Foreign Direct Investment in the Successor States of Yugoslavia: A Comparative Economic Geography 25 Years Later [1st ed.] 9783030557386, 9783030557393

Table of contents :
Front Matter ....Pages i-ix
Overview of Foreign Direct Investment in Former Yugoslavia and Related Scholarly Literature (Joel I. Deichmann)....Pages 1-21
FDI in Serbia (Ivan Ratkaj, Mikica Sibinović, Emilija Manić)....Pages 23-50
FDI in Croatia (Josip Tica, Tomislav Globan, Marin Levaj)....Pages 51-77
FDI in Slovenia (Simon Kušar)....Pages 79-107
FDI in Bosnia & Herzegovina (Almir Peštek, Lejla Lazović-Pita, Ademir Abdić)....Pages 109-139
FDI in North Macedonia (Rufi Osmani, Lorik Ahmeti)....Pages 141-166
FDI in Montenegro (Danijela Jaćimović, Maja Ivanović, Sunčica Rogić)....Pages 167-194
FDI in Kosovo (Kyle Conahan, Joel I. Deichmann, Besnik A. Krasniqi, Florin Peci)....Pages 195-212
Conclusions and Prospects for the Next Quarter Century (Joel I. Deichmann)....Pages 213-226

Citation preview

Economic Geography

Joel I. Deichmann   Editor

Foreign Direct Investment in the Successor States of Yugoslavia A Comparative Economic Geography 25 Years Later

Economic Geography Advisory Editors Dieter Kogler , UCD School of Architecture, Planning & Environmental Policy, University College Dublin, Belfield, Dublin, Ireland Peter Dannenberg , Geographisches Institut, Universität zu Köln, Cologne, Nordrhein-Westfalen, Germany Nuri Yavan , Department of Geography, Ankara University, Ankara, Turkey Päivi Oinas , Turku School of Economics, University of Turku, Turku, Finland Michael Webber , School of Geography, University of Melbourne, Carlton, VIC, Australia David Rigby, Department of Geography, University of California Los Angeles, Los Angeles, CA, USA

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Joel I. Deichmann Editor

Foreign Direct Investment in the Successor States of Yugoslavia A Comparative Economic Geography 25 Years Later

Editor Joel I. Deichmann Global Studies Department Bentley University Waltham, MA, USA

ISSN 2520-1417 ISSN 2520-1425 (electronic) Economic Geography ISBN 978-3-030-55738-6 ISBN 978-3-030-55739-3 (eBook) https://doi.org/10.1007/978-3-030-55739-3 © Springer Nature Switzerland AG 2021 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Publisher’s note: Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. In this volume, Kosovo is treated as a geographic territory without prejudice to status, in line with United Nations Security Council Resolution 1244/1999 and the International Court of Justice opinion. For more information, please see https://ec.europa.eu/neighbourhood-enlargement/ sites/near/files/20190529-kosovo-report.pdf This Springer imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Preface

Approximately one quarter century since the outset of transition in Yugoslavia’s successor states, this volume advances scholarly understanding of foreign direct investment (FDI) in the region by bringing together in a single volume expertise by scholars from across the former federal republic. Chapter 1 provides an introductory comparative overview for the seven geographic entities, including Serbia, Croatia, Slovenia, Bosnia & Herzegovina, North Macedonia, Montenegro, and Kosovo, then summarizes some key papers in the theoretical and empirical literature on FDI to the region. In the following seven chapters, the contributing scholars examine the temporal dynamics, national origins, and location choices of investors from abroad over the past 25 years, loosely following John Dunning’s (1980) eclectic framework. They highlight mode of entry, industrial composition, and other features of contextspecific relevance. They then clarify the major trends in FDI in their respective countries, as well as prospects for future FDI inflows. Each contributed chapter concludes with a discussion of the outlook for FDI with regard to economic growth projections, EU integration expectations, and other country-specific insights by the authors. The final chapter sums up the geographic trends across the region based upon the authors’ contributions and speculates on prospects for FDI considering rising trends and subject to unpredictable events such as international conflict, the Global Financial Crisis, and the COVID-19 pandemic. The chapters in this book are organized in order of cumulative FDI value as of 2018: Serbia, Croatia, Slovenia, Bosnia & Herzegovina, North Macedonia, Montenegro, and Kosovo. This interdisciplinary and international author team was in order to provide the first comprehensive scholarly volume on the economic geography of FDI flows to the former Yugoslavia. Contributing authors include scholars from across former Yugoslavia, representing the faculties of some of the region’s most prestigious academic institutions. The Serbian authors include Ivan Ratkaj, Mikica Sibinovi´c, and Emilija Mani´c at the University of Belgrade’s Faculty of Geography. The Croatian team, from the University of Zagreb Faculty of Economics and Business, is composed of Josip Tica, Tomislav Globan, and Marin Levaj. Simon Kušar in the Department of Geography at the University of Ljubljana contributes our chapter on Slovenia. Bosnian authors include Almir Peštek, Lejla Lazovi´c-Pita, v

vi

Preface

and Ademir Abdic at the University of Sarajevo’s School of Economics and Business. The North Macedonian team is composed of Rufi Osmani and Lorik Ahmeti at Southeast European University. FDI insights from Montenegro are contributed by Danijela Ja´cimovi´c in the Faculty of Economics at the University of Montenegro, along with her research assistant Sunˇcica Rogi´c and Maja Ivanovi´c (Central Bank of Montenegro). The chapter on Kosovo was developed by an international team of Kyle Conahan of James Madison University, Besnik Krasniqi from the University of Pristina, Florin Peci from University Haxhi Zeka, and the editor of this volume. I would like to thank all of the contributors, and especially the authors who committed to the project in its formative stages. These include Josip Tica (Croatia), Mikica Sibinovi´c (Serbia), as well as Ivan Ratkaj (Serbia), the latter of whom provided a face-to-face forum for the team to meet and discuss our research at CATference Belgrade 2019. Lejla Lazovi´c-Pita (Bosnia and Herzegovina) joined the project on particularly short notice. I would also like to acknowledge Monica Schwarzhappel at the Vienna Institute for International Economic Studies, who has assisted generously not only with data, but also with punctual and reliable answers to my questions related to this and other research projects on FDI in Central and Eastern Europe. In addition, I greatly appreciate the financial support of Bentley University in making it possible for me to travel to the Balkans twice to meet with members of the author team. Above all, I am grateful to my amazing wife Karen and our children Charlie, Isabela, and James for their support and interest in my work. This book is dedicated to the memory of my parents Charles and Alice Deichmann, and my sister Rachel. Nashua, NH, USA October 2020

Joel I. Deichmann

Contents

1 Overview of Foreign Direct Investment in Former Yugoslavia and Related Scholarly Literature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Joel I. Deichmann

1

2 FDI in Serbia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ivan Ratkaj, Mikica Sibinovi´c, and Emilija Mani´c

23

3 FDI in Croatia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Josip Tica, Tomislav Globan, and Marin Levaj

51

4 FDI in Slovenia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Simon Kušar

79

5 FDI in Bosnia & Herzegovina . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 Almir Peštek, Lejla Lazovi´c-Pita, and Ademir Abdi´c 6 FDI in North Macedonia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141 Rufi Osmani and Lorik Ahmeti 7 FDI in Montenegro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 Danijela Ja´cimovi´c, Maja Ivanovi´c, and Sunˇcica Rogi´c 8 FDI in Kosovo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 Kyle Conahan, Joel I. Deichmann, Besnik A. Krasniqi, and Florin Peci 9 Conclusions and Prospects for the Next Quarter Century . . . . . . . . . . 213 Joel I. Deichmann

vii

About the Editor

Joel I. Deichmann Ph.D. is Professor of Geography in the Global Studies Department at Bentley University in Waltham, Massachusetts, USA. He earned his Ph.D. from the University at Buffalo in 1999 after completing his B.A. in Geography at SUNY Geneseo (1993) and M.A. in Geography at the University of Cincinnati (1995). His has published extensively on geographic aspects of foreign direct investment, international tourism, and economic convergence. His regional focus is Central and Eastern Europe, where he has lived and traveled widely. Professor Deichmann’s travel book entitled Passion for Place: Embracing Global Wanderlust was published by 1st World Publishing in 2015. He teaching specialties include Globalization, Global Regions, the Geography of Europe, and Comparative Government and Politics. Several of these courses have been offered as short-term travel programs to locations throughout Central and Eastern Europe.

ix

Chapter 1

Overview of Foreign Direct Investment in Former Yugoslavia and Related Scholarly Literature Joel I. Deichmann

Abstract In setting the stage for analysis, this chapter provides an overview and comparison of FDI across the former Socialist Federal Republic of Yugoslavia (SFRY). The territories considered include Bosnia and Herzegovina, Croatia, Kosovo, Montenegro, North Macedonia, Serbia, and Slovenia. The chapter then examines the most important scholarly literature on determinants of FDI in transition economies of Central and Eastern Europe (CEE), with special emphasis on the geographic coverage of this book. Next, recognizing the potential differential effects of FDI, some key findings on its positive and negative economic impacts are discussed. Finally, the data used in this volume are introduced and critiqued with reference to their merits and limitations. Within this discussion, the growing phenomenon of offshoring is considered as an impediment to a robust understanding of FDI, as is the recent acceleration of divestment by multinational enterprises (MNEs), a phenomenon that has emerged since the global financial crisis (GFC) and is likely to continue as the economic effects of COVID-19 play out. Keywords FDI · Transition economies · Former Yugoslavia · Southeastern Europe

1.1 Introduction Foreign direct investment (FDI) can be defined as a cross-border transaction by which an enterprise resident in one country establishes an interest of at least ten percent of value as well as significant influence over an enterprise resident in another country (OECD 2019). FDI is the main mode of international operation by multinational enterprises (MNEs), as well as an important element of globalization (Dicken 2015). FDI is widely regarded as a potential engine for economic growth, especially in transition countries that lack sufficient domestic capital (Hunya 2000a; Alfaro 2017; Estrin 2017). UNCTAD (2018) reports that global FDI flows totaled $1.43 trillion

J. I. Deichmann (B) Global Studies Department, Bentley University, Waltham, MA, USA e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_1

1

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J. I. Deichmann

in 2017. Given the recent of FDI around the world, the importance of understanding the factors that attract and inhibit FDI is crucial. FDI can be instrumental for host countries in general (Balasubramanyam et al. 1999; Dicken 2015) and for Europe’s “transition economies” in particular (De Mello 1999; Hunya 2000a; Dunning 2008, 1994; Estrin 2017) in promoting economic growth, employment, and productivity, albeit in some cases more than others. This is not to argue that all FDI is inherently good for the host economy, and critical literature calls into question any assumption that its net effect is necessarily positive (Pavlinek 2004; Alfaro and Charlton 2018). The impacts of FDI are numerous and complex, and often depend upon features including but not limited to its origin country (DeMello 1999), its industrial composition (Pavlinek 2004; Estrin and Uvalic 2016), and the destination itself (Ford et al. 2008). FDI in the post-communist countries was negligible during the early 1990s until liberalizing reforms in some countries began to take effect and open the floodgates to foreign capital, mainly through the privatization of public entities. Dunning (2008, 185) observes that “technological advances and sweeping changes in the global economic scenario have no less influenced the country-specific opportunities and challenges affecting the pull of FDI; and none so much as those within the transition economies of Central and Eastern Europe.” As a subset of countries within this rapidly changing region, the Balkans (and particularly SFRY) have received less scholarly attention than the well-known cases of Poland, Czechia, and their neighbors. The benign neglect of the Balkan region and particularly the successor states of SFRY is noted by Demekas et al. (2007) and Estrin and Uvalic (2014), providing a strong justification for this volume. Moreover, in support of this geographic perspective on FDI are repeated supplications by other scholars, including Dunning (2009) and Dicken (2015), who emphatically underscore the importance of location as essential for a robust understanding of FDI. Scholarship on the political and economic transition of the region offers an excellent portrayal of the comparative investment environments of successor states (Bartlett 2009; Cvii´c and Sanfey 2010) but pays scant attention to the accumulation of FDI, one of the transition’s important results. Perhaps this dearth of research on the activities of MNEs reflects the late start these countries experienced vis-à-vis their competitors in East Central Europe in the aftermath of a series of wars on their territory (Slovenia, Croatia, BiH, Kosovo), as well as subsequent exclusion from the global economy due to sanctions and embargoes (Serbia, Montenegro, North Macedonia) by key economic players in Europe and elsewhere. It is also plausible that scholars have thus far avoided any comprehensive study of FDI in the region due to its complexity, the difficulty of obtaining data, remaining uncertainties concerning politics and economic integration, and the delicate relations between Yugoslavia’s successor territories, which remain a daunting challenge to address.

1 Overview of Foreign Direct Investment in Former Yugoslavia …

3

Fig. 1.1 Map of former Yugoslavia and its neighbors

1.2 Distribution of FDI Across the Region The seven states and geographic entities of former Yugoslavia (SFRY) that declared independence at different points since 1991 include Bosnia and Herzegovina (BiH), Croatia, Kosovo,1 North Macedonia, Montenegro, Serbia, and Slovenia. These seven territories (Fig. 1.1) share considerable political and economic history, joined first as the Kingdom of Serbs, Croats, and Slovenes in 1918, then as Yugoslavia until WWII, and as SFRY until 1991. Although culturally heterogeneous, important similarities such as language, alphabet, and religion remain across two or more of today’s entities. For example, Croatian, Bosnia, and Serbian tongues are mutually intelligible, although they are considered distinct languages. The Cyrillic alphabet prevails in Serbia, Montenegro, and portions of BiH, while most of the other territories favor Latin characters. Slovenia and Croatia are predominantly Catholic, with Orthodox Christianity dominating Serbia, North Macedonia, Montenegro, and the Republika Srpska in BiH. Islam is most common in Kosovo and portions of North Macedonia. Arguably, BiH stands out as a microcosm of the former SFRY, with the most internal cultural heterogeneity among its successor states. 1 The

authors treat Kosovo as a geographic territory without prejudice to status, in line with United Nations Security Council Resolution 1244/1999 and the International Court of Justice opinion. For more information, please see https://ec.europa.eu/neighbourhood-enlargement/sites/near/files/201 90529-kosovo-report.pdf.

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J. I. Deichmann

Table 1.1 Comparative data on territories of former Yugoslavia Area (km2 )

Population 2018 (mil)

GDP 2018 (e)

GDP growth

EU status

GCI 2017

EDB rank 2018

CPI 2018

BiH

51,197

3.232

10,810

3.13

–

54.2

89

38

Croatia

55,960

4.089

20,031

3.03

2017

60.1

58

48

Kosovo

10,887

1.845

6695

4.14

–

N/A

44

37

Montenegro

13,450

0.622

4620

4.17

(2010)

56.6

10

37

N. Macedonia

25,220

2.082

11,426

1.91

(2005)

59.6

50

45

Serbia

87,460

6.982

13,589

3.23

(2012)

60.9

48

39

Slovenia

20,142

2.067

27,747

4.15

2004

69.6

40

60

Sources World Bank (2019), World Economic Forum (2019), Transparency International (2019). GDP growth is the average of 2016–2019. GCI global competitiveness index, EDB ease of doing business, CPI corruption perceptions index 2018. Accession or (YEAR) indicates EU candidate timing (European Commission). For current status, visit https://ec.europa.eu/neighbourhood-enl argement/

Each of the geographic entities examined in this volume is substantively unique from all of others, making the region one of utmost heterogeneity. As a starting point for comparing the countries and their capacities for attracting FDI, it is worthwhile to examine some basic social and macroeconomic indicators (Table 1.1). Populations range from 622,000 (Montenegro) to 6.982 million (Serbia), and dramatically different physical and human geographies characterize each entity. Among their other differences is a wide range of income levels from EUR 4620 in Montenegro to EUR 27,747 in Slovenia. Each state has fared very differently, both at the national scale and the local scale, during periods of military conflict as well as the global financial crisis (GFC). Concerning economic integration, Slovenia and Croatia have already become EU members, while North Macedonia, Montenegro, and Serbia are candidates, and the EU has officially recognized the remaining two entities as “potential” candidates. Following other research comparing FDI host environments (Bartlett 2009; Toskovi´c et al. 2016), Table 1.2 reports the global competitiveness index (GCI) and east of doing business (EDB) rankings across former Yugoslavia. In terms of national competitiveness (World Economic Forum 2019), Slovenia (69.6) is in the best position, followed by Serbia (60.9) and Croatia (60.1). With regard to the World Bank’s (2019) ease of doing business (EDB) score, Montenegro stands out from its peers despite being the smallest country examined in this book, ranked 10th globally (the next highest is Slovenia at #40). Toskovi´c et al. (2016) attribute this attractive environment to the protection of economic freedom and maintenance of a stable currency. Given the prevalence of the informal sector across the region, the countries’ most recent corruption perceptions indices (CPI) are provided. The most recent results of this Transparency International survey2 place Slovenia far above most of 2 For

more information, please visit www.transparency.org.

1 Overview of Foreign Direct Investment in Former Yugoslavia …

5

the region with a score of 60/100, followed by Croatia (48/100) and North Macedonia (45/100). These measures highlight the competitive environments of the territories, reflecting some potential aspects of attractiveness for MNEs. Since 1991, when Yugoslavia ceased to exist as a federation, its successors have pursued unique paths toward political and economic transformation. Cvii´c and Sanfey (2010) provide a systematic overview of the former SFRY states from a historical perspective, tracing events in the region back to World War II (WWII). Replication of their detailed analysis would be both tedious and beyond the scope of this book. Nevertheless, inherited conditions largely beyond the control of decisionmakers, as well as country-specific development strategies have resulted in a range of current business environments presented in Table 1.1. With the notable exceptions of Slovenia and Croatia, the countries in this book exhibit lower incomes, higher unemployment rates, and more widespread corruption than most other transition states of CEE. These place-specific circumstances, and the political and economic integration and disintegration of SFRY, along with multifaceted cultural and economic ties between successor states and external actors, help explain different levels of success in attracting FDI. Table 1.2 offers alternative comparative measures of FDI intensity over the bulk of the period since Yugoslavia’s disintegration. Scholars use several yardsticks of FDI to assess the phenomenon (Janicki and Wunnava 2004). Most typically, they focus either on total value or the number of transactions that take place. The choice of variable usually depends upon data availability as well as the purpose of analysis. The value of FDI (as well as value as a proportion of GDP) is most useful when examining the impacts of FDI, as the central issue of concern tends to be economic spillovers. Spillovers from greater FDI values have the potential to be more significant, so values are the primary unit of analysis in this book. Other research focusing exclusively upon the location decision itself often examines the number of transactions, either as a continuous integer or a binary variable of whether FDI at a destination occurred during a given period (Deichmann et al. 2020). Table 1.2 FDI indicators for former Yugoslavia Entity

Cumulative 2018 Cumulative 2018 2018 FDI inflow 2018 inflow as % (mil EUR) as % of GDP of GDP

Serbia

28,209

81.3

3495.1

8.2

Croatia

22,345

55.8

982.2

1.9

Slovenia

15,152

32.1

1201.0

2.6

BiH

7309

41.6

396.3

2.3

North Macedonia 5307

48.5

624.5

9.0

Montenegro

4626

99.6

414.8

5.8

Kosovo

3692

55.1

213.7

3.3

Source WIIW (2019)

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J. I. Deichmann

In terms of total cumulative value, Serbia, Croatia, and Slovenia are former Yugoslavia’s three leading FDI destinations. With regard to cumulative FDI relative to the size of the domestic economy, Montenegro has been most successful, with enormous implications for its economy (see Ja´cimovi´c, Rogi´c and Ivanovi´c, Chap. 7). Serbia had the highest inflow in 2018, followed by Slovenia, Croatia, and North Macedonia. Relative to the size of its own economy, North Macedonia attracted the most considerable relative amount in the year 2018 (see Osmani and Ahmeti, Chap. 6). Figure 1.2 demonstrates spatially that the FDI landscape has become dominated by the larger states of the former SFRY, specifically Serbia (EUR 28.2 billion) and Croatia (EUR 24.3 billion), followed by Slovenia (EUR 15.2 billion). At the time of writing, these are the most recent data available, although they are subject to calculation corrections and adjustments as some investments are periodically reversed. In the chapters that follow, contributing scholars also offer year-specific insights on withdrawn FDI at the subnational scale, as exemplified in the case of Croatia by Tica, Globan and Levaj (Chap. 3). Figure 1.3 portrays comparative annual fluctuations in FDI value during the time period under investigation. Inflows were negligible at the turn of the century as the

Fig. 1.2 Spatial distribution of cumulative FDI through 2018 across former Yugoslavia. Source WIIW (2019)

1 Overview of Foreign Direct Investment in Former Yugoslavia …

7

Bosnia & Herzegovina 4500.0

Croaa Montenegro North Macedonia

3500.0 Serbia Slovenia Kosovo

2500.0

1500.0

500.0

01

02

03

04

05

06

07

08

09

10

11

12

13

14

15

16

17

18

-500.0

Fig. 1.3 Annual inflows of FDI to former Yugoslav territories since 2001 (EUR million). Note Country codes are as follows: Bosnia and Herzegovina (BA), Croatia (HR), Kosovo (XK), North Macedonia (MK), Montenegro (ME), Serbia (RS), and Slovenia (SI). Source WIIW (2019)

region emerged from the aftermath of conflict. Bosnia and Herzegovina continued to languish as the memory of war remained in the consciousness of potential investors, as did Croatia to a lesser degree (Brada et al. 2006). Serbia experienced the continued effects of international sanctions, even long after changes were made in its government and those restrictions were lifted (Ratkaj, Sibinovi´c and Mani´c, Chap. 2). Large values for subsequent years mainly reflect corporate acquisitions that took place after major privatizations, and precipitous drop-offs beginning in 2008 correspond to the GFC. Notably, however, each of the seven destinations has managed to attract positive net FDI flows for nearly every year since 2001, except for Slovenia at the height of the financial crisis in 2009, and in 2013 (see Kušar, Chap. 4). Wild fluctuations reflect the volatility of FDI inflows, subject to privatized property availability, the irregular offering of government incentives, and other factors. Annual inflows are less than satisfactory for developing a robust understanding of FDI in the region, toward which the contributing authors of this book’s chapters lend their local insights. FDI to former Yugoslavia originates from more than 150 countries (WIIW, 2019). These multinational enterprises (MNEs) often leverage geographic or cultural advantages in their location decisions across the region (Hunya 2000b; Deichmann et al. 2020). Table 1.3 suggests the existence of MNE preference to conduct FDI in host countries with pairwise similarities, which are often locatin-related or cultural. Following Dunning’s (1980) theoretical framework of origin-specific advantages and

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J. I. Deichmann

Table 1.3 Top five origins of FDI in each destination through 2018 (EUR million)a Serbia

Croatia

Slovenia

Bosnia and North Herzegovina Macedonia

Montenegro Kosovo

Austria (3842)

Austria (5651)

Austria (3632)

Austria (1360)

U.K (740)

Italy (492)

Turkey (470)

The Netherlands (3803)

Hungary (3177)

Luxembourg Croatia (2083) (1172)

Austria (687)

Russia (491)

Germany (434)

Germany (2139)

Luxembourg Switzerland (2967) (1593)

Serbia (1035)

Greece (488)

Cyprus (264)

Switzerland (421)

Luxembourg Italy (2004) (2720)

Germany (1361)

Slovenia (550)

Netherlands Serbia (426) (251)

Austria (223)

France (1590)

Italy (1192)

Netherlands (445)

Slovenia (363)

Slovenia (266)

Germany (2301)

UAE (248)

+ reinvestment of earnings + debt instruments—valid for all countries. Based on BPM6, directional principle. Source WIIW (2019) as reported by each country’s central bank

a Equity

subsequent empirical work by Ó hUallacháin and Reid (1992), Grosse and Trevino (1996), Hunya (2000b), Bitzenis (2004), it can be expected that MNEs seek opportunities in locations where they may exercise home country advantages such as geographical proximity or market size, in addition to realizing relational advantages pertaining to familiarity with nearby markets or production processes. As an origin of FDI, Austria dominates the top four FDI recipient states in this book, while also ranking second overall in North Macedonia and fourth in Kosovo. This intense investment activity undoubtedly reflects historical legacies associated with the Austro-Hungarian Empire. Such linkages are observed throughout this book (e.g., Ratkaj, Sibinovi´c and Mani´c, Chap. 2; Kušar, Chap. 4). With very few exceptions, Austria and other EU countries represent all top five leading origins, an indication of geographic and cultural proximity, as well as the positive effects of EU economic integration on FDI inflows. The role of the EU is also evident in the observation that its members represent the origins of 83.8% of cumulative FDI stock in Slovenia and 84.7% in Croatia, the only two EU states examined in this book. As new EU members in 2004 and 2013, respectively, Slovenia and Croatia have attracted the highest proportions of FDI from MNEs based elsewhere within the EU. The EU represents 75.3% of value in North Macedonia, 73.6% in Serbia, and 66.7% in Bosnia and Herzegovina. Montenegro and Kosovo received merely 44.3 and 37.1% of their FDI stock from the EU, respectively. Notably, Montenegro’s leading origins include Russia, Serbia, and the United Arab Emirates (UAE), while the leading source of FDI in Kosovo is Turkey. It is worth also pointing out that centrally—located BiH receives considerable FDI from MNEs based in adjacent Croatia (EUR 1.17 billion), Serbia (EUR 1.04 billion), and Slovenia (EUR 550 million). Although FDI across former states of Yugoslavia is common, Bosnia and Herzegovina’s values from other successor states are exceptional in relative terms.

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Although most published scholarship on FDI in CEE is concerned with the states that emerged from the breakup of the Soviet Union as well as its satellites, many of its insights carry over to former Yugoslavia. Fundamentally, all of the countries along a broad geographic swath from Estonia to Albania share challenges associated with the political transformation from authoritarianism to various forms of democracy and the conversion of state-controlled entities to private ownership. Indeed, the pivotal events of the 1990s differed between the Western Balkans (WB)3 and the Soviet Union and its satellites, making the study of FDI particularly fascinating as an unprecedented post-communism phenomenon. Where are active MNEs in former Yugoslavia based, and how can these origins be explained? Which successor territories are favored as business locations, and why? A brief look at the mainstream literature on FDI in post-communist Europe is in order before conveying analytical insights from resident scholars in the following chapters.

1.3 Theoretical and Empirical Literature The scholarly literature informing this book includes theoretical explanations of FDI as well as empirical applications of the theories that have been used to explain the origins and destinations of FDI flows to CEE, with some attention given to the Balkan region. A considerable English-language literature on FDI in transition economies has emerged over the past twenty-five years, and some of it focuses specifically on the states of former SFRY. This brief review includes some essential research published in English as relevant to the book. In subsequent chapters, contributing authors provide additional overviews of scholarship published in their native languages as well as pertinent English-language research that is germane in their respective contexts. Although not specific to these countries, Dunning’s (1980) pioneering work is known as the eclectic paradigm or “O-L-I” framework. In this scheme, “O” represents ownership advantages, or origin-country assets, giving firms from one country a comparative advantage over firms from other countries to operate in a given context. “L” denotes location advantages that characterize the investment destination. Such advantages may include lower costs for transportation, labor, raw materials, or other considerations. Finally, “I” advantages indicate that it is preferable for a MNE to own an affiliate (through FDI) rather than licensing or trading, enabling a firm to keep its assets (such as sensitive technology) internal and safe from potential competition. Examples of empirical work employing each of the three components of Dunning’s eclectic paradigm are available in the scholarly literature. Research on ownership advantages of FDI highlights the advantages in a source country that enable or encourage its firms to operate abroad (Ó hUallacháin and Reid 1992; Grosse and Trevino 1996; Hunya 2000b; Bitzenis 2004; Deichmann 2012). In their definitive study, Ó hUallacháin and Reid (1992) use location quotients to 3 For

a detailed country-by-country report on the Balkans, see Civic´c and Stanley (2010).

