16.3 FDI typologies

16.3.1 Market-seeking FDI

The removal of trade barriers and the consequent economic integration facilitate access to the markets of new EU member countries . Hence West European businesses will be able to serve CEE markets as an extension of their existing European operations. For some businesses this will require the establishment of sales or service operations, which may lead to FDI in distribution or services.

However other businesses may already be present in the accession countries and be serving the local markets from their local operations. These operations may have been established to overcome trade barriers “ so-called ˜ tariff -jumping FDI . As the trade barriers are removed their operations across Europe will be integrated to a higher degree, which in turn may lead to the centralization of production facilities and therefore the closure of peripheral operations. This will mainly affect smaller operations with few economies of scale, production sites in unfavourable locations in terms of Europe-wide logistics, and locations with high production costs. At the same time the main European production sites may be extended.

The net effects of this aggregation on any particular country are hard to predict. However they may be small because of the countervailing effects of labour cost differentials and the establishment of Europe-wide logistical operations.

16.3.2 Resource-seeking FDI

The removal of trade barriers facilitates the location of production wherever production costs are lowest . Hence accession countries may benefit from their relative cost advantage in respect of semiskilled labour, as long as this advantage is not overly counteracted by lower productivity or higher transport and logistical costs.

Given their geographical proximity to Western Europe, there will be considerable scope for the accession countries to exploit their comparative advantages. Theoretical considerations as well as experiences in East Asia suggest that the combination of cost differentials and close geographical proximity may trigger considerable regional FDI (Meyer, 2001). Firms may increasingly break up their production processes and locate specific stages of production in different countries to take advantage of relative cost advantages, especially small and medium- sized firms that have no experience in global operations and would find it difficult to take advantage of the lower production costs in East Asia.

However for this option to be attractive the cost advantages of regional vertical integration will have to be larger than the additional costs incurred for coordination and transportation. Empirical studies, such as that by Bevan et al. (2002), confirm the attractiveness of low unit labour costs to foreign investors. Resmini (2000) has found that lower factor cost is a motivational factor for investors in scale- intensive and science-based industries but not in traditional industries.

The acquisition of relatively low-cost production bases with access to EU markets has also provided opportunities for non-European businesses to enter EU markets with a cost-competitive product. Korean firms such as Daewoo and Samsung pursued such a strategy in the 1990s, until the Asian crisis of 1997 brought a (perhaps temporary) halt to their aggressive international expansion efforts. Similarly American and Japanese investors who do not yet have a manufacturing base in the EU may find this option attractive.

In the long term , the attractiveness of locations in the accession countries for cost-sensitive operations will depend on the evolution of their labour costs and productivity. If, as is widely expected, wages and nonwage labour costs rise faster than productivity, then manufacturers may continue to seek new locations further east, especially in such costsensitive industries as textiles .

However cost-oriented production relocation accounts only for a small part of global FDI capital flows. Access to cheap labour may not even require any FDI, as a subcontracting arrangement with an independent firm may suffice.

16.3.3 Service- related FDI

Service industries in CEE offer investment opportunities for West European businesses as there is considerable potential to create value by transferring technology and organizational methods . The attractiveness of this is likely to increase upon the CEE countries accession since trade barriers and differences in standards will be reduced when they assume the European Acquis. At the moment manufacturing accounts for only 41 per cent of the total FDI stock in Poland, and service industries are gradually taking over the lead in respect of FDI (see Section 16.6). The leading industries in Poland and other countries are telecommunications, banking, insurance and trade, including retail trade, and services such as utilities and tourism-related activities are clearly lagging behind in terms of foreign investment.

Privatization and speed of opening has so far determined the flow of FDI into East European service industries. Expansion may be increasingly constrained by the capacity of Western European firms to absorb and restructure new acquisitions in the east. However acquisition opportunities will decline with the completion of the privatization process in several countries. Accession to the EU will also open up sectors that are considered politically sensitive by local politicians , such as service industries that have not yet been fully liberalized or privatized. However the volume of FDI may decline if investors choose less capital-intensive greenfield projects when entering new markets.