Think Tank: FDI in Europe outside the eurozone

Economists argue the point that the EU’s economic track record since the launch of the euro in January 1999 has not been impressive. When measured against the EU’s track record for attracting inward investment, the point seems somewhat excessive.

Although the EU in the next decade is likely to consume a smaller share of global output than it does today, Europe in the future could be a more dynamic place to invest than today – especially if Poland, the Czech Republic and perhaps Hungary adopt the euro. In considering the future potential for inward investment in Europe, we should look through the lens of both eurozone and non-eurozone FDI recipients, specifically those countries that joined the EU after 2004.

Blurring boundaries

Within Europe, globalisation has involved a steady decline in the importance of national political boundaries and a fading of geographical distance among member countries. In the context of globalisation, the role of investment in promoting the technological transfer of knowledge and innovation and in providing investors with access to previously inaccessible markets has resulted in FDI becoming a key focus for many governments, both in and outside Europe. Although statistics vary, based on global economic growth and gross fixed capital formation, global FDI is expected to reach €2000bn in 2018.

Most studies on FDI point to differing benefits depending on the country of origin and industry sector. FDI into an economy is either horizontal or vertical. Horizontal FDI is where firms set up subsidiaries in another country to gain access to a given market. Vertical FDI is where firms locate different stages of production in other countries according to comparative advantage. Within Europe, most horizontal FDI takes place between similar countries while vertical FDI occurs between dissimilar ones.

An important feature of European FDI is the means by which it is accomplished. In the past, greenfield investment was the preferred choice, but more recently the vast majority of FDI has been through mergers and acquisitions. While the EU is dealing with some complex political and economic issues such as Brexit, free movement of labour and labour market performance, the case for investing in Europe rests on the fact that Europe is a continent of success. With a population of 510 million, it is Europe’s size and wealth, depth of human capital and respect for the rule of law that makes it a natural partner for many foreign investors.

New opportunities

The newer EU member states (EU-13), including Bulgaria, Croatia, the Czech Republic, Hungary, Poland and Romania, represent latent opportunities for investors, especially in the area of intangible investment such as R&D and in business functions designed to extract commercial value from new technology.

Despite favourable investment regimes, including low corporate taxes, significant challenges remain for many EU-13 countries. For example, the Bulgarian government has established a highly advantageous taxation system in order to attract investors, while the cost of creating a company in the country is relatively cheap. However, corruption in public administration, a weak judiciary and the presence of organised crime continue to be an issue for many investors.

Like most central and eastern Europe countries, Croatia experienced an abrupt slowdown in its economy following the banking crisis. Croatia has the important geopolitical advantage of lying along three transport corridors between the EU and south-east Europe. Since becoming an EU-13 member, it has received reasonable levels of FDI inflows, most of these through privatisation in the services sectors, banking, telecommunications and financial services.

Though still one of the wealthiest of the former Yugoslav republics, Croatia’s investment environment is complex, mainly due to the banking system (more than 90% of all bank assets in Croatia are foreign owned). Economists from leading Croatian banks are warning the government of the need to implement reforms to modernise the country's economy. Success in the short term is unlikely, since Croatia’s problems are akin to those of Greece – namely a lack of competitiveness compared with other, much more productive EU neighbours. 

Similar to Bulgaria, Croatia and the Czech Republic, Hungary was affected by the 2008 financial crisis. The global economic downturn, declining exports, low domestic consumption and government austerity measures resulted in a severe economic contraction of inward investment. In the past five years, global demand for high-yield investment opportunities has helped Hungary to obtain funds on international markets to stimulate productivity and reduce its debt levels.

Hungary’s progress to reduce its deficit to below 3% of GDP has permitted it to exit the European excessive deficit procedure. Investor confidence in the economy is slowly gaining momentum, and leading companies that announced investments in 2015 include Audi, Bosch and Xerox. As part of the national development plan, further expansion in tourism, healthcare, infrastructure and environmental protection programmes are envisaged.

Polish stability

Poland is the eighth largest economy in the EU and enjoys a well-managed financial system. Among the top countries in Europe in terms of FDI, Poland’s main assets are its strategic position, a large population, its EU membership, economic stability, below-average labour costs and a fiscal system attractive to businesses. Poland’s biggest investors include Germany, Netherlands, France, and Belgium.

According to the European Commission, future FDI investment into Poland is expected to grow strongly as a result of an already high degree of capacity utilisation. The transparency exercise, carried out by the European Banking Authority, confirmed the overall healthy state of the Polish banking sector. However, structural issues in the labour market, education and innovation systems persist to hinder investment opportunity for those investors outside central Europe.

Romania is the largest former Communist economy in south-eastern Europe. Following the global financial crisis, its GDP contracted but has since recovered. Capital Bucharest is the country’s commercial and finance centre, and foreign-owned banks from Austria, France and Greece dominate the sector. 

Romania has bilateral investment agreements with 96 countries, including the UK, the US and China. In the past few years, the country has witnessed a return in investor confidence reflected in a rise of foreign investment of 60% compared with 2014. The country has 28 large-scale FDI projects in the transport, energy and construction sectors, the largest of which is the Pan-European Corridor Modernisation Project, which has seen investment of about €3.6bn committed to the Romanian rail sector.

Apart from infrastructure, other activities to attract significant FDI into Romania are financial and insurance services, trade, real estate, IT and communications. Romania’s economy remains vulnerable to geopolitical decisions and external shocks, however, with a low fiscal deficit and public debt being the economy’s top vulnerabilities. The manufacturing sector remains a significant source of FDI, and future investors are likely to be attracted by the low wages and flexible employment legislation compared with its regional peers.

In summing up, inward investment to non-eurozone countries will continue at a level commensurate with each country’s ability to reduce debt, increase productivity and absorb investment opportunities comparative to each country’s growth in GDP.

Dr John McManus is a UK academic and author. His latest book, Managing Global Business Strategies, is published by Elsevier.