Vol.

5 Issue 1 2013

TheEffectsofForeignDirectInvestmentsforHostCountrysEconomy
SelmaKURTISHIKASTRATI
AmericanUniversityoftheMiddleEast,FacultyofBusiness,Kuwait
selma.kurtishikastrati@aum.edu.kw

Abstract:
ForeignDirectInvestment(FDI)isseenasthefundamentalpartforanopenandsuccessfulinternational
economicsystemandamajormechanismfordevelopment.Inthiscircumstance,thepaperexaminesthe
benefitsofFDIasakeycomponentforsuccessfulandsustainableeconomicgrowthandalsoasapartofa
methodtosocialimprovement.TheaimistohighlightthemostimportantchannelsthroughwhichFDI
makesasignificantandexceptionalimpactontheeconomicdevelopmentofthehostcountries.Atthesame
instance,itisimportanttorecognizethat,likeallthings,FDIisnotallgoodnobad.Aseparatediscussion
isdevotedtothepotentialnegativeimpactsofFDIflowsonhosteconomies.

Keywords:FDI,resourcetransfereffects,internationaltrade,privatisation
JEL:F21,M0,F40,L33

1.Introduction:TheBenefitsofFDIforHostCountrysEconomy
Developingcounties,emergingeconomiesandcountriesintransition,duetoadvantages
relatedtoFDIhaveliberalizedtheirFDIregimeandfollowedbestpolicies toattract
investment. It has been recognized that the maximizing benefits of FDI for the host
country can be significant, including technology spillovers, human capital formation
support,enhancementofcompetitivebusinessenvironment,contributiontointernational
trade integration and improvement of enterprise development. Moreover, further than
economicbenefitsFDIcanhelptheimprovementofenvironmentandsocialconditionin
the host country by relocating cleaner technology and guiding to more socially
responsiblecorporatepolicies.Allofthesebenefitscontributetohighereconomicgrowth,
whichisthemaininstrumentforalleviatingpovertyinthoseeconomies.However,the
economicimpactofFDIisdifficulttomeasurewithaccuracy.BenefitsofFDIdonot
increaseautomaticallyandequallyacrosscounties,sectorsandlocalcommunities.These
benefitsvaryfromonecountrytoanotherandaredifficulttobeseparatedandmeasured.
WhereFDIentryhaslarge(nonmarginal)effects,measurementisevenmoredifficult:
thereisnoprecisemethodofspecifyingcounterfactual(i.e.whatwouldhavehappenedif
aTNCorTNCshadnotmadeaparticularinvestmentorinvestments).Theassessmentof
thedevelopmenteffectsofFDIgenerallyresortstooneoftwoapproaches.Oneisthe
econometricanalysisoftherelationshipbetweeninwardFDIandvariousmeasuresof
economicperformances.ThesecondisaqualitativeanalysisofvariousaspectsofTNCs
impacts, without any attempt at calculating a precise relationship or rate of return
(UNCTAD,2006).Thelatterapproach,whichistheoneadoptedinthediscussionof
hostcountryimpactbelow,includes,inparticular,aconsiderationofthewaysinwhich
theuniquecharacteristicsofTNCsinteractwiththeuniquecharacteristicsofcountries
(Dunning,1993).
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1.1.ResourceTransferEffects
Foreigndirectinvestmentcanmakeapositivecontributiontoahosteconomyby
supplyingcapital,technologyandmanagementresourcesthatwouldotherwisenotbe
available.Suchresourcetransfercanstimulatetheeconomicgrowthofthehosteconomy
(Hill,2000).
Capital
As far as capital is concern, multinational enterprises (MNEs) invest in longterm
projects,takingrisksandrepatriatingprofitsonlywhentheprojectsyieldreturns.The
freeflowofcapitalacrossnationsislikelytobefavouredbymanyeconomistssinceit
allowscapitaltoseekoutthehighestrateofreturn.ManyMNEs,byvirtueoftheirlarge
size and financial strength, have access to financial resources not available to host
countryfirms.Thesefundsmaybeavailablefrominternalcompanysources,or,because
oftheirreputation,largeMNEsmayfinditeasiertoborrowmoneyfromcapitalmarkets
thanhostcountyfirmswould(Hill,2000).
JenkinsandThomas(2002)arguethatFDIcancontributetoeconomicgrowthnotonly
byprovidingforeigncapitalbutalsobycrowdinginadditionaldomesticinvestment;soit
increasesthetotalgrowtheffectofFDI.BosworthandCollins(1999)provideevidence
on the effect of capital inflows on domestic investment for 58 developing countries
between 197895. They distinguish among three types of inflows: FDI, portfolio
investment,andotherfinancialflows(primarilybankloans).Theyfoundthatabouthalfof
eachdollarofcapitalinflowtranslatesintoanincreaseindomesticinvestment.According
to them an increase of a dollar in capital inflows is associated with an increase in
domesticinvestmentofabout50cents.(Bothcapitalinflowsanddomesticinvestmentare
expressedaspercentagesofGDP.)
OncethecapitalinflowstaketheformofFDI,thereisanearonetoonerelationship
betweentheFDIandthedomesticinvestment.Moreover,Borenszteinetal(1998)found
some evidence of a crowdingin effect, i.e., that FDI is complementary to domestic
investment.AonedollarincreaseinFDIinflowsisassociatedwithanincreaseintotal
investmentinthehosteconomyofmorethanonedollar.
Feldstein (2000) emphasized a number of advantages that are related to unrestricted
capitalflows,suchus:
1International flows of capital reduce the risk faced by owners of capital by
allowingthemtodiversifytheirlendingandinvestment.
2The global integration of capital markets can contribute to the spread of best
practicesofcorporategovernance,accountingrules,andlegaltraditions.
3Theglobalmobilityofcapitallimits theabilityofgovernments topursuebad
policies.
Technology
Thecrucialroleplayedbythetechnologicalprogressintheeconomicgrowthisnow
widelyaccepted(Romer,1994).Technologycanstimulateeconomicdevelopmentand
industrialization.Itcantaketwoforms,bothofwhicharevaluable.Technologycanbe
incorporatedinaproductionprocess(e.g.,thetechnologyfordiscovering,extractingand
refiningoil)oritcanbeincorporatedinaproduct(e.g.,personalcomputers)(Hill,2000).
However,manycountrieslacktheresearchanddevelopmentresourcesandskillsrequired
todeveloptheirownnativeproductandprocesstechnology.Thisisparticularlytrueof
theworldslessdevelopednations.Evidenceprovidesthatthevastmajorityofeconomic

