: Indeed, yes.
Dr Serwicka: I do have the greenfield investment figures, accidentally. These are from the fDi Markets database. Last year, 942 greenfield investment projects were announced in the UK. The numbers for the job creation and capital expenditure are estimated in part, but about 60,000 jobs were created as part of these greenfield investments. The value of this investment was worth some US$33 billion. That has come from fDi Markets.
Q39 Chair: The M&A figures?
Dr Serwicka: I don’t have these to hand. I may have it somewhere in the file.
Chair: Okay, that is fine, if you come across them well and good.
Emma Little Pengelly: I want to touch on the regional variations in relation to FDI. In my previous role, when I worked within the Northern Ireland Assembly, we would have been focusing on FDI to create investment for jobs, particularly high-value jobs, working very closely with our regional body, Invest NI. I think that we had quite significant successes through that comparative to the rest of the UK.
What has struck me is that London and the City investment market is very different from what, I suppose, the devolved or other regions of the UK look for in FDI. How closely do you work with the regional bodies that are trying to promote inward FDI in Scotland, Northern Ireland and across perhaps the north of England as well? In that sense, do you have information on the motivations for companies that invest there? What is being sold in terms of attracting those companies, and could that be used then post-Brexit to look at economic stimulus and different measures that can take place to increase our FDI in that context?
Chair: A challenging question.
Dr Loewendahl: We are working with all the investment promotion organisations across the UK. For example, on investment for Ireland, our main office is in Belfast. We represent them fully in India, so the outsourced tracked investment from India to us. We have a good idea of how they operate. The data—whether it is ONS data, whether it is fDi Markets data, whether it is DIT data—is disaggregated down to the regional level. We know what the trends are and what is happening. We know what the drivers are. We are tracking the location determinants in FDI markets, why companies are investing in different jurisdictions, so we can see very clearly what the differences are. A lot of it is just driven by industrial specialisation. If London is strong in financial services and creative industries, they have different drivers to Northern Ireland, Scotland or Wales, which are strong in different industries. A lot of it comes down to what the sector specialisation is and what is driving FDI in those sectors.
Dr Serwicka: When it comes to us at the UK Trade Policy Observatory, we wrote our analysis around the potential impact of Brexit on greenfield investment into the UK, but when it comes to discussing those issues with businesses, there is a potential scope for doing more of that. For example, we are also doing research around free ports, free zones, which one of your colleagues will probably be interested in.
Yes, when it comes to me, sometimes I feel guilty about just sitting at my desk and doing the number crunching where I think there is a potential to discuss more with businesses across the country. We have been in conversations with local government in Belfast, Northern Ireland. They have been interested in our work, but I have to say, when it comes to extension of the analysis, we would want to do something more around the regional picture that we have not done yet.
Q40 Catherine West: The ONS says the UK inward FDI flows decreased from a record high of £192 billion in 2016 to £92.4 billion in 2017. Last time Mr Athow came to the Committee we discussed the fact that this reflected a large M&A.
Jonathan Athow: Yes.
Catherine West: Could you expand a little bit on what impact that has on the data? Given that trade is becoming more important politically, how can we establish better datasets so that we can compare like with like?
Jonathan Athow: I think that there are two aspects. In both 2016 and 2017 the inward flows of FDI were heavily influenced by M&A, particularly 2016 but also 2017. Of the ones that were publicly announced at the time, it was things like SABMiller—a large brewer—Arm Holdings and BG Group. There were some really big numbers and that drove what was going on in 2016. To a certain degree, we also saw a lot of M&A activity in 2017.
In some ways, those are abnormal years; therefore, comparing a fall between 2016 and 2017 or even the change between 2015 and 2017—which was a big rise—you are probably not comparing like with like. You have to look beyond. We have to wait for data that does not have some of those large M&A activities in it to understand what is going on. What we would like to do, as I said, is replicate what the BEA does, which is look at different sorts of investment. At the moment we cannot do that, so we cannot necessarily say, “Was that driven by a fall in greenfield investment or how much was different sorts of—”
Q41 Chair: Our first panel indicated that there was a decline in greenfield investment since 2016. Are other people picking that up in your own statistics?
