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Foreign Direct Investment

Changes in foreign trade patterns were inextricably linked to new patterns of foreign investment. FDI was a key element of the neoliberal model of transition. It played an important role in privatisation, deregulation and liberalisation, and was considered essential for ensuring competition in national markets, as well as the transfer of technology, knowledge and capital at a time when national financial markets were weak and deformed (Sheehy 1994). The assumed benefits of FDI did not automatically follow the big bang economic reforms and the Europe Agreements. The V4 countries had to compete for the EU’s financial and knowledge resources with incumbent EU members (Spain, Portugal and Greece, in particular), and other Central Eastern European countries such as Slovenia, Romania, Bulgaria and the Baltic countries. However, they had several key advantages. First, they had favourable geographical locations, and either bordered or were close to Germany and France, two major EU economies. Portugal, Greece, Romania and/or Baltic countries had more peripheral locations. Strategic locations between Western and Eastern Europe, and geographical proximity to the EU and Russian markets, were valuable assets for their export-oriented industries. Geographical location was particularly important in determining FDI inflows in all the transition economies in Central Eastern Europe (Estrin and Uvalic 2014).

Second, they had favourable labour costs and educational strengths. Average nominal gross earnings were 4-5 times lower in the V4 countries than in Spain or Greece in the mid-1990s. The gap somewhat narrowed in the mid-2010s, but gross wages are still 2-3 times lower in the V4 countries than in Spain or Greece (Eurostat 2015a, Average annual gross earnings by economic activity). Educational attainment was also higher in the V4 countries than in the southern EU Members. The southern EU Members, for example, had slightly higher population shares with graduate qualifications, but also much higher shares with less than primary and/or lower secondary education in2004 (Table 5.3). This reflected the existence of relatively well-developed systems of secondary education and vocational training in the V4 countries. This strong technically oriented secondary education was attractive to foreign investors in manufacturing, the automotive industry in particular. In contrast, the southern EU Members had high rates of early school leavers and lacked secondary school graduates in science and engineering in the mid-2010s.

Table 5.3 Population by educational attainment level, sex and age (%) for the age group 24-35, in 2004 and 2014








V4 avg

South avg


Less than primary, primary and lower secondary education (ISCED 0 and 2)





















Upper secondary and post-secondary non-tertiary education (ISCED 3 and 4)





















Tertiary education (ISCED 5 and 8)





















Source: Eurostat (2015g): Population by educational attainment level, sex and age (%25); Simple averages for the V4 and southern EU members.

Third, they had stable macroeconomic environments, and had experienced large-scale privatisations and rapid development of domestic financial markets. The ‘shock therapy’ reforms included policies aimed inter alia at price deregulation, and liberalisation of trade and capital flows. The liberalisation policies generated high increases in consumer prices but secured relatively stable price environment in the latter phases of the economic transition. Capital asset pricing models recognise two major determinants of the FDI inflows to emerging market economies, internal and external. The former refers to (country specific) ‘pull factors’, including economic, social and political developments: these can be further subdivided (Lensink and White 1998) into economic performance factors, such as GDP growth, inflation rates, trade and budget balances, saving rates, wage levels, and creditworthiness factors such as the debt to exports and GDP ratios, or international currency reserves to GDP. The latter refer to external (country non-specific) ‘push’ factors such as developments in international markets, and can be expressed in terms of differences between rates of return on alternative investment on international markets and those in the host country.

A comparative analysis of the V4 countries and newly industrialised Asian economies found GDP per capita, inflation and the ratio of M2 to GDP were the most significant determinants of FDI inflows in the 1990s (Williams and Balaz 2001). This broadly accords with Lensink and White’s (1998) findings that FDI tends to be directed to economies with relatively high development levels and relatively developed financial systems (indicated by ratios of broad money to GDP). FDI investors had longer term targets and were less influenced by fluctuations in interest rates and trade balances than speculative investors. Countries like Hungary, which privatised its financial sector early in the transition, enjoyed the advantage of a more sophisticated financial environment in the latter transition stages.

Fourth, there were well-established domestic industrial traditions in the V4 countries, which had strong manufacturing industries under state socialism. The former Czechoslovakia, for example, produced its own car brands (Skoda personal cars and Tatra trucks). Hungary exported Ikarus buses, and Poland produced Fiat cars under licence. The branches of MNCs mostly continued and extended manufacturing industries rather than building these from scratch in the V4 economies.

The average annual net FDI inflows generated 14.2% of the GFCF in the Czech Republic, 23.6% in Hungary, 15.0% in Poland, and 21.3% in Slovakia in 1993-2014. The high proportions in Hungary and Slovakia reflected particularly FDI-friendly national policies at different periods. These shares were substantially higher than those for the EU28 (11.6%), or for, say, India (4.4%), China (8.7%) or Latin America (13.9%). The contribution of FDI to the V4 economies, however, was higher than indicated by the shares of FDI in the GFCF. Financial and capital transfers were accompanied by knowledge transfers in terms of technologies and managerial practices.

The FDI inflows into the V4 economies were uneven, but they were generally positively related to their integration into the EU economy. The annual amounts of FDI reflected the privatisation and sales of domestic enterprises to foreign investors in the early 1990s, greenfield investments in new markets in the late 1990s and early 2000s, and different phases of V4 integration to EU structures (association agreements in 1991-1993 versus accession agreements in 2004). They were also related to business cycles, notably the 2001-2007 boom versus 2008-2009 boom. The first peak was in 1993-1995 while the second in 1998-2002 was related to the expected EU accession of the V4 region. FDI inflows peaked in 2007, when there were not only significantly lower inflows, but also substantial outflows of FDI from the V4 countries. During an economic crisis, ‘increased integration may result in more highly correlated business cycles because of common demand shocks or intra-industry trade’ (Frankel and Rose 1998). This accords with the notion of break points in transformation theory that are related to external shocks.