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analyze FDI employment in the USA by source country or global region, including Canada, Japan, Europe, and Latin America. They find evidence that differences in familiarity with the US across origin countries help to determine the location choices of MNEs. Moreover, they discover that the knowledge accumulated by these firms derives from trade relationships, migration flows, and transportation linkages with the USA. Such advantages are considered to be “border effects” that favor firms from particular origins over others. Hunya (2000b) laments that the FDI literature fails to address adequately the important differences between origin countries impacting overseas corporate activity. He stresses that “home country patterns of FDI (in transition economies) reveal the geographic pattern of reintegration into the global economy” (p. 88). The author argues that an origin country’s economic size and geographic proximity to target markets are crucial, as are pairwise trade relationships. In his analysis of mostly Western European FDI in Central Europe, he identifies a complex link of capital, imports, and exports. With Dutch and US MNEs, the link is mainly financial. Between CEE and other transition neighbors like Russia, as well as Italy, the exchange is mainly in imports and exports rather than FDI. In a related examination of MNE origin countries, Ford et al. (2008) discover that the role of FDI in the host economy can depend upon characteristics of the home economy. Bitzenis (2004) explores determinants of FDI from the four leading sources in Bulgaria: Germany, Turkey, Greece, and Russia, which at the time represented about half the total inflows. He attributes the domination of Greek FDI in Bulgaria to a handful of large companies that moved in during the early years of transition when most western MNEs were reluctant to do so. Greek firms also enjoy the advantages of existing trade relationships and geographic proximity. Similarly, these factors, as well as Bulgaria’s strategic importance and large Turkish minority helped gain the attention of Turkish companies. The author links Russian FDI to longstanding positive relations and cultural similarities between the two countries, as well as higher uncertainty in Russia’s own business climate as “push factors” for firms to move abroad. Finally, the author suggests that unexpectedly low FDI from Germany can be linked to other opportunities closer to home, in countries such as Poland, Hungary, and the Czech Republic. Grosse and Trevino (2005) examine the impact upon FDI of efforts by CEE host countries to build institutions to promote it. Looking at ten variables across thirteen economies from 1990 to 1999, their regression models reveal that corruption and political risk are both deterrents to FDI flows, and they call for host governments to do more to keep them in check. They also discover exchange rates and market size to be useful explanatory variables in their models. Using data collected from 64 firms operating in 1998–99, Bitzenis (2006) identifies several obstacles to FDI in Bulgaria, including bureaucracy, regulatory issues, corruption, and political and economic instability. He also discovers that Bulgaria’s relative absence of stability as well as skilled labor put it at an early disadvantage relative to Central Europe’s first movers in terms of reforms. Bandelj (2010) focuses upon EU integration and socialist legacies in her research on FDI distribution across Central and Eastern Europe. Following a descriptive

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overview of investment stock across the ten post-communist countries that joined the EU in 2004 and 2007, she runs a longitudinal regression with four model specifications. She finds that ability of new members to attract MNEs is indirect; it derives from the EU’s leverage for creating host country reforms and encouraging policies that are conducive to FDI. Estrin and Uvalic (2014) examine whether empirical explanations of FDI location in the Balkans are different from those in CEE. Noting that Balkan states started attracting FDI later and received far less than their neighbors to the north, they find that what governs FDI flows are labor costs, tax burden, infrastructure, and trade regimes. According to their findings, as late as 2003, a large gap between actual and potential FDI remained in (North) Macedonia, Croatia, Albania, Moldova, and Bosnia and Herzegovina. Dunning’s “I” (internalization) taxonomy is less relevant to the present study than “O” and “L” because we have already defined the typed of international production as either wholly owned subsidiary (WOS) or a joint venture (JV), rather than a licensing arrangement or trade. Blonigen (2005) observes that some uncertainty exists in the literature about the relationship between FDI and trade. Are they complementary or substitutional? MNEs have several levels of internalization from which to choose. In this volume, contributing authors consider both WOSs and JVs, provided they satisfy the conditions for inclusion in WIIW’s (2019) database, based upon the IMF’s accounting principles.4 Building upon Blonigen’s (2005) earlier work, Blonigen and Piger (2014) provide another comprehensive overview of variables that have been used to explain FDI activity. In their pursuit of an integrated and parsimonious model of FDI, they interrogate a laundry list of determinants using Bayesian Model Averaging (BMA) and conclude that most of them are off the mark. They find that the most robust explanations of FDI activity are “gravity-related” variables, including GDP, cultural distance variables, labor endowments, and openness to trade. The authors explicitly refute the importance of business costs, infrastructure, and political institutions. It should be acknowledged that their work is based upon data prior to the year 2001 and focused upon observations of OECD members. Gravity models are a useful tool for explaining FDI flow patterns (Borrmann et al. 2005; Kleinert and Toubal 2010; Deichmann 2012). They were first used in econometrics by Tinbergen (1962) for understanding international trade flows and have since been adapted for FDI modeling. A simple gravity model predicts pairwise investment flows to be greater between larger economies than smaller ones, and greater between nearby countries than distant ones. For example, one might expect Serbian FDI to its immediate neighbor Bosnia and Herzegovina to be larger than FDI from New Zealand, a smaller country located farther away. The gravity model, therefore, illustrates the notion of distance decay, a decreasing likelihood of interaction as distance increases. In its simplest form, the gravity model is presented as 4 See the 6th edition of the IMF’s Balance of Payments and International Investment Position Manual

(BPM6) Available at: https://www.imf.org/external/pubs/ft/bop/2007/bopman6.htm. Last updated November 2013. Accessed 6 October 2019.

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follows:   FDIi j = e Mi M j /Di j where FDI = value of foreign direct investment e = constant M = mass (GDP) D = resistance (geographical and cultural distance). Blonigen and Piger (2014, 776) praise the simplicity of gravity models for fitting observed FDI data, while arguing that additional factors must be at work in the real world. To address this uncertainty, they use a Bayesian approach, whereby the choice of variables represents an additional parameter in search of a “true” model. They assemble an extensive list of variables found in FDI studies published between 1994 and 2007. Models are run to explain foreign affiliate sales in 85 host countries from the 1980s to 1998, as well as M&A mergers and acquisitions data since 2000. Borrmann et al. (2005) argue that a host country’s market can extend far beyond its borders, and distance can be an asset instead of a barrier. To test these expectations, they offer a relatively sophisticated gravity equation to better understand German FDI in CEE. In addition to population, GDP, and geographical distance, they look at labor costs, political risk, corruption, and language dummies. Their result comes full circle, as they find these factors and the host country’s market size to be significant across models, adding only the market potential of host country’s neighbors to the list of previous explanations for FDI choice. Janicki and Wunnava (2004) examine pre-EU accession FDI inflows from fourteen origin countries into nine post-communist countries using a simple weighted least squares regression methodology. They discover that trade integration, low labor costs relative to the source country, market size, and political and economic climate together form a satisfactory explanation for FDI as a percentage of host country GDP. The authors call for policy measures to enhance host country investment climate by focusing on these four features, acknowledging that low wages are not desirable at the expense of social welfare. They also recommend the inclusion of other variables such as measures of transportation infrastructure to build upon their findings. In another rigorous and much more comprehensive study, Bevan and Estrin (2004) introduce an adapted gravity model on a panel dataset of bilateral flows to CEEs from 1994 to 2000. As explained above, gravity models include measures of the origin and destination country, as well as the relationship between them. Bevan and Estrin’s (2004) additional variables vis-à-vis Janicki and Wunnava (2004) include origin country size, the distance between the two countries, and more sophisticated measures of institutional development, modeled using a one-year lag. Except for Slovenia, their study includes no countries from the former Yugoslavia “because conditions during much of this period make them such special cases that would require country-specific explanations” (Bevan and Estrin 2004, 780). With the

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benefit of local scholarly expertise, this volume endeavors to address such contextual complexity. Kekik (2005) provides a mainly descriptive overview of FDI in the Balkans at the time of the EU’s major 2004 enlargement, and just before the financial crisis. The author offers an optimistic forecast for the region, subject to impediments such - and unrest as the 2003 assassination of Serbia’s pro-Western Prime Minister Ðindic in Kosovo in 2004. He highlights empirical data to support his claim that political risks affect not only FDI in the country where unrest is present, but also neighboring markets. He also compares business environment indicators across the Balkan region to several 2004 accession states that have surged ahead as recipients of FDI. Finally, mid-term projections of FDI for the region are offered, based upon the author’s literature review of effective means for attracting capital inflows. Jakliˇc and Svetliˇci´c (2016, 53) argue that in the WB case, understanding bilateral FDI requires looking “beyond the well-known determinants of FDI location choice.” The authors discuss the role of positive and negative stereotypes using scores derived from survey results by Udoviˇc et al. (2017) in the seven successor states of Yugoslavia. They then summarize interviews conducted with managers of firms that operate across borders in the former Yugoslavia, confirming that stereotypes and high context communication are at work and they can also change over time. The authors conclude that culture is often overlooked by researchers, calling for further investigation of its role in international business decisions. Toskovi´c et al. (2016) compare investment climates across the Western Balkans, focusing upon the structural characteristics of potential host countries. They examine inflows in five countries from 2005 to 2013 with respect to their existing and potential advantages for attracting FDI. These include proximity to the EU market, healthy economic growth, and a low-cost skilled workforce. Concerning countries’ respective scores in the Global Competitiveness Index and the Doing Business Report, the authors cite relatively good business environments and the protection of rights for investors as explanations of greater FDI. They argue that reforms remain necessary in the areas of infrastructure, tax policy, and judicial systems, the latter being necessary for tackling the menace of organized crime and corruption in the region. Also relevant to FDI inflows to the Western Balkans is a shift in global economic power toward Asia. In a special issue devoted to China-CEE relations, Vangeli and Pavli´cevi´c (2019) highlight rising interest by the government of the Peoples Republic of China in the CEE region. This is demonstrated through the introduction of China’s 16 + 1 partnership initiative and the subsequent growing presence of Chinese MNEs throughout the region. The authors argue that China will continue to play an increasing role in Southeastern Europe as it seeks to enter the EU market though its Belt and Road Initiative (BRI), one section of which passes through the Adriatic Sea, just off the coast of the Balkan Peninsula. Richet (2019) extends the discussion of the Western Balkans as China’s gateway to the EU in the context of BRI, which he terms the new Silk Road. Several Chinese government investments in infrastructure have already begun (e.g., see Ja´cimovi´c, Rogi´c and Ivanovi´c, Chap. 7), opening the door for acceleration of Chinese ventures and in some cases raising local concerns.

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1.4 Role of FDI in the Host Economy Most policymakers consider FDI to be a potential engine for economic development (Baldi and Miethe 2015; Estrin and Uvalic 2016; Alfaro 2017; Sachs 2018), using this reasoning to justify their provision of incentives and the promotion of investment opportunities to foreign MNEs. Indeed, evidence exists that MNEs can increase the productivity of domestic firms (Javorcik 2004; Pavlinek 2017). Whether the conventionally anticipated objectives of capital accumulation as well as transfers of technology, know-how, and managerial experience are achieved depends upon many factors, including characteristics of the origin country, characteristics of the host country, and whether the mode of entry is a joint venture or a full acquisition. These categories of impacts roughly reflect the structure of Dunning’s (1980, 1988) OLI paradigm of FDI. In other words, his framework can help explain not only where FDI takes place, but also its impact on economic development. Empirical research examining the effects of FDI corresponds to each of the three components of Dunning’s framework. As just a few examples, the ways in which the origin of investment (Dunning’s “O”) can influence its impact are addressed in Ford et al. (2008). Location-specific characteristics that can determine the nature of effects (Dunning’s “L”) are examined critically in Turkey by Yavan (2010) and in the Czech Republic by Pavlinek (2017). The role of entry mode and other firm-specific characteristics (Dunning’s “I”) is the focus of work by DeMello (1999), Pavlinek (2004, 2017), and Javorcik (2004). A sizeable scholarly literature examines the linkages between FDI and economic growth. DeMello’s (1999) econometric research features a pairwise global FDI database covering two decades from 1970 to 1990. He argues that growth effects of FDI are “less controversial in theory than in practice” (148), citing country-specific factors such as institutions, trade regimes, political risk, and policy that elude detection in time series analysis. He contends that economic growth is inversely related to technological gaps between partners. In some cases, he discovers that host countries fail to benefit from new technologies simply because they lag too far behind partner (origin) countries. Indeed, FDI’s late start in Serbia is of concern to Ratkaj, Sibinovi´c and Mani´c (Chap. 2) because the host economy remained off limits to the international community not just during the wars, but also as a residual effect of resulting sanctions against Serbia. Both positive and negative examples of FDI’s impacts on host societies are abundant, and therefore, some of the presented evidence can appear to be contradictory. Causality can depend upon the context.5 Almfraji and Almsafir (2014) and Baldi and Miethe (2015) provide reviews of the major empirical contributions relating FDI to growth, ranging from a strong and positive relationship to a negative relationship (Malovic et al. 2019). Additional research shows little (DeMello 1999) or no evidence (Khaliq and Noy 2007) that the two are even related. Estrin and Uvalic (2016) and Pavlinek (2017) argue that certain industries can be more susceptible to events such as the GFC, and therefore, host governments should seek to make FDI profiles balanced 5 See,

for example, Pavlinek’s (2017) chapter “Linkages and Spillovers” (149–183).

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across industries. Moreover, Almfraji and Almsafir (2014) and Pavlinek (2017) find that when FDI promotes growth, its benefits can be linked to unique characteristics of a specific context. FDI can also result in what Pavlinek (2017) terms dependent growth. In other words, the actions of MNEs are not necessarily constructive for all stakeholders over the long term; therefore, FDI should be scrutinized and monitored by host societies (Javorcik 2004; Ford et al. 2008). Moreover, the promotion of investment opportunities to foreign and domestic entities alike should be both transparent (Osmani and Ahmeti 2017) and impartially balanced (Estrin and Uvalic 2016).

1.5 FDI Data and Their Discontents The bulk of the data used in this descriptive analysis are obtained from the nonprofit Vienna Institute for International Economic Studies (WIIW 2019), as reported directly by the central banks of the countries. WIIW is arguably the most reliable regional authority on topics and data related to CEE, specializing in the issues of transition and convergence. The main databases include annual and monthly socioeconomic data, as well as specialized portals for industry and FDI, the latter being most helpful for analysis in this volume. The data are gathered from national banks, statistical offices, and other primary sources across the region, then made available through a paid membership to researchers such as those contributing to this book. Unless otherwise specified, the FDI values used throughout this book represent foreign equity plus reinvestment of earnings and debt instruments, based upon the direction principle of BPM6. As a policy think tank, WIIW also publishes reports on topics related to European integration and economic convergence. For example, Holzner (2019) critiques what he considers overcautious attitudes toward expansion by the EU in the Balkans, while hailing NATO’s 2019 admission of North Macedonia as a security guarantee for foreign MNEs. Other research specialties of WIIW include macroeconomic structural change, international economics, labor markets, social issues, and regional development. As this book goes to press at the end of 2020, the data used in the chapters are the most recent and reliable statistics available to the authors. They provide analysts with an excellent view of the origins, structure, and location of FDI in former Yugoslavia. Nevertheless, we should acknowledge several shortcomings in the data. First, the data are collected from each entity’s government, as reported by its central bank. Data are subject to collection and handling methodologies, and these may vary over time and across the authorities by whom they are collected and reported. Moreover, it would be ideal to have data to facilitate deeper discussion at the subnational level. However, as just one example, the government of BiH is composed of two major political entities, including the Federation of Bosnia and Herzegovina (FBiH) and Republika Srpska (RS), which jointly administer the small district of Brˇcko. As explained in Chap. 3 by Peštek, Lazovi´c-Pita, and Abdic, this administrative structure renders balanced comparative analysis extra challenging.

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It should also be pointed out that as several of the political entities in this book evolved, many of them changed territorial shape or status, confounding data reporting. For example, long after Slovenia, Croatia, and BiH seceded from Yugoslavia, Montenegro declared independence in 2006. Furthermore, the status of Kosovo, which declared independence in 1999, remains disputed by Serbia plus the UN Security Council’s permanent members Russia and China, as well as five EU member states: Cyprus, Greece, Romania, Slovakia, and Spain. For this reason, Kosovo is handled as a “territory” or “geographic entity,” and no inference should be made about the authors’ collective opinion with regard to its sovereignty. Of course, the presence of such spatial complexities helps justify the inclusion of local perspectives in this comparative analysis. It would be convenient to proclaim that the limitations of FDI data end with the aforementioned complexities. However, the reality of FDI is that “offshoring,” “conduit FDI”, or “round-tripping” has emerged over the past two decades as a relatively common practice, representing an estimated 30 percent of all FDI (UNCTAD 2018). Offshoring is the process by which investors from a given country use an intermediary location as a base for registration due to some local tax benefits that it offers. An offshore location could also be used as a haven for funds that originate in the host country (hence the term “round-tripping”). This, of course, means “FDI” can actually be domestic investments made through an intermediary to protect funds or take advantage of incentives offered exclusively to foreign firms. Aykut et al. (2017) examine the growing phenomenon of such “indirect foreign direct investment” and its negative effects on host countries, such as decreased tax revenue and public welfare. Highlighting several offshore financial centers (OFCs) and their origin-specific “specialties” (e.g., Russian firms investing through Cyprus) the authors call for government policy measures and international action against offshore investment. For a full understanding of FDI flows, they call for studies to identify and reveal the ultimate investing country of MNEs, rather than their places of registration. In a related inquiry using year 2010 IMF data on cumulative FDI, Haberly and Wójcik (2014) examine the geographic, historical, and political determinants of offshore FDI. The authors discover enduring linkages within former colonial empires, also revealing offshore FDI’s sensitivity to physical distance, which they find to be as important as with “real” FDI. The practice of offshoring is not uncommon among major FDI projects in former Yugoslavia. For example, the US-based firm Barr Pharmaceutical invested in the Republic of Croatia through Pliva, its Dutch subsidiary, as highlighted in Chap. 3 by Tica, Globan, and Levaj. In Chap. 6, Osmani and Ahmeti explore the phenomenon of “round-tripping” in the context of North Macedonia. Some of the world’s most important tax havens include Bermuda, the British Virgin Islands, Hong Kong, and Panama. Even within the EU, the Netherlands, Liechtenstein, and Luxembourg are well-known intermediate locations where MNEs often take advantage of more favorable tax structures. For all of these reasons, analysts should interpret published FDI data with caution. None of the suspected or verified offshore FDI projects were removed from the analyses. However, adding robustness to this volume are local insights shared by the contributing authors in cases where offshoring

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is a significant issue. When possible and appropriate, familiarity with their respective countries enables them to comment on the true origins of major investment projects made through an intermediate location (e.g., Ja´cimovi´c, Rogi´c, and Ivanovi´c, Chap. 7). Despite its role as the main form of international business (Dicken 2015), global FDI has generally decreased since the GFC, with differential impacts around the world. Most recently, the OECD (2019) reports that global FDI flows have declined by 35 percent during the first half of 2018 compared to the six preceding months. This drop was more severe in the large (OECD G20) economies than in the nonOECD countries. Moreover, Aykut et al. (2017) point out that among developing regions, Eastern Europe and Latin America were particularly hard hit, representing 70 percent of the global decline. This 35% overall decline reflects only a single snapshot of an ongoing trend since 2013, even before the spread of COVID-19 and its continuing economic fallout. Arte and Larimo (2019) provide a thorough literature review of scholarly work examining the forces driving a global rise in divestment (or disinvestment) as it accelerated over the past ten years. Their review covers publications over three decades from a wide range of perspectives and disciplines, including economic geography. The seminal work by Boddewyn (1983) assumes that because divestment is the reverse of FDI, it will take place when the advantages enumerated in Dunning’s (1980) OLI paradigm are reversed. Specifically, this would occur if an MNE loses net competitive advantages over firms from other countries; or, if it no longer finds it favorable to retain them directly; or, if it no longer finds it profitable to utilize its advantages abroad. This purpose of the preceding discussion is not to discredit research on FDI, and certainly not to compromise the credibility of this book. Instead, it is intended to acknowledge that analysts and scholars should interpret data with caution, notwithstanding their apparent comprehensiveness and purity. The contributing authors are scholars native to former Yugoslavia, and as resident experts they offer reliable analysis for a robust comparative understanding by this volume’s readership. As a general framework for organizing their chapters, they have been asked to follow Dunning’s (1980) OLI paradigm and adopt a spatial perspective whenever feasible. Moreover, as local experts, they are encouraged to add and elucidate additional context-specific information as they see fit or omit portions of Dunning’s framework that they find less relevant in their context. For this reason, the chapters do not follow identical layouts, an approach that might reduce the reading of a chapter to an exercise in tedium. Finally, it is worth acknowledging the potentially devastating effects on FDI of the events of 2020. At the time of writing, the COVID-19 pandemic has brought many of the world’s leading economies to their knees. Major corporations have laid off and furloughed millions of employees, and the resolution of this crisis is not yet in sight. In all likelihood, at least in the short term COVID-19 will have a highly detrimental effect upon FDI and other forms of globalization. If global FDI continues to decline as it had even before COVID-19 (UNCTAD 2018, 2019), competition between recipient states will intensify, and this does not bode well for the smaller economies

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in former Yugoslavia. Especially in the aftermath of COVID-19, UNCTAD (2020) urges leaders to protect domestic firms, citizens, and environments by scrupulously screening FDI projects, and offers some positive signs that the pandemic might actually lead to some new opportunities in certain industries such as health, passenger transportation, and hospitality.

List of Abbreviations BiH BPM6 CEE EDB EU FBiH FDI GCI GDP GFC JV MNE OECD OLI RS SFRY SME UAE UK US WB WIIW WOS WWII

Bosnia & Herzegovina Balance of Payments and International Investment Manual Version 6 Central and Eastern Europe Ease of Doing Business European Union Federation of Bosnia & Herzegovina Foreign Direct Investment Global Competitiveness Index Gross Domestic Product Global Financial Crisis Joint Venture Multinational Enterprise Organization for Economic Cooperation and Development Origin-Location-Internalization Republika Srpska Socialist Federal Republic of Yugoslavia Small- and Medium-Sized Enterprise United Arab Emirates United Kingdom United States Western Balkans Vienna Institute for International Economic Studies Wholly Owned Subsidiary World War II

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Dunning J (2008) Institutional reform, FDI and the locational competitiveness of European transition economies. In: Dunning J, Gugler P (eds) Progress in international business research Volume 2: Foreign direct investment, location and competitiveness. Elsevier, Boston, pp 175–201 Dunning J (2009) Location and the multinational enterprise: a neglected factor? J Int Bus Stud 40:5–19 Estrin, S. (2017) Foreign direct investment and employment in transition economies. IZA World of Labor Estrin S, Uvalic M (2014) FDI into transition economies: are the Balkans different? Econ Transit 22(2):281–312 Estrin S, Uvalic M (2016) Foreign direct investment in the Western Balkans: what role has it played during transition? Comp Econ Stud 58(3):455–483 Ford T, Rork J, Elmslie B (2008) Considering the source: does the country of origin of FDI matter to economic growth? J Reg Sci 48(2):329–357 Grosse R, Trevino L (1996) Foreign direct investment in the United States: an analysis by country of origin. J Int Bus Stud 27(1):139–155 Grosse R, Trevino L (2005) New institutional economics and FDI location in Central and Eastern Europe. Manag Int Rev 45(2):123–145 Haberly D, Wójcik D (2014) Tax havens and the production of offshore FDI: an empirical analysis. J Econ Geogr 15(1):75–101 Holzner M (2019) Making the best of a bad hand. Vienna Institute for International Economic Studies. https://wiiw.ac.at/making-the-best-of-a-bad-hand-n-399.html. Accessed 30 Oct Hunya G (2000a) International competitiveness impacts of FDI in CEECs (No. 268). The Vienna Institute for International Economic Studies, wiiw. Available at: https://ideas.repec.org/p/wii/rpa per/rr268.html. Accessed 14 Sept 2017 Hunya G (2000b) Home country patterns of foreign direct investment in Central and East European countries. Russ East Eur Fin Trade 36(2):87–104 Jakli´c A, Svetliˇci´c M (2016) Do stereotypes hinder or promote foreign direct investment? The case of western Balkan countries. Teorija Praksa 53(5):1095–1108 Janicki H, Wunnava P (2004) Determinants of foreign direct investment: empirical evidence from EU accession candidates. Appl Econ 36:505–509 Javorcik B (2004) Does foreign direct investment increase the productivity of domestic firms? In search of spillovers through backward linkages. Am Econ Rev 94(3):605–627 Kekic L (2005) Foreign direct investment in the Balkans: recent trends and prospects. Southeast Eur Black Sea Stud 5(2):171–190 Khaliq A, Noy I (2007) Foreign direct investment and economic growth: empirical evidence from sectoral data in Indonesia. J Econ Lit 45(1):313–325 Kleinert J, Toubal F (2010) Gravity for FDI. Rev Int Econ 18(1):1–13 ˝ Zdravkovic A (2019) Misunderstanding of FDI in the Western Balkans: Malovic M, Mustafa O, cart before the horse and wheels without suspension. J Balkan Near Eastern Stud 21(4):462–477 OECD (2019). OECD library: foreign direct investment. https://www.oecd-ilibrary.org/financeand-investment/foreign-direct-investment-fdi/indicator-group/english_9a523b18-en. Organization for Economic Development and Cooperation. Accessed 6 June ÓhUallacháin B, Reid N (1992) Source country differences in the spatial distribution of foreign direct investment in the United States. Prof Geogr 44:272–285 Osmani R, Ahmeti L (2017) ‘Fiscal and economic incentives for foreign investors at technological industrial development zones in Macedonia, empirical analysis of TIDZ Skopje 1. ISCBE’17, Tetovo Pavlínek P (2004) Regional development implications of foreign direct investment in Central Europe. Eur Urban Reg Stud 11(1):47–70 Pavlínek P (2017) Dependent growth: foreign investment and the development of the automotive industry in East-Central Europe. Springer International Publishing, Cham, Switzerland Richet X (2019) Geographical and strategic factors in Chinese foreign direct investment in Europe. Asian Econ Pap 18(2):102–119

