DEUTSCHE BANK AG Research Briefing
European integration
August 21, 2014
Recent trends in FDI activity in Europe
Regaining lost ground to accelerate growth
Author
Stefan Vetter
+49 69 910--21261 stefan.vetter@db.com
Editor
Barbara Böttcher
Deutsche Bank AG Deutsche Bank Research Frankfurt am Main Germany
E-mail: marketing.dbr@db.com
Fax: +49 69 910-31877 www.dbresearch.com
DB Research Management
Ralf Hoffmann
The European Union has lost its leading position as the world's most important recipient of foreign direct investment (FDI). While the countries of the EU accounted for 50% of global FDI inflows in the early 2000s, the share has fallen to less than 20%. By contrast, the BRIC countries have more than doubled their share in global FDI inflows since 2007. In 2013, China alone received more FDI inflows than all EU countries together.
Although the share of investments coming from non-EU countries is rising, still more than 60% of total inward FDI flows into European countries are intra-EU investments. For the EU as a whole, this means that the majority of recorded
FDI does not constitute genuinely new investment from abroad, but rather a shift of capital between EU member states.
The evolution of FDI activity across the euro area is very uneven. The highest inflows during the previous two years were recorded for Spain and Ireland. While Germany and Italy experienced an increase in FDI activity in 2013, it decreased strongly in France. FDI flows are very volatile and do not instantaneously track changes in business conditions. However, countries such as Italy and Greece are attracting much less foreign investment capital than comparable EU countries over a prolonged period, which is likely to reflect competitiveness deficits as well.
While the contribution of FDI to GDP growth is sometimes overstated, FDI would be particularly valuable for the euro area periphery in the current situation. After all, the majority of domestic companies is financially constrained and has problems to access financing via conventional channels. This means that the availability of capital to make large-scale investment in the economy is scarce.
By international standards the countries in the EU are already very open for foreign investors. Despite some efforts to promote FDI in the EU, a higher attractiveness for investments from abroad can only come from structural improvements of the economic conditions.
A new OECD benchmark definition (BMD4) will make FDI data more transparent in the future. So far, FDI data are sometimes heavily upward biased as they include also purely financial flows. For a few EU countries which are well known as investment locations, such financial flows are more than 10 times higher than genuine investments in some years.
Valuable research assistance by Jan Fritsche and Eva Schmithausen is gratefully acknowledged.
Recent trends in FDI activity in Europe
Foreign Direct Investment: Definition, typology, and motivation
Foreign direct investment (FDI) is defined as a business investment aiming at a long-term relationship, and reflecting a lasting interest and (partial) control by an entity resident in one economy (foreign direct investor or parent enterprise) in an enterprise resident in another economy (FDI enterprise or foreign affiliate). FDI statistics include both the initial investment and all subsequent investment by
the parent enterprise, which can be either in the form of equity capital, reinvested earnings or intra-company loans.
Generally, there are two main types of FDI: a greenfield investment is the establishment of an entirely new firm in a foreign country, including new production facilities. This can also occur in the form of a joint venture with a local company. Alternatively, direct investments can occur via mergers and acquisitions (M&A), the complete or partial purchase of an existing firm in a foreign country. The acquisition of company shares is regarded as FDI as soon as it exceeds 10% (according to the definition used by Eurostat, the OECD and UNCTAD, among others). Thus, FDI does not necessarily imply (full) control of the foreign affiliate. Ownership of less than 10% of a company's shares is considered a portfolio investment.
There are various motives for companies to engage in FDI:1
- Market-seeking: Investing in a host country in order to serve the market directly rather than through exporting ("horizontal" FDI). Determinants for the attractiveness of a host country for market-seeking FDI include market size, expected demand growth, and whether it provides access to both
regional and global markets. For non-tradable services, FDI is often the only way to access a foreign market.
- Resource-seeking: Companies which rely heavily on natural resources such as oil, gas, minerals and other raw materials can gain cheaper and more reliable access to these inputs by establishing or acquiring firms in
resource-rich locations.
