What factors attract foreign direct investment?

What factors attract foreign direct investment?

Fallon, Grahame


Increasingly the world is becoming globalised and the riots at Seattle, Stockholm and Genoa provide some evidence of the power and control of Multinational or Transnational Companies (MNCs/TNCs) and the subsequent backlash against this. The forces that have led to the growth of MNCs/TNCs are manifold but would include the reduction in trade barriers, the development of the global triad trading block system (South East Asia and China, Europe, and North America), the liberalisation and deregulation of markets, the move towards world-wide privatisation, strategic decisions by organisations that wish to dominate world markets as their domestic market growth rates have slowed down, and the increased competition some organisations are finding in their domestic markets. All these factors together have seen the growth almost year-on-year of foreign direct investment (FDI), as organisations seek to take advantage of market and cost saving opportunities both within Europe and in the UK in particular.

Whilst a growing number of econometric and survey-based studies have been published that focus on the key influences which determine inbound FDI at the national level, relatively few studies exist into the forces which affect the distribution of FDI between UK regions. The aim of this paper is to rectify this omission by seeking to identify and analyse a set of factors that influence the attraction of inbound FDI to UK regions.


Theoretical work by Stopford and Strange (1991) and Dunning (1993) suggests that four main factors determine the national and regional location of FDI by transnational corporations (TNCs). These are: (physical, labour or technological); the search for markets (following customers, suppliers or competitors abroad, seeking increased familiarity with the local business environment or reducing their costs of supplying a foreign market); the search for efficiency (exploiting different factor endowments, cultures, institutional arrangements, economic systems and policies and market structures); and finally the search for strategic assets (enabling them to sustain and advance their international competitive advantages). In addition, national and regional resource endowments; market access and potential; favourable competitive positions; strong consumer demand; and favourable government policies can all help in attracting FDI to specific national and regional locations.

This paper focuses on three main ‘influencers’ of inbound investment: market, resources, and efficiency-seeking FDI. Strategic asset-seeking FDI is excluded from the study, since it proved incapable of measurement using the published UK data available at the time of the preliminary study.


Studies carried out in the USA and the UK provide further support for the importance of resources, market and efficiency considerations in determining the distribution of inbound FDI at the regional level. A number of American studies (Bagchi-Sen and Wheeler, 1989; McConnell, 1980; Mandell and Killian, 1974; Arpan and Ricks, 1995) suggest that market-related factors, such as market proximity, population size and growth rates, levels of per capita retail spending and regional infrastructure provision are also found to be of importance in attracting FDI at the regional level. Other studies (Little, 1978; Glickman and Woodward, 1988; Mandell and Killian, 1974 and Arpan and Ricks, 1995) indicate that the location of FDI is especially sensitive to resource-based influences, such as labour availability, wage differentials and educational attainment levels. Efficiencyrelated factors including government aid, state spending levels, regional taxation levels and the level of industrial development in host regions are also significant (see McConnell, 1980; Mandell and Killian, 1974; Arpan and Ricks, 1995).

Studies based on UK regional data provide broad support for these American findings. Market-related influences such as infrastructure investment (Hill and Munday, 1991) and high population density (Billington, 1999) are considered to be significant in attracting inbound FDI to particular UK regions. In terms of resources, Billington (1999) suggests that high unemployment and related labour availability can both exercise a significant positive impact on FDI inflows at the regional level, whilst Collis and Noon (1994) show that high unit wage costs can have the opposite effect. Taylor (1993) and Billington (1999) provide evidence of efficiencyseeking FDI, arguing that preferential assistance to depressed regions and the regional industrial mix both exert a strong influence on the distribution of inbound FDI amongst UK regions. Hill and Munday (1991 and 1992) also find that government regional policy, based on regional preferential assistance and infrastructure spending, can help in attracting FDI towards particular UK regions.


Recent research evidence (Roberts et al, 1988; Collis et al, 1989; Hill and Munday, 1992, Meyer and Qu, 1995) suggests that changes have occurred in the distribution of inbound FDI between UK regions since the early 1970s. The heavy concentration of FDI in the south-eastern core of the UK economy has given way to a more even distribution, in which peripheral regions such as Scotland, Wales and the North of England, and latterly, intermediate regions such as the West Midlands have been increasingly favoured by foreign investors. These findings form the basis for the present study, and for the choice of regions included in it.

Data from the West Midlands and Scotland have been chosen as the basis for this study, due to the relative success which both have achieved in attracting inflows of FDI, compared with other UK regions.


Over 900 foreign-owned companies now have bases in Scotland, including Motorola, Compaq, NEC, IBM and Sun Microsystems (Invest UK, 2001). Over the nine-year period from 1991 to 2000, 742 inward investment projects were undertaken in the region, leading to planned investment levels of 8,974 million, and to the creation or safeguarding of 112,431 jobs (Locate in Scotland, 1991 to 2000).

The market for FDI in Scotland is geographically diverse, although new projects, capital inflows and job creation have been dominated by United States and UK-based donor companies over the period from 1991 to 2000. Smaller, but nonetheless substantial inflows of FDI have also been attracted from companies based in mainland Europe and the AsiaPacific region (Locate in Scotland, 2000).

