Foreign direct investments in Poland since 1989 - Theoretical background, specific advantages and recent developments

1 Introduction and academic method

The collapse of communism has started a dramatic change in the economies and societies of eastern and central Europe (ECE). The transformation from a pre-planned to a market-economic system has lead to the opening of previously shut markets. Since 1989 this region is not only a new market to sell to, but also a place to produce. And especially western-European enterprises might benefit form this due to short distances, which help to integrate these locations into a worldwide firm-strategy.

European companies now have got the same possibilities like the US or even Japan to produce cheaper directly at their doorstep. However, the integration of ECE does not simply mean the extension of western markets to a eastern location. There is much more such as the complete restructuring of western production chains. Or in other words, there is a dual process of transformation (east) and structural change (west).

Therefore companies now have to ask themselves how to participate and benefit from this challenge: Corporate investors face several options for expanding onto foreign markets. There are such possibilities like exporting to these regions, licensing to local partners, strategic alliances and joint ventures. But for several economic reasons, as outlined in the next chapter, foreign direct investments (FDI) seem to be one of the most common ways to go. But businesses also see, depending on contracts, the reduction of their own risk towards shared risk as a reasonable argument. Companies therefore are able to share their individual advantages and can concentrate on them. And this is done quite often within recent history. [Deutsche Bank 2003, pp8]

In general it is interesting to look at the geographical spread of FDI streams. [Piggott 1999, pp258 / Deutsche Bank 2003, pp12] The majority of these kinds of investments comes out of and also goes into the western hemisphere, but also to the south-eastern parts of Asia. To a smaller extent FDI flows towards Latin America and the Caribbean. Africa is nearly not relevant when it comes to FDI transfers. Moreover, the DC are not only responsible for most of the FDI, they are also investing it mostly in there own rows. Also differences in sectors are various. Within DC services and high-tech products dominate. While in LDC especially natural resources are involved.

Baring that in mind, this report focuses on Poland and its FDI inflows since 1989. Therefore three questions can be asked now to concentrate on: (1) Why do companies invest in general in foreign areas? (2) Why received this specific country capital from international investors? And (3) finally, to what extent and in which sectors have foreign investors invested? Or, spoken more generally, this report will try to answer, what the reasons are to invest in foreign countries and in particular why in Poland. Thus all underlying research on this topic was done by the review of current literature and the application of generally used economic theories. However, critical thinking in combination with the use of common sense helped, too.

For a clear understanding, there will be two main chapters. One, which deals with the theoretical background of FDI and political risk. Therefore some traditional and modern theories of FDI will be looked at more in depth. This is done basically from the company’s point of view (microeconomic perspective), rather than host country’s (macroeconomic perspective) one. However, the widely used concept (or paradigm) of ownership, location and internalisation (OLI) is applied to the whole report. And as a second major part of this chapter, the influence of political risk is assessed. For this reason, the obsolescing barging model will be explained.

The other main chapter links these two parts with the FDI-region Poland. Thus, several authors argue, Poland is worth to invest in. This statement has to be looked at more in depth to answer the underlying questions of this report. Therefore this chapter is going to have a close look on specific reasons to invest in Poland. But also the FDI-situation in Poland is part of the assessment. And in this chapter there are also figures provided on the Polish FDI-inflows since 1989.

FDI not always creates additional – obvious - value, apart from employment, for the host country. But often there are advantages of letting money into the country. For example the development from being a LDC towards a DC. This means the host country gains from specific advantages that come from outside (FDI investor). This topic will be looked at shortly as well. Moreover, afterwards a conclusion of the main findings combined with personal evaluations will be provided.

2 Theoretical background

2.1 Foreign direct investments

It seems that there is no general valid definition of FDI. But Piggott [1999, p255] define it ‘as the acquisition, establishment, or increase in production facilities by a firm in a foreign country.’ This means it has to be distinguished clearly to the sole credit-move of portfolio investment (PI). Whilst this means transfers to make profit, FDI as a production capital, a credit or even a mixed move of both is seeking for ownership and control over activities. But the process is more complex: it often does include not only financial involvement but also access to know-how and use of organisational and managerial abilities.

