The ROLE of WEST
The Role of the West in Post-Communism Transition
The late 1980's was a period of drastic political change in Eastern Europe and throughout the world. The political bipolarity that existed since the end of World War Two changed almost overnight. The Cold War was at its completion and all of the Communist ideas including planned economics were no longer the force that had threatened world peace for almost half a century. The Communist collapse would set off somewhat of a political and economic domino effect in Central and Eastern Europe. The Berlin Wall collapsed, Germany unified, economic reform movements occurred one by one starting in Poland, Yugoslavia became an area of smaller republics that engaged in destructive ethnic conflict, and Czechoslovakia divided into two individual states, the Czech Republic and Slovakia. The economic reforms in these countries could hardly be described as uniform but since the influence of the Soviet Union dwindled, who would help these countries in achieving their objectives? This essay will answer the question posed previously by illustrating the theories and objectives of transition and the role of the west in assisting these countries in attaining their economic targets.
The fall of Communism left Eastern Europe with some significant dilemmas, including how they should go about reforming their economies to the more favored system based on market principles. The two dominant theories about this transition are based of the speed of the reform. The first theory, known as the Big Bang theory, is based upon fast and comprehensive economic change. Alternatively, gradual reform idea has similarly comprehensive changes but not in the same manner of time as the Big Bang theory. Which ever system was followed, the new governments of the former Soviet Bloc would have to resole many issues that would arise from the transition process. The problems of transition include price liberalization, privatizing government enterprises, liberalizing the internal and foreign markets, taxation, welfare, making the local currency internationally convertible and movements within the labor force. "...the transition from a totalitarian system to political democracy and from central planning to the free market economy is much more difficult than anyone could have believed." (Kyn p.1) Due to the difficulties faced during the transformation, the Eastern European countries looked westwards for help.
The satisfaction of the people of Eastern Europe after the disestablishment of the Soviet Bloc was quickly followed by the realization that significant challenges stood before them. The satisfaction of the fall of Communism was not just limited to the nations it directly affected. Western nations embraced the change because it justified there economic practices and they soon devoted themselves to the reconstruction of the post-communist states. This commitment is verified by Francois Mittrand's statement in 1989. "We are ready to co-operate by all available means in creating healthier economies in exchange for a proven return to democracy, respect for human rights and the organization everywhere of free elections." (Barre et al, p.4) The reasons for assistance from the West for the Eastern European nations is obvious. However, the willingness of the West could be considered somewhat surprising as at first it would appear unlikely that aiding these countries could bear little benefit for the donating nations.
The surprising willingness of the West is based upon the knowledge that by donating capital into these countries mutual benefit will be seen by both parties. The definition of western assistance "...includes stabilization funds, balance of payments support, debt management, the provision of market access, private source of funding on a non-commercial basis, and technical and non-technical assistance." (Barre et al, p.2) In the first two years of the transition process, the West, IMF and World Bank pledged $33.8 billion to the former Czechoslovakia, Hungary and Poland. The main goals of the Western assistance were
With this assistance, the Eastern European countries could achieve a market economy, social content and a working democracy. In return, the West, by providing the aid, can maintain regional security and help prevent another ecological disaster like the one in Chernobyl from happening again. With these goals plus the common economic benefit that can be attained by corporation between the countries, the willingness to provide and receive assistance will result in mutual benefit for both sides.
The description of the challenges that Eastern European nations need to overcome in order to achieve a working economy and a surviving democracy can be greatly assisted by the Western countries that approve of this reform. The actual outcomes of the policies that each country chooses to adopt will only be seen in the long run but if the aid is put to positive use and a return to the previous insecure situation does not happen, the assistance by the West can provide all parties with shared benefits. The necessary foreign support, together with other crucial factors, will ensure the success of the reforms of the former Communist Bloc countries.
Foreign Investment in Albania
Albania is one of the smallest countries in central Europe and it has a population of 3.4 million people. Albania is located on the west coast of the Balkan Peninsula in southeastern Europe, it is bordered by Yugoslavia to the north, Macedonia to the east, Greece to the south, and the lonian and Adriatic seas to the west. Albania was under communism since 1944 and communism has lost effect on the country when the democratic party has come into power in 1992.
