The international competitiveness of the UK and its multinational enterprises

Structural Change and Economic Dynamics 12 (2001) 277– 294

www.elsevier.com/locate/econbase

The international competitiveness of the UK and its multinational enterprises L. Nachum a,*, G.G. Jones b, J.H. Dunning c a

Cambridge Uni6ersity, ESRC Centre for Business Research, Austin Robinson Building, Sidgewick A6enue, Cambridge CB2 3JW, UK b Department of Economics, Reading Uni6ersity, P.O. Box 218 Reading, RG6 6AA UK c Rutgers Uni6ersity, Graduate School of Management, 180 Uni6ersity A6enue, Newark, New Jersey, 07102 USA Received 22 December 1998; received in revised form 1 August 2000; accepted 1 January 2001

Abstract This study outlines the theoretical links between the international competitiveness of firms and their home countries and uses them to examine the dynamic relationships between the international competitiveness of the UK domestic economy and its Multinational Enterprises (MNEs). These are measured by the UK shares of OECD output, exports and outward foreign direct investment (FDI) respectively, since the late 19th century onwards. The main findings are that the shares of the UK in OECD exports, output and outward FDI have been declining during most parts of the last century, but UK MNEs have performed consistently better than the UK domestic economy. During the period studied, and particularly since the 1960s onwards, UK outward FDI, export and output shares have moved in tandem rather than as substitutes. The study concludes by drawing the policy implications of these relationships. © 2001 Elsevier Science B.V. All rights reserved. JEL classification: F14; F21; F23 Keywords: International competitiveness; Multinational enterprises

1. Background It is now conventional wisdom that the international competitiveness of the UK domestic economy, as measured by its export performance, has been declining over the last century in most industries. While, a hundred years ago, the UK exported * Corresponding author. Tel.: + 44-1223-335243; fax: + 44-1223-335768. E-mail address: [email protected] (L. Nachum). 0954-349X/01/$ - see front matter © 2001 Elsevier Science B.V. All rights reserved. PII: S 0 9 5 4 - 3 4 9 X ( 0 1 ) 0 0 0 1 6 - 9

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about 30% of world manufactured exports, its share fell to less than 7% in the early 1990s. In absolute terms, the UK’s exports were above the levels of all its main competitors in the 19th and early 20th century; in the 1990s, they were far below those of Germany, Japan and the US. The explanations that have been given for this decline have focused on factors such as macro-economic policies (Dunnett, 1989), low productivity (Craft, 1991), lack of innovative activities and low level of technology (Buxton, 1994; Buxton et al., 1994). Other explanations stressed the indifferent British attitudes towards business and lack of managerial skills (Chandler, 1980, 1990). The continued commitment of UK firms to traditional Empire markets, which allowed them to achieve growth and profits without innovations and modern technologies, has also been suggested as a factor inhibiting the modern transformation of the UK industry (Cairncross, 1992). Another hypothesis sometimes advanced is that the UK’s early start in industrialisation adversely affected its more recent economic growth (Craft, 1988). The success of the old industries reduced the incentive for the proper development of new, technologically advanced industries. One further explanation to which relatively little attention has been paid is the activity of UK-owned firms outside the boundaries of their home country. It might be that the decline of the UK’s export shares reflects a shift of location of production by UK firms rather than a loss of their competitiveness. Empirical studies based on data from the US and Sweden, have demonstrated that the export shares of these countries and the shares of their multinational enterprises (MNEs) in world manufacturing exports have changed in very different ways. While both countries have experienced declining export shares, their MNEs have been gaining competitiveness (Lipsey and Kravis, 1986; Blomstrom and Kulchycky, 1988; Blomstrom and Lipsey, 1989; Kravis and Lipsey, 1989; Blomstrom, 1990). These findings suggest that analyses based only on exports may provide only a partial picture of the international competitiveness of a country and its firms. The significant size and growth of overseas direct investment by UK MNEs, at a time when export shares of the UK have been declining, suggest that a similar situation may exist also in the UK (Jones, 1994). The UK was the world’s leading outward direct investor up to the Second World War. Since then, its share of world FDI has fallen, but the value of its overseas assets has increased continuously (Dunning, 1988). In 1996, the UK was the second largest outward FDI investor (following only the US) and held a larger foreign direct capital stake than any country except the US and Japan (UNCTAD-DTCI, 1997). There is some evidence that suggests that a shift of value-added activities abroad by UK firms may indeed explain, at least partially, the decline of UK’s export shares. Such developments have been demonstrated by Corley (1994) for the 1870–1914 period, by Reddaway (1968) for the 1950s and early 1960s, and by Dunning (1978) for the 1960s and early 1970s. Stopford and Turner (1985) provided additional support to this suggestion, based on the division of labour between affiliates and headquarters in a sample of leading UK MNEs in the 1980s. These studies highlight the need to acknowledge the competitive performance of

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both the UK domestic economy and the activities of UK-owned MNEs in order to assess the international competitiveness of the UK1. The present study seeks to provide a more comprehensive picture of the competitiveness of the UK both by acknowledging the competitive performance of the UK domestic economy and of UK-owned firms overseas and by examining the dynamic relations between them over the last century. By competitiveness of a country, we mean the performance of the immobile resources that are tied geographically to a particular location. As proxies for the competitiveness of these resources, we use GDP and exports, as a high performance of these measures, relative to a country’s competitors, implies that a country’s immobile resources are more competitive than those of its competitors. The competitiveness of firms stands to signify the competitive performance of the mobile resources that are owned by firms and can be mobilised by them across borders. These are measured by flows and stocks of outward FDI. The rationale for the choice of these proxies will be discussed in more detail in the following sections.

