How will Europe compete for investment amid ongoing turbulence?

Authors
Julie Linn Teigland

EY EMEIA Area Managing Partner and EY Global Leader – Women. Fast forward

Passionate about the transformational power of digitalization and innovation and its potential to deliver sustainable, inclusive growth for clients. Prominent voice of the Women20 global agenda.

Hanne Jesca Bax

EY EMEIA Markets & Accounts Leader

Experienced leader blending different cultures, generations, mindsets and genders.

Marc Lhermitte

Partner, EY Consulting, Global Lead – FDI & Attractiveness

Fascinated by the complex interactions between companies, people and the geographies they live in.

15 minute read 31 May 2022

EY research shows that despite the compounding complexity, Europe remains an attractive foreign investment destination in the longer term.

In brief
  • Foreign direct investment (FDI) in Europe increased 5% in 2021 as businesses reignited their expansion plans, but investment levels are still below 2019.
  • Just 25% of businesses surveyed after 14 March plan to establish or expand operations in Europe during the next year, the lowest number in the past three years.
  • Governments should focus on Europe’s digital, sustainability and fiscal competitiveness, and ensure that the recovery works for businesses of all sizes.  

Complexity is compounding. Just as the worst of the COVID-19 pandemic seemed to be over and European economies began to recover, war has returned to European soil. The consequences for businesses with people and operations in Ukraine and Russia are monumental. But all businesses with a presence in Europe have felt the ripple effect, whether that be escalating costs of energy and commodities, sanctions of clients and partners, or more pronounced undercurrents of social tension.

Data for the 21st EY Europe Attractiveness survey was collected before and after the war in Ukraine commenced. Significantly fewer businesses who were surveyed when the full extent of the war was apparent plan to invest in Europe than those surveyed beforehand. More specifically, 79% of those surveyed before 1 March 2022 plan to establish or expand operations in Europe, compared with 67% surveyed between 1 March and 14 March and just 25% of those surveyed after 15 March.

And the ripple effects are likely to continue into the medium and long term, joining other long-term trends also at play. Businesses continue to adopt new technology at breakneck speed. Consumers, employees, investors and regulators put more and more pressure on business to address climate change and other societal challenges. And hybrid work is becoming the norm. It’s no exaggeration to say that businesses face a more complex and rapidly evolving set of challenges than ever before.

Just like businesses, policymakers have competing priorities.  In times of crisis, there is an obvious need to focus on the “now” rather than the “next”. But this should not happen at the expense of fortifying Europe’s long-term attractiveness to foreign investors. Why? Because foreign direct investment (FDI) creates jobs, rejuvenates communities, boosts innovation and stimulates economic growth everywhere.

In times of crisis, there is an obvious need to focus on the ‘now’ rather than the ‘next’. But this should not happen at the expense of fortifying Europe’s long-term attractiveness to foreign investors.
Julie Linn Teigland
EY EMEIA Area Managing Partner and EY Global Leader – Women. Fast forward

Against this backdrop, this article explores whether FDI in Europe was showing any signs of recovery in 2021, following a 13% decrease in 2020. More importantly, it investigates whether growing complexity and turbulence has changed how business decisions are shaped and where facilities are located? If it has, is Europe still competitive?

Local Perspective IconA local perspective

When at crossroads, how does “digital” drive Latvia’s attractiveness?

Technology is always a key factor in deciding the attractiveness of a location and, in the next few years, digital sector is expected to drive growth in Europe overall. Latvia tops the list among Baltic countries with 58% of investors thinking that it’s the key business sector to drive growth. The European average stands at 45%, while the figures stand at 51% and 46% for Estonia and Lithuania respectively.

Almost 99% of respondents in the survey think that the support provided by Latvian government bodies and regulatory authorities in driving a digital agenda is better than or similar to the European average. Every investor believes that the rate of innovation and digital adoption by the public is as good as or better than the rest of Europe.

While short-term investor interest in Latvia is higher than the European average and the highest among the Baltic countries, the three-year forecast is not so positive.  A combination of new sectors, such as digital and emerging ones (e.g., cleantech), would take the country ahead. However, to achieve this, government and administration should take positive steps in terms of regulations and policies. 

