House of Commons - Scottish Affairs

Select Committee on Scottish Affairs First Report

INWARD/OUTWARD INVESTMENT IN SCOTLAND

THE BACKGROUND

9. The current economic position of Scotland was summed up by Scottish Enterprise in the strategy document setting its course for the next four years as one of standing 'at a cross-roads'. The document continues, 'changes in markets and advances in technology have created a very different economic world. To be successful, Scotland's organisations and people must learn to live in it. These changes promise many opportunities to create economic wealth. Scotland must put itself in a position to succeed in this different economic world, with new industries, new behaviours and new ways of doing business'.[4]

10. Scotland is often perceived as remote from the centre of gravity of the EU, a position which eastward expansion of the Union can only worsen. Technological advances such as e-commerce may mitigate these disadvantages, but physical infrastructure—roads, airports, power, telecommunication links, are important too, and here Scotland is not as well-serviced as it might be. Inadequacies in the physical infrastructure of Scotland loomed large in the evidence we received, particularly from LECs and local councils but also from Scottish Enterprise; the latter reminded us how vital transport links were, especially for products with short shelf-lives.[5] It was suggested that Scotland was out of the main-stream of UK transport links. Chief among the complaints was the failure to complete the M74 extension[6] but other infrastructural concerns related to road and rail links to Glasgow Airport,[7] the disappearance from the agendas of the second Forth Bridge[8] and the need for better transport links and telecommunications in rural areas.[9] By contrast, the educational infrastructure is traditionally strong, though here also changes are needed (see paragraphs 112 to 118).

11. We took evidence (some of it in the course of our tourism inquiry) specifically on air transport links, which are reserved to Westminster. The witnesses stressed the importance of air liberalisation to business in Britain. British Midland, in their submission, outlined plans to expand their service subject to a revision of the current 'Bermuda II' bilateral to an Open Skies air services agreement saying that the conclusion of an Open Skies agreement between the UK and the US would increase passenger numbers, lower fares, expand services, stimulate employment and enhance economic co-operation between the two countries.[10] In terms of air cargo, Glasgow Prestwick International Airport stressed that at present freight cargo companies are forced to fly empty planes from Prestwick onto Europe and all points beyond. An Open Skies agreement would allow them to fill up at Prestwick with Scottish goods and fly them to customers around the world. One company, Federal Express, has filed an application for 'extra bilateral authority' in the absence of an overall agreement. The Government is currently consulting on this. The development of a Scottish freight hub at Prestwick is seriously under threat without an Open Skies agreement and thousands of manufacturing and service industry jobs will be under threat. The diversion by British Airways of domestic flights to Gatwick was a common grievance[11] and The Scottish Office pointed out that the shortage of direct flights to and from Scotland, especially to various parts of Europe and beyond, necessitating travel via London, was a disincentive to some business people.[12]

12. Those most concerned about these infrastructural problems have very little power to influence them, though Scottish Enterprise told us that in their case 'they do have a small group ... that does all our physical business of infrastructure including transport policy. Obviously we do not have a lot to spend on transport infrastructure, it is not particularly our job. We can work with the transport bodies that are in place and with the Scottish Office to try and feed back to them what we think are the policy implications of certain acts that they would want to take'.[13] All transport infrastructure is critical to the task of improving economic development and we therefore recommend that the relevant bodies both at the UK and Scottish level give these transport issues higher priority.

13. Another feature of Scotland which poses special problems, both in terms of inward investment and more generally, is the extent of its rural areas. We heard that Locate in Scotland, the agency charged with promoting inward investment has established a separate rural unit with its own targets; this is welcome although it is too early to measure the unit's success. Locate in Scotland in the USA certainly felt it would have a hard task, as it was difficult enough to position Scotland as a whole in the minds of potential investors, let alone to persuade them to take the further step of considering remote areas (an opinion which conflicts somewhat with the suggestion expressed by the Consulate in New York and by Robert Crawford of Ernst & Young[14] that Scotland has a well-defined product).

