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East: Foreign Investment Brings Benefits, Problems For Economies

  • Ben Partridge

New evidence shows that many Central and East European countries are receiving above-average amounts of foreign direct investment in relation to their size. This trend is helping to boost their economic transitions to free markets.

London, 2 December 1999 (RFE/RL) -- While foreign investment has reportedly been dropping for Russia, it has been rising for seven countries in Central and Eastern Europe.

A recent conference at the University of London looked at the latest estimates of the flow of foreign direct investment (FDI) to the region. The conference was told that FDI is playing a key role in the transformation and restructuring of former command economies, although economic performance across the region remains mixed.

The conference focused primarily on Poland, but also looked at the role of foreign investment in the other nations known as the CEE-Seven: the Czech Republic, Hungary, Slovakia, Slovenia, Bulgaria, and Romania.

Gabor Hunya, of the Vienna Institute for Comparative Economic Studies, gave an overview of investment patterns in the region:

"The largest amount of investment per capita has been attracted by Hungary, followed by Estonia, the Czech Republic and Poland. This has several reasons: one is, of course, general economic stability and openness to foreign investment."

Foreign direct investment can be beneficial to transitional countries because it brings with it knowledge of how a market economy functions; the benefit of new technologies; and access to foreign markets. Above all, Hunya says, it creates new jobs and new opportunities.

The study by Hunya suggests that the Central and Eastern European countries received about 4 percent of the global flows of investment capital in the period from 1995 to 1997, although this figure dipped to less than 3 percent in 1998. Hungary was one of the world's leading countries in attracting foreign direct investment. Even Bulgaria and Romania -- whose economies have performed poorly -- have had high FDI inflows compared with their very low levels of domestic capital formation.

The study says that FDI accounts for an average of about 8 percent of the output of goods and service worldwide, but all CEE-Seven countries had rates above that average in the later 1990s (the highest percentage was in Hungary, the lowest in Slovakia).

The largest sums of money have been invested by Germany and the United States, followed by the Netherlands. Germany has the largest share of investment in the Czech Republic. The U.S. ranks first in Poland, second in Hungary and third in the Czech Republic. Austria is also a key investor in the Czech Republic and Hungary, and is among the most important investors in its small neighbors, Slovenia and Slovakia. Other important investors in the region include Switzerland, France, Italy, and the United Kingdom.

Hungarian companies have the highest share of foreign equity capital among countries in the region. Foreign penetration in Hungary is on average double the penetration rate in Poland and three times higher than in the Czech Republic, Slovakia, and Slovenia.

But high levels of foreign equity investment can also cause problems, as economist Hunya explains:

"But, in the longer run, problems may emerge with too high a rate of foreign penetration. When [you look at] a country like Hungary, where two-thirds of industrial output is done by foreign affiliates, or about 80 percent, or even more of exports is produced by foreign affiliates, then the fortunes of whole branches of the economy and companies depends on decisions beyond the control of subsidiary areas. So they can be locked into limited technology and limited specialization, they can be prevented from penetrating new markets."

Across the region, labor productivity in firms with significant foreign equity investment is on average as much as twice as high as in domestic enterprises. These firms also pay around 20 to 30 percent higher wages than domestic companies.

Still, persuading workforces of the benefits of foreign investment can be problematic. A study by (Maria Jarosz and Piotr Kozarzewski of) the Polish Academy of Sciences, found that some Polish managers and workers feel that Germans, Americans and Russians have too much influence over the Polish economy. Workers and managers said they believed that the least "dangerous" investors were Dutch and British companies.

Another study by a British academic (Ian Hamilton) found that multinational enterprises tend to invest in countries that are on the verge of EU accession but have not yet joined the union, so as to exploit the benefits of the enlarged market from the outset. What are the problems related to foreign investment? One is that foreign owners generally expect to take their profits back home with them. The sovereignty of companies and national economic polices can be reduced with foreign ownership. And the availability of high competence jobs may shrink if decision-making centers are located abroad.

And the advantages? The conference was told that the pace of restructuring has been fastest in countries where privatization attracted significant foreign investment. More important, FDI has had a stabilizing effect on transitional economies. It has brought to the countries modern technologies, and helped them develop up-to-date industrial and export structures.