EU enlargement and FDI: Implications for the Pan-PRD region Fabrice MAZEROLLE Université Paul Cézanne, Aix-Marseille, France
International Symposium on European Union’s Economic Operating Mechanism & its Implications to the Strategic Economic Development of Pan-Pearl River Delta
GDUFS GUANGZHOU, PR China
Last update: December 9, 2006
Abstract This paper reviews the impact of EU enlargement on FDI stocks, mostly inward. Using yearly data on FDI stocks published by UNCTAD, it is argued that enlargement favors inward FDI. The main reasons for this link are discussed and illustrated with factual examples. A parallel is drawn between EU and the Pan-PRD region. Based on the positive impact of the May 2004 enlargement on EU’s FDI, it is suggested that new economic clusters should be created at the north borders of the Pan-PRD region, as well as within YUNAN, GUIZHOU, GUANGXI, HUNAN and JIANGXI, so as to favor a better allocation of FDI within the Pan-PRD region, and allowing for a more balanced path of interregional development and resulting, globally, not only with a redistribution of a constant flux of inward FDI, but with an increase of this flux.
Questions and comments are welcome
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Contents
I – Inward FDI comparison between Pan-PRD and EU25 II - The 2004 EU enlargement and the rise of FDI in the new EU members III – Motives for FDI and the Investment Development Path (IDP) theory IV – Implications for the Pan-PRD Region Bibliography
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I – Inward FDI comparison between PAN-PRD and EU25 In 2005, the share of the Pan Pearl River Delta Region (Pan-PRD)1 in world inward FDI stock was equal to 7.13% whether than the share of the European Union (EU 25) was 44.1% (see table 1). Table 1: Indicators of FDI, GDP, population and surface for Pan-PRD and EU25 – 2005 A: Share in world inward FDI stock
B: Share in world GDP
Comparative Performance Ratio A/B
7.13%
1.85%
3.85
HK+ Macao + GD
6.22%
0.91%
6.81
8 provinces
0.91%
0.94%
0.96
44.1%
30%
1.47
EU15
41.4%
28.8%
1.44
EU10
2.7%
1.2%
2.25
Pan-PRD
EU25
Population millions
Surface millions km2
450
3.1
460
3.9
Sources: The FDI stocks for EU are from UNCTAD (2006), World Investment Outlook, Annex table B2, page 303-6. The GDP data are from the September 2006 IMF World Economic Outlook database. The FDI stocks and GDP data for Hong Kong, Macao and the 9 Chinese Provinces are 2003 data taken from HAVRYLCHYK O. and Sandra PONCET (2006), “Foreign Direct Investment in China : reward or remedy”, CEPII Working Paper. These 2003 data by provinces are then adjusted to the 2005 aggregate data from UNCTAD and IMF. Population and surface data are from the CIA World facts book.
The difference between the two is important but misleading. It is better to scale each percentage by the corresponding share in world GDP2. In 2005, the share of PAN-PRD in world GDP was 1.85% and the share of EU in world GDP was 30%. That is, the difference between the two regions in the share of the world inward FDI stock is around six fold, but the difference in the share of world GDP is around fifteen fold, much more.
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By Pan-PRD, we mean Hong Kong + Macao + 9 provinces (SICHUAN, YUNNAN, GUIZHOU, GUANGXI, HAINAN, HUNAN, JIANGXI, FUJIAN and GUANGDONG) 2 GDP is measured in current dollars.
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We can therefore infer from this scaled comparison that the Pan-PRD region has been so far comparatively very efficient in attracting FDI. This performance can be summarized in a “Comparative Performance Ratio (CPR)” which is given by column 4 of table 1 and is defined by3:
CPR of region i =
Share of region i in world inward stock of FDI Share of region i in world GDP
We can see, then, that the CPR index for Pan-PRD is 3.85, more than twice the index of 1.47 for EU25. Since our purpose here is to study the impact of enlargement on FDI (both inward and outward), it is interesting to compare the two regions (Pan-PRD and EU25) in terms of their enlargement and its impact on FDI. This can be done first by defining a “core” and then “enlarging” around this core. For Pan-PRD, we define the core as GUANGDONG plus HONG KONG and MACAO and the enlargement will consist of adding the 8 other Pan-PRD provinces to this core. For EU25, we define the core as EU15 and the enlargement will consist of adding the ten new member countries to this core. Figure 1 below illustrates the position of the core with respect to the rest for each region4. The core region of Pan-PRD has 6.22% of the world inward stock of FDI, while the core region of EU has 41.4%. Again, once scaled down by the share of each region in world GDP, the HONG KONG, MACAO and GUANGDONG region has a comparative performance ratio of 6.81, much higher than the ratio for EU15 (1.44). If we “enlarge” the two regions, adding 8 provinces for Pan-PRD and adding 10 countries for EU, we see different results. In the 8 provinces, there is less of 1% of the world inward stock of FDI while the ten new members of EU have 2.7% of the world inward stock of FDI. The 8 provinces of Pan-PRD and the 10 new countries of EU receive approximately the same percentage of world GDP (0.94% for the 8 provinces and 1.2% for the ten new members), so that the comparative performance ratio of the ten new EU members (2.25) is much higher than the one for the 8 provinces (0.96).
