Fiscal attraction

By Neil Davey

Europe is the most attractive region in the world in which to invest according to a new study. Business Management takes a look at the reasons for its appeal, the countries ranked most attractive in Europe – as well as the challenges that lie ahead.

With emerging economies such as China and India batting their eyelids at foreign investors, fears have grown that Europe’s leading figures are to be increasingly overlooked. But according to the latest Ernst & Young European Attractiveness Survey, Europe is still the big winner in this international beauty contest. Analysing the investments and expansion projects of foreign investors in Europe in 2005, together with the perceptions of over a thousand foreign investors, the survey concluded that at a global level the European zone is the most attractive region for investment in the world.

Although internationally the United States and China are the joint leaders in terms of appeal to global investors, six European countries rank in the top ten attractive locations. And the findings suggest that the near future looks similarly bright – a majority of the CEOs felt that the image of Europe as a whole had improved in 2005 whilst other regions, notably China, have declined in popularity. The findings of the study are in stark contrast to the recent IMD World Competitiveness Yearbook, where European countries had a disappointing showing compared with those of North America and Asia. Marc Lhermitte, a Partner at Ernst & Young and author of the repot, explains the factors by which a country or region’s ‘attractiveness’ is measured.

“Fundamentally, it has to be a source of business for companies,” he says. “Secondly, it has to be cost competitive, particularly in labour costs which account for most of the investment outline of a company, whether they are in manufacturing, logistics or services. It doesn’t have to necessarily have the lowest cost, however, just be the most competitive in line with a company’s strategic and operational objectives. And the final factor is quality. Can a company develop the skills that it needs in the country or region? To be attractive it has to have the education system, the technology clusters system and sometimes the incentive system.”

Certainly Europe’s market is an enormous source of business for companies. With nearly 500 million inhabitants harbouring some of the highest purchasing power in the world, Europe is a veritable goldmine for investors and ongoing efforts to complete the single market have contributed to its appeal.

“The basic attractiveness of Europe is that it is a huge market,” suggests John Hawksworth, Head of Macroeconomics at PricewaterhouseCoopers. “And although some barriers do still exist in the European Union, you have a single market that does not have trade barriers. This has made Europe a market of somewhat comparable size in total to the US, so it is an attractive place to come to sell your goods. If you are looking to set up distribution retail outlets, it is attractive. And it is also an attractive market for services as well – if you are a US company providing legal services or advertising or accountancy then Europe is a big market for you to get into.”

Europe’s workforce also offers additional appeal to firms looking to invest in the region. “Due to the EU and freedom of movement, the continent is unique in creating a special blend of workforce; one that is not only multilingual but one that is confident and competent in working cross-culturally,” highlights Neil Payne, Managing Director of cross-cultural communications consultancy Kwintessential. “Along with many other, primarily financial and economic factors, investors see the European workforce as one that offers the experience, skills and know-how to instil confidence in the future business success of the continent.”

The old guard

Of course, Europe is ultimately the sum of its parts, and six European countries made the top ten most attractive destinations. The Ernst & Young study ranked Germany as not only the most attractive business location in Europe, but also the third most attractive worldwide, with only the United States and China ranking higher. The reasons for its appeal? Take a pick: its infrastructure, its quality of R&D, its education and training of the work force, and not to forget that as the biggest economy in Europe it has a robust domestic market. Gerhart Maier, Managing Director of Invest in Germany GmbH, is understandably enthusiastic.

“Germany has traditionally been very open concerning free trade and globalisation and it is very open-minded to foreign investors. We have a very dense and efficient communication and transport infrastructure, which is much in favour of logistic investments. The economic and political stability also produces an environment of social stability and our legal system is of high integrity and ensures the protection of property and enforcement of law – compare this, for instance, with the US where you risk high damage claims with unknown possibilities in law courts. And then we have a very efficient small and medium-sized business area in Germany which is very innovative and which has created an enormous flexibility of our market economy.”

“Germany offers an attractive prospect due to its long experience with major industry and commerce,” adds Payne. “Within that the population also act as an effective gateway to the East and West of the country through linguistic and cultural ties to the nations around it, i.e a good level of English plus knowledge of German by neighbouring nations.”

