Still coming in

FOR many years governments of both parties have boasted about Britain's success in attracting foreign direct investment (FDI). Britain attracts more inward investment than any country in the world, except the United States. Between 1987 and 1998, 26% of all FDI into the 15 current European Union countries went to Britain.

While boasting about foreign investment is an old tradition, so is warning that Britain is imperilling FDI if it stays out of Europe's single currency, the euro. One top Foreign Office mandarin recalls sounding the alarm to Margaret Thatcher at the Madrid summit of the then European Community in 1989. “I was wrong then,” he says, “but I'll be right eventually.”

Not so far. In 1998 FDI into Britain was the highest ever, and in the first nine months of 1999, estimates Ciaran Barr of Deutsche Bank, it was on course for another record.

All the same, there are now some mutterings from foreign investors. A fortnight ago Stephen Byers, the trade and industry secretary, told the New Statesman: “Recently, for the first time, big inward investors are telling me that we need to make a decision on the euro early in the next parliament.” The Guardian newspaper pointed the finger at a Toyota boss in Japan who it said had told Mr Byers that “if the present situation continues then at the very least it will be impossible to expand our UK operations. If there is no change in the longer term, then we would have to decide whether even our existing operations should continue.”

Toyota's British subsidiary describes such quotes as “inaccurate”. Like many other inward investors, it says the company is worried about the strength of the pound against the euro: no wonder, given that it exports 70% of the output of its Derby factory to other European countries. “But we did not say,” said a spokesman, “that we intend pulling out of the UK.” Indeed, Toyota is just completing a £150m ($245m) investment in a factory in North Wales, which will make engines for the new French-built Yaris model.

There is no doubt that staying out of the euro-zone increases uncertainty for some investors. Anyone serving the euro-zone from Britain must either live with sterling's variability against the euro or hedge against exchange-rate fluctuations as far as they can. At the moment the strength of the pound against the euro is causing headaches. This week, at the equivalent of almost DM3.17, sterling was at its highest since 1989. Not surprisingly, many companies would dearly love to lock in a lower exchange rate.

Take Nissan's British car-making subsidiary. It exports 75% of the output of its Sunderland factory, mainly to the euro-zone. According to the Economist Intelligence Unit, a sister company of The Economist, Nissan Sunderland has the highest productivity of any car plant outside Asia. This week it started producing the Almera model, to add to the 270,000 Micras and Primeras it made last year. Yet the exchange rate is hurting. John Cushnaghan, managing director of the subsidiary, says: “We are strongly in favour of joining the euro as soon as sterling reaches a competitive level. Future investment in the UK will undoubtedly be affected by staying outside the euro.”

So far, though, Britain's absence from the euro seems to have had no adverse effect on investment, even in the sterling-sensitive car industry. Garel Rhys, professor of motor industry economics at Cardiff University Business School, points to a swathe of recent investments by Ford, Honda and others, made even though it was clear that Britain would not be in the euro from the outset. Rover, owned by Germany's BMW, plans to spend £3.3 billion in Britain by 2005. A new engine factory at Hams Hall in Warwickshire, for instance, will turn out 450,000 petrol engines a year, half of which will go into BMWs made in Germany. That said, Rover describes the high pound as “very damaging”. As a hedge against exchange-rate fluctuations, it is planning to reduce its dependence on British suppliers from 90% to 50% over the next four or five years and is asking British suppliers to invoice it in euros.

Although car makers enjoy a high political profile, as a group they are in fact relatively small investors (see chart). And foreign investors in financial services, say, are likely to be less concerned by the currency issue.

In a MORI poll last autumn, 84% of businesses said that British membership of the euro would make no difference to their investment decisions. For many companies, Britain is simply a big market that can only be served properly through a local presence. Consider Microsoft and Oracle, the world's two biggest software companies, which employ 850 and 4,500 people respectively in Britain. Both have offices at a Reading business park, housing British sales, marketing and customer-support operations. Oracle's office, its biggest in Europe, also handles marketing for the region. Microsoft also has a research lab in Cambridge, which benefits from links with the university. Originally, says Oracle, Britain was chosen as the site of its first European subsidiary because of “the common language, the technology-friendly culture and more flexible labour laws than the rest of Europe.”

Look also at Britain's biggest recipient of FDI: the financial industry. Although some feared that the City would suffer because Britain was outside the euro, it thrived last year. Its share of foreign-exchange trade, of which it is the leading centre, went up. And in the third quarter of last year, 58% of euro-denominated Eurobonds were issued in London, up from 48% in the first quarter. Foreigners are still keen to buy the few bits of the City they do not already own: this week America's Citigroup snaffled the investment-banking arm of Schroders (see article).

Does all this mean that if Britain stays outside the euro, it need have no fear of losing FDI? Not necessarily. Some investors doubtless assume that Britain will join eventually: they are prepared to put up with fluctuations against the euro for a few years, but not for ever. This may explain why many American corporations, who are by far the biggest investors in Britain, have paid little attention so far to Britain and the euro. However, Joseph Quinlan, an economist at Morgan Stanley Dean Witter in New York, argues that “Britain's arms-length stance toward the EMU does come at some expense to the US firms that have made the UK central to their European strategies.”

Even the seemingly impregnable City is not entirely out of the woods, says Graham Bishop of Salomon Smith Barney, an investment bank belonging to Citigroup. “The first 12 months were fine,” he says; “what about the next 12 years? With Britain out, is there a risk that the evolution of a single financial market may not favour the City?”

Still, the portents are good for now. Investment is booming. And as long as the pound stays so high, few exporters, foreign-owned or not, will rush to join the euro.