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This index is very close to the Inward Performance Index used by UNCTAD except that UNCTAD uses flows of FDI whether here we use stocks of FDI. For the definition of the UNCTAD index, see http://www.unctad.org/Templates/WebFlyer.asp?intItemID=2469&lang=1 4 For EU, there is a clear enlargement in 2004 and things change dramatically. But for Pan-PRD, there has never been any enlargement. So how can you compare? The comparison is therefore just hypothetical: we just assume, for the sake of comparison, that the integration of the 8 provinces into the core (HK + Macao+ Guangdong) is equivalent the adding up of ten new countries to the core-EU15.
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Figure 1: Cores of development in Pan-PRD and EU25
II - The 2004 EU enlargement and the rise of FDI in the new EU members In general, the successive enlargements of EU since 1956, has been very beneficial to EU in terms of FDI. To show this, one can ask how much of FDI, both inward and outward, each group of countries is representing in 2005. This is shown in figure 2 below.
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Figure 2: Contribution of country groups to the EU 25 inward FDI stock (left) and outward EU25 FDI stock (right)
Source: UNCTAD (2006), World Investment Outlook, Annex table B2, page 303-6.
As we can see, the contribution of the enlargement to FDI is quite substantial. For exemple, the 6 initial countries of the EU only represent 52.27% of the total inward stock of FDI located in EU25 in 2005. Similarly, the 6 initial countries of the EU only represent 58.28% per cent of the total outward stock of EU25 FDI in 2005. It means, in both cases, that the countries that joined the EU after 1956 now represent about half of its inward as well as outward FDI stock. Of course, these data have a caveat (but they are no other exhaustive data to replace!). They do not allow distinguishing intra FDI from extra FDI. For exemple, if FRANCE invests in GERMANY, it should not be considered as EU25 outward FDI. Similarly, this French investment in GERMANY should not be considered as inward EU25 FDI. But in both cases, it is considered as FDI. We will focus now on the effect of the last enlargement of EU, the May 2004 enlargement, to see more precisely the effect on FDI. To see this, we can compare the country by country inward and outward FDI stock in 2000 (three year before the enlargement) and in 2005 (one year after the enlargement). As can be seen from table 2, between 2000 and 2005, some countries have experienced an increase in their share in total EU25 inward stock of FDI and some have experienced a decrease (shaded in grey on the table). But one striking fact seems to be that the new members are benefiting and, at the same time, some but not all the older members are losing. More precisely, the 10 new members have gain 1.58 % and, at the same time the “1975 accession group” (UK, IRELAND and DENMARK) have lost 4.51%. This seems to support the idea of a relocation of FDI from west to east. Of course, this is a well known fact, and it has recently been documented in various studies.
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Table 2: Share in EU25 inward FDI stock before and after the 2004 enlargement Share in EU25 inward stock EU25 countries ranked by order of entry into EU
Delta 2005
2000
Belgium France Germany Italy Luxembourg Netherlands Total "1956" countries
10,96 13,37 11,19 4,89 1,54 10,31 52,27
7,89 11,99 12,54 5,59 1,08 11,25 50,35
3,06 1,38 -1,35 -0,70 0,46 -0,94 1,92
United Kingdom Ireland Denmark Total "1975" countries
18,04 4,70 2,26 25,00
20,25 5,87 3,40 29,51
-2,20 -1,17 -1,14 -4,51
Greece (EU 1981)
0,652
0,065
0,59
Portugal Spain Total "1986" countries
1,44 8,18 9,62
1,48 7,22 8,70
-0,04 0,97 0,92
Austria Finland Sweden Total "1995" countries
1,37 1,18 3,82 6,36
1,40 1,12 4,34 6,86
-0,04 0,06 -0,52 -0,50
Czech Republic Estonia Latvia Lithuania Hungary Poland Slovak Republic Slovenia Cyprus Malta Total "2004" countries
1,32 0,27 0,11 0,14 1,36 2,08 0,34 0,18 0,20 0,09 6,095
1,00 0,12 0,10 0,11 1,06 1,58 0,17 0,13 0,13 0,11 4,511
0,32 0,15 0,01 0,04 0,31 0,50 0,17 0,05 0,06 -0,02 1,58
Source: UNCTAD (2006), World Investment Outlook, Annex table B2, page 303-6.
