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How Foreign Direct Investment Facilitates the Globalization Process and Stimulates Economic Growth in Central and Eastern European Countries Lucyna Kornecki Department of Economics, Finance, and Information System College of Business Embry-Riddle Aeronautical University (ERAU) 600 S. Clyde Morris Blvd. Daytona Beach, FL 32114 [email protected], phone: (386) 226-4963, fax: (383)226-6696 ABSTRACT This paper examines the role of the Foreign Direct Investment (FDI) in facilitating advancing globalization process in the Central and Eastern European (CEE) economies and explores the relationship between increasing FDI stock and economic growth in analyzed countries. The first section discusses FDI inflows into the CEE countries. The second section analyzes FDI stock as a percentage of the Gross Domestic Product (GDP) and FDI stock per capita. The third section provides an overview of GDP growth in CEE. The fourth section includes propositions for the future research and concludes that this study can be extended to verify the correlation between FDI stock and the economic growth. EXECUTIVE SUMMARY This study reviews the experience of Central and Eastern European (CEE) countries in integrating into the global market and suggests a link between FDI stock and economic growth. FDI inflows into CEE economies have been a vital factor facilitating the privatization process in the first stage of the transition period. At present, as the privatization and restructuring process comes to an end, the main reasons to pursue FDI are to boost productivity, encourage employment, stimulate innovation and technology transfer and enhance sustained economic growth. Attracting foreign investment and liberalizing economy have become the key components of national strategies for CEE countries. The governments of those countries have officially encouraged FDI and have provided substantial incentives for foreign companies. The most vital factor contributing to the growth of FDI in CEE countries over the past few years has been their accession to the European Union (1 May 2004). High foreign capital inflows and high percentage shares of FDI stock in GDP indicate that foreign capital plays a vital role in CEE economies and has become an important indicator of advancing globalization.

INTRODUCTION This paper focuses on FDI as an important factor facilitating the globalization process of CEE economies and stimulating economic growth. Globalization signifies a process of intensification of economic, political, and cultural interconnectedness among the various actors in the global system. In the economic arena it represents a process of integration of national economies with the global economy. (Kidane Mengisteab, 2005). Globalization is a dynamic process of liberalization, openness, and international integration across a wide range of markets, from labor to goods and from services to capital and technology. Globalization is based upon the freedom to trade with the rest of the world and to capitalize on each country’s comparative advantage, the freedom to invest where returns on capital are greatest (Guillermo de la Dehesa, 2006, p.1). The global economy is in a state of transition from a set of strong national economies to a set of interlinked trading groups. This transition has accelerated over the past few years with the collapse of communism and the coalescing of the European trading nations into a single market (Gillespie, Jeannet, Hennessey, 2004). One of the most important paths driving global development into the twenty-first century is the advanced Economic Integration of Europe (Vietor, 2005, p.7). Never before have so many economies been open to global trade and finance flow then now, after the liberalization of the former communist economies (Guillermo de la Dehesa, 2006, p.8). Maler empirically examined globalization and considered three different modes of globalization: foreign trade, FDI and international financial flows (Kahai and Simmons, 2005). THE FDI INFLOW INTO CEE COUNTRIES FDI refers to an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. The investor’s purpose is to gain an effective voice in the management of the enterprise. Some degree of equity ownership is almost always considered to be associated with an effective voice in the management of an enterprise and a threshold of 10% equity ownership qualifies an investor as a foreign direct investor (the Balance of Payments Manual BPM5: Fifth Edition, International Monetary Fund, 1993) (www.unctad.org/Templates/Page.asp?intItemID=3146&lang=1). Following the collapse of the communist regime, CEE countries began the transformation toward a market economy and identified the positive effect of FDI on the transition process (Kornecki, 2005). FDI inflow to CEE countries has been developing in parallel with improvements in political stability and progress in transformation. Recent inflows can be attributed to the positive impact of the last EU enlargement. On 1 May 2004, the Czech Republic, Hungary, Poland, Slovakia and Slovenia have been reclassified from Central and Eastern Europe (CEE) category to the EU category and are now included among the developed countries (along with Latvia, Estonia, Lithuania, Cyprus and Malta).

