East Europe Investment Lagging

PRAGUE -- Six years after most of post-communist Eastern Europe began economic reforms, the region has yet to attract the huge foreign investment which sparked the rapid expansion of Southeast Asia, studies show.

Analysts say that closing the gap with rich Western economies more rapidly -- seen by many in Eastern and Central Europe as a primary goal -- investment must accelerate.

But Asian tigers still continue to devour much of the foreign direct investment, or FDI, made to emerging markets.

While there was some growth in the amount ploughed into Central and Eastern Europe this year, FDI for the whole of the former Soviet bloc will comprise less than 5 percent of the total $235 billion forecast for 1995 worldwide.

The UN's Conference on Trade and Development said last week that Central and Eastern Europe, or CEE, including the former Soviet Union, with over 300 million people, attracted about $6.5 billion in direct foreign investment in each of the last two years.

That is less than the FDI placed in Singapore alone with a population of less than three million people.

"There remains a significant gap between investors' commitments and actual implementation of the investments in the [Central and Eastern] region," the UNCTAD 1995 global investment report said.

In terms of direct foreign investment at the beginning of this year, the CEE countries had $21.5 billion compared with $22.9 billion in Argentina alone, and $214 billion in Britain.

Investment which has been made in the region has clearly beaten a path to more stable currencies, calmer political waters, and more rapid privatization.

More than two-thirds of it has gone to the Czech Republic, Poland and Hungary -- all countries relatively advanced in macroeconomic reforms and privatization.

Meanwhile, Russia, with more than half of the people, has attracted just about a tenth of FDI in the region.

The Czech Republic -- thanks mostly to a $1.32 billion equity expansion of SPT Telecom from a Dutch-Swiss consortium -- should surpass $2 billion in FDI this year after an $862 million inflow in 1994.

Poland's 1995 investment has already surpassed $2 billion, more than a third of the total since 1989, while Hungary expects FDI to surpass its 1994 figure of $1.15 billion.

The investments which have been made in the region have disproportionately increased productivity and profitability. UNCTAD said in Hungary, where 91 of the top 200 firms have some foreign ownership, the sales of foreign affiliates rose 47 percent compared to 3.5 percent for domestic firms in 1993.

"Productivity measures suggest that in the Czech Republic, performance has increased far more significantly in foreign affiliates than in domestic firms," it said.

Germany's Volkswagen AG, which took control of the Czech car maker Skoda, boosted the company's output by 40 percent in 1994, and is pushing ahead at a similar pace this year.

But CzechInvest, a foreign investment promotion agency supported by the Czech government, admits that Central Europe is quickly losing its labor cost advantage as wages surge.

The onus is on agencies such as CzechInvest to match up investor needs with highly-skilled but under-used workforces.

"Cheap labor is not here to stay. The costs will rise, but the productivity uplift is absolutely tremendous in companies that get it right, with the right management and the right investment," CzechInvest advisor David Brown said.

Once investment flows accelerate, the process feeds on itself.

"Successful investments can lead to sequential investments by the same firms and can encourage other foreign firms to invest as well," UNCTAD said. "In other words, FDI can start a virtuous circle that leads to larger amounts of FDI."

It said the region cannot yet depend on its securities markets to raise needed capital.

"FDI constitutes the most feasible form of obtaining foreign capital as the stock markets in the region are generally underdeveloped and unstable, discouraging portfolio investment," UNCTAD said.

Poland, the Czech Republic and Slovakia are expecting to post 4 to 6 percent growth in their economies this year, after severe contractions after the fall of communism in 1989.

But economists such as Harvard professor Jeffrey Sachs say such growth rates are not enough to quickly close the gap with Western European countries which have per-capita incomes four to five times higher.

"If you can achieve a growth rate of 7 percent per year, that is consistent with doubling income levels every decade," Sachs told a recent economic conference in Prague.

That "is about the range of growth that a country like this can achieve and needs to achieve to overcome the historical legacy of 40 lost years," he said.

Sachs said to catch up with Western Europe -- instead of marking time with 4 or 5 percent growth rates -- Central and Eastern Europe must adopt Asian tiger strategies of massive investment and lower taxation.