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Notably, a study by OCO Consulting (2006), using data from January 2003 to March 2006, has revealed that the post period accession was characterized by an increased of inward FDI into the 10 new member states when compared to the pre-accession period. On average, 62 FDI projects per month went into these countries during the 19 months prior to accession. This increased to 69 projects on average during the 20 months post accession. According to OCO Consulting this is significantly higher growth than both the global trend and EU15 trend during these periods. In the same study, it is also shown that: 1) FDI between the 10 new member countries also increased significantly after joining the EU. 2) The number of projects coming from outside EU is also growing. Another recent study, by Deutsche Bank Research (2006) has shown that Central and Eastern Europe (CEE) is an important region for services offshoring. The imports of IT-based services from Central and Eastern Europe into the EU-15 rose by an average of 13% per year between 1992 and 2004. This is because close cultural and geographical ties make suppliers from CEE an attractive option. The close ties – in terms of culture, geography and partly language – between the CEE countries and the key Western European markets, the low wages, the high standard of education and stable macroeconomic and institutional environment constitute the main strengths of the region. All these factors of attractiveness have been enhanced by the entry of these countries into a single common market and, sooner or later, into the Euro zone. Some examples of IT near shoring: • • • •
DHL has been operating a computer centre in Prague employing 800 staff since the end of 2004. COMMERZBANK has also been off shoring in Prague, where it has payment transaction receipts checked. SKYPE, an internet telephony provider, operates a development centre in the Estonian capital, Tallinn, with a staff of around 130. PROGEON, a subsidiary of the Indian IT service provider INFOSYS Technologies, offers BPO services to Western European clients from Brno in the Czech Republic.
According to the Deutsche Bank Research (2006) study, language skills and cultural ties make communication easier CEE countries have close geographical and cultural ties with the markets of Western Europe. Typical nearshoring locations score high marks because of their lower costs for communication between the purchaser and the provider of the nearshoring service. Another important area where the 8 new members are attracting many FDI is in the automobile industry, as can be seen from table 3 below.
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Table 3: Assembly and production facilities in Automobile Industry located in the 8 east European new Members Location
Manufacturer
CZECH Republic Kolin
Toyota
Mlada Boleslav
Volkswagen/Skoda
Hungary Esztergom
Suzuki (Swift, Wagon R+)
Györ
Audi Hungarian Motor
Poland Bielsko Biala
Fiat
Gliwice
General Motors/Opel (Opel Agila)
Lublin
Daewoo FSO
Poznan
Volkswagen (T4)
Warsaw
Daewoo FSO
Zeran
Daewoo (Lanos)
Slovakia Bratislava
Volskwagen
Trnava
PSA/Peugeot (2006)
Slovenia Novo Mesto
Renault (Clio)
Source: UNCTAD (2003), World Investment Outlook, page 61.
More recent data from UNCTAD (2006) confirms that the new EU member States have become new hubs of manufacturing for automobile production in Europe (see Figure 3). According to UNCTAD (2006) in 2005, passenger car production in the new EU members exceeded 1.6 million cars, equivalent to 9.5% of the total production in the EU-25. Foreign affiliates in this industry are concentrated in four countries: Czech Republic, Poland, Hungary and Slovakia. In the past 15 years, TNCs have invested heavily in the automobile industry in East European countries. About one tenth of inward FDI stocks in Hungary, Poland and the Czech Republic are in the automobile industry. Indeed, foreign firms dominate the automobile industry in the new EU member States. They account for about 70% of total employment in the industry. The bulk of inward FDI originates from European manufacturers. But since investing in these countries allows overseas investors to jump over EU tariff barriers, other investors (especially from Japan, the Republic of Korea and the United States) are becoming 11
increasingly interested in the region. As large component suppliers have followed car producers, a dynamic manufacturing cluster with high output and export potential has developed. Figure 3: Assembly and production facilities in Automobile Industry located in 4 east European new Members.