Enver Hoxha was the ruler of the communist era since 1944 until his death in 1985. Enver Hoxha was a passionate Stalinist, he cut the links with the west after the Second World War and broke off relations with Yugoslavia soon afterwards. In 1960 when he saw that Russia was watering down Stalinism he switched allegiances to China. Later after the Nixon’s visit to China the relation cooled down and China halted all its assistance to Albania. Enver Hoxha also banned all the foreign travels.
Now Albania is emerging from communism with technology of Chinese origin that is over 20 years old. Albanian industry can not compete with foreign industries and they even do not have the money to buy spear parts. Albanian export is at a very low level. Albanians need foreign investment in order to improve their technology, lift Hoti, the governor of central bank of Albania says “It is a vicious cycle. Without foreign investment we can not improve technology, which is vital for our exports.”, and Tern Pojani, director of foreign investment at the Ministry of Trade adds that” We want foreign capital to provide new and modem technology and raise the level of welfare. But our problem is not so much the level of technology as the lack of spare parts.”
The chromium industry is regarded as Albania’s best hope for higher export earnings in the near term. The industry was reorganized back in July 1992 by Albachrome and the company is being prepared fir privatization. Foreign interest is high with at least six companies considering a strategic investments in Albachrome, including:
“-Macaulay Corporation of the US
-A unit of Summitomo Corporation of Japan.
-AWT, the commodity-trading of Creditanstalt Bankverein of Austria.
-CMI of south Africa.
-Italia Trading Services
-Samacor of South Africa, the worlds largest chromium producer.” from (Euro Money Central European Aug 1 ,1993).
Albania’s copper industry is also handicapped by Chinese technology and the lack of spear parts. The industry needs investments all around but the weakest part is transportation. Hadjani believes that Albania needs at least $ 70 million of investment, but he has been disappointed with the level of foreign investment so far because in one case foreign investor has requested 70% partnership and refused to help pay for a feasibility project.
Tourism was banned when Hoxha was in control but now there is nothing to stop this sector from improving. The war in Yugoslavia is actually an advantage because tourists who used to visit Croatia’s Adriatic coast are now attracted to Albania. Joint ventures are helping to improve standards of hotels. A French company already got the management for the Hotel Daijtiand and a new wing of the hotel is being added. There is also a chance of signing a contract with an Italian company for the management of Tirana Hotel.
In total there are 140 joint ventures in Albania (as of 1993. Euro Money Central Europe Aug.! 1993 ).. Because of cultural links Greek and Italian companies account for 70% of foreign investment. Albania is not a place for big investments but for small investment it is like a paradise. If you don’t need high technology and if you need many workers Albania is the place. The labor costs only about one about fifteenth of what it would cost in other European countries. For example let us take the Italian shoe company Filanto. It has a plant with 4000 workers in Albania. To do the same job in Italy they would need only 1000 workers but they would have to pay them many times more.
One of the big problems that the foreign investors have to face is having to cope with the changes in Albanian law. A foreign investment law was passed in August 1992, which protects foreign investment and gives them a three-year tax holiday. However, it requires certain approvals depending on the size of the investment. In the area of privatization the law has been changed many times and the barriers for foreign investment has been reduced.
Martin Mata at the department of foreign relations at the National Agency for Privatization (NAP) said that : “No one is against foreign investment, but when it comes to legal procedure, it is not always easy. In the past, privatization auctions were held in several stages and the foreign investors were only allowed at second round, but now there is only one single step where anybody can join”.
In conclusion Albania does not have much of the means to attract foreign investment but it surely is attractive in having low cost labor force. Albania now has more than 200 foreign investment projects, ranging from kiosk cafes to oil exploration in the Adriatic sea. The European Bank for Reconstruction and Development (EBRD) is financing nearly $100 million worth of projects, and playing an important part in providing comfort to the investors. The tourism also looks bright for Albania as some of the tourists that used to go to Yugoslavia are starting to go to Albania There are already signs of the positive improvement in the economy such as the positive interest rate and improving exchange rate. At the beginning of reforms the exchange rate was 130 -140 lek to dollar but towards the end of 1993 this figure changed to 110 - 120 lek. The future for Albania seems bright for now.
