Examine the significance of the single currency for decisions by TNCs to invest in Eurozone countries (40 marks)/"The UK is the largest recipient of inward forward investment within the E.U.". Evaluate the benefits of such investment for the U.K. economy

University Degree Business and Administrative studies

George Rose

a) Examine the significance of the single currency for decisions by TNCs to invest in Eurozone countries (40 marks):

TNCs are trans-national corporations who will be looking to invest various amounts of money and capital in the countries in which they invest. The single currency within this zone means that all countries within the area are operating in the same currency with identical monetary value and no exchange rates between the countries.

With a single currency between countries, there will be no transaction costs incurred when transferring money from one country to another. For TNCs these savings in costs (i.e. the cost of changing between different currencies of different countries) will be a great advantage as TNCs operate widely across different countries. This will allow for savings in costs as the TNCs will be able to move money around their operations in various countries (i.e. from office to office, or factory to factory) within Europe without incurring any costs. However although there will be savings due to the single currency, it is important to consider how significant these savings will be to a large TNC. Although any savings in costs will be important to a company wanting to make maximum profits, considering the scale of business that a TNC will be conducting, transaction costs will only represent a very small proportion of all costs and may be deeming far less important than other costs such as the costs of land, capital and labour in the Eurozone. If, for example the TNC chose to invest instead in a developing country such as China, though there would be transaction costs between here and other countries, the savings that could be made in other areas could definitely outweigh the transaction costs. It is also important to consider what volume of trade the TNC shall be doing within the Eurozone and what proportion will be out of the Eurozone. If a far greater proportion is being done outside of the zone there will be very little advantage to be gained from operating in a the “zero-transaction costs” zone and vice versa.

A second advantage for a TNC investing in the Eurozone would be the exchange rate stability. As all countries within the single currency have a consistent 1:1 exchange rate with each other (i.e. no exchange rate) there is long term assurance for a TNC that there will be no changes in costs due to exchange rate fluctuations. Advantages to be gained from this include price competition and import costs from other Eurozone countries. With no exchange rate the price competitiveness of the TNCs goods against all other Eurozone produced goods will be solely dependent on the production process itself. There will be no variation in price dependant on exchange rate, and so this will act as an incentive for TNCs as it ensures security. Also the lack of exchange rates will mean that TNCs will be assured that any resources or imports that they buy from other Eurozone will not be priced depending on exchange rates, but solely on inflation and other cost effecting reasons. This will be very attractive for TNCs as it will make planning far more easy and will allow firms to look further into the future with far less concerns about changes in costs and sales figures that would under other circumstances be exchange rate dependant.

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However for many firms, although security is important, taking calculated risks is often part of a profit making firm’s strategies. While constant exchange rates allow for easy planning of costs and sale prices, variable exchange rates between the countries a TNC operates in can often be beneficial to that company. For example is a TNC is operating in a country with a strong exchange rate against a country from which it imports, costs of imports will be cheaper and this can cut costs for a firm. Alternatively if a firm is based in a country with a weak exchange rate it will make the firms products very price competitive and this could be beneficial to the firm. In this way it may not be beneficial for a firm to be located in a single currency zone if it is importing/exporting with other countries in the zone. However, the Euro still holds an exchange rate against other currencies so there will still be some opportunity for gains to be made through currency strengths and weaknesses. Though it is important to remember that with any exchange rate, a strong currency has both its advantages and disadvantages to a firm as does a weak exchange rate.

It is also important to consider that there are a significant number of other factors that influence a TNCs decision to invest as well as costs and sales prices. Firms also consider the location of the country – if there is suitable demand in the market, the availability of suitable and skilled labour, the incentives offered by governments and the laws in operation in the country (i.e. advantageous labour laws) and also the possibility for future growth and expansion which may not be possible in somewhere like the Eurozone where there is already a very high concentration of TNC investment.

b) “The UK is the largest recipient of inward forward investment within the E.U.”. Evaluate the benefits of such investment for the U.K. economy (60 marks):

Inwards foreign investment is when foreign firms come to the UK to invest money in UK based projects – whether it be in setting up UK based branches of foreign companies or through investment in new capital and other similar resource-based investments.