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Sachs J (2018) Geography, geopolitics, and policy in the performance of transition economies. Econ Transit 26(4):1–9 Tinbergen J (1962) Shaping the world economy: suggestions for an international economic policy. Twentieth Century Fund, New York Toskovi´c J, Adzi´c J, Popovi´c S, Markovi´c J. (2016) Comparative analysis of the investment environment in the economies of the Western Balkans. Reg and Bus Stud Feb 158(1):15–27 Udoviˇc B, Jurše M, Korez Vide R, Raškovi´c M, Svetliˇci´c M (2017) Medkulturne razlike in stereotipi (zacija): prednost ali slabost pripolitiˇcnem in gospodarskem sodelovanju med dr´zavami nekdanje Jygoslavije. Osnutek. Fakultete za druzbene vede, Ljubljana UNCTAD (2018) World investment report. https://unctad.org/en/PublicationsLibrary/wir2018_en. pdf. United Nations Conference on Trade and Development. Accessed 31 June 2019 UNCTAD (2019) Global investment trends monitor. https://unctad.org/en/PublicationChapters/tds tat43_FS09_en.pdf. United Nations Conference on Trade and Development. Accessed 7 Oct 2019 UNCTAD (2020) Investment policy monitor: Special issue-investment policy responses to the COVID-19 pandemic. https://unctad.org/en/pages/PulblicationsLibrary/diaepcbin2020d3_ en.pdf. Accessed 20 May 2020 Vangeli A, Pavli´cevi´c D (2019) Introduction: new perspectives on China-Central and Eastern Europe relations. Asia Eur J 17(4):361–368 WIIW (2019) Database on foreign direct investment. https://data.wiiw.ac.at/fdi-database.html. Wiener Institut für Internationale Wirtschaftsvergliche. Accessed 20 Sept World Bank (2019) World development indicators. Key Data. https://databank.worldbank.org/. Accessed 10 Nov World Economic Forum (2019) The global competitiveness Report 2018. http://reports.weforum. org/global-competitiveness-report-2019/. Accessed 15 Mar Yavan N (2010) The location choice of foreign direct investment within Turkey: an empirical analysis. Eur Plan Stud 18(10):1675–1705

Chapter 2

FDI in Serbia Ivan Ratkaj, Mikica Sibinovi´c, and Emilija Mani´c

Abstract After the dissolution of the Socialist Federal Republic of Yugoslavia (SFRY) in the early 1990s, the Republic of Serbia found itself in an unprecedented social, political, and economic situation. Facing a significant delay in the transition process in comparison with other Central and Eastern European (CEE) states, Serbian governments since 2001 have opted for a model of economic development based on attracting foreign direct investment (FDI). This strategic commitment has led to complex and controversial effects on Serbia’s economy. On the one hand, FDI inflows benefited the local economy by increasing its international market competitiveness, contributing to a decrease in unemployment, and enhancing technology transfer. On the other hand, FDI is related to some negative economic trends such as expansion of labor-intensive jobs and an increasing dependency on unpredictable inflows of foreign capital. The aim of this chapter is to offer insights into the empirical literature on FDI to Serbia in the context of Serbia’s historical development and to explore the spatiality and influences of contemporary inflows with a special focus on prospects and suggestions for Serbia’s economic trajectory over the next 25 years. Conceptually, this text is based on Dunning’s eclectic approach to FDI by focusing upon the origins, location, and internalization of foreign capital in the country. Keywords Serbia · Economic sanctions · Delayed transition · Privatization · Foreign direct investment

I. Ratkaj (B) · M. Sibinovi´c Faculty of Geography, University of Belgrade, Belgrade, Serbia e-mail: [email protected] M. Sibinovi´c e-mail: [email protected] E. Mani´c Faculty of Economy, University of Belgrade, Belgrade, Serbia e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_2

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2.1 Introduction Serbia’s delayed transition into a market economy over the past twenty years has set it back vis-à-vis other Central and Eastern European (CEE) states in attracting foreign direct investment (FDI). Its historical context in the shadows of politically dominant neighbors at the beginning of the twentieth century, as well as Yugoslavia’s destabilizing war and state dissolution have handicapped Serbia’s efforts to attract favorable FDI. Even after emerging from conflict, Serbia was compelled to refocus its centrally-planned industry-driven economy toward small and medium-sized enterprises (SMEs) and establish a friendly investment environment for foreign firms in order to capture benefits from FDI. According to Dugali´c (2017), Serbia led the world with the highest greenfield FDI performance index in 2016. Most of the FDI in Serbia is from EU-based firms, although recent years have brought a noticeable diversification of origin countries. However, economic development policies that rely solely upon FDI can sharpen existing interregional disparities and create new ones, exacerbating the gap between more- and less-developed regions (Menciger 2003; Kovaˇcevi´c 2016a; Madžar 2019). After the devastation of the 1990s, Serbia entered a relatively steady but delayed phase of transition. The country’s underprivileged starting point left it not only with an exhausted and distorted economy, but also lacking institutions that are required for a stable and just society. The war in Yugoslavia and Serbia’s subsequent isolation from the global economy resulted in economic polarization, rampant corruption, severe unemployment, and a dramatic decline in living standards. As a result, Serbia entered its reintegration process and opened its economy for international trade and investments as a dysfunctional and impoverished country by European standards. FDI has been propagated as a remedy for troubled economies, including those of Europe’s post-socialist countries (Horvat 1970; Bevan and Estrin 2009; Kovaˇcevi´c 2010; Drahokoupil and Galgoczi 2015). Serbia was no exception to a general consensus by policymakers that FDI is desirable and should be welcomed as a driver for the improvement of important macroeconomic indicators. The general inclination of Serbian economic policies toward the promotion of FDI is additionally evidenced by the 2001 founding of the Serbian Investment and Export Promotion Agency (SIEPA) and its far-reaching incentives granted to foreign firms. Serbian leaders, like those in other countries, have been preoccupied with emphasizing comparative advantages for the attraction of MNEs and doing their best to lure capital from abroad. However, it is clear from the Serbian case that the anticipated benefits of FDI such as capital inflow and market access, as well as the transfer of new technologies, knowledge, and managerial skills, are often overestimated. At the same time, incidents of negative consequences such as overdependence upon foreign entities, repatriation of profits abroad, as well as employee and environmental abuse by foreign companies are often overlooked. This chapter offers insights into the FDI picture in the unique context of Serbia, the former political and economic core of Yugoslavia, and the largest of its successor states, both territorially and in terms of population.

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2.2 Empirical Literature on FDI to Serbia While many scholars emphasize the importance of FDI for contemporary economies (Kovaˇcevi´c 2019; Petrovi´c et al. 2016; Madžar 2016; Stamenkovi´c et al. 2012; - c et al. 2012), it is important to mention that foreign capital has also played Ðordevi´ a significant role in the Serbian economy during the country’s long history. The period prior to World War I (WWI) was marked by intense linkages between Serbian and Austro-Hungarian economies that characterized the majority of investment flows (Gnjatovi´c 1991; Kovaˇcevi´c 2017). In the period between the two World Wars, foreign investments in Serbia (Kingdom of Serbs, Croats and Slovenians; later Yugoslavia) were aimed at the banking and real sectors, and only sporadically at manufacturing because overall, the Serbian economy was poorly developed (Jurkovi´c 1941; Mirkovi´c 1958; Dimitrijevi´c 1958). The systemic and political changes after World War II (WWII) did not open much ˇ space for foreign capital inflows (Gligori´c 1970; Horvat 1970; Cobelji´ c 1989). This was true until the end of the 1980s, when the first steps were taken toward economic transition. However, the painful final decade of the twentieth century also kept foreign investments to a rather modest level (Pelevi´c and Vuˇckovi´c 2007). It was only after the year 2000 when foreign capital began to be attracted by the privatization of stateowned companies, which later caused extremely high foreign capital domination in some sectors such as banking, oil exploitation and refining, cement, non-ferrous metal, iron and steel, and automobile industries (Draškovi´c and Milojevi´c 2016; Esrin and Uvalic 2014; Draškovi´c and Rajkovi´c 2009). In an attempt to determine the causes of Serbian FDI inflow oscillations, as well as their importance for the Serbian economy, many analyses focused on FDI structure and dynamics, as well as both positive and negative effects of FDI in Serbia (Maksimovi´c and Kosti´c 2019; Madžar - c 2016; Madžar 2016; Kovaˇcevi´c 2010; 2019; Bjeli´c and Orlovi´c 2016; Ðordevi´ Stamenkovi´c and Kovaˇcevi´c 2016; Aykut and Sayek 2007; Menciger 2003; Begovi´c, Mijatovi´c, Paunovi´c and Popovi´c 2008; Pelevi´c and Vuˇckovi´c 2007; Morgan 2006; Janicki and Wunnava 2004; Herrmann and Lipsey 2003; Obersfeld and Taylor 2001). One group of studies revealed institutional framework to be the primary supporting pillar for stimulating FDI flows (Petrovi´c et al. 2019; Šoški´c 2017; Maksimovi´c and Kosti´c 2019; Madžar 2019, 2016; Kovaˇcevi´c 2016a, b; Bevan and Estrin 2009; Botri´c and Škufli´c 2006). Other researchers criticize government incentives promoting FDI such as the practice of direct payments for new jobs (Kovaˇcevi´c 2016b; Kapor 2016).

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2.3 The Historical Context of Serbia 2.3.1 Serbia’s Unique Political and Economic Position in the Nineteenth Century The modern Serbian state emerged in 1878, when it was integrated as a political and territorial entity by the Treaty of Berlin, to be eventually declared as the Kingdom of Serbia in 1882. Several turbulent historical events preceded this independence, including the First and Second Serbian Uprisings against the Ottoman Empire in 1804 and 1815, respectively. These events resulted in Serbia’s autonomy and proclamation of the Principality of Serbia within the Ottoman Empire (1830 Hatt-i sharif). Gradually liberating itself from Ottoman rule, Serbia was in no position for significant economic development. As a rural region producing only agricultural products for export, it lacked the preconditions for the development of manufacturing. However, during its vassalage under the Ottomans, Serbia strived to make its foreign trade policy as independent as possible: Autonomous customs tariffs were introduced during the period 1819–1836 (Mili´c-Miljkovi´c 1959), and also in 1843 and 1854 (Jovanovi´c 1933). With full independence, Serbia established closer links with the economy of its powerful northern neighbor, the Austro-Hungarian Empire. However, this was not voluntary, nor did it represent an equal trading relationship. Austria-Hungary managed to achieve privileged access to the Serbian market for its manufactured products, while at the same time allowing Serbia to export only agricultural products to the Austro-Hungarian market (Pertot 1971). Austria-Hungary maintained this type of policy toward all small Balkan states, deliberately keeping them in an economi´ cally dependent position as resource bases for its economy (Corovi´ c 1992). Due to Serbia’s inability to develop its own economy and address its capital deficit, Serbia incurred debts, especially in the Austrian currency (Gnjatovi´c 1991). This unfavorable economic structure formed at the beginning of the twentieth century remained one of Serbia’s greatest systemic problems for decades.

2.3.2 The Twentieth Century and Serbia’s Central Role in Yugoslavia Serbia’s history in the past century is vital for understanding its role as the core of the Yugoslav state, as well as its relationship with neighbors. This is particularly true of the Austro-Hungarian Empire and its successor states. In 1905, AustriaHungary imposed a blockade on Serbia, resulting in the Tariff War. As a result, it became necessary for Serbia to seek solutions by reorienting itself toward other, mostly regional markets. The Belgrade-Niš Railway (1884) offered the opportunity to transport Serbian goods across territories under partial Ottoman jurisdiction to the

2 FDI in Serbia

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Port of Thessaloniki in Greece, while the establishment of navigation on the Danube river opened up a second export channel toward the Black Sea (Kovaˇcevi´c 2017). After the Tariff War with Austro-Hungary (1906–1911), changes began to occur in the modest foreign capital flow to the Serbian economy. The largest sectors for foreign investments became natural resource exploitation. French capital was active in the mining sector even before the Tariff War, and later in the railway construction as well, while English and Belgian capital were mainly present in mining. Investments were also made in the food processing sector, including English investment in the meat-processing industry, and German investment in the sugar industry (Kovaˇcevi´c 2017). After WWI, a new state was created with Serbia as its backbone; a territory for Southern Slavs except Bulgarians. This Kingdom of Serbs, Croats and Slovenes was founded in 1918, and renamed as the Kingdom of Yugoslavia in 1929. The new state inherited inadequate economic structure and remained weak after experiencing devastating losses in the war. Serbia suffered massive destruction and lost 28% of its total population. To make matters worse, it faced new challenges introduced by the Great Depression of the 1930s. These events further hampered Serbian economic development, and as a consequence it remained a poorly developed agricultural country through the end of WWII. Foreign capital inflows into the Serbian economy in the 1920s were considered as low production costs attracted foreign investors. At that time, Mirkovi´c (1958) points out that more than half (52%) of the total share of capital in Yugoslavia was in foreign hands. Importantly, the complete banking sector was owned by foreign interests. This had a huge impact on the early stages of industrialization and also resulted in a heavier dependence on loans. With regard to origins, Germany held around 32% of total foreign investments, followed by Czechoslovakia, Hungary, France, and Switzerland. English capital was linked to the exploitation of lead–zinc ore in the mines in Kosovo and Metohija. In Bor and Majdanpek, Serbia’s largest copper mines were in the hands of Belgian and French shareholders (Jurkovi´c 1941). The electricity industry was dominated by French, Swiss, and US owners, and US firms controlled more than half of petroleum exploitation. The proportion of Serbia’s resource extraction in the period between the two wars is discussed in Mirkovi´c’s (1958) analysis, where it is noted that 20 years of net profit gained by foreign companies would have been sufficient to build 60 large factories in Yugoslavia, each worth 100 million Yugoslav dinars of investment capital. However, no factories were actually built. During this period, the economic policy of Serbia relied on maintaining currency stability by frequent interventionist measures, even at the cost of failing to develop the country’s economic infrastructure (Pertot 1971). Thus, the lack of systematic economic interventions compounded Serbia’s inherited structural problems. The manufacturing sector started to develop more intensively in Yugoslavia during the 1930s, but went largely unnoticed due to the onset of WWII. Foreign capital remained dominant in industries that required larger investment, such as wood and lumber, metal, chemical, electricity, cement, and glass production. At the same time, domestic capital was scarce and related mostly to less attractive sectors such as food processing and textile industries. As a result, the Kingdom of Yugoslavia became an

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agricultural-industrial country with an unfavorable foreign trade structure. Agriculture, timber, and metal products remained its dominant exports, while manufactured products needed to be imported from more industrialized partners such as Austria, Germany, Czechoslovakia, and Great Britain. For the Kingdom of Yugoslavia, WWII began on April 6th, 1941 with the Nazi bombardment of its capital city Belgrade. The German army quickly crushed the resistance and occupied Yugoslavia. Several months later, freedom fighters began guerilla resistance against the German occupier. In 1943, the National Liberation Movement, led by Josip Broz Tito, proclaimed a federal state republic, which became the Federal People’s Republic of Yugoslavia (FPRY) after WWII. Ruled by the Communist Party, with Josip Broz Tito as its leader, this new state adopted a centrally-controlled planned economy. As part of the changes, the king and his family were exiled, and nationalization of private property began, as did agrarian reform. Serbia became one out of six socialist republics and itself contained two autonomous provinces: Vojvodina as well as Kosovo and Metohija. With the new Constitution of 1963, the state changed its name to the Socialist Federal Republic of Yugoslavia (SFRY) and continued as such until 1992. Renewal and reconstruction followed WWII, accompanied by an emphasis on industrialization. Following the Soviet model of a centrally-planned economy, Yugoslavia espoused state intervention in an effort to minimize its dependency on the world economy. Yugoslavia’s connections with the USSR existed until the Tito–Stalin split in 1948. Yugoslavia then introduced a system of self-management, as articulated by Chittle (1975), developing a rigid policy favoring self-sufficiency (Kovaˇcevi´c 2017). As a result of Yugoslavia’s rapid industrialization, growth rates remained extremely high throughout the 1960s, when the country reached the world average for GDP per capita as a middle-income country. According to Devetakovi´c et al. (2008), the average annual growth rate in Serbia during this “Silver Age” was 8.7%, and it represented the highest share of all Yugoslav republics in federal gross domestic production. Such high economic growth rates were not sustainable in the long-run, as growth slowed during the 1970s. In its attempt to save the economy, Yugoslavia’s government introduced liberalizations set forth in the constitutional changes of 1974. Each republic within SFRY assumed responsibility for its own economic development, including the borrowing and repayment of loans, which turned out to impair the country’s uniform foreign currency system. This decentralization led to the problem of republics transferring their debts to the federation, causing a non-uniform exchange rate for the national currency and undermining the country’s monetary system. During the 1980s, ˇ Yugoslavia’s average annual GDP growth rate was only 0.8% (Cobelji´ c 1989). This recession impacted the republics unevenly, with Serbia hit much worse than Slovenia and Croatia. Serbian GDP fell to around 8% below the Yugoslav average, with Croatia’s GDP 20% higher (Statistiˇcki godišnjak Jugoslavije 1989; World Bank 2019). Babi´c (1984) and Kovaˇcevi´c (2017) provide additional useful accounts of Yugoslavia’s deep crisis of the 1980s. As labor productivity declined and inflation

2 FDI in Serbia

29

reached full swing, unemployment mounted, and investment declined. The country’s trade balance remained favorable, only because import limitations were imposed. Due to the increasing pressure of external debt, in 1984 the state started looking for new sources of capital by opening more opportunities for foreign investors with the help of the Law on Investment of Resources of Foreign Persons in Domestic Organizations of Associated Labor. Prior to this law, while it was officially possible for foreign firms to invest, Verbi´c (1976) argues that Yugoslavia’s laws and regulations effectively prevented it in practice. During this attempt to stabilize the country’s economy with the help of foreign capital, investors from West Germany and the USA first entered the trade sector and gambling industry. Foreign interest also increased in vehicle production and the chemical industry (Cory 1984), followed by the food and metal industries. The government then began permitting joint ventures (JVs) through the Law on Joint Ventures in 1988 (Zakon o stranim ulaganjima 1988), in order to encourage more foreign capital. From 1989 to 1990, JVs comprised only 13% of the total number of contracts with foreign partners, but they carried 44% of the total value of the invested assets (Kovaˇcevi´c 2017). Efforts to preserve Yugoslavia’s economy failed completely in the beginning of the 1990s, and the situation became progressively worse due to deteriorating political relations between the republics. The dissolution of Yugoslavia began in 1991, first by Slovenia and Croatia leaving the Federation, followed by Bosnia and Herzegovina (B&H), and then Macedonia (FYROM, presently North Macedonia). The two remaining republics, Serbia and Montenegro, remained federated and in 1992 established the state of Federal Republic of Yugoslavia (FRY). As the legal successor to SFRY, FRY faced huge political and economic challenges immediately after it was formed: Economic sanctions by the EU and UN Security Council (1992), civil war in its immediate neighborhood, and an enormous number of refugees from the war-inflicted areas of Croatia and B&H (Bjeli´c 2003). A lack of raw materials and spare parts due to trade sanctions drove many industrial behemoths to bankruptcy, and production decreased dramatically. Inflation reached levels unprecedented in world history (19,810%), and unemployment spiraled. The decrease in Yugoslav GDP was severe; in 1993, GDP reached just 45.5% of its 1991 level (Kovaˇcevi´c 2017). Hyperinflation destroyed the tax system and jeopardized the ability of the entire country to function. The informal economy grew stronger by the day; at one point, it comprised 60% of the country’s GDP. At the same time, the economy contracted by 22.5% (Devetakovi´c et al. 2008). In 1993, FRY’s government introduced a reconstruction and recovery strategy, establishing social consensus and emphasizing monetary policy stabilization without any help from the outside. This resulted in a partial recovery, with an average GDP increase of 4.7%. FRY remained without access to international financial institutions and the international market and was unable to pay installments on its debts, which caused the principal to remain the same while interest grew and compounded. The state intervened heavily in the economy, but institutions were weak, causing corruption to become widespread.

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Even in such unfavorable circumstances, Yugoslavia continued to pursue foreign capital with policy changes through new Laws on Foreign Investments in 1994 and 1996 (Zakon o stranim ulaganjima 1994, 1996). These legislative changes allowed JVs dated from 1980s to be transformed into branches of foreign-owned companies. After the cessation of sanctions against FRY in 1996 and 1997, there were about 2800 foreign investment contracts (Nestorovi´c 2015). However, the total value of foreign investments in the whole decade remained modest, with only one important financial inflow from abroad. This occurred in 1997, when Italian Società Finanziaria Telefonica (STET) and Greek OTE paid USD 738.5 million for 49% of the shares of Telekom Srbija. Predominantly, the origins of foreign capital were EU countries, with 88.5% of total investments, led by Greece, the Netherlands, Germany, Italy, and Belgium (PKJ 1998). Unfortunately, another political and economic downturn occurred in 1999, with NATO’s bombing of Yugoslavia. During 78 days of relentless bombing of different targets across the territory, many people were killed and additional material damage decimated an already struggling economy. Estimates of indirect damage exceeded those of the direct material cost. According to the balance sheet prepared by a group of independent economists, the total damage amounted to USD 11.7 billion. Adding the effects of economic sanctions of 1992, the estimated cost to Serbia’s economy during the period 1991–2000 approaches USD 67.2 billion (Bošnjak 2002). This destruction approximates the value of two years of Yugoslavia’s GDP.

2.3.3 The Serbian Economic Context Since 2000 At the beginning of the twenty-first century, Yugoslavia embarked upon its political and economic transition already lagging behind the rest of the former socialist European countries by at least one decade. Political changes that occurred in Serbia after the 2000 presidential and parliamentary elections contributed to thawing of political relationships between FRY and foreign countries. Nevertheless, new governments faced challenges such as inflation in excess of 120%, an enormous budget deficit, minimal borrowing opportunities, and an average monthly salary of merely EUR 40. The country received urgent financial aid that was primarily used to settle its debts toward international financial institutions and the creditors of the Paris and London Clubs. By 2002, Yugoslavia had paid off 60% of the foreign debts that had accumulated due to compound interest from the years when it was impossible to make payments. The decade-long alienation of Yugoslav companies from the world market caused immeasurable damage. Firms in other CEE countries enjoyed a significant head start while their production costs declined, sharpening the already-fierce competition. At the same time, in Yugoslavia, the pace of progress remained slow. Serbia gradually began to participate in regional economic integration, and to earn back its political and economic status in international institutions. However, it is important to note that

2 FDI in Serbia

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with political change, the structural problems inherited from the past did not simply disappear. Economic experts were aware that fixing the trade deficit required increasing exports of goods and services. Although Yugoslavia had established preferential access to EU markets, export growth continued to lag behind import growth during the first decade of the twenty-first century, leading to a slower economic recovery. For this reason, the government enforced a series of stabilization measures, as well as a liberal environment for attracting FDI. In 2003, FRY redefined the relationship of its members with the declaration of the State Union of Serbia and Montenegro. This union ceased to exist in 2006 after both states declared their independence, and Serbia became once again an independent state.

2.4 Examining Contemporary Trends in FDI to Serbia Dicken (2015) contends that the acceleration of global integration has increased the relevance of FDI for the growth of national economies. The connection between FDI and economic growth has been embraced by decision-makers in countries across the development spectrum, including the Republic of Serbia. From the perspective of the host country, the extent of incoming FDI depends largely on various factors including geographic location, political and economic risks, access to local and regional markets, legal systems, security, institutional transparency and efficiency, and labor attributes (Savi´c 2002; Stojanovi´c 2018). According to Dunning (1980), the determinants of where and how FDI from different origins takes place can be understood in terms of advantages related to “ownership” (home country) and “location” (host country), as well as the strategic extent of internalization in the overseas venture.

2.4.1 Inflows of FDI to Serbia Changes in the political relationship between the international community and FRY initiated by the elections in 2000, alongside the country’s economic reintegration processes led to a heightened interest in Serbia by MNEs. The decade of conflicts and isolation had ended, and reasonable political and economic stability was reestablished, putting Serbia back on the map of international flows of capital. As illustrated in Table 2.1, Serbia entered the phase of economic growth marked by relatively significant but fluctuating inflows of FDI, with noticeable peaks in 2006 and 2011. These data are expressed in annual inflows and cumulative stocks, both in absolute values and per capita. At the beginning of economic reconstruction and opening to the international market, the Serbian government decided to speed up its process of public enterprise privatization. Privatization became facilitated through the 2001 Law on Privatization

56.2

56.2

7.5

7.5

0.2

0.2

Inflow (EUR million)

Stock (EUR million)

Inflow (EUR per capita)

Stock (EUR per capita)

Inflow (GDP %)

Stock (GDP %)

2002

2003

2005

2006

2007

771.9 1268.1 3392.4 2512.6

2004 2711.5

2008 2084.7

2009 1273.1

2010 3548

2011

11.1

6.9

277.8

173.8

14.3

3.9

382.1

103.4

340.4

18.5 29

5.7 13.1 31.8

8

554.2 1015.1 1360.5

170.4 457.7

368.9

38.9

7.6

1893.9

284.8

44.6

6.4

1982.7

174.6

52.9

4

2293.6

490.3

53.8

10

2641.6

1545.9

2013

1504.6

2014

2115.9

2015

58.5

3

2744.5

140.3

62.7

4.2

3193.9

215.7

68.7

4.2

3423.3

211

74.8

5.9

3773.7

298.2

19716.2 22833.7 24354.9 26704

1010.7

2012

78.5

5.8

4092.2

301

28810.6

2124.9

2016

Source National Bank of Serbia (2017) (Equity + reinvestment of earnings from 2007 + debt instruments. From 2008, based on BPM6, directional principle (inflow/outflow). Equity + reinvestment of earnings + debt instruments. From 2013, based on BPM6, directional principle. Cumulated inflows until 2007 (outward/inward stocks).)