- Strategic asset-seeking: Access to advanced technologies, skills and other highly developed productive capabilities can be secured by making investments in locations with a high quality of scientific and technological infrastructure and a high availability of skilled labour.
- Efficiency-seeking: Companies allocate different parts of their production chain to different countries in order to exploit specialisation advantages across the value chain (product specialisation) and along the value chain (process specialisation). Differences in labour costs, the quality of the local industrial infrastructure and the availability of suppliers create potential for
efficiency gains by means of "vertical" FDI.2
In the European context, market access is not necessarily a national question due to the free movement of goods, services, capital and people in the Single Market of the EU. In some industries, entering the trade area of the EU might be sufficient to enter any European market (an investor looking for market access
to France may invest in Spain or Luxembourg if there are labour cost or tax advantages). A possible implication is that competition for FDI within the EU could increase if countries can rely less on the sheer size of their national market.
1 This summary is based on the EU Commission's European Competitiveness Report 2012.
2 Note that also differences in tax rates create (undesirable) incentives for FDI.
2 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
Empirical studies on FDI: In search of growth effects
In theory, FDI brings foreign knowledge and capital, which can lead to technology spillovers, boost aggregate productivity and raise GDP growth. Foreign companies can transfer their technological advantage to the host economy and intensify competition. Additionally, new industries and technologies can be brought to the destination country. However, empirical evidence for positive effects from FDI is remarkably ambiguous.
The fact that many studies fail to identify positive effects of FDI flows on GDP growth can be due to a variety of reasons which include methodological deficiencies, data quality issues, a negative impact on domestic firms, but also the lack of complementary factors (e.g. human capital) in the host economy.3
FDI inflows alone are not sufficient to promote GDP and employment growth. The origin of the investment, the absorptive capacity of the host country, the functioning of financial markets and the general level of development are factors which affect the impact of FDI. In a regression framework, it may thus turn out that the coefficient of FDI is itself insignificant, while interaction terms with
factors such as human capital or financial market development indicate a positive and significant contribution of foreign investments. For example, Borensztein et al. (1998) find that FDI is important for the transfer of technology and contributes more to growth than domestic investment, but that the higher
productivity of FDI requires a sufficient stock of human capital.4 Alfaro et al.
(2004) show that the role of FDI flows is ambiguous but that countries with well- developed financial markets benefit significantly from foreign investments.5
Studies with firm-level data tend to find that domestic companies become more productive when foreign affiliates are present.6 For the UK, Haskel et al. (2007) detect a positive correlation between a local firm's total factor productivity (TFP) and the share of foreign affiliates in that industry.7 Small and less technologically advanced firms seem to benefit more from spillovers than companies at the technological frontier. However, the effect also depends on the country of origin
- even between similarly developed economies. FDI from France and the US enhanced TFP while investments from Germany had no significant effect and FDI from Japan even decreased TFP. For Romania, there is evidence for
country-of-origin differences regarding vertical spillovers to domestic producers.8
These may arise from the fact that the share of inputs sourced locally is likely to increase with geographical distance. Moreover, if inputs coming from outside the EU face (non-)tariff barriers, firms from non-EU countries have a stronger incentive to purchase inputs locally. Thus, the study finds a positive relationship between the presence of US firms and the productivity of domestic firms in the supplying industries, but no significant effect for European affiliates.
A conceptual problem related to FDI is that aggregate data do not take sufficient account of the inherent heterogeneity both between the types of FDI and the types of firms. Not all FDI flows are actually productive investments, and not all firms are equipped to benefit from foreign capital and knowledge. If the number of foreign affiliates and FDI flows in terms of GDP are low, a positive effect on GDP growth can only be identified only in the presence of huge spillovers. In
3 See also Contessi and Weinberger (2009), Foreign Direct Investment, Productivity, and Country
Growth: An Overview, Federal Reserve Bank of St. Louis Review, March/April 2009.
