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What the SoftBank-ARM deal says about Brexit Britain

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An ARM and SoftBank Group branded board is displayed at a news conference in London, July 18.   © Reuters

SoftBank has made one of the biggest takeover bids so far this year with its $32 billion offer for ARM Holdings, the U.K.'s leading chip and software designer.

The deal has implications for the global economy and Brexit Britain. The move appears to reflect a big bet by SoftBank to boost its presence in the internet-of-things sector, by acquiring a tech leader that can supply information-sharing chips in everyday objects.

But what does the deal tell us about Brexit Britain? The recent vote to leave the EU is deemed so important by global leaders that it was discussed at the recent G20 meeting of finance ministers and central bankers in Chengdu, China. Essentially what global leaders fear is that Brexit will not only unhinge global financial markets, but act as a catalyst for disintegration and instability in the EU. The latter is probably of much greater significance over the long-term. And in a way, that is why the SoftBank announcement is important. Here's why.

There are inevitable worries in the U.K. now as to whether the Brexit vote will trigger a recession. The evidence after such a short time is sparse, but the announcement on July 22 of a sharp decline in the latest Purchasing Managers Index to levels not since 2009 certainly sparked fears that it could happen. As well it might.

Yet, the real economic danger for the U.K. in leaving the EU is not so much a contraction in demand over the next three to 12 months, but rather a less noticeable, but more corrosive, impoverishment over the medium-term as the country's trade, investment and labor sources of growth are disrupted and undermined. So, does the SoftBank deal say that everything is okay?

Not at all. ARM Holdings is not a typical company, but a highly specialized one with revenues mainly in U.S. dollars. It is true that the U.K. has become the leading European country for inward foreign direct investment, not least from China, whose outward flows are rapidly increasing. According to government data, the U.K.'s stock of inward FDI hit a record of about 1 trillion pounds in the fiscal year to March 31, 2015.   

There is no question about the U.K.'s FDI appeal, attributable largely to language, quality of life, regulatory and competition regimes, and a reputation for high quality legal, accounting and financial services. Yet, Britons should not be myopic about these things. For 72% of foreign investors in the U.K. cited its participation in the EU's single market as central to the country's attraction as an FDI hub, according to a survey by global auditor group EY ahead of the June 23 Brexit vote .

Investor remorse

We can only speculate what leaving the single market might entail for foreign investors already in the U.K., and those considering new investments. For now, the UK will remain in the EU until at least 2019, assuming that exit negotiations begin in 2017. But companies, both in financial services and other sectors, are already reconsidering their future strategies, anticipating the day when the advantages of the single market are gone. The government will have to work hard and fast to come up with reasons why they should not reconsider their presence in the U.K.

The SoftBank decision clearly has its own drivers, but the nature of the decision is not necessarily in Britain's interest. It demotes the indigenous tech sector and confirms a suspicion that U.K. entrepreneurs are more interested in cashing out than building up.

More than this, it also points to a more globally challenging problem. According to the United Nations Conference on Trade and Development, the volume of global FDI is increasingly determined by tax considerations and related restructuring of corporate entities rather the increasing production capacity. This has important consequences for capital flows as reflected in the balance of payments, but amount to very little in terms of changes in the underlying size of corporate operations or expansion of productive capacity. This was highlighted in the organization's World Investment Report 2016, notwithstanding the fact that global FDI rose sharply last year to $1.76 trillion, the highest level since 2008, and just shy of the previous record of $1.9 trillion in 2007.

In fact, if we compare the share of global FDI to global gross domestic product, we can see a pattern that is troubling, regardless of the recent rise in FDI to an eight-year high in nominal dollar terms. At the peak of postwar globalization in 2007, global FDI reached a record 5.2% of global GDP. It dropped to 2.2% by 2009, and after a minor bounce in 2010-11, to 2.1% by 2014. Last year, it rebounded to 2.7%, but this is still half of the peak.

The outlook is not auspicious. International organizations such as the International Monetary Fund are not optimistic about the prospects for global growth or aggregate demand. The spur to global FDI flows provided by commodity and mining companies over the last 10-15 years is now a spent force. Tax and regulatory issues are going to become more prominent as government worldwide respond to economic and social pressures at home.

Brexit could certainly have a dampening effect on inward and outward FDI in Europe. The U.S., one of the largest and most important sources and destinations for FDI, will become under increasing scrutiny as its presidential campaign enters the home stretch, not least for the almost binary policy outcomes represented by the two protagonists. China is on an unsustainable path of state-sponsored credit expansion. It is increasingly perceived as a less desirable place to do business by foreign chambers of commerce in the country, although it is also pushing outward FDI as part of its One Belt, One Road and Asian Infrastructure Investment Bank initiatives.

It should be said that Japan, whose outward investment stock amounts to nearly $1.3 trillion or more than six times inward investment, will doubtless continue to feature in the global economy as a net provider of capital. SoftBank's ARM acquisition testifies not just to the goals of the companies in a highly specialized sector, but also to Japan's role as a global investor.

FDI downturn

But the scary thing to consider is that FDI flows, especially those aimed at expanding productive capacity, have not come close to the levels they reached during the heyday of globalization. The same is true of world trade, which once could be relied on to grow at twice the rate of global GDP year in, year out. This is no longer the case, as FDI flows struggle to even keep pace with an already weaker GDP growth rate.

That we should be faced with these realities several years after the biggest ever global policy stimulus was unleashed in 2008-09, followed by the easiest monetary conditions ever recorded, tells us that something is badly amiss. Even the best tech deals or trade agreements are not going to make it better.

George Magnus is an economist and author of publications including: "Uprising: Will Emerging Markets Shape or Shake the World Economy?"

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