On March 29, 2017, the British voted to leave the EU. As a consequence of that political decision, London, currently, the financial center of Europe, is likely to lose some of its influence and possibly even give up its title. Which cities are to gain because of Brexit? What will attract the investments from London to other cities, that remained in Europe? What makes a good investment climate in general? We will try to answer these and related questions in our article.

Currently, many international banks and financial companies have their European headquarters in London. According to Dunkley, passporting, which is the opportunity to do business in Europe without further authorization in each country, allowed such firms to operate in all of Europe, having the main office in London.

Many cities have the ambition to substitute London, but two are particularly likely – Dublin and Frankfurt. The main things that banks want to avoid are high cost of relocating and disruption. However, the attitude of their employees also plays a role. If traders would feel uncomfortable in their new location it would be bad for the banks.

Labor laws are also an important variable to consider. According to Makartoff, the decision by the German government to make it easier to recruit employees will have an impact on whether banks choose to move to Frankfurt. Banks might save lots of money if, for instance, they don’t have to pay high labor taxes or don’t have to spend money to search for employees for a long time.

From this comes one more factor – the amount of qualified workforce in that country. Perhaps, it would be illogical to move a very sophisticated front office division of a company into a developing economy, where people often do not have the opportunity to access university education on a large enough scale to supply qualified workforce.

In case of a retail company it could be not only important to be able to find the needed employees, but also to make sure that the market is big enough and the company is able to generate profits. This is the reason why many large international companies still don’t have their offices in Baltics. Despite the proportion of a population that has university education is one of the highest in the world, companies are still hesitant to open their offices in our region, all due to the fact that the market is too small. In addition to the size of the population, the amount of income also matters. The relatively low purchasing power is also the case why luxury brands are hesitant to enter the Baltics.

If we look more into the case of Latvia and how it is trying to attract foreign investment we see that there are three main concerns for investors:

Should Latvia become a tax haven?

One rather unconventional  way of attracting foreign investment could be becoming a tax haven or offshore. This means that companies in such state have little to no tax liability, and tax havens also often don’t disclose information about their firms.  Such measures are especially attractive for banking and financial services sectors because of easier conditions to make profits and less concerns about legal issues. Some examples of such tax heavens include Lichtenstein, Panama, The Bermuda Islands, Malta, Hong Kong. For instance, Hong Kong tax on capital gains and dividends is 0 per cent, VAT also being 0%, while taxes for corporations also being quite low at 16.5%.

However, one should mind that this model of attracting investments has quite significant drawbacks concerning legality and positive public opinion. Firstly, nowadays increasingly popular corporate social responsibility (CSR) goals include combating corruption which is an integral part of tax havens. A similar trend of following Sustainable Development Goals (SDGs) means that governments and companies are also bounded by directives on ecology, labor, equality and other factors. This poses a conundrum for certain economies.

For instance, Hungary in recent years has been struggling to reduce the budget deficit and dodge IMF bailout. The measures taken included imposing extraordinary taxes and additional charges on specific (mostly foreign-owned) industries, including media, tobacco and retail. This significantly influenced a foreign direct investment intensity decline from 4.5% of GDP in 2014 to 1.0% in 2015. Although the sector-specific taxes did repel current and potential investors, it helped to put together the country’s public finances. Due to tax revenues, the budget deficit of 2.1% GDP in 2014 declined to only 0.7% in 2016, while the general investment appeal of Hungary was enhanced enough to acquire investment-grade status. This example depicts how sacrificing short-term gains can lead to future revenues.

