Inward Investment in Wales

Written evidence submitted by Dr John Ball, Swansea University

INTRODUCTION

The timing of the committee’s investigation is fortuitous. The extended and much publicised success in attracting inward investment to Wales – especially FDI - has been steadily declining over the past decade, as other regions and nations have competed vigorously for investment. Furthermore, many of the organisations attracted to Wales during earlier investment phases have ceased to trade or withdrawn to areas providing different incentives, often cheaper labour costs. In addition, the National Assembly has pursued policies – it has to be said half heartedly – to encourage enterprise and indigenous business growth with little attempt to link policies with inward investment, past or future.

Much of the evidence provided for the committee’s inquiry, such as levels of investment, will directly address the five areas of investigation laid out in the committee’s original announcement and indeed, is likely to be repetitive. The purpose of this brief memorandum therefore is to draw the committee’s attention to past practices, advantages and limitations but also to suggest ways in which inward investment policy might successfully be directed.

The memorandum is presented in four sections –

· A review of the fundamental aims of regional policy

· A brief discussion on the role of inward investment in achieving these aims

· A review of the potential for increased investment together with a critique of past activities

· A discussion on the conditions necessary to attract inward investment, subdivided into taxation, the production mandate and the need to address competitiveness:

1. Regional Policy

Before inquiring into direct investment in Wales, it is worth re-emphasising the aims of regional policy, of which inward investment is one instrument.

· The regional problem is conventionally associated with the terminal decline of traditional industry found in the regions and is invariably referred to by one of its principal characteristics, that of unemployment. It is attributed to two fundamental weaknesses.

· Many regions have inherited an unfavourable industrial structure as a result of the industries upon which regional economies grew. In addition, the problem is seen as locational. The regions do not provide suitable locations for new industry and firms attracted to the regions are often subject to cost and other disadvantages. Of the two, the inherited industrial structure has been seen as the important determinant in the lack of economic growth.

· To address the above problems, the main aims of regional policy have been twofold: the provision of employment and the diversification of the existing industrial structure to encourage self sustaining growth.

· In reality, policy instruments have mainly been aimed at the former, to the detriment of the latter, and it is this emphasis that has led to criticism of the policy’s main instrument, inward investment. In employment provision terms, active regional policy has been successful, without it, the situation in Wales would have been worse in terms of unemployment, out-migration, economic diversification and alternative job opportunities.

2. The Role of Inward Investment

Although there are questions about the long term success of inward investment in resolving the continued decline of the Welsh economy – indeed it is argued that this success has in many ways had the opposite effect - it retains an important role for a number of reasons:

· a major source of employment

· the introduction of new skills and technology to the receiving region

· has a substantial multiplier effect

· encouragement of local suppliers

· becomes a long term strategic asset as a basis for economic growth

3. Potential for Increased Investment

Although successful in quantitative terms, previous inward investment has been only partially successful in achieving the aims of regional policy and is discussed in the following section. That is not to say that inward investment has no role to play, on the contrary, correct and appropriate investment can provide important economic stimulus. The important lesson for future activity is not to repeat the mistakes of the past and the challenge therefore is to strike a balance between employment provision and growth sectors.

3.1 Inward Investment Assessment

Although successful in creating employment (which became and to some extent remains, the over-riding motive), inward investment as a major instrument of regional policy, has many shortcomings. Success in employment provision has served to reduce the possibility of long term growth that inward investment is supposed to provide.

· Many of the investing businesses attracted to the regions diversified the industrial base but did little to encourage the technical, managerial or skill base; a pre-condition for successful economic growth.

· Financial inducements – invariably grants - have been the main instrument used and on occasions have supported projects with limited employment prospects, or which would have been undertaken without subsidy.

· Fundamentally, no attempt was made to differentiate between efficient and non-efficient firms, or those with products in a growth sector or on the quality of employment offered.

· The major criticism was that Wales became a "branch plant" economy; inward investment became synonymous with external ownership, low skilled employment, standard end of life cycle products, mature technologies and restricted management opportunities.

· The last decade or so has shown that many of these branch plants were temporary and did little to encourage long term change.

Almost half a century of attracting inward investment has resulted in large employers providing much needed employment, thereby fulfilling to some extent one aim of regional policy. But wealth creation and economic development do not arise solely from the provision of employment. In reality, success in creating employment has served to depress longer-term development because the skills required have not always been appropriate. An important policy assumption is that inward investment has a substantial multiplier effect in encouraging local businesses to supply goods and services, thus increasing the effectiveness of the original investment.

· The reality is that this often does not happen, managerial functions, especially purchasing, inventory and product development, remained outside Wales.

· Suppliers exist, but in economic space not in geographic space.

· Manufacturers of products at the end of the life cycle are driven by cost. This means for many of these products Wales has been competing against much lower labour costs in Eastern Europe and much of the rest of the world.

· More recent industrial policy in Wales has focused on products in sectors such as motor vehicles and consumer electronics, which are not growth sectors and for which there is derived demand; products incorporated into other manufactured goods sold under a variety of international brands. Local suppliers capable of supplying components invariably compete on price, since end of life cycle products are extremely price sensitive.