4 Borenstein, De Gregorio and Lee (1998), How does foreign direct investment affect economic growth? Journal of International Economics, Vol. 45, pp. 115-135.
5 Alfaro et al. (2004). FDI and Economic Growth: The Role of Local Financial Markets, Journal of
International Economics 64.
6 See Görg and Greenaway (2004). Much ado about nothing? Do domestic firms really benefit from foreign direct investment? World Bank Research Observer 19.
7 Haskel, Pereira and Slaughter (2007). Does inward foreign direct investment boost the productivity of domestic firms? Journal of Economics and Statistics. Vol. 89, pp. 482-496.
8 Javorcik and Spatareanu (2011). Does it matter where you come from? Vertical Spillovers from
Foreign Direct Investment and the Origin of Investors. Journal of Development Economics, 96 (1).
3 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
addition, the net effect will be small if domestic companies suffer from increased competition. Thus, it is important to look at foreign and domestic companies separately, and especially at firm-level data of different industries. Not surprisingly, when the industrial sector and industry characteristics such as the skill-intensity are taken into account, the growth effects of FDI become larger.9
Finally, aggregate FDI data mix different investment purposes. Some countries attract a disproportionately high share of FDI by means of (tax) incentives for profit shifting and for establishing holdings or nominal headquarters. In these cases, FDI is not associated with productive investments, and although the statistics show large FDI inflows, the growth effect is inevitably close to nil.
Understanding FDI data: When is FDI a productive investment?
FDI inflows to Austria, Hungary,
Luxembourg and the Netherlands 1
USD billion; data for 2013 are preliminary
900
800
700
600
500
400
300
200
100
0
2002 2004 2006 2008 2010 2012
Including SPEs Excluding SPEs
Source: OECD
The new OECD Benchmark Definition for FDI (BMD4), which is going to come into effect in late 2014, will significantly improve the quality of FDI data by providing a better distinction between genuine investments and purely financial flows. According to the OECD, it "will provide better measures of where international investment comes from, where it is going, and, most importantly, where it is creating jobs and value added." The new standard will require countries to report so-called Special Purpose Entities (SPEs) separately. These SPEs are "typically holding companies used to channel capital through countries without generating any significant real economic activity or employment."10
For some countries the new methodology indeed makes a huge difference. The OECD has made a comparison of the total FDI flows with the "real" FDI flows excluding SPEs for a group of four countries (Austria, Hungary, Luxembourg and the Netherlands). In the case of FDI outflows, the "real" investment
amounted on average to only 20% of what was officially classified as FDI. In the case of FDI inflows, the difference is even larger. In some years total FDI was more than ten times larger than genuine investment flows (see Figure 1). While some of these countries represent quite extreme examples, an OECD survey revealed that at least 19 countries recorded a significant bias of their FDI statistics due to substantial SPE flows. BMD4 will also improve the recording of round-tripping and capital in transit through intercompany loans. These loans can transit between sister companies with a common parent but with little or no equity stake in each other. Such treasury centres merely transit funds on behalf of their parents, thereby leading to a substantial overstatement of FDI flows.
Studies using data which include clearly non-productive investments suffer from measurement error problems. Conceptually, if the error is random in the sense that it is unrelated to observable characteristics of the country ("classical" measurement error), the estimated coefficient for the impact of FDI on growth/productivity is downward biased, making it more difficult to discern a significant relationship. This is clearly not the case here, since FDI numbers inflated by purely financial or accounting flows are biased upwards and related to country characteristics such as tax rates. However, data with measurement error create obvious problems for interpreting the results.
To sum up, the empirical evidence points to moderate growth effects from FDI. However, research on FDI is a typical example for a field where better (i.e. more disaggregate) data would be much more valuable than refinements of the empirical methodology. In this respect, the new BMD4 is an important step in
the right direction.
9 Alfaro, Laura and Andrew Carlton (2007). Growth and the Quality of Foreign Direct Investment: Is
All FDI Equal? CEP Discussion Paper.
