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Amid global competition for investment, what more can Europe do?

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15 minute read 19 Jun 2024
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Long term value
EU Institutions

Policymakers can enhance Europe’s attractiveness to foreign investors by focusing on nine critical areas.

In brief

  • Foreign direct investment (FDI) in Europe declined by 4% in 2023, the first annual downturn since 2020, according to EY research.
  • Policymakers can primarily boost Europe’s competitiveness by improving the regulatory balance between protection and innovation.
  • FDI could be increased by maintaining manufacturing competitiveness and creating a fertile environment for innovation.

Europe should be a magnet for FDI. It is home to 500 million consumers and is the world’s third-largest economy behind China and the US. It has a well-diversified industrial base, robust infrastructure, some of the world’s leading academic and research institutions, and a highly educated and skilled workforce. According to this year’s EY Europe Attractiveness Survey, 62% of businesses with and without operations in Europe believe the continent outperforms other regions on the availability of workers with advanced skills, such as scientists, engineers and data analysts.

But more and more data shows that Europe needs to rethink the way it stimulates economic growth and attracts FDI. Europe’s share of global industrial output declined from 21% to less than 15% between 2001 and 2021. More recently, the United Nations Conference on Trade and Development (UNCTAD) estimates that the value of greenfield FDI in Europe declined by 20% in 2023. In the same period, investment increased by 2% in the US, 8% in China and 17% across Asia. In addition, this year’s EY Europe Attractiveness Survey finds that the number of investments in Europe fell 4% annually — the first decline since 2020.


The cause of this downturn is a combination of slow economic growth, persistently high inflation, high energy prices, geopolitical uncertainty and declining demand for office space. Huge stimulus packages in other parts of the world may have also diverted investment from Europe. The US’s Inflation Reduction Act, for example, is credited with mobilizing US$98 billion in investment and creating more than 80,000 jobs.

Some of these challenges appear to be declining, but policymakers cannot just wait and hope that investment rises again when economic conditions rebound. For the businesses in the survey, the number one risk to Europe’s attractiveness is a longer-term issue: the increased regulatory burden. 


“The recent downturn in FDI in Europe, coupled with the huge stimulus in other parts of the world, most notably the US, is a wakeup call to European policymakers,” says Julie Linn Teigland, EY EMEIA Area Managing Partner. “Many acknowledge that urgent action is required. Now is the time to deliver.”

The European parliament elections in June 2024 are an opportunity to take another look at how to boost Europe’s attractiveness. EY research shows that policymakers could focus on nine areas, which we have divided into three groups based on the level of urgency and the scale of the intervention needed.   

We need a forward-looking European narrative that reminds investors of the power of Europe — its collective strength, above and beyond the individual economic interests of nations, regions or cities.

Julie Linn Teigland

EY EMEIA Area Managing Partner

Download the 23rd EY Europe Attractiveness Survey

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1

Chapter 1

Addressing three urgent areas: regulation, manufacturing and innovation

Europe’s direction of travel on the green and digital transitions is right, but policymakers must adapt to an ever-changing playing field.

1. Find a regulatory balance between protection and innovation

In our survey, businesses say that an increased regulatory burden is the top risk to Europe’s attractiveness over the next three years. Forty-one percent rank this as a top three risk, which is significantly more than the 33% who mention energy and political instability, which are a joint second. Businesses in the high-tech and industrial sectors are most at risk.

Europe prides itself on introducing regulation that protects citizens faster than anywhere else.

Marc Lhermitte

Partner, EY Consulting, Global Lead FDI & Attractiveness

Concerns about new regulation are increasing because of the introduction of new laws such as the Carbon Border Adjustment Mechanism, the EU AI Act, FDI screening and product regulation in specific sectors. Investors are also likely to be frustrated by the growing disparity of regulation between and within European countries.  