2. International competitiveness of firms and countries In a world in which firms produce only within the boundaries of their home countries and serve foreign countries by exports, the international competitiveness of a country, as measured by its export performance, is the sum of the export performance of all national firms. Under such circumstances, the international competitiveness of firms and countries alike is based on the location bound resources tied to the home countries. When firms produce outside the boundaries of their home countries, the competitiveness of a country, as measured by its export performance, is the aggregate of the exports of all the firms producing within its boundaries, but this is no longer equivalent to all firms owned by its citizens. Ownership-based measures thus differ (and sometimes substantially so) from location-based measures of competitiveness. Firms investing overseas have the ability to avoid unfavourable conditions in their country that reduce the competitiveness of the immobile factors of production located there, and they are able to benefit from more favourable conditions in other locations. The foreign activities of firms reduce their sole dependence on the resources and factors of production available in their home country, and their competitiveness may move separately from the resources determining the competitiveness of their home country. In such an economic scenario, different resources and assets may provide the basis for the competitiveness of firms and countries. The competitiveness of countries rests on the quantity and quality of the immobile resources located within them. These include climate, land and other natural resources, and most kinds of 1 The limitations of reliance on export statistics alone as indication for a country’s competitiveness could also be drawn from Porter’s analysis (Porter, 1990). Such an analysis had led Porter to view the UK as a country which is losing its competitiveness, ignoring the leading competitive position of UK MNEs in some industries.

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labour2. If a resource moves freely, or at low cost, from one country to another, it cannot be the basis for a country’s competitiveness. By contrast, the competitiveness of firms is based on the kind of assets that are transferable by the firms from country to country within them, but not from one firm to another, even within countries. Examples of such assets are technical skills (possibly, but not necessarily, derived from R&D within the firm) and skills in marketing and management. The more transferable an attribute is geographically, the less it can be the basis for national competitiveness. The more transferable it is among firms, the less it can be the basis for a firm’s competitiveness (Lipsey, 1995). As the competitiveness of firms and that of their home countries are based on a different set of assets with different characteristics, the link between them becomes somewhat tenuous, and in extreme cases, they might develop independently from each other. At the same time, there seems to be a common ground between the competitiveness of firms and their home countries. It has long been recognised that the competitiveness of firms is related to the resources and conditions of their home countries, as firms develop their ownership advantages based on the mobile and immobile assets of the countries from which they originate (Vernon, 1966; Dunning, 1979; Porter, 1990; Hu, 1992, 1993; Nachum, 1999, 2001). While, in principle, the characteristics of any location may be the basis for a firm’s competitive advantages, the characteristics of the home countries of the firms concerned have been shown by this research to be the most critical. This research has also shown that in a world that is becoming increasingly more globalised and integrated, and in which the advantages of firms derive from intangible assets that are seemingly not tied to any particular location, home countries continue to exercise a strong influence on the advantages that firms develop. This research thus provides grounds to expect that the competitiveness of firms would reflect, to some extent at least, the resources and endowments abundant in their home countries and would flourish in the same sectors and industries in which their home country has a comparative advantage. Indeed, exports and FDI, in which the international competitiveness of a country’s domestic economy and its firms, respectively, is measured, are often closely linked to each other. Traditionally, market-seeking firms typically exported their products before establishing foreign production3. The perception of such a sequential order of internationalisation (UNCTAD-DTCI, 1996) found its expression in the product cycle paradigm (Vernon, 1966); it sought to explain the movement of firms from domestic production to exports and eventually to foreign production in a dynamic model in which firms respond to the changing resource

2 Labour was traditionally assumed to be immobile. However, there is a certain variation in its mobility across occupations. The more skilled and highly trained labour tend to be more mobile than low-skilled labour, with top executives, managers and professional workers the most mobile of all groups. 3 This order is typical mainly of manufacturing and less of services and natural resources (see UNCTAD-DTCI, 1996).

