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Impact of FDI on European Economic Development


The functioning of a market economy under the conditions required by efficiency demands important financial resources, whose allocation must be directed to those areas which in their turn can generate value added and resume the active process of creating added value. If for a company the investment are realised mainly from classical sources, respectively the depreciation fund, profit or issuance of new shares, but with the risk of the dispersion of the proprietary right on business, to which we can add the financing of bank loans, a fairly expensive solution for a company in search of activity diversification.
Based on these considerations, the need to review the role and function of investment funds and FDI in the economy, in the reorientation and begining of the investment process is one of utmost importance.
Considering the last events that marked the world economy, from which the foreign investment funds, be they even FDI, to which we can add the stock innovation were among the main determinants of the process of translating the investment flows. Though investment funds in the conventional, manifesting as traditional investors, with a pronounced classical character, buying or selling financial instruments, stocks, bonds or other financial instruments or developing new production capacities, in their action they determine a significant impact on the economic activity outlining some features of the economic environment within which they occur.
For countries like Romania, for example, or Serbia, this process is actual, but difficult to achieve because it needed more than financial resources. From this point of view ‘Inadequate progress in second-generation reforms provides explanation in variation of FDI inflows. A number of empirical studies focusing on transition economies have corroborated this finding. Garibaldi et al. (2002) have shown, that the quality of institutions explains the variation in FDI flows to transition economies. [1, p.11]
The sustenable economic development requires the existence of a set of tools and specific mechanisms through which the financial resources necessary to achieve this goal must be mobilized but especially they must contribute to an efficient redistribution of financial resources in the process of social breeding. The only one able to achieve this requirements are the investments, which succeed through mobilizing the available capital to restart the complex process of production of plusvalue. Directing the financial resources, in the economic policy, to those economic objectives able to develop in their turn a growth of the rate of employment of labor requires a new governance in terms of investments, whose key source should be profit, fund depreciation or GDP, at the economic level.
As known, sometimes financial resources available to the national economy are not sufficient to promote massive actions, attracting new finance being required, in addition to foreign capital markets. These completion investments, although they are not quite common in many of the emerging countries, they use them. On the other hand we are witnessing independent investment flows, directed either to initiating new production capacity or upgrading existing ones, promoted by global financial players that make up the foreign investment flows.
As it is stated in one of the european documents “The fact that the market has failed in the financial sector does not mean that it does not work at all, but points out the need to avoid, namely to correct the wrong market developments, through legislative measures and of targeted surveillance. Therefore, the new policy must be built on the foundation of a market economy, which stimulates and rewards their initiatives and risk taking. “[10, pct.3.4]. So the financial resources attracted through foreign investments should be targeted at those areas that present a high reproductive capacity, either by the recognized degree of generating profits or by the significant beneficial efects that they have on the workforce. FDI should ensure a high degree of efficiency, both for the investor who chooses to invest and must be rewarded by high rates of profit, and for the country within which is achieved by increasing the resources mobilized through tax mechanisms, the state budget, and the remuneration for labor involved in achieving the resulting business.

Literature review

The analysis of the role of FDI in the economy was made in a number of important studies. From these we mention (Serbu, 2006) which claims that promoting FDI is not always in favor of countries that receive these flows, analyzed at least in terms of qualification of employment and not contribute to economic growth, so the role of FDI is questioned. On the other hand ÖZTÜRK, Ilhan (2007) argues the opposite, namely that the role of FDI in economic growth is major and decisive, which is achieved through multiple channels such as gross capital formation, technology transfer and effects on human capital. In another study[6], Ben Ferretti (2004) explores the relationship between FDI and productivity growth and concludes, after making a brief analysis of the theoretical models, in terms of game-theoretical models, that this is determined by the spatiality and the intensity of FDI flows on economy and economic agents in particular [4]. The same ideas has Damjan Joze et all (2003) which explores the role of accumulation of FDI and R & D on technology transfer and their effect on economies in transition [3] or Hunya, Gabor (2002) which analyzes economic restructuring phenomena from FDI perspectives on manufacturing industry.[5]

The analysis Market Integration from Foreign Direct Investment intensity perspective