Source : UNCTAD, World Investment Report 2006, page 91
Further investments in the new EU member States are expected from large carmakers and component suppliers in the coming years because of several factors, including: Æ Expected strong economic growth, Æ Low labour costs, Æ Skilled workforce, Æ Low tax environment. Table 4 shows that in 2005, the average effective top statutory tax rate on corporate income in the Czech Republic, Hungary and Poland was 20.1%, compared to an average tax rate of 36.6% in France, Germany and Italy. Wages in the new EU member States in 2005 are about 70% lower than those in the EU-15 countries can be expected to remain at this level for quite a while (UNCTAD, 2006).
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For all these reasons automobile production in the new EU member States is expected to double within the next five years, from 1.6 million to 3.2 million vehicles, increasing the share of the new EU-10 countries in total EU production to 16.5% (UNCTAD, 2006). Table 4: Comparative attractiveness of 3 east-European Countries for FDI
Source: UNCTAD (2006), “New EU member States continue to attract international car manufacturers”, box II.20, page 91.
III – Motives for FDI and the investment Development Path Theory It is helpful to clarify the main motives of FDI by classifying them geographically (see figure 4 below). Since we have defined the EU15 as the “core” and the EU10 as an “enlargement of the core”, one might be particularly interested in the following FDI flows in relation to enlargement: 1) FDI from EU15 to EU 10 (number 7 in figure 4) 2) Inward EU10 FDI flows from the rest of the world (number 4 in figure 4) Of course, the other flows may also be very interesting to study, as there are also, most likely, influenced by the enlargement process. But for now, we will focus on these two. This restricted interest will allow us making comparisons with the PANPRD “enlargement” (see the definition in section 1) as well as drawing implications from these comparisons. As we have seen in section 2, there has been recently a noticeable increase of FDI into the 10 new EU members, mostly into the east European countries (ESTONIA, LATVIA, LITHUANIA, POLAND, HUNGARY, CZECH REPUBLIC, SLOVAKIA and SLOVENIA). Of course, this increase cannot be fully attributed to the enlargement process. For exemple, the privatizations that have been under way since the mid 1990 in these countries have provided a lot of opportunities for foreign companies to enter into their markets, through joint ventures, Mergers and Acquisitions or Greenfield projects. However, it is difficult to deny that the prospect of the entry of these countries into the EU, as well as their effective entry since 2004, has influenced positively this trend.
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If we refer to the traditional theories of international investment as they have been recently summarized in UNCTAD (2006), the 4 main motives for FDI – whether horizontal or vertical -- are: market seeking, efficiency seeking, resources seeking and asset seeking. In the context of the last EU enlargement (from 15 to 25 countries) the first two motives (market and efficiency seeking) are widely present, whether than the fourth may play a role in the near future when these east European countries will become themselves significant outbound FDI investors. Figure 4: Geographical decomposition of FDI flow from and out the EU25, taking into account the 2004 enlargement
1) Market seeking FDI: it is rather obvious that the prospect of a larger market created by the enlargement has motivated some inward investments from UNITED STATES, JAPAN and other countries into EU10 (and also into EU15). In particular, the market in these 10 new countries, although with GDP per capita lower than those of EU15, are much more open to foreign competition and easier to satisfy (the penetration rates of many products, from TV sets, to mobile phone to automobiles, are much lower than in EU15). 2) Efficiency seeking FDI: Efficiency seeking has also been a very important motive for FDI inflows into the ten new members. One of the most celebrated aspects of it is the low labour costs in these countries. Although the manpower of these countries is highly qualified, it is much less costly than in the UNITED STATES or in the EU15 countries (including Ireland or Portugal). In addition to this, fiscal conditions are much better and, as seen in the previous section, the cultural ties and the geographical proximity makes it a first choice for many European companies.