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configuration of their home countries. This perception also underlay the internationalisation theory (Johanson and Vahlne, 1977), according to which firms increase their commitment to foreign markets gradually, as their knowledge of these markets increases and the perceived risk decreases. There is plenty of evidence supporting such a process of internationalisation (Nicholas, 1982; Jones, 1986; Dunning and Archer, 1987; Johanson and Vahlne, 1993), in which the investing firms exported to the target market prior to the investment. While this pattern has somewhat weakened over the past three decades (see below), a recent survey of 927 UK MNEs found that the majority, and particularly manufacturing firms, tended to build up their overseas activity in a series of stages, typically starting with exports, then establishing marketing and distribution operations and, finally, in some markets, investing in local production facilities (Department of Trade and Industry, 1996). Under such circumstances, goods previously exported from the country would eventually disappear from the trade statistics, and the competitiveness of a country, as measured in its export performance, would appear to be declining. However, the reasons for this discrepancy between exports and FDI may not necessarily reflect a deteriorating competitiveness of the firms making the investment. Furthermore, the shift from exports to FDI often generates additional trade from the home country, i.e. it has trade-creating effects. The trade-creating effect is brought about in a variety of ways. It may happen directly, for example, when home country firms export components for further processing by affiliates, or complementary products to those produced locally by the affiliates, or indirectly, when the presence of the affiliate helps to expand the demand for other home country products in the host country (Lipsey and Weiss, 1984). The evidence suggests that, on balance, the trade-creating effect of FDI in manufacturing tends to outweigh any trade replacing effects (Bergsten et al., 1978; Swedenborg, 1979; Lipsey and Weiss, 1981, 1984; Blomstrom and Kulchycky, 1988; Pearce, 1990). Hence, the competitiveness of firms and their home countries are likely to be closely linked to each other. In the more recent decades, however, with the advent of integrated cross-border markets (UNCTAD-DTCI, 1993), the link between the foreign activities of firms and exports from their home countries has somewhat weakened, as firms often start production overseas without serving a particular market by previous exports. Their advantages may no longer reflect so closely the resource configuration of their home countries as they did in the past, and the influences of the foreign countries in which the firms operate may be more apparent. Nachum (1998) has shown such an outcome with reference to a sample of Swedish engineering consulting MNEs. Moreover, much of the more recent FDI is asset-augmenting strategic and efficiency seeking, such that FDI and trade are strongly intertwined but in a manner different from the traditional link between them (Nachum et al., 2000). In such investment, firms engage in product or process specialisation in order to make use of international differences in locational comparative advantages and integrate

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them with other activities performed elsewhere through intra-firm trade4. While FDI and trade are closely intertwined as a result of these strategies of MNEs, they tend to flourish in different activities and industries, suggesting a discrepancy between the competitiveness of firms and their home countries. This discussion reveals the complexity of the link between the competitiveness of firms and their home countries and the large number of often contradicting forces that affect it. In what follows, we seek to examine this link in the context of the UK economy. In particular, we seek answers to such questions as: Have the competitiveness of the UK domestic economy and that of UK MNEs moved together, or rather independently of each other, during the last century? What developments of the UK’s mobile and immobile resources explain the changing competitive position of its domestic economy and that of its MNEs? Are these changes a result of other countries catching up or rather of an absolute deterioration of the mobile and/or immobile resources and capabilities of the UK?

3. Some methodological issues The examination of the relationships between the competitive position of the UK and its MNEs is based on a comparison between the UK’s shares of world exports and output and of outward FDI as proxies for the competitiveness of the UK domestic economy and of UK MNEs, respectively. Several proxies for competitiveness may be considered as candidates for this comparison. One is export shares of both firms and countries. A rise in a share of a country or a firm (or a group of firms) in world exports reflects factors that make the country’s or the firm’s goods more attractive to buyers, relative to that of another country or group of firms. The main advantage of using exports rather than other proxies (such as output) as a measure of competitiveness is that production for export is more footloose than production for consumption within the producing country. A country has more power to determine which producers supply its home market than it does over firms that supply world markets. Shares in export markets therefore may represent the underlying advantages of countries or firms to a greater degree than do shares in domestic markets (Lipsey et al., 1995). In their studies, US and Swedish scholars used export shares as a starting point for comparing the competitiveness of the US and Sweden and their MNEs. Along with Japan, these are the only countries about which export data of both overseas affiliates and the parent companies of their MNEs are available. Export shares, however, suffer several conceptual limitations, and some of them are particularly severe for analysis of the competitiveness of the UK. First, they are, 4 The dramatic increase of trade links within MNEs provides an indication for the prevalence of these investment types. In the early 1990s, intra-firm exports accounted for 34, 25, 38 and 36% of total exports of France, Japan, Sweden and the US, respectively. Shares in the country’s total imports were 18, 14, 9 and 43% for these four countries, respectively (UNCTAD-DTCI, 1996). These amounts are likely to underestimate the real value of the transactions, as many flows are not measured and reported, especially as far as the provision of services is concerned (UNCTAD-DTCI, 1996).

