In the context of conventional factors, such as production cost, market demand, resource acquisition, and others, investors weigh up the risks and uncertainties of potential investment locations. Although there are unique factors to each investment decision, making patterns difficult to discern, country level data can help in understanding how investment flows have varied and how they relate to some variables that are available to potential investors. Such data includes risk, corruption and an index of development compiled to compare countries on social, environmental and economic conditions (UNDP Human Development Report). These rankings can help to create an image of attractiveness (or lack thereof) for countries that might be considered potential investment targets, and aggregate flow patterns associated with countries’ relative positions on these measures should be expected.

Risk perceptions


Foreign investment has been an important strategy for Russia and other post-socialist countries as they move toward market economies and join global markets. Rates of FDI into these countries have not been uniform, however, and the differences are related to perceptions of risk and corruption, the development index ranking and other conditions unique to each country. With only 10 years of investment activity and, in the case of Russia, a major financial crisis that disrupted investment activity, the transition is still in progress and investment patterns could change in the future. Many experts consider Russia to be the ultimate destination of FDI when the inhibiting factors are corrected.

At the country level, growth in FDI can be measured in total value of inward investment and in net flows. In Russia and the central and eastern European (CEE) countries, inward flows are important and have been closely watched the 1990s. Annual inward investment flows of FDI for CEE countries during 1995-2003 are shown in table 1.

The total value of investments since 1995 has been highest in Poland, Czech Republic, Russia and Hungary. The relative size of these economies varies greatly, however, and it is important to look at FDI in terms of country size measures. Some smaller countries, such as Estonia, have emerged as leaders on an investment per-capita or per-GDP basis. The total investment numbers fluctuate by year reflecting the timing of inflows and this is more evident in smaller countries: for example, Macedonia’s increase in FDI for 2001 when major social capital firms (including banks and telecoms companies) were sold to foreign investors. Such sales have occurred in all CEE countries, including Russia, during the 1990s.

Russia lags behind

Russia stands out in the group of transition countries. Despite its large size, strong market potential and large inventory of natural resources, it has lagged behind neighbouring countries in FDI on both a per-capita and per-GDP basis, and its limited FDI activity has been concentrated in the two cities of Moscow and St Petersburg. Russia’s relative FDI measures place it near the bottom of the countries compared here, along with Ukraine, Belarus and Serbia and Montenegro. Reasons for such a low level of FDI activity correlate with some other indicators that might influence investors’ decisions about where to invest and how much to invest.

All of these countries received more FDI per capita in 2003 than they did in 1995, with the exception of Russia (its FDI per capita was low in both years with only modest growth). The financial crisis of August 1998 can explain part of this lack of investment, along with factors related to Russia’s image (that is, perceptions of risk).

Risk measurement

Three measures of business conditions vary among the countries considered here. The first measure is risk, meaning business risk associated with investing in a particular country. Most risk rankings include economic, political, legal and infrastructure risks, and are based on surveys of multinational corporate personnel. The key risk factors revealed in these studies with regard to newly independent and CEE countries are in the early 1990s shown in box 1.

In the early transition period, investment patterns had a geographic dimension reflecting both physical distance and ‘psychic’ distance, which resulted in a west-to-east pattern throughout the region. Companies perceived risk as inversely related to distance and were influenced by any history of involvement in trade during the command economy that might have offset risk perception through familiarity.

Using the UN measure as one example of risk perception assigned to countries, the comparison with FDI for countries in the region (see table 2 below) shows a relatively strong negative relationship between risk ranking and FDI per-capita. Russia is not in a favourable position relative to other investment opportunities in the region, and neither are its neighbours, Belarus and Ukraine. Russia’s high-risk position must therefore be offset by potential opportunities that exceed those in competing and ‘safer’ investment locations.

Czech Republic, Estonia, Hungary, and Slovenia are examples at the opposite end of the scale that have achieved positive images through various means. They are also closer to the west in both physical and perhaps psychic distance, giving them the geographic advantage of cross-border investment opportunities from neighbouring EU countries such as Germany, Finland and Austria.

