Foreign Investment in the East European Transition

By Welfens, Paul J. J. | Management International Review, July 1992 | Go to article overview

Foreign Investment in the East European Transition


Welfens, Paul J. J., Management International Review


Dr. Paul J.J. Welfens PD, University Lecturer in European Economic Policy/on leave from East European Economics, Westfalische Wilhelms-Universitat Munster, Munster, Germany.

Introduction Having experienced a decade of economic stagnation and increasing political and economic disruptions the East European economies -- including the republics of the former USSR -- have finally decided to radically change their socialist economic system and move towards a market economy. In order to achieve a market-based system one has to undergo a lengthy transition process in which new institutions are created, the distortions of the command economy removed and the supply-side is reorganized in a way that economic resources are efficiently produced and distributed. As opening up the economy and introducing domestic competition will render a great share of the capital stock obsolete the task of rebuilding the capital stock in Eastern Europe is decisive. Foreign investors could play a major role in this process in the long term, although it is doubtful that Eastern Europe is well positioned in the global race to attract highly mobile capital.

In the second half of the 1980s foreign direct investment (FDI) grew at annual rates that were three times as high as the growth of international trade which reached some $3000 bill. at the end of the 1980s. According to JETRO (1991) investment outflows reached in 1989 $197.8 bill. worldwide: Japan reached the position No. 1 for the first time, namely with FDI outflows of 44.1 bill. followed by the U.S., the U.K., France, Germany and The Netherlands with 31.7, 31.7, 18.1, 13.4 and 9.9 bill, respectively. However, Japanese investors do not play any significant role in Eastern Europe, and indeed it seems that they take a wait and see attitude that was already apparent in the case of Eastern Germany. West European and U.S. investors so far dominate, but this might change in the 1990s if politico-economic stability can be established at least in part of the East European region.

Compared to the former GDR the other countries of the former Council of Mutual Economic Assistance (CMEA) are facing a much more complex transition process to a market economy. The external transfer of resources will certainly remain modest and those countries have to develop the whole set of institutions for a market economy on their own. Moreover, the massive know-how transfer achieved in East Germany via West German firms and authorities dispatching senior management or consultants and experienced civil servants, respectively, is no feasible avenue for the former CMEA countries. Moreover, if firms are dismembered before privatization, the scarce management factor becomes an even more pressing bottleneck factor in Eastern Europe. A reasonable privatization strategy is therefore urgently needed on the one hand, on the other hand, a really open approach to FDI has to be developed -- and still existing restrictions on the purchase of land be abolished -- if foreign investors should really contribute for supply-side adjustment and economic growth. The traditional joint venture approach is absolutely inadequate; the series of foreign investment laws in the 1980s, most visible in Poland (Bieszki and Rath 1989), only testifies to the sustaining need to improve conditions for foreign investors in a region that was weakly integrated into the world economy.

A modern market economy is characterized by the interplay of the invisible hand of market signals and market forces as well as the visible hand of national and multinational companies; in such an economy government is no longer a major producer, but is assumed to provide a credible framework of institutions, laws and regulations that define individual rights and assure that legal claims can be enforced and liability rules applied. Only then can private contracts been enforced such that the market system can work. Non-market decisions play some role in the context of the labor market in all economies, but it is obvious that wage bargaining behavior will change in the transition to a market economy. …

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