“Europe prides itself on introducing regulation that protects citizens faster than anywhere else,” says Marc Lhermitte, Partner, EY Consulting, Global Lead FDI & Attractiveness. “This is a positive, but businesses are calling out for a more pragmatic balance between protecting citizens and help enabling investment and innovation.” 

How can European policymakers alleviate these concerns? 

  • Harmonize regulation: Policymakers should try to harmonize regulation within the single market. Introducing new laws through regulation, rather than through directives, would reduce the scope for Member States to diverge from EU law. To limit regulatory divergence, they should also exert their influence on jurisdictions outside the EU.
  • Reconsider the pace of introducing new regulation: The EU is typically a first mover in regulating areas such as data protection, AI and sustainability. A more gradual approach may be better, because it gives nascent industries more time to mature and for risks to materialize. Surveyed businesses agree. When asked where Europe should concentrate its efforts in order to maintain its competitive position in the global economy, they rank “allowing regulation to keep pace with technological and other disruptions” fourth in a list of 15 initiatives.
  • Repeal old laws: Old laws must be repealed when new regulations are introduced. When this does not happen, businesses can be overwhelmed by the need to comply with regulations that appear to overlap.

2. Maintain manufacturing competitiveness

FDI in manufacturing projects in Europe is proving resilient. The number of announced projects in 2023 was only down 1% from 2022 and 2% from 2020, but it was still higher than the annual average number between 2013 and 2022. 

However, there is no room for complacency. Domestic demand for manufactured products could decrease due to demographic changes. And another spike in energy prices would raise manufacturing costs. Europe is particularly vulnerable to these shocks because European countries export more of their manufactured goods than other countries do.  

The sheer scale of industrial stimulus policies around the world means that Europe must expand on its own policies that encourage manufacturing, such as the Net-Zero Industry Act. Policymakers could also boost European manufacturing in the following ways:  

  • Shore up supply of vital components: Whether it is microchips used for advanced digital products or rare earth materials used in electric vehicle batteries, there is a global shortage of the materials and components needed to support high-growth industries. For many years, China has invested in ensuring its businesses have access to vital materials and components. More recently, the US has taken steps to protect its chip industry with the CHIPS and Science Act. Europe has responded with its Critical Raw Materials Act, which sets out targets for the domestic mining, recycling and processing of specific raw materials. But Europe will still need to import large quantities of vital raw materials, so it needs a new, long-term strategy — especially when every non-European major industrialized country is doing the same. 
  • Allow businesses to scale up to global relevance: Policymakers must remove the barriers to the creation of large, Europe-wide businesses that can rival the scale of those in the US and Asia. Relaxing competition laws to allow mergers would help, as would harmonizing regulation across European countries. 

3. Create a fertile environment for innovation

Asked where Europe should concentrate its efforts to maintain its competitive position in the global economy, investors place “support high-tech industries and innovation” first.


How EY can Help

High-growth, AI-enabled businesses would benefit from many of the initiatives in this nine-point plan, including adjusting the regulatory balance from protection to innovation, encouraging AI, unlocking capital markets and improving skills. 

Businesses rank the environment for AI investment, development and use as the fourth most important technology-related factor determining where they invest. EY research finds that almost all European CEOs are making or planning significant investments in generative AI (GenAI), so this issue will become more important. But only 44% of the surveyed executives say that Europe performs better than other regions on this.

 

How can policymakers help Europe catch up?

  • Boost digital skills: Executives say that availability of a workforce with technology skills (e.g., scientists, engineers and data analysts) is the top technology-related factor that determines where they invest. So, Europe needs programs that build on its existing strengths and enhance existing capabilities.
  • Be prepared to adopt the EU AI Act: The EU has a track record of very slowly adapting regulation once it is implemented. This is not possible with AI because the technology and its applications evolve rapidly. Regulators will need to be agile and balance the need to encourage innovation with protecting citizens. 
  • Reduce bureaucracy: High levels of red tape compared with the US deter some technology entrepreneurs from establishing operations in Europe. Small and medium-sized enterprises (SMEs) that are developing AI-enabled technology will need access to EU funding and help with demonstrating regulatory compliance, so they do not become overburdened.