Local contact

Guntars Krols
EY Baltics Strategy and Transactions Partner, EY CESA Strategy and Transactions COO, North Cluster Strategy and Transactions Leader

 

The Baltics Attractiveness Survey, 2022

Request the report

 

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1

Chapter 1

A subdued recovery

FDI in Europe grew slightly last year, but investment remained below 2019 levels.

A snapshot of 2021

In 2021, businesses around the world announced 5,877 FDI projects in Europe, a 5% annual increase. The uptick followed a particularly weak year for investment in 2020, when the COVID-19 pandemic caused the number of projects to fall 13% on 2019. The subdued recovery still left investment in 2021 8% below 2019 levels, the last full year before the pandemic hit Europe, and 12% below 2017, a record year for FDI in Europe.

The gradual pace of recovery was in stark contrast to the immediate rebound in FDI after the global financial crisis. Following a sharp 11% decline in 2009, investment levels bounced back strongly in 2010 to record highs. The data for 2021 suggests that the shock of the COVID-19 pandemic may take longer to recover from than first expected.

Headwinds remain that could impact the FDI trajectory

It’s no exaggeration to say that businesses face a more complex and rapidly evolving set of technological, environmental, organizational and societal challenges than ever before.

Although the situation is very fluid, the most likely outcome of the war in Ukraine is a scenario in which the majority of international sanctions and supply chain disruptions persist. Continued geopolitical uncertainty and other second-order impacts, such as commodity price inflation and heightened risks of cyber-attacks on large businesses and critical infrastructure, would also continue to weigh on business.

It’s no exaggeration to say that businesses face a more complex and rapidly evolving set of technological, environmental, organisational and societal challenges than ever before.
Marc Lhermitte
Partner, EY Consulting, Global Lead – FDI & Attractiveness

The survey launched before the war in Ukraine began, so the war and its impacts were not included as an answer option when participants were asked to select their top risks to Europe’s attractiveness. That said, the war caused other risks to rise up the agenda. For example, surveyed businesses ranked high volatility in currencies, commodities and other capital markets as the joint-second top risk to Europe’s attractiveness during the next three years (Figure 2). Last year it ranked fifth.

Businesses ranked the legislative framework for digital services and markets as the second greatest risk to Europe’s attractiveness, up from fourth place last year. This likely stems from uncertainty about the impact of the Digital Markets Act, which is designed to stimulate competition within Europe’s digital sector, and the Digital Services Act, which is a range of regulations that protect technology users from misinformation, cyber threats and market dominance.

Shifts in European environmental legislation and policies ranked as the fourth-greatest risk to Europe’s attractiveness. This is likely a result of fears that climate change policies will push up energy prices, which have already increased significantly in some European countries since the beginning of 2022.

Then of course there is the risk that a new vaccine-resistant COVID-19 variant could materialize. If this resulted in the scale of lockdowns in 2020 and corresponding decline in economic activity, then FDI could be materially impacted.

Europe remains an attractive long-term destination

Foreign investment levels in Europe started to recover in 2021, but the survey data indicates that this may be short-lived given the war in Ukraine.

Some 53% of businesses planned to establish or expand operations in Europe during the next year, a significant increase on 40% in 2021 and 27% in 2020. However, the timing of respondents’ answers – in other words, whether they replied before or after the war in Ukraine began – played a major role. Just 25% of those surveyed after 15 March said they planned to invest in Europe. If the appetite of those surveyed with full knowledge of the war truly represents business sentiment, then appetite to invest during the next 12 months is actually at a three-year low.

Although businesses have throttled back on their investment plans, respondents said they were still positive on the long-term prospects for investment in Europe (Figure 3).

Why did investors say they were optimistic about Europe’s attractiveness given the war in Ukraine and future geopolitical uncertainty? Perhaps counterintuitively, the geopolitical situation may even increase FDI in Europe if supply chains are disrupted to the point that businesses begin to either re-shore or nearshore operations back to Europe. Investment could also recover quickly because the COVID-19 restrictions have impeded investment for the past two years, causing pent-up demand on the ability to initiate projects.

trekkers crossing gokyo glacier in khumbu valley chapter
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Chapter 2

Different fortunes for European destinations and sectors

FDI in 2021 presented a variable picture across countries and business sectors in Europe with many companies rethinking their operations.

