Addendum 13b

Seminar on the Promotion of
Foreign Direct Investment toSoutheastern Europe

Masahiko YOSHII,
Professor, Graduate School of Economics, Kobe University

English8 November 2002, Tokyo, JIIA
Ministry of Foreign Affairs of JapanThe Japan Institute of International Affairs

Nov. 8, 2002

Seminar for Promotion of Investments in Southeast Europe(Japan Institute of International Affairs)

Masahiko Yoshii(Graduate Course of Economic Studies, Kobe University)

Southeastern European Countries need to improve their balances of payments byincreasing the inflow of direct investment and cutting down on grant aid and debt in the
short term, and they also need to improve their trade balances by promoting exports
through the competitiveness improvement effect of direct investment in the long run.
From this point of view, the incentives for foreign direct investment (FDI) in Southeastern
European countries are not attractive enough. It would be difficult to compete with Central
European countries over FDI without offering more attractive incentives. We anticipate
competition over FDI incentives will take place to the extent permitted in the relationshipwith the EU.
The comparative advantage of cheap labor currently enjoyed bySoutheastern European countries is expected to diminish sooner or later. Establishingtechnological competitiveness over a short period before today’s comparative advantage
fades away is key to the FDI policies of Southeastern European countries.

1. Present Macroeconomic Condition of the Countries Participating in the Seminar
The present macroeconomic condition of the countries participating in the seminar(Southeast European countries) and Central European countries is shown in Table 1.
Southeast European countries experienced serious deterioration of macroeconomic
performance owing to transitional recession or civil war in the 1990s. As shown in Table 1,
however, the region started demonstrating favorable performance with GDP growth rates
turning positive in almost all countries and inflation (the rate of increase in the consumer
price index) dropping below the level of Central European countries in all countries except
Romania and Yugoslavia.
There remain, however, several problems.
First, GDP per capita in Southeastern European countries, with the exception of
Croatia, is on the level of 1,000 USD per year. This low income level is a negative factor
for attracting FDI, as is shown in the next section.
1

Table 1 Macroeconomic performance
Area

Population

km2
28,7502000, thou

AlbaniaGDP
growth rates

2000,% 2000, USD

3,401

Bosnia-Herzegovina
Bulgaria

110,910GDP
per capita

8,170

CPI

ExportImportTradebalance

Currentbalance

2000, mil USD

2000,%

7.8

1,094

0.1

256

1,070

-814

5.0

996

1.9

732

2,348

-1,616

-260
-909

5.8

1,476

9.9

4,812

5,988

-1,175-701

Croatia

56,540

4,381

3.7

4,179

5.3

4,567

7,771

-3,204-399

Macedonia

25,710

2,026

5.1

1,686

9.2

1,367

1,968

-601

-279

Romania

238,391

22,443

1.6

1,644

45.7

10,366

12,050-1,684-1,400

Yugoslavia

56,270

10,634

5.0

942

60.4

1,923

3,771

-1,849-680

Czech Rep

78,86010,272

3.1

4,797

3.9

29,05232,183-3,131-2,273

Hungary

93,02910,024

5.2

4,552

10.0

21,84424,020-2,176-2,081Poland312,685

38,649

4.0

4,108

10.1

28,27741,422-13,145-9,892

Slovakia

49,035

5,401

2.2

3,556

12.0

11,87012,786-917-713

Slovenia

20,273

1,989

4.6

9,073

8.9

8,808

9,947

-1,139-612

Eurostat, Statistical Yearbook on Candidate and South-East European Countries 2002.