14. Since 1980, the numbers and proportion of Scottish workers employed in manufacturing, and particularly in traditional manufacturing, has continued to decline.[15] Within the context of our inquiry, this is emphasised by the fact that whereas in 1980 the 100,000 manufacturing jobs provided by foreign-owned firms made up 16 per cent of the total whereas now the equivalent figures are 75,000 and 22 per cent[16] but another 60,000 are in services.[17]

15. With the continued decline in traditional industries such as shipbuilding has developed an interest in stimulating indigenous business growth. The business birth-rate in Scotland is lower than it is in England and that in turn lower than it is in the USA. Many witnesses attributed this to cultural factors including a greater stigma attached to failure,[18] though a counter-view was expressed that in fact in the USA the disgrace was perceived as even worse so that people struggled harder not to fail.[19] Others suggested that the education system was to blame for producing a nation of employees,[20] or that the lower prevalence of home-ownership (a common source of business finance) might be a factor,[21] or that shortage of start-up capital might be responsible,[22] or that the taxation system was at fault.[23] Whatever the reason, the circumstance is a significant barrier to economic growth and to job creation. According to Scottish Enterprise 'if during the 1980s our start-up rate had matched the rest of the UK we would have had another 70,000 jobs in Scotland'.[24]

16. Despite recent job losses and black spots, the economy of Scotland is generally in a better state than in the early 1980s, when massive job losses in manufacturing areas made creating jobs of any kind the first imperative, even at the expense of quality. Witnesses were unanimous in urging that effort be directed to attracting more sophisticated projects, (known in business terminology as 'moving up the value chain') though not to the exclusion of any that would produce jobs in large number if these were available; Scotland is by no means yet in the happy position of Singapore which can now tell a would-be investor offering a few research and development jobs and a large number of manufacturing ones that it will take the research and development jobs and put the manufacturing plant in a business park in China run by Singapore on behalf of the Chinese.[25]

17. Despite any apparent disadvantages, Scotland's record in terms of attracting inward investment is strong. We heard in New York that just under 40 per cent of US investment in Europe was directed to the UK. In 1997-98, total US investment into the UK was £5.5 billion and of that £552 million went to Scotland.[26] Between 1991-2 and 1996-7 Scotland attracted a disproportionately high 17 to 25 per cent of new jobs planned to be created by foreign direct investment in the UK.[27] Past success, however, as we were repeatedly warned,[28] is not necessarily a guarantee of future performance.

18. The importance of foreign direct investment in the Scottish economy has both intensified and changed somewhat in emphasis since 1980. Our predecessors reported that there were some 275 overseas-owned manufacturing units operating in Scotland. There are now nearly 600 overseas-owned concerns in Scotland. We have drawn attention in paragraph 14 to the shift from manufacturing to services. As inward investment matures, the importance of re-investment by existing investors has grown; it now represented 60 per cent of all inward investment.[29]

The changing world

19. The world economic and political situation has changed greatly since the 1980 Report was published and these changes have naturally affected the foreign direct investment market place. Ernst & Young identified the changes as including:

replacement of labour by capital for many production processes. Meanwhile, inputs which require more labour are shifting to low cost centres;

growth of focus on higher skill-sets and labour flexibility;

greater need for both advanced tele- and physical communications;

clustering of business activities around core-specialisms;

convergence of various information technologies;

outsourcing of equipment manufacture and assembly;[30] they also identified dramatic falls in the unit price of memory chips.[31] This development extends to other hardware products such as PCs and means a requirement for low labour cost manufacturing locations.

The competition

20. In 1980 the Committee compared Scotland's inward investment record unfavourably with Wales and, in particular, with the Republic of Ireland.[32] Both of these remain formidable. The Republic, in particular has been more successful in attracting projects offering sophisticated jobs

in high-value sectors. Also within Western Europe, the Netherlands provide intense competition.[33]

21. New competitors for inward investment have also emerged, challenging the UK and Scotland for both sophisticated and labour-intensive projects. Following the collapse of the Iron Curtain, for instance, Eastern European countries offer potentially the benefits of EU membership as well as lower wage costs; in Poland, for instance, wages are 25 per cent of the UK level.[34] Iberia and Italy are also becoming attractive locations for foreign direct investment.[35] China is now a contender, again offering low wage-costs and a huge home market; The Scottish Office told us that 'the percentage of the total amount of world mobile inward investment coming into Europe has declined over the last five years or so from 50 per cent to 30 per cent because of inward investment into places like China'.[36] Ernst & Young warned us that 'the rise of lower-cost locations is accelerating'.[37] While it is the received wisdom that 'screw-driver plants' are not to be particularly encouraged (though in deprived areas they remain welcome, as Lord Macdonald recently reminded us)[38] it is unlikely, for reasons given above that many more such would be forthcoming.

