The Technological Role of Inward Foreign Direct Investment in Central East Europe

J. Stephan

• Publisher: Palgrave Macmillan
• Year: 2013
• ISBN:
  9781137333766
• Topic: Commerce
• Subtopic: Commerce Général

Foreign direct investment (FDI) assumed a prominent role in Central East Europe (CEE) early on in the transition process. Foreign investors were assigned the task of restructuring markets, providing capital and knowledge for investment in technologically outdated and financially ailing firms.

1

Introduction

This book intends to assess the role that inward foreign direct investment (FDI) can have on the technological development of the recipient economy, in particular where the recipient country is in the process of economic catching up. This focus positions the analysis in the book between the body of literature testing the existence of economic effects of inward FDI on the one hand, and the management literature concerned with strategies of multinational enterprises in host regions with lower levels of economic development, possibly transition economies, on the other.

The book starts out with a fairly comprehensive introduction that not only discusses the motivation of the topic and the analytical implications that emerge from this focus for empirical analysis, but also provides some of the characterisation of the countries at hand and the issue of FDI itself.

1.1 Motivation of the topic

When the ‘historical experiment’ of central state planning collapsed in Central East Europe (CEE), it was widely assumed that the formerly socialist countries would be able to swiftly catch up with the West (Lipton and Sachs, 1990; Herr and Westphal, 1991; Sachs, 1992). The Washington consensus (Williamson, 1989, 1993; for critique, see for example Stiglitz, 2002; Rodrik, 2006) explored a path of comprehensive liberalisation of all internal and external spheres of the economy and assumed that entrepreneurial activity,¹ having been subdued for so long, would now thrive in the new pro-economic and competitive environment. Alas, history took a different path: the ‘lost decades’ of socialist planning had produced technological stagnation and had dried out individual entrepreneurial behaviour (because it was not regarded as a core competence (see Åslund, 2002, p. 283), and would also have run counter to the constituting criterion of the economic plan, resulting in a shortage economy unable to satisfy demand to a very large extent. The liberalisation of the thenceforth ‘transition countries’ was therefore in need of external help (to overcome the technology gap and to supply demand) – yet help in terms of development aid would have been inconceivable in the light of the large amounts that would have been necessary: the financial ‘transfers’ invested into the East German new Länder are an impressive case in point. Rather, foreign private economic activity had to be the main engine of the transition process and of the process of catching up at least during the first years. This is the role that FDI assumed.

FDI was assigned a pivotal role in the catching-up process of the Central East European countries (CEECs). The list of objectives to which FDI can contribute to at times of systemic transition includes the following, perhaps most prominent, points:²

•Alleviating capital shortage: even if doubtful in the medium term (credit gives rise to capital in a monetary economy), this assertion may possibly be acceptable in the case of CEE due to an environment of insufficient trust in the financial spheres around currencies that are newly establishing themselves in terms of international convertibility and acceptance as legal tender.

•Supply of technology: the socialist countries existed in economic autarky from the West within their own integration area of the Council for Mutual Economic Assistance (CMEA), which was both self-inflicted (or governed by the Soviet Union) and at the same time forced upon them by the West, exemplified in the CoCom-list (see for example van Brabant, 1980/2012). They were consequently delinked from the kind of technical advance so characteristic of the development processes in the West since World War II. Those had been broad in the sense of emanating from all sorts of industries and fields of science, were driven to a large extent by private risk-bearing economic activity, and have been – to a large extent, and by consequence – in coherence with demand by the users of new technology.

•Privatisation: who else should have (i) the necessary capital or ability to raise capital to foot the bill of desperately needed recapitalisation and restructuring, and (ii) the management skills, knowledge, and expertise to make the transforming economic entities in those countries internationally competitive?

•Competition: central planning consistently excluded and necessarily had to exclude competition from economic activity. It was foreign trade liberalisation and inward FDI which was to assume the role of enforcing competition on (formerly) state-owned monopolies.

