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Location Determinants of FDI in Transition Regions

An essential aspect of globalization in past period has been the progressing grows in foreign direct investment (FDI). According to assessments of UNCTAD (2000) expert’s estimation, since 1979 to 1999 the volume of the world FDI funds to world’s GDP boosted by 16 per cent and relatively the proportion of world FDI streams increased by 14 per cent. Such a progressive expansion explains as the FDI determinant’s plays a leading role in development of any country’s economy, in terms of macro and micro parameters (Lipsey, 2001).
Most of time FDI is provided with developed country’s strong market orientations to emerging countries, where market is weak. To expose most the effective conditions which are attracts FDI determinants in the host regions, a number of researches have been done. As a result of this study has concluded that there is a large impact on a market size, GNP and economic growth rather than investment incentives.
However, the circumstances of FDI are various in each country because all of them have weak and strong markets and therefore have different outcomes of FDI stocks. The transition regions such as CIS and CEE regions have been recently studied comprehensively. There is a large empirical literatures implemented the FDI effects, as an engine machine for the transition regions. Due to advantages that related to the introduction of new technologies and innovations, new managerial techniques, development of additional skills, increased capitals, improvement of working conditions and the development of the industrial sectors in the transition regions (Caves, 1974 and Perez, 1997). Although, several policy makers viewed that FDI activities might provide negative effects on country’s economic development. This diversification followed by foreigners’ intensity in the host markets.
The traditional debate stands for relationship among FDI and the prospects for economic growth.
The study is divided into six parts. Chapter two will examine the results of several empirical studies of FDI activities, by examining series of positive and negative effects on the transition regions’ economies. Chapter three will review the mechanism of FDI activity by exampling its various types. Moreover, this chapter will briefly estimate FDI types’ affects on transition companies. Chapter four draws economic overview of the Kazakhstan’s market condition and the intensity of economy growth since the country gained its independence, and furthermore, will illustrate foreign direct investment environment. Chapter five contains FDI challenges and problems in the Kazakhstan oil and gas field industries, and will show government strategies against foreign investors. Finally, the last chapter will conclude with the summary and implications of the study.
2. Literature review
Over the past years the endowments of Foreign Direct Investment (FDI) are becoming to be very important issue for transition countries. As the FDI activities contribute certain volume of assistances to the national economic growth. However the issue of FDI activities are often stands to be as the implicit hypothesis, in terms of its flows that transports benefit to the host region’s economy. The impact of such disputes generally depends on FDI forms behaviour that it takes. The several evidence of empirical literatures have drawn series of positive and negative features of FDI as a basis of assistance growth for transition regions, some of which are examined below.
The article by Kozima ( ) has expressed a macroeconomic explication of the FDI behaviours. Kozima’s observation analysed that FDI ought to operate as channel trade for the productivity goods and thereby its direction should be followed by the market forces rather than the micro level characteristics. The FDI flows transfer and promote productivity level growth in terms of technology, management skills and know-how from the developed industries to the developing industries. As the outcome of such investment types follow by the improvement of the welfare conditions and by the increase of the industries income. The case can describe the Japanese FDI activities in Asian regions. On the other hand, in some terms FDI activities correspond to negative effects of its location decisions. This presents the case of the presence of more technology advantaged foreign company in an emerging country, where domestic industry might not be comparatively competitive and efficient to compete with the advantaged foreign company. Therefore, the presence of more advantaged foreign company under such conditions can simply take over domestic firm’s market shares and decrease country’s economic welfare growth. The case explains by the United States FDI activities after the second war.
De Gregorio (1992) stated that FDI may bring several benefits that persuade economic development by its advanced technologies and skilled knowledge’s, as such factors may promote productivity growth in emerging regions. De Gregorio’s studies have estimated several facts on economic growth in Latin America. This followed by increasing investment growth which is approximately implemented 0.6 per cent of GDP growth annually from 1950 to 1985. Likewise, Blomstrom and Lipsey (1992) examined FDI’s positive externalities. However, such estimations studied under certain conditions that followed by high performed regions and therefore implemented positive performances. According to their studies, countries that only have attained certain level of returns can benefit from FDI activities. This can be correlated to human capitals that provide different income returns in transition regions. As well educated and skilled labour population can utilize the benefits of advanced technologies to the whole economy.