The EU15 economies were major investors in the V4 countries and were more severely affected during the economic recession than the USA and/or China. FDI flows from the EU15 to the V4 countries decreased more than the flows from the USA to Latin America and/or flows from China to developing Asia and Africa (UNCTAD 2015a). FDI inflows from the EU15 to the v4 economies resurged after 2010, albeit at a lower level than in 2004-2007. In the intervening period, the economies in Central Eastern Europe (CEE) had become less attractive than the Balkan economies.

Despite the relative slow down, the v4 economies had built substantial stocks of FDI by 2014. This accounted for 54.9% of GDP in the Czech Republic, 41.5% in Hungary, 36.6% in Poland and 55.0% in Slovakia. These were substantially higher than the proportions in the southern EU members in the same year: Greece -0.9%, Spain 4.0% and Portugal 23.9%. FDI in the V4 countries has usually been labour intensive and this provided a competitive advantage both for investors (MNCs) and the recipient countries. The V4 lost relative little foreign capital during the 2008+ economic crisis. European carmakers, for example, used lower cost V4 labour to cut production costs in the period of economic turmoil.

The success of industry-centred FDI in small and open economies (such as the Czech and Slovak Republics and Hungary) is understandable when these economies are well-integrated in global production chains. The Czech Republic and Slovakia had far stronger manufacturing sectors and received more FDI per capita than Hungary and Poland (Table 5.4). However, the low costs of production and proximity to EU markets constituted major competitive advantages for the v4 countries on international markets throughout the 1990s-2010s. The MNCs used the V4 countries as production bases for EU-oriented exports. Foreign capital targeted capital and labour-intensive and export-oriented, sectors such as the automotive and chemical industries. Foreign ownership was also significant in the financial and information and communication technologies (ICT) sectors. In contrast, there was relatively less FDI in those sectors serving domestic markets, such as food processing and transport. The FDI influx was reflected in changes in the ownership structure of the national economies. Eurostat data show that foreign controlled enterprises generated far higher proportions of total value added in the V4 (35.1-51.9%) than in Spain (18.7%) and Portugal (19.7%).

Table 5.4 Average annual net FDI flows in the V4 countries and southern EU members in 1993-2013








V4 avg

South avg


Average annual net FDI, €m






502 -










-97 -13,772




Average annual net FDI, € per capita





















Source: Eurostat (2015b): Balance of Payment Statistics; Eurostat (2015c): Financial account - Direct investment; and authors’ own computations. Simple averages for the V4 and Southern EU Members.

Most literature on FDI and economic growth identifies a causal relationship between the influx of foreign capital, and increases in exports and in GDP (for example, Makki and Agapi 2004; Alfaro et al. 2004). There is similar evidence for Central and Eastern Europe in the 1990s and 2000s. Kutan and Vuksic (2007) found that FDI contributed to higher exports by increasing supply capacity in the new EU member countries in 19962004. In a different study, Smiech and Zysk (2014) found that the FDI strongly influenced Polish, Slovak and Czech exports and imports in 2001-2011.

FDI boosted the competitiveness of the V4 countries via growth in the stocks of fixed capital, and diffusion of knowledge and advanced technologies. The latter correlated with significant growth in total factor productivity (TFP). According to the EC’s Annual Macroeconomic Database (European Commission, Economic and Financial Affairs 2015, AMECO database), the V4 countries enjoyed significant growth in TFP in 19952014, increasing annually by 1.1% in the Czech Republic, 0.8% in Hungary, 2.0% in Poland and 2.1% in Slovakia. This was much higher than in Greece (0.4%), Spain (0.1%), Portugal (0.3%) and the EU15 (0.4%) in the same period (Table 5.1). High growth rates in TFP in the V4 countries reflected several factors: low TFP levels in the early 1990s; technology transfers via foreign trade; substantial stocks of human capital; diffusion of knowledge and technology via FDI; and national R&D and innovation efforts. However, the latter were severely affected by the economic and social transition in the early 1990s and contributed less than FDI to national competitiveness.

FDI in the V4 countries also helped to improve the competitiveness of the MNCs. The shares of the automotive industries in total manufacturing employment were significantly lower than the corresponding shares of these industries in gross value added in all the V4 countries (Tury 2014, p. 91). The German and French automotive companies exploited low production costs in the Czech and Slovak Republics and Hungary and reinvested their earnings in the V4 countries. This was different to Spain, where Volkswagen (SEAT) planned to relocate its activities to Slovakia in 2002 leading to a bitter dispute between the Spanish and Slovak governments, and the Spanish government threatening to veto Slovakia’s accession to the EU (Medve-Balint 2014, p. 44).

The contribution of FDI to economic development was not always positive. The V4 countries also received substantial speculative investment in real estate. This was particularly pronounced in Hungary where a market bubble was fuelled by Hungarians taking out mortgages in euros and Swiss francs, leading to up to 40% of mortgages being denominated in foreign exchange in 2006 (Egert and Mihaljek 2007). The collapse of the Hungarian forint exchange rate impacted heavily on mortgage payments. The consumption booms and housing bubbles in the V4 countries, however, were smaller than those in the Baltic countries, Romania and Bulgaria (Bogumil 2014). And, as noted earlier, the openness of the three smaller V4 economies came at the price of considerable vulnerability to external shocks (Smith and Swain 2010).

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