10 See OECD. FDI in Figures. April 2014.
4 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
FDI flows into and out of Europe: recent trends
FDI flows are very volatile from year to year, but the geographic distribution reflects important global developments, e.g. European integration and the growing importance of South-East Asia. The most recent shifts were the global financial and European debt crisis, which considerably changed the distribution of FDI inflows to the detriment of European countries. In the late 1990s and early 2000s the countries of the EU at times accounted for up to half the global investment inflows, and the EU was thus by far the most important economic area for foreign direct investment. In 2012 and 2013, the EU's share has fallen below 20%, and the volume of USD 239 bn was roughly equal to the US and China. By contrast, the share of the BRIC countries (Brazil, Russia, India and China) reached 29.2% in 2013.
Global FDI inflows: EU is falling behind 2
Share of global FDI inflows
FDI inflows into EU, US and China 3
USD bn, preliminary values for 2013
60%
50%
40%
30%
20%
10%
0%
1995 1998 2001 2004 2007 2010 2013p
900
800
700
600
500
400
300
200
100
0
2004 2006 2008 2010 2012
EU US China BRIC
Source: OECD
EU China United States
Source: OECD
Extra-EU investments becoming
increasingly important 4
50%
45%
40%
35%
30%
25%
2004 2006 2008 2010 2012
Extra-EU share of outward stock
Extra-EU share of inward stock
Source: Eurostat
China was able to steadily increase its share during the previous decade and has been the largest host economy for foreign investments since 2010. With USD 258 bn it attracted around 65 bn more than the US as the second largest FDI recipient. However, China is still below the American record marks of 2000 and 2008, when investment flows into the US exceeded USD 300 bn.
Note that the FDI value for the EU is calculated as the sum of all individual countries' investment inflows. Thus, it includes both intra-EU and extra-EU FDI. In fact, the majority of direct investments in the EU originate from other EU countries, but the share coming from and going to non-EU countries is steadily rising. Between 2004 and 2012 the extra-EU share of the total inward stock increased from 34% to 37%, and from 37% to 42% of the total outward stock.
The dominant European position until the mid-2000s is reflected in sizable FDI stocks. The accumulated investment stock amounts to almost 240% of GDP in Luxembourg, 170% in Ireland and more than 80% in Estonia, Hungary and the Netherlands. Foreign investments play a more important role for the UK, France and Germany than for other industrialised countries (USA, Korea, Japan). FDI stocks are also still higher than in emerging economies (Brazil, Mexico, China, India) although this is bound to change.
In absolute terms the countries with the largest FDI stocks are the US with USD
3.2 trillion, followed by China (USD 2.2 tr) and the UK (USD 1.6 tr). The United Kingdom has been by far the largest beneficiary of foreign investments in Europe but, in line with the European trend, the inflows are steadily declining since the peak of 2007. The uncertainty surrounding the debate about UK
membership in the EU is presumably not helpful to attract investments from non- EU countries at this moment.
5 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
Small open economies attract a high share of FDI 5
FDI inward stock, % of GDP
240%
200%
160%
120%
80%
40%
0%
LU IE CH EE HU NL CZ SE UK PT ES PL AT FR CA BR MX DE CN RU IT US KR IN GR JP
Source: OECD
FDI outward stock in 2013 6
USD bn
6,000
5,000
4,000
3,000
2,000
1,000
0
US UK DE FR CH JP NL CA ES IT IE
Source: OECD
Regarding investments abroad, the US outward stock exceeds that of either the UK, Germany or France by a factor of three. The EU as a whole, however, owns roughly half the total FDI outward stocks of all OECD countries.