1. Financial Times, July 21, 1994, Thursday, Pg. 33, 1131 words, Survey of Albania, By LAURA SILBER
2. The Economist, March 5, 1994, Business, finance and science; BUSINESS; Pg.77, 293 words, Albania, land of opportunity, TIRANA
3. East European Energy Report, November, 1993, ENERGY, 279 words, New Albanian law boosts status of foreign investor
4. Euromoney Central European, August 1, 1993, 4334 words, ALBANIA: FOREIGN INVESTMENT IN ALBANIA. ALL EYES ON CHROME
Report on Government Involvement in Foreign Investment
Most Eastern European nations wrongly assumed (with the exceptions of Hungary and Czechoslovakia) that along with the transition of their economies would come a massive influx of foreign investment that could end the shortage of foreign currency as well as the massive budget deficits their governments were generating. Initially firms did jump on the band wagon of direct investment but then economic reality slowed the firm's activities immensely. In many nations the value of the firms to be privatized had been grossly overestimated by the government, and the wage level was not a bargain with respect to the disappointing skills of the work force. Further slowing of investment was also due to bureaucratic and legal difficulties associated with investment, as well as considerable skepticism about the progress of the transformation process.
Although it is now widely recognized that foreign direct investment will not alleviate large scale government budgetary problems, foreign investment still has a great deal to offer the privatization process. Foreign companies bring Western technology, management, and financial resources to the nations in which they invest (and these can be as important as the influx of foreign currency). But even with all of these benefits there still exists a great distrust of foreign investors. Citizens see their nation be bought (or rather stolen) from them at ridiculously low prices by foreigners who take advantage of government corruption and inexperienced managers. Part of this opinion is based on the close and necessary interaction of the foreigners with former communist government leaders, who also are not trusted. Another factor adding to the distrust is the lack of community involvement that had previously existed in relation to a town's major industry and its residents. They believe, not without some validity to the argument, that foreign firms will have employment policies that will disregard the needs of the community and its citizens, while domestic firms or shareholders would have a greater commitment to the social good.
Froot offers three models for direct foreign investment. The first embraces the idea that foreign investment should be limited and strictly controlled by the government. This principle would provide for fee-for-service agreements in order to gain Western technology, managerial skills, and business practices without allowing foreigners to take control of domestic institutions. The drawback to this is that, even though there is an abundance of experts available to sell their services, those experts may have personal motives that vary from the corporation's best interests. A good example of such a situation is Czechoslovakia's banking sector; they require Western technology and knowledge, but do not want to let such a crucial sector of the economy to be placed under the control of foreigners.
Froot's second model is the complete opposite of his first. He would put foreign investors on the same plane as domestic investors and encourage both to compete for assets through a series of auctions. These auctions would be either part of the first phase of privatization (in which assets are being auctioned by state organizations) or part of a transfer process in secondary markets (much like a stock exchange). In such a model competition would be maximized (theoretically) and assets would be sold at a real market value to the highest bidder, whether that investor is foreign or domestic. The problem that arises from this model is that there are too few foreign firms to foster real competition. As a result the selling price determined at auctions is often below that of a competitive market. Froot's third model attempts to alleviate this inadequacy.
The third alternative involves direct government intervention in the privatization process. A government agency is established to "identify and advertise assets, solicit bids for their use, and then aid in their restructuring and ultimate sale to foreign buyers." (294) An example of such an agency is Germany's Treuhandanstalt. It uses its power to get a combination of social and economic good out of the sale of state assets; the speed of sale and sale price are sometimes compromised in order to gain a favorable schedule of payments, politically acceptable employment levels, and macroeconomically beneficial levels of production and investment. The Treuhandanstalt alleviates the second model's pragmatic lack of competition through advertisement and close interaction with foreign investors while obtaining the higher social good sought in the first model using its inherent bargaining power. As good as this model sounds so far, it is not without its share of problems; "any interventionist strategy that gives discretion to government authorities is subject to both to possible administrative lags and to corruption." (295) Froot believes this approach would not be successful in most East European countries because it would proceed far too slowly and would be riddled with corruption, a point demonstrated during Poland's brief foray with sectoral privatization.
