Select Committee on Welsh Affairs Fourth Report


FOURTH REPORT


The Welsh Affairs Committee has agreed to the following Report:—

  

INVESTMENT IN INDUSTRY IN WALES

I  Introduction

1. During our first inquiry this Session, into the impact of the Government's devolution proposals on economic development and local government in Wales, we realised that the debate over the most effective means of encouraging investment in industry and economic growth, and in particular the proper balance between attracting inward investment and encouraging indigenous growth, was too complex to address in that wide-ranging inquiry.[1] We decided to undertake a further inquiry into investment in industry in Wales, though this was delayed till the Summer while we diverted our attention to the crisis in Welsh livestock farming. We have received written evidence from a wide range of people and organisations in Wales and outside, and we have drawn upon the evidence given in our earlier inquiry.[2] We have made a number of informal fact-finding visits in Wales and outside. We have met with the Welsh Development Agency in Cardiff, and with academics and industrialists at the University of Wales, Bangor. We have visited a number of businesses in West Wales. We have also explored what should be learned from the Scottish, Irish and Catalan experience, by visiting Edinburgh, Inverness and Ross and Cromarty, Dublin and Dundalk, and Madrid and Barcelona.[3] We have held five sessions of oral evidence, at Westminster and in Wales. We have been assisted in our inquiry by the specialist advice of Brian Morgan, Director of the Small Firms Research Unit of the Cardiff Business School. We thank all those who have given time to meet with us or prepare evidence for us.

2. These are exciting times for Wales. The creation of the National Assembly gives us an opportunity to develop a regional economic policy distinctive to Wales and framed to meet our particular needs. The creation of the new Welsh Development Agency (WDA) as a new "economic powerhouse" gives us an opportunity to reconsider and reinvigorate the way in which we seek to stimulate economic growth. Since we began this inquiry the Welsh Office has published "Pathway to Prosperity: a new economic agenda for Wales"[4], which analyses the state of the Welsh economy and suggests priorities for action. As the former Secretary of State said in his foreword to Pathway to Prosperity "this is a moment to seize".[5]

3. In our enthusiasm we must not forget the scale of the challenge that faces us in Wales. Pathway to Prosperity sets out the facts starkly.[6] The GDP gap not only persists but has grown in the last decade: GDP per head in Wales was 83% of the UK average in 1996, the lowest of all the GB regions[7], down from 87% in 1988. Wales's GDP is 80% of the European Union average, and (to compare it with European regions of a similar population) 70% of the GDP of Aquitaine and 61% of that of Schleswig Holstein. More striking still, Wales's GDP is only 52% of that of the state of Oregon, and 42% of that of Singapore (both of which also have a similar population). Pathway to Prosperity suggests that the key problem is the low level of economic activity. 5% of the working age population are unemployed, and an additional 10% are employed part-time when they would like a full-time job. 27% of people of working age in Wales are outside the labour market (neither working nor actively seeking work), in comparison with 22% in GB as a whole. Pathway to Prosperity suggests that the underlying shortage of jobs in Wales is in the order of 200,000. Those in work are, on average, relatively poorly paid: average gross weekly earnings for full-time employees was £330 in Wales, while £368 in GB as a whole. Skill levels continue to be low, with many pupils still leaving school with no qualifications at all. And statistics for Wales as a whole mask an imbalance within Wales, with much poorer economic performance in West Wales and the Valleys than in the South-East and North-East. Tackling these problems is essential to the future prosperity of Wales, and to the survival of many of our communities.

4. In this Report we do not seek to reiterate the analysis set out in Pathway to Prosperity or to comment in detail on the Welsh economy. We explore two main themes: the balance that should be struck between attracting inward investment and promoting indigenous industry; and the way in which the public sector can most effectively support businesses in Wales.

II  The balance between inward investment and indigenous industry

  

5. One area in which Wales has been markedly more successful than other parts of the UK over the last twenty years has been in attracting investment in manufacturing from overseas. While Wales's share of inward investment into the UK has fallen since 1991 (from 19% to 11%), it is still far higher than its share of the population (5%). However there has been growing concern about the costs to the public sector of securing inward investment projects and a perception that inward investment has been pursued at the expense of indigenous industry.