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by definition, limited to tradable goods, and take no account of the performance of non-tradable goods and services. This is a serious drawback in analysis of the competitiveness of the UK, where services account for large shares of economic activity. Second, export shares may be biased by the extent of intra-firm trade, which may reflect the organisational strategies of MNEs rather than the competitive performance of the exporting units5. Third, export shares underestimate the competitiveness of MNEs because, by definition, they omit one of the main methods by which most countries’ MNEs supply foreign markets, i.e. producing and selling within these markets. This deficit is particularly problematic in the case of UK outward FDI, which is predominantly of a market-seeking or efficiency-seeking kind (notably recent investments in the US and Europe). Finally, export shares are based on sales and cost structure, not on value added, which is the more accurate measure for competitive performance. Another possible measure for the competitiveness of both firms and countries is their share of world production (GDP). This proxy avoids the limitations of the export data but suffers a practical problem, resulting from the lack of a comparable set of MNE output. Very few countries report the value added of the foreign activities of their MNEs overseas, and the UK is not among those that do. At the end of the day, our choice of proxies for the present study was dictated by data availability. We use shares of both exports and GDP as proxies for the competitiveness of the UK and shares of flows and stocks of outward FDI as proxies for the competitiveness of UK MNEs. These proxies are not fully comparable, a drawback that unavoidably limits the validity of the comparison. Yet, they may provide a way (indeed the only way, given the data available) to examine the link between the competitive position of the UK as a location for economic activity, and that of its MNEs. Due to limitations of the historical data, we use OECD, rather than world total, as the denominators of all measures. Since the OECD countries account for the overwhelming share of international economic activity (over 90% in the case of FDI, and about 80% in the case of trade), this procedure only slightly overestimates the world shares of the UK. Both direct investment stock and flow data are used to assess the changing competitive position of UK MNEs. Flows are more comparable with exports and GDP data, both of which are flow measures. Stock data were added for two reasons. First, they are the only available FDI data for the late 19th century and the first half of the 20th century. Second, flow figures alone may underestimate the market power of UK MNEs, whose investments are, in large part, very mature, much of them consisting of reinvested earnings and capital raised abroad that are not captured by flow figures. We have chosen a time span for this analysis starting in the late 19th century. There is a general consensus that significant changes in the economic position of the UK occurred around the turn of the 20th century (see, for example, Pollard, 1985), and 5

Intra-firm trade also introduces technical measurement problem, as the same product may appear as parents’ exports of components to an affiliate and as the affiliate’s exports of a finished product (Lipsey et al., 1995).

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an analysis that covers this period would thus capture these changes and enable us to examine the current competitive position of the UK in perspective. This procedure, however, raises the problem of reliable data, particularly regarding FDI (historical GDP and export data are far better). The pre-1960s FDI data are based on estimates drawn from different provisional sources and should be regarded as no more than order of magnitude estimates (see Jones, 1996 for a discussion of the specific difficulties associated with these data). The post-1960 FDI data are substantially better as they are based on surveys of UK MNEs conducted by the UK Statistical Office. Also, world-wide data collection has become more systematic and reliable.

4. Statistical findings Fig. 1 and Table 1 present the performance of the UK domestic economy and its MNEs over the last century or so in absolute terms (measured by the amounts of

Fig. 1. Absolute and relative performance of the UK domestic economy and outward FDI , 1870 – 1994 (volumes in million US dollars and shares of OECD).

0.016 0.031 0.058 0.068 0.075 0.059 0.053 0.070 0.051 0.057

Exports 1870 58 1914 421 1938 879 1960 5813 1970 16 747 1975 34 074 1980 67 734 1985 90 781 1990 127 629 1994 165 376 541 1328 876 6866 18 099 53 120 116 030 101 674 216 588 235 505

71 419 132 963 185 633 341 353 586 812 690 434 807 081 870 199 1 008 601 1 042 522

1335 3100 2201 34 823 22 802

0.150 0.099 0.058 0.080 0.081 0.092 0.092 0.078 0.087 0.081

0.148 0.095 0.082 0.069 0.072 0.072 0.070 0.067 0.067 0.065

0.048 0.059 0.042 0.157 0.121

0.120 0.095 0.062 0.035 0.027 0.047 0.057 0.069 0.083

424 2454 2162 11 415 34 228 90 176 192 861 183 912 410 104 419 312

44 101 123 598 220 359 469 151 723 745 805 854 946 280 1 001 551 1 181 871 1 275 730

2015 4178 4934 24 214 14 653

1500 350 800 3000 18 400 43 127 59 909 151 581 199 701

Volume

Italy

0.117 0.183 0.142 0.134 0.153 0.156 0.152 0.142 0.164 0.144

0.092 0.088 0.098 0.095 0.088 0.084 0.082 0.077 0.078 0.079

0.072 0.079 0.093 0.109 0.078

0.103 0.013 0.012 0.017 0.047 0.086 0.092 0.095 0.090

Share

208 485 547 3654 13 206 34 808 77 929 78 712 170 486 189 805

40 900 93 326 140 833 290 574 510 200 585 330 738 598 791 741 919 511 953 602

346 744 1833 7585 5106

1100 2100 3300 7319 16 301 56 102 83 462

Volume

0.058 0.036 0.036 0.043 0.059 0.060 0.061 0.061 0.068 0.065

0.085 0.066 0.062 0.059 0.062 0.061 0.064 0.061 0.061 0.059

0.012 0.014 0.035 0.034 0.027

0.000 0.000 0.017 0.012 0.008 0.015 0.025

Share

Japan

15 315 758 4055 19 318 55 819 130 441 177 164 287 581 397 005

25 505 66 865 169 367 364 791 985 736 1 223 760 1 531 612 1 839 879 2 291 456 2 441 798

