Economic Determinents of FDI in Transition Countries: The Perspective of the SEEC

In a global economy, dominated by MNEs, foreign investment represents the main form of international business activities. As such, FDI incorporates more than merely cross-border capital flows and includes transfer of technology and know-how as well as creation of significant flow of goods. Positive spill-over effects on local economy and improvements in long term competitiveness can be regarded as ultimate positive advantage of inward FDI. Therefore, recent drop in international capital flows, resulting from global financial crisis and economic recession, have caused concerns regarding the growth prospects of the world economy in general and that of less developed countries in particular. Although the fall in inward FDI in the SEEC is modest in comparison to that of global economy, or developed countries, these negative developments are still worrisome due to worsening external position of the European transition countries, on one hand, and shrinking external sources of financing, on the other.

Based on an integrated approach to understanding motives behind FDI, the paper is mostly concerned with market- and efficiency-seeking FDI. In doing so, it refers to theoretical contributions which explain FDI by factor-proportions approach, but also by similarities in relative factor endowment and a ‘proximity-concentration trade-off’, thus giving theoretical background to analysis of vertical and horizontal FDI, respectively. This approach is useful for investigation of FDI-flows between countries at different stages of economic development and especially for transition countries. Introduction of aspects of industrial organization to explaining cross-border capital flows makes this integrated approach compatible with the classical factor proportions theory, the underlying concept of new trade theory and the OLI-paradigm at the same time, thus giving a solid theoretical basis for empirical analyses.

By hypothesizing that the SEEC, as non-members of the EU, have realized sub-optimal effects in attracting FDI, and that the competition in this field is expected to grow further, the aim of the paper is to find out the determining factors behind inward FDI to transition countries, in order to calculate theoretical levels of FDI in the SEEC. The purpose would be to find out capacities of the SEEC in hosting new FDI, reveal the most important determinants of FDI-inflows and empirically verify theoretical inferences.

Cross-country panel data analysis will focus on bilateral FDI between FDI-source and -recipient countries in order to find out country-specific characteristics relevant for determining inward FDI. Regression analysis will cover 12 advanced transition countries from Central and East Europe and five most important investors in the region over the period 1993-2004.

Key words: FDI, relative factor endowment, economies of scale, gravity equation, transition countries, SEEC.

JEL Classification: F21, F23, D43, F11, F12.