1.8 4.5

1.4 3

33.9 103.6

26.4 69.5

254.5 775.8 2075.6 2847.5 4115.7 7508.1 10,020.7 13,891.9 14486.9 16688.6 19070

198.3 521.3 1299.8

2000 2001

Measure (unit)

Table 2.1 Annual FDI data for Serbia, 2000–2016

32 I. Ratkaj et al.

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(Zakon o privatizaciji 2001) and its subsequent amendments, as well as by founding a designated Agency for Privatization during the same year. This initiated massive and enduring privatization processes in Serbia, largely involving foreign investors. By 2003, roughly one thousand companies had been privatized. Significant increase in FDI in 2003 was induced by the privatization of the Serbian tobacco industry, which is concentrated in two cities in southern Serbia. The tobacco factory in Niš was sold to Philip Morris International for EUR 387 million, and the factory in Vranje to British American Tobacco for EUR 50 million. In addition, the Russiabased company Lukoil paid EUR 117 million for 79.5% of shares of the petroleum company Beopetrol. After a short slowdown in 2004, FDI inflow increased rapidly over the next two years. The inflow spike in 2005 was mainly due to the investment of the Czech company Star Bev, which took over the public brewery in Apatin for EUR 487 million, and the acquisition of Delta Bank by Italian Banca Intesa SpA, which paid EUR 462 million for 90% of the bank shares. According to Kastratovi´c (2016), investments of Banca Intesa SpA increased to EUR 508 million by 2013. In 2006, an inflow of foreign direct investments amounted to EUR 3392 million (NBS 2017). The largest investments in 2006 were in the telecommunications sector, with the Norwegian company Telenor privatizing Serbian Mobtel for EUR 1602 million, and Mobilkom Austria Group acquiring the license for Vip mobile, the third-largest mobile phone operator in Serbia, for EUR 320 million. The latter represents one of the largest greenfield investments in Serbia, along with US-origin investments into Ball Packaging and Microsoft Development Center, both of which were opened in Belgrade during 2005 (Kastratovi´c 2016). Two major banks were privatized and sold to Greek investors in 2006: National Savings Bank and Vojvodanska Banka (Kastratovi´c 2016; NBS 2017). As the Serbian banking system had been depleted during the crisis period of the 1990s, FDI inflow to the financial sector and the privatization of Serbian banks were perceived as prerequisites for initiating the reindustrialization process. In 2007, the inflow of foreign capital dropped by 36% mostly due to the lower rate of privatizations. Although FDI became more diversified in this timeframe, its influence on the development of Serbian economy remained relatively limited. In general, most of these investments were oriented toward the domestic market and therefore did not contribute significantly to export value (Marinova et al. 2004; Zubovic et al. 2009; Bitzenis and Žugi´c 2014). In 2008, total FDI inflows remained substantial despite the global financial crisis (GFC) primarily due to the privatization of car factory Zastava Kragujevac and its purchase by the Italian company FIAT (Fiat Chrysler Automobiles Serbia). In addition, a strategic agreement in the energy sector was reached between the Republic of Serbia and the Russian Federation with Gazprom Neft taking over the Petroleum Industry of Serbia (NIS) for EUR 400 million. The effects of the GFC and a decrease in FDI reached the Serbian economy in 2009. During 2010, inflows of FDI fell by 39% compared to the previous year. A short-lived recovery occurred in 2011, when more than EUR 3500 million was invested in Serbia. The major transaction contributing to this peak in FDI was the acquisition of Maxi-Delta Holding by the Dutch/Belgian company Ahold Delhaize

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for EUR 932.5 million. The next year’s modest inflow can be attributed to the internal political instability that came with turbulent elections and a subsequent transition of power. In 2013, the single major investment was by Israeli firm Big Shopping Centers, accounting for EUR 470 million for the construction of two shopping centers in Belgrade, as well as one each in the cities of Novi Sad and Panˇcevo. FDI inflows remained modest in 2014, then increased to EUR 2000 million in both 2015 and 2016. A notable socially and strategically relevant FDI in 2016 was the takeover of SARTID, the steel factory in Smederevo, by the Chinese Hesteel Group for only EUR 46 million, but with the obligation to invest additional EUR 300 million in the modernization of the production process. It is worth mentioning that SARTID was privatized for the first time in 2003 when it was purchased by the United States Steel Corporation. However, after several years of poor business due to the low market price of iron, it was sold back to Serbia in 2012. Warmer political relations and a strategic partnership with China resulted in another important privatization by the Chinese company Zijin Mining, which in August 2018 took over 63% of the copper mining and smelting complex RTB Bor in a EUR 1126 million deal with the Government of Serbia (NBS 2019). The National Program for the Integration of the Republic of Serbia into the European Union (NPI 2008) estimates that approximately EUR 10,000 million of annual FDI is needed for the optimal economic development of Serbia toward achieving full EU membership, a goal that had been ambitiously set forth for 2012. Keeping this in mind, current FDI inflows to Serbia, although helpful, are far from the volumes desired and anticipated by Serbian governments. According to the Statistical Office of the Republic of Serbia (2018), 2713 foreign companies were operating in Serbia as of 2016, encompassing roughly 3% of the total number of business entities in the country. However, those companies employed 223,125 persons, or 21% of the Serbia’s workforce. Most employees of foreign firms are concentrated in the manufacturing sector (50.1%), followed by wholesale and retail trade and repair of motor vehicles (22.5%), and administrative and support service activities (8.8%).

2.4.2 Origins of FDI in Serbia From Dunning’s (1980, 2001) framework, it is implied that foreign companies investing in Serbia must possess certain ownership advantages over their domestic counterparts in order to operate there. Table 2.2 highlights origin countries with the highest cumulative FDI flows in Serbia from 1995 to 2016. Overall, companies from EU countries dominate Serbia’s investment scene. However, considerable inflows come from non-EU European countries, notably Norway and Switzerland, followed by rising interest from Russian, Chinese, US, Arab, and Turkish firms. Serbia’s Statistical Office (2018) reports that the EU dominates the number of foreign firms operating in Serbia with 77.2%, while the non-EU countries represent 21% of foreign firms, and the remaining 1.8% of companies are from foreign subsidiaries

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Table 2.2 Cumulative FDI inflows to Serbia, 1995–2016 EU states

FDI inflow (EUR million)

Non-EU states

FDI inflow (EUR million)

1. Austria

3470.1

1. Norway

1316.9 1073.5

2. Netherlands

2877.4

2. Switzerland

3. Luxembourg

1821.1

3. Russia

971.1

4. Germany

1670.2

4. China

396.2

5. Greece

1217.7

5. USA

335.8

6. Italy

1195.5

6. Montenegro

253.2

7. France

807.4

7. UAE

237.5

8. Slovenia

709.6

8. Israel

55.5

9. Hungary

247.9

9. Turkey

53.3

10. UK

231.3

10. Canada

16.2

Source National Bank of Serbia (2017)

via offshore financial centers such as the British Virgin Islands (147), Panama (35), Liechtenstein (33), Belize (22), and the Bahamas (12 firms). The Netherlands and Luxembourg are considered as tax havens, and are likely overrepresented in Table 2.2. At the global scale, the World Bank (2019) estimates that approximately 30% of FDI comes through intermediate locations with favorable tax policies. Table 2.2 summarizes the most important origins of FDI to Serbia through 2016. The domination of FDI by firms based in the EU and Schengen countries is attributable to Serbia’s ongoing process of stabilization and EU association. The perception of Serbia as an integral part of an enlarged future EU market, as well as the existing trade agreement between Serbia and the EU, bring diverse sectors of FDI by EU MNEs. Investments from Montenegro to Serbia represent the continuity of economic cooperation between two republics since the Federation period. This cooperation is additionally reinforced by voluminous migration flows from Montenegro toward Serbia that built strong cultural bonds between the two states. Important economic linkages are also reflected by the fact that Republic of Serbia is one of the most important trade partners of Montenegro. The US stands as out one of the world leaders in information technology (IT) sector, and the origin of many global IT companies. Some of these companies, such as Microsoft and NCR, found Serbia to be a favorable destination for their investments due to strengths in the local workforce, concentrated in urban centers such as Belgrade, Novi Sad, and Niš (Fig. 2.2). Serbian workers are highly educated, skilled, fluent in foreign languages, and comparatively inexpensive. On the other side of the spectrum, a considerable amount of FDI comes from less-democratic countries with strong state influence that may override companies’ pure economic interest in investing abroad. Frequently, the companies that invest abroad are state-owned or de facto state-controlled, causing investments to have a prominent geostrategic component reflecting state interest that modifies the effects of market mechanisms. They are also enhanced by non-transparent bilateral

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governmental negotiations and agreements. Investments from these countries tend to be more focused on a limited number of sectors. Russia’s investments, for example, are predominantly directed to the energy sector. In taking over the Serbian petroleum industry in 2008, Russia’s main geostrategic and economic interest in the region is to strengthen its position as the main gas supplier of Europe. These considerations drive the ongoing capacity enlargement of the underground gas storage in Banatski dvor in Vojvodina, in which Russian Gazprom has 51% of shares, compared with 49% shares retained by Srbijagas (Serbian’s state-owned natural gas provider), as well as of the construction of the TurkStream branch of gas pipeline from Bulgaria via Serbia to Hungary. China’s interest in Serbia can be understood in the context of the European portion of the Belt and Road Initiative (BRI). This ambitious program is supported by the Chinese government and involves infrastructure development at the global scale to access markets and promote local development, while at the same time extending Chinese influence. Thus, Chinese current and planned investments in Serbia are mostly in line with a “twenty-first century Silk Road” and related to transportation infrastructure, specifically highways, railways, river ports, and a metro system for Belgrade. These infrastructure projects are accompanied by FDI in other sectors to exploit natural resources of iron, copper, and gold through mining. It is also worth mentioning the major investment of tire manufacturer Shandong Linglong in Zrenjanin, with an estimated value of EUR 800 million. Turkey is also interested in building transport infrastructure of regional importance in Serbia, such as the international motorway between Sarajevo and Belgrade. The economic justification for investments in the transportation sector are complemented by cultural and historical considerations, namely a more efficient way to connect the Muslim population in the Western Balkans with Turkey. Investments from United Arab Emirates (UAE) have also grown rapidly during the past few years. According to local media and official statements, these investments are the result of close relations and backroom agreements between leaders of the two countries’ governments, suggesting a lack of transparency without public review. The first of such investments was a joint venture in air transportation in 2013, whereby UAE’s national carrier Etihad Airways bought 49% of the shares in the Serbian national carrier Air Serbia, which remains majority-controlled (51%) by Serbia. In addition, the highly speculative megaproject Belgrade Waterfront began in 2014, envisioned as a large and prestigious residential and commercial development. The investor is Eagle Hills, a private real estate investor based in Abu Dhabi, UAE. The third major investment from UAE is the 2018 EUR 105.5 million sale of privatized PKB agrobusiness in Belgrade to Al Dahra, which is perceived as potentially damaging for Belgrade because the real estate purchased has an excellent location with potentially high value if converted from agricultural use into urban use. Ownership-specific characteristics sometimes explain why firms from certain countries are able or willing to spread their business abroad. Such advantages are usually reflected in higher productivity, or in products and services of higher quality, caused by a company’s internal attributes such as advanced technology, organization, and management, allowing them to overcome the costs of operating in a foreign country. Dunning’s (2001) generalized typology falls short of clarifying the extent to

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which these advantages are country-specific, as well as whether they were inherent to the company prior to the investment abroad, or if they appeared because of that investment. In this sense, the ownership advantages overlap with location-specific and internalization advantages, as the second and third pillars of Dunning’s framework, respectively. However, even if some ownership advantages may be a result of investments abroad, the company’s ability to benefit must exist prior to the selection of a specific location (Dunning 2001). In the context of long-term economic growth for Serbia, it makes a difference if foreign investors are profitable in their home countries because of ownership advantages, or whether they became profitable exclusively because of low production costs abroad. As host country, it is in the interest of Serbia to acquire technology and know-how through FDI, and not simply welcome foreign investors unselectively and subsidize their profits, thereby enhancing the ownership advantages of foreign MNEs. However, it appears that many investors find efficiencies based mainly upon relatively cheap labor in Serbia, and such FDI contributes only minimally to economic growth.

2.4.3 FDI Sectoral Composition and Mode of Entry Following Dunning’s (1980) notion of internalization advantages, benefits ensuing from economies of scale are among the main reasons justifying foreign companies’ decisions to exploit their ownership advantages internally through wholly owned subsidiaries (WOS) instead of other business modes such as exporting, outsourcing, or JVs. In this respect, some investors find Serbia as suitable destination to expand their production of goods or services, gaining higher profitability primarily based on lower input costs in comparison with the costs in their countries of origin, which may overcome the additional expense of operating abroad. After the devastating 1990s, the gradual re-entry of Serbia into international economic flows started with political changes that were introduced by the 2000 elections. With legislative changes in 2001, privatization became the main lever for increasing FDI volume in Serbia. According to Jane Armitage, World Bank Country Director and Regional Coordinator for Southeast Europe, roughly 90% of cumulative FDI in Serbia as of 2008 was a result of privatization (B92 2008). Since 2009, as most of Serbia’s large public companies had already been privatized, other modes of FDI such as greenfield investments as well as acquisitions of domestic firms became more typical. As shown in Fig. 2.1, the largest share of cumulative foreign capital from 2004 to 2016 is concentrated in the financial sector (NBS 2017). FDI inflows in financial and insurance activities recorded their most significant growth from 2005 to 2008 when most of the Serbian banks were privatized. Privatization in this sector was accompanied by significant volumes of greenfield investments and acquisitions. According to the NBS (2019), the development of Serbia’s financial sector is widely considered to be a precondition for FDI. However, at one point the Serbian market became

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Fig. 2.1 Structure of FDI inflows in Serbia, cumulative value from 2004 to 2016 (analysis of the sectoral distribution of FDI inflows is limited to the period from 2004 to 2016, as the NBS does not offer earlier data on the distribution of investments by activity.). Data Source NBS (2017)

oversaturated with 35 operating banks. That number is decreasing due to M&A processes and amounts to just 26 in 2019 (NBS 2019). Besides being perceived as necessary early in the transition process, investments into the financial sector are usually considered as additionally beneficial for the host country. This is due to the transfer of knowledge and skills primarily among management personnel that can help narrow the gap between doing business in Serbia and abroad. The second-largest accumulation of FDI is in Serbia’s manufacturing sector, particularly since 2013. Most of this involves the manufacture of basic metals and fabricated metal products (28.5%), except machinery and equipment. The manufacture of transport equipment represents 13.9% of the total, followed by rubber, plastics, and other non-metallic mineral products (11.8%). These industries have long thrived in Serbia, resulting in an important pool of skilled workers, so the attention of MNEs toward these sectors is unsurprising. For some time, the privatization of the Serbian car industry and purchase by Italian FIAT in 2008 was considered to be one of the most important economic successes at the national scale. It was perceived as such because investments in an export-oriented sector based on advanced technology and skilled labor create high value-added. This generates growth in the domestic economy through supply chains with other local companies. FIAT initially triggered development in the manufacture of basic metals and fabricated metal products as well as in other subsectors, and at one point it had numerous partners in Serbia. However, during the past several years, it recorded low production volumes and operated with a sharply decreased number of workers,

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threatening to generate a deep economic and social crisis, primarily in the city of Kragujevac. Another significant FDI development related to the automobile industry was the privatization of Tigar Tyres factory in Pirot, which was purchased by the French firm Michelin in 2007. Michelin benefits from its location in an industrial park within a free trade zone.1 Furthermore, the City of Pirot excused Michelin from a number of fees related to the construction and use of its new facilities (Free Zone Pirot 2019). On the opposite side of the spectrum are sectors that have attracted negligible FDI through 2016, namely agriculture, forestry, and fishing sectors as well as mining and quarrying. The main obstacle for FDI in agriculture is of legislative nature, as the Law on Agricultural Land from 2006 and its subsequent amendments make it nearly impossible for foreigners to buy agricultural land in Serbia. According to this law, state-owned agricultural land is explicitly excluded from sale to foreign investors. If a foreign investor is interested in buying privately owned agricultural land, they must fulfill obligations such as a minimum of ten years of residence in Serbia. Moreover, they must work on that land for at least three years and possess the registered agricultural holding, machines, and equipment necessary for production. In addition, a restriction exists upon the sale of agricultural land to foreign holders within a 10 km zone of state borders (Zakon o izmeni i dopunama zakona o poljoprivrednom zemljištu 2017). FDI in the mining and quarrying sector is disproportionate to its resource potential, although the mining rent in Serbia is very low at 3–7%. By comparison, in most countries it ranges from 20 to 30%. Through the privatization of Serbia’s petroleum industry, Russian Gazprom Neft gained possession of the country’s oil fields and began exploiting them. The most recent investment in this sector (not covered with 2004–2016 data) is the Chinese Zijin Mining investment in RTB Bor for copper mining. It is noteworthy at the time of writing that 25 large companies are engaged in geological research on Serbian territory. These companies include Freeport-McMoRan Exploration, Nevsun, and Dundee Precious Metals. They are engaged in the geological exploration of copper, gold, and precious metals, while Rio Tinto and Erin Ventures are exploring for lithium and boron nitride (SEE 2019). The Serbian economy can potentially reap the benefits from FDI that introduces modern technologies including new equipment, knowledge, and expertise. These investments bring both tangible and intangible assets. In this respect, FIAT can be classified as a high-technology investment with development programs involving strong backward linkages with local SMEs intended to increase the share of domestic auto components in the final product, acting as significant lever for the industrial development of Serbia. Companies such as Gazprom Neft, Stada, Michelin, Hesteel 1 Serbia’s

Free Zones Administration was established in 2008 and is responsible for all activities related to the functioning, promotion, and development of free zones in Serbia. Free zones are recognized as additionally attractive and beneficial for investors. They are excluded from VAT, customs, and clearance. In 2018, there were 15 free zones with 204 multinational companies and annual turnover of EUR 5 billion, providing nearly 14% of all Serbian exports (Razvojna agencija Srbije 2018).

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and Zijin Bor Copper can also be considered as economically beneficial investments from the perspective of the host country. These companies have invested in the modernization and technological improvement of production and increased the quality of products to meet EU standards. Technology transfer to Serbia is also evident in trade, namely in new retail chains such as Ahold Delhaize, DM, Mercator, Lidl, and IKEA. These firms introduced a new approach in the Serbian trading sector based on customer behavior analyses, modern equipment, as well as the education and training of domestic subcontractors at all levels.

2.4.4 Geographic Distribution of FDI in Serbia Complementing the discussion of Dunning’s ownership and internalization advantages as they relate to Serbia, it is important to understand the country’s locational advantages, both at the national and subnational scale. Contrary to ownership advantages, location-based characteristics are generally fixed and specific either to Serbia or one of its regions, and they can help explain the location choices of MNEs. At the national scale, Serbia has proved to be a relatively attractive destination for FDI, as it dominates the FDI picture for former Yugoslavia with EUR 34,788 million in cumulative FDI at the end of 2018 (WIIW 2019), more than 30% of the total for all states. This is related to many factors embedded in Serbia’s complex economic, social, and political conditions. It is also a result of Serbia’s market proximity, its population size, and growth potential, as well as natural resources, labor costs, and skills, combined with a business-friendly environment supported by state and municipal policies and incentives that cater to foreign investors, sometimes favoring them at the expense of domestic firms. These location-specific advantages are explored in more detail in this section. Serbia’s spatial distribution of major FDI projects (Fig. 2.2) reveals that most of investments in the service sector are dependent on large urban agglomerations, attracting them to the capital city of Belgrade (e.g., Intesa, Delhaize, VIP, Telenor). Investments that are explicitly related to a skilled workforce (e.g., FIAT, Stada, Michelin, and Star Bev) or natural resources (e.g., Gasprom, Hesteel, and Zijin) are dispersed in other urban centers. The spatial distribution of major FDI projects plays an important role in shaping national plans for the development of transport infrastructure, altering priorities in transport projects at municipal and urban levels, which all become increasingly adapted to the needs of privileged MNEs. The geography of major FDIs in Serbia can lead to an illusion of relatively balanced decentralization. However, while the investments in Belgrade take the form of acquisitions and greenfield projects, all of the others in Fig. 2.2 result from the privatization process discussed earlier. Most foreign capital bypasses the local levels and accumulates in the central (state) budget, indirectly reinforcing economic disparities between Belgrade and the other regions. While Serbia is not considered a large market at the global scale, its population size is favorable compared to its regional competitors. Moreover, although some foreign firms in telecommunications and retail have been attracted by Serbia’s domestic

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Fig. 2.2 Distribution of selected major investments in Serbia (in EUR million). Source Razvojna agencija Srbije (2020), WIIW (2019)

market, arguably the country’s main advantages can be found at the broader Balkan and European scales. Being the Balkan regional hub for the export of products and services, Serbia is also convenient as an entrance point to the wider European market. This aspect of Serbia’s attractiveness is significantly enhanced by several recent formal integration processes. Of particular importance is the 2013 ratification of the Stabilization and Association Agreement with the EU, when Serbia became an accession candidate, as well as Serbia’s participation in the Central European Free Trade Agreement (CEFTA) since 2007. CEFTA involves Western Balkans states that are not part of the EU, as well as Moldova. This membership is further complemented by a bilateral trade agreement between Serbia and Turkey. Bilateral trade agreements between Serbia and Russia, Belarus, and Kazakhstan are superseded by the 2019 Eurasian Economic Union (EAEU) free trade pact encompassing Russia, Armenia, Belarus, Kazakhstan, and Kyrgyzstan. Serbia’s involvement in this organization triggered controversial debates and criticism from EU officials because of the EAEU’s geostrategic and political connotations. Serbia’s location, existing accessibility and ongoing infrastructure development between the Western Balkans countries, as well as between the Western Balkans and EU, is an advantage for attracting FDI. Its favorable position on major international transport routes has been only partially realized thus far. Additional improvements are

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required in order to comply with EU transport standards, which would help it integrate with the Trans-European Transport Network (TEN-T). It is also of critical importance for Serbia to alleviate non-physical (administrative and legislative) barriers, which cause problems and disadvantages such as long waiting times at the border crossings (Multi Annual Plan 2018). Together, these improvements have the potential to expand the markets for FDI projects located in Serbia, while at the same time increasing the country’s exports. However, it should be noted that the internationally agreed extension of the TEN-T core and comprehensive networks to Serbia favor cities over the vast underdeveloped periphery, threatening to intensify existing deep urban–rural disparities. Many MNEs seek to exploit Serbia’s raw materials, ranging from limestone and clay for cement factories, to copper ores for the metal industry. Perhaps even more important than its natural resources are Serbia’s human resources, which MNEs seek in order to reduce their labor costs. Serbia’s large unemployed workforce and low wages, together with little unionization, provide a strong magnet for labor-intensive FDI in Serbia. It follows that many MNEs are not required to bring advanced technology or knowledge with them while simply exploiting the advantages of low-cost labor. From the short-term perspective, this type of FDI can help decrease the unemployment rate but should not be perceived as a long-term solution for economic growth and rising living standards, let alone a means for narrowing the gap between more-developed and less-developed places. In addition, MNEs in Serbia prefer locations in or near large urban centers such as Belgrade, Novi Sad, and Niš. Urban areas provide them with infrastructure and accessibility, both at the national and international scale. Given such locational preferences by MNEs and recognizing that labor is a mobile factor of production, FDI reinforces migration flows toward large urban centers, which exacerbates interregional and urban–rural discrepancies in Serbia. Some labor-seeking manufacturing and service MNEs can create high valueadded in the host country. According to the survey conducted by Bitzenis and Žugi´c (2014), foreign manufacturing companies in Serbia are attracted not just by low-cost labor, but also highly-skilled workers. Locational advantages related to skilled labor may also be reflected in the presence of compatible SMEs that produce high quality products and services. However, Serbia suffers from large scale emigration, which affects a variety of occupations ranging from professional drivers to nursing staff and engineers. In this respect, it is doubtful whether Serbia can continue to provide this combination of both inexpensive and skilled labor in the future. Furthermore, Serbia’s eventual success in EU accession would inevitably be followed by an increase in international labor mobility. Mass emigration endangers the social and economic prospects for Serbia, hastening its demographic crisis and population shrinkage (Statistical Office of the Republic of Serbia 2012). Keeping this in mind, Serbia must make a radical shift toward increasing wages and overall living conditions to keep its most productive citizens in the country. Serbia cannot accomplish this by catering to MNEs that base their profits solely on low-cost labor-intensive processes.

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2.5 Prospects and Suggestions for FDI in Serbia Over the Next 25 Years This concluding section sets forth prospects for FDI in Serbia, focusing mainly upon policy suggestions to improve the quality of FDI entering the country. The volume of FDI inflows to Serbia in the future will undoubtedly depend on conditions in the global economic environment. While the influences of the 2007–08 GFC on FDI flows can be largely estimated, it is far too early to give any prediction of the economic consequences of the ongoing COVID-19 pandemic. However, in any scenario, prospects for long-term progress in Serbia will remain limited until substantial changes take place in the structure of the country’s economy. These are related to the hundreds of state-owned companies that are waiting to be privatized, with the process being hampered by inefficiencies in liquidation and bankruptcy procedures. According to the highly optimistic plans of the Serbian government in 2020 presented across domestic media, the country can expect several significant investments centered on mega-projects during the 2020s. The already launched Belgrade Waterfront project will offer an enormous complex of prestigious residential and office buildings and shopping malls in the city center. The widely propagated government plan is to build a modern Belgrade Port, which is intended to become the largest intermodal transportation hub in the region, with transshipment capacity of between three and five million tonnes of cargo. Through China’s Belt and Road Initiative, investment of USD 10,000 million is expected, mostly in the form of new transport infrastructure including highways and high-speed rail. In 2018, the Serbian government signed an agreement with the Chinese company CRBC for the construction of a science and industrial park in Belgrade. This park is projected to bring about EUR 2 billion in FDI and is expected to employ more than 10,000 workers. Serbia’s attractiveness as a destination for FDI is heightened by recent trade agreements with the EU and Turkey, as well as with other Western Balkan states and Moldova (CEFTA). Serbia’s participation in the 2019 EAEU, which includes Russia and some of its former satellites, generated criticism in international circles, especially within the EU. Involvement in this agreement was indirectly encouraged by the political crisis in the EU and that organization’s related reticence regarding the association process for Western Balkans states. Participation in CEFTA and the free trade pact with EAEU may be considered as an alternative to EU integration, which has been hampered due to internal EU issues such as Brexit as well as the refugee crisis. This diversification of Serbia’s integration processes, namely free trade agreements outside the EU-space, may have economic importance and increase investor interest in Serbia due to its expanded markets. However, the EAEU in particular is unavoidably suggestive of outside geopolitical interests and strategies. In the bestcase scenario, Serbia might develop into the “bridge of cooperation” between EU countries on one side, and non-EU European and Asian partners on the other. As we conclude this reflective analysis, it is both in order and prudent to also consider Serbia’s FDI experience critically. Moving into the next quarter century,

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Serbia should enhance its own competitiveness as an investment destination by developing its infrastructure and human capital, rather than offering excessive and irresponsible public incentives to attract FDI. Public investment in transport infrastructure is necessary in order to improve Serbia’s rudimentary highway and rail networks, which currently leave a considerable portion of the country without reasonable transportation accessibility. As called for by Petrovi´c et al. (2019), investment should also address improvements in national healthcare and education, as well as the ecologically sustainable exploitation of natural resources. Placing these priorities at the forefront, together with the imperative for legislative improvement, will help the country become more attractive to FDI for its own long-term benefit. Although investment origin—whether foreign or domestic—is sometimes neglected as irrelevant in economic theory, numerous empirical studies demonstrate the importance of domestic capital as a driver of the pace and extent of economic growth (Draškovi´c and Milojevi´c 2016; Kovaˇcevi´c 2016a; Madžar 2019; Petrovi´c et al. 2019). Following Arsi´c et al. (2019) Serbia’s level of domestic public and private investments must be increased. Their research suggests that FDI cannot be considered as merely a substitute for or supplement to domestic investments. Madžar (2019) contends that no empirical evidence exists for successful economic development based upon FDI alone and without a concurrent substantial increase in domestic capital accumulation. While FDI in Serbia has been increasing steadily since 2012, Serbia’s already-insufficient domestic investment is declining. Total domestic investment in Serbia is small relative to other countries in the region at approximately 18% of total value (Madžar 2019). Furthermore, due to fluctuations in unpredictable international capital flows, Serbia’s predominant reliance on FDI in an environment of weak domestic investments may lead to macroeconomic instability in the long term. Thus, Serbian economic policy should focus more on domestic capital. Unfortunately, since 2001 successive governments have seemed to place their priorities upon FDI, as indicated by FDI’s prominence in political campaigns. The Serbian society and economy are characterized by underdeveloped institutions. Unclear regulation, poor protection of intellectual property rights, corruption, and high input prices caused by bureaucracy are widely recognized as obstacles for business. However, foreign investments are better protected than domestic ones from the consequences of weak institutions. This is because they often enjoy the direct support of local and even national governments and special public agencies, exacerbating disparities between foreign and domestic firms (Arsi´c et al. 2019). This support is most evident in incentives and special agreements. Namely, in order to attract more FDI, Serbia introduced the policy of incentives related to wages and taxes. Although both foreign and domestic investors formally have access to incentives, in practice they are predominantly awarded to MNEs, suppressing domestic entrepreneurship and eventually pushing it abroad. With its unselective promotion of FDI, Serbia attracts highly speculative and initially unprofitable foreign investments that became profitable to the firm only through publically-funded incentives. As magnets for profit-driven MNEs with no intention to remain in Serbia, some incentives negatively influence the structure of FDI. Successive Serbian governments have

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fallen into this trap with their incentive policies, succumbing to continuous concessions to keep foreign companies in the country. From the national economic and social perspective, this level of unconditional support exemplifies an irrational use of already scarce public funds. In addition to discriminating against domestic investors, past FDI incentives also fail to treat foreign investors uniformly, as the result of non-transparent negotiations between government and company representatives (Madžar 2019). The most important details of these special agreements are usually hidden from the public behind the curtain of “business secrets,” which are deemed as proprietary. Thus, the exact amounts of public funds as well as other conveniences prescribed to MNEs remain unknown. The common practice in these agreements is to determine salaries outside the influence of market mechanisms and to jeopardize the position of workers by limiting the power of collective bargaining, among other things. One well-publicized example of worker deprivation and humiliation that remained long unresolved was by Yura, a South Korean producer of electric cables in Leskovac, Southern Serbia, which forbid its employees to use toilets during long shifts, compelling them to wear diapers (Bukvi´c 2016). According to Madžar (2019), imprudent incentives for investors create fertile ground for corruption and annihilate fair market competition, thereby erasing benefits that could otherwise be realized through FDI. Stronger institutions would make direct negotiations and incentives redundant and should therefore become the core of Serbia’s FDI policy. This would contribute to the fair market game between foreign and domestic investors, lessening Serbia’s irrational dependency on FDI and increasing foreign capital’s benefits for the national and local economies alike. Serbia’s current FDI policy reinforces modest economic growth, deepening the gap between itself and the most wealthy countries in the EU. Vasa and Angeloska (2020) confirm this with their recent analysis, which reveals no evidence that increasing FDI in Serbia decreases the unemployment rate, nor do the authors find that it stimulates substantial economic growth. FDI in Serbia should be judged qualitatively rather than quantitatively. Arsi´c et al. (2019) stress the importance of understanding indirect benefits from FDI rather than judging them solely by capital inflow values. These benefits are often specific to the unique characteristics of the involved MNEs and may include advanced technology and knowledge that lead to increased productivity and ultimately to economic growth. However, such benefits may be difficult to identify in many current investments in Serbia, which are driven by its low-cost labor, low taxes, high subsidies, free trade agreements negotiated with the EU, CEFTA, EAEU and Turkey, and direct support and protection from inefficient legal and bureaucratic systems. Although Serbia leads former Yugoslavia with a dominant share of FDI, the effects of MNEs operating there are not inherently beneficial (Zec and Radonji´c 2019). This is due to their sectoral concentration in services and simple manufacturing (Radenkovi´c 2016), industries associated with limited transfer of technology and know-how. Future proposed FDI projects should be scrutinized thoroughly and transparently with attention being paid to the motivations of MNEs, and with care being placed on sustainable economic development in Serbia. Boljanovi´c (2012)

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argues that technology transfer and other positive spillovers could be realized better through investments in more strategic industries. Such industries that should be targeted include but are not limited to those related to digital innovation and development. These may also include “Internet of things,” electro-mobility, smart cities, artificial intelligence, innovations in agro-industry, construction, tourism, trade, and transportation. Acknowledgements This work was supported by the Ministry of Education, Science and Technological Development of the Republic of Serbia under project No. 176017 and project 179065. We would like to express special gratitude to company CUBE team D.O.O Beograd for their generous assistance with data gathering.