France shines: mapping European FDI in 2021

In 2020, France, Germany and the UK were virtually tied in first place as the largest recipients of FDI within Europe. That changed in 2021.The number of announced projects in France rocketed 24% to 1,222 projects. In stark contrast, the number of projects in Germany tumbled 10% to 841. Investment in the UK remained steady, increasing 2%. As a result, there is now a clear gold, silver and bronze placing in the country FDI rankings.

EY Europe Attractiveness Survey 2022

24%

increase in investment projects in France from 2020.

Although France outperformed every other country in terms of the number of announced projects, these projects are typically smaller than elsewhere. Based on projects where the number of jobs created is disclosed, the average foreign investment created 68 jobs in the UK, 45 in Germany and just 38 in France. In fact, the UK attracted more investments that created more than 100 jobs than France in 2021.

Top 10 FDI countries in 2021

Rank Country Number of projects Percentage change
1 France 1,222 24%
2 United Kingdom 933 2%
3 Germany 841 -10%
4 Spain 361 2%
5 Turkey 264 27%
6 Belgium 245 8%
7 Italy 207 83%
8 Portugal 200 30%
9 Poland 193 -12%
10 Ireland 152 -8%

Source: EY European Investment Monitor (EIM) 2022.

The picture was mixed outside of Europe’s three major markets:

  • In Southern Europe, Italy (+83%), Portugal (+30%) and Turkey (+27%) experienced a sharp increase in the number of projects due to the reshoring and nearshoring of global supply chains.
  • In Western Europe, countries that were traditionally attractive but more service-oriented, such as the Netherlands (-22%) and Ireland (-8%), lost ground because of the decline in services projects following the surge in remote working.
  • In Eastern Europe, the stagnation in the number of projects suggests that this historically very strong FDI destination during the past decade is not benefiting from industrial and logistical reconfigurations as much as elsewhere.

Manufacturing and logistics recovery offsets downswing in office-based FDI

Countries welcome all forms of foreign investment, but industrial projects (manufacturing, logistics and R&D) are most sought after due to their ability to create jobs and stimulate growth. Encouragingly, the number of announced projects in all three of these areas increased significantly in 2021 to the extent that they are now above pre COVID-19 investment levels (Figure 4).

The increase was in part caused by the rebound effect: investors making up for lost time after not logistically being able to execute projects during the pandemic. It could also represent a degree of supply chain reorchestration. Burnt by lockdown-induced supply chain bottlenecks, some businesses were perhaps starting to bring industrial supply chains closer to home. 

On the other hand, the COVID-19 pandemic also forced employees around the world into remote working. After a year of broadly positive experiences, many businesses began adopting hybrid working practices, where employees work on a more flexible basis, as the new norm. This led to lower FDI because businesses could already mostly fulfill their office-based activities from existing locations. This materially impacted investment in sales and marketing offices, which fell 25% in 2021.

Sectors in focus: automotive, transport and aeronautics lead the way

In 2020, foreign investment fell in every major sector apart from life sciences. Transport manufacturing was most significantly affected, with FDI decreasing 35%. The picture was very different in 2021 (snapshot below).

Snapshot of sector foreign investment projects by sector

Sectors 2020 2021 Change Share of FDI
Transportation and Logistics 217 425 96% 7%
Transportation Manufacturers and Suppliers 305 503 65% 9%

Utility supply

145 203 40% 3%
Business Services and Professional Services 691 557 -19% 9%
Machinery and Equipment 425 384 -10% 7%

Source: EY European Investment Monitor (EIM) 2022.

Many sectors bounced back, including transportation and utilities. Following a 35% decrease in 2020, foreign investment in the automotive, public transport equipment and aeronautics sectors rocketed 65% to eclipse pre-pandemic levels last year.

In contrast, the business and professional services sector announced 557 foreign investment projects in Europe in 2021, a 19% and 28% decrease from 2020 and 2019 respectively. Office-based sectors such as this throttled back on investment as they determine their real-estate strategy.

