Foreign Direct Investment

1
Foreign Direct Investment in Transition
Economies
Why does it go where it does in Central and South
Eastern Europe, and how does this affects the
host nation?
By Michael Faul
2
Ways To Invest in a Foreign Market

• Foreign Direct Investment - When a firm directly
  invests in production or other facilities in a
  foreign country, and maintains effective control
  of said investment
• Foreign Portfolio Investment Investing in
  securities sold by a foreign firm or government

3
Advantages of Bringing in FDI

• Technology Transfers
• Inflows of foreign stable capital into the
  country
• Helps in the transition to privatization (when
  state owned firms are sold to foreign investors)
• Improves the countries infrastructures
• Brings foreign executives into the country with
  sufficient knowledge of macroeconomic global and
  local situations

4
The Asian Crisis

• Causes High levels of short-term dept vs. GDP
  led to a financial Panic
• Large inflows of Foreign Portfolio Investment led
  to huge amounts of short-term dept that was
  feared to never be repaid
• Investors began pulling out their funds from
  solvent but illiquid banks at the same time in
  1997

5
Short-Term Debt and Reserves
http//www.imf.org/external/pubs/ft/wp/1999/wp9913
8.pdf
6
Debt-to-GDP Ratio
http//www.imf.org/external/pubs/ft/wp/1999/wp9913
8.pdf
7
Financial Results of the Asian Crisis
http//www.imf.org/external/pubs/ft/wp/1999/wp9913
8.pdf
8
FDI and Stable Capital

• The capital investments that are made through FDI
  are long-term investments that are illiquid
  assets, and thus speculation cannot cause a mass
  pull-out of this capital
• Had the investments in Asia been of the direct
  rather than portfolio nature, the crisis may have
  been avoided

9
Factors Influencing FDI Inflows
http//www.univ-lille1.fr/afsemedee/communications
/toubal_farid.pdf
10
Traditional Variables in Determining Whether to
Invest FDI in an Economy

• Plant/Firm Level Efficiency
• Are labor costs low in this country
• Is there enough skilled labor in this country, so
  that there exists a relatively low
  productivity-adjusted labor cost
• Are there government policies, such as low
  corporate tax rates that could reduce production
  costs
• Transportation Costs
• Is there an existing infrastructure that will
  allow for the flow of both the inputs/outputs of
  a given investment
• Are there local suppliers in this economy, or is
  it necessary to look abroad for necessary inputs
• Are there tariffs or import/export quotas that
  prevent a multinational firm from maximizing the
  effectiveness of its foreign investment

11
Traditional Variables in Determining Whether to
Invest FDI in an Economy (Cont.)

• Market Size
• Once the multinational firm decides send FDI into
  a country is there going to be sufficient demand
  in their particular market
• Is this particular market already filled with
  competitors, or is it an untouched market that is
  ready to be exploited
• Is there a market potential in any of the
  neighboring countries

12
FDI Influencing Factors That Arise in Transition
Economies

• Country Risk
• The risk of non-payment or non-servicing of
  payments for goods or services, as well as loans
  and other finance tools
• The chance of repatriation of capital by the host
  government
• The possible loss of rights due to inadequate
  laws to protect intellectual property (i.e.
  patents, trademarks, processes, etc.)
• The Level/Method of Privatization
• How much has this country actually advanced
  towards a market economy (How high a share of the
  GDP is possessed by private businesses)
• How stable is the market that has been created in
  this country

13
Types of FDI

• Horizontal FDI - A multinational firm (MNE)
  enters a foreign country to produce the same type
  of products that it produces at home
• Vertical FDI - a multinational firm enters a
  foreign market to produce intermediate goods to
  be used in their final products

14
Vertical vs. Horizontal

• Horizontal FDI - Often the case when there exists
  high barriers to trade (i.e. tariffs,
  transportation costs, import quotas)
• Vertical FDI - More likely when there are few
  trade barriers and the different production
  factors exist at various prices in different
  economies

15
Locations of Transition Countries

• Poland, The Czech Republic, and Hungary compose
  the more centrally located transition economies
• Romania and Bulgaria are a part of the south
  eastern countries in transition

16
The Distribution of FDI in Transition Economies
Was Not an Equal Distribution

• In general, transition economies have not
  received large amounts of FDI (less than 1
  before transition, and only up to 5 of world FDI
  by 1995)
• The majority of this FDI inflow is located in the
  CEECs with only a small amount in the SE European
  countries
• Within these regions, a few countries have
  attracted the majority of the investment
  (Cumulatively, Hungary, the Czech Republic, and
  Poland have attracted 84 of all the FDI in
  Eastern Europe and Russia has attracted 85 of
  the FDI in the CIS region)