1760 2395 6427 48 024 18 521

300 750 500 1500 15 900 18 833 44 296 204 659 284 259

Volume

0.004 0.023 0.050 0.047 0.086 0.097 0.103 0.136 0.115 0.136

0.053 0.048 0.075 0.074 0.120 0.127 0.133 0.142 0.151 0.152

0.063 0.045 0.122 0.216 0.098

0.021 0.028 0.008 0.009 0.040 0.038 0.068 0.128 0.129

Share

158 413 568 4028 11 648 35 022 73 940 68 257 131 775 156 580

9545 23 692 44 486 92 868 152 159 178 164 202 708 213 081 247 730 263 947

2293 5983 3175 15 388 11 510

700 11 000 19 900 42 116 47 772 109 124 146 182

Volume

Netherlands

0.044 0.031 0.037 0.047 0.052 0.061 0.058 0.053 0.053 0.054

0.020 0.017 0.020 0.019 0.019 0.019 0.018 0.016 0.016 0.016

0.082 0.113 0.060 0.069 0.061

0.000 0.000 0.011 0.064 0.051 0.084 0.073

Share

UK

971 2555 2573 10 609 19 430 43 423 110 155 101 248 185 172 204 491

95 651 216 609 284 165 448 874 594 924 657 762 719 528 795 233 935 922 961 014

580 1678 3001 11 311 10 606 19 327 25 334

6500 10 500 10 800 23 700 50 700 80 434 100 313 230 825 281 170

Volume

0.269 0.19 0.169 0.124 0.087 0.075 0.087 0.078 0.074 0.069

0.198 0.153 0.126 0.091 0.072 0.068 0.062 0.061 0.062 0.059

0.131 0.107 0.214 0.201 0.087 0.134

0.500 0.446 0.398 0.163 0.138 0.129 0.161 0.154 0.145 0.127

Share

US

403 2380 3122 20 601 43 241 108 112 220 786 213 144 393 592 512 521

98 418 478 105 800 295 2 022 233 3 045 781 3 468 461 4 161 014 4 797 624 5 464 795 5 903 015

14 217 21 898 15 236 27 175 45 640

2652 7300 31 900 56 600 124 200 220 178 251 034 435 219 610 061

Volume

0.112 0.177 0.206 0.241 0.193 0.188 0.174 0.164 0.158 0.175

0.204 0.340 0.355 0.409 0.372 0.361 0.362 0.370 0.361 0.367

0.507 0.413 0.289 0.122 0.242

0.182 0.277 0.483 0.329 0.316 0.440 0.385 0.273 0.276

Share

Others

831 3059 3704 18448 47690 121937 278116 283754 570872 640756

89 944 240 896 360 354 763 395 134 804 7 168 175 8 1 981 989 2 201 044 2 559 765 2 711 958

11 234 2151 −345 3461 40 901 40 082

1730 4250 13 700 64 500 139 400 41 671 55 191 217 042 318 322

Volume

0.230 0.228 0.244 0.216 0.213 0.212 0.219 0.218 0.229 0.219

0.187 0.171 0.160 0.154 0.164 0.175 0.173 0.170 0.169 0.168

0.870 0.077 −0.007 0.066 0.184 0.213

0.119 0.161 0.207 0.375 0.355 0.083 0.085 0.136 0.144

Share

3609 13 410 15 189 85 489 223 607 576 491 1 267 992 1 298 646 2 493 799 2 921 351

481 537 1 406 920 2 254 818 4 944 725 8 198 138 9 614 775 11 480 676 12 962 461 15 131 168 16 102 926

12 912 28 014 52 961 52 786 222 162 188 429

14 582 26 350 66 100 172 100 392 800 499 854 652 840 1 593 531 2 212 111

Volume

OECD total

a 1914 Export data from 1913. 1970 FDI stock data from 1967. Sources of data for Table 1: GDP: Maddison (1995). Export: Maddison (1995); Lewis (1981); IMF (2001); FDI: Dunning (1983, 1993); United Nations Centre on Transnational Corporations (1988); IMF balance of payment tape retrieved in March 1996.

0.013 0.022 0.022 0.031 0.031 0.034 0.034 0.035 0.034 0.034

6054 30 866 49 326 151 486 250 734 323 252 391 866 452 109 521 517 549 340

GDP 1870 1914 1938 1960 1970 1975 1980 1985 1990 1994

0.032 0.070 0.093 0.021 0.025

896 3697 4913 4725 4781

FDI flows 1960 1970 1975 1980 1985 1990 1994

1750 2500 4100 6000 10 600 23 604 37 077 110 126 183 348

Share

0.010 0.027 0.038 0.021 0.026 0.045 0.063 0.049 0.048

Germany

Share

Volume

France

FDI Stocks 1870 1914 150 1938 700 1960 2500 1970 3700 1975 10 400 1980 22 572 1985 40 947 1990 78 853 1994 105 606

Canada

Table 1 Competitiveness of the UK and its main competitors (million US dollars and shares of OECD)a