Last year witnessed a record number of projects by foreign investors in Europe, some 3000 announcements, representing an increase of 6 percent on 2004. Whilst the UK emerged as the top investment location in 2005 with an 18.2 percent market share, it still trails Germany in third place in this year’s European Attractiveness Study. Nevertheless, recommended for its R&D facilities and location for headquarters, the UK boasts a bevy of charms that should ensure it will again feature highly in the investment rankings by the year’s end.

“The UK has all or most of the attributes of a global player,” suggests Olivier Morel, Head of the French Corporates Group at Cripps Harries Hall LLP, which helps French firms conduct business in the UK. “English is still the business language the world over, with five international airports in and around London alone. The country is an international travel hub, the UK is the favourite 'landing place' for US businesses investing in Europe – and the US is the largest economy in the world. And finally, the UK is seen as business-friendly, since it has lost the shackles of the traditional state-owned, heavily regulated, ideologically motivated economic policies that still exist in some other European countries.”

“The UK is a natural place to invest for companies looking move into European markets and companies such as ourselves enjoy a favourable business climate,” agrees Rajeev Sawhney, Corporate Vice-President and Head of Europe Business at leading investor HCL. “HCL has seen exceptional growth as it rebalances the geographic portfolio of the company. In five years we have gone from six percent to 26 percent of global revenues coming form the UK and we are very pleased with the experience so far.”

Eastern promise

But Europe’s old guard has far from a monopoly on investor appeal. Central and Eastern European nations have stamped their presence on the study, with two of the top five attractive nations hailing from the emerging East. Whilst China rules the roost in terms of manufacturing, Central and Eastern Europe remains an appealing region in this field, and countries such as Poland are reaping the benefit. Voted second most attractive in Europe and fifth overall, Poland saw 197,000 new jobs created last year as a result of foreign investment projects and is expecting another bumper year.

The largest of the Eastern European nations, with a population of around 30 million, much of its appeal lies with its solid base of creative and strongly motivated workers. Polish society is the youngest in Europe: 50 percent of Poles are under 35 years old and more than two million are enrolled in university studies. Competitively low labor costs are an additional asset. “On top of the fact that economic factors have made Poland a ‘safe bet’ in terms on investment, companies see promise in a young, hard-working and outward looking generation entering the employment market,” agrees Payne. “A cultural propensity towards scrupulousness, organisation and high standards mean local businesses are attracting the attention of investors. On the whole the language skills provide the added advantage that operations there can easily work within a global context.”

Payne also highlights that similar workforce attributes can also be located in the second of the Central and Eastern European contingent to break the top five, the Czech Republic. Ranked fourth most attractive European nation in the Ernst & Young study, the Czech Republic has a longstanding engineering background that has proven attractive to industries like the electronics and automotive sectors. This engineering base has been maintained and developed with a sound education system and an influx of R&D projects have created a wealth of highly skilled jobs in a country that is building on its increasingly tech-savvy labour force by boosting investment in R&D by 15 percent a year. Honeywell, Matsushita, Hyundai, Bang & Olufsen and the Behr Group are just some of the firms that have established a presence within the Czech borders.

“The combination of skilled people, developed local infrastructure, location and industrial history all combine to make us attractive,” says Rene Samek, Director or Investment and Applied Research Division at CzechInvest. “But I think it is the proven capability to deliver support for foreign investors that has had a major impact.” Samek also concedes that accession to the European Union has heralded a change of perception that has also benefited the Czech Republic and its Eastern neighbours.

“There was an important psychological change. In the 1990s most of the foreign investors in the region were large multinational corporations who could commit a lot of time into site selection and starting up factories. The region was seen as the Wild East and smaller businesses who couldn’t commit so many resources and so they preferred to invest in the old EU member countries. But the accession of the Czech Republic, Hungary, Poland and others changed this. Small companies took this as proof that it was a safe territory, which has more or less the same legal systems and other infrastructure as the old EU member countries.”

