Why foreign investment is good news for Scotland

With increasing globa-lisation, foreign direct investment continues to account for large flows of investment throughout the world. FDI is where multinational corporations invest with lasting interest in an enterprise outwith their home country.

Through Locate in Scotland, Scotland has established an international reputation in electronics, generated by the large concentration of foreign-owned plants such as IBM, Motorola, NEC, JVC and OKI. They account for almost four-fifths of the output in this Scottish sector, making up 21% of employment (72,000 employees), 38% of gross output and 40% of investment in Scottish manufacturing.

However, the degree of government financial support to FDI is controversial. Would the money not be better spent supporting local talent, Scottish-owned firms and indigenous development? Large foreign-owned plants import most of their intermediate production and, apart from exploiting the existence of a pool of skilled Scottish labour, is there any real impact on the Scottish economy?

Recent work at the Fraser of Allander Institute has measured the aggregate impact of FDI investment in Scotland, focusing specifically on the employment impacts of large electronics plants.

The contribution of such plants to the local economy varies markedly, depending on both the plant characteristics and their interaction with the economy. The pattern of a plant's local spending is the key. Where a plant has many local purchases and pays high wages, it will generate significant local demand and its local knock- on impacts will be large.

The claim made against such plants is that these knock-on effects are limited because they typically purchase a low proportion of their inputs locally. But our evidence suggests this is not the case.

Our analysis concentrates on "developmental" plants that have a relatively high degree of autonomy over decisions such as investment, recruitment and negotiation of government and agency support.

Such foreign-owned plants produce over 50% of the output in Scottish electronics, undermining the view that Scottish FDI plants are heavily dependent on decisions taken elsewhere. These plants are large, high-wage, capital-and-import-intensive, especially compared to the UK-owned plants in the same sector. While their links with Scottish-owned manufacturing sectors are very weak, they do make significant purchases from local services, transport, construction and public utilities.

The scale of their purchases per employee, plus high wages, means their knock-on employment effects are large. We estimate that by the end of 10 years, 100 FDI developmental electronics jobs will be creating an additional 259 jobs in the Scottish economy - and the relative scale of these knock-on employment effects is large compared to most other sectors.

However, these additional jobs are almost all in the non- manufacturing construction, transport and service sectors: the demand effects from FDI are of almost no consequence to the domestically owned manufacturing sector.

One argument for supporting FDI is the productivity improvements in other Scottish plants, with effective management practices and technological know-how filtering through.

Recent statistical work by the UK National Institute for Economic and Social Research has attempted to quantify these efficiency transfers and we have used their results to calculate the subsequent impact on Scottish employment and GDP. The efficiency gains lead to a fall in labour inputs and a rise in competitiveness in Scottish manufacturing. This increases output, causing domestically owned manufacturing plants to shed jobs. This employment decline is marked in the first three or four years after the inward investment has taken place.

However, improved productivity means that both output and employment increase in other sectors because the demand rises for intermediate inputs used in the production of manufacturing sectors.

From a policy perspective, the attraction of developmental FDI electronics plants to Scotland generates significant economic benefits, often to areas of initial high unemployment. There will also be positive gains to the UK economy. This contradicts the Treasury view that regional policy at best redistributes activity around the UK. We would argue strongly that this view is false and that increased FDI will stimulate both the Scottish and UK economies. However, our research identified differences between the impacts of individual plants and it is important for government to scrutinise each on its own merits.

Past policy to encourage developmental electronics investment in Scotland has been a substantial success. Over 2.6% of total Scottish employment is generated directly or indirectly by the final sales from these plants, and foreign-owned firms support 9% of Scottish employment. However, their strong export-orientation makes them sensitive to changes in trade conditions, such as the value of sterling against the euro.

The recent trend is for manufacturing FDI to be overtaken by service FDI, with an increase in the number of call centres. Employment in call centres has a much lower knock-on benefit than employment in electronics plants, which pay high wages and have large local spending per employee. They are also a source of potential local efficiency gains, which is not the case for call centres.

Professor Kim Swales is research director of the Fraser of Allander Institute www.lis.org.uk www.dti.gov.uk

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