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2

Chapter 2

How to accelerate existing work in energy, capital markets and trade

Policymakers could boost initiatives’ efforts to address areas of immediate concern for foreign investors.

4. Restore confidence in energy prices and supply  

Investors’ second-biggest risk to Europe’s attractiveness over the next three years is “volatile energy prices and energy supply issues.” But energy prices have decreased drastically since their peak in 2022 and, in some countries, are now lower than pre-pandemic levels. So why are investors worried? 

One reason could be future shocks that could plunge Europe into another energy crisis. This dents confidence in Europe’s attractiveness because competing destinations, such as the US, are less reliant on imported energy and have not experienced price increases that are comparable with Europe’s in the past two years. And Europe’s need to reduce its reliance on imported energy and to decarbonize energy generation might impact future prices.  

The EU and individual countries have already taken drastic action. EU energy subsidies rose from €177 billion in 2015 to €216 billion in 2021 and to €390 billion in 2022. There has also been a series of initiatives designed to accelerate the low-carbon transition of Europe’s energy sector — most notably, the EU Fit For 55 package.

How can policymakers help restore confidence in energy?

  • Fund and develop infrastructure: Assets such as grids and interconnectors could be funded at the European level. Interconnectors are crucial to integrating Europe’s energy market, which will reduce costs and improve resilience. Interconnectors need coordinated planning and financing, which is too complex for a single country to manage alone.  
  • Invest in Europe’s energy transition: An estimated €600 billion is required for Europe’s energy transition. This increases the importance of completing the capital markets union.

5. Unlock private investment with a full capital markets union

For investors, access to capital is vital. Thirty-two percent of executives say that “liquidity of financial markets and availability of capital” is one of the top three factors that determine where they invest — an increase from 28% in 2023 and 25% in 2022.  


High interest rates have increased the importance of capital availability. And the huge sums necessary for Europe’s energy and digital transition have made liquid financial markets more important.  

Enrico Letta’s proposal to create a savings and investment union is important. It would help to divert the €300 billion of individual Europeans’ savings currently allocated outside Europe to financing the EU’s strategic objectives. The union must be based on a fully integrated capital markets union, which would allow pension and insurance funds, and other institutional investors, to invest across Europe at scale. 

Unfortunately, there has been minimal progress toward a capital markets union. This should change. The Eurogroup has recommended ways to advance it in the next five years that include developing an EU securitization market, improving capital markets supervision with an updated rulebook and reducing regulatory burdens. 

6. Unify to respond rapidly to global trade wars 

Investors believe that political risks could undermine Europe’s attractiveness in the next three years. They say that “political instability in Europe (including upcoming elections, populism and polarization),” alongside volatile energy prices, is the second-biggest threat to Europe’s attractiveness. Geopolitical tension and conflict is the fifth-biggest threat.  

Major geopolitical events have highlighted the interdependencies among geopolitical rivals recently, whether that is Europe’s reliance on Russian gas or the US’s extensive use of chips manufactured in China. As a result, many countries have launched initiatives designed to de-risk global interdependencies.  

Amid increasing division and discord around the world, policymakers need to act with unity and urgency to boost Europe’s attractiveness to foreign investors.

Hanne Jesca Bax

EY EMEIA Markets & Accounts Leader

European policymakers need to be aware that there are trade-offs between de-risking from countries such as China, achieving net-zero targets and restoring economic competitiveness. For example, restricting imports of clean technology from China will reduce economic dependence, but potentially raise prices and therefore slow the rate of energy transition.

As geopolitical and global trade tensions intensify, European policymakers need to be able to respond decisively. This means the Member States must align on key areas. Which industries need to be protected? Which countries represent a strategic threat? The attractiveness of individual Member States relies in part on the attractiveness of the entire continent.  

