APPENDIX 12
Memorandum from Mr Brian Morgan
INTERNATIONAL INVESTMENT AND INDIGENOUS SMES
INTRODUCTION
The WDA has successfully pursued a high profile
policy of attracting quality inward investment to Wales and this
policy has been helped by some of the support programmes available
to indigenous businesses e.g., Source Wales. Despite these successes
some disquiet remains over the inward investment strategy because:
(i) the distribution of inward investment
has not been evenly spread across Wales and
(ii) there has been less resource available
for developing indigenous businesses compared with attracting
inward investors.
With the advent of the Assembly the opportunity
exists to promote new forms of economic development in Wales.
Although regional aid for attracting inward investment still has
an important role to play in facilitating economic renewal in
all parts of Wales, such aid is far less important than a stock
of innovative firms, a skilled and versatile workforce and a robust
networking capacity amongst indigenous firms seeking competitive
advantage. Much progress on these issues can be achieved through
more dynamic action at the local and regional level.
Two approaches to economic development have
traditionally been promoted by the development organisations:
inward investment and indigenous business growth. While both have
a role to play in Wales, to be successful, the economic strategy
requires a balanced and integrated approach.
A SUCCESSFUL INWARD
INVESTMENT STRATEGY
For inward investment to be successful in the
regional economy and to become an important engine of growth it
needs two vital ingredients:
1. good local supplier linkages
2. skilled workers and flexible labour markets
Multinational companies involved in inward investment
typically possess competitive advantage and they seek to improve
their own productivity by transferring technology to indigenous
companies. But to actually stimulate radical improvements in the
regional growth rate and raise regional prosperity, multinationals
must become `embedded' into the local economy; they must generate
good supplier linkages (both with other manufacturing firms and,
equally importantly, with the service sector)and networking activity
along the supply chain and enhance the skills base.
Labour flexibility is a related issue and refers
to hours worked, shift systems and part-time working. On most
measures the Welsh labour market is relatively flexible and it
must be emphasised that flexibility is not synonymous with low
wages. Indeed inward investment itself is not about low wages.
For example, in the electronics sector less than 5 per cent of
total costs are accounted for by direct labour costs. So competitive
advantage cannot be achieved simply by forcing down wages and
much survey evidence exists that suggests that inward investors
pay above average wages.
In a similar vein, there are few advantages
to be gained from highlighting low wages as a regional asset.
So, when marketing Wales to potential inward investors emphasis
is usually placed not on `low wages' but on `low unit labour costs'
and on the skills that are available in Wales compared with competitor
regions in the rest of the EU. `Low unit labour costs' are a combination
of (relatively) high productivity and competitive earnings.
Generally those labour markets with most flexibility,
like the US and the UK have created jobs and reduced unemployment,
whereas inflexible labour markets in Germany, France, Spain and
Italy have simply created unemployment. Similarly, those regional
economies that have invested in developing supplier networks have
both attracted and retained inward investors. Good supplier linkages
act as an important element both in attracting foreign investment
and in maximising its potential to stimulate the economy. Component
sourcing and flexible labour markets will remain crucial ingredients
of an inward investment strategy.
INWARD INVESTMENT:
AN ENIGMA
Despite some recent successes, questions remain
over the impact of inward investment on the indigenous business
sector. Afterall, the typical inward investor has low levels of
local sourcing and undertakes little or no R&D. Also, multinational
companies have few linkages with the service sector: the vast
majority of inward investment flows into the manufacturing sector
and, although very important, this sector employs less than 20
per cent of the workforce. The vast majority of the workforce
(around 70 per cent) are employed in the service sector and the
impact of foreign investment on this sector has been negligible.
Similar conclusions apply to the agricultural sector. Therefore
we cannot expect too much from foreign investment because a large
part of the sector has all the characteristics of the branch-plant
mentality and only a small percentage of the workforce (around
6 per cent in Wales) are employed in foreign-owned companies.
Hence the failure of inward investment to raise overall levels
of prosperity.
The apparent paradox between rising living standards
at the national level and low levels of prosperity in Wales can
be partially explained by the fact that:
(i) the growth prospects for service sector
firms in terms of output, employment and productivity are way
below the UK average and this is reflected in low wages in the
service sector compared with other areas of Wales and compared
with manufacturing
(ii) the rural economy has stagnated and
economic activity rates, in general, are below the national average
and in certain areas of the rural economy are considerably lower
(iii) the number and growth of indigenous
firms, in general, is below the national average but in some key
sectors—especially the high value added service sectors—the
trends are even worse.