Jonathan Athow: We would not have any data on that simply because of the way we collect the data. If you are talking to more people who are doing the project by project work, you would have some more of that. I cannot comment on that.
Dr Loewendahl: There is a really important caveat to make. The private sector data includes a lot of estimates of capital investment and job creation. Those estimates may not always be very accurate. It really should be the role of DIT to be making sure it has a very accurate dataset, but DIT does not publish data on capital investment or job creation. In job creation, it is also using the estimates provided by the private sector, so the whole dataset used, whether private sector published or DIT published, is rather suspect. If you drilled into those numbers and got the actuals it would be very different.
Dr Serwicka: My colleague Nico Tamberi and I looked at the fDi Markets database. You can see what numbers are estimated for job creation and capital value of investment. It is there marked with a star. We found that about 80% of numbers for job creation and value of investment have been estimated. That is part of the reason why we did not want to work predominantly with that measure of investment in our analysis of FDI because, when you think 80% is estimated and fDi Markets says that it tried to look at projects in similar scope to derive those estimated job creation and capital investment—
Q42 Chair: Are you also picking up a tail-off in greenfield-type FDI since 2016?
Dr Serwicka: Yes. There was a drop-off. In 2016, there were 1,041 greenfield investment projects. That fell to 942 in 2017, so yes.
Q43 Catherine West: Is that directly attributable to Brexit?
Dr Serwicka: Again, I think there is some level of doubt about any causal statement, but, from the analysis that we have done as part of this paper, we believe so because of the timing.
Q44 Catherine West: What is the relationship between the data that we are talking about this morning and the forecasts that the Treasury makes? We know that Mrs May’s deal is 3.9% loss to the GDP and no-deal Brexit is 8%. They are the two figures that have been talked about in the House of Commons, which are obviously based on this kind of data, I assume.
Dr Loewendahl: I don’t think so, no.
Catherine West: Come on, you are statisticians. People just do not make these figures up.
Jonathan Athow: You are getting me on to an area I am not an expert in, but I imagine that it probably would not directly be something that is modelled as part of those scenarios. In those scenarios, you would see a fall in investment or productivity, but you would not be able to tell how much of that is due to falling FDI. It is a plausible channel, if you believe those models, but you would not be able to say how much of a fall in FDI you would get. I do not think that is explicitly part of the model. I think that they would look at investment as a whole rather than splitting off FDI and domestic investment. That would be my understanding of how that would work.
Dr Serwicka: The model would be looking again at the possible introduction of trade frictions between the UK and the EU—so tariffs and estimated values of ad valorem equivalents for non-tariff measures.
Q45 Catherine West: At what point does the data collection intersect with the real economy? Had much of this been working for the real economy we may never have had a Brexit, because there was an element of dissatisfaction with the current model that led to Brexit. At what level can these data help to inform decisions so that the general population can be a bit happier with the economy, so that it can enrich our understanding of how to make a real difference? As you are aware from reading newspapers, eight out of the 10 poorest regions in the EU are in the UK. At what point does it intersect with the reality of the real economy?
Jonathan Athow: If you were standing back as an economist, you would be looking at what is happening with investment. Obviously, FDI is a source of investment, but it is a more general issue of what is happening with investment in local areas. That would be how economists would understand the issue. You would want to say, “What is happening with business investment?” That is when you would want the DIT data to understand what is happening with our local area: are we seeing investment in the north-east or the north-west, those sorts of questions. I think that is where people would be interested.
As I said, one of our plans is to try to offer more data so we can see what is going on with the greenfield investment, offering exactly the sort of split that the Americans have recently introduced.