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studiesdealingwiththerelationshipbetweenFDIontheonehandandproductivityand/or
economicgrowthontheotherhand,havefoundthattechnologytransferviaFDIhas
contributedpositivelytoproductivityandeconomicgrowthinhostcountries(OECD,
1991).
Technologies that are transferred to developing countries in connection with foreign
directinvestmenttendtobemoremodern,andenvironmentally cleaner,thanwhatis
locally available. Moreover, positive externalities have been observed where local
imitation, employment turnover and supplychain requirements led to more general
environmentalimprovementsinthehosteconomy.
Management
Bytransferringknowledge,FDIwillincreasetheexistingstockofknowledgeinthehost
countrythroughlabourtraining,transferofskills,andthetransferofnewmanagerialand
organizational practice. Foreign management skills acquired through FDI may also
produceimportantbenefitsforthehostcountries.Beneficialspinoffeffectarisewhen
localpersonnelwhoaretrainedtooccupymanagerial,financialandtechnicalpostsinthe
subsidiaryofaforeignMNEleavethefirmandhelptoestablishlocalfirms.Similar
benefitsmayariseifthesuperiormanagementskillsofaforeignMNEstimulatelocal
suppliers,distributorsandcompetitorstoimprovetheirownmanagementskills.
Workersgainnewskillsthroughexplicitandimplicittraining.Inparticular,trainingin
foreignfirmsmaybeofahigherqualitygiventhatonlythemostproductivefirmstrade.
Workers take these skills with them when they reenter the domestic labour market.
Trainingreceivedbyforeigncompaniessometimesmaybeconsideredunderthegeneral
headingof organizationandmanagement,meaningthatthehostcountrywillbenefit
fromthe managerialsuperiority ofMNCs.LallandStreeten(1977)emphasizethree
kindsofmanagerialbenefits:
Managerialefficiencyinoperationsarisingfrombettertrainingandhigher
standards;
2
Entrepreneurialcapabilityinseekingoutinvestmentopportunities;
3
Externalities arising from training received by employees (such as
technical,executive,accountingandsoon)(Dunning,1993).
1

