Fdi In Eastern And Central Europe

Globalization, Transnationals and economic policies.

(a) To what extent has FDI been important to the economic development of countries in Central and Eastern Europe over the last decade?

(b) What advice would you give to a government in Central and Eastern Europe on an appropriate policy towards FDI?

"The human capabilities and natural resources of most Central and East European

countries are impressive. What is lacking is the right institutional structure,managerial

expertise, access to foreign markets,entrepreneurial work culture,organizational

capabilities and monetary incentives to efficiently utilize and upgrade these resources

and capabilities."

John H. Dunning,

The Globalisation of Business

London and New York (p. 227)

In the years 1989 and 1990, most of the countries in Central and Eastern Europe and Central Asia (CEECs) started the transition from communist states to market economies. Given that the main task of economic transition is the structural change of the economic system from a socialist and extensive growth model to a capitalist and intensive one (Jensen, 2006), many CEECs have viewed FDI as a panacea to achieve fast economic growth. Indeed, FDI is expected to bring a wealth of benefits to the local economy including fresh inputs of capital and, most importantly, the impetus that knowledge from outside may bring to local processes of technological change (Barrell & Holland 2000). As a result, between 1991 and 1996 FDI inflows into European countries in transition more than quintupled (United Nations, 1997).

However, other economists tend to moderate the effects of FDI on structural change and claim that it depends fundamentally on the initial conditions of the recipient or host country (Ellingstad 1997). FDI flows towards less developed countries have not always resulted in the long-term growth outcomes one would expect (Lipsey 2002). As a result, some countries may end up marked by a dual economy structure characterised by a strong dependence on foreign capital but weak indigenous efforts.

The objective of this paper is to determine to what extent FDI can help a transition economy in terms of its development, defined as a sustained increase in the economic standard of living of a country's population, normally accomplished by increasing its stocks of physical and human capital and improving its technology.

There are various reasons why many policy makers believe FDI is beneficial to their country. A first reason is the need for strategic restructuring in firms in the emerging countries. Most firms in the emerging economies of the former Soviet block were characterised by obsolete machinery and outdated production methods. To compete in a market environment, firms had to improve their efficiency by engaging in strategic restructuring, i.e. updating the equipment and production process. (Irina Grossfeld and Gйrard Roland, 1996). Foreign investors quickly took measures to improve productivity and therefore reduced over manning of which suffered the majority of the companies, replaced the often obsolete apparatus of production by more productive equipment and, finally, introduced new methods of management and organization of work. These three elements explain the relatively fast increase in productivity in the companies repurchased by foreign investors. Thus FDI helped breaking the vicious circle of underdevelopment (low levels of productivity lead to low levels of wages, which lead to low levels of savings, which lead to low levels of investments, which perpetuate low levels of productivity) by complementing local savings and by supplying more effective management, marketing and technology to improve productivity (Gillis et al. 1996; Cardoso et Dornbusch, 1989). Thus, the most important development in the Romanian car industry was the sale of a majority share of the biggest Romanian car manufacturer Dacia to Renault in 1999. In 2000 Renault started the reorganization and modernization of Dacia's management and production facilities. Dacia already proved a successful bet after launching of the Logan model (The "Euro 5000 car") in 2004. As a result Dacia represented 6% of total turnover of the Renault group in 2005.

A second important reason why foreign investors are invited to emerging countries rests on the belief that they generate positive externalities to the domestic firms through a transfer of know-how and technology. Such spillovers occur when local firms benefit from the foreign investor's superior knowledge of production technologies or markets, without having to incur a cost that exhausts the whole gain from the improvement (Blomstrцm & Kokko, 1997). Intra-industry spillovers might occur when a FIE brings a new a new production technology that gives them an advantage over local competitors. Local firms might respond by buying the technology if the latter is not proprietary, by enticing skilled employees away from the foreign firm's affiliate, or by otherwise copying the technology. Moreover, the new foreign-owned firm's advantage over local firms might also force them to use their production factors more efficiently and lower production and marketing costs in order to defend their market shares and therefore improve their competitiveness. Therfore there might be beneficial impacts from FDI in related industries. In particular, upstream linkages between the foreign affiliate and local suppliers have been identified by several researchers. Thus, a study by Peter Walkenhorst (2000) of the Polish sugar industry shows intra-industry spillovers effects triggered by Sugarpol, a joint venture company created in 1989 with British Sugar (BS) being majority shareholder. Not only BS actions helped Sugarpol improved productivity through technical assistance but the improvements at SugarPol might have inspired other factories to copy and adopt similar sugar production techniques and thereby contributed to the increase in overall sugar industry performance. (Walkenhorst, 2000). Moreover, in 1995 two SugarPol factories were the first sugar plants in Central and Eastern Europe to obtain the ISO 9002 certificate. By 1998 three other sugar