Investment into the UK can create new jobs and can also secure those that already exist. Firms locating in the UK will often look to locate in areas with high unemployment – offering a large selection of labour to chose from. This allows for regional unemployment to be addressed and there will also be a “safeguarding” effect of those jobs attained. This increased employment can bring higher average wage levels to an area and this in turn can increase standards of living. More significantly if there is an increase in the income flow of an area there will be repercussions of this due to the multiplier effect. The multiplier effect is an illustration of how many times a volume of money will flow through the economy of an area. Through increased employment an area may find increased demand for goods and services, resultantly firms may do better and record higher profits and the money from this will again be re-invested in the area. This could have an effect on the macro-economic situation, as both aggregate demand and aggregate supply could be affected. Aggregate demand would increase due to the increased investment, increased consumption and possibly increased exports. Aggregate supply would also increase due to increased productivity and efficiency thus allowing for high production levels to be reached – there will either be a move towards the boundary of the PPF curve, or an actual shift in the boundary of this curve:

These changes in AS and AD will resultantly lead to an increase in the real national income level while the effects on the price level are far less significant due to the changes being both positive for AS and AD. Of course it is important to consider how large the changes are for both AS and AD and the actual point of intersection of the two. If the change in AD is far greater than that of AS there could be positive pressure on prices while the opposite may be true if the change in AS is greater than that in AD. Also if the intersection is near full employment the changes in price levels will be far more significant than changes in income level, while if one is far from maximum employment there will be large changes in income and small far less significant changes in price level.

Foreign investment (most significantly in the form of take-overs and mergers of firms) can bring into the UK the best ideas from abroad, helping to develop the UK’s exciting, high-value, and high tech business environment. This will in turn help to address productivity problems that the UK may be facing – new technology can help increase efficiency and can also boost the quality of produce being made. As economic conditions worldwide become increasingly more competitive, and as the pace of technological change quickens, inward investment, especially advanced technology investment in fields such as multimedia, telecommunications, software, pharmaceuticals and financial services will help to increase the UK’s competitiveness. While the UK will find it harder and harder to compete with developing countries in terms of labour costs and similar costs of production if the UK has a gain on these countries in areas such as technology and quality it will definitely being able to compete successful in non-price terms.

Firms that invest in the UK also contribute to the UK’s balance of payments account. The initial benefit of an investment will be on the capital account because there will be a net inflow of foreign currency into the UK when the investment occurs. However in the long term money will flow back to the home country of the foreign investor in the form of interest, profits and dividends causing an adverse effect on the current account. By investing in the UK and then exporting out of the UK the contribution onto the balance of payments of goods and services is a positive one – thus pushing the balance out of deficit. It is shown that about 40% of all UK gross exports are provided by inwards investors. Given the structural changes of the UK economy (the drastic fall in the manufacturing sector of the UK and resultant fall in export figures) this figure on the balance of payments is an important factor and it is the investment that foreign companies make into the UK that may well help to fund the UK’s large spending habits.

Inward investors also help to generate tax revenue as they will be expected to pay similar commercial taxes to those paid by UK companies. However, investors may well expect government subsidies as an incentive to invest in the UK and it is also very likely that a significant proportion of profits will be sent back to the parent country of the firm, so there outcomes of government subsidy investment will not all be returned back into the economy.

In conclusion I believe that the most positive effect for the UK of inwards foreign investment is the positive effects on employment (and of course unemployment). The multiplier effects that come from this will be very significant in effecting other areas of the economy and will allow for both growth in aggregate demand and aggregate supply. There is however a worry that the increased competition faced by domestic firms could lead to unemployment for some as firms find it hard to compete with large international investors. The effects on the balance of payments will also be on the whole positive as the investment will help to balance our trade in goods and services account, however the current account may slip towards deficit as a large amount of money will be leaving the UK to return back to the home countries of the investors in the form of interest, profits and dividends.