Corruption data

An obvious factor related to the risk ranking is corruption, and its association with political and legal risks. Corruption is a broad concept that takes different forms in practice, but commonly expressed problems have focused on bribe-taking by customs officials and other government agencies in charge of licences, permits and other aspects of commerce. Criminal activity and ‘mafia’ problems were also important in the early years, but these became much more manageable and therefore less important problems than the more insidious political corruption. As expected, corruption rankings vary also within the region and are similar to risk perceptions (see table 2 below).

Countries with a high corruption ranking (1 = most corrupt) have generally lower FDI per capita. Among these countries, Russia has a strong negative image compared with the leading FDI host countries, such as Estonia and Slovenia. Other factors are obviously important, as indicated by the large difference in FDI between, for example, Czech Republic and Latvia or Bulgaria, which have similar rankings on corruption but vastly different FDI measures.

Although these risk and corruption indices are based on perceptions, they reflect the important image and opinions that investors have formed for various reasons during the transition period. To be successful in the highly competitive arena of FDI attraction, potential host countries must pay attention to these rankings and work to improve their position. A strong negative image must be either improved or offset by superior potential economic benefits to attract investors in the future.

Development index

Another aspect of image and business attraction potential is measured by the human development index. This shows a combination of development indicators that measure infrastructure and human capital along with other characteristics of countries that are relevant to investors. Ranking on this index is inversely related to FDI per capita and countries are distributed in a similar order to risk and corruption (see table 2 below). The relatively disadvantaged countries of Russia, Ukraine, Belarus, Moldova, Albania and Romania are offset by the leading FDI countries of the region, as in earlier comparisons. The more empirical measure of development index correlates with risk and corruption.

A multiple regression with all three variables in the model (risk, corruption and development index) resulted in a value of R = .79. In the multivariate model, country risk ranking dominates, followed by development index and then corruption ranking.

Country image

It is clear that FDI per capita has varied and has probably been influenced by country image measures in this region. Image is not the only factor, however; other conditions, such as experience and economic factors, prevail in FDI decisions. Yet these data suggest that other considerations are filtered by an image of risk and corruption as companies make investment decisions in the CEE and former Soviet countries.

In many early studies of western FDI into the post-socialist CEE countries, and especially in the Baltic region, a common understanding was that Russia was the big market of the future and that FDI would gravitate there when the time was right. That time seems to have arrived, as FDI flow volumes are increasing. Major manufacturing and construction projects involving American, European and Asian investors have been important in Russia, despite recent evidence from a World Bank survey that Russia’s corruption problem has increased since 2002. Perhaps if Russia’s corruption and related risk factors can be reduced, it would do even better in the competition for FDI in future years.

Harley Johansen is professor of geography at the University of Idaho in the US.


Economic risks:

Despite actions by governments to remove risks – for example, insurance, investment guarantees, etc – problems expressed include:

  • Inflation
  • Rising prices
  • Convertible currency problems
  • High taxes
  • Weak financial institutions
  • Inadequate accounting standards
  • Cheque clearing delays

Legal risks:

  • Unclear foreign investment laws
  • Lack of clear legal criteria for denial or approval of FDI
  • Rules and restrictions on amounts and sectors of FDI
  • Cumbersome licensing laws and approval steps
  • Changing laws, often inconsistent with existing laws
  • Ambiguous legal protection

Political risks:

  • Political instability
  • Political decisions or events, effect on profits
  • Fear of expropriation
  • Limited insurance available for political risks to FDI

Infrastructure risks:

  • Inadequate transportation and communication services
  • Poor road conditions and equipment (increases costs)
  • Telecommunications unreliability

Investors’ responses to risk:

  • Limiting volume and direction of investment
  • Hedging strategies, diversifying holdings across countries
  • ‘Suboptimal’ investment pace resulting from risks or restrictions