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exports, GDP and outward FDI) and relative to their main competitors (measured by OECD market shares). Several conclusions can be drawn from the data set out in Table 1 and Fig. 1. First, while, in absolute terms, the UK domestic economy and UK FDI have exhibited continuous growth over the last century, their performance relative to other OECD countries deteriorated during the late 19th century and the first half of the 20th century. Since the 1960s, the UK has maintained fairly stable OECD shares. Second, UK FDI has consistently accounted for a larger share of OECD FDI than the corresponding shares of UK exports and output. In other words, during the last century, UK MNEs have been more competitive internationally than the UK domestic economy. However, as UK FDI accounted for far larger OECD shares than UK export and output around the turn of the 20th century, the competitive position of UK MNEs deteriorated faster than UK GDP and exports. Third, and closely related to the second, the gap between the competitiveness of the UK and its MNEs has diminished during the last century. It was very large in the late 19th century and the first half of the 20th century, but it narrowed substantially around 1960, and the two have moved almost in parallel since then. These relations imply that foreign investment and exports have developed in tandem rather than as substitutes for each other. As the first country to industrialize, the UK strongly dominated the world economy for a century and a half. During the 18th and 19th centuries it produced almost all the world’s manufactured goods, and its shares of both world industrial output and exports during these centuries were probably close to 100% (see, for example, Crafts and Woodward, 1991Dintenfass, 1992; Floud and McCloskey, 1994). The UK’s central position also facilitated its dominance in international business, and it soon became the home of an enormous number of MNEs active in both manufacturing and services (Jones, 1996). Some decline in the relative performance of the UK was therefore inevitable as other countries caught up. This explains much of the deterioration of market shares in the late 19th century and the beginning of the 20th century. The UK had lost its position as the world’s largest industrial economy to the US by the beginning of the 20th century, but it remained an important player in both the European and the global economy until the Second World War. As Fig. 2 shows, the UK’s GDP was second only to that of the US until the 1960s and was on a par with France or Germany during most of the 20th century. In 1914, the UK was still the world’s largest exporter, and until the Second World War, the US was the only country that had larger amounts of exports. In 1914, the stock of UK FDI was larger than the stock of any other country (see Fig. 2). The choice of UK firms in this period between export and FDI was influenced mostly by the imposition of tariffs in Europe and in the US and to some extent also by incentives in host countries. Dunning and Archer (1987) argue that it was these factors, rather than the location disadvantages of the UK or the ownership advantages of the firms themselves, that were frequently the single most important factor behind the decision of many UK firms to begin foreign production. Based on analysis of the 15 major UK MNEs active in 1914, Dunning and

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Fig. 2. Competitive performance of the UK and its main competitors (million US dollars).

Archer (1987) maintained that, to a large extent, their foreign activities mirrored the comparative advantage of their home country, as expressed by its export performance (which, in 1914, was most pronounced in the products that it had pioneered 50 years earlier). Between the two World Wars, the UK domestic economy experienced fast growth and rising productivity. The UK’s share of OECD exports declined only from 19% in 1914 to 17% in 1938 (see Table 1). This was mainly the result of shifts in world demand relative to the composition of UK’s exports. The rapid growth of UK MNEs during this period was matched by the expansion of MNEs from other countries, especially the US and later the new wave of Dutch, Swiss and Swedish MNEs (Jones, 1996), which eroded the dominant position of the UK. However, UK MNEs have not lost the strength of their ownership advantages, as indicated by their innovative activities in this period (see Cantwell, 1995), and the UK remained the world’s largest outward investor before the Second World War (see Fig. 2). It was during these years that the Empire– Commonwealth preference of UK MNEs emerged and grew in strength (Dunning and Archer, 1987). Many UK firms regarded the Empire markets as an extension of their home market, and most of them had already developed trade links with them. These markets were, at that time, characterised by political stability, large and growing markets, a good commercial and legal infrastructure (especially when compared with Europe, where the political situation was volatile, and domestic firms were buttressed by cartels and government policies). The major UK MNEs in this period tended to hold a strong position in the UK before undertaking foreign investment (Dunning and Archer, 1987), a pattern that suggests that their competitiveness was closely linked to the UK economy. Dunning and Archer (1987) maintained that the domination of UK FDI by MNEs from the mature, relatively low-technology industries in the inter-war period (and beyond)