  

6. Doubts about the cost-effectiveness of promoting growth by attracting inward investment were brought to a head by the announcement of the vast LG project in 1996. The South Korean company LG agreed to build two plants outside Newport, one an integrated monitor plant and one a wafer fabrication facility, together expected to cost £1,663 million and to create 6,100 jobs. Public sector support for this project totals some £248 million.[8] On a pounds per job basis this amounts to over £40,000 a job and looks expensive to say the least. In contrast, we were told that the Sole Trader Initiative in North Wales had created 342 jobs at a cost of less than £400 a job[9]. Even when taking into account the potential multiplier effect of such a large enterprise, the value of the public investment in LG must at best be unproven. There has been widespread concern in Wales, outside the Newport area at least, that public sector resources intended to stimulate indigenous industry have been redirected to fund LG.

7. To begin by clarifying definitions, what is usually thought of as "inward investment" is investment from overseas, or Foreign Direct Investment.[10] However, the term as used by the WDA strictly means investment from anywhere outside Wales, including other parts of the UK. Further investment by an enterprise that was originally created by inward investment is also regarded as inward investment by the WDA, however long that enterprise has been established in Wales[11]. Investment is considered to be "inward" if the head office of that company is based outside Wales. So expansion by a company such as British Steel would technically be classed as inward investment. Similarly, if, as often happens, a successful Welsh company is taken over by a larger UK company, or simply expands into England and decides to base its head office there, any expansion by that company in Wales would strictly amount to inward investment. The archetypal inward investment project is a large manufacturing plant developed by an overseas company or multinational, but there are many small inward investment projects in many sectors. The division between inward investment and indigenous industry is not as clear-cut as is commonly thought.

8. There is little doubt that attracting inward investment has been an effective way of creating large numbers of jobs quickly to replace those lost in the coal and steel industries in the 1970s and 1980s. The WDA and its partners in "Team Wales" (Government, local authorities and all agencies working for economic development in Wales, acting in partnership) have been conspicuously successful in competing with other regions of the UK and with countries overseas at winning inward investment projects for Wales. The WDA states that since 1983 some 1,860 projects have been secured, creating or safeguarding more than 160,000 jobs and representing over £11 billion in capital investment.[12] Some witnesses have expressed scepticism about these figures, suggesting that the WDA's statistics are based on the announcements made at the beginning of projects, rather than on careful follow-up, and that they take no account of displacement effects on jobs elsewhere.[13] Nevertheless, there is no doubt that the achievement has been considerable. The wider benefits to the Welsh economy of this inward investment may be even greater, but are harder to quantify. By bringing jobs to an area, an inward investment project contributes to the prosperity of an area: earnings are spent, in part, to the benefit of other businesses in the area. Where the inward investor itself buys from, or sub-contracts to, local businesses, the benefits to the local economy multiply. It was suggested to us in Ireland that for every job created in an inward investment project there would be at least another created in a company that supplies it.

     

9. The extent to which inward investment benefits indigenous industry in Wales is the subject of considerable dispute.[14] The WDA suggests that "inward investment and indigenous industry are mutually complementary".[15] Local businesses can benefit directly from supplying inward investors and indirectly from their investment in training the local workforce.[16] Suppliers can benefit from technology transfer, from the greater competitiveness that inward investors require and from their wider management experience. Others paint a different picture, suggesting that inward investors distort the local economy, contribute little to economic growth, poach the best employees from local firms and damage the local environment.[17] In our view, more needs to be done to monitor and evaluate the effects of inward investment projects on the local economy, and thus the cost-effectiveness of public sector support for such projects.