Dr Loewendahl: There is also a huge problem with the DIT data. If you look at DIT data, can you evaluate the performance of the UK attracting investment from DIT data? The answer is absolutely not. The reason is—and this relates maybe to dissatisfaction as well, especially in poorer areas—that they do not track how many companies close down or how many companies downsize. They may be working with 1,000 key accounts—existing investors—but they do not publish data or necessarily track it on what they are losing. It is like a business. I am presenting to my shareholders, “We won all these new clients this year” but I am not going to tell them how many we lost. You would not survive very long as a business. That is what is happening.
Catherine West: Can I just pursue that? I promise I will be quick.
Chair: Can we be aware of time while we are doing this?
Q46 Catherine West: Just, for example, the figure of the north-east economy losing 15% as a result of Brexit eventually, what is that forecast based on?
Chair: Yes, the methodology. We are looking basically at how conclusions have been arrived at around Brexit and its effects.
Jonathan Athow: This is my understanding here as an informed reader of what is going on rather than anybody who has done it. What you will do is look at the sectors of the economy and which sectors are most exposed to trade frictions. Then you would work that through and maybe you assume under certain scenarios that manufacturing is more exposed to trade frictions than, say, financial services, in which case you would say that parts of the country with high levels of manufacturing would be more exposed and, therefore, they have more to lose from a particular scenario. If you think that financial services are broadly unaffected by whatever scenario you have, that might say that London would be less affected.
It is very much thinking about what the industrial composition of a particular part of the country is and how exposed that sector might be to different scenarios. That is my understanding of the modelling but, as I said—
Catherine West: You are just a statistician.
Jonathan Athow: —I am an interested reader rather than anyone who is responsible for it.
Dr Serwicka: I can maybe add to that. What matters really, when it comes to the sectoral impact of Brexit, will be the underlying structure and pattern of trade: how different regions of the UK trade with the EU versus non-EU countries. Based on that, using computable general equilibrium models as well as partial equilibrium models, you can gauge what the possible sectoral impact of Brexit would be based—as Jonathan has said—on trade costs and possible non-tariff barriers. Based on that, it is possible to estimate across sectors what the output effect would be. Then knowing what the employment patterns are across different regions and different parts of the UK, it is possible to estimate.
Chair: Marcus Fysh has a brief question.
Q47 Mr Marcus Fysh: My impression of those Treasury forecasts is that there is a very high level of uncertainty as to the way in which those factors you mentioned interact. I was interested in what you were saying about the number of projects that you have observed effectively relative to the year before Brexit. Was I right in my recollection of that that, roughly speaking, it is down about 10%?
Dr Serwicka: Yes, exactly, from just over 1,000 projects down to—
Q48 Mr Marcus Fysh: Do you have any sense of how many in that reduction might be just delayed decisions, which might be ready to be made again? Out of that 10%, what is the proportion that has gone somewhere else and what would be the proportion that is just waiting for more certainty?
Dr Serwicka: This is a very good question and a question that we wanted to tackle in a paper because, as we see it, if the reduction is due to Brexit, then there might be two possible options. Investors may be just waiting to see what happens, so it is a temporary adjustment, or there might be a permanent shift because they cannot delay any investment decisions so they have to invest now. Rather than the UK, they might choose to invest in Germany, France and so on. Unfortunately, in the paper that is a question we posed and we would want to get deeper into it.
Mr Marcus Fysh: It is uncertain, yes, all right.
Dr Loewendahl: I have the full 2018 data, so for last year, and I think that the first panel also touched on this. From 2015 to 2018, the number of FDI projects, greenfield projects in the UK, declined by 25%. The number of manufacturing jobs created by FDI and the capital investment associated with those investments is down over 50%. That is what is driving the decline in the manufacturing, and that relates to what you said about, say, the north-east and other regions in terms of their sectoral composition. Because they are manufacturing-driven economies they are most impacted.
