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Review of Economics & Finance Submitted on 14/Sept./2010 Article ID: 1923-7529-2011-01-19-12 Lucyna Kornecki and Vedapuri Raghavan ~ 19 ~
Inward FDI Stock and Growth in
Central and Eastern Europe
Lucyna Kornecki, Vedapuri Raghavan
Department of Economics, Finance, and Information System College of Business
Embry-Riddle Aeronautical University (ERAU)
600 S. Clyde Morris Blvd. Daytona Beach, FL 32114, U.S.A.
korneckl@erau.edu, Tel: +1-386- 226-4963, fax:+1-383-226-6696
ragha8d6@erau.edu, Tel: +1-386- 226-6246, fax: +1-383-226-6696
Abstract: This article analyses the foreign direct investment
(FDI) in Central and Eastern Europe (CEE) during the post communist era
and tests the hypothesis that FDI contributes to the economic growth of
the CEE countries. It reflects macroeconomic changes in post communist
CEE and estimates the impact of the FDI stock on economic growth in the
CEE using model based on the production function. This paper finds a
positive association between FDI and economic growth in the CEE and a
tremendous impact of FDI stock on GDP growth.
JEL Classification: P50, P51, O52, O47, P20
Keywords: Foreign direct investment (FDI), Economic growth, Central and Eastern Europe (CEE)
1. Introduction
The FDI inflow in the CEE economies has been a vital factor in the
first stage of the privatization process during the transition period.
Currently, the main reasons to pursue FDI are to boost productivity,
encourage employment, stimulate innovation and technology transfer, and
enhance economic growth (Mueller & Goic, 2002). The CEE countries
have identified the positive effects of FDI on the transformation
process of their economies. FDI has increased in the past twenty years
to become the most common type of capital flow for the reconstruction
and stabilization of the CEE economies.
After the collapse of communism, central planned economies started to receive official assistance aimed primarily to support market reforms and private capital flows.
Official assistance has been provided by Organization for Economic
Cooperation and Development (OECD) in the form of foreign aids, grants,
and loans. The private flows including foreign direct investment (FDI)
and international portfolio investment (IPI) were dominated by FDI.
International portfolio based enterprises are controlled domestically
by local managers, as investors own a small shares of stock and have
little or no influence on the management of the enterprises (Zoltan,
2002).
The inflow of FDI into the CEE countries has had an upward trend
since 1990 with some minor variation. In 2003 there was a major dip in
the inward FDI (USD 9,648 million). However by 2004 inward FDI had
recovered and was on an upward trend reaching USD 26,764 million. The
official development assistance and official aid has been quite stable
across the years. The only noticeable anomalies were in 1991 (USD 3,479
million) and 1995 (USD 3,841 million). Both these years saw a sudden
spike in the inflow of official development assistance and official
aid. ISSNs: 1923-7529; 1923-8401 © 2011 Academic Research Centre of Canada ~ 20 ~
In recent years, there has been an increased interest in the new
investment called the Greenfield investment in the CEE. For example,
nearly 60 percent of Polish FDI inflows during 2006 was attributed to
Greenfield investments. Poland is currently competing for Greenfield
investments on export to the EU markets in the manufacturing sector
(automotive, chemical, and metal investments) and in the services
sector when in the past foreign investments in Poland were focused on
the domestic market.
The CEE countries have increased their participation in the world
economy since the fall of communism, particularly over the last few
years. They accepted the challenge of trade openness and attracted
significant foreign direct investment. Going global has helped them to
grow faster (Cernat & Vranceanu, 2002).
Comparison of the CEE Inward FDI Performance Index against the World
Performance Index between 1988 and 2005 indicates that the Inward FDI
Performance Index of CEE transitioning economies was above the world
average performance index. The Inward FDI Performance Index ranks 141
countries by the inward FDI relative to the economic size of the
country. The Performance Index represents the ratio of a country’s
share of global FDI inflows to its share in global GDP and it showed
that the CEE countries received more FDI than its relative economic
size.
