7. Investment
Section contents
- UK is a ‘low investment nation’ relative to its OECD peers (pre- and post-Brexit)
- Business investment is estimated to be 10% lower than without Brexit (reducing GDP by about £29 billion)
- If UK GFCF matched OECD average as % of GDP, it would be investing about £30 billion a year more
- UK business investment has only recently exceeded pre-pandemic levels
- FDI plays an important role in UK economy
- In 2023, global FDI flows declined for second year running
- UK ranked 4th globally for FDI inward stock (behind US, EU, China)
- UK’s stock of FDI comes mainly from its top trading partners – EU (34%), US (34%) and rest of Europe (14%)
- Top three UK sectors for FDI are financial services (29.8% of total), manufacturing (15.2%), and professional services (13.9%)
- Freeports provide limited economic benefits
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Gross fixed capital formation
Gross fixed capital formation (GFCF) is the investment part of the expenditure model of GDP described under ‘Why trade matters’ in the section on economic context. GFCF is an estimate of net capital expenditure by both public and private sectors.
Examples include spending on plant and machinery, transport equipment, software, new dwellings and other buildings, and major improvements to existing buildings and structures, such as roads. In 2018, the stock of GFCF accounted for £397 billion in 2019 prices (18% of GDP), including business investment of £224 billion (10% of GDP).
Investment is a key driver of future prosperity. It is important for the demand side of the economy, but it also affects the supply side, because of the link between investment and productivity growth. Hence, as the Bank of England notes, investment affects the balance between demand and supply, which has an impact on inflation. Economic models typically assume that a 3% increase in capital formation leads roughly to a 1% increase in GDP. So, if GFCF or business investment remain subdued for a long time, the cumulative long-term effects on the economy are substantial and would take a long time to reverse.
Business investment is a short-term indicator of net capital expenditure by businesses. Both GFCF and business investment are domestic measures. Investment by foreign companies in the UK and overseas investments by domestic companies are covered separately as foreign direct investment (FDI) – see below.
The UK’s stock of GFCF has been running at just under 20% of GDP for several years. The Resolution Foundation points out that the UK has become “a low investment nation” compared to other developed economies, and has consistently been in the bottom 10% of OECD countries by investment levels. On an internationally comparable basis, UK general government GFCF has averaged just over 2.5% of GDP since 2000. The OECD average is 3.7%. Had the UK been investing at the OECD average, it would have invested around £500 billion more since 2000 (in 2022 prices). The difference of 1.2% of GDP is currently equivalent to about £30 billion of GFCF.
The UK’s decision to leave the EU and Covid have had a large impact on new investment; see Figure 7.1. The trend from 2007 has been as follows:
- The global financial crisis of 2007-8 and the recession that followed caused a severe drop in both GFCF and business investment.
- Business investment then recovered steadily until 2016 (at an average growth rate of about 6% a year), growing faster than GFCF.
- After the referendum until the pandemic, business investment growth weakened and was flat 2016 to 2019 (but remained above GFCF growth).
- During the pandemic, UK business investment and GFCF dipped sharply.
- Both then rebounded, but business investment lagged GFCF growth until late 2023 and early 2024.
Brexit impact
Estimates of the GDP impact of reduced investment due to Brexit vary. A paper from the Economics Observatory looked at the issue from a variety of angles and suggests that in 2022, business investment was 10% lower than it would have been without Brexit. This implies a loss of 1.3% in annual GDP of around £29 billion.
This is consistent with Figure 7.1, which shows that, although GFCF and business investment, have renewed their growth paths after the pandemic, their trend post-TCA has shifted down from their trend pre-TCA.