Supply chain reorchestration comes to fruition

As a direct result of the war in Ukraine, businesses are seriously considering upending their supply chains. Fifty-three percent are considering nearshoring closer to customers, a significant increase on 23% last year. In parallel, 43% are considering reshoring activity back to their domestic market, compared with 20% last year.

EY Europe Attractiveness Survey 2022

53%

of businesses are considering nearshoring closer to customers.

The relocation of industrial activity back to Europe would certainly be a boon to Europe. But is it realistic? After all, as COVID-19 struck, a staggering 83% were considering reshoring or nearshoring. This sentiment rapidly dissipated, perhaps as businesses realized the hefty cost implications of shifting supply chains back to Europe.

Today, there is greater reason to believe that supply chain reorganization will take place. For a start, businesses will be forced to seek alternatives to sourcing components and materials from Russia. And although many factories still operate in the west of Ukraine, output has been disrupted to the extent that businesses may be forced to seek alternatives if the war persists and spreads.

Second, energy prices have risen such that transporting materials and components from Asia has started to erode the region’s cost competitiveness. Linked to this is the issue of sustainability. Regulatory and consumer pressure to decarbonize supply chains makes local sourcing more compelling.

Finally, the war in Ukraine has exposed deeper geopolitical tension between Europe and other countries. None of these issues by themselves would necessarily be a sound reason to relocate supply chains, but collectively they create a compelling business case.

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Chapter 3

Five business priorities for European governments

Businesses are optimistic that Europe will retain its status as a highly attractive long-term destination for foreign investment.

Many strategic, operational, financial and technological factors influence investors’ decisions, but the EY Europe Attractiveness Survey 2022 highlights five priorities that governments must address to maintain Europe’s attractiveness.

Priority one: Focus on digital

The level of technology adoption by consumers, citizens and administrations is the most important factor that determines where businesses invest. Last year, this only ranked joint-fifth. The increase in importance reflects the huge investments many businesses have made in technology since the onset of the COVID-19 pandemic to facilitate remote working and digital customer propositions.

Businesses need employees with technology skills to sustain their increasingly digitalized operations. And this is likely why the level of technology adoption is considered so important: businesses view this as a proxy for countries with an abundant supply of workers with technology capabilities. Skills aside, businesses also consider this so important because it eases the process of interacting with tax authorities, regulators and other government agencies.

Furthermore, when asked which technology-related factors are most important when choosing a country to invest in, the availability of a workforce with technology skills ranks first (Figure 5). 

Intellectual property rights protection is the second most important technology-related factor that influences location decisions. This is understandable. Businesses will not invest in R&D if they perceive that their creations will not be protected.

Encouragingly, 56% of investors believe Europe is more attractive than other regions when it comes to technology-related factors. Just 12% say it is less attractive.

EY Europe Attractiveness Survey 2022

56%

of investors believe Europe is more attractive than other regions when it comes to technology-related factors.

Priority two: Secure Europe’s competitive edge in sustainability

This year, businesses rank the policy approach to climate change and sustainability as the second-most important factor that determines where they invest. Last year, this ranked second to last.

Why have sustainability policies risen up the agenda? Firstly, most businesses now realize that the COVID-19 pandemic has raised the expectations of consumers, investors, regulators and their own staff to tackle climate change and other societal issues. They therefore see it as a key competitive differentiator. This influences location decisions because businesses wish to be situated in countries where funding for sustainability initiatives is available and where the regulatory landscape supports sustainability practices.

Sustainability has also risen because more government funding is now available for sustainability initiatives under EU and national stimulus plans. For example, 37% of stimulus funding provided as part of the Recovery and Resilience Facility (RRF) must be devoted to measures that support the green transition.

The majority of businesses (83%) already see Europe as a “green leader.” But at the same time, businesses consider environmental legislation a major risk to Europe’s attractiveness. They must therefore proceed with caution and strike a careful balance between promoting sustainability while not overburdening business.

EY Europe Attractiveness Survey 2022

83%

of investors see Europe as a global green leader.