Those four points can be directly deducted from the dichotomy in the world during the socialist era: in economic terms, the distinction between the two worlds, East and West, is best harnessed by characterisation of the constituting criteria of the two systems (see for example Riese, 1991, 1992): whilst the West was governed by competitive and (more or less) free markets that incentivised private economic activity, the East was governed by an overarching economic plan that transcended into nearly all aspects of economic activity. Consequently, economic activity was public and did not involve (or involved to only a very small extent) privately organised economic activities.³ In the West, the coherence of the economic sphere was based on competition⁴ and money. In the East, it was administrative planning. The western world generated an environment conducive to intensified economic foreign integration by way of private foreign investment, private foreign trade and the cross-border migration of labour; the conditions for those were framed in bilateral and multilateral institutions such as the work of the then GATT and the institution of international (reserve-)currency regimes, the International Monetary Fund. The ‘communist bloc’, on the other hand, planned, controlled, and executed external economic relationships through the political administration such as the CMEA (see, for example, Brezinski, 1978), thereby not allowing the emergence of private internationalising activities (private exporting and importing, outward or inward FDI with internationally owned property rights, international licensing or franchising etc.). Indeed, foreign ownership during socialist times rested by default with the country hosting the property – no other legal arrangement would have been consistent with the system of economic planning. Where new firms were established involving cross-country ownership, international production agreements in intergovernmental contracts guaranteeing ‘inter-country socialist ownership’ had to align the respective economic plans of respective participants to preserve consistency of the economic plans (see Brezinski, 1978, p. 172–3).⁵

Despite the obvious role that FDI could potentially play in the transition process, the countries in CEE were in reality regarded as unattractive locations for FDI in the early years, due to fears of a return to communism and the significant political risks in some of the countries (for example, the civil war in the former Yugoslavia, the uncertainties souring the break-up of Czechoslovakia, the despotized political regime in the early years of the Slovak Republic, and the non-transparent situation in Romania). When privatisation programmes in the CEE countries started, they flooded the markets with institutionalised productive capital to such an extent and in such a short period of time that prices and values of to-be-privatised firms fell sharply (in Germany to symbolic amounts, and even at times effectively negative due to guarantees and state aid). It was to a large extent foreign capital that took advantage of this (for an early account of the relationship of FDI and privatisation in CEE, see Welfens and Jasinski, 1994, Chapter D). Once the worst transitional recession was overcome in the early 1990s and the economies started on their process of catching up with Western European levels of GDP per capita, CEECs became more interesting targets for FDI. This was spurred not only by mass privatisation, but also by the expectation that these countries would swiftly integrate their already industrialised and now liberalised economies into the European economic area and hence offer profit rates in excess of risk premia. The hope amongst CEECs was that they would not only receive the capital needed to restructure their industries but also that they would get access to modern western knowledge and technology. Most of the CEECs adopted FDI policies based on attracting as much FDI as possible without any concern about the quality of investors (Rugaff, 2008). Over time and with rising stocks of productive capital and levels of economic development, wages also increased. Where wage increases surpass productivity growth,⁶ the (unit labour) cost advantages in CEECs melt away; yet now, two decades after the transition process started, CEECs are still offering sizeable unit labour cost advantages in comparison to the West.⁷ Where unit labour costs are converging to western levels, strategic motives tend to shift towards building industrial and service networks with the local host economies, reaping localisation advantages beyond motives of pure efficiency. Today, it is the technology-intensive networks that can be expected to be particularly competitive not only as FDI projects, but also as drivers of international competitiveness for the foreign investor in the home country. An increasing number of foreign affiliates in CEECs assume the character of ‘developmental subsidiaries’, build capacities of technological development, and become active drivers of knowledge and technology in their own right.

This is the empirical starting point of this analysis. The starting point unveils the overarching research question guiding the analysis: under what conditions can inward manufacturing FDI serve as a panacea for transition and catch-up development in CEE? This analysis cannot, of course, answer that ambiguous question to a satisfactory extent, yet it contributes some important insights that should help generate answers.