Figure 7.1: Gross fixed capital formation and business investment 1997 – 2024
Sources:
ONS, Quarterly National Accounts, Quarter 1 2024
ONS, Business investment in the UK: January to March 2024 revised results, 28 June 2024
Bank of England, Influences on investment by UK businesses: evidence from the Decision Maker Panel, 25 June 2021
Resolution Foundation, Cutting the cuts – How the public sector can play its part in ending the UK’s low-investment rut, Felicia Odamtten and James Smith, March 2023
Economic Observatory, How has Brexit affected business investment in the UK? Jonathan Haskel and Josh Martin, 13 March 2023
Foreign direct investment
What does FDI mean?
Foreign direct investment (FDI) is defined as investment in an enterprise operating in a foreign economy, where the purpose is to have an ‘effective voice’ in the management of the enterprise. In FDI statistics, an ‘effective voice’ means owning 10% or more of a company; any investment below this is counted as a ‘portfolio’ investment and excluded from FDI statistics.
FDI can be inward or outward. Inward FDI is investment from a foreign country into the UK. Outward FDI is investment from the UK into a foreign country.
FDI covers a range of company investments, such as:
- establishing a branch or subsidiary in a foreign country, injecting start-up capital – a ‘greenfield’ investment;
- buying or selling (fully or partially) the equity of an existing foreign company – M&A activity; or,
- putting additional capital into an existing foreign subsidiary or allowing it to retain profits rather than returning them to the parent.
FDI statistics measure stocks and flows.
- Stock of FDI is the net book value of foreign investment (it is not the cumulative sum of annual FDI flows). Stock is subject to changes in valuation in company accounts and exchange rate fluctuations, which means the value of FDI stock can change without new flows.
- Flow of FDI is the amount invested in a given period, usually one year. Annual flows can be volatile, for example, reflecting exceptional one-off M&A activity rather than significant ‘greenfield’ investments.
If you would like to know more about FDI, please see the House of Commons Library Report of 2023 on FDI statistics, the annual UNCTAD World Investment Report (2024) or the OECD’s reports on FDI.
Recent global trends
In 2023, global FDI flows declined for the second year running. Global FDI flows dropped by 7%, to USD 1,364 billion*, remaining below pre-pandemic levels for the second year in a row both in absolute terms and as a percentage of GDP (see Figure 7.2). In the same year, FDI inflows decreased in more than two-thirds of OECD economies, with significant drops in other economies also playing a role.
The balance between inward and outward FDI, including investment income, can have important implications for the exchange rate, but these are not addressed here.
Figure 7.2: Global FDI flows 2013 – 2023
United Nations Conference on Trade and Development (UNCTAD) reported the key themes for 2023 over 2022 and the outlook for 2024 (see Figure 7.3: FDI by type of project, and Figure 7.4: Trend in FDI by income group and region):
“Global foreign direct investment (FDI) in 2023 decreased marginally, by 2 per cent, to $1.3 trillion*. This headline figure was affected by wild swings in financial flows through a small number of European conduit economies; excluding the effect of these conduits, global FDI flows were more than 10 per cent lower than in 2022.
The global environment for international investment remains challenging in 2024. Weakening growth prospects, economic fracturing trends, trade and geopolitical tensions, industrial policies and supply chain diversification are reshaping FDI patterns, causing some multinational enterprises (MNEs) to adopt a cautious approach to overseas expansion.
International project finance and cross-border mergers and acquisitions (M&As) were especially weak in 2023. M&As, which mostly affect FDI in developed countries, fell by 46 per cent in value. Project finance, important for infrastructure investment, was down 26 per cent. Tighter financing conditions, investor uncertainty, volatility in financial markets and – for M&As – tighter regulatory scrutiny were the principal causes of the decline.
Greenfield investment project announcements provided a bright spot. Project numbers increased by 2 per cent, with the growth concentrated in manufacturing, interrupting a decade-long trend of gradual decline in the sector. Furthermore, growth was concentrated in developing countries, where the number of projects was up by 15 per cent. In developed countries new project announcements were down 6 per cent.”
*Note – there can sometimes be differences between the figures that UNCTAD and OECD choose to use for FDI because global reporting of FDI inflows does not always equal FDI outflows (although they should be the same).