The model of Malign emphasizes the potential interaction among FDI that realized by foreign company under the imperfectly competitive industry and a host region with imperfectly competitive domestic market. Hence the foreign firms operation in such market faces with several barriers to gain access into a market, and thus this increase market concentration instead of decreasing. (Cardoso and Dornbush 1989; Grieco 1986) In this term the presence of foreign company can simply turn down domestic savings and investment capacities by taking out rents and funds activity. Moreover, such case can basically trough out domestic firms from local business activities. The international firms might reinvest their capital flows to related industries in the host region and expand their market powers. The repatriation of such reinvestment profits may take out capital from the host region. Far from providing an encouraging impact on profits distribution and social environment improvements by foreigners might sustain a small power of local business partners and suppliers. As they utilize inappropriate intensive technology that might generate small number of labour forces, whereas consigning employees to the category of the unemployed, and this turns down them to set up more productive occupations. Their rigid control over advanced technology and skilled management channels may put off the favourable spillovers and externalities.
It is commonly acknowledged that attracting FDI spillovers promote development effects, as the FDI activities symbolize as an essential source of technological spillovers, and as one of the resourceful and practical tools for improvement and upgrading of transition industries. (Dunning and Narula 2004) In fact, FDI spillovers have been enthusiastically supported under the Washington consensus as a universal remedy that leads economic growth and expansion. Because, structural changes highly amalgamate macroeconomic stabilization strategies along with strategies that increase FDI flows. However, the benefit levels are considerably various and the results from FDI assistances procedure are not always positive. (Lall and Narula 2004)
Aitken and Harrison (1999) estimated the spillover effects to domestic companies in Venezuela. They investigated exceptionally limited effects of spillovers level. In addition, this spillover levels were mostly delivered from joint ventures. This suggested that relations among foreign and domestic company produce some amount of spillovers. However, its effects can not capture the whole economy. This can be explained when the foreign company in some way induced productivity growth but its financial sector would not be able to capture the plant stage, although it ought to capture even at the aggregate stage.
The effects of political intensity have been examined by several policymakers and suggested that relationship among FDI inflows and host country firstly based on the political stability. Alesina and Perotti (1996) examined the impact of political vulnerabilities on economic development and investment. They implemented that an increase of the political intensity in the host region leads to decrease of investment flows. By implementing index of political instabilities that stands beyond of political assassinations, corruption and coups. Campos and Nugent (2002) analysed the causal linkages among investment and growth index by utilizing pooled panel statistics. According to their investigation results, it suggested that there are not so many evidences for the negative linkages among political instability and GDP growth. However, in terms of investment facilities, there are strong causalities of political vulnerability to investment decline.
The relation among political volatility and asset markets has been examined by several policymakers. Robin, Liew and Stevens (1996) have examined factors of political volatility in transition regions. According to their analyses the importance of asset returns’ stands to be more significant in transition regions than in developing regions. As Bussiere and Mulder (1996) implemented their investigation in the twenty three regions and proposed that political vulnerabilities in economic models broadly explicate economic decline the aptitude of economic model to explicate economic decline of transition region. Moreover, they stated such conditions are vulnerable to economic crises when election consequences under uncertainty.
Kutan and Zhou (1995) investigated that political intensity in Poland during 1990s had introduced economic reforms that influenced foreign exchange returns and bid-ask spreads. According to their investigation, these events reflected by political volatility that seriously harmed the national currency value in international exchange market. This consequently boosted the bid-ask spreads under the foreign exchange transactions that formulated bid-ask spreads to be more expensive for foreign investors. Likewise, Melvin and Tan (1996) examined political volatilities on foreign exchange market by their studies that implemented similar causes.