Reforms and concrete projects

For investors, Western Europe and Central and Eastern Europe provide an excellent complement to each other. The combination of Western Europe’s maturity (68 percent of respondents cite Western Europe as one of their three preferred zones, up five points on 2005) and Central and Eastern Europe’s dynamism (52 percent cited Central and Eastern Europe) has certainly contributed to Europe’s position as leader on the global attractiveness map. But there are also indications that international decision-makers’ perceptions in 2006 show a preference for traditionally low-risk locations according to Ernst & Young, which would also explain the strong positioning of Europe this year.

Nevertheless, investors remain attracted by the possibility of cost reductions offered by the emerging markets, and whilst Central and Eastern Europe is an appealing option in this sense, China will continue to be almost peerless in this capacity. Although Europe is fairing well as a region, the gap between the continent’s highest placed nation, Germany, and China is a whopping 23 percent, underlining its sway.

“China is in the unique position of being able to do what it likes and others have to adapt, because of its sheer weight – 20 percent of the world’s population,” suggests Morel. “Increasingly there is an awareness among most of the European politicians that they do face an increasing competitive threat from places like China and India, which are becoming increasingly big players in the world economy,” adds Hawksworth. “They are growing at 8,9,10 percent a year whereas Europe is growing at 2 percent a year. And therefore we are in a competitive game.”

If Europe is to stay appealing in the face of competition from the likes of India and China, investors would like to see the region execute far-reaching reforms bringing about increased flexibility, simplified regulation and greater innovation. According to the Ernst & Young study, 57 percent of decision-makers consider that improving the attractiveness of Europe will be achieved through major or radical reforms. Countries such as Germany, France and Italy, for instance, continue to feature at the top end of lists of OECD labour market and product market regulation indices, an unattractive trait to investors from nations such as the US, who are used to quite light regulatory regimes.

Nevertheless, reforms are being made at national level to address such concerns. Spain continues to take measures to free up its labour market, whilst Germany has witnessed changes to labour market regulation and cuts in corporate tax rates. Maier highlights other progress being made in Germany.

“An increase in the budget for innovation has been promised, with a goal of 3.6 percent of the GDP for government spending on R&D,” he explains. “A new committee has also been formed to advise the Chancellor on innovation. There is also major education reform taking place concerning excellence in universities. This is a chance to create quality and competitiveness through structural adjustment programmes, which are perhaps even more important than talk about reforms concerning the flexibility of the labour market or tax.”

At European Union level also, reform is taking place. Whilst the EU’s efforts to improve the bloc’s competitiveness through the Lisbon Agenda have been derailed, its ongoing programme to complete the internal market rolls on. “We have seen gradual progress with the single market,” suggests Hawksworth. “Virtually all the trade barriers have gone, a lot of the product regulation barriers have certainly been reduced and there has been a degree of harmonisation on some aspects of indirect tax. But it has been and will continue to be a slow process because one has to get consensus from 25 countries. There will be some losers in that process and some people who are in quite protected industries will understandably want to protect their rights and they can argue to stop reform or to keep it going quite slowly. But I am quietly optimistic that it is going in the right direction.”

In the meantime, whilst Europe must ensure it integrates the reforms necessary to maintain its place amongst the world’s most appealing economies, it must also concentrate on translating its present investor appeal into concrete projects. Germany may rank first for its investor image, for instance, but it is only third place in real investment terms, a disparity that it will be keen to address. Whether Europe will keep its crown as the most attractive region in the world remains to be seen, particularly with such strong competition coming out of Asia. Nonetheless, as a region, Lhermitte believes that Europe has enough to compete with all-comers in the attractiveness stakes – beauty is in the eye of the beholder, and from the present evidence, investors like what they see.

“You find the largest volume of business and business potential in the world in the EU25,” he concludes. “It doesn’t have the growth that you find in Asia, especially in India and China. But it does have the certainty and history of a big market. And in terms of why Europe remains the top location it is also that you find a real choice for companies – they can set up operations in lower-cost higher-risk countries whilst 1000km away there are higher-cost but lower-risk, higher-quality countries. You have a whole product line from the west to the east, from UK to Romania, from Russia to Germany, and that is, for long-term purposes, a reason for Europe to remain attractive.”