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How can Europe reset the investment agenda now to rebuild its future?


COVID-19 has slowed foreign investment in Europe, but there’s still cause for optimism, according to EY’s latest Attractiveness survey.


IForeign direct investment (FDI) rarely makes the headlines. Browse the business pages of leading publications, and you’ll see a range of news about mergers and acquisitions (M&A), infrastructure investment and initial public offerings. FDI is often an afterthought.

It shouldn’t be. According to the European Commission, FDI totaled €7.2 trillion as of the end of 2018, accounting for 45% of the EU’s gross domestic product (GDP).

FDI also turbocharges research. Foreign-owned firms account for a quarter of business R&D in France, Germany, and Spain; between 30% and 50% in Portugal, Sweden, and the UK; and more than 50% in Austria, Belgium, and Ireland.

It is therefore vital to understand what drives businesses to invest in particular countries and regions, how their location priorities are changing, and what governments can do to influence these decisions.

In this spirit, EY has conducted extensive research on the level of FDI in Europe, and what drives it, every year for the last 19 years.

This year, our usual research program was interrupted by the coronavirus disease (COVID-19) outbreak. Like almost every aspect of life, the pandemic has disrupted, though by no means decimated, FDI.


To remain attractive in this reframed business environment, Europe - businesses and governments together - must think creatively, act decisively, and put cohesion and collaboration at the heart of everything it does

The results are sobering, but certainly not discouraging. For example, 9 out of 10 surveyed businesses expect to decrease or delay investment plans this year, though 51% plan to do so to a minor extent. The exact impact in investment levels will, of course, depend on the extent to which the global economy recovers and how FDI is incentivized at a local level.

We believe FDI can also spark Europe’s economic recovery and transformation. Of course, countries must count on investment from the United States (US) and Asia to remain active in Europe, the world’s number one economy. But we also think that FDI from Europe can be an incredible economic and transformational force for Europe.

For this to happen, European countries and institutions, as well as global companies headquartered in Europe, must grasp what it means to be an attractive FDI destination post-COVID-19.

“To remain attractive in this reframed business environment, Europe - businesses and governments together - must think creatively, act decisively, and put cohesion and collaboration at the heart of everything it does,” says Julie Teigland, EY EMEIA Area Managing Partner.


Chapter 1: How was European FDI performing when COVID-19 hit?

Chapter 2: How will COVID-19 affect new FDI in 2020 and beyond?

Chapter 3: Which trends will determine FDI in the new business environment?

Chapter 4: How can Europe attract the FDI critical to its recovery?

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Chapter 1

How was European FDI performing when COVID-19 hit?

European FDI stabilized in 2019, but projects are in jeopardy.

Today, 2019 seems like a distant memory; yet it’s worth reflecting on the state of FDI before the pandemic hit. EY analysis reveals that 6,412 FDI projects were announced in Europe last year, a 0.9% uptick on 2018. Investment was particularly strong in France and Spain, but global trade tensions, Brexit uncertainty and subdued economic growth caused investment across all of Europe to increase by only a modest amount.

Even so, measured by the number of announced projects alone, 2019 was the second-strongest year for FDI ever, behind 2017.

“Foreign direct investment can, in several ways, spark Europe’s economic recovery and transformation post COVID-19,” says Hanne Jesca Bax, EY EMEIA Managing Partner Markets & Accounts.

A record year for FDI
6,412
FDI projects announced in 2019 across the 47 countries of Europe, a +0.9% increase year on year, making it one of Europe’s strongest years ever.

Historically, only a marginal number of FDI projects announced in any particular year is not delivered. But COVID-19 interrupted project realization. EY analysis reveals that market uncertainty and, in some sectors, market decimation will result in only 65% of projects announced in 2019 being delivered on time. A further 25% are delayed and 10% are cancelled. 

COVID-19 interrupts - but does not stop - FDI
65%
of FDI projects announced in 2019 will be delivered on time. A further 25% are delayed and 10% are cancelled.

Even the projects that are proceeding as planned may not meet their investment and employment targets.

The impact of COVID-19 on project realization is less severe in certain countries. In highly competitive, service-oriented countries such as Ireland, Poland, and Portugal, where a large proportion of FDI involves shared service centers, software development offices or research and development facilities, up to 80% of FDI projects are likely to be maintained. This is significantly higher than the average 65% realization rate across Europe

A resilient Europe investing in itself is the foundation for recovery, and will reframe Europe’s future.