EBRD, Transition Report 2001

The second problem is the balance of payments (Table 2). With the exception of
Croatia, where the service balance surplus from tourism is high, the current balance ofSoutheast European countries is improving through current transfers, suggesting that
grant aid plays a big role. In regard to the balance of payments, the inflow of direct
investment has an effect in improving the international balance of payments in Bulgaria,
Romania and Croatia but plays a small role in other countries. There are also countries
where surplus from other investments plays a big role in improving the balance of
payments, suggesting the existence of debt financing by government and other entities.
As for future direction, it will be necessary to improve the balance of payments byincreasing the inflow of direct investment and cutting down on grant aid and debt in the
short term while promoting export through the competitiveness improvement effect of
direct investment to improve the balance of trade in the long term. Direct investment
policies in the Southeast European countries will be discussed below from this point ofview.
Table 2 Balance of Payments (2000, Mil EUR)
Albania

Bulgaria

Romania

Croatia

Macedonia

Yugoslavia

Current account

-164

-761

-1,474

-466

-117

-22

trade balance-882-1,275-1,827-3,490

-604

-119
22

services, net

24

548

-276

2,470

-59

income, net

116

-348

-305

-404

-49

0

current transfers, net

577

314

933

958

596

74
15

Capital account

84

27

39

23

0

Financial account

218

809

1,123

974

43

7

direct investment, net

155

1,088

1,124

1,145

191

2

portfolio investment, net

-27

-194

111

756

0

0

other investment, net

-7

358

895

-297

107

21

2

2. Motivation of FDI
Potential motivations behind companies making foreign direct investment are as
follows.
- Natural resources- Market proximity- Cost saving- Avoidance of trade friction
Under which of these patterns do the current and prospective inflows of direct
investment to Southeast European countries fall? We may safely exclude “natural
resources” and “avoidance of trade friction” from our consideration in view of the scarcity
of natural resources in Southeast Europe and the lack of major trade issues with the EU
and other foreign countries (although investments for avoiding local content regulations
may be made in the event such regulations are imposed).
Secondly, what is the market scale of Southeast European countries? As we haveseen in the previous section, the national income of Southeast European countries
remains at a low level. The percentage vis-à-vis the average GDP per capita for thecurrent 15 member countries of the EU is as low as 7% and 28% in Bulgaria and 8% and23.3% in Romania (current prices and purchasing power parity, respectively). Moreover,the small population of Southeast European countries — 22 million in the most populous
Romania and 2.2 million in the least populous Macedonia — does not make the region an
attractive market per se. In this respect, they are different from the Central European
countries that have already reached 50 to 60% of the purchasing power parity average
GDP per capita of the EU members.
For this reason, cost saving would provide the main incentive for companies in Europe
as well as those in the U.S. and Japan to invest in a region neighboring the giant
European market.

3

Table 3 Why Japanese companies have invested in Central
European countries
30
25
20
15
10
5
0
Possibility of
adopting euro

Political
situation

Level of labor

Labor cost

Transportation
cost

Land cost

Incentives

Czech Rep
Hungary
PolandThe Nikkei, November 30, 2001
Since cost saving is the primary reason behind the expansion of Japanese companies into
Central European countries, this aspect should become even more important in Southeast
European countries (see Table 3). (While proximity to Russia, which may rank as a big
market in the future, could provide an incentive for European and American companies toinvest in Central Europe, Japanese companies are not likely to have this incentive.)
Cost-saving direct investment can be divided into horizontal labor specialization (totake advantage of economies of scale through specialized division of labor backed byadvanced technology and know-how) and vertical labor specialization (or division of laborin production processes) based on low wages. Let us take a look at the level ofcompetitiveness based on the present level of technology and know-how in Southeast
European countries.
Firstly, since Southeast European countries are still proceeding with the transition to amarket economy, let us see to what extent transition to a market economy has beenachieved in the past 10 years by taking a look at the EBRD transition indicators (2001)(Table 4).

