Europe is the world’s favourite investment, but for how long?

If we can assume that investors behave reasonably rationally when deciding where to put their money, Europe’s future prospects are perhaps not as hopeless as some suggest.

A recent study by the Economist Intelligence Unit and the Columbia Program on International Investment (www.cpii.columbia.edu) shows not only that the EU will receive more foreign direct investment (FDI) than any other economic area in the world this year, but also that this is likely to continue to 2010.

FDI flows into the EU will total €417 billion in 2006, compared with the €150bn going to the US and €107.45bn going to the so-called BRIC countries - Brazil (€13.5bn), Russia (€17.5bn), India (€7.96bn) and China (€69.25bn) - seen by many as overtaking an ‘old’ Europe that has become economically insignificant.

Looking ahead to 2010, the good news for the EU is that it will still be the strongest magnet for FDI in the world. The bad news is that the sums involved will remain more or less the same as today, at €421.8bn.

It is perhaps not all that surprising that FDI into the EU will remain constant. We are, after all, talking about massive sums of money and Europe’s markets may well be saturated. It is more surprising that the BRIC countries are also forecast to receive more or less the same as they do now: €111bn.

It is also worth bearing in mind the findings of another recent report - the World Economic Forum’s competitiveness index for 2006 - which is based not only on short-term economic growth prospects, but also on an evaluation of the potential for sustainable long-term wealth creation. This puts nine European countries in the top 15, while India ranks 43rd, China 54th, Russia 62nd and Brazil 66th - again suggesting that the outlook for Europe is not as bleak as some maintain.

But nor is it as bright as others might like to suggest. The FDI survey predicts that it is Europe’s old rival, the US, which will gain most from increased FDI flows between now and the end of the decade, with a projected rise in its share from €150.4bn this year to €300bn by 2010 - beating both Europe and the BRIC countries.

There are, however, uncertainties in the US forecast. These include the recent moves in a protectionist direction highlighted in the FDI study and poor fiscal management, which largely prompted the World Economic Forum’s decision to downgrade the US from first to sixth place in the world competitiveness league. Continued record public deficits have led to rising public debt and an ever-increasing share of public expenditure going on servicing that debt, reducing the sums available for spending on education, infrastructure and other investments that could boost productivity.

Heavy government borrowing is also driving up general borrowing costs, making business investments more expensive. At the same time, the US has a record balance of payments deficit, which means that an increasing proportion of the wealth created in the US is sent abroad to creditors in Germany, Japan, China and elsewhere.

Within Europe, there are some small surprises in the FDI analysis which give food for thought.

First, while the UK is a European star in this respect now, the forecast suggests that its share of FDI will shrink from €104.3bn in 2006 to some €59.7bn by 2010. Germany and France will do better: Germany’s share is expected to almost double, up from €20.7bn to €37.4bn, with France recording an increase from €54.1bn to €59.7bn over the same period, putting it on a par with UK.

Second, while the EU’s newest member states in eastern and central Europe have benefited from an explosion in FDI in recent years, this is not

expected to continue, with no change in Poland and Hungary’s share in 2006-10 and the Czech Republic’s share falling by half.

But while there may be clouds on the horizon in some EU countries, the fact that Europe is expected to hold on to its current overall share of FDI and will still be the biggest beneficiary of FDI worldwide in 2010 shows just how great its potential for future growth is.

But global competition will continue to bite and Europeans will have to respond to the challenges it poses. Future growth and prosperity in Europe is by no means assured and will not happen without constant change and structural reform.

• Hans Martens is chief executive of the European Policy Centre.

If we can assume that investors behave reasonably rationally when deciding where to put their money, Europe’s future prospects are perhaps not as hopeless as some suggest.