How Foreign Direct Investment is Changing East European Economies Charles Kovacs Vice Chairman, Committee on Non-Member Economies, Business and Advisory Committee to the OECD, Paris RESEAU D’ECONOMIE INTERNATIONALE, Montreal, Quebec, Canada 30 March 2005

IN THE BEGINNING: 1990 Transformation and not revolution: radical political and structural change, but with pre-1990 power structure intact Stagnant economies; no foreign investment Low standard of living, but no formal unemployment Poland, Yugoslavia among defaulted countries, Bulgaria on the brink, of the rest, only Hungary had a large foreign debt Command economies closely linked to COMECON: dependent on USSR for exports and for oil and gas Only minority of exports were to First World Only Hungary had a legal structure that was close to Western law (e.g. Companies Act, Banking Law) Very limited entrepreneurism except Hungary and Yugoslavia

WESTERN REACTION TO THE COLLAPSE OF COMMUNIST RULE Surprise, fear of rapid change, switch to historical autopilot Divisions within EU about Yugoslavia Attempted marginalization of US preoccupied with Gulf War and its aftermath Establishment of EBRD Great commercial interest till August 1991 –Euphoric large banks and companies –Western SME’s with “ethnic” background –The beginning of tiering –The switch to Russia

THE AFTERMATH IN EASTERN EUROPE Chaos and war in Yugoslavia Unrest in Romania and in the Baltic States Hyperinflation in Poland Initial joy at freedom and independence gradually undermined by economic problems and absence of fundamental change Privatization slowed by local special interests and Western advice Modernization of legal structures] Initial exclusion of foreign banks in some countries Most FDI limited to Hungary till 1993, then increasing amounts for Poland, Czech Republic

1995: START OF THE RACE TO PROSPERITY Temporary peace in the Balkans Stability achieved in the Baltic States Break up of Czechoslovakia peacefully completed Good record of scandal-free elections, democracy and free press solidly established Legal reforms completed in Northern tier of E. Europe Significant privatization, FDI inflows everywhere Positive experience with green-field investments Revolution in retailing and banking Good progress in telecommunications

WHERE IS EASTERN EUROPE NOW?

WHERE IS EASTERN EUROPE NOW? Share of Global FDI Flows

WHERE IS EASTERN EUROPE NOW? Still marginal in global terms, but Massive qualitative and quantitative improvements in exports, largely to First World countries Modern economies in Northern tier Radical improvements in Baltic states OECD and NATO membership by 1998 for North EU membership for northern and Baltic states Stability in the Balkans after Kosovo air campaign Improvements in Romania, Bulgaria, Croatia Eventual EU membership for the Balkan countries

WHERE IS EASTERN EUROPE NOW? Market for Offices in 2004 Budapest Moscow WarsawPrague Office space (M of sq.m) Highest rent (Eu/sq.m/p.m) Source: Jones, Lang, LaSalle

PROBLEMS IN THE BALKANS FDI attracted through 2003

PROBLEMS IN THE BALKANS Tiering within the region: Albania, Bosnia-Herzegovina, Macedonia, Moldova have almost no foreign investment Improvements unlikely without resolution of Kosovo’s and Bosnia-Herzegovina’s problems Very limited progress in improving infrastructure, except Croatia and telecommunications in most countries US and EU attention shifting away from the region Slow progress of structural reforms, except Romania and Bulgaria

EASTERN EUROPE IN THE FUTURE: Issues, Problems and Questions Impact on the EU: The East European Perspective: –Distribution of subsidies –Constitutional issues: preference for a weak confederation –Preference for less regulation, freer economies, less socialism –Friendlier views towards the US –Preference for NATO –Potential disagreements about future expansion of EU

EASTERN EUROPE IN THE FUTURE: Issues, Problems and Questions Impact on the EU: The Western Perspective: Loss of subsidies for “old” members Immigration from new states (many pros and cons) New power relationships within the EU: weakening of the Franco-German Entente Disagreements on foreign and defense policies BUT: Eastern Europe is secure, peaceful, and increasingly prosperous