Sources:
OECD, Investment, accessed 30 July 2024
UNCTAD, World Investment Report, July 2024
Figure 7.3: Global trend in types of FDI 2022 to 2023
Figure 7.4: Trend in FDI by income groups and regions 2022 to 2023
Global rankings – inward FDI stock
FDI plays an important role in the UK economy, which has been an attractive destination for foreign investors. In 2023, the UK ranked fourth globally in terms of FDI stock, behind the US, EU and China, and just ahead of the Netherlands (see Figure 7.5). Inward FDI stock as a percentage of GDP, was 92% for the UK compared to 65% for the EU (the data excludes Special Purpose Entities – SPEs).
We focus on inward FDI as an indicator of the UK’s relative attractiveness as a destination for foreign investment. As an EU member and ‘gateway to Europe’, the UK had previously benefited from strong inflows of foreign investment, particularly in the 1980s.
Figure 7.5: Global rankings for inward FDI stock (2023)
Source: OECD, FDI in Figures, April 2024
Global rankings – FDI inflows
In 2023, the US, China, Singapore and Hong Kong continued to dominate global inflows as they had in 2022 (Figure 7.6).
The UK ranked outside the top 20 in 2023. This was because the UK had a net negative inflow in 2023 of USD 89 billion. However, the UK performed relatively well in terms of numbers of greenfield projects announced and international project finance deals. The UK had inflows of USD 53 billion for cross-border mergers and acquisitions and USD 65 billion for greenfield projects. The negative flows that outweighed these positive flows could include:
- disinvestment in assets – that is, the direct investor sells its interest in a direct investment enterprise;
- the parent borrowed money from its affiliate or if the affiliate paid off a loan from its direct investor; and,
- negative reinvested earnings because the affiliate loses money or if the dividends paid out to the direct investor are greater than the income recorded in the period.
Figure 7.6: Global rankings for FDI inflows 2023 and 2022
Sources:
UNCTAD, World Investment Report, 2024
OECD, FDI in Figures, April 2024
UK FDI stock
The UK’s stock of FDI of £2,002 billion in 2021 came mainly from the UK’s top trading partners – the EU (34% of total) and the US (34%). (As at July 2024, 2021 figures are the latest provided by ONS and the House of Commons Library). However, the ONS had also changed their methodology for collecting FDI statistics from 2020 onwards and advise caution in comparing FDI data pre and post 2020.
For 2021 (see Figure 7.7 from ONS data):
- EU was the UK’s slightly larger source at £685 billion, followed by the US with £676 billion.
- Within the EU, the main sources of investment for the UK were Netherlands (£218 billion, 11%), Luxembourg (£121 billion, 6%), and France (£101 billion, 5%).
- Non-EU Europe accounted for £286 billion (14%).
The corresponding changes in 2021 over 2020 were: EU(-£20 billion), US (+£90 billion), non-EU (+£37 billion). ONS notes that the main increases from the US related to professional, scientific and technical services.
The trend between 2018 and 2021 has been for EU investment to increase up to 2020 and then drop (an overall increase of £68 billion, 11%). Investment increases were much greater from the US (up by £241 billion, 55%) and non-EU Europe (up by £77 billion, 37%).
Figure 7.7: UK inward FDI positions by partner region, 2018 to 2021
Source: ONS, Inward foreign direct investment (FDI) involving UK companies: 2021 (Directional principle), January 2023
UK inward FDI stock by sector
Financial services was the sector with the highest net book value of FDI (see Figure 7.8 which shows the main sectors receiving FDI). In 2021, this sector accounted for 29.8% of total FDI stock. Like many sectors, it benefited from UK membership of the EU single market. Manufacturing came second with 15.2%. A further 13.9% was accounted for by professional services, 8.5% by retail and wholesale services and 6.8% by information and communication services.
The US was the biggest foreign investor in UK financial services (12.2%) and professional, scientific and technical services (4.8%). However the EU and the rest of Europe were the bigger investors in manufacturing (8.3%) and the other main sectors shown. There was a large chunk of smaller sectors or ‘other’ whose FDI was also mainly attributed to the EU (14.8%).
