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Impact of inward FDI on performance of domestic firms in CEE

The second part of this paper looks into the effects of outward FDI from CEE countries. Notably, with advancing restructuring in CEE countries, many thriv-ing domestic firms involved in consolidation within their local industries or started to organize their own value chains both domestically and internation-ally. This process has witnessed waves of local or international acquisitions after 2000, which is shown also in increased outward FDI flows from CEE countries.

These processes, in turn, contributed to restructuring and productivity growth of parent firms, but with ambiguous effects on home industrial output, exports and employment.

In the third part, we review the most recent episode of FDI patterns and its effects on CEE countries. With enhanced trade liberalization, CEE countries became attractive for greenfield investments in manufacturing, particularly to fragmented production processes that are integrated into the network of upstream and downstream suppliers organized by a dominating MNC. Though ownership control over these fragmented production processes abroad is not necessary due to ICT revolution, it is still preferred over contractual arrange-ments in some circumstances when the affiliates are engaged in design and production of strategic components. What is more, in this wave of FDI flows the importance of industry, technology segment and production stage to which FDI were attracted seems to be essential for future micro and macro perfor-mance. While firms in industries at either technology level are likely to increase their employment and export performance if they succeeded in attracting FDI, technology upgrading and productivity growth are more likely to occur only if FDI were plugged into according technology segment. In other words, position-ing within individual GVCs becomes critical for future economic growth and technology upgrading of CEE countries.

The paper is organized as follows. The next section reviews the effects of inward FDI on firm performance in CEE countries. The third section gives an overview of effects on performance of CEE firms investing abroad. The fourth section reviews the effects on industry performance of CEE countries in the era of GVCs, where technology segments of inward FDI become key to understand future performance of industries and technological upgrading. The last section concludes.

The catching up process of transition countries has coincided with robust inflows of foreign capital into the region (figure 10.1). While foreign investment is credited with providing access to new technology, improving availability of capital, intensifying local market competition, etc., its effect of productivity in host countries is still a hotly debated issue. Given the prevalence of foreign direct investment in transition countries, its importance in the convergence process is of particular interest to both researchers and policy makers alike.

Figure 10.1: Stock of gross inward FDI and gross value added per employee in CEE countries (2000–2013)

120 130 140 150 160

300 400 500 600 700 800

value added per employee

Inward FDI stock

90 100 110

0 100 200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013


stock of gross inward FDI (2000=100) value added per employee (2000=100)

Note: Both the stock of IFDI and value added per employee in current prices presented in terms of base indices (2000=100). CEE countries considered are Bulgaria, Czech Republic, Estonia, Croatia, Latvia, Lithuania, Hungary, Poland, Slovakia, Slovenia, and Romania.

Source: Eurostat, UNCTAD.

Figure 10.2: Share of gross inward FDI stock in GDP and value added per employee in CEE countries (2000–2013)

130 150 170 190

130 150 170 190 210 230

valuaddeper employee

share of IFDI stock iGDP

90 110

90 110

simple average share of IFDI stock in GDP (2000=100) weighted share of IFDI stock in GDP (2000=100) value added per employee (2000=100)

Note: Both the share of IFDI stock and value added per employee are presented in terms of base indices (2000=100). CEE countries considered are Bulgaria, Czech Republic, Estonia, Croatia, Latvia, Lithuania, Hungary, Poland, Slovakia, Slovenia, and Romania.

Source: Eurostat, UNCTAD.

Country and industry level studies of the link between inward flows of foreign capital and productivity have mostly found the effect of foreign investment to be positive. Holland and Pain (1998) explore the early stages of transition in CEE countries (1992–1996). They estimate a labour demand function using aggregate data for eight countries and find that stock of inward foreign invest-ment has a positive impact on productivity, with the beneficial effects being higher in the more market-orientated economies. These results were broadly confirmed by a related study of Barrell and Holland (2000), based on industry-level data covering eleven manufacturing sectors in the Czech Republic, Hun-gary and Poland. On the other hand, using aggregate data, Mencinger (2003) finds a negative association between FDI and GDP, which he attributes to the nature of privatisation-related FDI.

Given the intricacy and complexity of the effects of foreign ownership on the economy of the host nation, analysing the impact using aggregate data was always going to be a very difficult task. It is only at the firm level that direct and indirect effects of foreign ownership can be fully explored. Follow-ing improved availability of firm-level data, an increasFollow-ing number of papers

on the link between FDI and growth have also been focusing on productivity spillovers from foreign-owned companies to other firms in the economy.

Affiliates of multinational firms have been found to be different from local firms by a number of firm-level studies across a broad set of countries. They tend to be heavily involved in international trade, more capital and R&D inten-sive, pay higher wages and outperform their competitors at home as well as in host countries in terms of productivity.3

One of the earliest studies to focus on the effect of foreign ownership in CEE countries was Djankov and Hoekman (2000). Using data on Czech firms (1992–1996) they show that foreign ownership positively effects target firms.