List of Abbreviations B&H BPM6 CEE CEFTA EAEU EU FDI FRY GDP GFC IT JV MNE OECD OLI SFRY SME STET UAE WIIW WOS WWI WWII

Bosnia & Herzegovina Balance of Payments and International Investment Manual Version 6 Central and Eastern Europe Central European Free Trade Agreement Eurasian Economic Union European Union Foreign Direct Investment Federal Republic of Yugoslavia Gross Domestic Product Global Financial Crisis Information Technology Joint Venture Multinational Enterprise Organization for Economic Cooperation and Development Origins-Location-Internalization Socialist Federal Republic of Yugoslavia Small and Medium-Sized Enterprise Societa Finanziaria Telefonica United Arab Emirates Vienna Institute for International Economic Studies Wholly Owned Subsidiary World War I World War II

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Chapter 3

FDI in Croatia Josip Tica, Tomislav Globan, and Marin Levaj

Abstract During the process of transition from a planned to a market economy, much like other transition economies from Central and Eastern Europe (CEE), Croatia turned to international financial markets to boost growth, transfer technology, increase private ownership in its economy, and finance gross fixed capital formation. Although Croatia has attracted a considerable amount of foreign direct investment (FDI) inflows since its independence, the type of investment has generally been unfavorable for supporting economic growth. Croatian War of Independence and its aftermath, combined with isolation from the international community in the 1990s, largely excluded Croatia from European and global value chains. Subsequently, most of its FDI inflows took the form of acquisitions of existing companies and big market-share firms in non-tradeable sectors such as finance, retail, and real estate. The lack of both domestic and foreign investment in high value-added and high-tech industries such as machines, vehicles, electronics, and chemicals, resulted in a suboptimal industrial production structure and acute deindustrialization that was particularly detrimental for the inland regions of Croatia. Notwithstanding an unfavorable sectoral composition of FDI and lack of greenfield investments thus far, the Croatian economy remains an attractive investment destination. As a European Union (EU) member since 2013, Croatia’s expected accession to the Eurozone in the mid-2020s will eliminate the exchange rate risk, reduce the risk premium, and thus make Croatia even safer as a location for FDI. Keywords FDI · Croatia · Former Yugoslavia

J. Tica (B) · T. Globan · M. Levaj Faculty of Economics and Business, University of Zagreb, Zagreb, Croatia e-mail: [email protected] T. Globan e-mail: [email protected] M. Levaj e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_3

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3.1 Introduction This chapter investigates the origins of foreign direct investment (FDI) inflows to Croatia, with special emphasis on the industrial and sectoral composition of these flows. We also analyze the location choices of investors within the country and perform a spatial analysis of the distribution of population compared to revenues in foreign-owned companies. Finally, we discuss the prospects for FDI over the next decade, with respect to economic growth and further integration with core European Union (EU) countries. In the process of economic transition from central planning to market orientation, Croatia turned to international financial markets in order to augment growth, technology transfer, and encourage private ownership, as well as financing gross fixed capital formation. As such, its policy objectives were much like those of other transition economies in Central and Eastern Europe (CEE). As the financial liberalization process began in the early to mid-1990s, together with other transition-related reforms, foreign direct investment (FDI) become a very important source of external financing. Inflows grew continuously through the transition period until 2007, when the global financial crisis (GFC) began. Both domestic (pull) and foreign (push) factors play a role in stimulating capital inflows to Croatia and other CEE countries. For most of these inflows, EU accession negotiations were an important factor in attracting capital flows, as their completion signaled Croatia’s credibility with regard to economic policy, macroeconomic stability, and structural reforms, all resulting in a lower risk premium. Furthermore, as Ötker-Robe et al. (2007) point out, CEE countries including Croatia attracted foreign capital because of higher interest rates vis-à-vis their more-developed countries. Other factors like high levels of liquidity in the global market, privatization of large state-owned companies, financial deregulation, foreign debt restructuring, and access to EU funds, all acted as important drivers of capital inflows to this particular group of countries. The GFC brought a sudden decline of FDI inflows to Croatia and the region, and in some cases even led to the withdrawal of projects. This was unusual, given that FDI is known for its stability and low volatility and it had remained steady during several previous financial crises (Lipsey 2001). Several factors led to the decrease of FDI during the crisis of 2007–2009. Deteriorating conditions in global financial markets and considerably more difficult access to previously reliable sources of foreign financing reduced the rates of economic growth in the region. Moreover, the collapse of asset prices and the recession’s effects in Croatia’s major investment origins such as Germany, Italy, and Austria also contributed to the decline of FDI inflows during this period (UNCTAD 2009). The crisis had even more severe consequences for specific types of investment, predominantly foreign loans. Along with FDI, loans represent crucial sources of foreign financing for Croatia. After the crisis, economic recovery was not accompanied with a return of FDI inflows. Instead, Croatia’s recovery has been based on domestic savings and current account surpluses.

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The Croatian War of Independence and its aftermath, coupled with the isolation from the international markets, constrained Croatia’s inclusion in European and global value chains during the 1990s. Nevertheless, Croatia received a significant amount of FDI in the period between 1993 and 2017 with total receipts amounting to EUR 32.6 billion. In the context of Dunning’s (1980) Origins-LocationInternalization (“OLI”) framework, the origins of most of Croatia’s FDI inflows are other European Union countries due to advantages enjoyed by European MNEs. A significant part of these include horizontal FDI in the form of acquisitions of existing companies and big market-share firms in non-tradeable sectors primarily in banking, retail, real estate, telecommunications and energy. Greenfield investments have been scarce, resulting in an unfavorable sectoral composition of FDI. Equity investment accounts for more than two-thirds of cumulative FDI, driven mostly by the privatization of state-owned enterprises. The large majority of FDI in the banking sector, telecommunication companies, and energy companies theoretically fits within the concept of capturing net benefits of regional consolidation of MNEs within CEE in general. The same or similar global companies entered Croatia in parallel with their entry to the rest of CEE. There was not much of competition between Croatia and other transition countries in that respect. Out of local resources, the national market-share of privatized entities was of premium interest to investors. Regarding the spatial distribution of FDI in Croatia, most FDI is concentrated around the capital city of Zagreb and its surroundings due to the agglomeration of population, as well as this region’s skilled and educated workforce. Apart from Zagreb, coastal regions are attractive for FDI due to the tourism industry, especially in Istria and Split-Dalmatia county, which attract the highest number of tourist arrivals and overnights. In terms of Dunning’s (1980) OLI approach, the predominant reasons for FDI inflows in Croatia’s coastal areas stem from natural resource endowments and other amenities in the tourism industry. In order to intensify FDI in the future, Croatia will need to address the country’s insufficient institutional development, inefficient judiciary system, and high regulatory and administrative barriers at the national and local level that constrain both domestic and foreign investments. That said, the Croatian government is determined to attract more FDI, and has therefore passed the Law on Strategic Investment Projects in 2013, granting preferential treatment to all projects valued above EUR 10 million (Narodne novine 2018). Despite its unfavorable sectoral composition of FDI, Croatia remains an attractive investment destination in comparison to rest of the Western Balkans region. Membership in the EU provides MNEs with access to the single market when investing in the country, while the expected entry to the Eurozone by the mid-2020s could lead to even more foreign interest in Croatia. Euro adoption would eliminate the exchange rate risk, reduce the risk premium, and thus make Croatia a safer investment destination. Investment activity in the future will be supported by EU co-financed infrastructure projects and further privatization efforts.

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With regard to EU co-financed infrastructure projects, Chinese state-owned China Road and Bridge Corporation (CRBC) won the public tender in 2018 for the construction of Pelješac bridge, a project worth EUR 526 million, which is the first construction project carried out by a large Chinese construction company within the EU market. This nascent Chinese interest in the region, through which Chinese companies see the opportunity to penetrate the EU market, presents a significant potential for attracting FDI in Croatia. While tourism, transportation, and energy remain the most attractive sectors for foreign MNEs, the main task for the government is to create a better business environment and provide incentives for investments in industries with higher value-added potential. More favorable industries include machinery, vehicles, electronics, and chemicals. Unfortunately, the current sectoral composition of FDI in Croatia fails to support robust economic growth. This chapter is structured as follows: Sect. 3.2 reviews the literature concerning the determinants and economic effects of FDI flows to Croatia, while Sect. 3.3 examines in detail the dynamics, composition and origins of capital inflows to Croatia, with emphasis on FDI flows. Sections 3.4 and 3.5 deal with the sectoral and spatial distribution of FDI flows to Croatia, respectively, providing comprehensive insights into the cumulative sectoral distribution of FDI flows and location choices made by foreign investors. The final section of the chapter concludes our findings and offers some prospects for the future.

3.2 Literature Review As Croatia became more open to global trade and capital flows at the turn of the century and began pursuing accession to the EU, the debate over attracting foreign capital became very interesting not only to domestic scholars but also to the general public. Unsurprisingly, most scientific papers dealing with the issue of foreign capital inflows to Croatia began emerging in the early 2000s and continue in academic journals and policy documents to this day. Babi´c et al. (2001) provide a pioneering paper that summarizes the most important elements of FDI theory and the determinants influencing flows. The authors also review the theoretical and empirical research on FDI’s impact on macroeconomic conditions in the destination countries. These typically include growth in exports, imports, gross domestic product, and domestic investments. Theoretical considerations are complemented by past experiences of European transition countries such as Croatia in attracting FDI. Special attention is given to the Croatian Investment Incentive Act. Policies for attracting FDI in other transition countries are described and compared, with policy recommendations on effectiveness for attracting foreign investment. Jovanˇcevi´c (2003) explores the determinants of FDI from the perspective of European managers running companies in Croatia, focusing upon their views of the country as an investment destination. Although Croatia recorded a significant

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inflow of all types of capital inflows from 1998 to 2002, foreign managers highlight several factors that make it more difficult to invest from abroad. These include overwhelming and complicated administrative processes and an inefficient judicial system. Managers of smaller companies operating in Croatia believe that further corporate tax reductions would help to attract additional FDI, but the author points out this might reflect managers’ personal opinions and not necessarily the best interest of their corporations. Ani´c and Jovanˇcevi´c (2004, 2006) examine the motivations of foreign equity investors in the Croatian trade sector. Their empirical analysis shows that geographic proximity, stable macroeconomic policy, a relatively underdeveloped market, and ample labor supply are the most significant factors for attracting FDI. On the other hand, obstacles to even greater FDI inflows are identified in this small market characterized by low consumer income, drawn-out bureaucratic procedures for setting up a business, rigid zoning, and regulations on opening hours. Nevertheless, MNEs continue to invest in the Croatian market due to the developmental opportunities it provides, enabling them to gain a competitive advantage vis-à-vis domestic companies, thereby increasing profits. The authors conclude that when making foreign investment decisions, companies are primarily motivated by long-term profits. - (2006) finds a strong link between governance quality and the inflow Badun of foreign capital in all CEE countries except Slovenia and Croatia. In this study, governance quality is defined by levels of corruption, bureaucracy, rule of law, and regulatory burdens. The author states that in Slovenia, this is the result of a national investment strategy that aims to keep the most important companies under domestic ownership, while in Croatia the explanation stems from warfare during the first half of the 1990s. Since all CEE countries face the problems of inefficient justice - argues the priorities systems, corruption, and low administrative capacity, Badun of every government should be to strengthen the rule of law, depoliticize public administration, fight corruption, decrease the regulatory burden, and simplify the process for establishing a new company. Jovanˇcevi´c and Ševi´c (2006) address the motivational factors of foreign firms and stress the importance of a transparent and efficient domestic administration, credible legal system, and the elimination of customs and non-tariff barriers on cross-border cooperation. For transition countries including Croatia, they emphasize the importance of combating corruption, as such government actions evoke a positive reaction among foreign investors. They consider the efficiency of the property rights protection system to be a crucial determinant for attracting foreign capital and highlight the role of government in creating a modern and stimulating business environment, positively oriented toward FDI. Pavlovi´c (2007) points out that FDI inflows to Croatia are not determined by changes in the corporate income tax rate, but that macroeconomic stability, a stable social and political environment, ease of doing business, and an educated and skilled labor force have a significantly stronger impact on attracting foreign investments. Franc (2008) conducts a comparative analysis of FDI determinants in Croatia and 12 new EU member states. Significant factors influencing FDI inflows to these countries are lower labor costs (especially in Romania and Bulgaria), GDP growth rates, labor

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productivity, current account balance, trade openness, degree of corruption, as well as the duration and volume of legal and administrative procedures. Joši´c (2008) analyzes the effects of FDI on exports of goods from Croatia. He concludes that the high inelasticity of exports with regard to individual components of FDI is a result of an unfavorable investment structure dominated by investment in the services sector, which leaves no space for export growth. At the county and NUTS-2 regions level, Škufli´c and Botri´c (2009) investigate determinants of direct investment inflows. Their results confirm that the share of highly educated in the total labor force, export orientation, as well as a higher county-level share of domestic investment reflect positively toward foreign investors when choosing a location for investment within Croatia. Marijanovi´c et al. (2009) analyze the influence of FDI on the comparative advantages and specialization degree in international commodity exchange for a selection of transition countries and Croatia. The results, obtained through the RCA method and “Trade Overlap” index, show that Croatia deviates from other transition countries that have made a significant shift in economic convergence toward becoming industrialized countries. They argue that Croatia’s inability to converge is a result of the unfavorable structure of FDI, which neglects the manufacturing sector. Ljubaj et al. (2010) evaluate the value of Croatia’s offset coefficient, which shows the extent to which actions of the Croatian National Bank (CNB) in the domestic market have stimulated foreign capital inflows to the country. The results of the model point to the negative link between monetary multipliers and capital inflows, which can be explained by the fact that higher monetary multiplication contributes to the growth of liquid assets and consequently a fall in interest rates. This, in turn, should lead to the reduction in capital inflows from abroad. Furthermore, the results point to the expected negative correlation between the depreciation of the kuna against the euro vis-à-vis capital inflows, given that the CNB sells their foreign exchange reserves to avoid depreciation pressures, thus reducing its net foreign assets (proxy variance for capital inflows). Finally, the model indicates that general government debt growth leads to a larger capital inflow in Croatia. This suggests that the countercyclical activity of the CNB created foreign exchange reserves by neutralizing the inflow of foreign capital. Jovanˇcevi´c and Globan (2011) confirm the strong impact of the GFC on CEE capital flows and analyze other determinants of FDI flows to Croatia. Their econometric analysis shows that the movement of domestic GDP, Croatian negotiations with the EU, and price movements on the foreign capital market (Frankfurt Stock Exchange) had a statistically significant positive effect on FDI inflows to Croatia. On the other hand, price movements on the domestic equity market (Zagreb Stock Exchange), the domestic level of real wages as a labor cost measure, and the impact of the GFC had a negative impact on FDI. In sum, the results confirm their hypothesis about the non-resilience of FDI in Croatia under the conditions of the financial crisis. Kersan-Škabi´c (2013) investigates the institutional environment in Southeastern Europe and its importance in attracting FDI. Panel-analysis results indicate the importance of economic determinants (GDP and inflation) in attracting FDI

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inflows. Among institutional factors, only corruption, large-scale privatization, development of trade and forex systems, and overall infrastructure reform have a significant impact on FDI inflows. Property rights freedom and small-scale privatization are not found to be statistically significant. The effects of FDI in the Croatian tourism sector are investigated by Peri´c and Radi´c (2015) who find that Croatia’s accumulated FDI in tourism has a positive and significant effect on tourism productivity in Croatia. Their research indicates that more FDI is essential to further develop Croatian tourism, alongside the improvement of the substandard institutional environment that has been proven to have a negative impact on tourism productivity. Estrin and Uvali´c (2014) find that the Western Balkans countries receive less FDI than other transition countries, controlling for the economy size, geographical distance from investors, and the quality of institutions. They attribute the lack of FDI to the negative ‘Western Balkans’ effect. In other words, the recent conflicts, fragmentation, and slow economic growth have led to a long-lasting effect on FDI prospects in the region. They find that various unsettled political issues in the region continue to exercise a negative effect on FDI. Other authors lament the failure of economic policymakers in Croatia in establishing the conditions for a permanent and stable inflow of FDI to the country. For instance, Globan (2018) finds that the greatest pre-crisis wave of FDI to Croatia was primarily the result of favorable push factors in the Eurozone and less a result of attractive domestic economic indicators, much like in other CEE countries (Globan 2015a, b). This indicates the inability of the Croatian government to create conditions to control and attract FDI with active measures of domestic economic policy, limiting the potential for renewed growth in foreign investment and a new wave of equity capital inflows to Croatia.

3.3 Dynamics and Composition of Capital Inflows to Croatia At the beginning of the transition period (mid-1990s), capital inflows to Croatia accelerated in response to liberalization of the financial account and growing international financial integration of the Croatian economy. The initial transition period was marked by a relatively low level of capital inflows, at 2–3% of GDP, or EUR 246 million in 1993 and EUR 382 million in 1994 in nominal terms (Fig. 3.1). War and its aftermath had a strong impact, resulting in low levels of capital inflows, while at the same time, inciting capital flight from domestic to foreign banks. By the end of the twentieth century, the inflow of capital to Croatia reached almost 13% of GDP amid the post-war repatriation process of domestic savings previously held in foreign banks or outside the banking system as well as the stabilization program. The exception was in 1998 when the effects of the financial crisis in Russia spread to Croatia, and capital inflows dropped to only EUR 1.4 billion (6.1% of GDP).

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10000

25.0% 20.0%

8000

15.0% 6000 10.0% 4000 5.0% 2000 0.0% 0

-5.0% -10.0% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-2000

million EUR

% GDP

Fig. 3.1 Total capital inflow to Croatia (1993–2017). Sources Authors’ calculations, CNB (2019a), Eurostat (2019), MMF—WEO Database (October 2018)

At the same time, due to the crisis in the domestic banking sector in 1998, as well as the announced revision of the privatization process in the pre-election year 1999, significant capital flight from Croatia occurred, estimated at USD 2.7 billion (Vukši´c, 2001). Following a brief recession caused by the domestic banking crisis at the end of the 1990s, the financial crisis in Russia, and NATO military operations in Serbia and Kosovo, Croatia entered a period of economic growth that came as a result of rising domestic spending. The domestic demand-driven economic growth generated rising external imbalances in the Croatia economy, such as an increase in the current account deficit, representing 5.9% of GDP on average between 2001 and 2008 (CNB 2019a). This deficit was financed by foreign capital. Figure 3.1 shows that capital inflows more than doubled in just three years, from 2005 to 2008, up from EUR 3.6 billion (2005) to a record high EUR 8 billion (2008). Given that GDP growth in those years was at relatively high rates of 4.1% year-on-year (CNB 2019a) this increase in foreign capital flows was not so noticeable in terms of its percentage of GDP. A combination of domestic and foreign factors determined the capital inflow to Croatia until the GFC. Ötker-Robe et al. (2007) point out several of these demand and supply factors. On the one hand, the gradual integration of Croatia into international financial markets and increased market confidence in the Croatian economy created a large demand for foreign capital. On the other hand, a favorable environment for investors was created by macroeconomic stability reflected in steady prices and exchange rates, recovery of the banking sector, and the attainment of an investment credit rating in 1997. Foreign capital was attracted by a stable kuna/euro exchange

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rate, as well as relatively high domestic interest rates vis-a-vis the developed industrial countries. Moreover, at the beginning of the 2000s, rapid growth in demand for loans from domestic banks, financed by their borrowing abroad, increased the inflow of foreign loans to the Croatian economy. On the supply side, the increase in FDI was also stimulated by the Paris and London Club debt agreements in 1995 and 1996, as well as foreign banks with easy access to capital entering the Croatian market. The GFC brought about a sudden and sharp drop in investment activity, and like other European post-communist countries, Croatia experienced the consequences very strongly. Already by 2009, the inflow of capital to Croatia decreased by 33% compared to the previous year, and by 2012 it fell to just EUR 93 million (0.2%/GDP). The capital inflow slump that was recorded in Croatia was caused by unfavorable economic developments and weak domestic demand coupled with reduced investment activity in all EU countries amid the debt crisis in peripheral Eurozone countries. Strong deleveraging by banks also had a negative effect on the inflow of capital (CNB 2013). The scale of this capital contraction was so substantial that the last time such a low inflow of capital was recorded was in the war years of the 1990s (Fig. 3.1). In the following two years leading up to 2014, total capital inflow recovered and reached EUR 2.2 billion (5%/GDP) amid stronger government borrowing on the international capital market, recovery in foreign loans to credit institutions, and higher FDI inflows. Much of this was due to the effect of round-tripping investments. This capital inflow recovery lasted for only two years, and then in 2015–2016 entered negative territory for the first time in the observed period. This latter fall in capital inflow coincides with intensified deleveraging efforts by credit institutions, negative reinvested earnings due to losses generated by domestic banks in foreign ownership, as well as lower portfolio investments. Given the composition of total capital inflows into Croatia, it is noticeable that both FDI and other types of investment such as foreign loans played an equally important role in the period before the financial crisis. Both types of capital inflows followed a similar trend in the years before the crisis, with more intense inflows of foreign loans from 2002 to 2006 and at the beginning of the transition. Both FDI and foreign loans peaked in 2008, at EUR 3.5 billion and EUR 4.9 billion, respectively. After 2008, they experienced a strong decline, with foreign loans entering negative territory amid domestic banks deleveraging. Until the end of the observed period, FDI recovered slightly to EUR 1.8 billion, which is roughly at the level of 2005, while foreign loans remain in the red (Fig. 3.2). In the composition of the Croatian financial account, portfolio investments play the smallest role. During the period under investigation, they averaged merely EUR 385 million. Unlike the other two types of capital inflows, they did not record strong growth prior to 2008. The highest level of portfolio investments was recorded in 2012 and 2013, mostly due to greater investments in government long-term debt securities as Croatia recorded high general government deficits amid the recession. Figure 3.3 shows the composition of FDI in Croatia from 1993 to 2017. It is noticeable that equity investments account for the majority of foreign capital entering Croatia during the observed period, while reinvested earnings and debt instruments

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5000 4000 3000 2000 1000 0 -1000 -2000 -3000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-4000

FDI

Porolio investment

Other investment

Fig. 3.2 Composition of total capital inflows to Croatia, 1993–2017, in EUR millions. Source CNB (2019a), Eurostat (2019) 4000

3000

2000

1000

0

-1000

Reinvested earnings

Debt instruments

Fig. 3.3 FDI composition in Croatia, 1993–2017 (EUR million). Source CNB (2019a)

2017

2015

Total

2016

2014

2012

2013

2010

2011

2008

2009

2007

2005

2006

2003

2004

2001

2002

1999

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1998

1996

Equity

1997

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remain at lower levels. Not surprisingly, FDI in Croatia during wartime was negligible. The first noteworthy equity investment in independent Croatia occurred after the end of the independence war. Specifically, in 1996 significant funds from nonresidents were invested in the ownership structure of the largest pharmaceutical company Pliva and the largest domestic bank Zagrebaˇcka banka. Equity investments in Pliva and Zagrebaˇcka banka were only the beginning of a large wave of privatization of domestic companies, which became the basis for most of the inflow of FDI during the years that followed. By 2000, privatization projects were concentrated in the banking and telecommunication sectors. The first privatization round of Croatian Telecom (HT) was held in 1999, as well as the establishment of the first private mobile operator in Croatia, VIP Net (today known as A1). That year, the total FDI inflow to Croatia amounted to an unprecedented EUR 1.3 billion (Fig. 3.3). During the early 2000s, equity investments remained at modest levels, but new privatizations kept FDI inflows relatively high until the start of the new decade. In 2000, around 70% of FDI inflows were attributable to equity investments, such as privatizations in the banking sector, including partial offerings of Privredna banka Zagreb, Splitska banka and Rijeˇcka banka. In 2001, the second round of Croatian Telecom privatization took place, and Deutsche Telekom invested around EUR 500 million, thus gaining a majority share in the company (51%). The next year, equity investments fell slightly, but privatizations in the banking sector continued with Dubrovaˇcka banka, in addition to another round of privatization of Splitska banka, Rijeˇcka banka and Privredna banka Zagreb. FDI inflows in 2003 increased significantly by 56.3% year-on-year to EUR 1.6 billion, driven not by equity investment but by reinvested earnings which increased by 265% compared to the previous year. The largest contribution to the EUR 588 million of reinvested earnings came from the two leading telecommunication companies (HT and VIP Net), two largest banks (Zagrebaˇcka banka and Privredna banka Zagreb), and the pharmaceutical company Pliva. Such a rise in reinvested earnings is evidence that the majority of equity investments in the previous years were focused on sectors that were already highly developed, market-oriented, and profitable in the long run. The most notable equity investment in 2003 was the sale of 25% of INA, Croatia’s largest oil company, to the Hungarian company MOL for EUR 412 million (CNB 2004). Also in 2003, the state sold the majority share in one of the domestic breweries (Karlovaˇcka pivovara) to Heineken (CNB 2004). With no significant privatization projects in 2004, FDI inflows decreased by 34% to just EUR 1 billion, while in 2005 both equity investments and reinvested earnings recorded a recovery. The majority of equity investments in 2005 were in the financial sector, including the recapitalization of some foreign banks and the takeover of Nova banka d.d. by the Hungarian OTP Bank. In 2006, a swift increase in FDI began. During just one year, FDI inflows almost doubled to EUR 2.6 billion, driven by equity investments. In the financial sector, several domestic commercial banks were recapitalized at a total amount of EUR 700 million, while Sonic banka and Gospodarsko-kreditna banka were taken over by foreign owners (CNB 2007). Along with the financial sector, the largest inward investment was the takeover of Pliva by the Dutch subsidiary of US-based Barr Pharmaceuticals.

