The prospect of further EU enlargement has considerably increased foreign investor interest in Romania, Bulgaria and Croatia. However, barriers to doing business remain, making it difficult for these countries to compete with Central European EU members.
In the past ten to 15 years, foreign investment inflows to Romania and Bulgaria have significantly lagged those to the eight Central and East European countries (the CEE-8) that joined the EU last year. Foreign direct investment (FDI) per capita stands at 1,100 euros (1,420 dollars) in Bulgaria and only 700 euros in Romania, compared with an average of 2,200 euros for the CEE-8.
However, the prospect of EU membership for Bulgaria and Romania as early as 2007 has recently led to a major increase in investor interest. In 2004, Romania and Bulgaria received 75% of all FDI into South-eastern Europe. Romania alone received 50% of all foreign investment, although this partly reflects the
country's relatively large population of 23 million, and last year's big-ticket privatisations of important assets. Similarly, in Bulgaria, utility privatisations attracted nearly 2 billion euros of FDI.
Nevertheless, growing foreign investor interest owes much to the perception that, as EU members, these countries will offer a much more secure and attractive investment climate. Croatia, which is further behind in the EU accession process, but could perhaps join by 2010, also hopes to benefit from this effect. The CEE-8 experience suggests that FDI, by bringing not only foreign capital but -- equally importantly -- foreign know-how, is critical to prompting the structural change necessary for countries to compete once inside the EU. The promise of EU accession thus helps to create a virtuous circle, attracting FDI, which then acts as a catalyst for broader economic reforms, in turn increasing overall competitiveness.
Insecure environment
Yet, investors still face significant risks and costs:
Employment regulations. One of the legacies of CEE socialism is rather rigid labour market regulation. On the World Bank's Doing Business global index for hiring and firing workers (on a scale of 0-100 where zero registers the least rigid system), Croatia scores 57 for rigidity of employment and Romania 63,
compared with 34 for high-income OECD countries, 28 for Bulgaria and 10 for Slovakia. Firing costs (measured in weeks) are particularly high in Romania (98), compared with 55 for Croatia, 40 for high-income OECD countries and 30 for Bulgaria. Moreover, these costs are exacerbated by uncertainty about the regulatory environment, with changes in regulations particularly common in Romania.
Corporate governance
A major consideration for potential investors is the corporate governance framework of companies in which they might invest. Without legal protection for shareholders, disclosure of ownership and financial information, and use of accounting and auditing systems that meet international
standards, investment is extremely risky. Here, Bulgaria and Romania are extremely weak, scoring 2 on the World Bank's Disclosure Index (on a scale of 0-7 where 7 is best practice), compared with 5.6 for high-income OECD countries and 7 for the United States.
Judicial inefficiency
Investors need to be certain that their contracts are enforceable in a country's courts. Again, complex judicial procedures, massive backlogs of cases and widespread corruption make doing business in Bulgaria, Romania and Croatia far riskier than it would be in the EU-15 and many CEE countries. Assuming a standard payment dispute, the World Bank finds that the time to enforce a contract is 440 days in Bulgaria and 415 days in Croatia.
However, the average of 335 days in Romania is only two months longer than the 276-day average for the EU-15. The cost of enforcing a contract is cheaper in Croatia, at 10% of the value of the debt, than in the EU-15 (12.4%). However, more widespread corruption in the judicial systems of Croatia, Romania and Bulgaria mean higher uncertainty about contract enforcement -- a significant cost in itself.
Xenophobia
Foreign investors may also encounter xenophobia, particularly if they wish to lay off workers. This is likely to be a problem in the privatisation of large state companies and public utilities, where the foreign investors are likely to be blamed for redundancies and price increases (even if such measures would have been necessary anyway). For this reason, some foreign investors prefer to set up greenfield sites, where they can instead cultivate an image of creating jobs and boosting the local economy (even if the new company will in the longer term force existing companies out of business). On the other hand, greenfield investment also incurs other costs and delays associated with obtaining necessary permits and licences; such regulation is particularly onerous and time consuming in Croatia, but less so in Bulgaria and Romania.Portfolio investment is also largely immune to problems of xenophobia.
Investment opportunities
Owing to instability in the Balkans in the 1990s and the election of governments less committed to economic reforms, these three countries mostly missed the first big wave of foreign investment into CEE.
Moreover, the character of CEE FDI has changed over time, with investors increasingly looking for good skills bases suitable for higher value-added manufacturing, and information and communications technology (ICT) enterprises.
The three countries vary considerably in what they can offer to such investors: Bulgaria is attracting investors looking for highly skilled workforces at cheap rates. The country has a high reputation for training mathematicians and linguists, making it a good base for ICT, particularly customised software
development, design of internet solutions and applications, wireless application development, security solutions development, web design and CAD/CAM/CAE software. Bulgaria also appears to be developing a strength in such high value-added sectors as sophisticated electronic automobile components, following to a large extent the pattern of FDI in Hungary, which proved critical to Hungary's economic success in the late 1990s.
Romania has attracted foreign investment mainly in such low-value outward processing sectors as textiles. Since it increasingly finds it difficult to compete in this field with East Asian countries, the government is seeking to attract more investors from high-tech industry. To this end, Romania currently offers an extensive set of tax breaks and other incentives for investors, with an emphasis on high-technology sectors.
Croatia's relatively high level of FDI per capita (2,300 euros), generated mainly by the privatisation of large assets in energy, telecoms and banking, appears to have bred a certain degree of complacency. Very little effort is being made to cut back the burdensome regulatory framework and design incentives
to compensate for the relatively high wage costs. The main opportunities are in tourism, where demand continues to outstrip supply and there remains great potential for growth. However, a lack of structural reform in the economy generally limits opportunities elsewhere.
The country most prepared for EU accession, Bulgaria, is also by far the most attractive and secure site for foreign investment of the three. However, the process of accession will give impetus to economic reforms in Romania and Croatia which will ensure a much more favourable investment climate there too in the medium term.
By: N. Peter Kramer