With these three models in mind Froot makes some specific suggestions for governments now involved in the transition process. Because the acquisition process often takes a long period of time, a mass privatization scheme, possibly using vouchers as in Czechoslovakia, should be adopted in many countries. This would distribute state assets to a number of domestic investors, forcing foreign firms to approach multiple shareholders with an offer that would more resemble a true market value. Such a system would also legitimize the process in the eyes of both foreign and domestic investors whose reluctance to invest is often a symptom of their distrust of the government and its transformation policies. Froot also points out that the government could maintain its bargaining power by retaining control over a golden share of stock in corporations to be privatized. Using this tactic foreign firms would have to negotiate employment levels, production, and investment while purchasing the stocks from smaller, domestic investors.
Finally, Froot emphasizes the need for governments to collect information about assets available to foreign investors and then advertise this information. This takes the burden of research (which involves both money and a great deal of time) off of the interested investors and has been shown in practice to foster even greater competition among foreign firms. The last step for governments involved in privatization is to create and maintain a good working relationship with foreign investors. This makes the firm much more trusting of the fledgling economies and allows the government to protect some aspects of the social good, all while the economy moves toward a complete free market system.
The need for government involvement is obviously great in those countries who have so far been lacking in direct foreign investment. While Poland had over $47 billion in debt at the end of September 1993, its FDI was a mere $746 million, and in Slovakia and Slovenia FDI was just one ninth of the national debt. (These figures are taken from national statistics.) In these countries as well as Romania and Croatia the governments should take some of Froot's suggestions. Privatization policy should put foreign investors on the same level as domestic ones in secondary markets. This way national assets can be distributed to many domestic investors (who exist in the form of mutual funds or individual shareholders) and a real market value can be placed upon state assets. It follows that foreign investors will have to deal with many shareholders, providing confidence in the system for domestic and foreign investors while bringing an influx of foreign capital to the nation's economy. And in order to protect the social good, governments should take heed of Froot's suggestion to hold a golden share of privatized assets. Other than this role, the government should assume the role of a sales department in any private company. This involves identifying assets to be sold and matching them with investors who often would not have the access to necessary investment information. It is also crucial that this does not involve a large number of direct sales from the government to foreign investors because the extensive amount of time and great opportunity for unethical behavior will cripple the process in most East European nations (as it did in Poland). Following such a policy, governments can solicit investment from foreign corporations that would benefit both the nation and the investor with minimal risk of corruption and no greater administrative lag than in Froot's second model.
Froot, Kenneth A. "Foreign Direct Investment in Eastern Europe: Some Economic Considerations." The Transition in Eastern Europe. Chicago: The University of Chicago Press, 1994.
Case Study of the German-Hungarian joint venture "KEMIPUR"
KEMIPUR is a Polyurethane System Limited Liability Company founded in 1985. The partner from Germany is Elastogram Polyurethane GmbH. The Plastic Industry Company of Pest County and the Chemolimpex Trading Company comprise the Hungarian partners. The German partners have a share of 49% and the Plastic Industry Company has a share of 41% with the Chemolimpex with a 10% share. KEMIPUR produces and markets polyurethane foam systems. The Hungarian partners were interested in this venture because they wanted to establish a company in Hungary that would reduce the hard currency import and increase the hard currency export. The German partner was interested because of the growing Hungarian market and, of course, because of prospects of high profits from such a venture. Negotiations for this venture began in 1978 but the production did not begin before 1986. It took so long in part because it was the first joint venture to be established in Hungary.
The venture is managed by a board of supervision. This board decides on long-term plans and profit distribution. The board consists of five members: one from PEMU, and two each from Chemolimpex and the German partner. There are two managing directors who are in charge of the company's operation. The director from Hungary is in charge of commercial, economic and labor questions and the German partner is in charge of quality control.
Most of the materials for production come from outside of Hungary. Only the auxiliary materials come from Hungary. KEMIPUR does not face any domestic competition. KEMIPUR would be difficult to compete against because of its strict principle of quality control. A future competitor is possible though. KEMIPUR is located in Solymar, which is a small village. The Hungarians in that area are not very fond of the company because it pays higher wages than other businesses. KEMIPUR pays higher salaries because the work is more complex and requires higher standard.