Ivo Feierabend and Rosalind Feierabend (1966) formulated their Feieraben measure on political instability. This theory based on the country’s political vulnerabilities that considered the amount and concentration of political aggressiveness behaviour that takes place within a nation. According to their definition on political instability it is: the amount of Aggression directed by individual or groups within the political system against other groups or against the complex of officeholders and individuals and groups associated with them. Or, conversely, it is the amount of aggression directed by these officeholders against other individuals, groups, or officeholders within the polity.
Using this characterization Feierabend’s have examined various indicate scales of political vulnerability that based on the amount and concentration of political actions. Feierabend’s have segregated thirty categories of political actions that were given by various weights. As the more destabilise actions, then the higher influences it obtains. For example, during the election of public servants is estimated to be zero, as this was not followed by aggressiveness of political intensity. However, in cases of assassination of high politic figures, corruptions and coups had estimated up to 5 and 7 scales.
In the case of locational decision of foreign companies the political intensity of host regions might lead them out off their domestic market. Aharoni (1960) and Thunell (1977) showed that the intensity of political instability might be very significant measure in the foreign investment activities in the way of location decision. This has been examined that foreign investors in general consider the political vulnerability of the host regions in an unsystematic way. However, a foreign company that operates abroad should put forward its attention on political intensity. This would facilitate in the formulation of tactic for choosing the location and expand further its investment flows. As in some circumstances the host governments might change their political intensity in terms of nationalization.
3. The role of FDI’s
The priorities of developing economies are obviously comprise under constant revenue growth for their economies through strengthening technological capabilities, increasing investment rates, and enhancing the competitiveness of their production in the global marketplace. By providing the opportunities to economic growth, creating employment potentialities and conserving the environment for future population. As the globalisation and liberalization of the world economy constrains the developing economies to upgrade abilities and resources of their economies. The modern global can be classified by speedy progress in knowledge and economical capability under competitive circumstances. Therefore, in globalizing world the economic growth can be implemented constantly only if states can promote privileged value-added performances to supply goods and services for their open market strategies. Among these attitudes MNE’s and FDI activities can apply for an essential function in complementing their efforts. As their assets is one of the main features of promoting local markets or entire enterprises to the international market.
FDI has been characterized differently by several empirical literatures. The International Monetary Fund (IMF) describes FDI as an investment made to acquire a lasting interest in a foreign enterprise with the purpose of having an effective voice in its management (Bjorvatn, 2000).
Generally, FDI activities are undertaken by Multinational Enterprises (MNEs) that provide a huge capital of investment flows over the world. These investment flows classified as a market seeking, its purpose to serve for an existing market. For instance, owing to a high tariff rates, the company needs to relocate its activities to the emerging country, as firm’s activities were previously supplied by exporting. The motivation for such investment in the host economy explains in better serve for a local market through production, market growth and market size. The case of Japanese FDI in vehicle production in the US can be implemented as the market seeking (Duning, 1993).
The efficiency seeking appears with a firm that involves in gaining economic scale and scope activities from the host economy. In this perspective, close relations with the western countries would lead to corporate network linkages and the presence of high transport and communication costs will encourage more of efficiency-seeking FDI.
Finally, the asset seeking or resource seeking occurs when a firm invest into a foreign country to find natural and low cost labour force resources that not available within their country. It might follow by natural resources, cheap labour forces and furthermore, by raw materials. Again the case of the UN and Japan can present the view of asset seeking by searching for a cheap labour force in Asia. In contrast to market seeking, it is able to serve for a home and for a third country’s market. This tendency follows particularly by industrialised sectors that subsidized by MNE’s. Therefore, such accessibilities in physical infrastructure and skilled and cheap labour forces are the main trends of resource seeking.
