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12 April 2016updated 09 Sep 2021 1:11pm

The Brexit Conundrum

Uncertainty around Brexit will damage overseas investment into the UK, says Dr Maurizio Zanardi, Lancaster University Management School

By Maurizio Zanardi

The UK is currently the number-one receiver of foreign direct investment (FDI) in the European Union – it’s a major asset to our economy. We are also the undisputed leader in Europe when it comes to the value of FDI projects (UKTI inward investment report, 2014/2015). Foreign investors are keen on the UK because it is a member of the EU.

Countries such as the United States, the number-one UK investor, see us as a platform from which to reach the rest of the EU, which is our largest trading partner. The rules of the single market allow them to operate from the UK without facing any sort of barrier.

While pundits of every hue are happy to chorus on the impact of Brexit or its avoidance, it is very difficult to forecast what the impact would be on overseas investment into the UK. In this case, we don’t know the terms of the potential departure because we don’t know what agreement we’ll have with the EU if we leave. And we don’t know how long the UK and EU would take to finalise any deal. What we do know is that firms do not like uncertainty and that continuing investor uncertainty during the negotiations will drive investment away.

We don’t yet have the FDI data for recent months, but some commentators are already claiming that the uncertainty of the Europe referendum will have a negative effect even until June 2016, as foreign investors postpone any new FDI until the outcome of the 23 June referendum is known.

Uncertainty over Brexit can have negative effects on FDI decisions on multiple grounds.

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Being part of the single market means free movement not only of goods, but also of services, capital and labour.

To me, as a foreigner living in the UK, movement of labour appears to be one of the greatest issues over which British citizens wish to gain some sovereignty. If the UK regains this control through leaving the EU, it’s true that it will succeed in removing itself from any decision-making in Brussels regarding migration issues.

However, the UK will most likely want to enjoy the benefits of the single market for goods and services. This  will definitely require payments to the budget of the EU, as is the case for non-member countries such as Norway and Switzerland.

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It is unlikely that the EU will agree on a deal for a single market that does not also allow for free movement of people, so it is not clear how the UK could gain sovereignty over this domain through a Brexit.

Staying outside the single market would create huge difficulties for in­ternational trade, especially where recent globalisation movements have led to segmenting of the production process across countries (and hence an increase in the extent of trade in parts for assembling). In the absence of a trade agreement, it would also mean that all products (cars, for instance) manufactured in the UK would have duties imposed when exported to France and Germany, for example. Some firms are likely to move their FDI from the UK to continental Europe in order to jump trade, and any other, barriers.

How a Brexit will affect the City of London is the million-euro question. It is likely that there are major cities in Europe that will want to capitalise on this, but again, that will depend on the deal that is made.

There is bound to be some movement away from London. Financial institutions have considered relocation. For example, HSBC has recently decided not to move its headquarters from the UK to Asia, but that doesn’t mean that HSBC and others will decide to remain in the UK for ever.

Inward FDI brings employment ­opportunities, technological spillovers, higher productivity and therefore a big booster for GDP growth. Multinational firms are among the most productive and innovative, and that’s why any country tries to encourage inward FDI. We know that when foreign firms come to any country they bring with them their managerial know-how and technical knowledge, which spills over to benefit domestic firms. Multinational firms also pay higher wages than domestic firms, and that is why this has an impact on workers in the UK. It’s not only a financial transaction. Multinationals are also looking for the right skills from their workers.

Some politicians have stated that regaining sovereignty over movement could allow the UK to welcome more migration from skilled workers from outside the EU. This may be a great asset to multinationals; however, firms will also calculate the costs of more difficult movement within the EU.

While the UK is perceived as a riskier place to invest (until June, or afterwards in the case of Brexit), other countries in the EU are likely to benefit. Germany is an obvious example, because of its size and industrial structure, but Ireland also stands to gain. It already receives a lot of FDI from the US because of cultural affinities and language.

Ireland’s legal system also has more similarities to that of the UK than, say,  Germany’s. In this sense, it is seen as similar in many ways, and it is an obvious alternative destination for firms wishing to relocate their UK FDI. It has the potential to replace the UK as the export platform from which to reach the rest of the EU.

Uncertainty is the keyword when discussing the effect of the referendum on inward foreign direct investment. Part of the reason that this uncertainty prevails is that nothing like this has happened in the same way before; there is no direct precedent. The closest comparison was at the peak of the crisis of the euro in relation to Greece and its possible exit from the eurozone, but this was an economic rather than a political decision. The same uncertainty did apply to the Scottish independence referendum, as there was indecision around many issues in the instance of Scottish voters choosing to leave the UK.

In the same way as Scotland staying in the UK, we know what will happen if we stay in the EU. It will not be business as usual because David Cameron has negotiated some changes, which are not merely nominal. But we have no idea about what is ahead of us if we vote to leave. The consequences of continuing uncertainty will be significant for the UK and the EU, and will have global repercussions.

That the world economy is not performing at its best – considering the slowdown of the Chinese economy in particular – only adds to this fragility.

If it does make a Brexit, the UK needs to strike a good deal with the EU, but I suspect it will turn into a very nasty divorce. It’s hard to see how this will be arranged on amicable terms.

So far, the damaging effects of uncertainty on overseas investment into the UK are the only element about which we can remain certain. Brexit is a risk for everyone.