Tax rates for joint ventures were originally much smaller than for domestic companies but the 1989 change in the tax system reduced or eliminated this advantage. The KEMIPUR products fall into a category that has to pay an extra tax. It appears that many new tax laws are making Hungary less desirable for joint ventures. KEMIPUR also has to pay a "technical development contribution" although the company gains nothing from it. In 1988, KEMIPUR was planning to expand its production so they retained the profits and did not pay dividends. Overall, this has been a successful venture for both parties involved.
T. Benedek: EAST-WEST JOINT VENTURES, Basil Blackwell, Inc. 1991, p.278-285
Report on JOINT VENTURES IN BULGARIA
Joint ventures began to increase between Bulgaria and Western partners between 1986-1988. Normally, the Bulgarians did not take the initiative in establishing the joint ventures. They tended to be passive because they were not experienced in these matters. Also, the Westerners were seeking out efficient business opportunities.
The new attitude towards foreign investment in Bulgaria began with Decree No. 56 on January 13, 1989. This legislation put all forms of ownership on an equal basis. This included the introduction of contracts as the main form of relations between companies and the introduction of shareholders. This was also the first attempt to liquidate the monopoly the state had on foreign trade.
In a typical joint venture the Bulgarian partner provides the land and the equipment while the Western partner provides the technology and the hard currency. Bulgaria requires that the foreign investment be self-financed.
There were various problems in the establishment and operation of these ventures. A major problem in operating as a joint venture is the market monopoly that exists. Another problem is attaining a compromise fulfilling the interests of both partners. The main goal of the Bulgarians was to obtain access to foreign markets. The main purpose of the Western partner is to increase its share in the domestic market and to be a profitable firm.
Some want to avoid higher expenses and use the joint ventures as trade companies. These differences in goals tend to leave the Western partner uninterested in the sale of the product to third countries. Thus, the export goal of the Bulgarian partner may not be met. Another problem is the exchange rate for transfers of profits. The current agreement is to use the rate at which the Bulgarian National Bank buys currency from firms and individuals. Another problem facing the joint ventures is establishment of the common management approach.
One of the main incentives for the Western partner starting the joint firm in Bulgaria is the opportunity to make profit. For example, they can make profit through the use of cheap labor or by sharing the risk of business activities with the Bulgarian partner.
Bulgaria has begun developing more contacts with Western partners. The most common being coproduction with the West and delivery of plant and equipment. Coproduction usually makes the country-trade arrangements easier. It is also considered as transitional form towards joint legal or contractual ventures. Bulgaria not only has ventures in Bulgaria but also in Western countries, which are more common. The ventures in Western countries were mainly created for the promotion of mutual trade. Mainly, these companies deal with marketing, advertising, and distribution of export goods. By 1989, there were 20 joint ventures registered, including the firms in Bulgaria and those in the country of the Western partner. Some examples of these companies in Bulgaria are Systematics and APV-Bioinvest.
The joint ventures stabilize faster and provide services for Bulgarians to which they might otherwise not have access. This contributes to the stabilization of these companies in the domestic markets. Also, Bulgaria is able to gain a better position in the foreign market. It normally takes five years for these firms to show profit.
In 1980 joint ventures with foreign participation were allowed in Bulgaria by Decree No. 535. This stated that the joint ventures were part of the Bulgarian economy but not subject to regulations valid for all other socialist business organizations. In order to stimulate foreign investment, the joint ventures were divided into two groups. The first group of companies were required to obtain permission from the Ministry of Economy and Planning and the Ministry of Foreign Economic Relations. The second group had smaller foreign shares and functioned as all other national companies. The first group of companies were to pay 30 percent of their profits in tax while the smaller group were to pay 50 percent. To promote foreign investment, a firm can be in some cases exempt from taxes for 5 years.
Today, joint ventures are allowed to build on state-owned land with permission of the Ministry Council. It is possible to have a company fully owned by a foreign investor. Of course, they need the permission of the Ministry Council and at least 50 percent of the employees must be Bulgarians.
The hope of these joint ventures is to improve the standard of living in Bulgaria. Also, these joint ventures should give the Bulgarians insight on how a firm in a market economy operates. They should also be beneficial to the managers who are accustomed to associating the success of the firm with simply meeting the production targets.