Transcript Document

By Michael Faul
Ways To Invest in a Foreign Market

Foreign Direct Investment - When a firm
directly invests in production or other
facilities in a foreign country, and maintains
effective control of said investment
 Foreign Portfolio Investment – Investing
in securities sold by a foreign firm or
government
Advantages of Bringing in FDI





Technology Transfers
Inflows of foreign stable capital into the country
Helps in the transition to privatization (when state
owned firms are sold to foreign investors)
Improves the countries’ infrastructures
Brings foreign executives into the country with
sufficient knowledge of macroeconomic global
and local situations
The Asian Crisis

Causes: High levels of short-term dept vs.
GDP led to a financial Panic
– Large inflows of Foreign Portfolio Investment
led to huge amounts of short-term dept that was
feared to never be repaid
– Investors began pulling out their funds from
solvent but illiquid banks at the same time in
1997
Short-Term Debt and Reserves
http://www.imf.org/external/pubs/ft/wp/1999/wp99138.pdf
Debt-to-GDP Ratio
http://www.imf.org/external/pubs/ft/wp/1999/wp99138.pdf
Financial Results of the Asian Crisis
http://www.imf.org/external/pubs/ft/wp/1999/wp99138.pdf
FDI and Stable Capital

The capital investments that are made
through FDI are long-term investments that
are illiquid assets, and thus speculation
cannot cause a “mass pull-out” of this
capital
 Had the investments in Asia been of the
direct rather than portfolio nature, the crisis
may have been avoided
Factors Influencing FDI Inflows
http://www.univ-lille1.fr/afsemedee/communications/toubal_farid.pdf
Traditional Variables in Determining Whether to Invest
FDI in an Economy:

Plant/Firm Level Efficiency:
– Are labor costs low in this country
– Is there enough skilled labor in this country, so that there exists a
relatively low productivity-adjusted labor cost
– Are there government policies, such as low corporate tax rates that could
reduce production costs

Transportation Costs:
– Is there an existing infrastructure that will allow for the flow of both the
inputs/outputs of a given investment
– Are there local suppliers in this economy, or is it necessary to look abroad
for necessary inputs
– Are there tariffs or import/export quotas that prevent a multinational firm
from maximizing the effectiveness of its foreign investment
Traditional Variables in Determining Whether to Invest
FDI in an Economy (Cont.):

Market Size:
– Once the multinational firm decides send FDI into a country is
there going to be sufficient demand in their particular market
– Is this particular market already filled with competitors, or is it an
untouched market that is ready to be exploited
– Is there a market potential in any of the neighboring countries
FDI Influencing Factors That Arise in
Transition Economies

Country Risk:
– The risk of non-payment or non-servicing of payments for goods
or services, as well as loans and other finance tools
– The chance of repatriation of capital by the host government
– The possible loss of rights due to inadequate laws to protect
intellectual property (i.e. patents, trademarks, processes, etc.)

The Level/Method of Privatization:
– How much has this country actually advanced towards a market
economy (How high a share of the GDP is possessed by private
businesses)
– How stable is the market that has been created in this country
Types of FDI

Horizontal FDI - A multinational firm
(MNE) enters a foreign country to produce
the same type of products that it produces at
home
 Vertical FDI - a multinational firm enters a
foreign market to produce intermediate
goods to be used in their final products
Vertical vs. Horizontal

Horizontal FDI - Often the case when there
exists high barriers to trade (i.e. tariffs,
transportation costs, import quotas)
 Vertical FDI - More likely when there are
few trade barriers and the different
production factors exist at various prices in
different economies
Locations of Transition Countries
• Poland, The Czech
Republic, and Hungary
compose the more centrally
located transition
economies
• Romania and Bulgaria are
a part of the south eastern
countries in transition
The Distribution of FDI in Transition Economies
Was Not an Equal Distribution

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In general, transition economies have not received large
amounts of FDI (less than 1% before transition, and only
up to 5% of world FDI by 1995)
The majority of this FDI inflow is located in the CEECs
with only a small amount in the SE European countries
Within these regions, a few countries have attracted the
majority of the investment (Cumulatively, Hungary, the
Czech Republic, and Poland have attracted 84% of all the
FDI in Eastern Europe and Russia has attracted 85% of the
FDI in the CIS region)
The Distribution of FDI in Transition Economies
Was Not an Equal Distribution (Cont.)