1.2.EmploymentEffects
TheeffectsonemploymentassociatedwithFDIarebothdirectandindirect.Incountries
where capital is relatively scarce but labour is abundant, the creation of employment
opportunitieseitherdirectlyorindirectlyhasbeenoneofthemostprominentimpacts
ofFDI.ThedirecteffectariseswhenaforeignMNEemploysanumberofhostcountry
citizens.Whereas,theindirecteffectariseswhenjobsarecreatedinlocalsuppliersasa
resultoftheinvestmentandwhenjobsarecreatedbecauseofincreasedlocalspendingby
employeesoftheMNE.Inordertoillustratetheemploymenteffectsinhostcountrywe
willusetheexampleofToyotasinvestmentinFrance.Basedonadatapublished(Hill,
2000) this investment created 2000 direct jobs and conceivably another 2000 jobs in
supportingindustries.
Thedomesticprivatesectorcanbenefitbyenteringintobusinessrelationshipssupplying
inputs to these new market entrants (backward linkages) or processing a foreign
investors products (forward linkages). By promoting both forward and backward
productionconnectionwithdomesticindustriesandothersectors,forinstancethrough

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subcontractingsystemsbetweenaforeignfirmandlocalsubcontractorswhosupplyspare
parts, components or semifinished goods to the foreign firm, extra jobs are created
ultimatelyandfurthereconomicactivityencouraged.
TheemploymenteffectsofFDIareofconsiderableinteresttohostdevelopingcountries:
inmanyofthem,akeyrequirementforsustainablegrowthistheabilitytoabsorbthe
humanresourcereleasedfromagricultureintomanufacturingandserviceindustries.The
quantitativeeffectsofFDIonemploymentgloballyhavebeenfoundtobemodest,but
somewhatlargerinhostdevelopingthanhostdevelopedcountries,andespeciallysoin
themanufacturingsector(WorldInvestmentReport,1999).
AccordingtoNzomo(1971),astudydoneinKenyashowedthatFDImadeamodest
contribution with regard to the total employment creation since direct employment
creation was smallwhile noevidenceonits indirect employment creation.This may
suggestthatforeignfirmsoperatedinthatcountryhavenoproductionlinkageswithlocal
firms.Ontheotherhand,Aaron(1999)statesthatFDIwaslikelydirectlyresponsiblefor
26millionjobsindevelopingcountriesworldwide.Inaddition,foreverysingledirectjob
createdbyFDIitwasestimatedthatapproximately1.6additionaljobswereindirectly
createdthroughproductionlinkagesbetweenFDIandlocalsectors.
1.3.BalanceofPaymentsEffects
FDIseffectonacountrysbalanceofpaymentaccountsisanimportantpolicyissuefor
mosthostgovernments.Therearethreepotentialbalanceofpaymentsconsequencesof
FDI.First,whenanMNEestablishesaforeignsubsidiary,thecapitalaccountofthehost
countrybenefitsfromtheinitialcapitalinflow.However,thisisaonetimeonlyeffect.
Second,iftheFDIisasubstituteforimportsofgoodsorservices,itcanimprovethe
currentaccountofthehostcountrysbalanceofpayment.MuchoftheFDIbyJapanese
automobilecompaniesintheUSandUK,canbeseenassubstituteforimportsfrom
Japan.Athirdpotentialbenefittothehostcountrysbalanceofpaymentariseswhenthe
MNE uses a foreign subsidiary to export goods and services to other countries. The
evidencebasedonempiricalresearchonthebalanceofpaymentseffectofFDI,indicates
thatthereisadifferencebetweendevelopedanddevelopingcountries,especiallywith
respect to investment in the manufacturing industries. Dunning (1961, 1969) while
assessingtheimpactoftheUSFDIinBritain,heestimatedapositiveeffectofaround15
percentofthetotalcapitalinvested.Nevertheless,hisresearchonlydealtwiththedirect
effectofFDI,whichresultsinnoticeableflowsinthebalanceofpayments.Theindirect
effects,ontheotherhandarisingfromthechangesintheincomeofresidents,orchanges
inconsumptionpatternswerenotconsidered.
1.4.InternationalTrade
TheimpactofFDIonhostcountryinternationaltradewilldiffer,dependingonitsmotive
whetheritisefficiencyseeking,marketseeking,resourceseekingorstrategicasset
seeking.FDIcanhaveagreatcontributiontoeconomicgrowthindevelopingcountries
bysupportingexportgrowthofthecountries.Outputresultingfromefficiencyseeking
FDIistypicallyintendedforexport,andthereforetheimpactofsuchFDIislikelytobe
anincreaseinexportsfromthehostcountry.Iflocalfirmsprovideinputstoaffiliates
producinggoodsforexports,thelocalcontentofvalueaddedexportswouldbemuch
greater.Incaseswhereintermediategoodsareimportedfromoutsidethehosteconomy,
efficiencyseekingFDIwillincreaseexportaswellasimports.Nevertheless,sincecertain