New EU countries have improved the business environment and introduced policy measures aimed at liberalizing, promoting and protecting FDI. Attracting foreign investment and liberalizing economy to ensure free movement of capital and profit have become key components in the national strategies of CEE countries. The governments of those countries have officially encouraged FDI and have provided substantial incentives for foreign companies (Gabor, 2002). Corporate tax rates in analyzed countries decreased between 2003 and 2004 as follow; in Hungary from 18% to 16%, in Poland from 27% to 19%, in Slovakia from 25% to 19%. On January 2004 the Czech Republic and Slovenia applied respective corporate tax rates of 28% and 25%. For comparison, the highest tax rates in the world (2004) were in: Japan (42%), United States (40%), Germany (38.3%), Italy (37.3%), Canada (36.1%), Israel (36%), India (35.9%) and (35%) in Malta, Pakistan, Spain, Sri Lanka ( www.unctad.org ). According to the matrix of the United Nations Conference on Trade and Development (UNCTAD, 2002) all CEE analyzed countries were classified as having high FDI performance and high FDI potential. Poland and the Czech Republic were identified as the top FDI destinations in CEE countries. Germany and the United States are expected to be the principal investors in CEE region (www.UNCTAD/WIR/2003). The size of FDI inflows to transitioning CEE countries were impressive. Between 1990 and 2001, Poland was the leader in FDI in comparison with other CEE countries (Figure 1). FDI in Poland increased from 3 million (USD) in 1990 to 10 000 million (USD) in the year 2000. FDI inflow, USD million 1990 - 2001 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 Czech

Hungary

Poland

Slovakia

Slovenia

Figure 1. Source: Wiener Institut fur Internationale Wirtschaftsvergleiche. WIIW Annual Database Eastern Europe www.wiiw.ac.at After the CEE countries’ accession to the EU, FDI inflows increased dramatically. Between 2003 and 2004, the FDI inflows in the Czech Republic increased by 186.3% (from 1.863 to 3.596 million USD), in Hungary by 176.3% (from 1909 to 3365 million USD), in Poland by 133.7% (from 3660 to 4892 million USD), in Slovakia 142.1% (from 636 to 904 million USD) and in Slovenia by 141.1% (from 299 to 422 million USD). The decline in FDI inflows into CEE countries between 2002-2003 was due to the end of privatization process, particularly in the Czech Republic and Slovakia where Greenfield

projects (generally smaller in size and spread over a longer period of time) could not compensate for the fall in privatization (Figure 2). FDI Inflow in USD million 12000 10000 8000 6000 4000 2000 0 2000

Czech R

2001

Hungary

2002

Poland

2003

2004

Slovakia

2005

Slovenia

Figure 2. Source: Wiener Institut fur Internationale Wirtschaftsvergleiche. WIIW Annual Database Eastern Europe. page13 www.wiiw.ac.at THE FDI STOCK AND FDI STOCK PER CAPITA IN CEE COUNTRIES FDI inflow measures the amount of FDI entering a country during a one year period. The FDI stock represents the total amount of productive capacity owned by foreigners in the host country. It grows over time and includes all retained earnings of foreign-owned firms held in cash and investments. Statistical analyses of FDI as a percentage of the GDP between 1990 and 2001 in CEE economies indicate an increasing growth rate in foreign stock. The continuously growing percentage of foreign stock in the GDP indicates that foreign capital plays a fundamental role in CEE economies – it is one of the most important factors stimulating economic growth and an essential indicator of progressing globalization process in CEE countries. The EU countries hold the highest share of productive capacity owned by foreigners in CEE countries, while the USA and its many international corporations contribute a great deal of foreign stock to this region. The share of foreign stock as a percentage of GDP has been very high in the Czech Republic, Hungary and Slovakia, and constitutes respectively: 47%, 45%, 29% of each countries’ GDP. In Poland, the share of foreign stock as a percentage of GDP was much lower and amounted to 22% of the GDP, as compared to an 18% share in Slovenia (Figure 3).

FDI Stock as Percentage of GDP (%) 50 45 40 35 30 25 20 15 10 5 0 1990

1993

1994

1995

Czech Rep. Slovakia

1996

1997

Hungary Slovenia

1998

1999

2000

2001

Poland

Figure 3. Source: Wiener Institute fur Internationale Wirtschaftsvergleiche www.wiiw.ac.at WIIW Annual Database Eastern Europe. Table 4. Page 11 FDI stock per capita in CEE economies between 1991 and 2004 shows increasing tendency and between 2001 and 2004 increased in Hungary from USD 2 311 to USD 5 213, in the Czech Republic from USD 2600 to USD 4822, in Slovenia from USD 1 709 to USD 3218, in Slovakia from USD 1 115 to USD 2 431 and in Poland from USD 1 010 to USD 1 559. The lowest FDI stock per capita in Poland relates to relatively high population numbers in Poland, as compared with other analyzed CEE countries. The accession of examined countries to the EU (1 May 2004) stimulated FDI inflow and resulted in sharp increase in FDI stock per capita (Figure 6).