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FDI inflows continued to expand through 2007, reaching EUR 3.4 billion. Although equity investments remained the dominant form of FDI, the largest relative growth was experienced by debt investments, such as domestic sectors’ liabilities to their affiliated companies abroad. This form of debt investment more than doubled in one year and amounted to almost one quarter of all FDI recorded during 2007. Regarding equity investments, most of them relate to significant recapitalizations of foreign banks (EUR 1.1 billion), prompted by the tightening of CNB prudential measures (CNB 2008). Other substantial equity investments made in 2007 include the purchase of the petroleum company Tifon by Hungarian MOL, the sale of the Diners Club Adriatic card company to Austrian Erste Bank and the sale of the insurance company Osiguranje Zagreb to Swiss Balôise-Holding AG. The peak of FDI inflows was recorded in 2008, when Croatia received a record EUR 3.7 billion (Fig. 3.3). In addition to the recapitalization of banks, the largest share of equity investments relates to the purchase of 22.15% of INA shares by Hungarian MOL through a public takeover bid. A significant amount of investment was also realized through the purchase of the equity holding in Sunce koncern (CNB 2009). Meanwhile, debt investments increased by 71% to EUR 1.3 billion, as banks increased their liabilities by borrowing abroad in an attempt to offset the drop-in deposits generated by the household sector that withdrew their deposits during the GFC. The financial crisis had a strong negative impact on equity investments and total FDI inflows in Croatia. In 2009, equity inflows decreased by 76% year-on-year to only EUR 448 million. Reinvested earnings also declined reflecting weaker business results of enterprises and banks under foreign ownership. Significantly, total FDI dropped to EUR 2.3 billion. A rise in debt investments to EUR 1.5 billion prevented an even larger decline. However, it should be noted that this amount includes a round-tripping transaction of EUR 700 million, which has the effect of increasing direct investments in both directions (to Croatia and abroad) for the same amount and does not affect the financial account balance (CNB 2010). Unfortunately, the Croatian National Bank is not willing to disclose which companies are involved in round-tripping transactions. Negative trends in FDI inflows continued in the following years with total FDI hovering at around EUR 1.1 billion from 2010 to 2012 (Fig. 3.3). In 2010, equity and debt investments decreased, while only reinvested earnings were up due to better business performance of leasing companies and companies engaged in the production of refined petroleum products (CNB 2011). There were almost no new investment projects, with equity investments at only EUR 262 million. This represents the lowest level of FDI since 1996 and mostly reflects debt-to-equity swaps. The most significant decrease was recorded in debt instruments, which fell from EUR 1.5 billion in 2009 to meager EUR 274 million amid considerable repayments of debt by non-banking financial institutions to foreign owners (CNB 2012). The year 2011 brought a strong recovery, with EUR 1.8 billion in equity investments to Croatia, approximating pre-crisis levels. However, as in 2010, rather than new FDI the bulk of direct equity investment reflected debt conversions into equity, mostly in the chemical and metal industries as well as in trade and telecommunications (CNB 2012). The total amount of FDI in 2011 remained subdued as direct debt

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investments entered negative territory for the first time in the observed period (EUR − 1.1 billion) due to considerable repayments of debt by non-banking financial institutions to foreign owners (Fig. 3.3). In 2012, total FDI remained at a similar level (EUR 1 billion), with somewhat lower equity investments and direct debt investments reentering positive territory (Fig. 3.3). New FDI continued its downward trend in 2013, amounting to only EUR 738 million. A further decline was mostly caused by negative reinvested earnings amid weaker profitability of foreign-owned domestic enterprises and banks that were struggling with unfavorable domestic economic conditions. At the same time, equity investments fell 16.3% to just EUR 661 million, partly caused by a takeover by Crodux derivati of Austrian oil company OMV’s branch in Croatia. During this period, debt instruments increased slightly as a consequence of intensified government borrowing on international capital markets (CNB 2014). In 2014, total FDI inflows recorded a strong increase and amounted to EUR 2.3 billion, which was the highest level since 2008 (Fig. 3.3). Concerning the composition of this inflow, it is noticeable that the strongest positive contribution came from equity investments (EUR 2.2 billion). However, as in the previous years, this increase was a result of a round-tripping investment (EUR 1.5 billion), while new equity investment activities were mostly focused on real estate, hotels and restaurants (CNB 2015). Reinvested earnings remained in the red, while direct debt investments decreased amid external deleveraging of monetary financial institutions. FDI inflows in 2015 fell below EUR 200 million, the lowest level since 1995 (Fig. 3.3). This development was primarily caused by almost EUR 1 billion of negative reinvested earnings stemming from losses generated by domestic banks under foreign ownership. Such high losses in the banking sector can be associated with accounting for the expected effects of the conversion of loans in Swiss francs to loans in euros. Direct debt investments also fell into negative territory as a result of strong deleveraging efforts of credit institutions (CNB 2016). The largest equity investment made in 2015 was the purchase of the tobacco manufacturer TDR by British American Tobacco for EUR 505 million, while other investments were concentrated in the real estate sector as in the previous years. In each of the final two years of the observed period, FDI inflows to Croatia recovered slightly to around EUR 1.8 billion. New equity investments were modest and concentrated in real estate, trade, financial activities, accommodation, and information service activities. At the same time, reinvested earnings re-entered positive territory, driven by higher profits in financial activities (CNB 2017). Cumulatively, from 1993 to 2017, total FDI inflow in Croatia amounted to EUR 32.6 billion, of which EUR 22.1 billion or 68% were equity investments, while the rest was equally distributed between reinvested earnings and debt instruments. Figure 3.4 shows the composition of cumulative FDI in Croatia by country of origin. What is not visible in this illustration are the dynamics of the share of individual countries in total FDI. Namely, in the second half of the 1990s, the main origin of FDI to Croatia was the USA. With the start of the new millennium, flows accelerated from EU countries. The share of US investment in total FDI inflows to Croatia was relatively high until 2006, when Pliva was taken over by the Dutch subsidiary of American Barr Pharmaceuticals. This USD 2.2 billion transaction was recorded

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Other, € 2,557 NL, € 6,759

SE, € 673 AN, € 855 CH, € 821 FR, € 973 GB, € 1,190 AT, € 4,016 SI, € 1,447

HU, € 2,647 IT, € 3,382 LU, € 2,735 DE, € 3,125

Fig. 3.4 Composition of FDIs in Croatia by country of origin, 1993–2017, EUR million. Source CNB (2019a)

in the financial account as both a reduction in US investment as well as an increase in Dutch investment for the same amount, which is why the US share of cumulative inflows of FDI to Croatia decreased significantly and the Dutch share increased. The Netherlands is the leading origin of cumulative FDI by value, at just under EUR 6.8 billion, reflecting investments in the aforementioned pharmaceutical company Pliva, and Heineken’s acquisition of Karlovaˇcka pivovara. However, this major value of FDI from the Netherlands is largely influenced by a 2014 roundtripping transaction by Croatia’s largest conglomerate Agrokor, which took over Slovenia’s retailer Mercator for EUR 544 million through a company in the Netherlands (HGK 2015). The second most important origin country for FDI in Croatia thus far is Austria, with EUR 4.0 billion of FDI primarily in the banking sector. MNEs from Italy invested EUR 3.4 billion, and they are mainly concentrated in the banking sector, followed by Germany, led by Deutsche Telekom’s purchase of HT, as well as and several bank investments. Finally, FDI from Hungary is led by the entry of MOL in the ownership structure of INA.

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3.4 Sectoral Composition of FDI Although Croatia has attracted a high level of FDI in the past 25 years, even more important is the sectoral composition of these capital inflows because the productive activities of MNEs can determine their potential for promoting economic growth. The results from Aykut and Salek’s (2007) panel analysis suggest that as the sectoral composition of FDI becomes skewed toward the manufacturing sector, there is a significant and positive effect on economic growth. On the other hand, when the sectoral composition of FDI becomes skewed toward either the primary sector or services, a negative and mostly significant effect on economic growth emerges. Furthermore, Kinoshita (2011) finds that the sectoral composition of FDI is important, as large external imbalances can appear if FDI is concentrated in the nontradable sector. These findings are based upon FDI inflows to Croatia and 14 other CEE countries from 2000 to 2007, in the run-up to the financial crisis. FDI flows to many countries were dominated by the non-tradable sectors rather than the tradable sectors, fueling domestic demand rather than supply, which led to a surge in imports and large current account deficits. Consequently, countries which had large external imbalances were hit hardest during the GFC. Figure 3.5 shows that the majority of FDI during the period from 1993 to 2017 is in non-manufacturing sectors. The largest share of total FDI (EUR 10.5 billion) is concentrated in financial services, insurance, and pension funding. Out of that sum, EUR 9.7 billion is in financial services, chiefly the privatization and recapitalization of foreign-owned domestic banks. During the same period, the manufacturing sector Other 6,202 19%

Finance, Insurance and Pension Funds 10,494 32%

Telecommunicaons 1,974 6%

Real Estate 3,403 10%

Wholesale and retail 4,722 15%

Industry 5,829 18%

Fig. 3.5 FDI in Croatia by sectors, 1993–2017, in EUR millions and as a percentage of total FDI. Source CNB (2019a)

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attracted only EUR 5.8 billion, or 18% of total FDI. Within the manufacturing category, most of the FDI is concentrated in coke and refined petroleum products, the pharmaceutical industry, and the production of other non-metallic mineral products. Apart from the financial and industrial sectors, the largest amount of FDI is concentrated in wholesale and retail trade, real estate, and telecommunications (Fig. 3.5). Croatia’s unfavorable sectoral structure of FDI stock has limited the positive effects of FDI on employment, productivity, and economic growth. Moreover, most of the FDI is in the form of acquisitions of existing companies rather than investments in manufacturing with new production capacity. Enterprise takeovers in the manufacturing sector are mostly focused on already-successful companies that did not require capital restructuring, new technology, or organizational solutions (Škudar 2004). Likewise, most greenfield manufacturing investments are significantly smaller in value, while larger FDI transactions targeted wholesale and retail trade sectors, which only worsened the trade deficit in Croatia’s balance of payments, given the import orientation of domestic consumption in the country.

3.5 Geographic Distribution of FDI in Croatia The spatial distribution of FDI in Croatia is highly concentrated in urban areas, and there is strong empirical evidence that coastal areas are also attractive due to the vital importance of the tourism industry in the Croatian economy.1 In our discussion of the spatial distribution of FDI, we employ data for total revenues from profit and loss statements of all companies under foreign ownership.2 The dataset features revenues of MNEs for 20 counties and the City of Zagreb.3 The composition of total revenues of foreign-owned non-financial companies in Croatia shows a concentration of 64% in the city of Zagreb (City of Zagreb) with an additional nine percent located in the wider suburban area surrounding Zagreb (County of Zagreb).4 In total, this represents 73% of total revenues of non-financial legal FDI entities in Croatia. Bearing in mind that commercial banks and insurance companies are not included in the sample, it is reasonable to expect that the actual share is much higher than 73% (Fig. 3.6).5 1 Tourism

receipts to GDP ratio is over 20%, and added value of tourism is in vicinity of 10% GDP (DZS 2016). 2 Data on profit and loss statements are provided by FINA on all non-financial companies. Commercial banks and insurance companies are not included in the database. Also, the database does not have observations about the location where companies are operating. It only includes addresses of headquarters of non-financial legal entities. Therefore, due to data limitations, each company’s financial figures are matched with geographic locations using the address of their headquarters. 3 In the Croatian territorial organization, the City of Zagreb is formally both a city and a county at the same time. Therefore, it is considered to be 21st county in statistical publications. 4 The County of Zagreb is the “U”-shaped county that surrounds the City of Zagreb “county” from the east, south, and west. The County of Zagreb and City of Zagreb are two different and separate territories without any jurisdictional overlap. 5 Six out of eight of the biggest commercial banks are located in Zagreb.

3 FDI in Croatia

67 40.54%

Other 15 counes

11.54% 18.44%

City of Zagreb

County of Zagreb

63.81% 7.41% 9.32%

Istria

4.86% 4.07%

Varaždin

4.11% 3.39%

Split - Dalmaa

10.61% 2.91%

Primorje - Gorski kotar

6.91% 2.90%

Osijek - Baranja

7.12% 2.06%

Populaon (%) Revenues (%)

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00%

Fig. 3.6 Share of total FDI revenue and population by counties (% of national total). Source FINA (2018), CBS (2019)

As shown by Fig. 3.6, the concentration of FDI revenues is much higher compared to the concentration of population in Croatia. Zagreb is the capital and most populous city in Croatia, with 18% of the country’s population. If the population of the County of Zagreb is added, the population share of these two counties increases to one quarter of total national population. Croatia’s second largest city is Split in SplitDalmatia County, with a county population share of 11%, followed by Rijeka in Primorje-Gorski Kotar County, with seven percent of the population share. Osijek, in Osijek-Baranja County, is only marginally smaller. The City of Zagreb and County of Zagreb (the latter being the ring surrounding the City of Zagreb) register disproportionately high shares of revenues by foreign-owned companies at more than three times their populations. Croatia’s subsequent cities of Split, Rijeka and Osijek and their respective counties (Split-Dalmatia, PrimorjeGorski Kotar and Osijek-Baranja) indicate revenue shares that are smaller than their population shares. For example, Split-Dalmatia County includes the second-largest urban area in Croatia and 11% of the country’s population, but merely three percent of FDI revenue share. This observation is revealing given the fact that Croatia’s second city, Split, is located on the coast, and it features a booming tourism sector. Istria and Varaždin Counties are home to more FDI revenues than their share of population. Specifically, Istria County includes Pula, Croatia’s seventh largest city, with four percent of revenues and five percent of national population. Istria’s highly developed tourism sector and the role of considerable inbound tourist overnights are major drivers of FDI.

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Varaždin County, with four percent of the population, has received three percent of total FDI revenues. Its geographic advantages include proximity to Austria, Slovenia, and Hungary. In addition, a long tradition of industrialization links its economy to other nearby cities in the former Austro-Hungarian Empire. Moreover, the county contains a former capital city (Varaždin) and is famous as historical center of the Reformation movement in Croatia. In addition to its retention of international ties and cultural importance, Croatia’s northwestern region (including both Varaždin County and Medimurje County) is known for a stronger business-friendly institutional framework compared to the eastern and southern parts of the country. Figure 3.7 shows the spatial distribution of FDI intensity in Croatian counties as measured by the total revenues of foreign-owned companies per capita. This illustration is useful for interpreting the intensity of FDI adjusted for population. Clearly, Croatia’s FDI landscape is dominated by Zagreb (City of Zagreb and County of Zagreb), followed by Istria County and Varaždin County. The concentration of FDI

Fig. 3.7 Total revenues per capita in non-financial MNEs across Croatia (in Croatian kunas). Source FINA (2018)

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relative to population has enormous implications for the local economies of these countries. At the same time, Croatia’s second, third, and fourth largest cities and their counties of Split-Dalmatia, Primorje-Gorski Kotar and Osijek-Baranja represent laggards in terms of revenues per capita in foreign-owned companies. This analysis of the geographic distribution of per capita revenues by foreignowned companies reveals that FDI tends to cluster in urban areas such as the capital city of Zagreb, Croatia’s largest center of population. However, in per capita terms, other regions possess different advantages that are also attractive to foreign firms. These include the coastal Istria County, with an economy that is heavily oriented toward internationalization and tourism, and Varaždin County, which enjoys proximity to major cities of adjacent countries’ capitals, stronger historical linkages with these neighboring countries, and greater presence of small and medium enterprises (SMEs). Figure 3.8 presents the leading industrial sector of FDI by Croatian county. In the City of Zagreb, the highest share of revenues among the group of foreign-owned companies is in the distributive trades sector.6 In total, 53% of all revenue made by MNEs in the City of Zagreb involves retail, wholesale, and related activities. Distributive trades are followed by the information and communication technology (ICT) sector, which represents 13% of total revenues in the City of Zagreb. In the broader County of Zagreb, distributive trades account for 70%, followed by manufacturing with 19%. The ICT sector is dominated by mobile phone companies and Internet providers based in Zagreb, while FDI in distributive trades is concentrated in shopping malls and distribution centers whose rapid development was fueled by innovations in consumer credit, namely the dispersion of credit cards within the general population in the years prior to the GFC. Overall, manufacturing is the sector with the largest share of revenues by MNEs in fifteen counties. Exceptions include the City of Zagreb, County of Zagreb, and Primorje-Gorski Kotar, Lika-Senj, Split-Dalmatia, and Dubrovnik-Neretva counties. Similar to Zagreb, distributive trades (wholesale and retail) represent the most important sector in Primorje-Gorski Kotar and Split-Dalmatia. As these counties contain Croatia’s second and third largest cities, it is evident that foreign investors are attracted by their large markets. Indeed, the role of FDI in distributive trades is underscored by its status as the second most important sector in ten of Croatia’s counties, including those with the largest urban settlements. Although revenue data are unavailable for specific foreign-owned companies in the financial sector, it is plausible that almost the entire sector is concentrated in Zagreb. Furthermore, 90.1% of assets in commercial banks are in foreign-owned banks, and out of eight “too-big-to-fail” banks,7 only two banks are located predominantly outside of Zagreb (CNB 2019b).8 Among the insurance companies, MNEs represent less than one-third of Croatia’s total market (HUP 2019). 6 The distributive trades sector corresponds to the wholesale and retail trade; repair of motor vehicles,

motorcycles and personal and household goods. big to fail” describes a bank (or any other company) for which the government will prevent bankruptcy due to bank’s systemic importance for the functioning of the economy. 8 Rijeka and Split are alternative locations for bank headquarters. 7 “Too

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J. Tica et al. City of Zagreb - Informaon and communicaon… City of Zagreb - Distribuve trades Međimurje - Distribuve trades Međimurje - Manufacturing Dubrovnik-Neretva - Administrave and support… Dubrovnik-Neretva - Accommodaon and food… Istria - Distribuve trades Istria - Manufacturing Split-Dalmaa - Manufacturing Split-Dalmaa - Distribuve trades Vukovar-Srijem - Electricity, gas, steam and air… Vukovar-Srijem - Manufacturing Šibenik-Knin - Distribuve trades Šibenik-Knin - Manufacturing Osijek-Baranja - Distribuve trades Osijek-Baranja - Manufacturing Zadar - Transportaon and storage services Zadar - Manufacturing Slavonski Brod-Posavina - Agriculture, forestry… Slavonski Brod-Posavina - Manufacturing Požega-Slavonia - Distribuve trades Požega-Slavonia - Manufacturing Virovica-Podravina - Electricity, gas, steam and… Virovica-Podravina - Manufacturing Lika-Senj - Construcon Lika-Senj - Mining and quarrying Primorje-Gorski Kotar - Transportaon and… Primorje-Gorski Kotar - Distribuve trades Bjelovar-Bilogora - Distribuve trades Bjelovar-Bilogora - Manufacturing Koprivnica-Križevci - Distribuve trades Koprivnica-Križevci - Manufacturing Varaždin - Distribuve trades Varaždin - Manufacturing Karlovac - Distribuve trades Karlovac - Manufacturing Sisak-Moslavina - Construcon Sisak-Moslavina - Manufacturing Krapina-Zagorje - Distribuve trades Krapina-Zagorje - Manufacturing County of Zagreb - Manufacturing County of Zagreb - Distribuve trades

13% 53% 8% 83% 16% 44% 18% 52% 29% 34% 6% 91% 11% 44% 13% 74% 17% 44% 7% 80% 4% 95% 48% 52% 25% 56% 13% 30% 6% 92% 13% 66% 9% 83% 6% 91% 16% 74% 16% 76% 19% 70%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Fig. 3.8 Leading NACE sectors in each county by revenue (% of total revenues in each county). Source FINA (2018)

The diverse geography of Croatia clearly plays a role in the dramatically different industrial activities across counties that is depicted in Fig. 3.8. Tourism (specifically accommodation and food services) is the dominant sector in coastal DubrovnikNeretva County, while mining and quarrying prevail in Lika-Senj County. In both of these cases, the nature of foreign activity mimics domestic production, and follows the distribution of localized geographic assets, be they “sun and sand” assets on the coast or natural resources such as those abundant in Lika-Senj.

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Tourism plays a dominant role in Croatia’s coastal counties, but with the exception of Dubrovnik-Neretva County, it does not represent the leading sector for FDI revenue. Accommodation and food services account for 14% of MNE revenue in Split-Dalmatia, 13% in Zadar, 11% in Istria, 8% in Primorje-Gorski Kotar, 7% in Šibenik-Knin, and just 1% in Lika–Senj, which is considered the least attractive part of Croatia’s coastline. Another important sector is real estate, representing 11% of MNE revenue in Dubrovnik-Neretva 11%, 5% in Split-Dalmatia, 3% in Primorje-Gorski Kotar and Zadar, and 2% in Istria 2%. Finally, the city of Rijeka possesses strategic importance as a seaport, as do Zadar and Ploˇce. Accordingly, transportation and storage services represent 13% of FDI revenue in Primorje-Gorski Kotar, which contains the Port of Rijeka. The same sector yields 17% of MNE revenue in Zadar County and 4% in Dubrovnik-Neretva County, the latter containing the Port of Ploˇce.

3.6 Prospects for Future FDI The long-lasting recession of 2009–2014 left severe consequences in Croatia, including a failure to attract pre-crisis inflows of FDI levels despite the country’s post-crisis economic recovery. Furthermore, in the view of MNEs, Croatia’s 2013 EU accession did not prove to be a strong enough allure to offset the country’s insufficient institutional development, dwindling privatization opportunities, high regulatory burden, and administrative barriers at the national and local level. In addition, Croatia’s inefficient judiciary system continues to constrain both domestic and foreign investment. Although EU accession has not significantly increased FDI thus far, further European integration could intensify inflows. Specifically, the path toward ERM II participation and expected entry to the Eurozone in the mid-2020s could lead to more foreign interest in Croatia. Euro adoption would eliminate the exchange rate risk, reduce the risk premium, and thus make Croatia a safer investment destination that is more attractive to MNEs. At the same time, potential challenges that might prevent accelerating FDI include possible economic slowdowns or recessions in Croatia’s major trading and investment partners. As witnessed during and after the GFC, such events can significantly hamper inflows of capital. At the time of writing, the long-term economic consequences of the COVID-19 pandemic remain impossible to predict but they will likely be severely detrimental to FDI. Equity investment accounted for more than two-thirds of cumulative FDI from 1993 to 2017, largely made possible through privatization. It follows that further privatization efforts by the government could determine the majority of FDI inflows over the next decade. Although major privatization projects have been scarce and politically difficult in recent years,9 the potential for attracting FDI inflows in this way. According to the Croatian Bureau of Statistics (2018), as many as 1238 legal 9 Mostly

due to corruption scandals connected with earlier privatizations.