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valueaddingprocessestakeplacewithinthehosteconomy,theoverallimpactwillbean
improvementinthetradebalanceinthelongrun.Intheliterature,exportgrowthisoften
associatedwithtradeliberalization,althoughitalsomeansmoreimports.
However,weshouldtrytoanswerthequestionsifthereisapositivecorrelationbetween
tradeliberalizationorexportgrowthinspecificandeconomicgrowth;andalsoifthereis
apositivelinkbetweenFDIandexportgrowth.Inordertheanswerthefirstquestion,
economictheoryoffersmanyreasonstosupposethattradeliberalizationorexportgrowth
stimulate economic growth, since countrys openness offers many benefits including
accesstoglobalmarket,technologyandtoappropriateintermediateandcapitalgoodsand
rawmaterials;thebenefitsassociatedwitheconomiesofscaleandmarketcompetition.
Concerningtheotherquestion,Balasubramanyametal(1996)testedthehypothesisthat
exportpromoting(EP)countriesenjoygreaterefficiencyfromFDIusingaproduction
functioninwhichFDIisconsideredanadditionalinputtodomesticcapitalandlabour.
Theydisagreedthat,inviewofthefactthatitisaprimesourceofhumancapitalandnew
technologyfordevelopingcountries,theFDIvariablecapturestheexternalities,learning
bywatching,andspillovereffects.TheoutcomesuggestedthatFDIisavitalenginefor
exportgrowthindevelopingcountries.BlomstromandKokko(1996)analyzedempirical
evidenceonhostcountryeffectsofFDI,andfoundthatglobalcompanies playedan
important role in export growth in their host countries, but the precise nature of the
impactofFDIvariesbetweenindustriesandcountries.
Beyond the standard gains from trade, FDI inflows can provide dynamic gains from
technology transfer and skillbuilding. These benefits are especially important in
developingcountrieswhereforeigntechnologyandmanagerialexpertisearelacking.
High values of this indicator are preconditions for accelerated growth and
competitivenessoftheeconomy.DistinctionoftheindicatoramongtheSEEcountriesis
considerable,rangingfromaround50%forthebestperformersCroatia,Macedoniaand
Sloveniato20%forTurkey;whichisexpectedtoputfurthereffortstoencourageits
exportvolume.Transportequipment,refinedpetroleumproductsandchemicalproducts
aremajorexportcommoditiesforCroatiawhosemaintradepartnersareItaly,Bosniaand
HerzegovinaandGermany.Manufacturedgoods,food,beveragesandtobaccowerekey
exportsectorsforMacedoniawithmainexportpartnersSerbiaandMontenegro,Germany
andGreece.Sloveniahaspredominantlyexportedmotorcarsandpharmaceuticalstoits
majortradepartnersGermanyandItaly.Byprovidingtheexportdistributionnetworks
and the information needed to enter foreign markets, FDI can establish a niche for
domesticfirmstoexport(Markusen,Venables,1999).

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Figure1.1Exportsofgoodsandservices(%ofGDP)

Source:WorldBanknationalaccountsdata,andOECDNationalAccountsdatafiles.

1.5.EffectonCompetition
AccordingtoanOECDreport(OECD2002,p.16)thepresenceofforeignenterprises
maygreatlyassisteconomicdevelopmentbyspurringdomesticcompetitionandthereby
leading eventually to hi gher productivity, lower prices and more efficient resource
allocation.Increasedcompetitiontendstostimulatecapitalinvestmentsbyfirmsinplant,
equipmentandR&Dastheystruggletogainanedgeovertheirrivals.FDIsimpacton
competitionindomesticmarketsmaybeparticularimportantinthecaseofservices,such
astelecommunication,retailingandmanyfinancialservices,whereexportingisoftennot
anoptionbecausetheservicehastobeproducedwhereitisdelivered.
Julius (1990, p. 97) for example, writes that: As with trade, increased international flows
ofFDIshouldbeencouragedbecausetheybringbothglobalandnationalbenefits.They
stimulategrowththroughmoreefficientproductionandtheylowerpricesthroughgreater
competition. And accord ing to an OECD study, Like trade, foreig n direct investment
actsasapowerfulspurtocompetitionandinnovation,encouragingdomesticfirmsto
reduce costs and enhance their competitiveness (OECD, 1998, p. 47).