3.1. FDI types
In analysing market entry through FDI flows, there two choices such as, greenfield investment and takeover of an existing company. Through greenfield investments a company which invests a small amount of inputs, and afterwards when demand increases it can enlarge that investment. A greenfield investment frequently set’s up from building a new company after the governments of host countries would approve that, because of the location perhaps can be in the profitable place and produce a new production capacity. In discussing another type of FDI is the takeover of an existing business through the acquisitions and mergers (M&A). In other words, foreign companies appear in the emerging countries and purchases already existing local business by gaining the packages of the company, as a result, such companies turn out to be an affiliated. In the past years M&A have seen massive surge by reaching more than 50 per cent (Theodore 1998).
Admittedly, there are several trends that foreign firms seek to invest their capitals abroad. These features were partly analysed by Dunning’s OLI theory. As Dunning (1993) describes three conditions that firms carry to take FDI activities. Ownership advantages- appears, when the foreign firm is capable to compete with the domestic firm. It can be attained through specific skills or assets that follow by advanced management and technological capabilities. Companies that endowed with ownership advantages basically enlarge their operations in a foreign country to internalize the growing benefits from ownership advantages. Location advantages- aspects as natural and mineral resources, transport costs and low prices, access to the domestic market determine the presence of the investment. Moreover, factors such as social and political stability and business environment that follows by stable prices and sustainable budget deficit determines location. Internalization advantages- occurs, when the foreign firm is able to retain its multiple activities, rather than licensing or franchising technology to local firms. The case can be implemented, when the firm prevents the technology or assets imitation by rival firms. According to OLI theory, all these criterions should be fulfilled for firms to invest in the host economies.
In terms of investment incentives, Dunning (1993) pointed that OLI theory is generally stands for a characteristic of the host country and for the MNE’s. This follows by attracted or specific location, skilled or cheap labour forces, infrastructure and political stability. Undoubtedly, these trends are very significant for the location of FDI assets, however, the significance of investment incentives have raised in the past years. Over the world countries have lowered their entry barriers to persuade a massive amount of foreign subsidizes and generated FDI incentives to attract more foreign investment flows. Therefore, operations such as low taxes, attractive tariff regimes, and market preferences, investment in infrastructure, financial grants and loans for the foreign firms took the form of investment incentives. Basically, FDI incentives are similar in developed and developing regions. Regarding to UNSTAD (2001), a small number of regions participate for FDI activities without subsidies nowadays. This report estimates that 95 per cent of adjustments in FDI legislations for the 1990s were encouraging to foreign companies and furthermore, these adjustments followed by FDI promotions and incentives. The motivation of such reasons primarily tended by prospect of seeing positive spillovers inflows into host economies UNSTAD (2001).
In the context of positive spillovers host governments tries to attract foreign subsidizes to their economies as they considers that FDI’s spillovers generate positive externalities to the domestic companies by transferring know-how and advanced technology. The following terms can be implemented

  • Domestic companies might benefit from foreign production processes as they diffuse new technologies. It can be implemented through labour turnover and through imitation.
  • As the foreign firms gain access into domestic market equilibrium, it is makes domestic companies to be more an incentive to protect market shares income (Ponomareva, 2000).

These systematic alterations might cause various sorts of spillovers that bring to productivity growth into domestic companies, as the spillovers effects from foreign companies can be significant. On the other hand, several literatures provided that spillovers effects can have negative forms. In article by Aitken and Harrison (1999) the negative impacts of spillovers introduced on the domestic firms’ productivity, in terms of market steeling effect. For example, when the foreign company gain access to the foreign market and take over local market shares by its technology advantages. In other words, the MNE’s advantages can simply trough out domestic firms’ productivities and so, local company’s productivity declines.
3.2. Spillover activities and types.
There is a large empirical study that implements the significance of spillover activities in the host economies. According to Blomstrom and Kokko (1997), the importance of the FDI spillovers is not only the investment in a new plant and equipment, but also transfers of technology, skills and capital for the host countries. Consequently, FDI arrives through managerial and financial resources, technical support and strategic assets. This can be company’s brand name that takes place by comparative advantage to domestic entrepreneurs. Spillover activities can be taken during foreign companies’ presence that provides efficiency and productivity to the domestic firms. The positive spillovers followed by foreign investment enterprises that provide benefits to domestic companies, in terms of productivity technologies that do not exhaust cost for gains (UN-ECE, 2001).
