Silhouettes of businessmen and women in different locations across a map of the UK that is coloured like the Union Jack.

On the level: Trasformative foreign direct investment (FDI) couldreduce regional inequalities across the UK.

Labour has pledged to scrap the UK Government’s ‘levelling up’ slogan if it wins the general election.

There is no suggestion that inter-regional, or even intra-regional, inequality is going to fall down the political agenda. Quite the opposite.

But – just as a rose by any other name would smell as sweet – the challenge of levelling up remains a thorny issue, no matter how politicians choose to label it.

The Government White Paper Levelling Up the United Kingdom sets out a clear mission to boost productivity, pay, jobs, and living standards by growing the private sector.

The scale of the challenge is evident from a stark statistic quoted in the Financial Times. If London and the South East are taken out, productivity of the rest of the UK is on a par with Alabama, the 48th richest state in the US. Meanwhile, the tier one cities of the UK rank below cities such as Prague.

As we highlighted in a recent paper, some towns and cities in the UK are lagging even further behind, trapped in a recurring cycle of low skills, low pay, and low productivity.

Using foreign direct investment to break the productivity trap

At The Productivity Institute, we have been exploring how a more nuanced strategy towards attracting investment can help break this cycle.

This involves attracting inward investment, otherwise known as Foreign Direct Investment (FDI), that increases the demand for skills in low productivity regions.

This in turn can increase the rewards available for workers – such as improved pay and conditions – and create an incentive for more workers to acquire those skills.

When this is done effectively, it has the potential to 'move the dial' for the regional economy, rather than simply offering more of the same in terms of output, productivity, and employment opportunities. This is known as transformational FDI.

In order to achieve this, regions need a clear understanding of what they aim to achieve when they are targeting inward investment. As part of our study – which was undertaken for the Department of Business and Trade and the Office of Investment – we identified four fundamental questions regions must answer.

1 Existing strengths or new sectors

Local leaders must decide whether to identify existing areas of strong productivity and prioritise those, or leverage research and frontier technologies to target high growth areas that could make a substantial contribution to the regional economy.

Figures from the Orbis Crossborder Investment database and our own calculations show that high productivity FDI is often linked to a region’s pre-existing strengths.

If regions choose the first strategy, we might expect them to focus on innovation policies that encourage broader collaboration between businesses and universities to strengthen sites that are already competitive in an international market. For the latter, the challenges will centre around scaling-up nascent activity.

2 Is new investment necessarily better?

Prioritising new investment is likely to fulfil the Government’s short-term objectives for increasing direct investment.

However, well-designed interventions aimed at nurturing existing investments could lead to greater resilience and productivity gains, as well as fostering other innovations over the medium-to-long term.

3 Skills or innovation

Developing new technology can be a catalyst for growth. However, if it is not accompanied by a strategy to boost the supply of skills locally, there is a risk that the developers will relocate or be acquired by a foreign firm.

This could lead to that technology being exploited elsewhere, instead of contributing to the region where it was originally developed.

Equally, focusing on improving the skills of the workforce without driving innovation is unlikely to lead to sustained activity and could lead to workers relocating to other regions where their skills are better rewarded.

4 Job generation: new activity or traditional sectors

If regions that are lagging behind aim to build on areas of existing strength, they need to collaborate with incumbent businesses to rectify the market failure that has hitherto hindered productivity.

This includes fostering better co-operation between businesses and local research, setting an industrial strategy that identifies missing links in supply chains, and encouraging local organisations to fill them.

The trade-offs involved in attracting inward investment

In short, regions face a trade-off when attracting inward investment. Do they seek FDI that will create or protect jobs, or that will improve innovation rates?

This is no trivial question and the tension between protecting existing employment in the short-term and encouraging innovation in the long-term was a key challenge that Local Enterprise Partnerships - bodies set up as partnerships between local authorities and businesses in 2011 by the Government but now being phased out -faced.

As individual regions have started to lag behind in terms of economic development, they have seen levels of unemployment increase and proposed solutions have tended to focus on attracting jobs to the area, with less attention given to the type of investment and jobs they are attracting. This often results in investment that offers more of the same.

This has led to a ‘two-speed’ economy, with those regions that are already lagging behind more likely to attract investment that brings larger amounts of relatively unskilled labour, but lower levels of new technology.

Meanwhile, high-tech investment tends to go to a limited number of locations that are already suffering from skill shortages

Making transformational FDI work harder for regional economies

The key message from our research is that regions need to carefully evaluate the kind of investment the area needs, their ability to attract it, and how to maximise any benefits that spill over into the wider economy as a result of securing that investment.

This requires a shift from the current sector-based approach, which is determined centrally and adapted for use by each region across the UK, to one that explicitly requires regions to align attempts to attract inward investments with their individual strengths. Many city regions across the UK already adopt this approach, but take-up remains patchy elsewhere.

There is also a case for a more nuanced approach to targeting investment linked to particular activities, or even individual firms, to create stronger links between investors and local employers in order to generate a more transformative impact on productivity and earnings.

FDI can only be considered truly transformational if it is delivering better jobs, productivity, and outcomes for people living within a given region. The foreign firms and investment that local leaders attract cannot operate in isolation if they are to have a transformative impact.

Equally, FDI cannot be transformational in isolation. It needs to be considered as part of a series of policies that improve a region’s value proposition, making it a more desirable location in which to invest, work, and live in future. That really would be a step towards levelling up.

Further reading:

What is the key to 'levelling up' the UK economy after Brexit?

How to improve UK productivity

The Midlands is losing £20bn in lost productivity every year

How can inward investment become more transformational?


Nigel Driffield is Professor of International Business and Deputy Pro Vice Chancellor for Regional Engagement. He is also Midlands Lead for The Productivity Institute and teaches on the Undergraduate programme.

Xiaocan Yuan is a Research Assistant in the Strategy and International Business group.

Learn more about boosting productivity on the four-day Executive Education course Leading an Agile and Resilient Organisation.

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