4

Table 4 EBRD Transition Indicators (2001)
Markets andtrade

Enterprises
Private sector
share ofLarge-scaleGDPprivatization
Czech Rep
Slovakia
Hungary
PolandSlovenia

80
80
80
75
65

4
4
3+
3+
3

4+
4+
4+
4+
4+

3
3
3+
3+
3-

3
3
3+
3+
3+

Trade andforeignexchange
system
4+
4+
4+
4+
4+

Albania
Bulgaria
Romania
Croatia
Macedonia
Bosnia-Herzegovina
Yugoslavia

75
70
65
60
60
40
40

2+
43+
3
3
2+
1

4
444+
4
33

2
2+
2
41
24

3
3
3+
3
3
3
3

4+
4+
4
4+
4
3
3

22+
2+
2+
2
1
1

Telecom

Electric
power andpostal service

Railways

Roads

Water andsewage

4
2+
4
4
3

3
3
4
3
3

2+
2+
3+
4
3+

2+
2+
3+
3+
3

4
2+
4
4
4

3+
3
3
3+
2
3+

2+
3+
3
3
2
2

2
3
4
2+
2
2+

2
2+
3
2+
2
2

1
3
3
3
2
1

GovernancePrice& enterpriseliberalization
restructuring

Competition
policy33
3
33-

Infrastructure

Financial

Czech Rep
Slovakia
Hungary
PolandSlovenia

43+
4
3+
3+

Securities &non-bank
financial
institutions
3
2+
443-

Albania
Bulgaria
Romania
Croatia
Macedonia
Bosnia-Herzegovina
Yugoslavia

2+
3
33+
3
2+
1

22
2
2+
21
1

BankingsystemSmall-scale
privatization

EBRD, Transition Report 2001

When seen as a whole, Southeast European countries have areas where transition istaking place to a degree comparable to Central European countries (e.g., small-scale
privatization, price liberalization and liberalization of trade and foreign exchange systems).
On the other hand, these countries lag in areas such as large-scale privatization,
governance & enterprise restructuring, competition policy and finance. In addition,
infrastructure improvement on par with Central European countries has been attained withregard to electric power and postal service while a slight lag can be seen intelecommunication, railroad and roads and a more significant one in water and sewage.
By country, comparative slowness in transition to a market economy and in infrastructure
improvement is conspicuous in Albania and the former Yugoslavian countries with the
exception of Croatia.
One can easily imagine that lagging transition to a market economy and delays ininfrastructure improvement—along with undeveloped legal systems—have the effect oflimiting FDI from companies of the developed countries to Southeast European countries.
5

Table 5 illustrates the competitiveness indicators of Bulgaria and Romania. The list
was created by giving up to 7.0 points to 20 growth engines in examining thecompetitiveness of 75 countries in the world in a manner similar to the competitivenessindicators the World Economic Forum calculates every year. (Unfortunately, this study
was intended for obtaining the competitiveness of countries applying for EU membershipand has not been conducted for other Southeast European countries.) Group 1998
consists of five countries that in 1998 started negotiations for joining the EU (Czech
Republic, Estonia, Hungary, Poland and Slovenia) and Group 2000 consists of countries
that in 2000 started negotiations for joining the EU (Bulgaria, Latvia, Lithuania, Romania
and Slovenia).
As can be seen from these tables, the rankings for Group 1998 exceed those forGroup 2000 in the majority of growth engines (18 out of 20) and the rankings for Romania
and Bulgaria were lower than those of Group 1998 and Group 2000 in most cases. In
other words, Southeast European countries, as represented by Romania and Bulgaria, do
not possess industrial competitiveness based on technology and know-how, and must
relay on price competitiveness based on low wages to compete in today’s market.
Table 5 Competitiveness Indicators
Start-upconditions

Bulgaria
Romania4.4(55)4.5(53)2.0(69)1.0(75)2.8(62)2.6(64)4.9(65)5.6(52)3.7(24)
1.7(66)

Group 1998
Group 2000
EU average

5.1
4.7
5.8

3.9
2.3
4.8

3.8
3.0
4.8

6.5
6.1
6.7

Infrastructure Rule of law

Red tape

Education

Financialsytem

Openness to
CapitalQuality ofinternational
accumulatio
government
tradenMacroecono
mic stability

Low taxes

Innovations

Technology
transfer

New
Economy1.8(72)2.4(61)

2.2(64)2.0(69)3.1(64)2.6(71)