10. Much depends on the extent to which inward investors are "embedded" in the local economy: in other words, the extent to which they buy from local suppliers. The WDA claims considerable success in encouraging local sourcing or "linkage". The WDA's Source Wales programme produced deals worth £14.5 million in 1997-98, at a cost of £2 million.[18] However, we feel there is more that could be done. Source Wales has been effective in working with larger suppliers, but has not as yet done enough to create links with smaller companies and develop them so that they can meet the exacting quality standards demanded by the big multinationals.[19] The strength of the indigenous business sector is a crucial ingredient in the package on offer to potential inward investors.

11. During our visit to Dublin we were briefed by Forbairt on the Irish National Linkage Programme. We were impressed by their commitment to building local supply networks even in advance of agreeing inward investment projects. They appear to be much more proactive than the WDA. We were told, for example, that they keep in contact with Irish managers working in companies abroad and, when an opportunity arises to supply a potential inward investment project, they entice them back home to set up their own companies with offers of start-up funding. Of course, the Irish have a much larger, and more cohesive, expatriate population than the Welsh.

12. Inward investment into Wales has been principally in manufacturing. Wales has been particularly successful at attracting firms manufacturing automotive components, consumer and office electronics, semiconductors and aerospace products. Some of these have "clustered" in particular areas. Critics of inward investment suggest that inward investors create only production or final assembly facilities - sometimes described as "screwdriver" operations - while retaining research and development and higher value work at home.[20] While this is not universally true (Sony, for example, has its European R&D centre in Wales, and there are a number of state-of-the-art production facilities), more does need to be done to encourage inward investors to carry out R&D and high value work in Wales. CBI Wales suggested that inward investors should be given grant incentives to invest in R&D in Wales.[21] We believe that high value inward investors should be given priority when grants are allocated, and we return to this below.

13. Many of our witnesses urged that more be done to encourage inward investment from sectors other than manufacturing. The WDA acknowledges that Wales has underperformed in the financial services, transport and storage, and communications sectors and recognises the need to put this right.[22] It has been suggested that more should be done to attract investment in software development, design, and international telephone call centres, for example. We can all think of sectors in which we would like Wales to attract inward investment. The difficulty, of course, is to transform the wish list into reality. We are unlikely to be successful at competing for investment in sectors in which other countries are already well established.

14. Pathway to Prosperity appears to reject a sectoral approach, stating that the Government "have concluded that policy should not concentrate on the promotion of particular sectors".[23] However, the Minister told us that he "did not want to indulge in just a shopping list of sectors but rather to focus our energies .... in those areas of maximum international competitive strength"[24] —which seems to us rather like a sectoral approach. It is clearly important not to concentrate on old sectors and ignore new and perhaps unexpected developments.

15. The Irish approach is highly sectoral, identifying growth areas and carving out a specialist niche encouraging local clusters to develop. With growing competition from other countries and regions, they believe that it will be particularly important to specialise. We were impressed in Ireland by the commitment of resources by the IDA to anticipate the next generation of growth areas. Scotland too appears to commit considerable resources to research. During the 1990s Scottish Enterprise has developed three long-term strategic programmes in the areas of indigenous firm growth, commercialisation of university research and accessing the global economy. The WDA told us that there had been "some sectoral emphasis", but that only around half of the jobs created in the past year were in the "focused sectors".[25] The WDA must adopt a more strategic approach to attracting inward investment and dedicate sufficient resources to identifying potential international growth markets, perhaps ten years ahead. Targeting key sectors must be part of that approach.

16. One of the most serious criticisms made against inward investors is that they have no long-term commitment to the local economy and when times get bad (or just better elsewhere) they close down and leave. There is as yet little evidence of this in Wales, but recent closures in Wales and in other parts of the UK are alarming. Of course, even the most embedded projects are not safeguarded against recession. It remains to be seen how inward investment projects in Wales survive the current economic downturn. Embedding inward investors in the local economy is vital, not only to maximise the local economic benefits but to make it more costly or less profitable for the inward investor to relocate away from its established supply chains.