On the other hand, they also find negative spillovers on the productivity of the remaining domestic firms. Konings (2001) finds positive performance effects of FDI only in case of Polish firms, while no correlation is found in cases of Bulgaria and Romania. In addition, no spillovers effects to other domestic firms are found. Damijan et al. (2003), looking at data for 8 CEE countries, similarly find foreign-owned firms outperform their local rivals, while, again, not finding conclusive evidence of spillovers to other incumbent firms. While most studies fail to find evidence of positive horizontal spillovers of FDI, there are exceptions (Sgard, 2001, and Schoors and van der Tool, 2001 for Hungary; Sinani and Meyer, 2004, for Estonia; Lutz and Talavera, 2004, for Ukraine).

While Smarzynska Javorcik (2004) also finds no evidence of horizontal spill-overs in case of Lithuanian firms, she does find robust evidence of backward spillovers. That is firm productivity is positively correlated with the extent of potential contacts with multinational customers but not with the presence of multinationals in the same industry. She argues that while multinationals have an incentive to prevent knowledge from leaking to their local competitors they may have an incentive to provide assistance to their local suppliers in upstream sectors. A one-standard-deviation increase in foreign presence in the sourc-ing sectors is associated with a 15 percent rise in productivity of Lithuanian firms in the supplying industry. The productivity effect is found to originate from investments with joint foreign and domestic ownership but not from fully-owned foreign affiliates, which is consistent with the evidence of a larger amount of local sourcing undertaken by jointly owned projects.

Javorcik and Spatarenau (2011) extend this line of research by showing that the origin of investment matters for positive backward spillovers in case of Romania. Arnold et al. (2011) find additional evidence in favor of backward spillovers in case of service-firm liberalization in the Czech republic.

Damijan et al. (2015) compare foreign and domestic mergers and acquisi-tions in seven CEE countries and show that firms targeted for foreign takeovers start as underperforming prior to the takeover and gain considerable improve-ment in productivity. The later does not come at the expense of downsizing,

3 Aitken and Harrison (1999) found that foreign affiliates exhibit a higher productivity than domestic plants in Venezuela, Javorcik (2004) and Sabirianova et al. (2005) found the same pattern in Lithuania and the Czech Republic, respectively. Yasar and Paul (2007) show that foreign affiliates differ from Turkish plants in terms of productivity, size and wages paid.

but rather due to a more efficient use of factors of production. However, these effects cannot be generalized for all CEE countries, but are confined to a few countries only.

Overall, there seems to be substantial support for a positive effect of foreign ownership on the affiliate firms in CEE countries itself, which could be due to the transfer of knowledge, improved distribution networks, easier access to capital or a number of other factors. On the other hand, there is very scant evidence in support of horizontal spillovers within the same industry, as most studies either find no significant effects or even find significantly negative effects. More promising results were found in case of vertical spillovers, where primarily upstream industries in CEE countries appear to benefit from foreign presence amongst their buyers.

However, a more comprehensive recent study by Damijan et al (2013) covering ten CEE countries and taking into account heterogeneity of firms in terms of absorptive capacity, size, productivity and technology levels, arrived at more nuanced findings. The study finds that horizontal spillovers have become increasingly important over the last decade, and they may even become more important than vertical spillovers. Positive horizontal spillovers are found to be equally distributed across size classes of firms, while negative horizontal spillovers appear to be more likely to affect smaller firms. Furthermore, posi-tive horizontal spillovers seem more likely to be present in medium or high productivity firms with higher absorptive capacities, while negative horizontal spillovers are more likely to affect low to medium productivity firms. These findings suggest that both direct effects from foreign ownership as well as the spillovers from foreign firms substantially depend on the absorptive capacity and productivity level of individual firms affected by FDI.

2.2 Inward FDI and the labour market in CEE countries

Traditionally, proponents and opponents of foreign investment disagree on the net effect of aggregate job creation stemming from the entry of foreign capital.

The former claim that foreign owners introduce more efficient technologies and access to wider markets, stimulating overall employment, where the latter associate firm restructuring of foreign owners primarily with reductions in the wage burden while trying to maintain a similar output level.

Geishecker and Hunya (2005) suggest that the effect of foreign direct invest-ment on host country employinvest-ment in CEE countries has two distinct phases:

the restructuring of former state-owned enterprises in the wake of privatization often meant massive labour shedding. In later years, particularly in manufac-turing, most of the FDI has been investment in new assets. FDI in most cases incorporated more modern technology than that available domestically and increased productivity in the host economy. New capacities usually increased employment while technological progress also triggered lay-offs. They also pro-pose that there is no simple correlation between rate of employment growth as output and employment suffered setbacks after initial foreign takeover, but firms became more efficient and resistant to subsequent competitive pressure.

Hake (2009) looks at a sample of 11 CEE countries between 2000 and 2007