Politics and investments

It is clear that politics play a crucial part in national appeal. Therefore, we have mentioned some of political factors like tax system but the so-called soft factors such as political stability are no less important. It is obvious that countries at a risk of war are a no-go zone for international companies. Therefore, a reasonable approach of avoiding that risk would be for politicians to avoid impulsive strong rhetorics addressing neighboring nations while simultaneously being aware and prepared for all kinds of aggression. This idea might be useful for certain officials in the Baltic states. For example, this December Lithuanian Prime Minister publicly claimed that he knows a secret plan by opposing party to overthrow current government by force and he ordered national security and special forces to be ready. The PM has not provided any actual evidence of such rebel plan but his quick word may have reached the ears of potential investors, who could conceive wrong opinion about Lithuanian political instability.

Reinventing cities

The business climate can differ a lot even in the same country. That is especially true for big federal states such as Canada or Russia, where local laws differ significantly across regions. But actually, every city has unique strategic positioning and should actually be analyzed individually to use most of its economic potential. International corporations always do their own research where to expand operations but often inviting action from the locals can attract significant foreign direct investments.

A good example of a troubled city reinvented is Manchester. It has suffered Irish terrorist bombings in its center during the ‘90s but when peace settled local authorities took necessary action. A public private partnership taskforce was created to revive urban central area. Quickly the city center achieved a modern look because of newly built steel and glass buildings. The architecture was not liked by everyone but the “urban vibe” seemed particularly attractive for students and young professionals. The parks and squares for recreation also added up to the appeal. Lofty living spaces appeal for those young and skilled, and this influx of intellectual capital is particularly economically beneficial. Manchester currently has the fastest growing education sector in the UK and has been hailed the UK’s most livable city.

Certain countries and cities all have their advantages and disadvantages concerning specific economic activities, because of unique consumer and household differences. This is why governments and councils should decide what types of investment they are most able to attract and use their potential. As expressed in Euromonitor yearly global cities report, “it is important to understand the differences in cities and each city should be analyzed on a case by case basis. “

Conclusion

We, authors, hope to have provided some interesting insights into international investment relations, driving factors behind them and most successful investing climate examples. The Baltic states have experienced a decent growth during the past decade after crisis and now The Ease of Doing Business index has Lithuania in 14th place, Estonia 16 and Latvia 19th in the World. There is still plenty of room for improvement and we believe that if a possible recession analyzed in previous iFund newsletters doesn’t come soon, we are on good track to further development.

Authors: Ispirs Haradžanjans, Vincas Vosylius

References:

Dunkley, E. (2017, June 08). Six cities in search of London’s business after Brexit. The financial times. Retrieved from https://www.ft.com/content/ba683c32-4c3e-11e7-a3f4-c742b9791d43

Makortoff. K. (2018, Nov 28). London to lose €800bn to Frankfurt as banks prepare for Brexit. The Guardian. Retrieved from https://www.theguardian.com/politics/2018/nov/29/london-to-lose-800bn-to-frankfurt-as-banks-prepare-for-brexit

Sauka (2015) THE INVESTMENT CLIMATE IN LATVIA: THE VIEWPOINTS OF FOREIGN INVESTORS (FICIL Sentiment Index 2015). Retrieved from: https://www.sseriga.edu/sites/default/files/news/ficil_sentiment_index_2015.pdf

Boumphrey S., Z. Brehmer Z. (2017) “Megatrend Analysis.Putting the Consumer at the Heart of Business”. Retrieved from: https://go.euromonitor.com/FR-EC-2018-Megatrends-and-Its-Impact-On-Innovation.html

Gordon L., Thapa R. W. (2017) “Hungary: A Return to Investment Grade Status Could Restore FDI Inflows” Retrieved from : https://blog.euromonitor.com/hungary-a-return-to-investment-grade-status-could-restore-fdi-inflows/

https://data.worldbank.org/indicator/IC.BUS.EASE.XQ

https://www.theguardian.com/cities/2015/nov/03/the-great-reinvention-of-manchester-its-far-more-pleasant-than-london

Image sources:

John Parkin for http://www.skyscrapercenter.com/building/beetham-tower/2800

https://www.advisoryexcellence.com/appleby-explored-connecting-tax-haven-halifax-leaked-documents-show/