17
The Distribution of FDI in Transition Economies
Was Not an Equal Distribution (Cont.)

• The FDI inflows in the Balkan Region between 1989
  and 2000 were insignificant, at less than 20
  billion USD in those 11 years
• This number (the combined total FDI inflow of 8
  countries over 11 years) does not even amount to
  that of one year of German or British FDI outflow

18
FDI Inflows To CEECs

• In China from 1993-2000, the Per Capita
  (Millions of US) FDI was 268.45, far higher
  than in any of these countries

http//www-wds.worldbank.org/servlet/WDSContentSer
ver/WDSP/IB/2002/11/22/000094946_02111304010628/Re
ndered/PDF/multi0page.pdf
19
FDI Inflows To CEECs
20
FDI Inflows To China and India
http//www.imf.org/external/country/IND/rr/2002/pd
f/092002.pdf
21
Chinas Employment Structure
http//www.imf.org/external/country/IND/rr/2002/pd
f/092002.pdf
22
Reasons For FDI Inflow Inequalities

• All of the determinants that a Multinational
  Enterprise (MNE) considers are important in
  deciding whether or not to invest directly in an
  economy, however, the level of privatization and
  the method of which it is reached is the foremost
  important measure that is considered
• This can explain why Bulgaria and Romania always
  performed relatively poorly in terms of FDI,
  despite their large markets and relatively low
  costs

23
By the Numbers 1999
http//www.univ-lille1.fr/afsemedee/communications
/toubal_farid.pdf
24
Reasons For FDI Inflow Inequalities (Cont.)

• Stability can be quoted as the reason that
  Poland, the Czech Republic, and Hungary attract
  so much of the CEECs FDI
• They were the first countries to enter into the
  Central European Free Trade Area (CEFTA) and thus
  investment in one of these countries guarantees
  trade amongst all the nations, and the EU as well
• They also are characterized by low risk of
  repatriation as private market shares compose
  large proportions of the GDPs, upwards of 80
• Large Markets, Stable Environments, and advanced
  trade situations lead to good performance in FDI

25
Reasons For FDI Inflow Inequalities (Cont.)

• It is not necessary for a country to be a large
  country in order to attract a decent amount of
  FDI
• Slovenia- a stable county which is perceived to
  have little risk attracts sufficient amounts of
  FDI
• Slovak Republic- which has about 75 of its GDP
  privatized also is successful in attracting FDI
  inflows

26
Reasons For FDI Inflow Inequalities (Cont.)

• In Bulgaria and Hungary, the process towards
  privatization has taken far longer than in the
  countries that are favorably attracting FDI
  inflows and are thus lagging behind in that
  regards
• I will use the case of Bulgaria to explain how
  FDI flows into these less open economies

27
Incentives for FDI in Bulgaria
http//www.city.academic.gr/material/academic_staf
f/business_administration/bitzenis/Bitzenis_VOLOS_
CONFERENCE.pdf
28
Obstacles To FDI in Bulgaria
http//www.city.academic.gr/material/academic_staf
f/business_administration/bitzenis/Bitzenis_VOLOS_
CONFERENCE.pdf
29
Regression Equation

• The factors presented in the aforementioned
  survey can be used to create a regression
  equation that is able to calculate the
  approximate FDI levels in a transition economy
• Although such a calculation is too complex for
  this course, independent economists as well as
  World Bank consultants have worked towards
  creating equations that can perform these
  estimations (this is where the importance of
  these surveys truly lies)

30
Bulgarian FDI Inflows

• The 2001 numbers do not represent an entire year

http//www.city.academic.gr/material/academic_staf
f/business_administration/bitzenis/Bitzenis_VOLOS_
CONFERENCE.pdf
31
Explanation

• These type of determinants were common in the SE
  European transition economies, and explain why
  the largest European direct investor into
  Bulgaria was Greece
• The history of trade between these two nations
  (which had occurred before Bulgaria had switched
  to a planned economy) fostered less fear of
  country risk than other investors felt
• The close geographic proximity also contributed
  to the fact that the largest FDI in Bulgaria by a
  EU country came from Greece (this proximity
  provides them with lower transportation costs
  than any other EU country)
• Cultural closeness also provided for an easy
  transition of Greek investors into the once
  closed Bulgarian market

32
Conclusion and Question

• FDI flows to the countries that best fit the
  needs of the firms and provide them with the best
  chance for profit with the most limited risk
• As the transition economies move closer and
  closer to free markets, they still compose only a
  small percentage of the worlds FDI inflows. Is
  there anything that these countries can do with
  their macroeconomic policies to entice more
  direct investment inflow, or are the traditions
  and policies of the developed market economies
  holding them back?