France overtakes the UK as Europe’s top FDI destination

Investment in France rocketed 17% to 1,197 projects in 2019, with a 18.8% market share. For the first time, France attracted more FDI projects than any other country last year. France’s resurgence, which has gathered pace since 2017, is a direct result of President Macron’s reforms of labor laws and corporate taxation, which were well received by domestic and international investors alike.

Europe’s top investment destination
17%
The annual increase in FDI in France, which attracted 1,197 new projects.

Across the Channel, investment in the UK increased 5%, demonstrating resilience to Brexit uncertainty. However, the country lost its top rank for the first time ever.

Other countries with strong performance include Portugal (+114%), Spain (+55%) and the Netherlands (+11%). It remains to be seen how COVID-19 will affect the realization of FDI projects, particularly in Spain, where the economy has been one of the more disrupted in Europe.

FDI decreased in Ireland (-7%), Russia (-9%), Poland (-26%) and Turkey (-33%). Germany’s stability in FDI reflects the structural difficulty for new entrants to hire staff in crowded labor pools, and the fact that supply chains are already very well organized and integrated. Decreases in Russia and Ireland follow strong levels of investment in 2018. 

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FDI surges in Europe’s major cities

Although European FDI only increased by 0.9% last year, investment in major cities exploded. In Greater London, investment increased 17% due to its digital and business services leadership, while investment in the Paris region surged 34%. These two regions account for 8% and 6% of FDI across Europe respectively.

The strong industrial regions of Bavaria and North Rhine-Westphalia (NRW) had mixed fortunes. Investment in NRW rocketed 44% and it is now the third-largest region for FDI in Europe, while investment in Bavaria dropped 24% and it is now ranked fourth. In both regions, the high proportion of manufacturing projects means more FDI projects announced in 2019 will be delayed or canceled, and those that proceed are more likely do so with less job creation.

Major European cities continued to attract foreign investors
14%
The share of FDI that Greater London and Paris attracted in 2019.

FDI dominant in digital and business services sectors

The digital and business services sectors attracted most FDI in 2019, collectively accounting for 31% of new projects and 24% of new jobs created. Anecdotal insight from local governments indicates that most projects in these sectors had already been implemented before COVID-19 unfolded.

Projects in the transportation sector, including automotive and aeronautic manufacturers and suppliers, which accounted for 7% of new projects and 23% of new jobs, are more at risk. Along with the industrial equipment, chemicals and plastics sector, our research shows that this industry has experienced the greatest supply chain disruption and revenue losses, leading to a greater proportion of projects being delayed or downsized than in other sectors.

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    Chapter 2

    How will COVID-19 affect new FDI in 2020 and beyond?

    Investors ease off new projects, but do not fully retreat.

    At the time of writing, COVID-19 had put the brakes on investment plans in Europe, though not halted them altogether.

    A survey of 113 businesses at the end of April 2020 revealed that 51% expect a minor decrease in 2020 FDI plans; 15% expect a substantial decrease; and 23% plan to delay new projects until 2021. Only 11% do not expect any change.

    FDI planning in Europe
    66%
    of business executives surveyed expect a decrease in 2020 FDI plans.

    Investment intentions have understandably fallen because lockdowns make it practically impossible to evaluate and execute investment projects. The economic uncertainty caused by the outbreak also means companies are reconsidering whether manufacturing, research or support services projects are still financially viable. Indeed, 73% of businesses expect COVID-19 to have a severe impact on the global economy, according to EY’s Capital Confidence Barometer launched in March 2020.

    If optimistic predictions of a V-shaped recovery materialize, in which economic activity rebounds strongly in the second half of the year, FDI could recover strongly. By contrast, pessimistic predictions of a protracted depression would dampen it for the foreseeable future. EY’s macroeconomic modeling suggests that an uneven, saw-toothed, slow recovery, marked by choppy, uneven growth, is most likely.

    FDI recovery rates are still difficult to predict because investment is also contingent on the rate of recovery in the regions from which FDI into Europe emanates, beginning with Europe itself.

    A protracted European recession would significantly affect FDI, given that 52% of European investment came from European companies between 2015 and 2019. That said, some countries are especially reliant on the US, such as Ireland, where 40% of the private sector depends on US companies.