Q49 Mr Marcus Fysh: Do you have any feel for how much of that might just be a different decision and how much might—
Dr Loewendahl: Yes, the projects have gone down lower than the jobs and the capital investment, which gives an idea that some projects are being put on hold. They are going to other countries in Europe, but the average size of projects is going down. While companies are still investing in the UK and the numbers are still high, they are coming from a very high level down to still a high level, higher than most other countries in Europe. It is not doom and gloom. It is just a downward trend at the moment.
The size of those projects is going down, and that could be because companies have to set up multiple operations now in Europe, whereas before they decentralised in the UK, as I think the previous panel said. We have seen that especially in financial services. Financial services FDI and greenfield investment has boomed in 2017 in the Netherlands, France, Germany, Switzerland and Ireland. Each of those five countries had either a three times increase in FDI in financial services or a three to six times increase. That is because companies were forced to set up other operations.
Q50 Mr Marcus Fysh: That is off a fairly low base, one would have thought, because it is not a very attractive—
Dr Loewendahl: It is off a very low base, and they are small cities, most of them, as well. There is a limit to what they can do.
Q51 Mr Marcus Fysh: Just coming back to your comment about not tracking the data of firms that are closing down in the same way, I am interested in a bit more colour on that and how you think we could improve that collection in the future. When we are talking about trade deals with different areas, obviously there are potentially some industries that might gain, and some that might lose. It is very important for us, in helping to advise the Government or the parliamentarians on how to react to that and to plan for the future, to make sure that adequate retraining and skills development go into certain places to potentially shift industries for the populations there. How can we address that?
Dr Loewendahl: There is a big difference. It is always good to look at best practices. Comparing the ONS data to the US allows us to see what the US has done, how it does it and whether that can be applied. The same could be done with DIT. What are the best practices? You can look at Ireland. IDA Ireland, which is the equivalent of UK Trade and Investment previously, and Enterprise Ireland, which is the trade development arm of the Irish Government, both have targets for net investment and net job creation. They have to track how much investment they lose versus how much they win.
In DIT their only targets are for new, even though a large part of the operations and a large part of that is also outsourced to the private sector, like the Big Four. They are not targeted in terms of preventing companies from closing down or downsizing, so you do not know what the net impact is at DIT. No one can tell you. That information does not exist, whereas in Ireland they have to track that.
If you look at IDA Ireland’s or Enterprise Ireland’s annual report—the same as DIT’s annual report—they show: these are the successes, the new investments, the expansions of existing, this is the amount we lost, companies that closed down or downsized, and this is our net impact, which is fantastic. That is what they are doing.
They also have a very clear target—relating to the previous questions—about the regional distribution of the investment they support. Again, the UK does not have that. They are targeted to get a certain amount of investment into deprived areas, which, as they admit themselves, is very challenging. In their reports they note how difficult it is to achieve that, but they are targeted to do that and it is a KPI. That could be something interesting for the UK, given that the regional disparities are so big within the country.
Q52 Chair: Efforts have been made over the years to get stuff into the west of Ireland and now in the south or in Waterford. It is those areas that they are probably talking about as challenging.
You mentioned there were five countries getting a sort of FDI Brexit bonus. It was France, Ireland, the Netherlands; who were the other two?
Dr Loewendahl: Germany and Switzerland.
Chair: Germany and Switzerland, thank you.
Q53 Julia Lopez: I want to shift to outward investment. Which are the destination countries that are most important when it comes to UK outward investment, and what trends are apparent in the data on the scale of UK outward investment?
Jonathan Athow: UK outward investment is much more mixed. Inward investment has remained positive pretty much all the way through our data. UK outward investment is more mixed and there have been some years when we have disinvested. We have sold more abroad than we have been buying. There are years where you see that. In 2014 and 2015 you saw some of that disinvestment. That has changed the picture a bit. For a long time, we were benefiting from a lot of investment but investing a lot overseas. That has changed a bit and foreigners now own as much here as we own overseas, so you see that.