 “Amid increasing division and discord around the world, policymakers need to act with unity and urgency to boost Europe’s attractiveness to foreign investors,” says Hanne Jesca Bax, EY EMEIA Markets and Accounts leader. 

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3

Chapter 3

How to maintain Europe’s leading position on sustainability, skills and tax

Policymakers should take action to preserve Europe’s competitive advantage.

7. Focus on the economic benefits of sustainability 

Countries’ approach to sustainability can help them to secure investment. Businesses rank “countries’ policy approach to climate change” as the fifth most important factor influencing where they invest.

Europe is already a sustainability leader: 67% of investors say that Europe is better than other regions at helping its businesses achieve their sustainability plans. They say that, within Europe, Switzerland, France and Germany are best equipped to do this. And investors want Europe to keep up this momentum. They rank “encouraging environmental policies and attitudes” as the sixth most important way to improve Europe’s attractiveness. 


How can policymakers retain Europe’s status as a sustainability leader?  

  • Release funding for sustainability projects: Just 42% of surveyed executives say that Europe outperforms other regions on the level of funding for sustainability projects. 
  • Balance environmental regulation with ease of doing business: Policymakers will need to be careful that any new regulation does not stifle business activity and impede Europe’s other strategic ambitions.

8. Boost workforce productivity and promote Europe’s critical skills  

The presence of a highly skilled workforce is a major factor in determining where businesses locate operations. When we asked businesses that are planning to invest in Europe this year about their motivations, “access skills” came second only to “reduce costs.” And investors ranked “skills and availability of the workforce” fourth in a list of 15 factors influencing where they invest.

Europe is doing well here. For example, 62% of investors say that Europe outperforms competitors on the availability of technology skills such as science, engineering and data analysis. But it cannot be complacent. Reports by the European Centre for the Development of Vocational Training and the European Labour Authority show that the continent has shortages of specific skills in the health care, software, construction, hospitality and engineering sectors. 

The EU has made a start, with initiatives to fill future skills gaps that include its Pact for Skills and the Skills and Talent Mobility package. It is vital that policymakers, businesses and academic institutions continue to collaborate to identify the types of skills that businesses need in the future.

9. Balance tax competitiveness and revenue growth 

European governments are attempting to raise revenue for increased expenditure while maintaining competitive tax rates. That is a difficult balancing act.

Tax is only one of many factors that influence where businesses locate their operations, but authorities should resist draconian measures that could harm Europe’s attractiveness. Investors in the survey say that tax authorities’ flexibility and pragmatism is one of the most important tax-related factors influencing where they invest. In particular, they value cooperative compliance processes and help with discovering and understanding local rules.

Europe’s introduction of a 15% global minimum tax on companies with more than €750 million in revenue will inevitably see jurisdictions compete to find new ways of offering tax breaks to companies. Countries such as Ireland, Luxembourg and Switzerland, which historically had lower rates of corporation tax, are signed up to the new rate. But the position of other major economies such as the US is less clear, which could give them an advantage — particularly if a Trump administration opts out.     

Although the revenue implications of the global minimum tax remain to be seen, experts expect the reforms to shift tax competition between jurisdictions to credits, grants and subsidies. Last year, the OECD confirmed that it will provide more favorable treatment for certain tax credits such as those contained in the US’s Inflation Reduction Act. 

How can Europe turn on the taps of foreign investment?

Dive deeper into the 23rd EY Europe Attractiveness Survey

Read our initial analysis
Download the full report

Summary

Europe’s decline in FDI, coupled with the targeted intervention in competing countries, creates the impetus for policymakers to act. Our survey data indicates that they should focus on the nine areas outlined in this report. Success requires collaboration between European countries and between politicians and business. They must harness the spirit of urgency and unity that Europe demonstrated in response to the two most recent crises — the COVID-19 pandemic and the war in Ukraine — to restore Europe's competitiveness on the world stage. 

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