14 February 2020

LSE: Export-platform FDI and Brexit uncertainty

[...]While the referendum on leaving the EU did not change the UK-EU relationship immediately, it generated uncertainty about future UK-EU trade policy. To try to understand whether firms have chosen not to invest in the UK because of this uncertainty, we looked at the investment behaviour of manufacturing firms from outside the EU that have developed export platforms in the UK – production facilities to sell to the entire EU market – both before and after the referendum.

The researchers' analysis indicates that this trade policy uncertainty caused a reduction of export-platform FDI of 13.5%. They find an opposite effect on other European countries, suggesting that some manufacturing firms switched from investing in the UK to investing in other EU Member States as a platform to the European market. [...]

If the UK does not manage to negotiate a friction-free trade agreement with the EU before the end of 2020, then its exports to the EU would face the EU’s MFN tariff. This would increase the cost of trade. The possibility of a future increase in trade costs makes the export-platform strategy less attractive to firms, and the higher the MFN tariff rate the higher the potential cost. Authors looked at the growth of manufacturing FDI before and after the referendum (2014-18) by non-EU firms and tested whether sectors with higher EU MFN tariffs faced a larger reduction in export-platform FDI. Their analysis shows that the higher the potential tariff, the greater the reduction in FDI. Since our approach is based on the possibility of the UK leaving the EU without a deal, we are able to estimate that non-EU firms perceived a probability of a no-deal exit of 18%.

Some of the firms might have just delayed investments in the UK during the period of uncertainty, but their results suggest that some investments might have gone to other EU countries rather than to the UK. Whether leaving the European Union will accelerate the decline of the manufacturing sector in the UK is a question that we can answer only in few years. What they see for now is that the uncertainty that dominated the last three years is taking the country in that direction.

The outcome of negotiations on a final agreement between the UK and the EU will be crucial for any business decision. In the meantime, uncertainty over the future trade relationship with the continent will keep affecting foreign direct investments in the UK. However, more transparency does not necessarily mean more investments. Indeed, if the Government announced that there is definitely a ‘no-deal’ exit from the EU, there would be certainty about higher trade costs that would deter export-platform investments. What their analysis shows is that just the possibility of a ‘no-deal’ exit affected export-platform FDI. A definite no-deal might have even larger effects. [...]

Working paper

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