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entities remain state-owned at the end of 2018, while the state retains a share in the ownership structure in another 897 companies. Regarding the sectoral composition of FDI, out of EUR 32.6 billion in total FDI from 1993–2017, the dominant share—almost one-third, or EUR 10.5 billion— is invested in financial services, insurance, and pension funding, mostly via the privatization and recapitalization of foreign-owned domestic banks. Another EUR 4.7 billion is concentrated in wholesale and retail, EUR 3.4 billion in real estate, and just under EUR 2.0 billion in telecommunications. Because the bulk of FDI is directed toward non-tradeable sectors, often including acquisitions of existing companies rather than investments in the manufacturing sectors and new production capacities, significant effects on economic growth, employment and productivity are limited. Meanwhile, the manufacturing sector attracted EUR 5.8 billion of FDI, comprised mainly of coke and refined petroleum products, the pharmaceutical industry, and manufacturing of other non-metallic mineral products. The spatial distribution of FDI in Croatia is concentrated in urban areas, especially around the capital city of Zagreb and the tourism-intensive coast. In the next decade, it can be expected for FDI inflows to follow a similar pattern. The structural breakdown of total revenues of foreign-owned non-financial companies in Croatia indicates that 73% of revenues is concentrated in the City of Zagreb and County of Zagreb. The financial sector is also concentrated in Zagreb, with six out of eight large banks located there. Zagreb and its surroundings remain the most attractive region for FDI due to the agglomeration of population, as well as the skilled and educated workforce. On the coast, the tourism sector is the main recipient of and attraction for FDI, especially in Istria and Split-Dalmatia county, which attract the highest number of tourist arrivals and overnights. After COVID-19 subsides, apart from expected continued growth in tourist numbers, FDI’s growth potential lies in the current peculiar structure of accommodation in the tourism sector. Specifically, Croatia still has the lowest percentage of hotel accommodation capacity of any EU member. Despite its struggle to tackle its the high regulatory burden, administrative barriers, and improve the business climate, the Croatian government is determined to attract more FDI and has therefore passed the Law on Strategic Investment Projects of the Republic of Croatia in 2013. The aim of this law is to improve the business climate and to speed up investment transactions. Under the latest version of this law (from 2019), all projects valued above HRK 75 million (~EUR 10 million) that satisfy specific conditions will get preferential treatment (Narodne novine 2018). The potential for increased FDI inflows to Croatia also stems from newfound Chinese interest in the region through which Chinese companies recognize an opportunity to penetrate the EU market. In 2018, the Chinese state-owned China Road and Bridge Corporation (CRBC) won the public tender for the EU co-financed construction of Pelješac bridge, a project worth EUR 526 million. The significance of the project is that it is the first construction project carried out by a large Chinese construction company within the EU, notably financed by EU funds. In addition to the Pelješac bridge, a plethora of Chinese investments into Croatia are planned or under way. These Chinese companies are mostly interested in infrastructure projects as a part of the Belt and Road Initiative, one branch of which ends at the Port of Rijeka. In

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that regard, Hong Kong’s Zhongya Holding acquired a majority stake in the Port of Zadar in 2018, one of six ports in Croatia open for public traffic of outstanding (international) economic importance as defined by the Ministry of the Sea, Transport and Infrastructure. Chinese companies are also interested in investing in the Port of Rijeka, the biggest and most important port in Croatia, through which they could export commodities to the European market. A prerequisite for the extension and significant investments in the Port of Rijeka is the project of reconstructing the Rijeka-Zagreb railway and extending it to the Hungarian border with a two-track lowland railway. The project will soon be underway, as the EU has given approval to co-finance the first section between Hrvatski Leskovac and Karlovac, valued at around EUR 472 million. China’s interest in the construction sector is also reflected in the recent takeover of Tehnika, one of the largest construction companies in Croatia, which is speculated to be funded by Chinese capital. Regarding Chinese investments, there are also plans for the construction of new sport stadiums (“stadium diplomacy”) in Rijeka and Velika Gorica, investment in the spa resort Krapinske Toplice, and an investment in a conference and health tourism complex in Kumrovec. The Rijeka Basin, where the aforementioned Port of Rijeka is located, enjoys an excellent geographic position. It offers exposure to the core of Europe, which can significantly reduce the cost of transporting goods to and from Central European markets and make Rijeka an important trade hub. For this reason, the Rijeka Basin is chosen as the location for the construction of an LNG terminal. More precisely, the LNG terminal will be constructed in Omišalj on the island of Krk. The significance of the terminal is that it will secure a new supply route for Croatia and other Central European countries. The European Commission will finance EUR 101 million of the EUR 234 million investment. The LNG terminal will transport up to 2.6 billion cubic meters per year of natural gas into Croatia national transmission network starting in 2021 (European Commission 2019). This investment in infrastructure enhances Croatia’s access to the global economy and is therefore a promising development in enabling future FDI. In the energy sector, apart from the LNG terminal, the key question for future investments and FDI inflows is the resolution of the conflict between Hungarian MOL and the Croatian government on the future of the largest domestic oil company INA. According to Zagreb Stock Exchange data, MOL and the Croatian government currently hold 49.08% and 44.84% of the company shares, respectively (ZSE 2019). The conflict is based upon the future of INA and its development strategy. While MOL sees INA as its retailer on the Croatian market, the government wants INA to be a vertically integrated company with drilling and R&D departments, as well as its own refineries and ambitions of expanding to Southeastern Europe. Although a possible nationalization by the government was discussed, the status quo remains for now. Nevertheless, finding a new strategic partner that would redeem MOL shares could bring a significant boost to future FDI inflows. Croatia has attracted considerable FDI since its independence, second only to Serbia as an independent state. Still, as discussed in this chapter, the sectoral composition is unfavorable for supporting robust economic growth. The war of independence

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and its legacy, combined with isolation from the international community throughout the 1990s, prevented Croatia’s inclusion in European and global value chains. Subsequently, most of the FDI inflows took the form of acquisitions of existing companies and major market-share firms in non-tradeable sectors such as finance, retail, and real estate. The lack of domestic and foreign investment in high value-added and hightech industries such as machinery, vehicles, electronics, and chemicals is noteworthy. Of course, exceptions include the acquisition of the ICT company Nikola Tesla by Swedish Ericsson (today ERNT—Ericsson Nikola Tesla) and Porsche, as well as Chinese Camel group investments in electric cars and components producer Rimac Automobili. Overall, however, the nature of activities by MNEs in Croatia contributed to a suboptimal industrial production structure and acute deindustrialization that was detrimental for continental parts of the Croatia. Notwithstanding the unfavorable sectoral composition of FDI in Croatia and a lack of greenfield investments thus far, the country has attracted a significant amount of foreign capital and remains an attractive investment destination. Given that Croatia is a member of the EU, foreign companies can access the large single market by investing in the country. Further integration including accession to the Eurozone in the mid-2020s will undoubtedly attract and facilitate new FDI inflows as the exchange rate risk will be eliminated. Investment activity will be supported by EU co-funded infrastructure projects and further privatization efforts. While the tourism and energy sectors have the greatest potential for attracting new investments, the main task for the government is to create a better business environment and to provide incentives for investments in industries with higher value-added potential. Specific industries that will enable Croatia to move up in the value chain include the manufacturing of machinery, vehicles, electronics, and chemicals. Acknowledgements This work has been supported in part by Croatian Science Foundation under the projects UIP-2017-05-6785 and IP-2019-04-4500.

List of Abbreviations AN AT BE CBS CEE CH CNB CRBC CZ DE EC ERM II

Netherlands Antilles Austria Belgium Croatian Bureau of Statistics Central and Eastern Europe Switzerland Croatian National Bank China Road and Bridge Corporation Czechia/Czech Republic Germany European Commission Exchange Rate mechanism

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EU EUR FDI FINA FR GB GDP GF HRK HT HU HUP ICT IT LNG LU MNE NL NACE

European Union Euro Foreign Direct Investment Financial Agency France Great Britain Gross Domestic Product Global Financial Crisis Croatian Kuna Croatian Telecom Hungary Croatian Employers’ Association Information and Communications Technology Italy Liquefied Natural Gas Luxembourg Multinational Enterprise Netherlands Statistical Classification of Economic Activities in the European Community (Nomenclature Statistique des Activités économiques dans la Communauté Européenne) RU Russian Federation SE Sweden SI Slovenia UNCTAD United Nations Conference on Trade and Development USD United States dollar VAT Value-added tax ZSE Zagreb Stock Exchange

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Chapter 4

FDI in Slovenia Simon Kušar

Abstract The Republic of Slovenia is known for its open and competitive economy. It is strongly export-oriented and well-integrated with global value chains. Representing less than one-third of Slovenia’s economy, the role of FDI is relatively small. Inward stock has increased relatively steadily since independence in 1991, from EUR 1376 million in 1995 to almost EUR 14,680 million in 2018. Slovenia’s recent strong FDI inflow results from its favorable labor market, new wave of privatization, expansion of existing foreign-owned companies, and the changed policy approach toward attracting FDI. According to the structure of FDI inward stock in 2018, the most important foreign investors in Slovenia originate in Austria, Luxembourg, Switzerland, Italy, and Germany. Croatia is the only noteworthy origin of FDI from former Yugoslavia, ranking seventh. Foreign-owned companies in Slovenia show aboveaverage economic performance compared to domestic firms. Slovenia has especially high potential for attracting new investments in logistics, tourism, renewable energy resources, and high-tech sector. The future of FDI in Slovenia depends greatly on economic conditions in the European Union (EU), which in the past have been impacted by events such as the global financial crisis, and are currently uncertain due to economic fallout from the COVID-19 pandemic. Keywords Foreign direct investment · Slovenia · Economic geography · Location

4.1 The Geographic and Economic Context of FDI in Slovenia When analyzing the structure, dynamics, and location of foreign direct investments (FDI) in the Republic of Slovenia following Dunning’s “OLI” paradigm (Origins– Location—Internalization), it is necessary to highlight key geographical features. They influence the economic and the institutional environment in Slovenia and consequently, they affect FDI dynamics, structure and location. The “O” element of the S. Kušar (B) Department of Geography, Faculty of Arts, University of Ljubljana, Ljubljana, Slovenia e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_4

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paradigm can be seen mainly through the context of geographic and cultural distance, and foreign trade relationships developed by independent Slovenia with neighboring countries and other EU members. The “L” aspect is addressed through the analysis of FDI on the level of statistical regions and by the role of local geographic units or municipalities in attracting investors. Detailed consideration of the “I” aspect of the paradigm is somewhat limited by the availability of data, which has also constrained the existing literature. The Republic of Slovenia is a relatively small country with an area of 20,273 km2 and slightly more than two million inhabitants (SORS 2019). Slovenia is positioned strategically at the junction of several major European physiographic regions: the Alps, the Mediterranean, the Dinaric Mountains, and the Pannonian Basin. Slovenia’s position at the crossroads of South-Central Europe helps explain the openness of its society and economy. Throughout history, Slovenia has been incorporated into a variety of global economic processes. Although once a peripheral region of the Austro-Hungarian Empire, Slovenia’s current territory had an important transit role for trade between Vienna and Trieste, the empire’s main port on the Adriatic. Despite having been under-industrialized compared to central parts of the monarchy surrounding Vienna as well as Silesia and the Czech regions, important mining activities were placed in the territory of today’s Slovenia. These include Idrija, Europe’s second-largest mercury mine, and Mežica, known for lead and zinc. Slovenia’s industrialization began in the second part of the nineteenth century based on foreign capital and on the increased transport role of the territory after the construction of the Vienna– Trieste railway in 1857. Slovenia’s industrial development was encouraged even more strongly after the First World War, when it became the most developed part of the new Yugoslav monarchy. After the Second World War, Slovenia was again the most developed part of the Socialist Federal Republic of Yugoslavia (SFRY), specializing mainly in labor-intensive manufacturing. At the time Yugoslavia began to dissolve (1991), around half of Slovenia’s working population was employed in manufacturing (Vrišer 2008). The economic structure in Slovenia at that time can be divided into three categories: (1) manufacturing for the Yugoslav market, (2) export-oriented manufacturing, and (3) craft entrepreneurship of micro and small companies. The spatial structure of industry was significantly different from that in other Yugoslav republics. It followed the polycentric concept of spatial development and the promotion of less-developed areas in Slovenia. Small factories were located also in peripheral, sometimes rural parts of the country where regional and municipal centers gained economic strength. Vrišer (2000) points out that industrial development in Slovenia’s traditional industrial core had stagnated in the region comprising Gorenjska, Ljubljana, and its surroundings, as well as Zasavje, Savinjska Valley, and Maribor at that time. This region was well-known for automotive and machinery sectors, as well as textile, electro-technical and wood processing industries (Vrišer 1992). After Slovenia embarked upon its transition to a democracy and market-oriented system in 1990, the difficult legacy of socialist industrial policy became evident, compounded by some specific Slovenian characteristics. Stagnation and the outset of the economic crisis in the second part of the 1980s were further deepened by

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the disintegration of the common Yugoslav market, war in Croatia and Bosnia & Herzegovina, and the global economic sluggishness at that time. Intense deindustrialization took place, especially in old industrial regions that were strongly oriented toward the Yugoslav market, decreasing the role of manufacturing to approximately one-quarter to one-third of the gross value added (Vrišer 2008). The process of privatization gave every Slovenian certificates that could be exchanged for shares in companies or signed over to be managed by investment companies. The presence of multinational enterprises (MNEs) was not significant in Slovenia during the first half of the 1990s, especially compared to the post-Soviet bloc economies in Central and Eastern Europe (CEE) such as Hungary, Slovakia, the Czech Republic, Estonia, and even some ex-Yugoslav republics. Slovenia elected to pursue a gradual transition to a market economy rather than shock therapy as prescribed by the World Band and the International Monetary Fund. Slovenia’s approach, known as gradualism, enabled it to maintain its developmental advantage over other countries in the region while ensuring a relatively high level of well-being for its citizens. This approach is reflected in Slovenia’s modest economic structural reforms as it transitioned from a socialist planned economy into a market-oriented economy. As a result, the state-owned sector remaining large and the level of inward FDI remained low. One of the main motivations for Slovenian leaders to pursue independence from Yugoslavia was to participate in the Euro-Atlantic integration process. EU accession took place in 2004, and in subsequent years, Slovenia experienced rapid economic expansion with annual Gross Domestic Product (GDP) growth upward of four percent, reaching a high of 6.9% in 2007 (SORS 2019). During this period, Slovenia appeared on the global map as an economic participant, and its enterprises were free to take full advantage of the benefits of the large EU market. With the assistance of EU funds, highways were being built, which improved accessibility within the country and integrated the Slovenian transport network into international transport corridors. Economic well-being was evident also in the low rate of unemployment and intense residential construction. This economic optimism depleted during the global financial crisis (GFC), which impacted Slovenia severely from 2009–2013. The economy entered into a recession in the first quarter of 2009. Within the EU, Slovenia had one of the largest decreases in economic activity (Eurostat 2018). Causes for the severity include recession in Slovenia’s most important trading partners and constrained access to financial resources, as well as domestic companies’ indebtedness. This, in turn, resulted from management buyouts, unfinished structural reforms, the isolation of the banking sector, as well as the small role of FDI. The economic crisis triggered a new phase of deindustrialization. As reported by SORS (2019), Slovenia’s unemployment level grew beyond 13% in 2013 and 2014, and its debt as a percentage of GDP also rose drastically, from 21.8% in 2008 to 82.6% in 2015. The crisis affected manufacturing, construction, and real estate markets worst. Interestingly, among the most resilient and flexible regions were those that had already faced strong deindustrialization in the 1990s, including the Pomurska and Zasavska statistical regions (Lapuh 2016).

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Following the double-dip recession, since 2014, Slovenia’s economic situation has been improving. Although it took until 2017 for GDP to reach pre-crisis levels, and the growth levels continue to lag behind other new EU members, the economic situation at the end of the second decade of the twenty-first century in Slovenia is favorable. In 2017, Slovenian per capita GDP reached EUR 20,951 (SORS 2019) representing about 85% of the EU-28 average. According to the OECD (2019), although recent economic growth has been driven mainly by exports, domestic demand has been making a greater contribution as well. Growth is also attributed to the more prominent recent role of FDI, which is sometimes controversial. Public discourse has been addressing FDI as well as related environmental concerns about several major greenfield and brownfield projects. These include Magna and TAM (automotive industry) in Maribor, Yaskawa (industrial robots) in Koˇcevje, Longstroff (medicinal elastomers) in Logatec, and Gorenje (household appliances) in Velenje. Slovenia’s small, open, competitive economy is deeply internationalized through trade as a very high share of GDP, as well as integration within global value chains. Slovenia trades mostly with the EU, which is the destination of 76% of its exports and the origin of 81% of its imports. The most important trading partners include Germany (19.2% of exports; 20.7% of imports), Italy (15.4% of exports; 11.0% of imports), and Austria (11.3% of exports; 7.9% of imports). Slovenia’s key export products are vehicles (14.8%), medicinal and pharmaceutical products (10.0%), electrical machines and devices (9.9%). Its most common imports are vehicles (13.3%), electrical machines and devices (6.6%), oil and oil derivatives (5.8%), and medicinal and pharmaceutical products (4.8%), as reported by SORS (2017). Moreover, Slovenia ranks second in the integration of the domestic value added in foreign exports among EU members during the period 2005–2015 (IMAD 2019). Integration into international markets is much stronger in the commodity market than in services, which is quite unusual for a relatively well-developed country (OECD 2009). Nevertheless, Slovenia still lags considerably behind the most developed countries with regard to economic, social, and environmental development, with the extent of these gaps varying from region to region. Important challenges continue to hamper economic expansion in Slovenia. These include relatively low productivity, high long-term unemployment, and high unemployment among older workers, as well as difficulty in adapting to demographic changes. Furthermore, the state has long lacked effectiveness in promoting development, reflecting poor coordination between regulatory bodies, as well as long court procedures and inefficiency in managing state-owned enterprises (GODECP 2017; OECD 2019).

4.2 Empirical Literature on FDI in Slovenia The most detailed and up-to-date information on FDI in Slovenia is available through annual reports published by the Bank of Slovenia (2017). These reports include the latest data and analysis of FDI flows and cumulative stocks, including

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outward investments of Slovenian companies as well. Additional data on FDI are reported by the Statistical Office of the Republic of Slovenia (SORS), and the Public Agency for Entrepreneurship, Internationalization, Foreign Investments and Technology (SPIRIT). Insights into Slovenia’s strengths and weaknesses can be revealed by examining companies that have invested foreign capital in Slovenia, as was done in recent survey research by Jakliˇc et al. (2017). As in previous surveys, these authors examine motives of investors and obstacles to foreign investments in Slovenia by verifying the business climate, evaluating the business environment, and by reviewing their plans for the future. The most important scholarly contributions for understanding FDI in Slovenia focus upon its determinants, dynamics, structure, and effects on the host economy. Rojec (1994)’s scholarship represents the seminal work on FDI in newly-independent Slovenia. He presents selected theories and determinants of FDI, historical insights into foreign investments during the socialist time in Slovenia (and Yugoslavia) after 1967, dynamics of FDI after Slovenia’s independence in 1991, and results of a field survey about the motives and strategies of foreign investors. He concludes with a description of the basic characteristics of foreign-owned enterprises in Slovenia and many impacts of FDI on the national economy. Rojec later (1998b) examines the ways in which FDI helps restructure the Slovenian economy. Jakliˇc and Svetliˇciˇc (2005) assess the internationalization of Slovenian multinational firms with reference to inward FDI. In 2007, the Institute of Macroeconomics published a working paper on FDI in Slovenia focused on factors and indicators on attractiveness of the state for foreign investment and the proposal of policies, measures, and activities for attracting FDI (Rojec et al. 2007a). An analysis of policy effectiveness to encourage FDI in Slovenia and abroad was prepared by Kostevc et al. (2011), while similar themes were addressed by Burger et al. (2012) during the following year. Slovenian FDI data and analyses are regularly published in Ekonomsko ogledalo (Economic Mirror in English) between 1996 and 2002, mostly prepared by Rojec (e.g., 1996, 1997, 1998a, 1999a, 2000a, 2001a, 2002). The dynamics of FDI inflows and inward stock are presented in various articles, reports, and professional monographs (Štiblar 1993; Rojec 1999b, 2000b; Stefancic 2005; Jakliˇc and Rojec 2014; Justinek 2015). Some papers discuss FDI in a more theoretical context, analyzing various theories of FDI, defining possible outcomes of FDI, and various issues and perspectives (Burger and Svetliˇciˇc 2005). Slovenia is also included in bilateral or multinational comparison studies on determinants and dynamics of FDI across Western Balkan countries, as well as those in CEE (Rojec 2001b; Svetliˇciˇc and Bellak 2003; Inotai 2007; Kersan-Škabi´c and Orli´c 2007). Determinants that (positively) influence FDI dynamics in Slovenia are the topic of additional research (Jakliˇc et al. 2010). Still other inquiries about the strategic communication and marketing of the country as a location for FDI are available (Ašanin Gole et al. 2016). Kostevc et al. (2007) examine the role of taxes, especially those on profits by MNEs, while Kamenšek (2003) considers the role of human capital. Additional surveys highlight specific factors influencing FDI issues such as the role of public opinion generated by mass media (Jakliˇc et al. 2011). Additional

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related scholarship assesses the wider social aspects of FDI (Gradišnik 1993; Kos 1993; Orel 1993). Research has also been published on the diverse effects of foreign investments in Slovenia at three levels: the national scale, industrial sectore, and domestic firms. Discussions of national-level effects are concentrated on the overall impact on economic development (Damijan and Rojec 2004), competitiveness of the economy (Rovˇcanin et al. 2008), and export dynamics (Kumar and Zajc Kejžar 2003; Kumar and Zajc Kejžar 2004). At the sectoral level, scholars offer insights on the restructuring and transformation processes of various economic activities because of FDI (Rojec 1998b, c; Stare 1999; Zajc Kejžar and Kumar 2006; Zajc Kejžar 2007, 2008). Additionally, some analyses define types and magnitudes of FDI impacts on Slovenian companies (Sok 2007; Maˇcek and Ovin 2011; Zajc Kejžar 2011). Researchers are also interested in FDI policy incentives. Jus et al. (2006) examine subsidies for MNEs. They find that Slovenian FDI incentive schemes are comparable to those of competing destination countries but criticize them for their lack of intensity. Rojec et al. (2007b) enumerate possible measures to promote FDI more effectively, citing the existing Slovenian FDI incentives policy. Kostevc et al. (2011) and Burger et al. (2012) contribute a detailed analysis of successful FDI incentives in Slovenia. Their results cite an above-average functioning of state-supported MNEs and the successful fulfillment of qualitative criteria for the allocation of funds. Incentive recipients were successful in pursuing employment and sales growth goals. At the same time, the authors discover that knowledge creation and spillover, technology transfer, and innovating were less successful in their sample. The existing literature on FDI in Slovenia is dominated by economists, and it is possible to distinguish between three periods of interest. The first period (1993–1994) is marked by the new political–economic reality following Slovenian independence and the transition from a planned socialist system to the present market-oriented economy. Scholars including Gradišnik (1993), Kos (1993), Orel (1993), Štiblar (1993), and Rojec (1994) examine the situation in former Yugoslavia with reference to the effects of FDI on the economy and society. The second period (2003–2008) was strongly influenced by the accession of Slovenia to the EU, which ushered in new economic opportunities. Despite the fact that the early EU period was marked by slower growth dynamics, greater volatility, and weaker effects of FDI inflows (Jakliˇc and Rojec 2014), most of the research during this period focuses on the FDI’s effects on the Slovenian economy with reference to industrial sectors and the restructuring at the company level (see, for example, Stefancic 2005; Burger and Svetliˇciˇc 2005; Zajc Kejžar and Kumar 2006; Zajc Kejžar 2007; Sok 2007; Zajc Kejžar 2008). These studies address questions on directing the policy approach at attracting FDI as well (see Rojec et al. 2007b). The third (present) period is distinguishable by the vast number of published papers, yet addresses similar questions to the previous “EU” period (see Kostevc et al. 2011; Maˇcek and Ovin 2011; Burger et al. 2012; Zajc Kejžar 2011).

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4.3 Temporal Dynamics of FDI Inflows to Slovenia In 2016, cumulative inward stock of FDI reached almost EUR 13,000 million, or 32.1% of Slovenia’s GDP. These numbers lie in stark contrast to 1995, when foreign investment represented merely EUR 1376 million, or 8.4% of GDP. As shown in Fig. 4.1, the value of inward stock peaked in 2008 at EUR 9765 million, or 27.8% of GDP. The average annual growth of FDI inflow between 1995 and 2006 was 18.4%. There were two exceptions to this linear trend: In 2001, a small decrease was recorded (−5.5%), while in 2007, it was far above average at +43.1%, increasing from EUR 6822 to 9765 million. After 2007, the total inward stock decreased substantially until 2010. This section highlights some explanations for these temporal patterns. FDI inflows to Slovenia were relatively small throughout the 1990s. The average FDI inflow between 1995 and 2000 was EUR 166 million, accounting for less than one percent of GDP (0.9%). In 2002, a major FDI inflow occurred in the value of EUR 1722 million, probably in anticipation of Slovenia’s 2004 EU accession. Surprisingly, Slovenia’s FDI inflow declined relatively after EU accession, especially compared to the other new member states (OECD 2009). Jakliˇc and Rojec (2014) note that the period following 2004 is marked by slower dynamics, greater volatility, and weaker effects of FDI inflows. In 2007, a new record of EUR 1106 million was invested, but the crisis caused rapid decline with the withdrawal of foreign capital in 2009 (EUR 343 million) and in 2013 (EUR 114 million). Jakliˇc and Rojec (2014) argue that this trend was the result of investment diversion within the EU during the crisis, while Slovenia became less competitive and its business climate became impaired.

Fig. 4.1 FDI inflow FDI inward stock in Slovenia 1995–2016. Source WIIW FDI Database, 2019

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The period between 2008 and 2013 was marked by the GFC and its aftermath. Consequentially, investment flows from Slovenia’s main trading partners became quite unsteady. After decreases of total inward stock in 2008 (−12.0%) and 2009 (−9.0%), stagnation in 2010 (+2.0%) and return to growth in 2011 (+4.1%), a new decrease occurred in 2012 (−3.8%) following the general characteristics of the double-dip recession in Slovenia between 2009 and 2013. The lowest total value of any single year was EUR 7828 million, recorded in 2009, and reflects a loss of nearly one-fifth (−19.8%) compared to 2007. After 2013, FDI inward stock began to grow again at an average annual rate of 13.4%. Between 2013 and 2016, the FDI inward stock increased from EUR 8897 million to EUR 12,971 million. In 2016, for the first time ever, the value of FDI inward stock exceeded 30% of GDP after having averaged of 24.0% of GDP value between 2004 and 2015. This can be explained by more favorable economic conditions among Slovenia’s trade partners, as well as Slovenia’s economic ascent (IMAD 2019). In 2015, FDI inflows exceeded EUR 1500 million, accounting for almost four percent of GDP. The 2016 inflow represents the third-largest overall value during the 1995–2016 period (EUR 1126 million). During the 1995–2016 period, Slovenia’s cumulative net FDI inflows totaled EUR 11,083 million. The most abundant years for FDI inflows were 2002, 2015, 2007, and 2016, with the annual attraction of more than one billion euros of FDI. Notably, FDI accelerated substantially starting in 2002. Despite two very problematic years (2009 and 2013), the average value of the FDI inflow between 2003 and 2013 was EUR 411 million, or 2.5 times higher than the average throughout the 1990s. The 2014– 2016 period was in this sense even more prominent, with the average annaul FDI inflow being EUR 1142 million. The largest transactions in 2016 took the form of equity transactions amounting to EUR 938 million. The Bank of Slovenia (2017) attributes these increases to financial and insurance activities and manufacturing, which totaled EUR 643 million that year. It is important to acknowledge that data sources for FDI yield variations in the number of relevant MNEs due to different methodologies. According to the Statistical Office of the Republic of Slovenia (SORS 2019) in 2016, there were 8053 foreign affiliates in Slovenia, while Bank of Slovenia data include 3051 enterprises with foreign capital (4.7% all companies in Slovenia) for the same year (Bank of Slovenia 2017). On the other hand, the Slovenian Business Register includes data on 8934 non-financial enterprises under foreign control in 2016 (Jakliˇc et al. 2017). MNEs in Slovenia experience better economic results than domestic companies on average. They grow faster than their Slovenian counterparts in terms of both the sales volume and the number of employees, as well as in value added per employee and exports (Jakliˇc et al. 2017). Moreover, companies under foreign ownership generally have higher profits than other companies. They earned a record EUR 1118.4 million in profits during 2016, mainly based on activities in financial and insurance activities as well as manufacturing. Return on equity (ROE) at companies involved in FDI stood at 10.4% in 2016, compared with 7.3% across all firms. MNEs likewise achieved higher net profit per employee than their domestic counterparts.

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Consequently, the wages per employee in MNEs were 12.7% higher than wages in domestic firms in 2016 (Bank of Slovenia 2017). After 2013, Slovenia experienced a significant increase in FDI inflows, both in absolute and relative terms as a proportion of GDP. As a result, the attitude of policymakers and the public toward FDI in Slovenia changed as well. During this period, the privatization process was accelerated, importantly influenced by activities of the Bank Assets Management Company responsible for the sale of shares in acquired non-performing assets from four banks during the GFC, together with more intense sales of equity stakes in Slovenian companies. There have also been expansions of the existing foreign-owned companies in Slovenia. It should be pointed out that the recent growth of FDI in Slovenia corresponds to a more favorable labor market and cost trends compared to some other EU new member states. Namely, these countries have already experienced labor shortages and wage hikes during this period due to their very low unemployment rates. Furthermore, Slovenia even managed to increase its ranking in the two international indicators representing the economic situation and the business climate (World Economic Forum Global Competitiveness Index, World Bank Doing Business Ranking). It is also true that Slovenia’s national industrial policy has become more active in attracting new greenfield FDI (IMAD 2019; Jakliˇc et al. 2017). However, according to Jakliˇc et al. (2017), it would be an exaggeration to discuss a “boom” of FDI to Slovenia and a radical increase in the country by MNEs. The recent increases are in large part attributable to events in other EU new member states. Moreover, even with the third-greatest cumulative value among Yugoslav successor states, Slovenia remains among the EU countries with the smallest stock of FDI as a share of GDP. Only France, Germany, Italy, and Greece report smaller shares than Slovenia (IMAD 2019), and each of them is much larger in terms of population and GDP.