22. It is not only the fact that new competitors are emerging, and existing ones getting stronger, that makes the attraction of new inward investment ever more difficult. Despite the reticence of the UK authorities in respect of the maximum allowable cost per job, (see paragraph 77) inward investors are getting increasingly sophisticated and, aided by the growing army of professional consultants, know pretty well what the 'going rate' is and what incentives are available; Scottish Enterprise admitted that 'people are getting smarter at working the system in that a lot of people are using advisers'.[39]

European rules

23. The rules governing European assistance to disadvantaged areas are also changing. Whereas the Highlands and Islands have enjoyed Objective 1, and Eastern and Western Scotland Objective 2, status, under the new dispensation agreed at Berlin in March 1999 these advantages will be lost, although a special deal (which the Government claim to be the financial equivalent of Objective 1 status), has been negotiated for the Highlands and Islands. The outcome of the discussions on the future of European assistance is expected to be known shortly.

Globalisation of the world economy

24. As companies respond to technological change and deregulation by becoming more and more mobile and sourcing their products from wherever is most advantageous to them, the world economy is becoming increasingly global; IBM in the US explained to us that many organisations were now engaged in 'virtual manufacturing' with, for instance consumer products made in Holland but controlled from Greenock. This poses problems for Scotland but also offers opportunities to participate in the supply chain.

Globalisation by Scottish companies

25. Scottish Enterprise has identified the extent to which Scotland has indigenous global companies strategically controlled from a Scottish base as being important to the future economic welfare of Scotland and has undertaken research on the subject. Discussion is still going on as to what exactly constitutes a global company. Scottish Enterprise identified global companies as follows:

a global company is different from a multinational and an exporting company;

being global involves international co-ordination of operations and can apply to both manufacturing and service companies;

being global is not necessarily the 'holy grail' although in some sectors it is essential from inception;

the evolution and application of information and communications technology (ICT) means that being global does not necessarily mean being big.[40]

Using the Business Week Global 1000 and the FT 500 as a guide, though as both Scottish Enterprise and the Wood Group pointed out, 'neither size nor being publicly traded is a necessary prerequisite for being global',[41] Scottish Enterprise identified 5 Scottish companies as being global: Royal Bank of Scotland, Bank of Scotland, Scottish Power, Scottish and Newcastle and Stagecoach Holdings. They point out that the Scottish companies in the category tend to be in 'traditional' sectors and, with the exception of Stagecoach, are long-established. Nonetheless, it is encouraging that Scotland can grow such companies even if they are small by the standards of the competition. The BVCA identified some smaller companies, in particular Orbital Technologies and Atlantech as having a global approach.[42]

26. The Committee also heard evidence from the head of the Wood Group, Sir Ian Wood, who is currently Chairman of Scottish Enterprise. The Wood Group is a relatively small global company. Sir Ian's definition of a global company differed slightly from that published by Scottish Enterprise. Describing the process by which his company strategy changed from internationalisation to globalisation and the changes in thinking to which this led, Sir Ian wrote:

(ii) Much greater movement of international personnel round the world. The change is away from UK personnel moving to key roles overseas and is now more an international workforce and skills being applied.

(iii) There are still significant important headquarter activities taking place in the UK but to some degree these are dispersed as appropriate. Thus, a significant proportion of the Petroleum Services Research and Development (R&D) is carried out in the States because this is where the key technical personnel capability is available.

(iv) Clear move towards global sourcing with purchasing carried out in the country(s) that can provide the best quality and best price for the manufactured product. An extension of this is distributive manufacturing where the parts are manufactured in the country(s) that can provide best quality, price and delivery. The parts are then despatched to the country of final use and assembled in a small local workshop that provides local content and a focus for the local customer in the country of use.

(v) Change in the Group PR presentation from "Wood Group—the UK's largest indigenous oil survey company" in the early 1990s to "Wood Group—the international oil services company" in the last three or four years'.[43]

We feel inclined to prefer Sir Ian's more practical definition of what constitutes a global company. A firm which globalises will inevitably develop different local identities and different ways of approaching the market place. Sir Ian's strategy of being prepared 'to go out into other parts of the world and build up a global capacity in the oil industry' was endorsed by the Scottish CBI, who added 'we could do with more business leaders like that in Scotland but that it is really

what it is going to take'.[44]

Service industries

27. We have already noted that the economic importance of service industries has changed since 1980 (paragraph 14), but that is not the only change in this sector. Scottish Enterprise suggested that it is not always possible any longer 'clearly to distinguish between manufacturing and service because everything is disaggregating so much. In any manufacturing company, a lot of the added value, a lot of the higher type level jobs and the value of a company is more and more in its research, design and marketing, on the customer handling that it does, in the new, innovative services that its provides. To distinguish between manufacturing and services in an old fashioned ... way is not always that helpful'.[45] Also, as technology advances, service industries no longer have to be close to their markets, but have 'locational choice'.[46] Professor Young told us that 80 per cent of investment in electronics is now in the software side, and one quarter of IBM's business is now e-commerce.