2.CostofFDItoHostCountrysEconomy

ThenetbenefitsfromFDIdonotaccrueautomatically,andtheirimportancediffers
accordingtohostcountryandcondition.Recognitionoftheeconomicbenefitsafforded
byfreedomofcapitalmovementssometimesclashwithconcernsaboutlossofnational
sovereigntyandotherpossibleadverseconsequences.FDI,evenmorethanothertypesof
capitalflows,hashistoricallygivenrisetotheseconflictingviews,becauseFDIinvolves
acontrollingstakebyoftenlargeMNEsoverwhichdomesticgovernments,itisfeared,
have little power. The controversies have mostly focused on in ward FDI, due to
sensitivityaboutforeigncontroloverdomesticindustry
Aswementionedearlier,thispaperwillnotbefocusedonlyonthepositiveeffectofFDIbut
itwilladdressconcernsaboutthepotentialnegativeaspectofhosteconomies,botheconomic
andnoneconomic.Insmalleconomies,largeforeigncompaniescanandoften

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do,abusetheirdominantmarketpositions.Basedontheliterature,itiseminentthatFDI
isnotalwaysinthehostcountysbestinterestandthereforeitshouldbecontrolled.
Countries facing increased inflows of FDI have often experienced unease. Many
developingcountrieshaveuntilrecentlybeenwaryofinwardFDI.EvenintheUnited
States,thesurgeofJapaneseFDIinthe1980sledtowidespreadconcernsaboutexcessive
foreigncontrolandadverseeffectsonnationalsecurity,asexpressedinthepopularpress,
andinlegislativeaction.CriticsofinwardFDIarguethatthereareadverseeconomicand
politicaleffectsonthehostcountry.Theallegedeconomiceffectsincludebalanceof
paymentsdeficits,reduceddomesticresearchanddevelopment,diminishedcompetition,
crowdingout of domestic firms and lower employment, the potentially harmful
environment impact of FDI, especially in the heavy industries and the effects on
competitioninnationalmarkets.Economicanalysishasshownthatmostofthealleged
economicdrawbacksofFDIareoflittlemerit(Graham,E.M;Krugman,P.R,1995).
Moreover,sometimessomeestimatedbenefitsmayproveelusiveifthehosteconomy,in
its current state of economic development, is not able to take advantage of the
technologiesorknowhowtransferredthroughFDI.
ThefactorsthatholdbackthefullbenefitsofFDIinsomedevelopingcountriesinclude
the level of general education and health, the technological level of hostcountry
enterprises,insufficientopennesstotrade,weakcompetitionandinadequateregulatory
frameworks.Ontheotherhand,aleveloftechnological,educationalandinfrastructure
achievementinadevelopingcountrydoes,otherthingsbeingequal,equipitbetterto
benefitfromaforeignpresenceinitsmarkets.
2.1.AdverseEffectsonEmployment
ScepticsaboutFDInotethatnotallthenewjobscreatedbyFDIrepresentnetadditions
inemployment.InthecaseofFDIbyJapaneseautocompaniesintheUS,somearguethat
thejobscreatedbythisinvestmenthavebeenmorethanoffsetbythejobslostinUS
ownedautocompanies,whichhavelostmarketsharetotheirJapanesecompetitors.Asa
consequenceofsuchsubstitutioneffects,thenetnumberofnewjobscreatedbyFDImay
notbeasgreatasinitiallyclaimedbyanMNE(Hill,2000).
In the case ofRepublic ofMacedonia the high unemployment represents the biggest
economic problem and it has a direct effect on low economic growth and the small
numberofnewlyopenedworkplaces.Therestructuringprocessoftheenterprisesinthe
courseoftransitionresultedinincreasedunemploymentintheshortrun.Asexpected,the
former FDI in the Republic of Macedonia could not significantly influence the
employment inthe country, neither in scope, norin quality. Inthe last 15years the
averageamountofforeigndirectinvestmentsisaroundUS$80millionannually,whichis
not sufficient for significant influence on the economic growth in general, and
employmentinparticular.
2.2.AdverseEffectsonCompetition
Although in the previous section we outlined how FDI can boost competition, host
governmentssometimesworrythatthesubsidiariesofforeignMNEsmayhavegreater
economicpowerthanlocalcompetitors.Ifitisapartoflargeinternationalorganization,
theforeignMNEsmaybeabletodrawonfundsgeneratedelsewheretosubsidizeitscosts
inthehostmarket,whichcoulddrivelocalcompaniesoutofbusinessandallowthe

