The hit parade of foreign investment in Europe shows that FDI flows are moving east. The combination of cheap and often highly skilled labour, low taxation and attractive incentives is changing perceptions of the newly developing economies of central and eastern Europe.

The 2005 Ernst & Young European Attractiveness Survey, released at the World Investment Conference in La Baule this summer, revealed the scope of the new trend. In all, 52% of international business executives surveyed regard this ‘new Europe’ as the top destination for expected investments over the next three years.

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Western Europe is still fighting. At present, developed economies retain a 63%-55% lead in terms of attractiveness perceptions. The Ernst &Young Investment Monitor, which tracks projects already realised, shows that the UK and France managed to maintain their positions as the top FDI destinations in Europe. But Poland and Hungary are now among the top five, with the former barely behind third-ranking Germany in terms of market share.

Taken together, central and eastern European countries (including Russia) tapped an impressive one third of world investment in Europe in 2004. James Turley, CEO of Ernst & Young, says: “Investors are drawing a new map of Europe, which is extending to the east.”

If that were not worrying enough for western European countries, the new shape of FDI going into central and eastern European locations provides even more grounds for concern. These countries no longer want to be low-cost workshops and are evolving into sophisticated investment markets with growing potential.

Economy ministers and other high-ranking officials interviewed by fDi are aware that labour costs are bound to increase and so they are determined to go for higher-value-added projects in high technology, biotech and research and development (R&D).

Better paid jobs

Competition with western European countries, which regard innovation as the best way to keep high-paying jobs that require highly qualified labour inside their borders, seems unavoidable.

Hungary’s minister of economy and transport, János Kóka, sums up the appeal of locating in countries such as his: “You will find the same cost as south-east Asia but with the political stability of western Europe.”

The Czech Republic, which boasts the highest percentage of FDI per capital ($4100) of all economies in transition, is well along the path of snatching R&D investments away from the West. Martin Jahn, the charismatic, 35-year-old deputy prime minister for economic affairs, believes his country’s competitive advantage is evolving. “Labour costs are going up. Manufacturing will not be the cheapest option in the Czech Republic any more. World companies are no longer investing so much in production but in sophisticated services and R&D. FDI is moving up in the value chain and we are very pleased about that,” he says.

 

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Martin Jahn: deputy prime minister for economic affairs, Czech Republic

 

Investment boost

R&D projects are creating a wealth of highly skilled jobs in a country that is building on its increasingly tech-savvy labour force by boosting investment in R&D by 15% a year. Honeywell, for example, established its first R&D unit outside the US in Prague in the 1990s. In Brno, the country’s second largest city, the company has recently opened a new, state-of-the-art Global Design Center that employs 150 engineers.

Matsushita is hiring about 160 electronics and electrical engineering experts, as well as industrial software developers and programmers, in its new development centre in Plzen, which will concentrate on advanced television technology for Panasonic. Rockwell Automation is already employing 50 researchers in its R&D centre in Prague.

The qualifications of the Czech workforce are a draw but attractive incentives offered by the government add to the country’s R&D appeal. Companies investing in technological centres (R&D units for the conception and production of innovative products) can obtain subsidies covering half of investment costs for up to 10 years. Investors can obtain subsidies for personnel training and education as well. This year, the Czech parliament adopted an amendment of the income tax law stipulating the deduction of 100% of R&D expenditures from the tax base.

Even before the Czech Republic joined the EU in 2004, the government took great pains to negotiate with European authorities so that these incentives would be deemed compatible with EU law. Officials at CzechInvest, the investment and business development agency, say they have been able to reassure international investors that these advantages will not be compromised.

Scientific excellence

Hungary is also emerging as a formidable competitor to western European countries for FDI in high-value-added projects. The country is on a roll in terms of inflows. In 2004, Hungary attracted $3.4bn of foreign capital. This year is shaping up even better: during the first quarter, the country recorded $1.1bn in foreign inflows, a 40% increase over the previous year.

Much like the Czechs, the Hungarians trumpet a tradition of scientific excellence. Eleven of their scientists have won the Nobel Prize for their work abroad. They have renowned universities. The Science, Technology and Industry Scoreboard of the Organisation for Economic Co-operation and Development ranks Hungary sixth among the top 20 countries that are best placed to develop high-tech industries.