The CEE countries increased their percentage share in the total EU
trade. Between 1996 and 2003, the share of analyzed countries in the
total EU trade increased from 4.5% to 7.5%. The CEE share in the world
GDP increased between 1996 and 2006 from 0.4% to 1.6%.
This paper reviews the experiences of the CEE countries transforming
from a central planning to market oriented economies, analyzes the
basic economic growth trends, and the link between increasing FDI stock
and the growth of real GDP. The following countries will be examined in
this article: Poland, the Czech Republic, Hungary, Slovakia and
Slovenia. All these countries became members of the European Union (EU)
on May 1, 2004. http://www.eurunion.org. The EU membership has shaped major aspects of economic policies and legislation in CEE (Sohinger, 2005).
The largest economy among the countries that will be analyzed is
Poland, with the population of 38.1 million. This compares to 10.4
million in the Czech Republic, 10 million in Hungary, 5.4 million in
Slovak Republic, and 2 million in Slovenia http://www.worldbank.org.pl.
This research utilizes 1960-2006 archival data from the United
Nations Conference on Trade and Development (UNCAD), United Nations
Economic Commission for Europe (UNECE), World Investment Reports, as
well as other selected databases.
2. GDP and FDI in the CEE
“The purpose of economic activity is to increase the well-being of
individuals, and economic structures that are able to do so are more
desirable than those that do not” (Stiglitz, 2002). There is a variety
of indicators assessing transition outcomes in the CEE transforming
economies. The GDP per capita constitutes a very important economic
index used in the international comparisons, which shows a change in
the standard of living. Increasing GDP per capita during the
transformation period between 1990 and 2006 indicates rising standard
of living in the CEE countries (Figure1). Since 1990, GDP per capita in
all analyzed CEE countries has been increasing. In 2005, the relatively
high GDP per capita has been found in Slovenia (USD 22.632) and the
Czech Republic (USD 20.417), in comparison with Hungary (USD 16.994),
Slovakia (USD 15.214) and Poland (USD13.791). Review of Economics & Finance ~
21 ~
05,00010,00015,00020,00025,00019901992199419961998200020022004YearsGDP
per Capita, US Dollars Czech RepublicHungaryPolandSlovakiaSlovenia
There are different patterns of economic growth and differences in
output performance of various CEE countries, during transition period.
However, all of the transition CEE countries have been building the new
macroeconomic structure via deregulation of prices, liberalization of
trade, privatization, external assistance and capital market
development (Paliwod, Thomas & Farfus, 1998).
Figure 1. Real GDP per Capita in the CEE Countries
Source: UNECE Statistical Database, Economic Statistics: http://w3.unece.org/pxweb/Dialog/statfile1_new.asp
Foreign direct investment has increased in the past twenty years to
become the most common type of capital flow during transition period in
the CEE. The most important economic reason for attracting FDI at the
beginning of the transformation process was to facilitate the
privatization and restructuring of the central planning economies
(Heimann, 2003). At present as the privatization and reconstructing
processes come to an end, the main reason to pursue FDI is to enhance
sustained economic growth (Gao, 2005).
The volume of FDI inflows has grown rapidly, as the Governments of
the CEE countries have been officially encouraging FDI and developing a
formal FDI promotion programs providing substantial incentives for the
foreign companies. The size and increasing FDI inflows to transitioning
CEE countries has been impressive. Poland, Hungary, and the Czech
Republic have become the most attractive destination for foreign
investments.
Important factor influencing business environment in the CEE
countries is their membership in the EU. The EU policies and the
national incentive based FDI policies are two driving forces
influencing business environment in the CEE countries. During the
preparation period of CEE countries to become members of the EU
(2003-2004) the FDI inflows in the Czech Republic increased by 186.3%
(from USD 1.863 to 3.596 million), in Hungary by 176.3% (from USD 1.909
to 3.365 million), in Poland by 133.7% (from USD 3.660 to 4.892
million), in Slovakia 142.1% (from USD 636 to 904 million) and in
Slovenia by 141.1% (from USD 299 to 422 million).