2013: FDI rebounding in Spain, but slipping in France
In 2013, the top FDI destinations in the EU were Spain, UK and Ireland, which
all received around 15% of the total EUR 240 bn inflows. Compared to 2012 this corresponds to a large increase for Spain but minor decreases for the UK and Ireland. Large gains compared to the previous year were recorded for Luxem- bourg, Germany, the Netherlands and Italy. A number of countries also attracted significantly less FDI. This is true first and foremost for France, but also for Sweden, Portugal and Hungary. Greece recorded a modest increase from an equally modest base, and a few countries (e.g. Finland, Belgium and Poland) had negative net inflows in 2013.
The 15 largest European FDI recipients in 2013 7
FDI inflows, USD bn
50
45
40
35
30
25
20
15
10
5
0
ES UK IE LU DE NE IT AT SE CZ FR RO PT HU GR
2013 2012
Source: UNCTAD
Among the countries of the euro area periphery, the picture is mixed. With the exception of 2009, Spain has consistently been among the European countries which attracted most foreign investments, although lately clearly below the pre- crisis levels of 2007 and 2008. The recent decline in Portugal was preceded by two years during which FDI reached more than 4% of GDP, which was among the highest relative values in Europe. By contrast, Italy and Greece have not been particularly successful in attracting substantial amounts of investment capital from abroad.
6 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
USA and UK are the most important destinations for FDI from the euro area 8
Average of 2011-2013 outflows; incl. SPEs
The breakdown of FDI originating in the euro area reveals that the US was by far the most important destination for investments made by companies between
2011 and 2013, accounting for 30% of total outflows.11 The UK held the second
position with a share of 18%, followed by Brazil and Switzerland. With a share of only 3% of total outflows China played a relatively minor role during this period.
Regarding FDI inflows, the dominance of the US is even larger. Between 2011
31%
3%
3%
30%
18%
and 2013, 58% of foreign investment capital came from the United States. Switzerland is a very distant second with a share of 7%. In both cases, the group "others" includes so-called offshore financial centres, which the ECB classifies separately. They account for a substantial proportion of total extra-EU
3%
5% 7%
investment flows (8% of outflows and 9% of inflows during 2011-2013) and can
occasionally reach 20% in some years.
Source: ECB
US UK BR CH CN CA RU other
FDI by industry: services dominate but manufacturing remains important
More than half of FDI inflows into the
euro area come from the US 9
Average of 2011-2013 inflows; incl. SPEs
23%
3%
The impact of FDI on the host economy differs across (sub-)sectors. For example, in skill-intensive industries where technological advantages play an important role, the scope for technology transfers is much higher than in low- tech sectors. Moreover, in sectors which require many intermediate inputs (e.g. automotives) the entry of foreign firms increases demand for products of local suppliers more than industries in which locally produced inputs play a minor role (e.g. real estate or financial services).
4%
5%
7%
Source: ECB
58%
US CH UK BR SE other
Most investments by foreign firms either flow into manufacturing, financial intermediation, or other (i.e. non-financial) services. These three sectors account for between roughly 75% (Spain, UK) and almost 100% (Luxembourg,
Ireland, Germany, France) of total FDI inflows. The primary sector, consisting of mining and quarrying, as well as agriculture, is of minor importance in most European countries.12
The Netherlands and Sweden are the countries where the manufacturing sector has the highest FDI share (more than 40%). Luxembourg, Ireland, Spain and
the United Kingdom attract predominantly investments in the financial intermediation industry. In Germany and France, non-financial services are the most important sector and account for 80% of the total FDI stock.
FDI stocks by industry 10
2012 or 2011(*), in descending order of manufacturing share;
Non-financial services are defined as the difference between total services and financial intermediation
100%
80%
60%
40%
20%
0%
NL SE LU GR* CZ PL IT ES* IE DK HU UK BE DE* FR Manufacturing Non-financial services Financial intermediation
Source: OECD
11 We consider three-year averages in order to reduce the high annual volatility of investment flows.
12 Note that the primary sectors attracts a much larger share of FDI in countries which are either less developed or particularly rich in natural resources. In Australia, for example, mining and quarrying accounted for 68% of the country's FDI inflows in 2011 and 2012, and in Chile for even
80%.