In sectoral terms, Scotland has achieved particular success in attracting inbound FDI to its electronics and services industries. Taken together, these sectors accounted for 46% of all new foreign direct investment projects in the region between 1994 and 2000 (during which time electronics brought in 23% of FDI and services 25%). Scotland is now home to a key cluster of over 420 electronics companies (158 owned by overseas firms), which together make up ‘Silicon Glen,’ arguably ‘the largest concentration of electronics companies anywhere in Europe’ (Invest UK, 2001). Scotland’s electronics industry has achieved this position due to a decade of rapid and sustained growth in output and product sales, while the region is now at the forefront of global technology developments in the electronics sector (Locate in Scotland, 2001). The industry also possesses strength in diversity, since Scotland claims to have ‘Europe’s largest concentration of semiconductor fabricators,’ together with a number of leading global players in the ‘computer, consumer electronics, office products and telecommunications equipment’ markets (Locate in Scotland, ibid.).

In the years since 1996, Scotland’s services industry has replaced electronics as the prime target for inbound FDI in both volume (number of new projects), value (capital investment) and employment (job-creation and safeguarding) terms. Service sector activities now account for 38% of inbound FDI projects, 19% of investment and 39% of planned jobs

(Locate in Scotland, 2000). Services FDI in Scotland covers a broad compass, including higher value-added activities such as electronics design and biotechnology research, design and development (R,D&D). The financial services sector has also shown strong interest in investing in the region, as has the dot.com sector (until recently), while Scotland is attracting increasing attention as a location for major call centres (Locate in Scotland, 2000).

UK government sources suggest that a range of factors may have been important in attracting FDI to Scotland, including market-related factors such as the size of its population (5.1 million) and the quality of its infrastructure. Resourcesrelated factors, such as its ‘highly skilled, flexible workforce;’ and efficiency-related factors, including Scotland’s status as a ‘major centre for high-tech R,D&D’ also appear to play an important role (Invest UK, 2001). High valued added activities in the electronics and R,D&D sectors can be expected to be attracted to Scotland by the agglomeration economies available in ‘Silicon Glen’, by the high quality of Scotland’s human skills capital and by the sophistication of Scotland’s telecommunications network. Market related factors such as the availability of a high-speed distribution infrastructure could also be considered to be powerful incentives driving the location of such FDI in Scotland. On the other hand, lower value-added activities such as financial services and call centres may be more attracted by resource related factors, such as the availability of a pool of affordable labour (due to Scotland’s relatively high unemployment and relatively low wage rates) (Locate in Scotland, 2001).


The West Midlands has long been established as a major European region for attracting inward investment. In 2000 it was the UK’s most successful region in attracting foreign direct investment, and was amongst the top five in Europe. Of the 40 per cent of foreign investment in the EU, the West Midlands consistently secures 20 per cent of these projects.

Much of the FDI into the West Midlands has traditionally been headed by activity into the industries in which the region is strong, such as automotive, added value engineering, rubber and plastics, manufacturing and food and drink. However, towards the end of the 1990s the region has found some success in attracting business service companies and in particular Information Technology and software companies. For example, in 2000 the region had 116 enquiries from software companies compared to 97 from engineering companies and 81 connected to the automotive industry. Overall, the flow of FDI into the region can be seen in the fact that in 2000 the West Midlands attracted a total of 103 overseas investments with a recorded capital expenditure totalling in excess of L2.2 billion, creating 4,772 jobs and safeguarding a further 20,650.

If the stock rather than the flow of FDI into the region in 2000 is considered, the region contained six of the top ten software companies together with 18 of the top 20 global automotive suppliers, 25 of the top 30 global automotive plastics suppliers and a host of global telecommunications companies (Advantage, 2000). In fact the region has the strongest regional financial services sector outside London. In total by 2000 more than 223,000 people were employed through FDI within 1,925 companies (over a third of which have moved into the region since 1991) from a range of host economies including the USA, Germany, Japan, France, Taiwan, the Netherlands, Switzerland and Sweden. These companies include BMW, Denso, Ford, Fujitsu, Magneti Marelli, NEC, Oracle, Peugeot, GAP and OSI Pharmaceuticals.

What leads the region to be so attractive to FDI? Advantage West Midlands (2000) suggest the following. “The region boasts a skilled and dedicated workforce of more than 2.4 million people, who have consistently demonstrated their versatility, flexibility and competitive instinct over many years. They are ready to be flexible in working practices and committed to meeting targets”. In addition the workforce is seen as highly skilled with the region generating 34,000 new high quality graduates from its nine universities each year. These together with its 60 higher and further education colleges provide a ready supply of welleducated graduates particularly in the area of Information Technology. The region is also seen as a relatively low cost of living area and its location at the very centre of the UK’s transport infrastructure is also considered to be of major importance. “High quality and highly reliable road, rail and sea connections are all part of the region’s well-developed and extensive transport infrastructure, all supported by an advanced telecommunications network’ (Advantage West Midlands, 2000). Seventy five per cent of the UK’s population is within a half-day truck drive of the West Midlands and this has resulted in more than 300 major distribution companies establishing themselves within the region.