4. Conditions Necessary to Attract Inward Investment

Whilst it is recognised that the need significantly to improve education standards, skills levels and transport infrastructure are matters for the Assembly, any inquiry into inward investment cannot ignore their vital importance to investors. There remain serious concerns about standards of education and the level of skills available to incoming investors to Wales and these need urgently to be addressed. There is also the vexed question of transport infrastructure, not least the M4 in south Wales, notably the tolls at the Severn Bridge, access to valley communities and poor communications by rail and air. All these need urgent attention and have been discussed ad infinitum.

Despite criticism of previous inward investment, lessons have been learned and the development of appropriate incentives and policies can ensure that future investment plays a full part in economic development.

However, so far as attraction of investment is concerned; and recognising international competition for such investment, original and innovative policies are required.

4.1 Taxation:

· Whatever powers may or may not accrue in the future to the National Assembly, attractive tax regimes are being used by regions and states competing for the same investment and to be able to compete, the use of such incentives must be addressed.

· Taxation based economic development has been remarkably successful in other parts of Europe and its use in tackling the urgent needs of the Welsh economy needs to be addressed. Tax incentives in many forms – although principally corporation tax - have proved successful in many European states, and in a lesson for the UK, within states, such as Catalonia in Spain. Low levels of corporation tax have been used as a principal tool of economic development in Ireland, which at 12.5 per cent is the lowest rate and although currently there are serious sovereign debt problems, there has been no reduction in inward flowing investment.

· Carefully targeted corporation tax incentives are attractive for the investing business because they are, by definition, profitable and seeking to reduce their tax liability. For the receiving region, tax incentives are internal to the firm and consequently the bureaucracy associated with traditional incentives is reduced and the need to prove "additionality" and job creation is removed.

· Incentives other than corporation tax are an important instrument of policy, including lower taxation on business that export or which re-invest profits in new products or technology.

· Research has shown an unexpected effect of reducing corporate tax. A cut in corporation tax leads to an increase in employees’ earnings. This seems perverse, but with higher profits, capital in the form of innovation and technology is substituted for labour and consequently, there develops a need for employees to develop greater skills.

Within the UK there is the perceived danger that different taxation incentives, albeit limited in application and approach, will result in some regions gaining an unfair advantage. However, addressing the use of taxation is recognition of the need to address the continued decline of the Welsh economy. The concept of regional taxation within the UK is not a new idea, indeed the concept of a universal UK wide tax system is a myth.

· The Selective Employment Tax of the 1960s taxed services and re-used the tax take to support manufacturing and was in reality, given the industrial structure of the UK at the time, a de facto regional tax.

· Traditional instruments of economic development – grant aid and regional selective assistance – were regionally based and reflected the re-distribution of taxation, although not in name.

· Similarly, differences in capital allowances over time and used to encourage investment in regional manufacturing areas is by definition, a tax incentive.

· .Fiscal transfers by HM Treasury from one part of the UK to another again represent a de factor taxation difference.

· Council taxes differ by region and the concept of local income tax to replace council tax enjoys growing, if limited support.

4.2 The Production Mandate:

In spite of the advantages argued for taxation based incentives that are particularly attractive to footloose inward investors, there is always the danger of competing with other regions and nations with a race to the bottom. Noting criticism of the partial success of past inward investment, courage must be shown in efforts to attract investment and incentives, in addition to financial, should be offered on the basis of the "production mandate" concept.

· Incentives remain available, but are offered on the basis of the amount of ‘mandate’ (local autonomy) given to local management

· The mandate applies to the amount of autonomy to purchase, recruit, and undertake training, research, product development and innovation at the receiving local site.

· If there is insufficient mandate, then incentives are reduced or withdrawn.

· Although the current investigation is concerned with FDI, there is a wider case for the mandate to be applied to all incoming investors including incoming multiple retailers and service sector organisations.

· Philosophically, the production mandate approach would represent a fundamental difference from the major criticism of past policy that any employment was acceptable.

4.3 International Competitiveness:

In its announcement of this inquiry, the committee made specific reference to the potential for increased investment, both in traditional sectors and emerging sectors. Future inward investment must avoid the errors of the past and be part of an over arching, coherent economic development policy aimed at attracting investors capable of global reach

· Economic growth partly emanates from identifying and building upon existing strengths. The inability to understand this simple idea has been a constant failing of policy.

· Inward investment must be in sectors that reflect the real level of skills within the economy and the need for, and ability to develop, local suppliers.

· There are distinct skills with the Welsh economy, notably (but not only) manufacturing and engineering, which in many ways are two sides of the same coin. These should form the basis of policy in attracting investors requiring engineering skills.

· There is too great an emphasis on voguish high tech sectors, software or ‘fashionable’ sectors such as financial services. The reality is that aside from competition from the rest of the world, Wales simply does not have the skill levels needed.

· There must be careful analysis of inward investors in emerging sectors to seek a match with skills – to a great extent some energy sectors do require traditional engineering skills

· A fundamental weakness of the Welsh economy has been the failure to produce final demand products (not necessarily in ‘traditional’ engineering) and the search for such sectors must be a priority.

· Any re-location of government offices should be resisted; the Welsh economy is already over reliant on the public sector.

March 2011