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firmtomonopolizethemarket.Thisconcerntendstobegreaterincountriesthathavefew
largefirmoftheirown(i.e.lessdevelopedcountries)orminorconcerninmostadvanced
industrializednations.
2.3.AdverseEffectsonBalanceofPayments
TherearetwomainareasofconcernwithregardtotheadverseeffectsofFDIonahost
countrysbalanceofpayments.First,setagainsttheinitialcapitalinflowthatcomeswith
FDImustbethesubsequentoutflowofearningsfromtheforeignsubsidiarytoitsparent
company.Suchoutflowsshowupasadebitonthecapitalaccount.Somegovernments
have responded to such outflows by restricting the amount of earnings that can be
repatriatedtoaforeignsubsidiaryshomecountry.
Asecondconcernariseswhenaforeignsubsidiaryimportsasubstantialnumberofinputs
fromabroad,whichresultsinadebitonthecurrentaccountofthehostcountrysbalance
ofpayment.InthecaseofNissansinvestmentinUK,Nissanrespondedtoconcerns
aboutlocalcontentbypledgingtoincreasetheproportionoflocalcontentto60percent,
andsubsequentlyraisingittoover80percent(Hill,2000).
The net benefits from FDI do not accrue automatically, and their importance differs
accordingtohostcountryandcondition.Thefactorsthatholdbackthefullbenefitsof
FDIinsomedevelopingcountriesincludethelevelofgeneraleducationandhealth,the
technological level of hostcountry enterprises, insufficient openness to trade, weak
competition and inadequate regulatory frameworks. On the other hand, a level of
technological,educationalandinfrastructureachievementinadevelopingcountrydoes,
otherthingsbeingequal,equipitbettertobenefitfromaforeignpresenceinitsmarkets.

3.NonEconomicDrawbacksEnvironmentalImpactand
Sweatshops
AnothermajorconcernregardingFDIisitsenvironmentalimpact.Localenforcementof
environmentalprotectionlegislationthatisnegligentorweakinrelationtoforeignfirms
hasledtodisastrousconsequencesinmanypartsoftheworld.However,intheglobal
competitionamongdevelopingcountrygovernmentstoattractFDI,thereisoftenarace
tothebottom,whichleadscountriestooffermorerelaxedregulationsinordertoattract
foreigninvestment.
TheworkingconditionsofworkersinfirmssponsoredbyFDIhavealsobeenaconcern.
The presence of sweatshops in some countries, which subject labourers, who are
sometimes child labourers, to dangerous, subhuman working conditions, often in
violation of local workplace regulations, is a serious issue. The race to the bottom
phenomenonisalsopresenthere,asgovernmentsminimizetheenforcementofworkplace
regulationsinordertoattractFDI.Althoughmultinationalspaytheirworkersmorethan
theircompetitors,manypeoplehavecomplainedthatmultinationalsabusetheirworkers
insweatshopconditions,andhavedemandedthatproducts fromthesesweatshopsbe
bannedfromU.S.markets(Brown,DeardorffandStern,2004).
Inordertocontrolsweatshops,twomajorantisweatshoporganizationshaveemerged:
1FairLaborAssociation(FLA,1998)andthe

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WorkersRightsConsortium(WRC,1999).

FLAismorecloselyassociatedwiththeapparelindustry,whereasWRCmoreclosely
associated with unions. Both organizations have developed codes of conduct and
enforcementmechanisms.SuchpotentiallyadverseeffectsofFDIshouldnotbeignored.
Afterall,evenwhenFDIprovidesnetgainstoaneconomy,thepresenceofabroadarray
of adverse effects from FDI, especially for particular groups or sectors within the
economy, means that countries must seriously consider the extent to which they
compensatethosewholose.