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reflected mainly the characteristics of the UK economy. The high-income, large and standardised UK market fostered large firms, product differentiation and marketing skills — characteristics favouring the consumer goods MNEs that emerged during the inter-war years. During the decades following the Second World War, the UK domestic economy experienced slow economic growth. It missed the ‘economic miracle’ era of fast growth between the 1950s and 1973, when most Western European countries and Japan narrowed the technological and managerial gap between themselves and the US (Jones, 1997). Macro-economic policies of the Governments of both the Labour party (1945–1951) and the Conservatives (1951–1964) facilitated a substantial weakening of the UK’s domestic economy, which was further enhanced by the oil crises and stagflation of the 1970s (Sharp and Walker, 1994). Micro-economic policies in this period created an uncompetitive market, in which ineffective firms were kept alive due to the support of the government rather than to their ability to compete effectively (Jones, 1997). In the early 1950s, between 50 and 60% of domestic manufacturing output in the UK was regulated by cartels. In the 1960s and 1970s, there was a series of ad hoc attempts to create ‘national champions’ in manufacturing. UK domestic firms were also characterised by under-investment in human capital, and subsequently became distinguished by low skill levels which, in turn, both explained their low productivity and acted as an obstacle for the introduction of new technology (Jones, 1997). Indeed, while, in 1950, the UK accounted for 25% of the world’s exports, its share fell to 7.5% in 1975 (Table 1). The decline in the UK’s export performance in these decades is also attributed to the restructuring of the UK economy and its transformation into a service economy. The manufacturing sector, which dominated the UK economy ever since the Industrial Revolution, was shrinking during the decades following the Second World War. The share of manufacturing in GDP declined from 35% in 1960 to 28% in 1980 and to 22% in 1990. At the same time, service shares of GDP increased from 45% in 1960 to 55% in 1980 and to 64% in 1990 (Reynolds, 1990). Although all advanced industrial countries experienced a decline of their manufacturing sector during this period, in no other OECD country has this decline been so pronounced as in the UK (Reynolds, 1990). Since services are for the most part not tradable, when relying on FDI as the main modality of servicing foreign markets, such a structural shift is likely to lead to deteriorating world shares of exports and increasing shares of FDI. In contrast with the decline of the UK domestic economy during the decades following the Second World War, UK outward FDI flourished, in particular in the 1960s and 1970s (Table 1). At the same time, however, world-wide FDI activity expanded at an unprecedented rate during this period, and this caused the relative position of the UK to deteriorate (Fig. 1). During the 1950s, US MNEs benefited from the strength of their domestic economy and expanded very rapidly. After 1960, the dominance of US firms declined as first European and later Japanese MNEs began making extensive FDI. Though UK FDI continued to be vital and grow fast (Jones, 1986), its relative position continued to fall (Fig. 2). The process of relative economic decline of the UK domestic economy was interrupted in the 1980s. Amounts of exports more than doubled from 1975 to 1980

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and then doubled again between 1985 and 1990. Several reasons may be advanced as an explanation for the accelerated growth of exports in this period. First, the policies pursued by Mrs. Thatcher’s administration since 1979 resulted in such substantial improvements in the UK economy in the late 1980s that there were talks of an ‘economic miracle’ (see, for example, Britton, 1993; Maynard, 1993). The most significant change was the substantial increase in labour productivity, both in relation to the UK’s own past performance and in comparison to its main foreign competitors (Wells, 1993). This economic boom facilitated domestic investment and resulted in an accelerated growth of exports. Second, and related to the first, UK exports became more price-competitive due to relatively low labour costs. In 1980, UK wage costs were a third lower than West Germany, and later in the decade, they were also lower than in France, Italy, Japan and the US (Buxton, 1994). Third, foreign-owned affiliates were increasing production in the UK during this period (Bostock and Jones, 1994; Jones and Bostock, 1996), and a major part of their output was exported (see Strange, 1993 for evidence related to Japanese investment in the UK). In 1967, inward direct investment accounted for 7.2% of UK GDP (Dunning, 1993). By 1995, this ratio had risen to 28.5%, compared with an average for all developed countries of 9.1% (UNCTAD-DTCI, 1997). Much of the improvement of the export performance in the manufacturing sector in the last two decades has been due to the activities of foreign firms in the UK (see Jones 1997). The improvement of the UK domestic economy during the last two decades went hand in hand with an improved competitive position of UK MNEs. During the 1980s, the UK became again the world’s second largest home country for outward FDI, with average annual outflows representing about 20% of the world total (UNCTAD-DTCI, 1995). In absolute terms, the stock of UK FDI more than doubled between 1985 and 1990 alone (Table 1). This simultaneous growth of the domestic economy and FDI during the 1980s suggests that, at least during this period, the competitiveness of the UK and of its MNEs moved in tandem with each other rather than in different directions. The discussion so far suggests that, to some extent at least, the decline of the competitive position of the UK economy and its FDI during the last century is a result of the dominant position of the UK in the world economy in the 18th and 19th centuries and the subsequent development of other countries, which diminished the relative position of the UK. The UK lost its position not because it did not grow in absolute terms but rather because its growth rates fell behind those of its main competitors. Fig. 3 presents the growth rates of the UK’s exports, output and outward FDI, relative to those of its main competitors, and allows us to examine this proposition. Such an exercise has to take into consideration differences in growth rates between leaders and followers, as growth rates tend to be higher when countries catch up. Fig. 3 demonstrates that the UK did indeed lag behind other OECD countries during most of the 20th century, i.e. its decline was caused by rival countries expanding at a faster rate. There is one exception for this generalisation, however, in the early 1980s, when the growth rates of both exports and outward FDI stocks and flows exceeded the OECD growth rates. During most of the 20th century, the UK lagged behind OECD countries more in terms of its FDI growth rates than in

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Fig. 3. Growth of the UK and OECD countries, 1850 – 1994 (growth rates).

terms of exports or GDP. This implies that the relative decline of UK FDI was sharper than the relative decline of the UK domestic economy. As already discussed, the main reason for this lies in the dominant position of UK FDI in the beginning of the century, which far outweighed its position in terms of exports and GDP.

