Competition from emerging economies, fuelled by the abundance of skilled workers at a significantly lower cost, presents an ever growing threat to the UK’s position as the world’s number two investment destination. Countries such as India and China are churning out graduates at a rapid-fire rate and capturing not only manufacturing and business services investment, but also higher value functions such as research and development. Microsoft, Cisco and IBM are among the multinational companies that have set up R&D bases in emerging economies.

Emerging economies are important investors themselves, with India now the second largest contributor to UK business after the US. The investment flows emanating from developing economies – a good measure of their development – are also a measure of their ability to compete as investment destinations. The challenge from emerging markets has become a priority for British policy-makers, prompting a concerted effort to promote international business relations, improve UK skills and expedite the transition from a manufacturing economy to a high value, knowledge-based economy. But without improvements to the UK skills base (one in six children leaves full-time education unable to read or write properly), the country is in danger of diminishing its appeal as an investment destination, and some even say heading for a skills crisis.

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Skill shortage

The debate around skills is not a new one, and a government call to action has resulted in a strong campaign to improve the UK’s skills base. The campaign’s roots go as far back as 2004, when prime minister Gordon Brown, then the UK’s chancellor, commissioned Lord Leitch to carry out a comprehensive review of UK skills. Findings of the report, published in 2006, outlined proposals to make the UK a world leader in skills by 2020, aiming for a basic literacy and numeracy rate of 95%. In addition, the report recommended 90% of adults should be skilled to GCSE level or to vocational equivalents compared with 69% in 2005; and 40% to graduate level and above, compared with 29% in 2005.

As for vocational skills, the report advised that the number of apprentices in the UK needs increasing to 500,000 each year. Meeting the targets is crucial because out of 30 Organisation for Economic Co-operation and Development countries, the UK is 17th on low-level skills, 20th on intermediate skills and 11th on high-level skills, according to the Department for Innovation, Universities and Skills (DIUS).

Implementation of the report’s recommendations is being overseen by the DIUS, headed by secretary of state John Denham. The new skills system was devised with greater employer engagement and is based on the needs of the UK’s employers, according to Mr Denham. “That is why the focus of the implementation plan is on adults,” he says. This is good news for the five million adults in the UK lacking functional literacy and 17 million who have difficulty with numbers. “Today we need to raise skills levels to take advantage of the opportunities an innovative economy brings,” he adds.

Whitehall has put its money where its mouth is by offering tax credits to R&D investors. In addition, a corporation main tax rate cut was announced in the 2007 Budget, reducing the current rate of 30% to 28%, effective from April this year. But critics of the current tax regime say the treasury did not go far enough. In December 2007, the manufacturers’ trade body, EEF, called for a rate cut to 25% by 2011 to encourage investment. However, the UK’s 28% is loosely on a par with the EU 25% average and many experts say the proposition the UK offers more than makes up for a higher corporation tax rate.

Infrastructure improvements

Added to lower taxation, a number of infrastructure improvements should also encourage foreign investors to put their faith – and their money – into UK business. “Transport links are a major factor in the decision-making process of where to establish a business,” says Clemens Betzel, president of solar panel firm G24 Innovations. “Transport is a problem in the UK – it’s too expensive and partly unreliable and it’s a problem for people who do international business.”

Compared with the rail network in Switzerland, for example, Mr Betzel believes that the UK scores very poorly. Improvements to the UK’s high-speed train links to the continent were completed in November last year. The new high-speed line started service from St Pancras International station – redeveloped at a cost of £800m ($1.58bn) – which became the new London terminus for all Eurostar services.

The improvements aligned the British part of Eurostar’s route with the same standards as the French and Belgian high-speed lines; non-stop journey times were reduced by 20 minutes – London to Paris to two hours, 15 minutes; and London to Brussels to one hour, 51 minutes. Also newly developed is the £100m Ebbsfleet International near Dartford in Kent, which together with St Pancras will provide direct services to the 2012 Olympic site in London’s Stratford.

London and the South-east stand to benefit most from infrastructure projects to accommodate the 2012 Olympics, most significantly BAA’s schedule of improvements to Heathrow airport. Heathrow Terminal 5 will open in March at a cost of £4.5bn and will address an expected increase in passenger volumes during the Olympics, with associated road improvements to follow.

There is also speculation surrounding a controversial plan for a third runway and sixth passenger terminal to alleviate congestion, which would cost around £9bn, according to the Civil Aviation Authority.

Despite improvements to its infrastructure and a buoyant economy, London cannot afford to become complacent about its leading FDI position, as companies continually re-evaluate their presence in London, says Michael Charlton, CEO of investment promotion agency Think London.

More than half of all companies review their global strategy every three to five years, and 13% do so every year, he says. “Every year, moving from one city to another becomes easier so London must ensure it stays on top by continuing to drive improvements to infrastructure, a supply of talent, and an attractive fiscal and ‘business friendly’ environment.” Food and drinks producer Kraft is just one firm that has announced plans to move its European headquarters from London, in this case to Switzerland. Others may follow if trading in the capital ceases to outweigh the cost of maintaining a presence in Europe’s most expensive city.

The West End of London has the highest rental costs not just in Europe but across the world, according to Cushman & Wakefield’s 2007 Office Space report. At €1594 per square metre per year, the gap between London and Europe’s second most expensive city, Paris, continues to widen as rental growth in London is more than three times that of Paris. But property supply, skills availability and infrastructure are all known quantities, on which good governance can improve. It is the left-field attack, such as the current credit crunch, which tests the robustness of a country’s investment pulling power.

The knock-on effects of the credit crunch on FDI remain unclear. What is certain is that the UK must prepare itself by being in the best shape possible when crisis hits. That means offering investors a proposition to rival any other global market: world-class skills in an unbeatable location.