How can inward investment become more transformational?

This blog was written by Nigel Driffield, Warwick Business School, Professor of International Business and Xiaocan Yuan, Warwick Business School, Research Fellow about their recent work for the Department for Business and Trade and the Office for Investment. Nigel leads The Productivity Institute’s work on organisational capital.

The levelling up challenge aims to tackle the problem of certain locations being trapped in a recurring cycle of low skills and low productivity. The Productivity Institute was asked by the Office for Investment and The Department for Business and Trade to explore how a more nuanced strategy towards inward investment attraction can help break this cycle. This involves attracting investment that not only boost the demand for skills, but also enhance incentives for individuals to upskill.

Inward investment, or Foreign Direct Investment (FDI), can enhance the returns on skills, and therefore boost the incentives for individuals to acquire them. Transformational FDI, which refers to investment with the capacity to “move the dial” on productivity for the location, represents a substantial advancement or a step change compared with current activity, rather than just adding to existing capabilities.

To address these challenges, we recently conducted a study on inward investment attraction and the levelling up for the Department for Business and Trade and the Office for Investment. This work was partly initiated in response to the National Audit Office Report on inward investment promotion in the UK, the Harrington Review on inward investment, and  a collaboration between TPI’s Midlands Productivity Forum and the CBI concerning the challenges of attracting re-investment from existing foreign-owned enterprises into the UK.

There are four fundamental questions regarding the attraction of inward investment:

1. Do locations prioritise areas of strength with above-average productivity, or seek to catalyse new, potentially high-growth sectors by leveraging research and frontier technologies? If the former strategy is chosen, we might expect place-based innovation policies to encourage broader interactions and collaborations between businesses and universities – potentially strengthening sites already internationally competitive. Alternatively, if the latter approach is adopted, then the primary challenges are likely to revolve around scaling-up nascent activities.
2. Do locations seek to crowd in new investment, or nurture existing investment? While prioritising new investment is likely to fulfil the government’s short-term objectives for increasing direct investment, well-designed interventions aimed at nurturing existing investments could enhance resilience, potentially leading to productivity gains and fostering other innovations over the medium to longer term.
3. Do locations put the emphasis on the creation of knowledge, which can be potentially exploited internationally? Lacking a strategy to boost the supply of skills, developed locally technology is at risk of being exploited elsewhere, either through relocation, or acquisition by foreign firms. Similarly, solely focusing on skills without innovation is unlikely to lead to sustained activity.
4. Do locations aim to generate jobs by either attracting new activities or supporting traditional sectors? If leveraging existing strengths, the focus needs to be on collaborating with incumbent businesses and rectifying the market failure that has hitherto hindered better cooperation between business and local research. This approach involves local institutions filling gaps in supply chains, and industrial strategy identifying, for example, missing links in supply chains.

Location, location, location

The key message from our research emphasises the need to evaluate a location’s capacity to attract investments and subsequently maximise the benefits of such investments, particularly regarding spillovers to the wider economy. This requires a shift from the current sector-based approach which is initially determined centrally and then adapted by UK regions, towards one which explicitly requires regions to align inward investment promotion with sectors where locations perceive their strengths lie. The city regions of the UK largely adopt this approach, while its adoption elsewhere remains patchy, often driven by supply considerations, namely what they perceive they can attract.

This also highlights the potential for public policy in this realm. Interventions can be grouped into improving absorptive capacity, or strengthening linkages between inward investors and local firms. Absorptive capacity improvements include, for example, policies targeting skills, support for innovation, start-ups (potentially including venture capital), and transportation improvements to widen Travel to Work Areas (TTWAs). The latter includes policies promoting local content to increase the utilisation of local supply chains and encouraging local firms to adapt to fill such gaps. This illustrates that inward investment policies and efforts designed to improve the local ecosystem go hand in hand.

For future research, we will extend our analysis by developing a policy framework that connects the dynamic capabilities at the regional level with those of individual firms. This aims to establish a framework to maximise FDI benefits at the local level, through targeted policy and associated interventions, such as localised skill provision. Moreover, we will explore the role of evolving geopolitics in understanding the outside options of regions in FDI attraction, considering the trade-off between employment opportunities and the risks such as technological appropriation by foreign firms.