Figure 7.8: UK inward FDI stock by sector
Source: ONS, Inward foreign direct investment (FDI) involving UK companies: 2021 (Directional principle), January 2023
Brexit impact on FDI
The 2021 value of UK inward FDI flows relative to GDP experienced the fifth successive year of decline since 2016 – see Figure 7.9. Note that 2016 was a record year for inflows due to a few high-value mergers and acquisitions.
Brexit and the associated uncertainty have delayed investment decisions and reduced annual domestic business investment. The same applies to FDI. However, in 2021, the fall in FDI was in part as a result of the coronavirus pandemic and global recession with their associated disruptions to investment activity.
Figure 7.9: Trend in net FDI inflows to the UK 2012 – 2021
Source: House of Commons Library, Foreign Direct Investment Statistics, June 2023
Freeports
Introduction
Special economic zones such as freeports and enterprise zones are often used to attract investment, both domestic and foreign. This section looks at:
- Freeports
- UK Enterprise Zones (introduced in 2011)
- UK Investment Zones (introduced in 2023)
- EU rules
- Post-Brexit considerations
The section is based mainly on papers by the UK Trade Policy Observatory. Also, in April 2024, the House of Commons Business and Trade Committee published the findings of its inquiry into the performance of English Freeports and investment zones.
Freeports
A freeport is a type of free zone, which is subject to special regulatory requirements, tax breaks and government support. A freeport aims to encourage businesses that import, process and then re-export goods, whereas an enterprise zone aims at general business support or regeneration objectives (such as ‘levelling up’). Freeports can range from secure warehouses to sites where added-value manufacturing occurs before goods are re-exported.
The 2019 Conservative manifesto committed to set up ten freeports around the UK. This followed a 2016 paper from the Centre for Policy Studies by Rishi Sunak. The government published a consultation paper on freeports in February 2020: ‘Boosting Trade, Jobs and Investment Across the UK’. After publishing its response to the consultation in October 2020, the government then invited bids for the ten freeports.
There are currently 13 UK Freeports (see Figure 7.10), with eight in England.
Previously, there were freeports (designated airports or seaports) in the UK until 2012, when the government allowed the UK laws that set them up to expire. The UK had seven freeports between 1984 and 2012, including Liverpool, Southampton, the Port of Tilbury and Glasgow Prestwick Airport. Within the EU, there are around 80 free zones. However, EU freeports are more limited in their powers than other freeports around the world.
Freeports are places where normal tax and customs rules do not apply. At a Freeport, imports can enter with simplified customs documentation and without paying tariffs. Businesses operating inside and around the port can manufacture goods using the imports and add value, before exporting again without full tariffs or procedures. However, if the goods move out of the Freeport into another part of the country or as exports, they must go through the full import process and pay tariffs. Note that Freeports may simplify some trade in goods but do little for services.
Businesses operating in Freeports can therefore benefit from:
- Simplified customs procedures;
- Relief on customs duties relating to transhipment, handling and processing of goods destined for re-export;
- Cash-flow benefits of duty deferral until goods are released to the domestic economy (or used within the free zone);
- Added security from the perimeter fence enclosing the free zone;
- Tariff inversion: some finished goods incur lower tariffs than intermediate goods; this means that goods can be imported to free zone tariff-free, processed and sold as a final product incurring lower tariff rates.
However, the benefits of the UK Freeport model are limited. As the UKTPO paper states, the Business and Trade Committee found in April 2024:
- Customs benefits available to Freeports are limited. As UK tariffs are very low, the customs benefits derived from being within the Freeport, would not be very high. Moreover, if Freeports did benefit UK competitiveness, trading partners would be entitled to invoke “duty drawback” provisions in FTAs (including the TCA) to deny preferences to the UK or to use anti-subsidy countervailing duties.
