International investment in Europe: A canary in the coal mine?

Brussels, we have a problem
Brussels, we have a problem

In today’s post, Michael Gestrin of the OECD Directorate for Financial and Enterprise Affairs looks at whether declines in the EU’s flows of foreign direct investment (FDI) simply reflect a particularly severe FDI cycle or whether there might also be structural factors involved.

At the start of the 2007 crisis, global foreign direct investment (FDI) stocks actually declined, and even today, global flows of FDI are still 40% below their pre-crisis peak. Generally, OECD countries were the sources of the biggest declines while many emerging economies experienced increases in FDI flows. Europe has been one of the worst affected regions. EU inflows are down 75% and outflows are down 80% from their pre-crisis levels.

Inflows into the EU are currently around $200 billion, down from $800 billion at the peak of the global FDI cycle in 2007 (see figures). Outflows are also currently around $200 billion, down from $1.2 trillion in 2007. For the rest of the world, a global economy “without” the EU is doing quite well. In this global economy, inflows recovered strongly starting in 2010 and reached new record heights in 2011, at just over $1.2 trillion. With respect to outflows, the FDI crisis was limited to a one-year decline of 20% in 2009. Although world-minus-EU outflows have not grown over the past three years, they have been at record levels.

Part of the strong performance of the world-minus-EU can be explained by the growing importance of the emerging markets, in particular China, as sources and recipients of FDI. In 2012, emerging markets received over 50% of global FDI flows for the first time, and China is now consistently among the world’s top three sources of FDI.

The crisis initially gave rise to a significant gap between the non-EU OECD countries and the rest of world with respect to both inflows and outflows, just as it did for the EU (see figures). A big difference, however, is that for the non-EU OECD countries the gap closed after only two years. While the EU and the world-minus-EU group have been going in different directions ever since the start of the crisis, the non-EU OECD group and its rest-of-world counterpart appear to have returned to a similar cycle after parting ways for a much shorter period during 2008-9.

Comparing the EU and non-EU-OECD shares of world inflows and outflows highlights the extent to which the positions of these two groups have reversed in recent years (see figures). At the turn of this century the EU accounted for over 50% of global inflows and 70% of global outflows. By 2013 both shares were down to 20%. Conversely, the non-EU-OECD countries have seen their shares of global FDI inflows and outflows recover to pre-crisis levels. This group overtook the EU in 2010 in terms of its share of both inflows and outflows, thus reversing the historical relationship.

Why? The greatest declines in inward FDI in the EU have been from within Europe itself (see figures). Before the crisis around 70-80% of the region’s inward FDI consisted of intra-EU investment. Today only 30% of inward FDI is intra-EU. This sharp decline in the share of FDI that EU countries receive from their EU neighbours also helps to explain the decline in outward EU FDI.

The decline in the share of intra-EU in total EU inward FDI would seem to suggest a lack of confidence on the part of EU investors in their own regional market. One tempting explanation for this is that these declines have been concentrated in a sub-set of EU countries that have experienced particularly difficult economic conditions (such as Greece, Ireland, Portugal, and Spain) during the crisis.

This has not been the case. The FDI crisis in Europe has been broad-based, with the bulk of the declines in FDI flows concentrated in the largest economies. France, Germany, and the UK accounted for 50% of the $600 billion decline in FDI inflows between 2007 and 2013. Over the same period, Greece, Ireland, Portugal, and Spain accounted for only $14 billion, or 2%, of the inflow decline. With respect to outflows, France, Germany, and the UK accounted for 59% of the $1 trillion decline between 2007 and 2013. Over the same period, Greece, Ireland, Portugal, and Spain accounted for 12% of this decline.

Part of the explanation for the decline in investment in Europe is linked to an increasing share of international divestment relative to international mergers and acquisitions (M&A, see figures). While pre-crisis levels averaged around 35%, they reached almost 60% in 2010-11 and now stand at around 50%. In other words, for every dollar invested, 50 cents is divested. Consequently, net international M&A investment in Europe is currently at its lowest levels in a decade, at around $100 billion.

The clear “leader” in this regard is the consumer products segment, with a divestment/investment ratio of 148%. This means that for every dollar invested in consumer products over the past six years, around one and a half dollars was divested. This is an example of investment de-globalisation. Domestic and international M&A in Europe have generally followed the same pattern: both are on track to reach their lowest levels in a decade (see figures). Conditions that are holding back international investment in Europe would seem to be discouraging domestic investment as well.

From a policy perspective, the challenges of breaking out of this regional investment slump are daunting but urgent. A useful starting point is the recognition that a supportive environment for productive international investment needs to reflect the evolving needs of international investors. Such a supportive environment has three dimensions.

First, investors generally favour predictable, open, transparent, rules-based regulatory environments, much along the lines put forward by the OECD’s Policy Framework for Investment. Where impediments to investment have not been addressed by governments this often has more to do with implementation challenges rather than disagreement over principles. For example, it is widely accepted that excessive ‘red tape’ is an obstacle to investment but in many countries this is still often cited by business as being one of the most important impediments to doing business. In Europe, many such impediments represent relatively easy opportunities for improving the regional investment climate.