7 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
Income and returns from extra-EU FDI
The investments abroad make a substantial contribution to domestic income in the EU. The income from FDI accrues in the form of dividends, reinvested earnings or interests on loans between affiliated enterprises. The years 2010-
2012 saw historically high earnings from FDI, which provided a much welcome relief at the height of the economic crisis. In 2012 the income from FDI was marginally lower than in the previous year but remained above EUR 300 bn. In return, investments from non-EU countries in the EU generated an income of EUR 170 bn in 2012, which was also slightly lower than the record EUR 178 bn in 2011. As in the previous years, the euro area received 70% of the total income derived from extra-EU FDI. Concerning income paid to extra-EU countries, the Euro area's share was 77% in both 2011 and 2012.
The rate of return on extra-EU FDI stocks, calculated as the FDI income in year t divided by the stock in t-1, went down from 8% to 6.8%. The return on inward FDI stocks amounted to 4.5% in 2012, roughly 1 percentage point lower than in
2010 and 2011. In terms of profitability, extra-EU investments are below pre- crisis levels when rates of return on FDI stocks reached 10% for outward FDI and 7% for inward FDI.
FDI income and rates of return in the EU 11
FDI income flows, EUR million
400,000
300,000
200,000
100,000
0
2006 2007 2008 2009 2010 2011 2012
12%
9%
6%
3%
0%
EU27, Income from extra-EU FDI EU27, Income paid to extra-EU
Rate of return on outward FDI stocks Rate of return on inward FDI stocks
Source: Eurostat
Investment policies for Europe: few FDI
restrictions but competitiveness deficits
Despite the sometimes overstated importance of FDI for growth, Europe would undoubtedly benefit from regaining attractiveness as investment location. What matters for direct investors is a combination of uncomplicated and inexpensive access, an attractive local market, and the possibility of exploiting a technology or cost advantage via a foreign affiliate. Regarding restrictions for foreign investors, the EU countries have already eliminated most barriers and discriminatory measures, and facilitate investments from abroad more than most other countries. The OECD's FDI Regulatory Restrictiveness Index (RRI) assesses the openness to FDI by considering four types of measures: (i) equity restrictions, (ii) screening and approval requirements, (iii) restrictions on foreign key personnel, (iv) other operational restrictions (e.g. limits on land purchase or
on repatriation of profits or capital).13
13 In this context, what matters is whether there are discriminatory measures against foreign investors or specific rules which are harder to meet for them than for domestic investors. The enforcement of discriminatory rules is not taken into account. For a detailed explanation see Kalinova et al. (2010). OECD's FDI Restrictiveness Index: 2010 Update. OECD Working Paper.
8 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
According to the RRI, there are very few remaining barriers to entry for foreign capital in Europe, while significant restrictions exist in developing countries such as China, Indonesia or India. Australia, Korea or the United States also have more regulations concerning FDI than most EU countries. However, since other factors such as the size of the market or the skills and wages of local workers are often more important than regulatory FDI obstacles, the correlation between the RRI and the stock of FDI is quite low. In addition, the RRI measures only formal restrictions but cannot take into account factors such as the degree of enforcement and the rule of law. For example, while Argentina has a good RRI score, the nationalisation of the Argentinean branch of the Spanish energy company Repsol and the lengthy settlement of the issue have harmed the country's reputation as investment location.
Few restrictions for foreign investors in European countries 12
2013 FDI Regulatory Restrictiveness Indicator; 0 = no restrictions for foreign investors
0.50
0.40
0.30
0.20
0.10
0.00
Italy attracts far less FDI than other
large EU countries 13
Source: OECD
Inward FDI stocks, % of GDP
70%
60%
50%
40%
30%
20%
10%
0%
2001 2003 2005 2007 2009 2011 2013
FR DE IT UK ES
Source: OECD
Smaller countries attract more FDI,
except for Greece 14
Inward FDI stocks, % of GDP
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2001 2003 2005 2007 2009 2011 2013
CZ EE GR HU PT SI
Due to the already high degree of openness there is virtually no scope for the EU to increase FDI by removing discriminatory regulation. Thus, Europe must find other ways to revive interest of foreign companies. Having access to the internal market of the EU remains a significant advantage for non-EU firms and it is not surprising that in the discussion about a possible EU exit of the United Kingdom especially foreign producers have expressed very critical views.