Foreign direct investments consist of significant vectors in achieving economic and social objectives, in the context of diversification of society needs in satisfying the goals promoted at the macroeconomic level. The need for financial resources is an ever growing from year to year and the financial resources attracted from the foreign capital market is a solution to achieve these goals. From this perspective each state’s ability to attract these resources depends to a very high measure on the degree of integration of national markets in the total investment flows but also on the degree of atraction of each state. In this context the analysis of foreign direct investment in the community economy is of special importance. Referring to GDP make these data to show a high relevance through removing the national economies’ dimension outlined by each state. These data are presented in the table below.
As seen from the data presented above, there is a syncopated evolution of investment flows, both in integrated economies in the economic space, but also for those who want integration (Croatia and Turkey) and especially the most developed economies (USA and Japan).
At the EU level we can see an increase in the intensity of FDI during 2004-2007, from 0.9 in 2004 to 3.8 in 2007, meaning an increase of 4.2 times. This growth rate was a syncopated one which means that the european economy has been trained in the massive wave of investment and capital flows with relatively high degree of risk, which resulted that since 2008 this indicator decreased by 1.7 times compared to last year.
In the case of member countries we can see a different evolution. If in the case of the last two countries that joined the EU in 2007 we may find a slight improvement, as is the case of Romania, this indicator increased from 3% to 3.5%, a low level compared to 2006 when this indicator recorded 4.8% when the interest of foreign investors was much higher than the economy, or maybe they were just strengthening their investment positions by purchasing generators of economic value added or Bulgaria, which after membership is growing at 12.6% in 2006 to 15.2% in 2007, the next year it registers a 10.3 drop. This situation can result from the inability to pay on which is encumbered the whole bulgarian economy.
For the european countries which were old members, this indicator presents a high volatility. After register significant levels of 6.7% as in the case of Germany in 2000 it reaches in 2008 at a value of only 2.4%. Such is the case of France which in 2000 recorded 8.2% and eight years later only 5.2%. These developments are mainly due to the “shaken” european economic environment, where the investors are orienting and reorienting the capitals according to high profit rates than to business stability.
For Serbia, a non-EU country assets owned by foreign entities in Serbia are growing in nominal values. But if we look at share of foreign owned assets in total financial institutions, we may observe that there has been a decrease of 0.2% from 84.3% to 84.1%, despite the entry of 13 new fully foreign owned institutions during the analyzed period. This confirms that financial institutions owned by domestic entities are operating even better than the foreign owned ones. Since we know that before the restructuring of the financial sector in Serbia most banks and insurance companies have operated with significant loss, we may conclude that that remaining domestic owned institution have significantly changed their business culture.[8]
Regarding the U.S., the evolution of this indicator for 2000-2006, reflects the difficult moments that this country’s economy has passed. If in 2005 this indicator recorded the lowest level of the period analysed, of only 0.3% (more than up to 5 times compared to 2001), one year later to grow by 500%, due to the trust granted in the economic development through FDI. For the Japanese economy the evolution of this indicator is ranging at around 0.4-0.5%, which means the sustainability of investments supported through these instruments, especially the economy of this country design was based more on capital exports to third countries than absorption of this type of capital in its economy. But 2007 brings a doubling of the level of this indicator actually marking the shift towards exporting the capital investment to emerging economies, in particular.
In one of the UNCTAD documents it is shown that “The ISD explosion in some developing economies in transition reflects the growing competitiveness of many firms in these economies. The evolution of ISD in some countries was partialy feed by the income from exports of manufactured goods and natural resources, which have increased the financial strength necessary to engage in investment from abroad. Perhaps most important is that the firms in these economies have been increasingly affected by global competition. They came to understand how important it is the entering on international markets and connect to global production systems and knowledge networks. Therefore, their view of the business was internationalized and ambitions and their concerns are more regional or global.’ ‘.[9].
Over time many countries have became sources of financing through FDI as a solution generating of resources or partners to enhance or start some income-generating activities. The stock of FDI is an important element in the analysis of investment flows in the european economy against the background of increased interdependencies among these economies. In the table nr.2 is presented the FDI stock in some european countries but also for the two biggest economies of the world USA, respectively Japan.
If we consider the definition of FDI stocks in the acceptance of UNCTAD these are presented at book value or historical cost, reflecting prices at the time when the investment was made. For a large number of economies, FDI stocks are estimated by either cumulating FDI flows over a period of time or adding flows to an FDI stock that has been obtained for a particular year from national official sources or the IMF data series on assets and liabilities of direct investment [8]
From this perspective we can see an increase in direct investment stocks both at EU-27 level over the period 2004-2008, from 15.2% share in GDP from 19.4% share in GDP in 2008.
This situation of growth can be observed in the case of Japan but with values much more reduced. If in 2000 in the case of Japan these represented only 1.1% in GDP, seven years later this share was 2.9% in GDP, an increase double to the reference year. This can not be saidin the case of the U.S., where direct investment stocks have a fluctuant evolution. Against this background is noted that “The convergence of corporate governance models, combined with ICT development, with an increasing activism manifested by the institutional investors and their reference measure regarding the profitability, all these put the large companies in a position to maximize with any price the profitability (dividends and capital gains) of shares held by them. Considerations on the ability to generate future cash flows as well as the nature of partnership highlighted by the european social model were left on the second level. ” [11]
