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Trade Openness and FDI in the UK After Brexit

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Brexit and the Consequences for International Competitiveness

Abstract

The aim of this study is to examine the possible effects that the UK’s decision to leave the European Union will have on its economy due to a change in the country’s attractiveness to foreign direct investment (FDI). The study focuses on openness to trade as a channel through which Brexit will impact inward FDI activity in the UK. After establishing the benefits of being an FDI host and the role of trade openness as one of the key determinants of inward FDI, the study finds that the relative attractiveness of the UK as a host of FDI has decreased as less of the world’s inward FDI is being directed at the UK. With a set of econometric tests, the study shows that the relationship between trade openness and inward FDI for the UK is positive and strong, and that the causality runs from trade openness to inward FDI, with no feedback. Therefore, the UK leaving the EU, through a fall in trade openness and therefore a fall in inward FDI, would have a significant negative impact on the UK’s economy.

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Notes

  1. 1.

    Defined by UNCTAD, the source of data, as “an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. Further, in cases of FDI, the investor’s purpose is to gain an effective voice in the management of the enterprise… [with]… a threshold of 10% of equity ownership to qualify an investor as a foreign direct investor” (UNCTAD 2017a).

  2. 2.

    Adding to the topic, two authors, Carstensen and Toubal (2003), state that the market potential is related to markets present in neighbouring economies, in addition to the host’s own domestic market. As a result, the researchers take into account the distance (i.e. proxy for the host’s internal transportation costs) as well as the transportation cost between the recipient and the investing economy.

  3. 3.

    The work of Xun and Awokuse (2005) is an interesting one as it uses comparative gross domestic product determinants, such as the squared difference between the two parties involved and the sum of the host’s and home’s values of this economic variable adding also an interaction term between the skill and gross domestic product differences.

  4. 4.

    Given that the paper focuses on the UK as a recipient of FDI, only inward FDI activity will be analysed.

  5. 5.

    “For associates and subsidiaries, FDI flows consist of the net sales of shares and loans (including non-cash acquisitions made against equipment, manufacturing rights, etc.) to the parent company plus the parent firm’s share of the affiliate’s reinvested earnings plus total net intra-company loans (short- and long-term) provided by the parent company. For branches, FDI flows consist of the increase in reinvested earnings plus the net increase in funds received from the foreign direct investor” (UNCTAD 2015a).

  6. 6.

    This surge in inflows of FDI into the UK is, at the time of this study, treated as an outlier, as changes in the key macroeconomic determinants of FDI (e.g. GDP, labour costs) do not seem to justify such a significant increase. This treatment is further supported by the fact that the start of the Brexit procedure significantly increased the risk on undertaking FDI in the UK, which should result in a fall in inward FDI activity. However, one must recognise that the shock of the decision to Brexit may not yet be fully represented in the available data as decisions to conduct FDI take time to make; hence, the shock of the referendum results may not have yet been calculated in the said decisions.

  7. 7.

    “For associate and subsidiary enterprises, it is the value of the share of their capital and reserves (including retained profits) attributable to the parent enterprise (this is equal to total assets minus total liabilities), plus the net indebtedness of the associate or subsidiary to the parent firm. For branches, it is the value of fixed assets and the value of current assets and investments, excluding amounts due from the parent, less liabilities to third parties” (UNCTAD 2015b).

  8. 8.

    This conclusion is further supported by the works of Buch et al. (2001, 2003), Napiórkowski (2014), and Dhingra et al. (2016), which show that EU membership can be a significant determinant of inward FDI. In addition, Dhingra et al. (2016) show that “[s]triking a comprehensive trade deal—for example, joining Switzerland in the European Free Trade Association—would not significantly reduce the negative effects of Brexit on FDI”. Interestingly, Simionescu (2017) suggests that the “UK should follow the model of Norway and Iceland after Brexit in order to avoid significant losses in the FDI inflows”.

  9. 9.

    The reason for excluding flows is the 2016 value, which significantly distorts the data.

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  1. Collegium of World Economy, SGH Warsaw School of Economics, Warsaw, Poland

    Tomasz M. Napiórkowski

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  1. Collegium of World Economy, SGH Warsaw School of Economics, Warsaw, Poland

    Arkadiusz Michał Kowalski

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Napiórkowski, T.M. (2018). Trade Openness and FDI in the UK After Brexit. In: Kowalski, A. (eds) Brexit and the Consequences for International Competitiveness. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-03245-6_9

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  • DOI: https://doi.org/10.1007/978-3-030-03245-6_9

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