In the perspective of the FDI spillovers, several policymakers have concerned that the presence of foreign firms lead to productivity growth of domestic companies. Whereas, other authors implemented that, there is also a negative impact of FDI spillovers. One of the common explanations of FDI in transition regions is assistance in restructuring domestic firms. As Wallner (1998) suggest that, partly an emerging firm occurs under the soft budget constraint and thereby FDI’s activity might provide in a positive way. As the presence of the foreign firms provide various incentives to reduce funds to domestic companies and as a result involves in companies’ restructuring. Another positive feature of FDI spillovers importance is transfer of technology and know-how to domestic firms. On the other hand, this can also provide negative spillovers. For instance, in terms of product market under imperfect competition, that can follow by a considerable decrease of the market shares of the local firms and moreover, can trough out domestic firms from the market. The literature by De Gregorio and Lee (1998) and Kokko and Borensztien (1994) stated that FDI spillovers can generate in positive way, if only the technology development among foreign and domestic company is not so great. The trends of positive spillovers were found in the next literatures Blomstrom, Sjoholm (1999) in Indonesia, Caves (1974) in Australia and Globerman (1979) in Canada. In the case of negative spillovers the following studies such as Kornings (1999) in Poland and Romania and Aitken and Harrison (1999) in Venezuela have implemented such effects
Spillover activities determine two approaches such as direct and indirect approach. The direct approach examines through statistical examples, as the spillover activities are directly correlated to presence of foreign firms (Blomstrom The purpose of the direct approach frequently leads to productivity measure of local firms to the MNE’s presences. There is on common method that utilizes evaluation of production functions that estimates through the foreign firms presences upon industry productivities and on its levels. In studies of econometric the spillover activities might expose the total impact of productivity to host firms under the foreign presence. However, the impacts are frequently not specific nor implement its effects (Blomstrom and Kokko 2003). The indirect approach examines through channels in which FDI spillovers may take in, and afterwards estimate the forcefulness of those channels. Likewise direct approach, there is a large studies on its channels, but it can be difficult to implement general conclusion from these studies (Blomstrom
Another spillover activity in the host industries persuaded by two types such as inter (vertical) and intra (horizontal) industry spillovers. The vertical spillovers appear when foreign company provide impacts to the domestic suppliers. This can be under different industries that engaged in a long term contract among foreign company and a domestic supplier (Smarzynka, 2002). The horizontal spillovers result from the occurrence of the MNE’s that brings competition to the host economy. There are five channels that chase horizontal spillover activities such as competition, transfer of technology and R&D, industrial management, demonstration and imitation activities and human capital and labour turnover (Blomstrom et. at. 1999). According to UNECE report (2001), on intra industry spillovers in transition regions have estimated FDI’s horizontal and vertical impacts. The following (Table 2) estimated that basically the presences of foreign companies did not perform better and thus, they have not generated the expected positive spillovers to local companies.
Virtually, the FDI spillovers turned to be negative in these manufacturing regions. Generally, CEE regions were under negative coefficient performances. The exception was followed with Estonia’s and Russia’s manufactures which are presented positive coefficients. The results suggested that it is not unexpected as the initial conditions and economic environment was critical during the transition period. Those countries essentially had experienced various shocks and thus, local companies were not capable to react to the challenges that followed by FDI. This however, can be temporary factors and these regions will be more competitive with the next FDI flows.