4.PrivatizationasaMajorChannelforAttractingFDI
The most important progress in many developing and transition economies are large
amountofinflowofFDIandprivatizationofthestateownedcompaniesacrossdifferent
sectors.AllgovernmentsintheSEEregionhavestatedtheircommitmenttoprivatization
andtheprinciplesofthemarketeconomy.Privatizationhasbeenasignificantrevenue
earnerandamajorchannelforforeigndirectinvestment(FDI),whichinturnisasource
ofbenefitsnotonlytothereceivingfirmbutalsotothewidereconomy.However,the
levelofcommitmenttoprivatizationhasvariedacrosscountries.Asaresult,progressin
SEEhasgenerallybeenslowerthaninCentralEuropeandBalticStates(CEB).There
hasbeenacloselinkbetweenFDIinflowsandprivatizationsinSEE.Theannualchanges
in gross FDI inflows to SEE and in privatization revenues have moved in the same
directionovertime,exceptin1999whenFDIfellslightlybutprivatizationrevenues
remainedfloatingduetoseverallargetransactionsintheregion.
Thebenefitsofprivatizationdependnotonlyonhowmanyenterprisesaresoldoff,but
alsoonthemethodusedtoprivatizethem.Enterprisedevelopmentmaybeheldbackby
aninappropriatechoiceofprivatizationmethod.Privatizationisindeedstronglylinkedto
enterpriserestructuring,onaverage,privatizationtooutsidebuyersisassociatedwith50
percentmorerestructuringthanisprivatizationtoinsiders(peoplealreadyinthefirmat
thetimeofsale)(Djankov,S.;Murrell,P.,2002).Theproblemwithinsiderprivatization
isthatitoftenleavesinchargepartieswithvestedinterests,whichhavelittleincentiveto
implementchanges.Thisreducesthepotentialinterestofoutsideinvestors(Zinnes,C.;
Eilat.Y.;Sachs,J.,2001).CountriesinSEEhaveusedavarietyofprivatizationmethods,
includingdirectsales,vouchers,management/employeebuyouts,andoccasionallyother
means.Thechosenmethodoftendependsonthesizeoftheenterprisebeingsold,with
auctionscommonforsmallenterprisesandtendersfordirectsalesmorelikelyforlarger
companies.TheTablebelowsummarizestheprimaryandsecondarymethodsusedover
thetransitionperiodineachSEEcountry.

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Table1.2PrivatizationMethodsinSouthEastEurope

ManagementEmployee
buyouts(MEBOs)

Vouchers

DirectSales

Secondary
Method

Albania

PrimaryMethod

BH

Bulgaria

Croatia

PrimaryMethod

Macedonia

PrimaryMethod

Moldova

Secondary
Method

Romania

PrimaryMethod

SecondaryMethod

Serbiaand
Montenegro

PrimaryMethod

SecondaryMethod

PrimaryMethod
Secondary
Method

SecondaryMethod
PrimaryMethod

SecondaryMethod
SecondaryMethod

PrimaryMethod

Source:EBRDTransitionReport2003

AswecanseefromthetableBulgariaistheonlySEEcountryusingdirectsalesasthe
primarymethod(incommonwithHungary,PolandandtheSlovakRepublic).Although
thedirectsaleprocedureisoftenlengthyandcomplex,itusuallyresultsinthehighest
privatization revenues and interest of strategic investors. Bulgaria has attracted fresh
outsideinvestmentthroughdirectsalesaswellasasignificantamountofgovernment
revenuerelativetoGDP.Incontrast,massprivatizationthroughtheissuingofvouchers
tocitizens,asfavouredbyBosniaandHerzegovinaandMoldova(andalsoMontenegro),
doesnottypicallygenerateeithersignificantgovernmentrevenueorinvestment;instead,
itleadsonlytotheredistributionofpropertyandoftenpoorqualitygovernance(Hunya,
2000). Albania, Croatia, FYR Macedonia and Romania have followed the Slovenian
model ofmanagementemployee buyouts (MEBOs) insider privatization as their
primarymethod,withlessuseofvouchersordirectsales.
InthecaseofMEBOs,thereasongenerallygivenforthisassumptionisthatthenew
ownersmanagersand/oremployeeshaveotherinterests,e.g.savingtheirjobs,thatfar
outweigh the goal of profit maximization, and may even make it seem totally
insignificant.Asaresult,theydonotimplementthemeasuresthatarealmostalways
necessary,i.e.theyfailtorestructurethecompanytomeetthenewdemandsofamarket
economy.Theproblemwithvoucherprivatizationisthateachofthenewownersholds
suchasmallshareoftheprivatizedenterprisesthat,eventhoughtheymaywellhavea
genuineinterestinprofitmaximization,itisnoteconomicforthemtobearthetransaction
costsinvolvedinexercisingcorporategovernance.Moreover,theholdersofthevouchers
generallyhaveneithertheknowhow,northecapital,toinitiatearestructuringprocessin
their enterprise
Privatization has been the main channel for FDI in SEE. Successful largescale
privatizationshaveprovidedrevenuestogovernmentandrelievedtheburdenoflosses;
moreovertheyhaveofferedencouragementandguidanceforsuccessfulrestructuring.In
Macedoniatheprivatizationturnedouttobegreatpriorityeversincethetransformation
ofownershipwasrecognizedascrucialforthetransitiontowardfreemarketeconomy.