1.2 Setting the research agenda: the technological aspect of the ‘developmental role of inward manufacturing FDI’

This overarching question forms part of a wider research agenda on the developmental role of FDI in general. The agenda has been evolving for many decades in the bodies of literature on economic development, international economics and, to a lesser extent, in the international business literature. This has produced ‘conventional wisdoms’ that over time have adapted to new empirical trends and research results generated by more powerful methods and firm-specific data. Three sets of ‘conventional wisdom’ are summarised in a volume edited by two Washington institutions: the Institute for International Economics and the Center for Global Development (Moran et al., 2005, p. 2):

•The ‘Washington consensus’ enthusiasm is shared mostly by multinational investors and business lobby groups. It holds that FDI always has a positive effect on the host economy, hence countries should attract as much inward FDI as possible.

•Academic scepticism however prevails over the relationship between inward FDI and economic development. It may well be that the effects of FDI will not yield beyond the effects of any other domestic investment.

•‘Dirigisme resurrected’ describes a contemporary tendency by policy-makers in some developing countries to revert to heavy-handed regulation of inward FDI. This may include provisions for minimum technology transfer, compulsory licensing, local content requirements and other measures targeted at increasing technology transfer and spillovers to the benefit of the economy that hosts inward FDI.

This list obviously lacks some more critical views that may not make it to a Washington-accepted ‘conventional wisdom’ yet still remain important in many host economies, and not only in the third world. Those views direct attention to the possibility that inward FDI may cause environmental damage and may deplete natural resources, and there are allegations related to land grabbing and its potential risks for the indigenous societies. Neglecting those points certainly makes an odd compilation: they may not apply to a large share of inward FDI, they may be overstated in some cases, they may have been more frequent some years or decades ago, and yet they do exist today, and in some cases put immense strain on the host countries (see, for example, the problems associated with environmental damage from oil extraction in some African countries, predominantly Nigeria, see also the critical discussion about the role of recent FDI inflows originating from China around the developing world).

Moran et al. (2005) see the benign effects of FDI to be conditional on and driven by an open trade and investment policy framework that gives rise to competitive markets.⁸ On the other hand, where foreign affiliates operate behind trade barriers and without local competition, FDI may even subtract from host country welfare (ibid., p. xii).⁹ Today, the empirical literature on average and at the most general level assumes a rather positive view of inward FDI: “FDI is generally associated with positive technological spillovers, economic growth, and increasing income inequality. [ ... ] In all three areas there are, however, significant counter examples in the literature which must be respected.” (Clark et al., 2011, p. 2). As much as the Washington consensus can be criticised, it did contribute to generating a competitive and liberalised economic environment for foreign investors, hence it secured the right kind of incentives for efficient economic activity, upon which sustainable economic growth and development can build. It may also be argued that the prospect of EU membership had an even stronger disciplining effect (see perhaps most prominently Lavigne, 1998, in a very large body of literature). It is the securing of such an economic environment that gave rise to the general contention that inward FDI into CEECs had so far positively contributed to systemic change and catch-up development.

This already sets the research agenda for this book: the objective is to assess the conditions that have to be fulfilled so that inward FDI can have a positive and important role in the technological process of catching up in CEE. A positive general developmental role, not restricted to the technological impact, may be rooted in a number of effects at very different levels:

•Inward FDI increases employment opportunities for local workers, inasmuch as the additional investment has increased the amount of productive capital w...

Table of contents

• Cover
• Title
• 1 Introduction
• 2 The Database Used in the Empirical Analysis
• 3 Foreign Direct Investment Motives and the Match with Locational Conditions in Central East Europe
• 4 Conditions of Internal Technology Transfer and Spillovers between Foreign Investors and Foreign Affiliates in Central East Europe
• 5 Central and East European Innovation Systems as Knowledge Sources for Foreign Affiliates Own Technological Activity in CEE
• 6 Foreign Affiliates as Knowledge Source for Host Regional Innovation Systems in CEE
• 7 The Role of Intellectual Property Rights for Technology in FDI into CEE
• 8 Conclusions on the Technological Role of FDI into CEE
• Annexes
• Notes
• References
• Index