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3) Asset seeking FDI and the investment development path theory The search for strategic assets, enabling a company to create, to sustain or to advance its international competitive advantages will be associated with the rise of FDI FROM the new members, first into EU15, but then outside EU. This argument can be formalized into the Investment Development Path (IDP) theory. The IDP theory, developed by DUNNING et al (1998) can be summarized as follows: countries tend to go through five different stages, from “least developed” to “developed”. Each of these stages is characterized by a position in terms of the net inward stock of FDI. In the first stage, there is very little if not none inward and outward FDI. This is because, at this stage, there are very few factors such as a sizeable market or clusters of other firms that might attract inward FDI. At the same time, local firms have not created or acquired many firm-specific advantages that might allow them to invest overseas. In the second stage, inward FDI starts to rise because of the increase of per capita incomes due to the integration into the EU market, but outward FDI remains low or negligible (because local firms are not strong enough to invest overseas). In the third stage, as local firms become more competitive, the rate of growth of inward FDI will decline, but outward FDI will grow faster. The motives for this outward FDI will be mainly asset seeking, although the market and efficient seeking motives might also be present. In the fourth stage, a country’s outward FDI stock should exceed or equal the stock of inward FDI. By this stage, most domestic firms are now capable of competing with foreign firms abroad as well as in their own market. At stage five, the net investment position of a country tends to fluctuate around zero, reflecting relatively similar magnitudes of the stocks of inward and outward FDI. Figure 5 show that this model is fitting approximately the data for the EU25 group. In particular, we can see that the 10 new members are still mostly in stage 2 and some in stage 3. On the horizontal axis, the countries are ranked according to their GDP per capita in 2005. On the vertical axis, corresponding to each country GDP per capital, the Net Outward Investment (NOI) stock per capita is recorded.
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Figure 5: Net Outward FDI stock per capita as a function of GDP per capita, for European countries (2005).
IV – Implications for the Pan-PRD Region We may now draw a parallel between EU and the Pan-PRD region. Based on the positive impact of the May 2004 enlargement on EU FDI, we suggest that new economic clusters should be created at the north borders of the Pan-PRD region, an also within YUNAN, GUIZHOU, GUANGXI, HUNAN and JIANGXI, so as to favor a better allocation of FDI within the Pan-PRD region, and allowing for a more balanced path of interregional development and resulting, globally, not only with a redistribution of a constant flux of inward FDI, but with an increase of this flux. This is because, right now, most of the inward FDI attracted into China is directed to the five existing Special Economic Zones (XIAMEN, SHANTOU, SHENZHEN, ZHUHAI and HAINAN), as well as, of course, HONG KONG, MACAO and the GUANGDONG province (see table 1). There is no need of many data to support this affirmation: special Economic zones are attracting most of FDI because it is their purpose to attract it! If new economic clusters were created elsewhere in the 8 provinces, this will opens up new opportunities and attract investors, especially efficiency seeking firms, because of the need of cheap labour. In addition, with appropriate access to market policies, market seeking foreign investors might complement investors form HONG KONG and GUANGDONG to set up facilities for production and distribution, both in manufacturing and IT services. This trend has been observed with the enlargement of EU from 15 to 25 and may be playing a role as well if the 8 provinces are more 16
integrated with the core of the PAN-PRD region represented by HONG KONG, MACAO and the GUANGDONG province (see figure 6) Figure 6: New economic clusters may be created into the PAN-PRD region to better allocate inward FDI as well as favoring “inside” investment (from HK or GUANGDONG)
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Bibliography DEUTSCHE BANK RESEARCH (2006), “Off shoring to new shores: Nearshoring to Central and Eastern Europe” (August). DUNNING, John H., Roger van HOESEL and Rajneesh NARULA (1998). “Third World multinationals revisited: new developments and theoretical implications”, in John H. DUNNING, ed., Globalization, Trade and Foreign Direct Investment (Oxford and New York: Pergamon). HAVRYLCHYK O. and Sandra PONCET (2006), “Foreign Direct Investment in China: reward or remedy?”, CEPII Working Paper. KALOTAY, K. (2004), The European flying geese: New FDI patterns for the old continent? Research in International Business and Finance 18, pages 27–49. OCO Consulting (2006), “Has accession to EU benefited FDI in new member states?” (Issue 4, Qtr 1). NEARY, Peter J. (2002), Foreign Direct Investment and the Single Market, The Manchester School, vol .70, num. 3, June, pp. 291314. UNCTAD (2006), World Investment Report, FDI from Developing and Transition Economies: Implications for Development. UNCTAD (2003), World Investment Report, FDI Policies for Development: National and International Perspectives.
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