Central Europe Review: politics,
society and culture in Central and Eastern Europe
Vol 1, No 22
22 November 1999

Sam Vaknin A   B A L K A N   E N C O U N T E R:
Lessons in Transition
What Central European countries need to do to attract investment

Sam Vaknin

What are the criteria for foreign investment in a country undergoing transition? Dr Vaknin answers the critical questions:

What have been the most successful approaches to attracting direct foreign investments: offering prospective investors tax breaks and similar benefits, or improving the overall investment climate of the country?

Empirical research has demonstrated that investors are not lured by tax breaks and monetary or fiscal investment incentives. They will take advantage of existing schemes (and ask for more, pitting one country against another). But these will never be the determining factors in their decision-making. They are much more likely to be swayed by the level of protection of property rights, state of the physical infrastructure, education and knowledge of foreign languages and "mission critical skills," geographical position and proximity to markets, culture and mentality, transparency and the degree of corruption.

What have been successful techniques for countries to improve their previously negative investment image?

The politicians of the country need to be seen to be transparently, non-corruptly encouraging business and liberalizing and protecting the property rights of investors. To achieve this, useful weapons are: one real, transparent (for example through international tender) privatization; one case where the government supported a foreigner against a local; one politician severely punished for corruption and nepotism; one fearless news medium changing a country’s image.

Should there be restrictions on repatriation of foreign investment capital? Such restrictions could prevent an investment panic, but at the same time they could negatively affect investor's confidence.

Short-term and long-term capital flows are two disparate phenomena with very little in common. The former is speculative and technical in nature and has very little to do with fundamental realities. The latter is investment-oriented and committed to the increase of the welfare and wealth of its new domicile. It is, therefore, wrong to talk about "global capital flows." There are investments (including even long term portfolio investments and venture capital) and there is speculative, "hot money." While hot money is very useful as a lubricant on the wheels of liquid capital markets in rich countries, it can be destructive in less liquid, immature economies or in economies in transition.

The two phenomena should be accorded different treatment. While long-term capital flows should be completely liberalized, encouraged and welcomed – the short-term, hot money-type should be controlled and even discouraged. The introduction of fiscally oriented capital controls (as implemented in Chile) is one possibility. The less attractive Malaysian model springs to mind. It is less attractive because it penalizes both the short-term and the long-term financial players. But it is clear that an important and integral part of the new International Financial Architecture must be the control of speculative money in pursuit of ever higher yields. There is nothing inherently wrong with high yields – but the capital markets provide yields connected to economic depression and to price collapses through the mechanism of short selling and through the usage of certain derivatives. This aspect of things must be neutralised or at least countered.

What approach has been most useful in best serving the needs of small businesses: through private business support firms, business associations, or government agencies?

It depends where. In Israel (until the beginning of the 90s), South Korea and Japan (until 1997) the state provided the necessary direction and support. In the USA the private sector invented its own enormously successful support structures (such as venture capital funds). The right approach depends on the characteristics of the country in question: how entrepreneurial are its citizens, how accessible are credits and microcredits to Small or Medium Enterprises (SMEs), how benign are the bankruptcy laws (which always reflect a social ethos), how good is its physical infrastructure, how educated are its citizens and so on.

How might collective action problems among numerous and dispersed small and medium entrepreneurs best be dealt with?

It is a strange question to ask in the age of trans-Atlantic transportation, telecommunication and computer networks (such as the Internet). Geographical dispersion is absolutely irrelevant. The problem is in the diverging self-interests of the various players. The more numerous they are, the more niche-orientated, the smaller – the lesser the common denominator. A proof of this fragmentation is the declining power of cartels – trade unions, on the one hand and business trusts, monopolies and cartels, on the other hand. The question is not whether this can be overcome but whether it should be overcome. Such diversity of interests is the lifeblood of the modern market economy, which is based on conflicts and disagreements as much as it is based on the ability to ultimately compromise and reach a consensus.

What needs to be dealt with centrally is public relations and education. People, politicians and big corporations need to be taught the value and advantages of small business, of entrepreneurship. And new ways to support this sector need to be constantly devised.

How might access of small business to start-up capital and other resources best be facilitated?

The traditional banks all over the world failed in maintaining the balancing act between risk and reward. The result was a shift to the capital markets. Stock exchanges for trading the shares of small and technology companies sprang up all over the world (NASDAQ in the USA, the former USM in London and the Neuemarkt in Germany, for example). Investment and venture capital funds became the second most important source quantitatively. They not only funded budding entrepreneurs but also coached them and saw them through the excruciating and dangerous research and development phases.

But these are rich-world solutions.

An important development is the invention of "third-world solutions" such as microcredits granted to the agrarian or textile sectors, mainly to women, which involve the whole community.

Women start one-third of new businesses in the region: how can this contribution to economic growth be further stimulated?

By providing them with the conditions to work and exercise their entrepreneurial skills. By establishing day care centres for their children. By providing microcredits (women have proven to be inordinately reliable borrowers). By giving them tax credits. By allowing or encouraging flexitime or part-time work or work from home. By recognizing the home as the domicile of business (especially through the appropriate tax laws). By equalizing their legal rights and their pay. By protecting them from sexual or gender harassment.

Dr Sam Vaknin, 15 November 1999

The author is General Manager of Capital Markets Institute Ltd, a consultancy firm with operations in Macedonia and Russia. He is an Economic Advisor to the Government of Macedonia.

DISCLAIMER: The views presented in this article represent only the personal opinions and judgements of the author.

Dr Vaknin's website is here.



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