The region, therefore, is one of the most successful in the UK in attracting and keeping FDI. At the same time there has been a concerted effort to attract more value-added jobs and to diversify away from the more traditional manufacturing, with which the region has come to be associated, towards more business services and IT based employment opportunities.


On one level therefore, the support agencies in both Scotland and the West Midlands appear to suggest similar factors as the major determinants of FDI into their regions. However, a study undertaken by Fallon et al (2001), based upon data collected at both regional and national level suggest that differences do exist between the attraction factors for the two regions.

For example, in the West Midlands the most important FDI-inducing factor in this study appears to be regional preferential assistance levels followed by education and market size. In Scotland, the results suggest that levels of unemployment may be most important, followed by market size, regional assistance and average wage costs. Taken together, they suggest that it may prove difficult to explain the regional distribution of inbound FDI in the UK using a common set of independent variables.

Not only is it important to establish the factors that may affect the flow of FDI into a region but it is also important to establish the direction of any relationship that exists between an explanatory variable and FDI. The results from Fallon et al (2001) suggest that in the West Midlands, education and preferential regional assistance both have a positive effect on FDI as might be expected. This suggests that increased levels of human capital and government assistance to industry tend to attract increasing levels of inbound FDI. The coefficient of market size, unexpectedly, has a negative sign, suggesting that reductions in the region’s market size have been associated with increased FDI over time. This apparently perverse result can however be explained by the region’s particular experience since the early 1980s. Net emigration, brought about by deindustrialisation and reduced employment opportunities for a highly skilled and mobile workforce, has coincided with an increasing governmental push for inward investment, linked to the availability of financial incentives for foreign investors.

In the case of Scotland, unemployment and market size are positively related to FDI, as expected, suggesting that increases in market size and unemployment levels help to attract inflows of market – and resources-seeking FDI respectively. The remaining results generated from Scottish data run contrary to a priori expectations however. It might be expected that rising average wage costs would act as a deterrent to inbound FDI, but the results suggest that this variable has a positive influence on FDI in Scotland. This apparent contradiction may perhaps be explained by reference to the ambiguous effects of labour costs. On the one hand high labour costs might lead to a reduction in resource-seeking FDI as they raise the total costs of the investing firm. On the other hand, they will help to create higher real incomes and purchasing power at the regional level, so providing a possible stimulus to market-seeking FDI. In addition, in the case of Scotland, increasing levels of regional preferential assistance are associated with lower inflows of FDI into the region. This result may be explained, at least in part, by the heterogeneity of the Scottish economy, where the impact of government regional assistance on some of the peripheral areas is not sufficient to overcome their inherent difficulties in attracting inward FDI, such as their remoteness from markets, relatively poor infrastructure and lack of agglomeration economies. These circumstances would appear to argue strongly for the adoption of a more focussed approach to RPA in the case of Scotland.


The findings reported in this paper provide tentative support for the hypotheses that the attraction of inbound FDI into the West Midlands and Scotland is related to the search for markets, resources and efficiency. Both Advantage West Midlands and Locate in Scotland suggest a series of common factors as to why their regions are attractive to FDI. On the supply side these include a highly skilled, welleducated and flexible workforce, and efficiency related factors including agglomeration economies. On the demand side market related factors such as the availability of a pool of affordable labour appear to be important, as do the size of the local market and transport and telecommunications infrastructure.

The results from our study suggest that different factors may be attracting inbound FDI into the West Midlands and Scotland from the TNC decision-makers point of view. For the West Midlands, government regional assistance and levels of education are significant positive determinants of FDI, while the size of the regional population has a negative effect on FDI inflows. For Scotland, unemployment, average regional wage earnings, and the size of the regional population all have positive impacts on FDI, while government regional assistance is negatively related to FDI.

These findings also help to explain the difference between the types of FDI which each region predominantly attracts: engineering, automotive and software activities, in the case of the West Midlands, and electronics and services activities, in that of Scotland.

This contrasting pattern can be explained at least in part by the findings reported above. Both regions exhibit path dependency in terms of the type of FDI that they attract, showing an apparent continuing tendency to attract FDI into sectors such as engineering and electronics that are already significantly represented in the West Midlands and Scotland. However, the aggregate data collected over time hides the fact that there are changes taking place in the structure of both regional economies influencing the focus of FDI.

In the West Midlands there has been a growing trend towards, business service companies and in particular IT and software organisations. In the case of Scotland the services sector has also come to the fore in recent years as a prime target for inbound FDI. The use of aggregate FDI figures alone for each region makes it impossible to pick-up these more recent changes in the focus of FDI.

There is therefore, some difference between the factors that are suggested as being the drivers behind FDI into the West Midlands and Scotland by the official inward investment agencies and those which appear to be important from the findings discussed in this paper.


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Grahame Fallon, Mark Cook, Anti Bilimoria University College Northampton

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