Policymakers also need to build a democratic consensus for Europe’s sustainability drive and ensure that businesses and individuals that might be adversely affected, such as those that work in “brown industries,” are protected as much as possible. Urgent action is required to make a green and innovative Europe a reality.

Urgent action is required to make a green and innovative Europe a reality.
Hanne Jesca Bax
EY EMEIA Markets & Accounts Leader

Priority three: Create the skills needed to transform European business

Businesses rank the presence of a skilled workforce as the number one HR-related factor that determines location decisions (Figure 6). 

Today, two types of skills that enable businesses’ digital and sustainability transitions are in high demand. Indeed, when asked which sustainability-related factors are most important to choosing a country to invest in, the presence of a workforce with the skills and competencies needed to facilitate sustainability projects ranked joint-first alongside the presence of regulation that supports sustainable business practices.

This is unsurprising. The International Energy Agency (IEA) estimates that 14 million new jobs will need to be created in the energy sector alone by 2030 in the transition toward net-zero emissions. An additional 16 million workers are needed in the efficiency, automotive and construction sectors. 

This is a rallying call to European and national governments. They must work with businesses and academia to ensure that the right skills are being created. Timing is all important. Produce skills too late and Europe’s digital and green transition will be slowed. But produce skills before they are needed, and individuals may move out of Europe to where they are required.

Priority four: Reinforce tax competitiveness and agility

Businesses want the process of tax compliance to be as simple as possible. And when complex issues arise, they want tax authorities to demonstrate a degree of pragmatism and flexibility. This is why the degree of digitalization of tax authority systems is the most important tax-related factor that determines where businesses invest (Figure 7). Digitalization is so important because it helps businesses demonstrate tax compliance as simply and effectively as possible.

Digital communication channels also enable more frequent and direct interactions with tax authorities, which helps to resolve complex matters  ̶  all the more critical in a time when they need to adapt quickly.

Businesses rank the scope and rate of environmental taxes as the second-most important tax-related factor that determines location decisions. This likely reflects concerns that governments will introduce new taxes or raise existing taxes to fund the transition to the green economy.

The availability of R&D tax credits ranks third. This is likely because it is one of the few remaining areas of tax competition in Europe, and an important lever that governments can pull to attract investment and boost their country’s competitiveness.

Priority five: Refresh support for small and medium-sized companies (SMEs)

The survey reveals that the perception and outlook of executives of small and medium-sized companies (SMEs), which includes enterprises below €1.5 billion in revenues, is less positive than those of multinationals. For example, 34% of small businesses’ 2022 investment plans are still delayed or curtailed due to the COVID-19 pandemic. This is only the case for 13% of large businesses.

EY Europe Attractiveness Survey 2022

34%

of small business’ 2022 investment plans are still delayed or curtailed due to the COVID-19 pandemic.

Small companies may need a different form of government support. All large companies report that the RRF has been a deciding factor in their decision to maintain or expand their operations in Europe, compared with only 54% of small companies. 

Although the RRF will undoubtedly indirectly benefit smaller organizations, the survey data indicates that they need additional support. Policymakers must work closely with SMEs to understand their challenges and requirements, and design support packages appropriately.

Useful support might include enhanced protection for late payments, improving access to financing and reducing regulatory burdens. This is vital: SMEs employ about 100 million people, account for more than half of Europe’s GDP and play a key role in creating value in all sectors.

Summary

Businesses face more complexity now than ever before. Although there were signs of investment recovery in 2021, ongoing turbulence means Europe cannot be complacent when it comes to long-term attractiveness. Looking ahead to the next three years, policymakers should respond to businesses’ changing investment criteria to reinforce Europe’s performance in attracting foreign investment.

About this article

Authors
Julie Linn Teigland

EY EMEIA Area Managing Partner and EY Global Leader – Women. Fast forward

Passionate about the transformational power of digitalization and innovation and its potential to deliver sustainable, inclusive growth for clients. Prominent voice of the Women20 global agenda.

Hanne Jesca Bax

EY EMEIA Markets & Accounts Leader

Experienced leader blending different cultures, generations, mindsets and genders.

Marc Lhermitte

Partner, EY Consulting, Global Lead – FDI & Attractiveness

Fascinated by the complex interactions between companies, people and the geographies they live in.