In most developed economies of the EU-27, namely Germany, France and UK we see during the long analysed period significant growth which means that investments made in this period were so well-consolidated that they increased their value through engaging in activities with value added to high. In the case of the last two states that joined EU in 2007 the situation is quite different. If for Bulgaria since 2007 we saw some increase from 92.9% share in GDP to 96.5% in GDP in 2008, to Romania it means a return to pre-integration values (2006) respectively 35 , 3% share in GDP.
Analyzing the situation of direct investment stocks we observe, analysing economy as a whole, with few exceptions, an increase of this indicator’s value. The causes may be diverse but reflect the economic situation conducive to the development for the period analyzed.
In this context the situation intra-EU direct investment reported by EU member states provide an integrative picture on the amplitude of this phenomenon. Each economy is closely linked, interdependencies manifesting deeply both at macroeocnomic level but especially at the micro level, where FDI contributes to strengthening the business relations and the transfer of knowledge and technology. The level of investments made in each national economy and the member states within the EU economic space reflects the importance of this type and level of investment for mobilizing financial resources for economic exploitation.
In Serbia FDI in the previous decade has reached US$ 17 billion, which was sufficient to boost the economic activity. Highest investments were in the financial sector, accounting to over US$ 5 billion. This sector which was characterized by low capitalization and weak profitability in the past has due to foreign capital become sector with very high growth rate. The influence of foreign capital to Serbian financial sector was twofold.[8]
Evolution is presented in Table 3 Intra-EU direct investment reported by EU Member States, Financial account, Direct investment, in there porting economy for the period 2001-2008.
Investment flows that occurred outside the community space have reflected the strength of economic ties with other states that benefit from this transfer of resources. Knowing that they represent over 10% in the company capital or voting rights we see the interes in promoting and acquiring production capacity with significant economic impact.
If in the period 2005-2007 we saw a growth of FDI flows within the community space, the year 2008 brings a reduction in these flows, below those of 2002. The investment relations generated by FDI at community level enhance the process of interdependence of community economies, especially that for the old member states like Germany, France, UK, the flows registered massive drops, especially as they represented “exporters” of financial resources for the transition and emerging economies. In terms of FDI flows, at least for Romania, as an example of an economy new entrant in the community economic space, in the year 2008, according to BNR data there were 9.496 billion euros, mostly oriented towards economic objectives that have been designed for the privatization process as well as for the initiation of new economic objectives like car production capacity at Pitesti or mobile phones in Cluj-Napoca. So in this context, “Net participations of the direct foreign investors to the social capital of foreign direct investment enterprises in Romania amounting to 4.873 billion euros (51.3% of the net flow of ISD). These resulted from the reducing of the participations worth 5.265 billion euros with a net loss, amounting to 392 million euros. The net loss resulted from the decrease in net profit of foreign direct investment enterprises in 2008, worth 6.412 billion euros, with 2.696 billion euros in dividends distributed in 2008 and with foreign direct investment enterprises losses in 2008 amounting to 4.108 billion euros. “[12]
Opening economies and accepting a high degree of penetration of FDI flows made possible the development of economic sectors, which until yesterday were doomed to decay due to the rising need for capital. Revitalization of these sectors able to generate profits at the expense of FDI has contributed to diversification but generating added value and growth and diversification of portfolio risk.
At the end, we may say that quality of operations of Serbian financial institutions is growing, that assets values are rapidly increasing, and that all companies, regardless weather it is domestic or foreign owned are equally profitable. It is certain that this sector is ready to become core of Serbian economy, and a boost for increased FDI in the second stage of transition.[]
Regarding the other component, namely “The net credit received by firms with foreign direct investment from the foreign direct investors included in the group, amounting to 4.623 billion euros, representing 48.7% of net flow of ISD”.[12] This situation defines the degree of atractability for foreign investors that the economy shows, especially because of some factors that accentuate their competitivity degree like very cheap labor force and highly qualified but also the strategic position that this economy has in the community space. The following table gives an overview of direct investment flows as% of GDP, made by the member states of EU.
In this context we can see that the community space was an important source of investment for emergent countries in particular. They have targeted primarily the purchase of economic objectives or develop new ones. FDI is an instrument to achieve economic potential.
In this context, according to numerous research carried out, it is considered that â€Å¾A very large number of foreign firms combined with relatively business friendly environment may explain uniqueness of Romania in terms of the existence of very significant knowledge spillovers to domestic firms, as an econometric study of CEEC-8 (excluding Latvia and Lithuania) has shown. Finally yet importantly, the share of FDI in total capital formation together with the length of a period offers some insights as to their relative weight in the economy. The average share of FDI in Gross Domestic Investment of around 20% in the 1997-01 period suggests a significant presence of foreign firms. With around one-fifth of domestic investment carried out by foreign firms, the associated influx of management skills and technology has already had a beneficial effect on the entire economy.’ [1, p.15]


As we have seen FDI is an essential component in the economic development, thus creating a proper environment to achieve this point is an object of profound significance for each economy separately. FDI directs the necessary financial funds to those areas that can generate high VAB, implicitly identifying those economic areas with high potential. We must accept however that the promotion of FDI absorption brings some risks, the investor can always choose to leave the country, giving away his investment.
The analysis made at the level of the community space, reveals the fact that FDI represented fundamental economic levers to promote economic growth, especially for those countries that joined the EU in the second wave. Massive transformations that have taken place in the community economy had an impact on the flows of FDI. Through FDI, capital was aimed at those companies able to carry on business profit activities, often engaging with themselves a technological transfer contributing to sustenable development as a whole.

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