In many ways what you see, in terms of the patterns of investment, is very similar to the patterns of where we invest. We invest a lot in the US, a lot in European countries, and also in countries that are financial centres. The Netherlands and Luxembourg remain important places where the UK invests. It has been a more mixed picture but, in terms of what we invest in or where we invest and the sectors we invest in, it is quite similar to the sort of investment we get into the UK.
Dr Loewendahl: If you look at how much we invest overseas versus how much we get inward, I don’t know if I am correct, but I think that with the ONS it is not too big a difference, is it, mostly on average?
Jonathan Athow: No, indeed. It used to be that the UK had a history of having quite a lot owned overseas in terms of FDI. It is probably more evened out now over time but, given what we talked about with mergers and acquisitions, this is very lumpy. One or two transactions can easily change that balance quite a lot.
Dr Loewendahl: The greenfield FDI is a zero net position, in terms of the amount of projects that UK companies set up overseas versus in the UK. It is pretty much the same number but, in terms of the size of the projects, UK companies are creating more jobs overseas than foreign companies are in the UK because they are investing in India and China, labour-intensive and job-intensive economies and bigger job-creating operations. The greenfield FDI data shows that the US is the biggest recipient—about 20% of foreign direct investment projects from UK companies go to the US—and then it is Germany, India, China, Australia, all with about 4% to 6% by their numbers of greenfield projects.
Q54 Julia Lopez: You have not seen a shift in those destinations over the last couple of years?
Dr Loewendahl: No, those destinations have been consistent for many years. China has increased. Last year, 2018, the biggest growth from UK outward investment, in terms of greenfield investment, was to Spain and China, but in Spain it is mainly real estate. When you look at the data, it would be great, of course, to have the breakdown of greenfield M&A for the UK, inward and outward, as the US does, but then you go and look at that greenfield, what does that comprise? Half of the job creation by greenfield FDI in the UK is retail, construction, and sales and marketing. That is not exactly strategic investment or high value-added investment, and maybe it is not investment that DIT should really be involved in and recording in its results, which it does.
I think that you need to look at the high-quality investment as well, the high-technology manufacturing, the high-technology services. If you start looking at greenfield investment by the high-technology investment and the UK’s performance, France is neck and neck with the UK. In some years it is a little bit higher, some years a little bit behind. Ireland is very high as well; Germany is very high. It is head-on competition for the high technology and foreign direct investment.
Q55 Mr Marcus Fysh: You have already touched on this to some degree in terms of the composition of outward FDI by industrial sector. Do you have any more to say on the lines that you were just talking about? It was very interesting.
Jonathan Athow: I would just say that in the top-down numbers you do see financial services. Again a lot of that is likely to be mergers and acquisitions, those sorts of things. The UK also invests in some niche sectors, like real estate and those sorts of things, where the UK seems to have a very strong advantage and, therefore, invests a lot overseas. As I said, you do not see a big difference between the inward investment and the outward investment in terms of either destinations or industrial structure, for the top-down numbers anyway.
Dr Serwicka: I do have my folder with all the numbers here. I consulted the OECD figures on the outflows of investment. Unfortunately, when it comes to partner/sector composition, it is not available for 2017, so you just have total number for 2017. There is the sectoral breakdown for 2016 and the top for UK outflows, the sector that comes there, is activities of holding companies. The second would be accommodation and food service activities, followed by chemicals and chemical products. Again, they are quite broad sectors if you think about this, but yes, just to give you a—
Q56 Mr Marcus Fysh: It all depends on what our industry does as to what it chooses to invest in overseas as well and the whole global cache of finance, so I would say it would vary a lot over time.
Jonathan Athow: When you look at the holding companies, that is, for example, where you see real estate investment and those sorts of things.
Chair: As we are coming up against time, we will lastly turn on the home straight to Sir Mark Hendrick. Who better to bring our session to an end but the good Sir Mark himself?