    The shape of the recovery curve will vary depending on individual countries’ ability to control infection rates within health care capacity and according to different levels of exposure to global value chains.

    FDI is most at risk in sectors hit hardest by COVID-19

    COVID-19’s impact on market demand and the ability to execute operations varies significantly by sector. This has a direct knock-on effect on FDI. Companies in sectors experiencing a surge in demand due to COVID-19 (such as life sciences, essential consumer goods and retail, e-commerce, and online entertainment) are more likely to maintain their investment plans.

    By contrast, a global survey of investment promotion agencies conducted by the World Bank revealed that supply chain disruptions are hitting production and revenues. This is resulting in Capex and employment reductions in investment plans, particularly impacting manufacturing investment in the transportation and textile industry.

    With regard to manufacturing FDI projects, the transportation industry (including automotive and aeronautics), chemicals and plastics, machinery and industrial equipment, and agri-food sectors will all be hit hard. The pharmaceutical and medical equipment sectors appear resilient for now. 

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    National stimulus packages sway foreign investors, but cities and regions need a fresh approach

    COVID-19 is likely to reset investors’ perceptions about which countries and cities are attractive. With scientists unsure whether a second wave of COVID-19 will materialize in the last quarter of 2020, businesses might start to favor FDI in European countries less affected by the first wave of COVID-19 at the expense of those worst affected.

    The same applies to cities. COVID-19 might reverse the fortunes of Europe’s major cities such as London and Paris, with those that appear less resilient to pandemics potentially becoming less attractive in the future.

    Leaving aside their specific vulnerability to COVID-19, major cities may lose economic muscle due to several trends accelerated by the lockdown experience. Businesses may no longer consider it necessary to locate offices in dense cities if they allow greater numbers of staff to work from home, and citizens may be attracted away due to concerns about future outbreaks and air pollution. Certain European countries, such as the UK, are actively trying to rebalance prosperity away from capital cities to smaller cities and regions.

    Cities and countries of all sizes have an opportunity to shape their own attractiveness. Indeed, 80% of business leaders surveyed at the end of April 2020 say that the nature and weight of the stimulus packages-mostly national-will influence their future location choices. Countries and cities can increase their attractiveness with targeted FDI support; however, unexpected but necessary spend on wage subsidies, tax deferrals, rate reductions and business interruption loans may leave little scope for it.

    This new reality presents a new set of challenges and demands innovative policies and ideas, from both the public and private sector, with the EU assuming an important role

    Brexit no longer the major threat to FDI, but uncertainty remains

    Fears of a no-deal Brexit were put to bed following the decisive victory of the Conservative Party in the UK general election in December 2019. The subsequent implementation of the Withdrawal Agreement was supported by business leaders because it removed the immediate possibility of a no-deal Brexit. This is reflected in our survey data, with just 24% identifying Brexit as a top-three risk to Europe’s attractiveness in the next three years, compared with 38% last year.

    The EU and the UK wish to enter into a free trade agreement, but there are major disputes about the extent to which the UK will have to continue to abide by EU regulation. COVID-19 has also delayed negotiations, and most observers believe there is simply not enough time to agree and ratify an all-encompassing free trade deal.

    If a deal is not agreed in time and the transition is not extended, the UK and the EU will face trading on World Trade Organization  terms. However, a more realistic scenario is that a narrow trade deal covering goods will be agreed, but that discussions relating to services will be pushed back.

    A comprehensive free trade deal would boost FDI in the UK and in its trading partners significantly; however, the 5% increase in UK FDI in 2019, when Brexit uncertainty was at its peak, indicates that the lack of a comprehensive free trade deal will not sever long-term investment prospects.

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    Chapter 3

    What will drive FDI in the reframed business environment?

    Technology, sustainability and a reconfiguration of supply chains will be major areas of focus.

    EY’s research in April 2020 shows that executives making location decisions expect three megatrends to influence their European investment plans:

    1. The acceleration of technology for cost reduction and customer access
    2. A sharper focus on climate change and sustainability in investment decisions
    3. A reconfiguration of supply chains, with a new mix of reshoring, nearshoring, and offshoring
    The fate of FDI in Europe will not just be governed by economic forces. FDI itself can also spark Europe’s economic recovery and transformation

    Technology investment set to accelerate

    COVID-19 has altered consumers’ and businesses’ relationship with digital technologies in a matter of a few weeks.