3.8(70)5.8(44)4.4(50)4.0(59)

3.1
3.0
3.8

3.7
3.0
3.2

3.3
2.7
2.6

4.0
3.3
5.1

5.3
4.8
5.2

5.4
4.7
5.9

Corruption

Competition

Local
supplier

Workplace Labor market
Cluster
incentives
flexibility development

Bulgaria
Romania3.7(43)4.4(34)

3.7(63)3.1(69)3.2(61)
4.3(51)4.0(54)4.5(43)4.9(34)4.1(58)4.0(70)4.7(42)3.9(49)4.0(47)

3.4(66)
4.6(39)4.0(37)7.0(1)

1.0(74)4.0(21)

Group 1998
Group 2000
EU average

5.1
4.3
5.4

5.4
4.2
6.1

5.3
3.7
6.3

4.8
3.9
5.1

4.8
4.9
5.9

5.4
4.8
5.7

4.7
4.3
5.2

4.9
4.3
5.1

4.1
4.6
2.9

2.0
2.6
4.1

World Economic Forum, The European Competitiveness and Transition Report 2001-2002 , Oxford University Press, 2002.

3. Incentives for Attraction of FDI
The important role FDI will play in the economies of Southeast European countries
was explained in Section 1. FDI to Southeast European countries, as is shown in Table 6,
remains low at present compared to Central European countries. For this reason, it will be
crucial for Southeastern European countries to offer attractive incentives for promoting
FDI. The incentives these countries can offer, as can be determined from the papers thathave been presented, are summarized in the following.

6

Table 6 FDI in Eastern Europe
Inflow per
capita,mil USD
USD
2001 2002 foreca
2001
4,916
3,500
478
1,475
3,500
274
2,443
1,000
240
8,000
6,000
207
442
600
222

Inflow (mil USD)

Stock (mil USD)
mil USD
2001
2001
21,644
26,7644,504
6,000
19,80423,56233,60339,0002,809
3,400

Stock percapita
USD
2001
2,604
1,115
2,311
1,010
1,709

Czech Rep
Slovak Rep
Hungary
PolandSlovenia

2000
4,986
2,075
1,649
9,342
176

Central Europe

18,22817,276

14,600260

82,364

98,726

1,485

Albania
Bulgaria
Romania
Croatia
Macedonia
Bosnia & Herzegovina
Yugoslavia

143
1,002
1,040
1,126
176
150
25

200
689
1,137
1,502
442
130
165

200
600
1,000
1,100
500
200
500

58
86
51
343
217
35
20

568
3,309
6,561
5,202
381
340
990

800
3,997
7,698
6,703
824
470
1,155

233
504
343
1,530
403
125
139

South Eastern Europe

3,662

4,265

4,100

79

17,351

21,647377

http://www.wiiw.ac.at/pdf/wiiw-wifo_fdi_June02_summary_eng.pdf

Albania
Relevant law: Law No. 7765, Nov. 2, 1994 “On Foreign Investments”-No permission or approval needed for investment-Not subject to expropriation or nationalization-All investment-related funds and goods can be transferred overseas
Incentives for investment are offered equally to domestic and foreign nationals.
-Four-year tax holiday offered to all companies that will engage in economic
activities for at least 10 years in the manufacturing sector-Sixty-percent tax refund offered to reinvested profit in the manufacturing sector-Five-year tax holiday offered to companies engaged in recommended activities inthe tourism development zone
-Tax incentives for companies that are doing business in the free zone or signing a
concession contract-No restrictions concerning debt/equity ratio-Loss can be carried over for 3 years-No withholding tax charged on dividends sent out of the country
Croatia
Relevant law: Investment Promotion Act (2000)-Incentives are offered to newly established enterprises registered in the area thatthe incentives are offered.
-Incentives
7