Q57 Sir Mark Hendrick: I would like to address this to the entire panel. The 2017 FDI data showed a slight negative net FDI investment position of £23.2 billion. It is the first time that this has been recorded. What is the significance of this?
Jonathan Athow: It is difficult to know. Well, let me say this is part of the general trend we have seen that, for a long time, the UK held much more FDI assets overseas than foreign companies held here. If you go back, say, 10 years ago to 2008, the UK held about £1.1 trillion of assets overseas and inward investment was just over half a trillion. What we have seen over that time is the gap between that close and for the first time you saw that switch over.
The net position is probably not worth reading too much into. When we are talking in trillions, even a few billion gets lost. I think that is a general trend, and we also see this with our other balance of payments statistics; we are running a current account deficit. That means we are drawing on funds from the rest of the world.
In many ways, what you are seeing in FDI is mirroring what is going on with our overall financial position. We are more dependent on investment from overseas than we are in making that investment ourselves. That is a broader economic change, the fact we are running a current account deficit. It is more consistent with a wider economic picture and whether you are concerned about the current account deficit is an area that—
Chair: Another matter altogether.
Jonathan Athow: Another matter. The Bank of England would be the people to ask about those sorts of concerns.
Dr Serwicka: What I can add to that would be that, when you think about outward investment, these are UK assets, so of course it is a positive thing that we are investing out in other countries but, when it comes to this balance—as Jonathan has indicated—the net position is a fraction of the total.
Chair: A billion here or there, who cares?
Dr Serwicka: Exactly, but what is important is: if the reason for this position shifting into negative territory is because inflows into the UK have declined, you have to think: why is it that this decline has happened? Is it Brexit? Is it not? What is the underlying motive for it?
Q58 Sir Mark Hendrick: Is it declining or is it the fact that the outflows are much bigger?
Jonathan Athow: The big rise has been in inflows and that might well be mergers and acquisitions. For example, we have been selling some of our companies overseas and that has driven up inward investment. The flip side of that is that foreign companies or foreign individuals now own more of the UK. Therefore, our liabilities to the rest of the world are higher and, obviously, there are flows of income associated with that that now flow overseas. That is consistent with what you see more generally with our external current account position.
Dr Loewendahl: You are going to see in a few months the official data published by UNCTAD for 2018. What you are going to see is the UK FDI inflows going up a lot, everyone talking about how amazing the UK is because the FDI has gone up and UK outflows going down a lot, but it is all driven by M&A. When this data goes live by UNCTAD, you will see. UNCTAD is forecasting UK FDI to go up by 20% or something for 2018.
Q59 Sir Mark Hendrick: Has the exchange rate influenced it?
Dr Loewendahl: It has an influence, but then you have to ask yourself: why is it happening? Why has UK M&A investment overseas in 2018 declined? Why is it increasing in the UK? We are talking about economics and so on, but a lot of it is political as well. The UK is the most open major economy in the world to M&A and the UK Government do not restrict M&A. They do not screen them in terms of having a proper Investment Canada Act or what the US or EU are planning or what Germany is doing. It is the most open so it is more attractive. It is easier to buy UK companies than anywhere else.
Then, with Brexit, the exchange rate changes means it is cheaper—as mentioned in the previous panel—but the uncertainty is also affecting the stock market valuations of companies. The P/E ratios look more attractive as well, so you can get a better ROI. It is all building together to make the UK really attractive, especially for US investors who are cash rich. That is also happening at the same time where US investors have unlimited access to finance, pretty much right now, and it is focusing on the UK. When the figures are published, you will see that the UK has probably had a great performance last year in FDI flows, but it is M&A.
Chair: Fascinating, thanks for that. The second panel was just as interesting as the first panel, and that was quite a challenge to follow the first panel. We are coming up against time and, as ever, that pressure builds on our panels as we approach midday. Thank you very much to the three of you for your time and your expertise.