Login 

Share

THE BREXIT HIT TO FOREIGN INVESTMENT IN THE UK: New evidence

The UK’s departure from the EU single market may reduce the stock of foreign direct investment from Germany, France and the Netherlands by as much as 30%. That is one of the findings of research by Ray Barrell and Abdulkader Nahhas, to be presented at the Royal Economic Society”s annual conference at the University of Sussex in March 2018. Their results also suggest that the UK has no special labour market or competitive environment advantage when attracting foreign investment.

The new study investigates bilateral stocks of foreign direct investment (FDI) from the 14 largest high-income OECD countries to all OECD countries between 1995 and 2015. This covers the period of intense globalisation and European integration that began after the establishment of the World Trade Organization (WTO) and the completion of the single market in Europe. Among the findings:

• The single market has raised flows of FDI within the member states by around 40%. The formation of the North American Free Trade Area (NAFTA) has not had a similar impact.

• If two countries are both members of the EU, then bilateral FDI stocks are likely to be 40% higher than they would otherwise have been.

• Setting up a new free trade area is no substitute for the single market, as there is no evidence that NAFTA had an impact on FDI stocks.

• FDI stocks are significantly influenced by relative country size and their distance apart. Distance effects may be dying, but it is happening very slowly.

More…

Economic integration between countries has many forms, and they can integrate parts of their economies together through economic union such as the EU or through a free trade agreement such as NAFTA. Economic integration is often thought to attract FDI from countries outside of the economic integration area. But the effect on FDI from countries within the economic integration zone is ambiguous.

This study investigates bilateral FDI stocks from the 14 largest high-income OECD countries to all OECD countries over 1995-2015, covering the period of intense globalisation and European integration that began after the WTO was set up and the single market in Europe completed. The authors look at measures of market size, proximity and distance, membership of the single market and the Eurozone.

The most important finding is that the single market has significantly increased stocks of FDI within the members, given the other factors driving FDI. Single market membership raises FDI from other members by over 40%, with supply chains spreading across the market area. When a country leaves the single market, FDI stocks will fall by 30%.

The UK has not attracted additional FDI from outside the EU, apart from that which can be explained by the use of a common language with economies such as the United States, Canada and Australia.

The researchers test for equivalent effects in NAFTA and they are not significant. The nature of integration within the NAFTA region is different from that within the EU, and the trade agreement is not aimed at increasing economic integration between the countries involved.

These results bring out the strong differences in the impacts of the two sets of integration forces in North America and Europe, with Europe displaying a pattern designed to increase competition within the region, and not just trade between partners.

The introduction of foreign producers within European countries reduces the political power of local sectional groups and hence allows the EU to increase competition across the single market by significantly more than could be achieved by a simple trade agreement.

These findings indicate that there is no additional effect for the creation of a common currency. When both countries are in the Eurozone, FDI is around the level other factors would predict.

If distance increases by 1%, the bilateral stock of FDI falls by about 0.43% in the long run. Gradual improvements in communications technology and the growth of the internet may lead to the ”death of distance”. These findings indicate that distance is becoming a less important factor over time, but given the speed of decline, it will remain important for the next 150 years or more.

The effect of host country size is 50% larger than that of distance elasticity. FDI is market-seeking, and leaving the single market will reduce the size of the market available to foreign producers.

Trade Blocks, Common Markets, Currency Unions and FDI stocks: The impacts of NAFTA and the EU by Ray Barrell, Centre for Macroeconomics, LSE and Brunel University London and Abdulkader Nahhas, Department of Economics, University of Exeter.