| The Vienna Institute for International Economic Studies - WIIW |
SUMMARY
Hungary has been the most successful central and east European country to attract FDI. This gives rise to a number of questions: Why did this happen? What was the role of economic policy in attracting FDI? What were the motivations of investors? What is the impact of foreign penetration on the Hungarian economy? The two studies in this volume provide answers to these questions based on thorough research in this field. Both papers were written in the framework of the research project 'Impact of foreign direct investment on efficiency and growth in CEEC manufacturing', carried out with the financial support of the European Union's Phare-ACE programme.
The first study in this volume examines the main elements of Hungarian economic policy and their relevance to foreign investors. The basically liberal environment proved to be attractive to foreign companies. The privatization policy had a positive effect on that portion of FDI realized by acquiring Hungarian firms. Capital flowing in via privatization proved to be sensitive to policy changes. In the case of greenfield investments, investors were able to take advantage of tax allowances and special regulations such as the customs-free zone status. These zones are export oriented subsidiaries and play a decisive role in the Hungarian economy. Major investors and large-scale projects (especially in the automotive industry) were able to negotiate special incentive packages. After the initial years of generous tax concessions, which benefited only foreign investors, fiscal policy changed, thus since 1995 allowances benefit all investors.
Stabilizing fiscal rules and regulations and curbing inflation have been the major objectives of macroeconomic policy. Indirectly, however, other factors are also important for foreign investors, such as the state of the road and telecommunication networks, the qualifications of the work force and living conditions.
A major problem in the Hungarian economic policy in the years to come will be how to attract foreign capital once the privatization process is complete. The lack of restrictive regulations and the liberal character of economic policy as a whole will secure the lasting confidence of foreign investors. Among the direct policy objectives remaining is the promotion of greenfield investment and further investment in firms with foreign participation. Two new tax allowance schemes with effect from 1998 are good examples of these objectives. The one is for investment in underdeveloped regions, the other promotes the creation of R&D laboratories. Other measures intend to activate local authorities to attract FDI by local subsidies, infrastructure investment, allowances promoting industrial parks. Hungarian municipalities have actually started their promotional activities ahead of other CEECs.
The second study summarizes a large body of literature on empirical research on foreign investment enterprises in Hungary. Experiences of investment motivation, the role of Hungarian affiliates in international corporate networks, modernization effects and performance of foreign affiliates are covered by the surveyed authors.
The overview of research results reveals a large diversity of foreign affiliates in almost all possible respects. The fact that the sectoral affiliation of companies determine their performance and not their ownership pattern, the confusing results of sample surveys concerning FDI motivations and the extensive variation in the behaviour of foreign affiliates – all these features stress the need for a better understanding of differences between foreign affiliates. These differences can best be described by two characteristics: the original motivation for the investment and the actual role of the enterprise in the investor’s global strategy. Three major types of investments can be identified: the domestic market-oriented (based on local suppliers), the assembly-type export oriented (greenfield investment with intra-firm trade dominance), and the export oriented local supply-based company (usually privatized firms or joint ventures). The approximate share of these types has not been identified.
As investors may be involved in highly differentiated activities, the above typology can be used to characterize activities rather than companies. Moreover, activities follow a clear process of evolution, especially in greenfield projects and joint ventures. After an initial test project, further investments may follow with a shift in the major activity from assembly to more sophisticated production. In other cases, locally produced goods are coupled with imported products and together they provide full market supply.
'Assemblers' but also other foreign investors tend to fit their Hungarian affiliates into their international network. In many cases, this means incorporation into a global production and sales network. Needless to say, greenfield projects were planned and established according to this requirement. Acquisitions were followed by a streamlining of activities in order to fit the affiliate into the division of production within the multinational enterprise. In some cases, this means degrading activities, in others the opposite; in general, however, restructuring resulted in the establishment of intra-firm trade links with the parent company. This was typical for almost all companies, regardless of type. A possible explanation for this trend is the 'sunk' character of FDI. Investors do not solely pursue a primary goal, i.e. utilizing cheap labour or penetrating the local market. FDI is also a tool in global competition because it heightens the barriers to competitors entering a specific market. The 'sunk' character of FDI is also underscored by the fact that it does not usually involve a relocation of existing capacities from other countries.
A large part of the literature deals with efficiency and performance indicators in foreign affiliates. Many scholars wished to verify their assumption concerning the generally superior performance of foreign affiliates compared to domestic enterprises. They have not been very successful, except in the case of the manufacturing sector. The efficiency of foreign affiliates started to improve somewhat earlier than that of other companies after the transformation shock, but their financial performance, especially profit rates, did not show a parallel improvement. Both efficiency and profitability thus lagged far behind expectations, at least up until 1995. An improvement has been registered since then; however, given the short time period it is still uncertain whether this was only a temporary development.
The reasons for the efficiency-profit trap described above can be several. Efficiency improves more slowly than expected because of the time lag in correcting weaknesses inherited on account of sluggish investment. Profits may remain low because of the same time lag in adjustment efforts or the slow recovery of local demand. Another possible explanation for the efficiency-profitability trap is the transfer pricing activity of multinationals. Research in this direction indicates some suspicious circumstances, e.g. adverse price developments in exports and imports of FIEs; however, no direct evidence was found. On the other hand, there is extensive empirical evidence of companies reinvesting profits and expanding their activities in Hungary on a massive scale. Most probably Hungary does not differ much from other recipients of FDI in respect of transfer pricing.
Restructuring former SOEs was aimed at improving efficiency and product
quality rather than at a complete change in activity. The most common restructuring
steps included: reorganization of the organizational structure of the company;
a take-over of key management positions by foreign experts; and an improvement
in and rationalization of management decision-making systems. All companies
invested in up-dating data and information communication systems so as
to enhance the introduction of up to date corporate management systems.
All these steps were also designed to fit the new facility into the international
network. Streamlining activities as well as downsizing (shedding of labour)
also contributed to this purpose. Strong emphasis was also placed on human
resource development. Training and retraining were customary and many companies
tried to recruit young, rather than older professionals. There was also
a tendency to cream off the labour force: above-average salaries were offered
to selected personnel who were also required to perform at above-average
rates of productivity.
WIIW Research Report No. 244, A. Éltetö: "Economic
Policy Background to Foreign Direct Invesment in Hungary", M. Szanyi:
"The Role of Foreign Direct Investment in Restructuring and Modernizing
Transition Economies: An overview of literature on Hungary", April
1998 (59