    More than half of companies (55%) plan to enhance digital customer access, virtualize business-to-consumer interactions and engage in more e-commerce in the short term.

    In parallel, we expect companies to accelerate investment in more intelligent automation and robotization of manufacturing and transactional services such as IT, human resources and finance.

    While digitalization was a “can” before the pandemic, it is now a “must.” Businesses clearly recognize this, with 82% expecting technology adoption to accelerate in the next three years as a result of COVID-19. 

    Technology adoption
    82%
    of surveyed business leaders expect technology adoption to accelerate in the next three years as a result of COVID-19.


    Countries’ digital competitiveness, including digital infrastructure, digital skills, and a dynamic environment of technology companies, has long determined their attractiveness. Before COVID-19, businesses ranked gaining global leadership in the digital revolution as the top priority for Europe to increase its attractiveness. In parallel, businesses ranked the availability of a workforce with technology skills as the most important factor to determine where they invest. 

    Accelerated technology adoption will make countries’ digital competitiveness an even more important factor in investment decisions. Governments must therefore ensure fair access to fast internet and communications infrastructure in remote areas. This would help improve FDI attractiveness beyond major cities. 

    Renewed sustainability agenda will reshape the way investment decisions are made

    COVID-19 has enhanced citizens’ and consumers’ appreciation of, and demand for, sustainability. They enjoy the benefits of lower air pollution caused by the lockdowns. The closure of all but essential shops has forced frugality, which may endure. And awareness of income inequality has grown, especially in relation to frontline health care workers.

    Therefore, populations will increasingly demand that businesses address major societal challenges, such as climate change and income inequality. Moreover, governments may impose regulations that encourage businesses to drive this change.

    Most businesses recognize this: 57% anticipate a renewed focus on sustainability and climate change in the next three years due to COVID-19.

    Sustainability
    57%
    of surveyed business leaders anticipate a renewed focus on sustainability and climate change in the next three years.
    The economic recovery from the COVID-19 crisis has the potential to accelerate the transition to a sustainable future. And the push for sustainability also creates industrial opportunities.

    How will this influence FDI? Businesses that already have sustainability at the heart of their corporate agenda may find Europe more attractive from an FDI perspective if the continent’s business, regulatory and societal climates reflect their own aspirations.

    On the flipside, there is a risk that overbearing regulation and uncompetitive taxes implemented to enhance sustainability may detract from Europe’s attractiveness. 

    Reconfigure supply chains for resilience and agility

    The risk of future pandemics, increased geopolitical tension, and climate change will reinforce the need for flexible supply chains. Quite how this is implemented depends heavily on the needs of individual companies and the sectors in which they operate, but FDI is likely to play a strong role.

    Rather than a massive reshoring movement, a regionalization of supply chains is expected by 83% of the surveyed executives, with a move of certain production sites and their value chains closer to the borders of the EU and Africa. At the same time, some onshoring of critical activities will happen, help create a more agile value network and restart production, while mitigating risk of disruptions in the future.

    Location considerations aside, 61% of businesses expect to reduce their dependence on single-dominant-source countries. 

    Supply chain
    61%
    of surveyed business leaders expect to reduce their dependence on single-source countries.

    Technology will play a role here, too. Almost 80% of businesses plan to move to lean or additive manufacturing (e.g., 3D printing) to gain advantages in speed, cost, precision and materials.

    Technology may have a further role in keeping manufacturing facilities open by improving health and safety: for example, technologies will be deployed to track employee health, reduce human-to-human interactions, and improve ventilation.

    Those with a resilient supply chain have seen huge competitive advantage in the recent period of COVID-19, and I think this will continue in the longer term.
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    Chapter 4

    How can Europe attract the FDI critical to its recovery?

    We offer four recommendations on how Europe can act decisively to retain its attractiveness.

    An alarming number of executives are pessimistic about Europe’s prospects post-COVID-19, with 49% believing that Europe is at risk of being less or much less attractive for investment. Of course, all regions are likely to be less attractive for cross-border investment, not just Europe. Nonetheless, Europe must act decisively to retain its attractiveness. Here are four ways it can achieve this.

    Recommendation 1: Protect globalization, starting within Europe

    COVID-19 has accelerated existing anti-globalization trends. Many national governments, including those in France and Germany, have touted the need to develop domestic supplies of certain products. At the same time, barriers to acquisitions of key companies from foreign acquirers have been fortified.

