'Expanding the European Investment Frontier: Eastern European Investment Summit'
Robert J. McIntyre
Local Development in Transition, UMass-Amherst
Institute for International Economic and Political Studies, Moscow
Lack of policy attention to this issue means that even countries that have secured extensive green-field expansion often see construction of 'cathedrals in the desert': modern facilities highly dependent on imported components and sub-systems with few positive spill-overs into sub-contractor and supply-chain links involving local small enterprises. The tendency for sharply increased current account deficits to coexist with large reported DFI inflows at least in part reflects this lack of local participation in the supply chains of the new facilities. It also reflects loss of market access by local producers who, in the absence of actual consumer choice, are replaced by imports as retail distribution channels change.
FDI of the on-going character and geographical distribution is likely to expand the informal economy and increase poverty, at least in those areas away from the national capital or other FDI concentration points. Successful efforts to 'regularize' the informal economy have depended on providing active incentives for 'emergence', usually taking the form of local-level provision of real services. Few of the Eastern European and CIS transition countries have embraced this kind of local-level industrial policy. As a result proven policy approaches drawn from directly relevant East and South Asian experience are ignored by recipient government, in part because they are seen as 'market unfriendly' by potential providers of DFI. This company-level logic sharply contradicts the longer-term interests of the European Union in stable and social harmonious accession states and their nearby 'periphery'.
These are difficult policy-making circumstances, not least because the desperation of recipient government to show 'success' makes good bargaining difficult, but clearly more active and far-sighted government engagement is required to assure that the positive developmental potential of FDI is realized by these recipient countries. Without such active policy attention to the real implications of FDI there is little reason at the macro level for DFI to lead to current account improvements and no basis at all for expecting the emergence of significant local productive SMEs as part of large enterprise supply chains.
1. LITTLE REAL SUCCESS FOR SMEs IN TRANSITION THUS FAR
New UNU/WIDER research (Small and Medium Enterprises in Transitional Economies, McIntyre and Dallago, eds., Palgrave Macmillian, 2003) shows that the reported success of SMEs in transition is mostly illusory. Small retail shops and kiosks have proliferated at least temporarily, but globalization poses great danger to the development of productive local small enterprise systems. leaving a still gaping small enterprise 'black hole'.
Assumptions about the automatic emergence and developmentally functional articulation of markets led to a failure to work seriously to establish the institutional, structural and demand conditions that would allow real growth.
2. SME SUCCESS REQUIRES PATIENT POLICY
Despite the tendency to think of and present the SME as an alternative to the former SOE, except for the face-to-face retail and service delivery sector, little can be expected from the SME without either: (a) active support efforts at the local level; or (b) the survival or development of a healthy large enterprise sector which the SME can utilize as supplier, customer and provider of various social and technical externalities. If ways can be found to encourage the formation of purpose-built alliances and sub-contracting relationships, positive and mutually reinforcing interactions can be expected to emerge.
The SME sector needs the large enterprise sector as a source of inputs, a market for its output and also as source of individual entrepreneurial leadership. This requires a synergistic relationship between SME and large enterprise sectors, not a zero-sum environment where 'success' of the small can only be secured by destroying or disassembling the large. FDI does not solve these problems, but may (for reasons cited below) exacerbate them.
3. THERE ARE SUCCESSFUL POLICY APPROACHES
These examples embody a vital insight: too often SMEs in transition economies are assumed to only have a future as atomistic competitors, whereas real-world experiences point to the centrality of a small-enterprise system for both micro- and macro-level success and support consideration of a wide range of possible organizational and ownership forms. The arrival of FDI does not change or ease this need for effective policy. The issue of how the SME sector interacts with the large and/or foreign-owned sector is central. Positive developmental effects are strongly dependent on the conditions under which FDI interacts with the local economy.
4. FDI DOES NOT SOLVE THE PROBLEM
Foreign direct investment (FDI) is often viewed as the crucial way out which has the added advantage of avoiding the need for active policy formulation by recipient countries. Both more generally and viewed from the point of view of the SME sector, FDI is in fact problematic for several reasons:
First, there is the pervasive linguistic confusion between the purchase of existing assets (= asset-swaps with no change in productive capacity) and the creation of new productive capacities (= increased production and income-generation capacity). Only the later is 'investment' in the sense that economists use the word to discuss growth and its determinants. When some one says "investment is the key to growth in transitional economies" either they are not talking about the purchase of existing transition country assets, or they do not understand the words they are using. Adding the word 'foreign' has no effect on this point.
When FDI is mentioned it is generally understood on a grand scale involving large old or new enterprises, but many new entities that do in fact represent 'real' foreign direct investment will themselves be SMEs, and in this way they do make a contribution to the growth of the SME sector.
Even non-investment ('asset swap') changes of ownership can have positive effects, by bringing new management and motivational techniques or access to established foreign marketing channels. These results can however also be achieved by a number of paths such as licensing, use of consultants, technology transfer or alliances, and so on, that do not involve ownership change.
Second, large-scale 'asset swap' purchases by foreign firms often have strong negative effects on those local SMEs that are involved in the production sphere. When foreign purchases of retail and wholesale distribution assets are involved, the effects on local SMEs are likely to be especially awful. Even short periods without access to local consumer can kill off otherwise promising local production capacities.