The FDI inflows in the Balkan Region
between 1989 and 2000 were insignificant,
at less than 20 billion USD$ in those 11
years
– This number (the combined total FDI inflow of
8 countries over 11 years) does not even
amount to that of one year of German or British
FDI outflow
FDI Inflows To CEECs
• In China from 1993-2000, the Per Capita (Millions of US$) FDI was $268.45, far higher
than in any of these countries
http://www-wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2002/11/22/000094946_02111304010628/Rendered/PDF/multi0page.pdf
10000
9000
8000
7000
6000
Czech Republic
Poland
5000
4000
3000
2000
1000
0
Hungary
Bulgaria
Romania
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
Net FDI Inflow (millions of US$)
FDI Inflows To CEECs
Year
FDI Inflows To China and India
http://www.imf.org/external/country/IND/rr/2002/pdf/092002.pdf
China’s Employment Structure
http://www.imf.org/external/country/IND/rr/2002/pdf/092002.pdf
Reasons For FDI Inflow Inequalities

All of the determinants that a Multinational
Enterprise (MNE) considers are important in
deciding whether or not to invest directly in an
economy, however, the level of privatization and
the method of which it is reached is the foremost
important measure that is considered
 This can explain why Bulgaria and Romania
always performed relatively poorly in terms of
FDI, despite their large markets and relatively low
costs
By the Numbers: 1999
http://www.univ-lille1.fr/afsemedee/communications/toubal_farid.pdf
Reasons For FDI Inflow Inequalities (Cont.)

Stability can be quoted as the reason that Poland,
the Czech Republic, and Hungary attract so much
of the CEECs FDI:
– They were the first countries to enter into the Central
European Free Trade Area (CEFTA) and thus
investment in one of these countries guarantees trade
amongst all the nations, and the EU as well
– They also are characterized by low risk of repatriation
as private market shares compose large proportions of
the GDPs, upwards of 80%
– Large Markets, Stable Environments, and advanced
trade situations lead to good performance in FDI
Reasons For FDI Inflow Inequalities (Cont.)

It is not necessary for a country to be a large
country in order to attract a decent amount
of FDI:
– Slovenia- a stable county which is perceived to
have little risk attracts sufficient amounts of
FDI
– Slovak Republic- which has about 75% of its
GDP privatized also is successful in attracting
FDI inflows
Reasons For FDI Inflow Inequalities (Cont.)

In Bulgaria and Hungary, the process
towards privatization has taken far longer
than in the countries that are favorably
attracting FDI inflows and are thus lagging
behind in that regards
 I will use the case of Bulgaria to explain
how FDI flows into these less open
economies
Incentives for FDI in Bulgaria
http://www.city.academic.gr/material/academic_staff/business_administration/bitzenis/Bitzenis_VOLOS_CONFERENCE.pdf
Obstacles To FDI in Bulgaria
http://www.city.academic.gr/material/academic_staff/business_administration/bitzenis/Bitzenis_VOLOS_CONFERENCE.pdf
Regression Equation

The factors presented in the aforementioned
survey can be used to create a regression equation
that is able to calculate the approximate FDI levels
in a transition economy
 Although such a calculation is too complex for
this course, independent economists as well as
World Bank consultants have worked towards
creating equations that can perform these
estimations (this is where the importance of these
surveys truly lies)
Bulgarian FDI Inflows
• The 2001 numbers do not represent an entire year
http://www.city.academic.gr/material/academic_staff/business_administration/bitzenis/Bitzenis_VOLOS_CONFERENCE.pdf
Explanation

These type of determinants were common in the SE
European transition economies, and explain why the
largest European direct investor into Bulgaria was Greece
– The history of trade between these two nations (which had
occurred before Bulgaria had switched to a planned economy)
fostered less fear of country risk than other investors felt
– The close geographic proximity also contributed to the fact that the
largest FDI in Bulgaria by a EU country came from Greece (this
proximity provides them with lower transportation costs than any
other EU country)
– Cultural closeness also provided for an easy transition of Greek
investors into the once closed Bulgarian market
Conclusion and Question


FDI flows to the countries that best fit the needs of the
firms and provide them with the best chance for profit with
the most limited risk
As the transition economies move closer and closer to free
markets, they still compose only a small percentage of the
world’s FDI inflows. Is there anything that these countries
can do with their macroeconomic policies to entice more
direct investment inflow, or are the traditions and policies
of the developed market economies holding them back?