5. Research contribution and policy implications The literature on issues related to the competitive position of the UK economy has usually focused on exports and excluded FDI. Such an approach is likely to produce misleading conclusions regarding the international competitiveness of the UK and the causes for changes in that competitiveness over time. Our present contribution has sought to correct for this limitation by examining the performance of both the UK domestic economy and of UK-owned MNEs. The analysis conducted in this paper illustrates a continuous decline of the UK shares of OECD GNP, exports and FDI shares between the late 19th century and the 1970s. This decline is largely a result of the dominant position of the UK in the world economy in the 18th and 19th centuries and the subsequent catch-up by other countries. In absolute terms, the stock of UK FDI has risen substantially, and the performance of the UK domestic economy has improved continuously during most parts of the 20th century. Since the mid-1970s, OECD market shares of the UK and its MNEs were stable. An analysis of the two components of the competitiveness of the UK gives an indication of the causes of its changing competitive position. A comparison of the performance of UK MNEs relative to that of UK domestic resources and capabilities suggests that the locational advantage of the UK has deteriorated at faster rates than the competitive (ownership) advantages of UK MNEs and vice versa. Throughout the period studied, UK MNEs held larger shares of the OECD market

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than the UK domestic economy. This implies that the immobile resources, and indigenous firms whose performance is tied to these resources, have performed poorly compared with the mobile resources that have been utilised elsewhere. These findings exclude many of the explanations given for the decline of the UK, notably those that emphasize the lack of technological capabilities of UK firms and their poor managerial performance. The persistently high performance of UK MNEs (at a time where world FDI increased very rapidly) could not have been achieved unless UK firms possessed strong ownership advantages enabling them to compete successfully against domestic firms and other rivals in foreign markets6. The strong outward FDI flows imply that UK firms possess competitive advantages vis-a`-vis foreign firms, but they prefer to utilise them overseas rather than in the UK. The search for an explanation for the economic decline of the UK should thus be directed to the availability and quality of its immobile resources. However, given the leading role of the UK as a host country for FDI, citing the deterioration of the domestic immobile resources as the reason for the economic decline should be considered with caution. The UK has attracted a disproportionate share of US FDI in Europe throughout the 20th century (Dunning, 1998) and of Japanese FDI in Europe during the last decade (Dunning, 1986; Strange, 1993). The ability of the UK to attract such amounts of inward FDI is an indication of the high quality of its immobile resources. Moreover, much of this development has occurred in years in which UK MNEs have increased substantially their outward activities, much of it by establishing production facilities in countries previously supplied by exports. This seems to suggest that the UK’s indigenous firms (as a whole) lack the ability to utilise the immobile assets of their home country and use them as the basis for their own advantages. It was suggested, for example, that Japanese firms, by importing their own corporate cultures, investing in greenfield sites and employing young workers who are given training, have been able to insulate themselves from some of the debilitating effects of the UK’s domestic resources (Dunning, 1986; Hood and Young, 1997). It remains for future research to examine why it is that foreign firms, rather than UK-owned firms, benefit from the locational advantages of the UK and what are the capabilities that they possess, and UK-owned firms seem to lack, that allow them to turn these resources into ownership advantages. The findings of the present study show that during most of the last century, and particularly since the 1960s, outward FDI and exports moved parallel to each other. This implies complementary, rather than substitution, relations between FDI and domestic investment. The lesson of this finding for government policies is that policies designed to promote FDI should not discourage exports and vice versa (UNCTADDTCI, 1996). Furthermore, the correlation between exports and FDI suggests that government support of the mobile resources that are not tied to the UK, such as subsidies to R&D, management or technical training, designed to enhance the competitiveness of UK MNEs, may affect also the competitiveness of its immobile resources, as measured by the export performance of the UK, and vice versa. 6

An indication of the satisfactory performance of UK MNEs was given in an analysis of some 200 of the world’s largest MNEs, where UK MNEs reached by far the highest return on foreign assets. Their rate of return was 7.78% followed by US MNEs with only 6.24% (Gestrin et al., 1998).

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Due to serious data limitations, particularly of the pre-1960 FDI data (discussed above), and the fact that the proxies used for the competitiveness of the UK and its MNEs are not fully comparable, the findings of this research can at most be interpreted as an illustration of general trends. Partially as a result of the limitations of the data and partially as a result of different methodologies, our findings are not fully comparable with those of similar studies for the US and Sweden (discussed above). With this limitation in mind, however, it is interesting to observe that these studies found the competitiveness of the home countries and their MNEs to move in opposite directions. While the export shares of the country were deteriorating, their MNEs were gaining exports shares, in contrast to our findings, which show that during most of the last century, the competitiveness of the UK and its MNEs moved parallel to each other. This finding implies that for the most part, UK investment abroad has not replaced domestic investment, while more substitution is observed in the case of Sweden and the US.

Acknowledgements The authors wish to acknowledge useful comments of Professors Cantwell and Corley on previous drafts of this paper.

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