Third, even when new foreign investment takes the form of 'green-field' construction of large production facilities the effect on SMEs is clouded, with positive results appearing to be heavily policy-dependent. Analysis of the largely unsuccessful "jump-starting" of the economy of the former GDR is useful here (Pickel 1992). Grabher (1992, 1995) has coined the evocative term "cathedrals in the desert" to describe the utter lack of local developmental effects from most of green-field investment that occurred, with nothing beyond salaries percolating into the local economy. Of course, this income has multiplier effects on the local service economy but virtually no supplier relationships emerge in which autonomous local producers join in the 'value chain' of the large enterprise.
The experience of Hungary later in the 1990s directly illustrates this pattern. Hungary received a great volume of FDI (concentrated in automobile and connected areas), but there was very little developmental spill-over beyond salaries paid. Only after explicit government pressure, leading to 'voluntary' cooperation and supported by explicit attention in an economic development plan (the so-called 'Szécheny Plan' for 2000-2006 and 'Szécheny Plus Plan' for 2003-2004) did foreign firms begin to address this issue (Dallago 2003, pp. 88-90 and 94-96).
The effects of this particular ‘Szécheny’ initiative are yet to be determined, but the analytical point is clear -- without explicit policy attention to this issue, very little involvement of small productive enterprises was occurring despite an impressive flow of 'real' FDI.
For transition countries yet to commit themselves to specific FDI projects, experience thus far underlines the need to proceed carefully. What will work in a situation depends on careful analysis of the micro-, mezo- and macro-level internally, as well as the external features of the concrete situation. The simple question of "How did this work elsewhere, according to its critics?" needs to be asked in order to open up the policy making process.
5. ASYMETRIC OPENING: MARKET ACCESS AND OTHER NECESSARY PROTECTIONS FOR SMEs
The major problems of SME development -- an inadequate institutional/ organizational context, lack of product-market access for small-scale producers and most critically finance -- are made worse by rapid, uncontrolled and asymmetric market opening. A recent UNCTAD (2002) study suggests that the process of opening up even well-established market economies has strong negative effects on the SME sector. This reflects a mixture of the effects of domestic demand repression and the arrival of more mature foreign competitors in all economic sectors. More negative results should be expected in those (many) transition countries where an era of normal growth is yet to occur, magnifying vulnerability to outsiders.
With the arrival in developing markets of large, well-financed foreign producers and distributors, even potentially promising local production capacities may be destroyed before finding their feet. Local producers may expire as a result of short-run 'predatory' tactics (penetration pricing, loss-leaders, bribery/black mail of distributors or retailers, etc.) or loss of market access. A central but often invisible aspect of the survival or growth of productive SMEs is the ability to expose their products to the processes of consumer choice. It is especially important to maintain consumer access to locally produced goods when new distribution channels emerge. Only a short period of exclusion from the market is enough to kill off otherwise viable and promising local production capacities. It is important to link financing of small enterprises based on localized savings and investment cycles with measures to support local production in the face of the pressure of internationalization of the market. 'Full-information' approaches to labeling and non-tariff preferences for locally produced goods are possible policy responses.
Dynamic economic growth requires credit cooperatives and other forms of locally-owned banking institutions tasked with serving local small enterprise interests. A parallel concern arises over the concrete local development effects of the absorption of local banks by international banking companies. The indebtedness and low profitability of large banks strengthened their inherited attitude of avoiding risky financing, requiring high collateral and charging high interest rates. Consolidation, restructuring, and privatization of large banks prevented the establishment and development of financial institutions for SMEs. Once under foreign ownership they are very unlikely to devote significant resources to support foundation or growth of SMEs.
Locally-owned banks and local small enterprise systems in various countries function successfully on the basis of accumulated 'social capital' that is very costly for large banks (that have no inherent local development mission or mandate) to acquire. It does not make sense for them to provide the type of patient, step-by-step credit and other financial service support that firms of a nascent small enterprise sector require.
6. CONCLUSIONS
Successful long-term development will not occur unless there is sustained growth of internal demand and active policy measures to protect local capacities. This must include attention to the competitive threat posed by new EU members who will experience great difficulty selling in old EU markets but will dispose of various EU subsidies for exploring 'outside, but nearby' markets. This competition may damage transition country SMEs, but their lower costs (deriving from lower wages, weaker social protection and less rigorous regulation) offer EU firms great opportunities to establish transnational networks that include them. In this way transition country SMEs may find important market access and incentives for modernization.
A successful SME sector that goes beyond neighbourhood-level services and retail distribution (the later often doomed in any case) requires both active support services at the local level and the survival, revival or development of a healthy large enterprise sector as supplier of inputs, output market, provider of various social and technical externalities, and also (unexpectedly) as source of individual entrepreneurial leadership. Systems success is more a question of quality than quantity, particularly concerning the interconnection of all the elements that form the economic system. SMEs are a crucial element, but policies that target the SME sector without paying attention to these surrounding conditions are unlikely to have substantial and long-lasting positive effects. Efforts to provide direct assistance to SME often end up mired in corruption, have high overhead costs and ultimately serve other than announced programme interests.
SMEs supply the bulk of employment in EU and transition countries and the integration process will have a great impact on both. The forces changing the SME landscape within Europe present dangers and opportunities for transition countries, calling for institutional policies and governance mechanisms that reduce the former and support the latter. Hopes that internationalization and the local effects of globalization will make it unnecessary to formulate local-level development polices are likely to be forlorn. Internal 'liberalization' only intensifies the need for SME policy and when unmediated FDI arrives it is likely to devastate the nascent productive SME sectors of transition countries. Only early policy attention to building positive linkages between specific FDI projects and local productive entities will prevent an exploding current account deficit from being only the first on a list of unhappy 'side-effects' of FDI in-flows. The failure of the expected export booms to materialize is a reflection of the extent to which the reality of FDI has differed from its image.
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