It would be wrong to view the large decline of FDI flows into EU countries since
2007 as a purely cyclical (or crisis-related) phenomenon. After all, the large decline in FDI flows into EU countries is not observed for the United States, despite the financial crisis. The share of the United States has remained quite stable around 15% for more than a decade. In addition, some EU members have not been able to attract substantial FDI flows even before the crisis.
As large countries typically have a lower FDI position in terms of GDP than small countries, it is instructive to consider larger and smaller countries separately. The evolution of the FDI inward stocks in the five largest EU countries shows that Italy always had a much lower FDI stock than Spain or the UK (Chart 13). Germany and France are in the middle. When looking instead at smaller countries with a similar level of per-capita GDP, most of them have total FDI stocks in excess of 50% of GDP (Chart 14). The exception is Greece (11.5%) where FDI inward stocks in percent of GDP amount to only one third of Slovenia's, which is the second weakest performer among the smaller EU members. However, Slovenia managed to double the investment stock in the course of the last 10 years, whereas it stayed effectively flat in Greece.
In their respective peer groups both Italy and Greece are among those with the highest unit labour costs and at the same time with the poorest valuations in the World Bank's "Doing Business" report or the competitiveness ranking compiled by the World Economic Forum. This is an indication that the low inflow of investments may be linked to structural competitiveness deficits. In such a case,
Source: OECD
9 | August 21, 2014 Research Briefing
Recent trends in FDI activity in Europe
there is no justification for specific policies aimed at attracting foreign firms. What is rather needed is a better business climate and structural economic reforms, which would benefit domestic companies alike. Improvements in competitiveness might also help the euro area periphery to raise the proceeds from privatizations of (partially) state-owned enterprises. Especially Greece has generated far less revenues from privatisations than initially hoped and agreed on with the Troika, not least because of the limited interest of potential foreign investors.
Outlook
The European Union has lost its dominant position as the main recipient of global FDI flows and, despite a small rebound in 2013, will probably not be able to regain it. However, the growing economic importance of China and other emerging market economies also creates opportunities for the EU to attract investments from those countries. Especially Chinese firms are increasingly pursuing the strategy of acquiring controlling stakes in selected European firms. While Greenfield investments are increasing, they are still rare. However, the acquisition of stakes in existing companies by foreign firms can also have some negative effects, for example due to the geographical restructuring of assets
and the relocation of higher-value headquarter functions to the home country of the investor. Thus, attracting more Greenfield investments would be desirable
as they represent a genuine addition to the investment stock of the host country.
Some of the euro area countries which were heaviest hit by the sovereign debt crisis in Europe have received far less FDI than comparable EU countries in the past. Thus, a rebalanced and structurally reformed economy could also yield the prospect of attracting more foreign capital in the future. In light of the empirical evidence, which suggests that complementary factors such as human capital
and well-developed financial markets are important prerequisites for a positive growth contribution from FDI, the European countries would actually be well positioned to reap substantial benefits from foreign direct investments.
Especially in the current situation, the positive effect of FDI on domestic growth may even be larger than in "normal" times. A substantial share of companies in the euro area periphery is financially constrained and with insufficient access to financing. As a consequence, most of these companies are unable to make substantial business investments and create jobs, at least for the time being. As foreign direct investors are not only generally larger but also less dependent on local financing conditions, they should encounter less problems regarding access to finance. Ongoing improvements in competitiveness might ultimately help the euro area periphery to generate more growth also via attracting investments from abroad.
Stefan Vetter (+49 69 910-21261, stefan.vetter@db.com)
10 | August 21, 2014 Research Briefing
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