The underbelly of FDI-driven investment

26 Feb

P1000213

Ok, there’s a lot of a good stuff with FDI in Eastern Europe. Chief among them is that the region now has more complex and higher value-added exports. Yet the crisis brought to the fore a long list of issues. Here are several examples, drawn from the case of Romania, which is not that different from East-central Europe:

By 2008 Romania began to look more like Poland than the small export oriented economies of Slovakia, the Czech Republic or Hungary when it comes to the makeup of FDI flows: three times more investment went into commodities and banking than on complex products. In the ranking of export complexity done MIT’s Economic Observatory, the level of complexity of Romanian exports has gone from a low level in the early 2000s to ranking close to the Netherland’s, lower that that of Hungary, the Czech Republic or Slovakia as well as higher not only relative to Bulgaria and the Baltics, but also than in Spain and Portugal.

The share of FDI in exports grew, as did exports themselves. By the end of that decade, Austrian, German, French and Italian firms (in this order) accounted for about two thirds of Romania’s exports. Of the top 100 exporters (who cover half of all exports), 96 were subsidiaries of multinationals in 2011. Thanks to such firms, exports boomed: compared to the 1990s, exports in 2010s were 600 percent bigger.

The Great Recession brought many problems to the fore, though. First, FDI is pro-cyclical source of investment. During the crisis it dropped from an average of 6 billion a year to around 2 billion a year after 2009. Second, deindustrialization was not arrested. Every year between 2001 and 2008 the share of industry in GDP shrunk by nearly 1 percent a year and industrial employment continued to decline. This became worse during the crisis.While the car industry boomed, the steel industry shrunk by a third, for example and both industries are foreign-owned.

Third, strategic FDI investments were exposed as living in part on government dole. Once removed the vast net of perks with which FDI was attracted, some multinationals confronted the Romanian government and society with a rude awakening to the reality of disloyal capital. A few high employment multinationals cut down their operations as a result of falling demand in Western Europe. Others (Finnish Nokia and Russian Mechel) simply used up the FDI incentives and then swiftly moved out to economies with even lower wages. Moreover, the fiscal crisis of the state forced out revelations that the oligopoly of five Western European energy companies saved about 250 million euro by not investing in the modernization of the power grid infrastructure they purchased with a discount in 2005-08, often causing the power infrastructure to be increasingly disfunctional.

Fourth, the piecemeal privatization of large SOEs that had been designed as integrated systems led to dramatic deindustrialization episodes in some parts of the country. Take the examples of Arpechim, one of the refineries owned by Petrom, the national oil company sold to Austrian-owned OMV. During the crisis OMV found this refinery to be unprofitable and decided to shut it down. But since Arpechim had been designed by socialist planners to provide Oltchim, the biggest plastics plant in Eastern Europe, with cheap raw materials, the shutdown of Arpechim means the death of state-owned Oltchim.

Finally, privatizations of the electricity grid were associated with expensive inputs for non-protected corporates and consumers and creating incentives for the central bank to have a procyclical interest rate policy. Thus, since 2005 the price of electric bills doubled, a significant cost increase for doing business in Romania.

The last decade almost seemed like the beginning of a turnaround and FDI seemed like the superhero of an industrial renaissance. Ironically, the socialist planner and the foreign investor had the same preferences: as in 1970s and 1980s, the bulk of FDI was invested in energy, chemicals, means of transportation, industrial equipment, mining and steels. Textiles and footwear, the erstwhile export niche of the Romanian economy, received only 1.4 percent of FDI, three times less than the IT sector. Manufacturing attracted most FDI (44 percent), as the low wage army of labor with solid engineering skills made possible in part by the modernist educational philosophy of Romanian socialism made possible a boom of Western investment in manufacturing, from cars to aircraft parts. But the crisis has showed that FDI-centric development needs to be reexamined. And soon.

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