The second dimension concerns important changes in the structures and patterns of global investment flows as well as in the way MNEs are organising their international operations. This is reflected in investment de-globalisation and “vertical disintegration” which has seen MNEs become more focused on their core lines of business over time and more reliant upon international contractual relationships for organizing their global value chains.

Finally, Europe would seem to be confronting a competitiveness puzzle in which declining competitiveness is discouraging investment, and declining investment is in turn undermining competitiveness. A few years ago, OECD Secretary General Angel Gurría outlined six policy recommendations for getting Europe back on a sustainable growth path that also hold for investment:

  1. Further develop the Single Market.
  2. Ease excessive product market regulation;
  3. Invest more in R&D and step up innovation.
  4. Make sure that education and training institutions deliver highly sought after skills.
  5. Increase the number of workers participating in labour markets and make markets more inclusive to address social inequalities.
  6. Reform the tax system, including by reducing the tax wedges on labour.

Useful links

Foreign Direct Investment (FDI) Statistics – OECD Data, Analysis and Forecasts

EU public procurement: Opening markets by example, and if that doesn’t work…

Today’s post is from Karel De Gucht, EU Trade Commissioner  and Michel Barnier, EU Commissioner responsible for internal market and services

How do you open markets world wide, to the benefit of European consumers, companies and jobs? Europe’s answer to that question is equally short: we lead by example. We are the world’s largest single market, and our foreign trade policy is actively focused on further liberalising trade through both multilateral and bilateral negotiations. But what happens if others don’t follow our example? What incentives do our partners have to open their markets to our businesses when their own businesses have full access to ours? As negotiators, that’s a question to which there are no short and simple answers.

 Take public procurement, a sector of major economic importance. In the EU, purchases by government correspond to around 19% of GDP and companies whose business directly depends on procurement represent over 30 million jobs. It is also a booming sector in emerging economies and one in which European companies are very competitive.

The European public procurement sector is the most open in the world. Outside contractors are able, welcome even, to compete on our market, subject to the same conditions as European companies. Between the EU’s 27 member states procurement markets are also liberalised. And rightly so: this has driven down prices, increased the competitiveness of our companies and offered more value for money to authorities and tax payers across Europe.

And yet, we are far ahead of other countries in this approach. Other economies, though they enjoy access to the EU market, are far more reluctant to open their own markets to the EU. While some €352 billion of European public procurement is included in the WTO agreement on government procurement (GPA) and therefore open to bidders from member countries of the GPA, the value of American procurement offered to foreign bidders is just €178 billion, for Japan that figure is only €27 billion. China and India have not yet committed any part of their fast growing procurement markets and currently, EU business wins only a fraction of the Chinese and Indian procurement contracts.

Whatever the overall economic merits and flaws of this situation, this is increasingly hard to explain to our businesses, who see foreign competitors actively engaging on our markets while they are barred from doing the same elsewhere.

This undermines the legitimacy of our open markets. It hampers the pro-active trade policy we want to pursue.

At the end of last year, the EU was at the forefront of efforts to renegotiate the WTO Government Procurement Agreement. We were happy to come to a new deal among the 15 WTO members that are party to the agreement to improve the disciplines for this key sector of the economy and expand the market access coverage with up to 100 billion euros a year. There can be no doubt about our free market credentials. But we cannot accept that imbalances grow ever larger between those that push for market opening and those that refuse to do so to.

For that reason, we have devised an instrument that will, if approved by EU Member States and the European Parliament, allow us to tackle imbalances in international public procurement markets. Through this procedure, contracting authorities in Member States may exclude bidders for large contracts who use goods and services mainly originating in a non-EU country that upholds a high degree of closedness of their procurement markets. They will need a green light from the European Commission to do so, which will only be given if these goods and services are not subject to any agreement the EU has signed up to, or part of serious negotiations on such an agreement.

And we have built in a threshold below which third country bidders cannot be discriminated against so that the new regime puts pressure on foreign companies and governments without leading to unnecessary bureaucracy. In case of serious and repeated discrimination, the Commission may start consultations with the government in question and, if that government continues to bar European companies from its market, the Commission may close a certain sector of the procurement market of the EU as a whole. Naturally, if the EU has taken a legal commitment to the third country in the WTO GPA or a free trade agreement to keep its market open, it will fully honour its commitments.

The measure is designed to be used as a carrot, rather than as a stick, but we should not be afraid to brandish it if need be. In this way we are confident to strengthen our negotiating position when discussing access to third country public procurement markets. Only in this way can we make foreign companies aware that they cannot continue to enjoy the benefits and the opportunities offered by our open markets while their home governments continue to close theirs . Our proposal will also clarify the rules of access to the EU’s public procurement market, and in doing so bring more legal certainty for both international suppliers and public entities that need goods or services. It will confirm that the EU market is basically open, and that we want to keep it that way.

But the door of free trade has to open both ways – otherwise public demands to shut it altogether will gather strength.

Useful links

OECD statistics on international trade in services

OECD work on integrity in public procurement

Chapter 3 of OECD Insights: International Trade discusses trade in services