Most major multinationals already have a presence in Hungary. Some were there even before the fall of the Berlin Wall. In future, greater efforts will be placed on attracting small and medium-sized companies and on grabbing projects in services and R&D. Multinationals are using Hungary as a base to develop products for the wider region, and indeed for the world.

Tax incentives

The Hungarian government does not hold back on incentives either, ranging from a 100% R&D corporate tax credit on R&D investments to tax-free employment for PhD or MBA students who wish to work in research activities.

Projects are pouring in. Sweden’s Ericsson was among the first to establish an R&D centre in Hungary, where it evaluates the performance of complex networks. Company officials say Hungary has what it takes to make R&D work: technical quality of the workforce, reasonable costs and efficient operations. Audi, General Motors, Michelin, Samsung and Cisco are also conducting R&D in Hungary.

Hungary believes it can afford to be choosier about its FDI inflows than most other countries in the region. Speaking to fDi at the BIO 2005 event in Philadelphia, where he had travelled to try to drum up some biotech investment, Mr Kóka says: “If you look at neighbouring countries, Slovakia and Poland, for example, are going for every type of investment. But we are in a position to be selective.”

Being selective also means being realistic. “We are a small country – we can’t have dozens of strategic fields,” he says. So Hungary is focusing on attracting investment in seven key sectors, including biotech, information technology, logistics and environmental technology.

For biotech especially, being a latecomer offers the advantage of being able to learn from others’ successes and failures. “We can look at models where biotech worked, like in the US, and where it didn’t, like in France,” he says.

Latvian growth

For the less populated (2.3 million) but fast-growing Latvia, foreign investment is critically important. FDI accounts for 30% of GDP. Capital inflows have been the main engine of growth: 7% a year for the past seven years, one of the highest rates in Europe. Since the country joined the EU, FDI inflows have doubled.

Yet Latvia, too, is becoming more discriminating. Artur Krisjanis Karins, the Latvian minister of economy, says that because of a lack of cash, the country has under-invested in R&D. But this is changing fast.

 

 

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Artur Krisjanis Karins:'We want to be net contributors to the EU'

 

“A lot of investments in the past have been in low-value-added manufacturing because of our low costs of land, energy and labour. We know this will not last. Costs will go up to the European level. This is why we are putting a lot of money in R&D and education so that we can transform the very basis of our competitiveness,” he says.

Last April, the Latvian parliament adopted a law on scientific activities, stipulating that the country will accomplish the Lisbon objectives and bring R&D spending up to 3% of GDP by 2010. Expenditures are already expected to go up by 20% in 2004 and will increase by 87% next year due to multiple projects in new research institutes, fundamental and applied research, and the creation of a Science Agency. Because Latvia is a small country, the government encourages international partnerships. The Biomedical Research and Study Centre of the University of Latvia, for example, has research contracts with European biotech companies such as Cytos Biotechnology and Medeva Pharma. Grindex, the largest Latvian pharmaceutical producer, actively collaborates with US companies such as Johnson and Johnson.

Latvia’s success in attracting FDI has much to do with its aggressive policies to stimulate business growth. Corporate taxation is down to 15%. There is no secondary tax on dividends. Any company registered in the country can apply for EU structural funds even if it is 100% foreign-owned.

Are the central and eastern Europeans competing unfairly? Profound resentment over what is perceived as social and fiscal dumping was a major reason for France’s rejection of the European constitution. Similar feelings are voiced in other countries, too.

Officials from central and eastern Europe are unimpressed by these arguments, however. “If we do not grant these advantages, we will not grow. If we do not grow, we will be a burden. We do not wish to be a burden; we want to be net contributors to the EU,” says Mr Karins.

Corporate tax

Others, like Mr Jahn of the Czech Republic, point out that the world is open now and that they are not just competing with other European countries. “We face strong competition from China, Russia, Ukraine. The old Europe needs the new Europe to grow,” he says.

If anything, countries plan to push their advantages even further. The Hungarian corporate tax is 16%; the government is going to bring it down to 10% for small companies and start-ups. “If we do not make these changes, we will lose,” says Abel Garamhegyi, state secretary at the Hungarian economics ministry.

Despite the frustration, western European economies will have to adapt to yet another challenge – this time the one presented by their eastern neighbours.