FDI stock per capita in USD 6000 5000 4000 3000 2000 1000 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2004

Czech Rep

Hungary

Poland

Slovakia

Slovenia

Table 4. Source: Wiener Institute fur Internationale Wirtschaftsvergleiche www.wiiw.ac.at WIIW Annual Database Eastern Europe. Table 3. Page 11

THE FDI INFLOW AND ECONOMIC GROWTH The FDI has increased in the past twenty years to become the most common type of capital flow. The most important economic reason for attracting FDI at the beginning of the transformation process was to facilitate the privatization and restructuring of the CEE economies (Heimann, 2003). At present, as the privatization and reconstruction process comes to an end, the main reason to pursue FDI is to enhance productivity, encourage employment, stimulate innovation and technology transfer as well as enhance sustained economic growth. There are a variety of indicators assessing the level of economic development and transition outcomes in the CEE economies. One of the most important indicators of macroeconomic performance is the Gross Domestic Product (GDP) and its rate of growth. There are different patterns of economic growth and differences in output performance during the transitioning of various CEE countries. However, all of the transitioning CEE countries have been building the new macroeconomic structure via deregulation of prices, liberalization of trade, privatization, external assistance and capital market development. The economic growth rate is a major indicator for judging transition. The characteristic aspects of transition economies include an initial collapse of output followed by a slow recovery. During the early years of transition (1991-1993), the downslide of economic activity was significant. Between 1993 and 1995, all analyzed CEE economies started to show an increasing trend in economic growth (Figure 4). After their accession to the EU, the economic growth rate in Poland and the Czech Republic increased significantly. Between 2003 and 2004, economic growth in Poland increased from 1.4% to 3.8% and in Czech Republic from 1.5% to 3.2%. Between 2004 and 2005, all examined economies showed an increase in economic growth rates: in the Czech Republic 3.2% to 4.4%, in Hungary - 2.9% to 4.2%, in Poland - 3.8% to 5.4%, in Slovakia - 4.5% to 5.5%, and in Slovenia - 2.7% to 4.2%. This data suggest a very strong link between increased FDI inflows and economic growth in the CEE countries. Economic Growth Rate (real GDP) (%) 10

5

20 05

20 04

20 02 20 03

20 01

19 99 20 00

19 98

19 96 19 97

19 95

19 93 19 94

-5

19 92

19 91

0

-10

-15

-20

Czech Rep

Hungary

Poland

Slovakia

Slovenia

Figure 5. Source: WIIW Database. Handbook of Statistics. Overview Tables 1990 – 2004. Macroeconomic indicators. Page 9.

IMPLICATION FOR THE FUTURE RESEARCH The results of this study constitute strong base for the further research on positive correlation between growing FDI stock and the economic growth rate in the CEEC. A large number of empirical studies on the role of FDI in host countries suggest that FDI is an important source of capital, complements domestic private investment, and is usually associated with new job opportunities and enhancement of technology transfer, and boosts overall economic growth in host countries (Chowdhury & Mavrotas, 2006, p. 9). Based on references from current research studies, the consensus seems to be that there is a positive association between FDI inflows and economic growth, provided that receiving countries have reached a minimum level of educational, technological and/or infrastructure development (Hansen & Rand, 2006, p.29). The inflow of FDI increased rapidly during the late 1980s and the 1990s in almost every region of the world. The relationship between FDI and economic growth has motivated a voluminous empirical literature in developed and developing countries. Research methodology related to FDI and economic growth relationship in the literature has been based mostly on VAR (Gholam, Sang-Yong, Lee & Heshmati, 2006, p.43), production function and regression models (Brock, 2005, p.319). The author will submit in the near future empirical and scientific evidence that FDI has made a positive contribution to the economic growth of the CEE developing countries. SUMMARY •

• • • • •

The collapse of communism and the advanced Economic Integration of Europe shaped the global development in the twenty-first century. Analyzed CEE economies have been integrating in to the global market and this process has accelerated over the past few years. The objective of this study was to demonstrate the importance of FDI in macro economy of Central and Eastern European Countries (CEEC) using FDI inflows and FDI stock as a percentage of GDP High foreign capital inflows and very high percentage share of FDI stock in the GDP indicate that foreign capital plays a vital role in CEE economies and has become an important indicator of the advancing globalization processes in CEE countries The economic growth rate is a major indicator for judging transition. With the increase in FDI inflows all analyzed CEE economies started to grow, showing an increasing trend in economic growth The result of this research implies a positive association between increasing FDI stock and growth of GDP in the CEEC The outcome of this study leads to the answer to “So what question?” and suggests conducting empirical research which will statistically verify positive correlation between FDI inflows and economic growth in CEE transforming economies BIBLIOGRAPHY

o

Brock Gregory. Post - Communist Economies. Abingdon: Sep 2005.Vol.17, Iss.3; pg. 319. Growth in Russia During 1990s- What Role Did FDI Play?

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