17. Of some 380 overseas companies investing in Wales, 182 are European, 143 from North America and 60 from Asia and the Far East. Naturally, successful projects encourage other companies to follow, and the WDA has developed valuable expertise and contact networks in these markets. The WDA's International Division has 27 people based overseas, with offices in Australia, Belgium, Canada, Hong Kong, Italy, Japan, Korea, Taiwan and the USA (Boston, Chicago and San Francisco). Maintaining overseas offices is expensive, but it is regarded by the WDA as a key element in its competitiveness. Indeed the WDA's witnesses suggested that their overseas resources were "at danger level", pointing out that the Irish Industrial Development Agency (IDA) has 54 people based overseas.[26] Others, however, suggest that the overseas offices have not proven their worth, that most contracts come from contacts developed in the UK, and that the greatest potential source of inward investment is reinvestment by companies which are already in Wales.[27] We would urge the National Assembly to look carefully at the WDA's overseas offices to ensure that they provide good value for money. As we discuss below, there may be scope for using the resources currently allocated to attracting inward investment more efficiently by linking them with export promotion.

18. While Wales's success in attracting investment from Asia and the Far East is very welcome, this has left the Welsh economy badly exposed to the effects of recession in that area. While it is to be hoped that projects already located in Wales will survive the current financial crisis in Asia, it must have had considerable impact on the opportunities for future investment. It is essential that the WDA encourage investment from other areas. The WDA told us that they were conducting an exercise exploring the inward investment potential of small-town companies in America.[28] As the traditional sources of inward investment shrink, it is essential to explore new markets.

19. "Aftercare" of inward investors is crucial. Not only are existing inward investors a potential source of further investment, but maintaining close contact offers greater scope for increasing local sourcing and embedding the inward investor, as well as ensuring early warning of any risk of project failure. Inward investors we have met in Wales have suggested that the WDA is less good at aftercare than it is at attracting inward investors; that, once here, they were more or less left on their own. In Ireland we were told that considerable effort is put into aftercare. CBI Wales suggested that grant-aided investors might be required to accept a local non-executive director as a condition of grant.[29] The new WDA must plan to improve its aftercare of inward investors, especially smaller companies.

20. Another of the criticisms levelled at inward investment is that it has benefited only South-East and North-East Wales. [30] Certainly, the big manufacturing projects have been attracted to areas of Wales in easy reach of markets in England and elsewhere. For the past three years, the WDA has been set a target for creating jobs outside the eastern M4 and A55 corridors, and there have been some welcome successes in attracting inward investment further West. Most commentators suggest that it is unrealistic to expect heavy manufacturing businesses to locate to remoter areas: transport costs would be too significant. There is more potential in attracting service industries or businesses either manufacturing small, high value products (where the demand for labour would be modest and transport costs would be proportionately less) or products which can be transported electronically. However, there are exceptions to this rule. We were surprised to learn, for example, of a successful freezer production plant at the very North of Scotland. How to attract inward investors to remoter areas was an issue we explored in our visits to Scotland and to Ireland. The Irish appear to have been remarkably successful in attracting inward investment to the West of Ireland, though this may be partly explained by the fact that American investors regard the West as the nearest point in Europe rather than the most remote. While we would want the WDA to ensure that inward investors consider sites in West and Mid Wales, and believe that the grant regime should be weighted to encourage this, it is essential that we do not lose for Wales high quality investors who are only interested in location in the East.

21. Many of our witnesses suggested that the potential for future inward investment was much reduced. The global economic downturn, the greater effectiveness of other regional development agencies in the UK and elsewhere in Europe, growing competition from Eastern Europe, the likely reduction in the grants available to entice investors, all will make it harder to attract large scale new investors in future. The then Secretary of State for Wales himself told us last January that he suspected that "the era of large-scale inward investment projects is probably coming to an end".[31] The WDA was, however, relatively upbeat about the prospects for future inward investment, quoting economic forecasts that the global inward investment market was set to continue and even speaking of a second East Asian economic miracle in the longer term.[32] It would be a mistake to assume that inward investment is a thing of the past. There are still considerable inward investment opportunities to exploit, especially in re-investment by existing investors and in new growth markets.