3.3. FDI flows in transition economies.
Over the decade ago the former Soviet Countries and central and eastern Europe regions have been transferred themselves from centrally planned system to open market economy. This systemic transformation has seen a massive upsurge in FDI inflows that afterwards assisted to recovery their internal economic vulnerabilities. As the initial stages of economy conditions experienced several economic shocks and therefore domestic growth of these regions went down. According to UNECE report (2001) the industrial productivity decreased by 34 per cent over the transition regions. Furthermore, in some regions it even followed by 64 per cent. This economic collapse was stated by macroeconomic imbalances, monetary overhangs, and by external debts. Consequently, these host regions were under extremely necessitate of liberalization, privatization and stabilization reforms that followed with the foreign subsidizes. There are strong evidences that FDI tends to boost the initial stage of economic performances. The following trends were considered such as,
– FDI frequently helps to the host country to amalgamate into the global economy.
– FDI increases the aggregate rate of investment.
– FDI generates transformation of hard technology that process technology and product.
– FDI engenders relocation of soft technology that processes organization, management and sourcing technologies
– FDI tends to encourage networking and subcontracting patterns that conducive for host firms to improve their technologies and productivities. (Dyker 1999)
Thus, the importance of FDI in these regions was not only in supplying funds for the acquisition of new equipment, but also it seen transformation of advanced technology and organisational forms that led from more developed economies. Attracting FDI assets are considerable issue for the transition regions, as it leads to catch up policy with more developed economies by improving their economic efficiency. According to Transition Report (EBRD 2007), in the past decade the former soviet regions and central and eastern European countries have been successfully stabilized their economic circumstances. As their living standards have improved and moreover political, social, economic and legal issues were adopted and improved by state agencies. The transformation processes however implemented in different stage as their initial conditions were varied over all regions. Some of regions have simply been mistreated by foreign investors as the investment inflows directed more toward to some regions. (EBRD, 1999, Henriot, 2003) This discrepancy might be implemented by the high economic dynamism of more advanced transition economies. There are some regions that have been under the greater concern to investors due to of their mineral wealth resources, and close frontiers to the European Union countries. Moreover, in the last 10 years, it was obvious that foreign investors were in favour to a more stable political economy and to a favourable environment that had followed a consistent privatization policy (Henriot, 2003). According to table the following four regions experienced a large amount of FDI flows.
It is clearly seen that Hungary’s state was dominant in foreign investment flows. Its economic condition was greater then in other regions and furthermore political relations with the western countries brought attention of foreigners. As the view of Hungary implemented beneficial infrastructure and economical ability to adopt foreign subsidizes. In addition, in its early sophisticated privatization strategy on state owned firms made favourable environment for foreign investors. Likewise FDI flows in Poland and Czech Republic also had experienced a fast growth. This rapid increase was experienced through acquisition of state owned enterprises that had involved foreign investors. The Slovak’s FDI inflows entered later in contrast to Hungary, Poland and Czech Republic and therefore had the lowest rate. Although, in most cases its small sized enterprises were privatized by foreign investors. Through the government policy that could proceed with the well managed economic reforms and external relations with the neighbouring regions. The total stock of FDI inflows for country size by population and GDP analysed that Hungary and the Czech Republic have succeeded significantly then Poland and Slovak Republic. Nevertheless, these regions tended to recover faster in contrast to the CIS regions.
In the perspective of CIS regions, FDI stocks remain with low attitudes, despite their performance in accomplishing macroeconomic policy and managing relatively high growth rate. (Table 2.1.) illustrates that regions such as Kazakhstan and Azerbaijan have chased the largest proportion of FDI stocks, whereas Tajikistan demonstrated the lowest amount of FDI stocks.
Similarly, shares of FDI stocks in GDP for Azerbaijan and Kazakhstan have performed better. In terms of per capita of FDI stocks, regions as Kyrgyzstan and Azerbaijan have performed worthily, whereas Uzbekistan and Azerbaijan turned with the lowest rate. In comparing the result of FDI stock levels of Central European to Central Asian regions, the Republic of Kazakhstan, Azerbaijan and Russia were shown with the better perform attitudes. This impact followed with large inflows of FDI stocks in oil and gas fields. Nevertheless, these regions levels of FDI stocks are still smaller then in other central European regions. The case of such underperformance of the some CIS regions can be attributed by the tardiness in privatization, incapability and disinclination in reform strategies and inefficienc

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