Trade deals alone won’t transform UK trade performance -time to get real.

Brexit offers the potential for improved UK trade…

The ability for Britain to trade freely on the world stage, unencumbered by restrictions from its European Union membership, is one of the potential benefits advanced by supporters of Brexit. New trade agreements could allow the UK to trade more effectively with the fastest growing countries in the world.

…but are we being realistic about our capabilities?

However at a recent lunch with senior executives of a FTSE 100 company this positive view was challenged. I was the only UK national in the group of 5, and the other 4, all of whom have extensive international business experience, made clear how they were unconvinced about the UK’s trade expertise. For example one attendee questioned whether the UK can really aspire to be a top trading nation when our language skills are so poor?

Research by the EY ITEM Club found that Britain’s trade performance has been weak for some time, with a declining world market share since the Second World War. Their analysis also showed that the UK has tended to perform less well than our European peers in growing exports to the fast growing markets.

While the UK performs well in attracting inbound investment…

Modern trade in goods is crucially dependent on the supply chains deployed to produce and move them. As EY’s 2017 European Attractiveness report illustrates, European supply chains are becoming ever more integrated. In recent years, manufacturing and back office activities have been moved to Central and Eastern Europe but we are now seeing higher value added activities such as R&D moving eastwards.

As EY’s Attractiveness Reports have demonstrated for over a decade, the UK has been and continues to be leading destination for Foreign Direct Investment (FDI) in Europe. Germany is equally firmly established in second place and the countries have relatively similar profiles for FDI. Between 2012 and 2016, the UK secured 3,527 projects compared to 3,258 by Germany. The UK attracted around a third more R&D and Logistics projects, more than twice as many HQs, manufacturing project numbers were similar and Germany attracted around 10% more sales offices. Overall, therefore, the mix of projects shows the UK as a clear leader in terms of both the financial value and economic benefit of FDI secured.

Chart 1

When we look at the origins of the investment, differences start to appear. Germany attracts more European investment while the UK is much more dependent on investment from North America, securing 1,345 projects compared to 686 by Germany between 2012 and 2016. By contrast, Germany attracted 572 projects from the BRICs in this period compared to the 500 that the UK secured. While the UK clearly has trading strengths, such as our relationship with the USA, we also appear to have a weaker appeal to the fast growing markets than Germany using FDI as a guide. This is consistent with the findings of the EY ITEM club mentioned earlier.

…the overall investment story is not good…

When we consider outbound direct investment, we find significant differences between the UK and Germany. Globally, Germany makes about a third more investments than the UK on average and between 2012 and 2016 initiated 2,463 projects in the rest of Europe compared to 1,401 by UK investors, a major difference.

Chart 2

However, it is the nature of investments that is so different. Germany made 1,020 manufacturing plant investments and 374 in logistics compared to 181 and 83 respectively by the UK. Germany invested in nearly twice as many R&D facilities and almost twice as many HQs internationally.

Germany is a very successful exporter of manufactured goods and related services and it seems that part of this success reflects an integrated approach to trade covering exports, FDI and Overseas Direct Investment (ODI). Germany invests in physical facilities both in markets it sells to but also in countries where it can access capabilities across industry supply chains. This combined approach provides access to markets, efficiency benefits in production and soft power – German investment directly creates economic activity in many countries.

…even for services…

Given Germany’s reputation in goods trade, the extent of Germany’s outbound investment activities is unsurprising. I had, however, expected the UK to be a clear leader in investing internationally in services but this is not the case. The UK did make 398 investments in business services in Europe between 2012 and 2016 compared to 102 by German investors and 139 versus 75 in financial services but Germany led on software projects with 147 to 132. Overall the UK’s ODI in services is not comparable to the scale of Germany’s investment in goods. Moreover, the UK’s investment in services compared to the total size of services in the UK economy is small relative to the same ratios for manufacturing by Germany.

…so it is time to get real.

The evidence appears to support the opinions of my lunch guests. The UK has to work hard to improve its export performance significantly. Trade agreements will be helpful but more fundamental changes in our approach to trade, especially the integration across the various dimensions, and a significant increase in international investment are required. Our analysis of FDI shows how far the UK has to go and it does suggest that public sector support will be required to drive this transformation. This is the perfect opportunity to use the much touted Industrial Strategy to generate improved economic performance. The UK needs to identify its priority sectors and develop a plan for attracting inbound investment to increase our competitiveness but also to offer more support and incentives for outbound investment, securing market access, participation in competitive value chains and increasing soft power.

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