22. For all the attention that is given to inward investment, it must be remembered that most businesses in Wales are indigenous and these have played an important role in employment growth with very little in the way of public sector support. Under 10% of the workforce in Wales work for foreign-owned companies.[33] The great majority of firms in Wales are Small or Medium-Sized Enterprises (SMEs). Pathway to Prosperity suggests that 52,000 out of 58,000 firms in Wales employ less than 25 employees, and that almost half the Welsh workforce works for organisations with less than 200 employees.[34] It has been pointed out that if each of the SMEs in Wales took on only one new employee, this alone would get us well on the way to meeting the Government's target of 200,000 new jobs. There seems to be a growing consensus that the key to future economic growth in Wales is in developing indigenous industry.

23. Indigenous industry is particularly important to the rural areas of Wales. In West and Mid Wales, the vast majority of businesses are SMEs. While every inward investment opportunity should be exploited, the potential for inward investment in the remoter areas of Wales is severely limited. Encouraging indigenous businesses to expand, and new businesses to start up, is the only realistic way of creating new jobs and increasing prosperity in rural Wales.

24. There is a widespread perception that indigenous industry has been neglected in the past by Government, and more particularly by the old WDA. This is in part unfair. In 1992 the then Secretary of State for Wales took away from the WDA its powers to support business start-ups and small businesses with less than ten employees, and transferred responsibility for this to the TECs. The WDA can hardly be faulted, therefore, for having done nothing to support business start-ups, as it was not empowered to do so. However, while the WDA retained responsibility for developing businesses with more than ten employees, it appears to have concentrated on larger companies. We share the view that the old WDA concentrated on inward investment at the expense of indigenous industry. Promoting inward investment and indigenous growth are not mutually exclusive - indeed we accept that they can be complementary - but it is time to shift the balance of emphasis and funding in favour of indigenous industry.


1  First Report of the Welsh Affairs Committee, Session 1997-98, HC 329-I: see especially paragraph 45. Back

2  A number of organisations (eg Wales TUC) have felt that their views were fully set out in the memoranda published with our First Report (see HC 329-II). Back

3  An outline programme of these visits can be found in the Annex to this Report. Back

4  Welsh Office, July 1998. Back

5  Pathway to Prosperity, p iii. Back

6  Pathway to Prosperity, paragraphs 3.1 to 3.6. Back

7  In the UK, only Northern Ireland has a lower GDP per head. Back

8  See Third Report from the Welsh Affairs Committee, HC 751, Session 1997-98, "The Welsh Office Departmental Report 1998", paragraph 13 and Evidence, p 30, A56. Back

9  Evidence, p 1, paragraph 2.6; also Q 4. Back

10  See Evidence, p 170. Back

11  The DBRW however regarded such expansion as indigenous business growth: see Evidence, p 134, paragraph 3.4. Back

12  Evidence, p 134, paragraph 3.3. Back

13  Evidence, p 194, paragraphs 4.1-4.5. Back

14  See Evidence, p 169. Back

15  Evidence, p 135, paragraph 5.1. Back

16  See Evidence, p 158-159. Back

17  Evidence, pp 159-162; 191, paragraph 5; pp 192-194. Back

18  Evidence, p 139, paragraph 14. Back

19  See Evidence, p 101. Back

20  Evidence, p 193. Back

21  Q 280. Back

22  Evidence, p 134, paragraph 3.7. Back

23  Pathway to Prosperity, paragraph 5.28. Back

24  Q 420. See too Official Report, Welsh Grand Committee, 13 July 1998, col 73. Back

25  Q 348. Back

26  Q 347. Back

27  Q 346. Back

28  Qq 346, 349. Back

29  Evidence, p 129. Back

30  Evidence, pp 172, 187. Back

31  HC 329-II, Q 691. Back

32  Q 345. Back

33  Evidence, p 163. Back

34  Pathway to Prosperity, paragraph 3.11, see also Evidence, p 100. Back


 
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