Recent inflows can be attributed to the positive impact of the EU
enlargement in May of 2004. For example the value of FDI located in
Poland in 2006 (USD 22. 123 million) was higher by 81.9% when compared
to the previous year (USD 12. 162 million). The greatest amount of FDI
inflow in 2006 was invested in real estate and other business
activities (USD 7. 197 million), manufacturing (USD 5.241 million),
trade and repairs (USD 3.150 million), financial intermediation (USD
2.448 million), and buying and selling of real estate by nonresidents
(USD 1.336 million, (http://www.unctad.org/Templates/Page.asp?intItemID=3277&lang=1).
The percentage share of the FDI in the CEE with regards to the
countries origin indicates that the private investment from the EU
countries represents the highest share of productive capacity owned by
foreigners in this region. For example in Poland, the EU countries hold
74% of ISSNs: 1923-7529; 1923-8401 © 2011 Academic Research Centre of Canada ~ 22 ~
productive capacity, while the private investment originated from
USA constitutes 13%, in comparison with international corporations
representing 6% of the foreign productive capacity (Kornecki, 2006).
New EU countries have improved the business environment and
introduced policy measures aimed at liberalizing their economies. The
EU reshaped conditions of doing business in the new Member States and
shaped major aspects of economic policy and legislation. The
statistical data on inward FDI confirm the positive reaction of FDI
flow to the EU membership. The implementation of the EU policies
changed the following: trade policy, competition policy, consumer
protection policy, environmental policy, public procurement policy,
policy towards small and medium enterprises, social policy, transport
policy and socio-economic cohesion policy (Witkowska, 2000).
The EU policy towards enterprises aims to promote entrepreneurship,
encourage innovation, improve competitiveness of firms, create a
financial climate encouraging business activities, promotion of
cooperation between enterprises. The firms can also receive assistance
from the EU structural funds. Between 2007 and 2015 Poland will receive
over 67 billion EUR from the EU’s budget. Poland will be the largest
recipient of EU funding in the coming years. The EU grants may be
allocated to projects from virtually all sectors of the economy and
intend to raise the economic competitiveness, among others, through
transport infrastructure reform. The country’s Eastern regions and the
rural areas are the priority of the modernization policy for the near
future (Witkowska, 2007).
Table 1. Inward FDI flow as a % of GDP, 1990-2005 Year / Country | Czech Republic | Hungary | Poland | Slovakia | Slovenia | ||||||
1990 | 0.20 | 0.14 | |||||||||
1991 | 2.01 | 9.04 | 0.36 | ||||||||
1992 | 3.31 | 8.12 | 0.76 | 0.80 | |||||||
1993 | 1.84 | 12.98 | 1.90 | 1.33 | |||||||
1994 | 2.08 | 5.64 | 1.80 | 1.75 | |||||||
1995 | 4.62 | 11.12 | 2.63 | 1.32 | 0.74 | ||||||
1996 | 2.39 | 7.11 | 2.87 | 1.76 | 0.85 | ||||||
1997 | 2.31 | 8.87 | 3.12 | 1.08 | 1.69 | ||||||
1998 | 6.10 | 6.90 | 3.68 | 3.16 | 1.02 | ||||||
1999 | 10.73 | 6.71 | 4.33 | 2.08 | 0.49 | ||||||
2000 | 9.05 | 5.76 | 5.45 | 9.42 | 0.70 | ||||||
2001 | 9.42 | 7.40 | 3.00 | 7.51 | 1.87 | ||||||
2002 | 11.87 | 4.52 | 2.09 | 16.69 | 7.34 | ||||||
2003 | 2.31 | 2.54 | 2.12 | 2.25 | 1.19 | ||||||
2004 | 4.51 | 4.57 | 5.14 | 3.00 | 2.59 | ||||||
2005 | 8.49 | 6.01 | 2.65 | 4.21 | 1.44 | ||||||
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