Foreign Direct Investment Jaromír Šindel ECES The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Topics about FDI What is FDI? Effects? Why FDI into C&EE? Transformation and Integration Consequences Structural Changes (more on Wednesday) External (Im)Balances –Current Account, Financial Account, Monetary Crisis, Reinvested and Repatriated Earnings Investment Incentives  Competition The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

What is FDI? Definition –Investment into basic capital –Long-term loans joint with yields or decision power –Reinvested earnings –10% share on equity  Investor has long-term interest about his investment Financial Account in Balance of Payments … more at FDI & External (Im)Balances The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Forms of FDIs Greenfield investment –High inflow of FDI; new production capacity – investment and employment effect Brownfield investment –Like greenfield – investor buy real estate; quicker spillover effect Mergers & acquisitions –High inflow of FDI, but no new production capacity; higher spillover effect; Investment only into better technology and for higher productivity Joint ventures –Easier penetration for foreign investor; higher spillover effect The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Effects of FDI? Source: Newton. Country Report. January Amount of investment and crowding-in of other nvestment; Creation of new jobs, training and human capital development; Transfer of technology and managerial skills; Structural change and shift up on technological ladder; Increasing of exports performance and substitution of imports; Regional development and cluster creation. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Effects of FDI? Source: Newton. Country Report. April The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Determinants of FDI? Characteristic of market (doing business) –Economic and political stability –Geographical position –Factors of production – costs and quality –Institutional environment –Technology level –Purchasing power of domestic demand –Business environemt Investment Incentives The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Why FDI into C&EE? Source: Newton. Country Report. October The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

In comparison with other countries… Source: Newton. Country Report. November The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

… most FDI goes to developed countries Source: UNCTAD Global FDI inflowsGlobal FDI outflows The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

…inward FDI stock in EU-15 … in new EU-10 … Source: UNCTAD. World Investment Report The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

…but the importance of FDI in C&EE… Source: Newton. Country Report. November The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

FDI inflow and stock in C&EE Source: Newton. Country Report. November The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

FDI and C&EE Transformation consequences Privatisation Structural changes Integration consequences Better environment for foreign investment, better rating (OECD, NATO, EU, euro) Better growth The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Why FDI into C&EE? Privatisation Lower wages (Productivity) Geographical position Qualified labour force Investment Incentives Membership of the EU –the adoption of the full body of EU laws (the acquis communautaire)... reduce risk premiums for investors –EU funds... better business environment EURO... better financial conditions The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Why FDI into C&EE? market-seeking investors –the strong economic growth of new EU member countries –in 2004: their real GDPgrew by 5.5%, more than double the EU-15 average –favourable growth prospects efficiency-seeking investors –competitive unit labour costs are particularly important (wages vs. productivity) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

FDI inflow and M&A in C&EE Source: Newton. Country Report. November The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

FDI after privatization? Privatisation is important reason for FDI inflow into CEEC Greenfield FDI, reinvested earnings (capacity extension or intension) are good indicators how the CEEC are prepared for the period without privatisation related FDI –Estonia (in % of FDI are RE), Poland, Czech Rep. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Role of FDI (or FCE) FCEs Penetration in Manufacturing (share in employment in %, the latest year available) Source: Newton. Country Report. December The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

FDI – sectoral view FDI inflows by industry in CR, (Millions of dollars) Source: UNCTAD FDI in the car industry in CEE, 2003 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Lower Wages Source: Newton. Country Report. October The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Lower Wages … Future? Source: UNCTAD. World Investment Report Convergence of wage levels in the EU: a projection, 2004, 2020 (Average of EU-15=100) Note: Under the assumption of a convergence rate of 1.5% per year. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Investment Incentives? Source: Newton. Country Report. January The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Investment Incentives in 2000 Source: Newton. Country Report. October The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Best incentives... taxes Taxes in V4 countries in July 2003 and announced (per cent) Note:a Excluding local/municipal taxes. b gradual reduction until early a In addition, Hungary levies a “trade tax”, although this is often waived for major investment projects. Source: “Adólicit Közép-Európában”, Magyar Hírlap Online (Budapest), 30 June From UNCTAD. WIR The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Invesment Incentives – problems? Domestic vs. Foreign Investors –Selective or Non-selective Incentives –Changes in Investment Incentives – the same condition (lately in Slovakia) Principal-agent problem, rent seeking of pressure groups … … Moral Hazard, Corruption –KIA in Slovakia (amount of money from 6 bln. SVK to 3 bln. SVK) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Invesment Incentives – problems? Prisoner Dilemma –incentive´s competition among governments –Multinational enterprises sometimes have bigger economic size and power than governments or nations International competition in FDI inflow –Germany vs. C&EE (tax policy) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Invesment Incentives – problems? Prisoner Dilemma –Incentive´s competition among governments –Government compares the yields from FDI inflow with costs from investment incentives. Government wants benefit from FDI. –Explaining why governments offer invest. incentives, even with risk of lower benefit from FDI in comparison with situation without invest. Incentives (only yields without costs). The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague FDI inflow into CR and HUN in the four different sitatuations Czech Government YES to Inc.NO to Inc. Hungarian Gov. YES to Inc. CZ: 180 CZ: 80 HU: 230 HU: 250 NO to Inc. CZ: 200 CZ: 100 HU: 90 HU: 110 !! INCENTIVE COSTS !!

FDI & External (Im)Balances Source: Newton. Country Report. April Trade balance effect (imports and exports) –Export orientation, FDI´s import demand (type of FDI – buildings, machinery; FDI branch – importance and resources of raw materials, competition with domestic supliers) Earnings effect Exchange rate effect Non-debt financing source of Current account deficit The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Trade balance effect The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Type of FDI –Greenfield FDI, Brownfield FDI, M&A, Joint Ventures Kind of FDI –Market-seeking investor vs. Efficiency-seeking investor Type of branche –Low-tech vs. High-tech vs. Resource intensive sector

Trade balance effect Source: Newton. Country Report. April Share of FDI in Manufacturing Exports (in %) Exports per Sales in Manufacturing - Comparison between FDI and Domestic Enterprises (domestic enterprises = 100) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Non-debt financing source of Current account deficit Source: Newton. Country Report. April The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

FDI and double-entry Earnings Source: Newton. Country Report. April The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Dual Economy … Labour market … higher wages, better employees Productivity Trade performance … export ratio, investment ratio, returns of equity, … Exchange rate appreciation … price competition The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Dual Economy … Labour market Effect of FDI on Wages in CR, 2003 Source: KB. Economic Trends, No. 43, The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Dual Economy … Productivity Source: Newton. Country Report. December Productivity Gap: FCEs and DCEs in 1999 (value added / employee, DCEs = 100) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Dual Economy … Productivity Source: Newton. Country Report. December Relative Level of Labour Productivity in the Czech Economy (EU average = 100) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Dual Economy … Productivity Effects of FDI on Labour Productivity in CR, 2003 Source: KB. Economic Trends, No. 43, The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Dual Economy … Trade performance Source: Newton. Country Report. December Comparison of FCEs and DCEs in the Czech Manufacturing (DCEs = 100) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Dual Economy … Exchange rate How to cope with appreciation? Higher productivity, better know-how,... Brand, lower transaction costs,... Multinational corporation, intra-firm trade,... Inter-enterprise relationships The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

FDI in C&EE - Conclusion Positive EffectNegative Effect The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Task: COMPLETE