28. Not only has the world changed since 1980, it is changing ever-faster.[47] We were told 'There is no question that the pace of evolution in the international environment has accelerated dramatically since 1980. Rapid technological development, especially but not solely in telecommunications, short product cycles, greater capital intensity of production, and the requirement for high labour skills and flexibility are all features of this new environment. In services, deregulation world-wide is enabling companies to capitalise upon technological innovations'.[48] Some developments are impossible to predict: call-centres were hardly even considered in1980 but now they may already be on the point of being superceded by e-commerce and other new technologies.[49] The service sector has expanded enormously. Increasingly, the value of businesses lies not in their capital equipment but in the knowledge they possess and use. The world over, economic development agencies are faced with the task of persuading universities of the importance of aligning their product with the needs of the economy, to their mutual benefit.

Other factors

29. It is not only the economic environment which is changing. Scotland (and the UK as a whole) are undergoing major constitutional change. As from 1 July 1999 the new Scottish Parliament and Executive have assumed responsibility for a wide variety of matters: crucially (in terms of this inquiry) for economic development, inward investment, the provision of financial assistance to industry, the promotion of trade and exports, transport and education. While the Scottish Parliament has significant legislative powers it is still likely to find itself constrained by its position as part of a larger whole, but the relatively small scale of the Scottish operation should facilitate the development of an integrated policy. English regions are also to be given a strengthened role, however, and this in turn will affect Scotland as they become stronger and more skilled competitors. The effects of devolution are of course, not yet clear; as the BVCA pointed out it may lead either to uncertainty or to improved education levels and re-focused economic developments and structures.[50]

30. Within the EU attempts are being made to create a level playing field for competition to attract inward investment. An upper limit is placed on state aid to industry.[51] Despite this, suspicions persist that some EU countries do not play entirely by the rules. The Scottish Office explained to us that infringements are very hard to prove[52] but Scottish Enterprise did provide

a few examples where offenders had been punished.[53] Since UK offers do not reach the overall EU limits, efforts to reduce these are to the UK's (and Scotland's) advantage.

31. There is some evidence, as we heard in the USA, that the decision of the government not to go into the single currency immediately is being used by competitor countries as an argument against investing in the UK. The Consulate told us of hard work by Ministers and diplomats to explain that UK membership of the single market is not affected, and suggested that it has been helpful to the UK case that much of the reporting on the first day's trading had come from London. IBM in the USA however did indicate that there was a potential problem if the UK remained outside and some witnesses wanted the UK position clarified. The STUC commented, without committing themselves, 'In terms of whether or not the single currency will damage our ability to attract inward investment, there is a number of things, imponderables ... which will only become clear over time ... obviously that will impact on the decision ... But we do have to realise that, in large measure, we have attracted inward investment into Scotland with a platform into the European market. Now one of the dangers in the single currency for Scotland arises from being peripheral from the centre of the single currency area, so potentially when you take away the exchange controls between other European countries their ability to attract inward investment will be a lot higher than ours; our ability to export, given that we have already got additional transportation costs, for example, will be diminished'.[54] The Scottish CBI take the view, following polls of their membership, that the UK should go in when the time is right but that the necessary economic convergence is unlikely to take place before the next general election.[55]

4 The Network Strategy, p 3. Back

5 Q 80. Back

6 eg Q 398, 597, 726. Back

7 Q 409 and evidence from Scottish Airports Limited passim. Back

8 Q 480. Back

9 Q 369. Back

10 HC (1998-99) 85-v, p 192 Back

11 eg Q 399. Back

12 Q 1214. Back

13 Q 399. Back

14 Q 1003. Back

15 The number of employees in manufacturing declined from 469,000 in 1981 to 317,000 in 1998 (source: ONS (NOMIS) Database). Back