-Leasing, granting of construction rights and sale or usage of real estate or otherinfrastructure-Creation of new jobs
-Vocational training or re-training-Custom benefits to equipment that is part of the investment
Bosnia Herzegovina
Relevant law: Direct Foreign Investment Policy Law-National treatment of foreign investors-Free investment of assets and services in all sectors except weapon production
and official information-Tariffs waived for foreign investment
Bulgaria-National treatment of foreign investors-Investment protection-Incentives
Macedonia-National treatment of foreign investors-Alleviation and exemption of taxes and other legal measures-Partial exemption of corporate income taxes and tariffs
Yugoslavia
Relevant law: Law on Foreign Investment (Jan 2002)-No restrictions in areas of investment with the exception of weapon production anddistribution-No restrictions in sending funds to home country and purchase of real estate-Tariff exemption for equipment import with the exceptions of passenger cars andslot machines-Preferential treatment on other taxes and tariffs
Romania
Relevant law: Law No.332/2001 Regarding the Promotion of Direct Investment with
Significant Impact on Economy, etc.
-Exemption of tariffs and VAT-Payment deferral for VAT-Twenty-percent tax exemption on new investments-Five-year carry-over of loss
-Utilization of accelerated amortization8

Czech Republic
Incentives listed in the Act on Investment Incentives-Tax incentives
Corporate tax relief for up to 10 years for new companies
Partial tax relief for up to 5 years for existing companies-Job creation grants Financial support for creation of new jobs
-Retraining grants Financial support for retraining new employees-Site support
Provision of low-cost building land and/or infrastructure
The incentives are available singly or collectively and are designed to havemaximum impact in the early stages of a project.
http://www.czechinvest.org/ci/ci_an.nsf/Links?OpenPage
Based on the information available in the seminar, the aspects commonly foundamong the FDI incentives of the Southeast European countries are as follows:-National treatment of foreign investors (although purchasing land is possible insome countries and not possible in others)-Investment protection and free remittance to home country-Tax exemption available for tariffs and VAT
There are also following incentives that are offered by some countries but not referred
to in others:- Reduction and exemption of corporate taxes- Use of free trade zone
- Preferential treatment for investment (e.g., accelerated amortization, tax reduction
for reinvested profit)
As far as the information we obtained from the papers presented in the seminar isconcerned, we could not help but gain the impression that investment incentives available
in Southeast European countries were not attractive enough. With the Czech Republicpresently offering preferential treatment to foreign investors for corporate income tax andalmost all Central European countries offering similar or better incentives, it would be
difficult for Southeastern European countries to compete with Central European countries
over FDI without offering incentives that are much more attractive. We anticipate
competition over FDI incentives taking place to the extent it is permitted in light ofrelationships with the EU.

4. From FDI to Competitiveness Gaining Policy

9As we have seen in Section 1, FDI is desirable for Southeast European countries in
improving the balance of payments in the short term. However, it is necessary to pay
attention to several points concerning the inflow of FDI.
1) FDI has the effect of improving the balance of payments in the short term. In themid- and long-term, however, it may have a negative effect on the balance of
payments as a result of the remittance of profits to the home country and invested
capital being withdrawn when FDI does not generate the anticipated profits.
2) Aside from the benefits mentioned in the foregoing paragraph, the benefits expectedfrom FDI are as follows:-Creation of employment-Transfer of tangible and intangible technology and management resources torelevant companies and to other companies to improve the country’s economic
performance-Increased competitiveness of products and services resulting from transferredtechnology or management resources to improve the country’s balance of
payments through the increase of exports-Other effects (e.g., increased revenue)
However, there is no guarantee that these effects will be realized. In particular, thetransfer of technology is often not realized in cases where the company in the homecountry simply limits FDI to building factories to take advantage of low-wage labor andwithdraws this FDI as soon as it determines that this effect is becoming weaker,
moving it to countries offering lower wages. For this reason, efforts and systembuilding for realizing the aforementioned effects are needed, particularly in the
manufacturing industry.
Local content is often used to realize this. However, it is difficult to tighten the local
content regulation as far as the EU—an entity based on the premise of the equality ofdomestic and foreign investors—is involved. It is therefore essential to step up policies forsmall and medium enterprises and create subcontractors and supporting industries withtechnical capabilities. Furthermore, it is necessary to have a clear notion of the industrial
sectors that are to be developed in the future when fostering small and medium
enterprises. In other words, it is necessary to establish priority industrial sectors andimplement industrial policy, starting with education, for this sector.
The promotion of exports backed by cheap labor may work under the present
framework in Europe. However, the comparative advantage from cheap labor currently
enjoyed by Southeast European countries is expected to diminish sooner or later as aresult of the EU’s policy to incorporate Africa through the Lome Agreement, the expansionof subcontracting to former Soviet republics such as Russia, and the economic
10