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The privatizations of State owned enterprises were performed quickly and almost
completelyinthe90s,mostlythroughsalestothemanagementandemployeesofthe
companies.TheMacedoniangovernmenthasengagedinafinalprocessofprivatization/
concession of the public sector. After the successful privatization of the
telecommunicationsindustryandpartialprivatizationoftheenergysector(thenational
electricity distributor having been sold to EVN from Austria), the Government has
ambitiousplanstorestructureandprivatizetheremainingpubliclyheldenergy,transport
and health sectors. Four lossmaking stateowned enterprises including the chemical
manufacturer, Ohis, the tobacco producer, Tutunski Kombinat, the electronics maker,
EMO and the military equipment production company, Eurokompozit Prilep, are
currentlyupforsale.Thedeadlineforthetendershasbeenpostponedseveraltimesdueto
lackofinterest.WiththeexceptionofOhis,whichwillbesoldseparatelyinatenderthat
hasbeendelayeduntilfurthernotice,thedeadlinefortheothercompanieswassetforthe
endofSeptember2010.Countriesthathavesucceededinprivatizingtheirformerstate
enterprisesprimarilybythedirectsalemethod,andinwhichalargesectorofnewprivate
enterprises has evolved that choose to operate largely in the formal economy, report
highergrowthratesthanthosecountrieswhichoptedfortheMEBOorvouchermethod
and inwhichthe new private sectoris stillsmalland/or is forcedto operate largely
informally. Macedonia falls into this second category. The distinguished foreign
companies and banks that have invested in the process of privatization and post
privatizationinMacedoniaareshowninthefollowingtable.
ThePrivatizationAgencyoftheRepublicofMacedoniaisthekeyinstitutionresponsible
for administrating and supporting of the privatization process. According to Forbes
GlobalMagazine,agencysmissionisassociatedwiththefinalgoaloftheownership
transformationinMacedonia:toimprovetheefficiencyofthecountryseconomy,by
establishing wellmanaged companies, which can successfully compete in the
internationalmarkets.Macedoniaismakingsignificanteffortstoattractforeigninvestors
(August20th,2001Issue).
Ingeneral,FDIinflowstotheSEEregionarestilldrivenlargelybybigsalesofstate
assets incontrasttoCEB,wherethelargescaleprivatizationprocessisapproaching
completionandthemajorityofFDIinflowstaketheformofGreenfieldorBrownfield
(i.e. investment in an existing, privately owned company) investment. Some political
controversieshave,however,occurredbecausetheefficiencygainswereoftenassociated
withsizeableneartermjoblosses.
Inrecentyears,FDIlinkedtotheprivatizationofpublicsectorenterpriseshasresultedin
substantialimprovementsinthesupplyofservicesthathavestronglinkagestotherestof
theeconomy.Theprivatizationofpublicutilities,transportation,telecommunicationsand
other services can provide substantial increases in productivity to households and
businesses in the rest of the economy. Increased capacity, improved management,
transfersoftechnologyetc.,canallowtheFDItoprovideagreatersupplyofservices
withenhancedqualityatalowerprice.
In Macedonia, privatization may seems to have been successful in formal terms, or
judgedonthebasisofthestatisticaloverview,butoncloserlookitturnsouttohavebeen
a failure and a significant obstacle to growth and employment creation, because the
corporategovernancestructuresintheprivatizedandstateownedenterprisesectorhave
remainedvirtuallyunchangedsincethestartofthereformprogram.Neithertheproviders
ofequitynortheprovidersofloancapitalhaveputpressureonmanagementtorestructure
theirenterprisestothepointwheredebtscanbeservicedandprofitsearned.

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Studies

Consequently,theseenterpriseshavedonenothingtopromotegrowthandemployment
(WorldBank1999).

5.Conclusions
To reap the maximum benefits from foreign corporate presence a healthy enabling
environmentforbusinessisparamount,whichencouragesdomesticaswellasforeign
investment,providesincentivesforinnovationandimprovementsofskillsandcontributes
toacompetitivecorporateclimate.
The net benefits from FDI do not accrue automatically, and their importance differs
accordingtohostcountryandcondition.Thefactorsthatholdbackthefullbenefitsof
FDIinsomedevelopingcountriesincludethelevelofgeneraleducationandhealth,the
technological level of hostcountry enterprises, insufficient openness to trade, weak
competition and inadequate regulatory frameworks. On the other hand, a level of
technological,educationalandinfrastructureachievementinadevelopingcountrydoes,
otherthingsbeingequal,equipitbettertobenefitfromaforeignpresenceinitsmarkets.
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