For a clear distinction FDI has to be divided into three parts: (1) Inflows, (2) outflows and (3) stock. The first one describes the amount of FDI received while the next means FDI, that went off the country. And finally stock is the total amount of all inward FDI undertaken yet. Since this report concentrates on FDI inflows, more comments can be made on this area: The certain country also has to be open in both ways – inward and outward - for capital flows. But its economy also should be attractive in general. [Zukrowska 2002, pp2]

Generally investor’s reasons to do FDI are easily to understand. Often there is the argument investors want to gain form lower labour cost in foreign countries. But this is not always the case as FDI are undertaken mostly in DC. Also the share of labour cost compared to total cost declined over the last 50 years. [Piggott 1999, pp258 / Deutsche Bank 2003, pp12] But the cost for raw material, transport and power seem to be one key factor for investors. Therefore it can be regarded as more important, that high productivity, available knowledge and developed infrastructure are the stronger reasons for a investment-decision. Also access to resources, either human or natural, and local markets might be an argument. Moreover the overcome of barriers of entry and the diversification of the investing firm have to be taken into account as well. And a further explanation for FDI rather than another option are expected economies of scale. This means the average cost of production has an tendency to fall with an increase in size. Especially international specialisation can lead to dropping average costs through efficient resource allocation.

2.2 Paradigm of ownership, location and internalisation

The paradigm of OLI is a very general way to explain why enterprises undertake FDI. The following descriptions as well as the explanation of different FDI theories are based on Piggot [1999, pp260].

OLI names the three specific types of advantages, which are assumed to give MNC advantages. (1) Ownership-specific (OSA), (2) location-specific (LSA) and (3) internalisation-specific advantages (ISA).

The first one seems to be important when markets show some kind of imperfections. For example product differentiation, collusion and oligopoly. But these imperfections also may arise from economies of scale as well as due to governmental policies. Generally OSA can be divided into four main fields of advantages: Technical (e.g. patents, commercials secrets), industrial organization (e.g. economies of scale, joint R&D), financial and monetary (access to money) as well as access to raw materials.

The second type of OLI advantages, LSA, deals with advantages that come up for companies form being located in a particular region. Not only access to the market and savings in transport cost but also in time are relevant for MNC. LSA as well can be divided into four fields: access to raw materials, imperfections in international labour markets, trade barriers and government policies (e.g. taxation, regulation).

Finally the third type arises when imperfections make a market solution more costly than a firm solution. Therefore the decision often is to carry out the task within the company for a cheaper price. But to gain form this it is necessary to have the needed materials and skills. If this is not the case, companies are able to internalise them from another firm that has them already. And especially vertical integration leads to more market power and assumable to more profit. But also the internalisation of specific human skills and access to research activities make ISA attractive to foreign investors.

2.3 Traditional theories of foreign direct investments

Traditional theories of FDI are based on the neo-classical economic theory. They especially focus on LSA, while modern theories see the existence of imperfections in markets either nationally or internationally. Therefore these theories suggest the arise of considerable transaction costs for market solutions. But they also take managerial and organisational functions into account as they are assumed to play a important role. In the following, the most recognized traditional theory is looked at more in depth.

2.3.1 Capital arbitrage theory

Developed by Samuelson the capital arbitrage theory suggests that money is perfectly mobile. This is valid not only nationally (across industries) but also internationally (across borders). It flows form investments in either an industry or a country with low return on investment to the ones with higher profits. And it does not matter whether the theory is applied on PI or FDI – they flow both for the same reason the same way.

Reality, however, might be different: Some countries are both source of but also host to FDI. This might be due to the fact that there are differences in the return on capital between industries within a certain country. Further on, PI and FDI indeed do not always follow the same direction. The US for example is a net exporter of FDI but a net importer of equity capital. [Dunning 1997, pp307]

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