- Some tax benefits at Freeport sites may contribute towards attracting employers and creating new jobs. Government estimates suggest Freeports have created 5,600 jobs in England since their creation. However, evidence received suggests that around two-thirds of these jobs may not be incremental, but jobs that would have been created regardless, or displaced from elsewhere.
- Concerns about governance and transparency. While all English Freeports are governed through partnership boards incorporating both the public and private sectors, the level of business involvement and degree of control by local government varies. The well-documented allegations of financial mismanagement linked to the Teesside Freeport highlight the risks posed by complex governance and weak accountability.
UKTPO also observes that the dual purpose of the current UK Freeport model creates confusion because it aims to both boost international trade and operate as a traditional Special Economic Zone.
Figure 7.10: Location of UK Freeports
UK Enterprise Zones
- Business-rate discounts (up to £275,000 per business over five years);
- Tax breaks for new plant or machinery;
- Location-specific amenities (such as rail links, ports, high-speed broadband);
- Simplified planning process.
There are 61 enterprise areas across the UK: 48 in England, eight in Wales, four in Scotland and one in Northern Ireland.
The experience of UK Enterprise Zones in the 1980s found:
- Success in dealing with dereliction and considerable environmental improvement (e.g. Isle of Dogs).
- Often created in areas that only offered a limited chance of long-term success (for example, in areas with poor transport connectivity or with limited access to large, skilled labour markets, suppliers, customers).
- Inner city zones were more successful at creating new jobs than those outside urban centres and in remote areas.
- Simplified planning processes were not delivered in practice.
- Rather than creating additional jobs, economic activity was displaced:
- Up to 41% of the 58,000 jobs created in the enterprise zones of the 1980s were relocated from elsewhere in the UK.
- The zones were expensive:
- Public sector cost per additional job created in a zone was £17,000 per job in 1994-95 prices.
- Business rates relief and enhanced capital allowances were the main attractions for businesses.
- In practice, business rates relief often led to higher rents, which benefited landlords. Occupiers gained only around 10-55% in urban zones, 30-50% in accessible zones, and between -25 to +45% in remote zones.
UK Investment Zones
Introduced in 2023, there are 13 UK Investment Zones. It is too early to say whether they will be effective, but it’s clearly confusing for businesses and local authorities to have three types of special economic zone with overlapping goals.
EU rules
Medium-sized enterprises are entitled to aid of 10% of the total investment (in addition to any regional aid they have already received), while small companies are entitled to 20% more.
EU state aid rules constrain the options for free zone and enterprise zone operations, but exemptions may be granted if the zone benefits the economic and social development of underdeveloped EU regions:
- Areas where the standard of living is abnormally low or where there is serious underemployment, and of the regions.
- Where aid does not affect trading conditions contrary to the common interest.
Many EU free zones and enterprise zones are in the ‘new’ EU Member States in Central and Eastern Europe. They set up special economic zones in the mid-1990s to attract FDI offering incentive schemes such as tax holidays, reduced corporate income tax rates or customs duty exemptions / deferrals. However, in the run-up to EU accession, these countries had to revise their schemes to align with EU state aid rules.
EU rules mean it’s more difficult for EU businesses to engage in “tariff inversion”.
Brexit impact
Based on the evidence to date, the post-Brexit impact of Freeports is likely to be positive but immaterial:
- Studies show that the net benefit of free zones is limited.
- Confirmed by the Business and Trade Committee’s inquiry in April 2024.
- For US Foreign-Trade Zones, there is little evidence of how many new jobs are net new job creations. The main purpose of the US Zones appears to be to supply the domestic market without having to pay high tariffs on imported inputs.
- When tariffs are low, the benefits of freeports are small.
- UK Global Tariff rates mean that there are not any major differences between the rates for component goods and the final products. This means the benefits from tariff inversion will be small.
- Freeports defer but do not remove duty payments and import VAT, which gives a small gain to cash-flow.
- There may be some potential benefits from simplified customs procedures.