By Daniel Hunter

The UK remains Europe’s top destination for foreign direct investment (FDI) but will lose its crown to Germany within two years unless action is taken, according to Ernst & Young’s annual UK Attractiveness Survey.

The report, which analyses inward investment and the attitudes of global investors, shows that the UK attracted 679 projects in 2011 creating nearly 30,000 jobs.

However, the UK suffered a 7% decline in overall projects, with financial services investment, a traditional source of FDI, dropping by 15%. In contrast, Germany’s share of overall inward investment rose by 15% - leaving it only 2% behind the UK. For the first time in 15 years Germany secured a higher share of manufacturing projects and overtook the UK in securing investment from Japan. Germany also swept up investment from the BRIC countries, winning twice as many FDI projects from Chinese businesses.

UK must maintain its strengths while finding new ones

The report demonstrates how dependent the UK is on a small number of countries, especially the US, and sectors, such as financial services, for the majority of its projects. Germany’s growth illustrates the importance of two way trade and strong domestic demand, in driving investor choice and shows how linked success in attracting inward investment is to wider economic performance.

The 500 decision makers surveyed as part of the report called for greater focus on supporting R&D and innovation, developing education and skills, and improving attractiveness via incentives, taxation and attention to real estate and labour costs.

“The ability to win investment has been a crucial source of pride, job-creation and growth over many years and is now more important than ever. These findings must act as a wakeup call to prevent the UK losing its lead in foreign direct investment," Ernst & Young UK & Ireland managing partner Steve Varley said.

“The UK needs to keep existing FDI sources and investors happy, while also seeking out new markets and opportunities. The consistent theme coming through loud and clear from investors is that the UK needs to focus on three areas to increase its attractiveness: R&D and innovation, developing education and skills and creating a strong economic environment that balances demand, efficiency and incentives.”

Investors find positives, but barriers remain

The main foreign investment into the UK comes from the US, followed by Germany and India. India is the bright spot among the BRICS — with the UK receiving by far the most investment from the country. The leading sectors for the UK were business services, software and machinery and equipment.

Despite overall positivity about the UK as an investment destination, barriers to investment remained. Less than half of major investors cited labour costs as appealing. One in six said the cost and availability of real estate was unattractive, while only 53% found the UK’s corporate taxation appealing.

The survey found that the UK’s most attractive qualities among foreign companies are its quality of life, culture and language, stable political environment and infrastructure. It shows 86% of investors are confident the UK will overcome its economic challenges — higher than for other European countries (81%) — excluding Germany.

However, there are clear warning signs about the risks if the economy does not recover; the level of domestic demand is the single most important factor driving decisions to locate in the UK. The importance of the UK as a gateway to export to other markets was also highlighted, an issue that may become more significant as the economic and political situation in the Eurozone and wider EU develops.

“The results illustrate that inward investment is not a standalone activity but is one component of the overall economic landscape," Mark Gregory EY’s Chief Economist commented.

"The performance of the UK economy and success in exporting will all influence the level of inward investment. A joined up economic policy is required to maximise the UK’s economic potential.

“Looking to Germany, investors value its transport and logistics skills and infrastructure and its telecommunications infrastructure very highly. The UK’s tends to attract investors based on softer criteria such as quality of life and political stability. We believe more analysis is required to understand f more investment is required in physical facilities to reposition the UK.”

London supreme but a double digit decline in regions

London is the jewel in the UK’s crown, attracting more projects than any other city and more than all, but four countries. Despite the overall fall in UK projects, London actually increased its share of FDI by 13%, securing half of all UK investment. The report found that 60% of all investment was to London and the South.

In contrast, all other English regions saw double-digit declines in projects. Wales suffered the biggest slump, with its share of overall UK projects falling to 1.3%, compared to a high water mark of 9% eight years ago.

While there is no clear-cut cause-and-effect relationship, the closure of English Regional Development Agencies was announced in 2010, and it remains to be seen how this affects the UK’s ability to reinvigorate FDI at a local level.

Scotland, which retains the Scottish Enterprise agency, enjoyed the highest FDI-sourced job creation in the UK (5926) followed by the East Midlands (3819) North-West (3715) and London (3711). Despite the superior number of projects in the capital, these were focused on business services, software and financial services, while the top UK job creators were retail (3350 jobs) and automotive assembly (3208).

Overall, investors’ most important consideration in choosing a region was availability and skills of the local workforce (52%) followed by strength of business locally (35%) and access to regional grants and incentives (31%).

The car’s the star

While automotive assembly did not rank in the top ten for number of projects, it came second in job creation, while car components investment was sixth most important for employment, despite a small pool of projects. Overall the top three job-creators for FDI across Europe were automotive components, machinery and equipment, and automotive assembly.

“The automotive industry is the real success story with inward investment by companies in the sector being used to harness the UK’s potential to relaunch a sector the UK was once famous for," Mark Gregory, Ernst & Young Chief Economist, said.

"The UK has a significant installed base in all of Europe’s top employment three generating sectors, and could boost employment by building on this solid platform with new and follow-on investments.

“There are a broad number of positive reasons investors have to invest and a great number of strengths but there is clearly a need for the Government and the business community to work together to capitalise on the UK’s proven strengths and global brand.”

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