    Perhaps reflecting this, 37% of surveyed businesses are considering increasing their manufacturing presence in Europe. It is unclear whether this trend will grow to include investment in multiple sectors or just in essential products, such as medical equipment. In addition, major countries, particularly the US, continue to repudiate critical international institutions and treaties. 

    Manufacturing
    37%
    of surveyed business leaders are considering increasing their manufacturing presence in Europe.

    Against this backdrop, the EU has an opportunity to act as a strong voice for international collaboration and coordination, starting within its own borders. This spirit is required not only to build resilience to future shocks, but also to create an environment that attracts future investment, growth, and prosperity for all.

    EY’s analysis shows that investment projects from European companies into another European country represented more than half (52%) of FDI in the past five years. This, we believe, is the foundation for Europe’s recovery. Rebuilding confidence among and between European citizens, consumers, manufacturers, and financial investors must be the priority to restart the European engine.

    Europe now needs to turn its attention to supporting business and investment in the long term. As a starting point, it must revisit tax reform.

    Recommendation 2: Invest in technology, health care and environmental industries

    The importance of Europe’s technology and sustainability sectors in economic growth is not lost on survey participants. They rank CleanTech first in terms of its potential for economic growth across Europe in the coming years. The digital economy sector ranks second, and the health care and well-being sector third.

    But continued investment in Europe’s technology-intensive sectors is not guaranteed. The continent needs a robust digital infrastructure, with fast and reliable connectivity. To protect the health of Europe’s 500 million citizens, the EU will also need a plan to promote research for treatments and vaccines, and to work together with EU Member States to reinforce national health care systems.

    To remain a priority destination for talent, entrepreneurs and global firms, European countries must adapt their education and training systems to equip people with the right skills for the labor market.

    Companies that establish in-house digital training and development opportunities will be better positioned to attract and retain talent

    Recommendation 3: Fund the “new normal” with a careful balance between public support and economic competitiveness

    EU Member States and the EU itself have provided significant funds to help businesses deal with the economic impact of COVID-19. However, funding is needed not only to weather the storm, but also to rebuild after it. Infrastructure investment will be needed to rejuvenate distressed regional economies; early-stage financing will be needed to catapult new businesses; and multinationals will need capital to fund expansion.

    This calls for new sources of public and private finance and a gradual reduction in the dependency on bank loans. For example, Europe has long looked with envy at the US’s vibrant venture capital environment. Perhaps now is the time to create the conditions in which venture capital in Europe can thrive. In addition, some of the debt incurred by small and medium businesses could be turned into equity in the long term.

    Where public finance is concerned, governments must strike a careful balance between increasing taxes to pay for the recovery and stimulus, and ensuring European businesses are competitive with their Asian and US competitors. For example, the technology sector, was identified by our survey of 500 European executives as the number one priority for the attractiveness of Europe. This sector must be taxed appropriately, but overbearing costs or regulation may deter future investment. 

    Recommendation 4: Prepare for the next crisis

    After COVID-19, being an attractive investment destination means being resilient and agile. Europe must ensure it is prepared for future shocks, whether it be another pandemic, a mass cyber event or an environmental catastrophe.

    Preparation must take place on a number of fronts. As a starting point, the advanced analytical power of Europe’s academic and corporate sector must be used and increased to predict, track, and mitigate future crises more effectively.

    The EU’s key institutions must also ensure they are adequately prepared. Many of the institutions that bind Europe together faced heavy criticism for their response to COVID-19. While organizations will need to learn vital lessons, calls to disband or dismantle these institutions must be resisted. FDI in Europe will only prosper with collective action and initiatives spearheaded by cohesive European institutions.

    Finally, the pandemic has highlighted the economic vulnerability of certain segments of society and demonstrated that the vulnerability of some increases the vulnerability of all. Businesses and governments must protect not only the most vulnerable sectors, but also the most vulnerable people, including part-time, independent and gig workers.

    We can’t forget that people may lose the incentive to acquire the skills if all they see in the future is the precarious gig economy.
    Improving resiliency will not only protect businesses and people but also make Europe competitive and attractive to foreign investors, which will be needed to accelerate the recovery.

    Summary

    Europe must take decisive action to drive economic recovery after COVID-19. To remain attractive in this new business environment, EU Member States must focus on intra-European investment and create more agile and resilient markets.


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