The Role of Foreign Direct Investment in Eastern Europe

The inflow of foreign direct investment in the Eastern European countries increased from US$ 7½ billion in 1994 to US$ 12½ billion in 1995; its total stock is estimated at US$ 38 billion. East European companies with participation of foreign capital often exhibit above-average productivity. The flow of foreign direct investment (FDI) into Eastern Europe jumped from almost zero in 1989 to US$ 7 billion in 1993. After a stagnation in 1994, preliminary data for 1995 show an increase to a total of $ 12½ billion. This strong advance is partly due a number of large privatization projects (e.g., in telecommunication). Foreign investment is mainly directed towards the transformation countries in East-Central Europe; the inflow into this region has nearly doubled, from US$ 4.6 billion in 1994 to US$ 8½ billion in 1995. Data on direct investment in the CIS (US$ 1.9 billion, of which US$ 1 billion in Russia) are less reliable than those for East-Central Europe, they may also include projects not yet carried out. The total stock of FDI in the East is estimated at US$ 25 billion for end-1994 and US$ 38 billion for end-1995, the number of companies with foreign participation at 173,000 (1994). Hungary has so far attracted the largest amount of direct investment (US$ 12.7 billion at end-1995), ahead of Poland (US$ 6.5 billion) and the Czech Republic (US$ 5.7 billion). FDI stocks per capita are also highest in Hungary, followed by Slovenia, the Czech Republic and Estonia. In an international comparison, FDI in the Eastern countries are still rather low, accounting for some 3 percent of worldwide cross-border investment estimated at a total US$ 226 billion (developing countries claim a 37 percent share, of which China 15 percent). Out of global FDI stocks estimated at US$ 2,319 billion, the share of Eastern countries is roughly 1 percent. This share has, however, risen markedly in 1995. Private FDI are one of the major instruments to support successful transformation to a market economy in Eastern Europe and to reduce the gap in living standards vis-à-vis the West. International studies show that foreign companies in the eastern countries attain substantially higher levels of productivity and growth rates of sales than domestic ones (thus, in Hungary the productivity differential was 2:1 and growth of sales in 1993 was 47 percent against 3½ percent). The regional pattern of growth in Eastern Europe exhibits no straightforward correlation between growth dynamics and the size of FDI. Countries with high FDI (Hungary, Czech Republic) have so far shown below-average growth performance, whereas high-growth countries like Poland have received comparatively small amounts of foreign capital. This prima-facie conclusion is confirmed by more sophisticated statistical analysis. With the exception of Hungary, FDI has so far played a relatively minor role in the financing of investment. In all, foreign private capital, while playing an important direct and indirect role in the transformation process of Eastern Europe, makes a relatively small immediate contribution to GDP growth and the financing of gross fixed investment. The future contribution of foreign private capital to economic growth is likely to be significant only in those countries, which by relying on their own strength have successfully met the challenges of transformation and have moved to a path of solid growth. The danger of abuse of market power created by FDI may be reduced by economic and political stabilization, but also by integration of the Eastern European countries into the EU competition framework.