development of China, which is predicted to become the “world’s factory” in the near
future. Establishing a technological edge over a short period of time before thecomparative advantage is lost is key to the industrial and FDI policies of Southeast
European countries.

【Appendix】
Several participants from the Southeast European countries commented that theSoutheast European countries as a region have an adequate market size, and that they
hoped Japanese investors would invest in the region. I would like to respond to thecomment here, as I was unable to do so in the seminar.
Table 7 shows the shares of exports and imports of each Southeast European country
to other Southeast European countries and the EU. It is obvious that trade between
Southeast European countries remains at a extremely low level with the exception of trade
between Croatia and Bosnia & Herzegovina, and Yugoslavia and Macedonia.
Table 7a Share of exports to specific countries as a percent of total exports (2000)
Of
ALB
B&H
BUL
CRO
MAC
ROM
YUG
EU
Albania
0.1
0.5
1.3
0.1
0.1
0.0
Bosnia&Herzegovina
0.2
11.6
1.7
0.1
0.0
Bulgaria
0.0
0.0
0.1
1.8
1.8
2.4
0.1
Croatia
0.1
10.2
0.1
3.7
0.2
0.2
Macedonia
1.7
13.0
2.3
1.4
0.1
0.1
Romania
0.0
1.0
1.8
0.1
0.2
0.4
Yugoslavia
7.8
22.4
0.1
EU
85.4
67.2
51.2
54.9
46.4
61.7
75.9
60.8
To

Table 7b Share of imports to specific countries as a percent of total imports (2000)
To
Of
ALB
B&H
BUL
CRO
MAC
ROM
YUG
EU
Albania
0.0
0.2
0.1
1.1
Bosnia&Herzegovina
0.0
0.0
1.0
0.5
0.1
2.2
Bulgaria
2.5
0.4
0.1
5.4
0.6
14.3
0.1
Croatia
1.0
19.3
0.1
2.8
0.0
0.1
Macedonia
2.0
0.9
0.4
0.7
0.0
0.0
Romania
0.7
0.5
3.6
0.2
0.5
0.3
Yugoslavia
0.4
9.6
0.0
EU
77.8
44.5
44.9
56.0
47.1
63.7
61.5
58.0
V. Gligorov, "European Union Enlargement and the Balkans", in The European Competitiveness andTransition Report 2001-2002 , op.cit .

First, according to the gravity model, the trade level of one country has a positive
correlation to the income level of trade partners and a negative correlation to the distance.
Hence the low income level of Southeast European countries keeps intra-regional trade at11low level. It will take a long time before the income level of Southeast European countries
goes up enough to regard these countries as a region.
Furthermore, the low income level alone cannot explain why the spoke-shaped trade ofSoutheast European countries with the EU as a hub and intra-regional trade remain at low
levels. I can point out two other reasons:
1) Southeast European countries have a long history of bitter ethnic problems thathave stopped a network-shaped trade structure from developing.
2) COMECON forced Southeast European countries to engage in spoke-shaped tradewith the USSR as a hub. Despite the start of the transition to a market economy, thespoke-shaped trade has remained, although the hub has shifted from the USSR tothe EU. The pattern is the same in Central Eastern European countries.
These factors developed over a long time cannot easily disappear even after FTAs
remove the trade barriers. From this point of view, it will also take a long time to regard
Southeast European countries as a region.

12