AN INTEGRATED
APPROACH TO
DEVELOPMENT
A balanced strategy for growth would need to
be based firmly on the belief that equal resource, in terms of
business support services, will need to be allocated to the sector
which employs the overwhelming majority of the workforce —i.e.
indigenous businesses and particularly high value-added services.
An opportunity now exists to get the balance
right in terms of achieving parity of esteem and parity of resource
between inward investors and indigenous SMEs (where this term
is defined to include farms, related agri-businesses and hotels).
However, for this to become a reality it will be necessary to
address some of the problems that inward investors create
for indigenous firms (such as the way they exacerbate the skills
gap), and also strive to harness the opportunities they
offer SMEs (such as the way these international firms provide
small firms with access to the global economy).
The over-riding objective of a new economic
strategy should be to develop a co-ordinated economic development
structure within Wales capable of addressing these issues. It
will need to respond effectively to related problems such as the
training and skills needs of industry, the low levels of R&D
and the infrastructure deficit. R&D by the business sector
is extremely low in Wales but, in contrast, the Welsh economy
has one of the highest levels of specialisation in high-tech manufacturing.
Hence opportunities exist to begin to address some of these problems.
However, the provision of proactive business
support services is currently hampered by a lack of information
on the sectoral performance of SMEs and of their needs. This condemns
the Business Connect partnership to be totally reactive. To be
effective the economic strategy will need to improve not only
the information flow to SMEs but also improve the quality of information
on SME needs that is available to economic development agencies.
One way to generate information that would allow
a more proactive delivery mechanism to be developed would be to
create a representative database of SMEs in the manufacturing
and service sectors. The database could focus on relevant sectors,
such as `producer services' i.e., those services such as design,
R&D, marketing etc. that add value to the manufacturing sector.
If the objective is to raise the quality of business support services
available to indigenous SMEs then this will require development
of a data base that identifies SME needs and can be used to target
firms with the potential to grow.
Therefore in addition to attracting investment,
the economic strategy should focus on:
(i) improving the productivity and growth
of small firms by identifying potential growth SMEs and developing
supplier networks for these firms (especially those in key growth
sectors) and focusing business support services on them with the
aim of achieving excellence in high value added products and services
(ii) raising economic activity rates in rural
and deprived urban areas to the national average through revitalising
business start-ups and developing retraining schemes and incentives
that encourage people, particularly women, to re-enter the labour
market
(iii) identifying opportunities for indigenous
businesses to become more focused on international markets and
developing international / SME linkages that encourage SMEs to
access the global economy and benefit from inward investment successes.
(iv) raising awareness of the opportunities
afforded by new sectors such as environmental and related energy
products; e.g., the EU recently emphasised the prospect for massive
growth in demand for renewable energy goods and environmental
goods and services with opportunities for both inward investment
and SME growth.
There is much evidence that the number of indigenous
firms per head of the population is well below the national average
and that this is a contributory factor to the low level of prosperity
in Wales. Policies to reverse these trends are urgently needed.
However, it is important to see SMEs not only in terms of numbers
but also in terms of the qualitative contribution that they make
to the regional economy.
In particular the flexibility of SMEs must be
appreciated: they are the major providers of "new" jobs
and of "first" jobs for young people, particularly in
more peripheral communities. SMEs are usually the most adept at
providing job opportunities and training to disadvantaged groups
in society, notably the young, the unskilled and female "returners".
Hence the SME base of the regional economy will remain crucial
to the economic regeneration of Wales as a whole and local communities
in particular.
CONCLUSION
In the context of indigenous growth, the current
proposals to restructure the quangos will not provide any more
resources or assistance for small businesses and, in addition,
the current lack of coordination in service delivery and the overlap
of responsibilities will remain in place.
To be successful any new economic strategy must
concentrate on integrating and rationalising all the numerous
agencies involved in economic development. In this respect the
rationalisation of the delivery mechanisms for business support
services should be given top priority and the creation of a new
integrated organisation could become a vital objective of the
Assembly.
Brian Morgan
Director of Small Firms Research Centre
Cardiff Business School
15 March 1998
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