4.4 Origins of FDI in Slovenia The analysis of FDI inflows is challenging because reliable data are available only since 2005. As shown in Table 4.1, Slovenia’s most successful years for attracting foreign investments include 2007, 2015, and 2016. In each of these years, Slovenia received an inflow of more than EUR 1 billion. In 2009 and 2013, Slovenia witnessed retreats of foreign capital with negative values of FDI inflow. On average, every year, Slovenia attracted EUR 585 million of new capital in the context of the equity, reinvestment of earnings, or debt instruments. The majority of FDI inflows originate from other EU member states, averaging 80.4% of the annual total. However, in 2009 and 2012, non-EU MNEs became more important, while the share of the FDI inflow from EU member states decreased to around 50%. The pre-2004 EU-15 member states continued to dominate the FDI picture, but their share of FDI inflow differs significantly between years. It is clear from Table 4.1 that the inflow and outflow of investments in Slovenia are very volatile

88 Table 4.1 Annual inflows of FDI to Slovenia, 2005–2016

S. Kušar Year 2005

Value of FDI inflow FDI inflow EU (EUR mil) (%)

FDI inflow EU-15 (%)

473

103.1

105.9

2006

513

90.5

93.3

2007

1106

78.6

77.1

2008

832

76.0

66.1

2009

−343

50.5

67.2

2010

80

74.3

−138.9

2011

782

81.1

81.0

2012

264

50.1

64.2

2013

−114

86.8

143.5

2014

791

95.2

60.8

2015

1510

87.9

71.2

2016

1126

90.5

82.0

Source WIIW FDI Database (2019)

and attributable partly to the country’s diminutive size. The structure of FDI in 2016 closely resembles the typical year of inflows. The majority of Slovenia’s EUR 12.971 million (84.6% or EUR 10,970 million) during that year was from MNEs based in other EU member states (EU-28). Of that total, 86.4% originated in the “established” member states (EU-15). However, some notable differences exist at the national level compared to the export structure of Slovenia. As shown in Table 4.2, the highest share of FDI cumulative through 2016 stock is from Austria (24.7%). This observation is unsurprising, given the earlier discussion about the importance of the two countries’ adjacency, and proximity of cities like Maribor to Graz and Austria’s capital of Vienna. The second most important origin is Luxembourg, with a much lower share (11.1%). Following Luxembourg are Switzerland (10.6%), Italy (8.8%), Germany (8.5%), Netherlands (7.8%), Croatia (6.9%), and France (4.9%). Five additional countries each represent more than one percent of total cumulative value: Sweden, United Kingdom, Czech Republic, Cyprus, and Belgium. Together, MNEs from these fourteen countries account for 93.2% of the total FDI inward stock in Slovenia. The first non-EU country on the list is Japan (0.6%), ranked in fifteenth place and followed by Russia (0.5%). Notably, FDI from the USA and China—the world’s two largest economies—remains relatively insignificant, together accounting for just EUR 65 million (0.5%) of total FDI inward stock as of 2016. Table 4.2 does not reflect changes over time, nor are such data practical to portray here. However, it is worth mentioning that according to the WIIW (2019), the structure of Slovenia’s FDI inward stock was much more concentrated in 1995, and this warrants further discussion. That year, only five countries (Austria, Croatia, Germany, France, and Italy) accounted for 84.5% of the total FDI inward stock in Slovenia with Austria being the most important partner (29.0%) followed by Croatia

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Table 4.2 Origins of cumulative FDI in Slovenia (2016) Rank

Country

Value in mil EUR

% of total

% of total (ultimate investing country)

1

Austria

3197

24.7

10.4

2

Luxembourg

1441

11.1

1.2

3

Switzerland

1381

10.6

8.1

4

Italy

1146

8.8

9.0

5

Germany

1108

8.5

14.4

6

Netherlands

1016

7.8

3.2

7

Croatia

895

6.9

4.5

8

France

634

4.9

5.3

9

Sweden

336

2.6

0.9

10

United Kingdom

302

2.3

n.a

11

Czech Republic

266

2.0

n.a

12

Cyprus

191

1.5

n.a

13

Belgium

173

1.3

n.a

… 15

Japan

73

0.6

1.0

16

Russian Federation

70

0.5

2.2

19

USA

54

0.4

13.9

30

China

11

0.1

n.a

Source WIIW (2019); Bank of Slovenia (2017); author’s calculations. Note n.a. = not available

(23.4%). By the end of 2016, by contrast, the top five countries account for merely 63.7% of FDI (Table 4.2). Such geographic diversification reduces the vulnerability of Slovenia in the event of recession occurring in a small number of dominant origin countries (Dicken 2015). As early as the 1990s, Austrian firms already held many brownfield investments in Slovenia, mostly in banking, retail, and manufacturing. Austria remains the most important origin of FDI throughout the entire 1995–2016 period. Its share of inward flows reached 30–45% in years 2000 and 2007, respectively. Only in 2016 did Austria’s inflow drop to second rank with EUR 134 million, representing 11.9% of the total for that year. Austria’s highest values of FDI inflow were recorded in 2007 (EUR 670 million) and in 2011 (EUR 597 million). Luxembourg strongly increased its role as an FDI origin from 5.0% in 2015 to 11.1% in 2016, when it led with EUR 425 million, or 37.7% of the total FDI inflow. The most important economic sector for Luxembourg’s MNEs is financial and insurance activities (Bank of Slovenia 2017). Other high values were recorded in 2015 (EUR 201 million) and in 2014 (EUR 128 million), while the figures were negative for 2005, 2010, and 2012. Swiss firms increased their presence in Slovenia starting in 2000. Prior to that year, they accounted for less than 5% of cumulative inward stock. In 2016, Swiss MNEs invested merely EUR 62 million, dwarfed by

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2007, 2008, and 2015 with more than EUR 100 million each. These investments are concentrated in manufacturing (Bank of Slovenia 2017). Italy ranks fourth in cumulative inward stock, with EUR 1146 million or 8.8% of the total FDI inward stock in 2016, averaging about EUR 35 million every year. German FDI decreased to below 10% of the total after 2002. Although the share increased after 2013, Germany ranked only fifth in 2016, with 8.5% of total FDI. During the period 2005–2016, its firms invested EUR 771 million in Slovenia, including invested EUR 379 million in 2014 (47.9% of the total). Notably, Germany is Slovenia’s most important trade partner as a destination for 19.2% of its exports and origin of 20.7% of its imports. This suggests that cooperation between German and Slovenian companies has been most prominent through arms-length value chains rather than through direct ownership. Dutch MNEs follow a similar temporal pattern to firms from Luxembourg. In 2016, investors from the Netherlands invested EUR 123 million (10.9%), while in 2006, 2009, 2010, 2011, and 2013, there were net outflows of bilateral FDI returning to the Netherlands. In 2016, the Netherlands was ranked sixth with its 7.8% share of total FDI. Croatia, Slovenia’s adjacent neighbor and former Yugoslav counterpart had been the second most important origin but lost its prominence in 1998 and is ranked seventh according to the most recent data in Table 4.2. Upon joining the EU in 2013, Croatian firms became much more active in Slovenia. In 2014, they invested a total of EUR 247 million, or 31.3% of the total for that year. France, the third most important origin of FDI in Slovenia at the end of the 1990s, now ranks eighth. French automaker Renault was an important investment project in Novo Mesto during socialist times, and Societe Generale was one of the first investors in the Slovenian banking sector. Although French MNEs are well known in Slovenia, they collectively hold less than 5% of the FDI cumulative stock, dropping from a peak of 14.9% in 2001. The Czech Republic is the most important source of FDI in Slovenia from the group of seven other formerly communist new member states that joined the EU in 2004. Although accounting for just EUR 266 million (2.0%) of the FDI inward stock in 2016, it became more visible as an initial source of capital to Slovenia after 2012 with EUR 45 million annual average since then. The categorization of FDI by national origin is done according to the registered office of the direct investor (the first counterpart). However, as explained in Chap. 1, the complex structure of multinational firms sometimes conceals the true origin of capital, or the ultimate owner. Keeping this consideration in mind, it should be noted that some countries including Germany, the USA, France, and the Russian Federation are much more important investor countries in Slovenia than suggested by the origins of FDI by immediate partner country listed in Table 4.2 (Bank of Slovenia 2017). When taking into account the ultimate investing country, the rank of the most important investor changes dramatically. If we unveil the original origin of foreign capital, the most important investors in Slovenia in 2016 were enterprises from Germany, with 14.4% of the FDI inward flow. German MNEs hold the majority of their indirect investments in Slovenia via their Austrian subsidiaries, exaggerating

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the role of Austria in Table 4.2. The second most important origin of ultimate investment is the USA with a 13.9% share (EUR 1795 million), which is 34-times more than what is shown by official statistics. According to the Bank of Slovenia (2017), the majority of US investments are held indirectly via subsidiaries in Luxembourg (EUR 1118 million), Sweden (EUR 215 million), Germany (EUR 104 million), and Switzerland (EUR 89 million). Using these data, Austrian capital ranks third (10.4%), significantly less than portrayed by the direct investor data (24.7%). Similarly, MNEs from the Russian Federation are also more important than listed in Table 4.2, with 2.2% of Slovenia’s cumulative inward stock in 2016. Like US-based MNEs, many investors from the Russian Federation entered the Slovenian economy through Luxembourg. Using the ultimate investment origin compared to the resistered investment origin, the most notable difference in the share of Slovenia’s FDI inward stock is from Luxembourg: Instead of 11.1% in the case of the direct investor approach, it is merely 1.2% in the case of the ultimate investing country approach. This important clarification should also be noted in the case of Dutch FDI (rather than 7.8%, it is reduced to 3.2%).

4.5 Composition of FDI in Slovenia When analyzing FDI in comparison with Slovenia’s dominant economic activities, it becomes evident that the majority of MNEs are involved in the manufacturing sector. In 2016, FDI in this sector reached EUR 4219 million or 32.5% of total FDI. Within this dominant FDI sector, the most important products are basic pharmaceuticals (19.2%), rubber, plastics, and other non-metallic mineral products (16.4%) and food products, beverages, and tobacco products (11.7%). These three manufacturing groups account for almost half (47.3%) of manufacturing FDI. Additional manufacturing activities contribute approximately 8% of FDI value in manufacturing: wood and paper products and printing (9.0%), transport equipment (8.8%), chemicals and chemical products (8.2%) and electrical equipment (8.0%). Remaining manufacturing activities are less important, but nevertheless play a role in the development of the Slovenian manufacturing sector. Following manufacturing, financial and insurance activities rank second in value with EUR 2923 million, or 22.5% of total FDI. Another sector of high importance is retail, with EUR 2495 million or 19.2% of total value. Together, these three activities account for almost three quarters (74.3%) of the cumulative FDI in Slovenia at the end of 2016. Other activities played a minor role in the composition of FDI, with the exception of real estate and information and communication (ICT), each with around 6% of cumulative stock (Fig. 4.2). The territory that today represents Slovenia has a long industrial tradition and was well known as the manufacturing core of the former Yugoslavia (Civic´c and Sanfey 2010). Unsurprisingly, manufacturing also played the most important role in cumulative FDI from 1995 until 2006, peaking at 53% of total value in 1998. After 2005, its share decreased dramatically, first to 37% in 2006, then to 26.8% in 2007. Because these data are only recently available, it is impossible to examine this trend more closely. The sectoral composition of FDI changed abruptly in 2009 with

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Other 14%

Real Estate 6%

Wholesale & Retail 19%

Finance and Insurance 23%

Manufacturing

Wood and paper, Transport prinng, 5% equipment 3% Food and Beverages, 4% Other, 11% Rubbers and Plascs, 5% Pharmaceucals, medicinal chem. 6%

Fig. 4.2 Total FDI in Slovenia by economic activities, with breakout chart for manufacturing, 2016. Source IIW FDI Database (2019)

the further decline of manufacturing. In the wake of the GFC, 2009 and 2010 are marked by negative net FDI values of almost EUR 200 million and EUR 144 million, respectively. In subsequent years, FDI moved into positive territory again with an average inflow of EUR 330 million per year and a strong peak of EUR 729 million in 2015. Despite the relatively high FDI inflow into manufacturing activities after 2010, the share of manufacturing remained at only around 30% of total FDI inward stock. Analysis of specific portions of the manufacturing sector demonstrates important changes in their relevance between 1995 and 2016 (Table 4.3). Many of these changes correspond to the arrival of a handful of specific large MNEs in Slovenia during the period under investigation. One example of sectoral change relates to pharmaceuticals, medicinal chemistry, and botanical products, which was of low importance in 1995 especially compared to other manufacturing sectors. Pharmaceuticals became visible in Slovenia only in 2002, when they accounted for 19.3% of manufacturing FDI. That year, the first large takeover was completed when Novartis acquired a 99% stake in Lek, Slovenia’s largest domestic pharmaceutical company, for EUR 876 million. Lek had been owned by the state of Slovenia and several small stakeholders, of which 18,151 accepted the buyout offer (Uspešen zakljuˇcek … 2009). This firm had a strong positive effect on the Ljubljana Stock Exchange index, Slovenia’s stock market. One year later, pharmaceuticals increased to EUR 905 million, or 36.8% of cumulative FDI, leading all other sectors. In subsequent years, the share of pharmaceuticals began to wane, and in 2008, it slowly decreased toward its current share (19.2%). It also declined in absolute value, with the exception in 2008 when it amounted to EUR 951 million. Nevertheless, pharmaceuticals continue to retain an important position in the structure of inward manufacturing FDI.

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Table 4.3 Rank of major manufacturing activities in 1995 versus 2016 by relative contribution to inward FDI Rank

1995

2016

1

CC Wood and paper products and printing

CF Pharmaceuticals, medicinal products

2

CL Transport equipment

CG Rubber, plastics, other non-metallurgical minerals

3

CE Chemicals and chemical products

CA Food products, beverages and tobacco

4

CJ Electrical equipment

CC Wood and paper products and printing

5

CG Rubber, plastics, other non-metall. mineral

CL Transport equipment

6

CA Food products, beverages and tobacco products

CE Chemicals and chemical products

7

CB Textiles, apparel, leather, related products

CJ Electrical equipment

8

CI Computer, electronic, optical products

CK Machinery and equipment n.e.c

9

CK Machinery and equipment n.e.c

CH Basic metals, machines and equipment

10

CM Other manufacturing, repair, installations

CI Computer, electronic, optical products

11

CH Basic metals, fabricated metal products

CM Other manufacturing, repair, installations

12

CF Pharmaceuticals, medicinal products

CB Textiles, apparel, leather, related products

Source WIIW FDI Database (2019)

Rubber, plastics, and other non-metallic mineral products gained importance in the late 1990s, reaching 11.6% of manufacturing FDI in 1997, followed by further increases of 17.1% and 18.3% in 1998 and 1999, respectively. Until recently, this group of economic activities maintained approximately 18% of total FDI inward stock in manufacturing. Most recently in 2016, the sector totaled EUR 682 million, or 16.4% of cumulative manufacturing FDI. Slovenia’s first cooperation in this sector can be traced back to 1967, when a license agreement was made between Semperit and Sava for the production of tires. In 1998, Sava Tires was acquired by the US-based Goodyear Corporation. Table 4.3 shows that the role of FDI in food products, beverages, and tobacco has also changed dramatically during the past quarter century. In 1995, they collectively represented 7.0% of manufacturing FDI, which positioned them mid-rank of all activities. However, in 2005, their share decreased substantially to less than one percent, returning to five percent only in 2013. In 2015, they peaked at 13.4% of the FDI inward in manufacturing (EUR 530 million). In 2016, it was placed on the third position with EUR 495 million or 11.7% of the FDI inward stock in manufacturing. Slovenia’s food processing industry was of interest to MNEs from Croatia (Droga

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Kolinska of the Atlantic Group, Mercator of Agrokor, and Žito of Podravka) as well as Serbia (Fructal of Nectar). The majority of funding for these transactions was conducted after 2010 (Slovenska Živilska Industrija 2010). Within the manufacturing sector, transport equipment had been the second most important economic activity, with EUR 108 million (18.6% of total share) in 1995. It decreased to EUR 76 million in 2001 and then rebounded between 2004 to 2006 before again stagnating during the GFC. From 2013–2015, the role of transport equipment increased to 15.0% before declining to 8.8% in 2016. Currently, it remains the fourth most important sector for FDI. Slovenia has a long tradition of producing automobiles, motor homes, and specialized parts for the manufacture of cars. The French automaker Renault makes the largest investments in this sector, including a factory in Novo Mesto (Revoz), producing Renault Clio, Twingo, Smart Forfour and Smart Forfour EV. Cooperation between Renault and Revoz has a long history beginning in 1973, when Renault 4 was first assembled in Revoz, followed by Renault 5. In 2004, Renault became the sole owner of the Revoz Company. As shown in Table 4.3, the sector of wood and paper products and printing was the most important economic manufacturing activity in 1995. In the 1990s, these economic activities reached almost 20% of inward FDI in manufacturing due to several major investments during that period. For example, foreign firms bought two large paper producers in Slovenia. Vipap Videm Krško, a company producing newsprint, coated graphic papers, and packaging papers, was acquired by a Czech investor in 1996. This was followed by the purchase by Austria’s Mayr-Melnhof Karton of Koliˇcevo Karton factory near Domžale in 1998. The paper production industry maintained its importance (13% of manufacturing FDI), until it began to decline in 2013 to 381 million in 2016 (9.0% of the total). Chemicals and chemical products had the third-largest share of manufacturing FDI in 1995. In that year, EUR 83 million (14.3%) was invested in this sector. After 2001, both absolute and relative values started to decline from EUR 207 million (18.8%) to EUR 153 million (5.2%) in 2008. After 2009, the relative role in the structure of the FDI inward investments in manufacturing rebounded, although it remained three ranks lower than in 1995. Recent FDI in this sector includes the takeover of Helios by Ring Holding from Austria, co-financed by Franklin Templeton in Blackstone funds. The value of the takeover was EUR 145 million, but this amount was not listed in the FDI inflow for 2014, when according to Bank of Slovenia only EUR 27.7 million net investment in this manufacturing branch was reported. Later, Kansai Paint from Japan bought Helios for EUR 572 million in 2017 (Helios dokonˇcno pod okrilje japonske družbe Kansai Paint, 2019). Electrical equipment accounted for 13.7% of employment at the end of the 1980s (Vrišer 1992) and remained the third most important economic manufacturing activity as Yugoslavia’s dissolution proceeded in the early 1990s, reaching EUR 108 million (18.6%) in 1995. However, by 2016, only EUR 339 million was invested in this sector, representing merely 8.0% of cumulative manufacturing FDI. Germany BSH Home Appliances in Nazarje specializes in the development and production of small household appliances for the preparation of food and beverages.

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It is part of the BSH Home Appliances International Group and this facility is its largest factory in Europe for producing Bosch small home appliances. The company was owned by Gorenje from Velenje, but it was sold to BSGH in 1993. The company in Nazarje has a large research and development department. Manufacturing combined with related industrial activities accounted for 37.8% of the inward stock of FDI in Slovenia at the end of 2016. These other activities include mining and quarrying, electricity, gas, steam, air conditioning supply, water supply, sewerage, waste management, remediation, and construction. By the end of 2016, services had become the leading industrial sector for FDI, with agriculture, forestry, and fishing playing only a minor role (EUR 19 million; 0.1% in 2016). FDI in the service sector accelerated especially after 2005, when the share of manufacturing decreased dramatically nearly half of all FDI to less than one-quarter. The prominence of services is attributable to a number of financial and insurance activities and wholesale, retail trade, as well as the repair of motor vehicles, largely servicing foreign-built automobiles and lorries. Financial and insurance activities represent between twenty and thirty percent of FDI, depending on the year. During the dramatic decrease in the value of manufacturing that occurred after 2005, financial and insurance activities began to surpass manufacturing. In 2007, the share of manufacturing decreased to 26.8% of cumulative stock, while financial and insurance activities increased to 44.5%. In 2014, financial and insurance activities reached its lowest share in the studied period (15.6%) with important negative net flows (EUR −187 million in 2013 and EUR −127 million in 2014), only to rebound in 2015 and 2016 with more than EUR 400 million of fresh capital each year. The first large investment in Slovenia’s banking sector was in 2001, by Societe Generale from France that acquired SKB bank.1 In 2002, KBC entered the partial ownership of NLB, the largest bank in Slovenia, but stepped out in 2012 because of state aid to KBC during the financial crisis. The process of bank privatization accelerated in recent years because of commitments made by the Slovene government to the European Commission in resolving the banking hole during the financial crisis. Gal and Sass (2014) point out that the majority of Central European countries had already privatized their banking sectors in the 1990s, while Slovenia decreased the domestic ownership of its banking sector only in recent years. Wholesale, retail trade, repair of motor vehicles, and other economic activities in the G section of the NACE (Rev. 2) categorization were the third most important sector for attracting FDI to Slovenia since 1995. This sector’s average share throughout the 1995–2016 period was 17.8%, and reached more than twenty percent each year from 2007 and 2016. In 2014, the sector saw record values, reaching almost EUR 500 million or 68.2% of value for that year. This value is largely attributable to the EUR 320 million sale of Slovenia’s largest retailer Mercator to Croatian Agrokor, which also returned Croatia to the list of top origins of FDI. Unfortunately, it is not straightforward to differentiate between brownfield and greenfield investments using statistics reported by the Bank of Slovenia and Statistical Office. According to the analysis portion of the FDI report for 2014, new (greenfield) investments are investments where a non-resident is the founder or co-founder of the company. Investments where a non-resident is the founder of the company 1 In

2019, SKB was sold to Hungarian OTP bank.

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remain greenfield investments for their duration, and not only in the year in which they were initiated. Brownfield investments are defined as the purchase of facilities where MNEs are not the founders of the company. Unfortunately, Bank of Slovenia data are not segmented according to these two categories. Typically, brownfield investments are large scale, while greenfield investments are of smaller value. To compare and contrast examples of greenfield and brownfield investments, it is necessary to combine different resources on FDI, such as SPIRIT, newspapers, and public discourse. While a detailed discussion falls outside the scope of this chapter, it is worthwhile to provide some illustrative examples of major transactions in these categories. Table 4.4 provides a selection of recent brownfield investments in Slovenia, which was prepared by SPIRIT and published in Jakliˇc et al. (2017), supplemented here with some additional relevant data. As already discussed, the recent interest shown by foreign capital was a result of internal and external factors. In the context of internal factors, it is necessary to point out the new wave of privatization process in Slovenia. Foreign investors were not only offered publicly owned enterprises, but also previously privatized companies that were searching for new strategic partners or owners in order to enable enterprise development in the context of globalization. As shown in Table 4.4, companies in a wide range of economic activities have attracted foreign investors from a variety of origins. Examples of greenfield investments are presented in the next section of this chapter, which focuses on the role of the Slovenia’s local level of governance as an especially important player in attracting new investments.

4.6 The Location FDI in Slovenia In harmony with Dunning’s (1980) FDI motivations, the main enticements for MNEs to invest in Slovenia are the pursuit of markets and strategic business development. Market motives are connected with access to the European market, growth of sales, maintaining and increasing market share, and establishing a comprehensive marketing network. MNEs invest in Slovenia also because they recognize the possibility of realizing their long-term development strategy. Namely, Slovenia offers qualified labor with good knowledge and competencies, possibilities for the innovation, and access to technology. Market access to Slovenia itself is an important motive for investors, but this advantage should not be viewed in isolation. From Slovenia, investors can access markets of the EU, especially markets of the new EU members and states in Southeastern Europe (Jakliˇc et al. 2017). Therefore, geographic location and developed infrastructure (e.g., motorways and the Port of Koper) are important considerations in the decision to invest in Slovenia. Interestingly, quality of life and business environment (tax incentives, political and economic stability) are of marginal importance when selecting Slovenia (Jakliˇc et al. 2017) Nevertheless, it is widely recognized that Slovenia offers a high quality of life as a result of its geographic characteristics, history, and relatively well-developed transportation,

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Table 4.4 Selection of recent brownfield investments in Slovenia by the year of transaction Slovenian enterprise

Main economic activity

Foreign investor

Origin of investor

Year of transaction

Fructal, Ajdovšˇcina

Food processing industry

Nektar

Serbia

2011

Ljubljanske mlekarne, Ljubljana

Food processing industry

Dukat (Lactalis)

Croatia (France)

2013

Mlekarna Vipava, Food processing Vipava industry

Ekolat

Italy

2013

Stekarna Rogaška, Rogaška Slatina

Glass production

KPS capital partnersa

USA

2013

TKK Srpenica, Srpenica

Chemical industry Soudal

Belgium

2013

Varstroj, Lendava

Machinery industry

Japan

2014

Helios, Domžale

Chemical industry Ring holdinga

Austria

2014

Metropol resort (hotels), Portorož

Tourism

Hoteli cavtat (Liburnia riviera hotels)

Croatia

2014

Aerodrom Transport Ljubljana, Zgornji Brnik

Fraport

Germany

2014

Mercator, Ljubljana

Retail

Agrokor

Croatia

2014

Hotel Kanin, Bovec

Tourism

Alpe adria hoteli

Russia

2015

Trimo, Trebnje

Metal industry

Innova

Poland

2015

Adria Airways tehnika, Zgornji Brnik

Maintenance of aircrafts

Linetech holdings

Poland

2015

Nova KBM, Maribor

Banking

Apollo global management

USA

2016

ETI Izlake, Izlake Technical ceramics

Andlinger and company

Austria

2016

Adria Airways, Zgornji Brnik

4 K Investb

Luxembourg

2016

Transport

Daihen

Source SPIRIT; cited in Jakliˇc et al. (2017); additional data collected by the author Note a new owners have already re-sold companies to another investor: Steklarna Rogaška to Fiskars, Finland (2015); Helios to Kansai Paint, Japan (2017); b Adria Airways went bankrupt in September 2019

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social, and economic infrastructure. Corroboraing these statements, Maier and Beck (2000) argue that Slovenia is not valued for its “soft” location characteristics alone, but also through its traditional (“hard”) location factors. Jakliˇc et al. (2017) report on a recent survey of MNEs in Slovenia regarding their investment motives and obstacles. Based on a sample of 238 enterprises, the results enumerate the advantages and of limitations of Slovenia as a location for FDI. Corporate respondents highlight Slovenia’s well-qualified and educated workers that often speak more than one foreign language (Jakliˇc et al. 2017). This is a result of achievements in the educational system. Namely, Slovenia has produced a large expansion in its proportion of tertiary graduates. More than half of 20-years-old are enrolled in tertiary education, the third-highest share among OECD countries (OECD Economic Surveys: Slovenia 2019). According to the survey, the second and the third most important motives for investing in Slovenia, respectively, are efficiency of production and services in Slovenia, and relatively low labor costs. The country’s geographic location, flexible market, and EU integration also play a role in MNEs’ decisions to select Slovenia (Jakliˇc et al. 2017). Jakliˇc et al. (2017) also examine inhibitors to FDI in Slovenia, mostly related to the institutional environment in Slovenia. Investors criticized high labor taxes and frequently changing taxation legislation, and the relatively heavy administrative burdens they face. Also problematic are complex regulatory procedures, changing regulations, and a lack of coordination between numerous government agencies, creating regulatory uncertainty and increased costs (OECD 2019). This situation is reflected in long and expensive procedures for obtaining permits due to environmental protection and spatial planning laws. Kostevc et al. (2007) and Jakliˇc and Rojec (2014) report similar findings from the previous surveys. The authors highlight the problem of high taxation, high administrative burdens, and inefficiency of the court system, rigid labor market, and long procedures to obtain building licenses as the most problematic issues hindering FDI into Slovenia. State-owned enterprises remain important in the economic structure of Slovenia. Public ownership together with strong government involvement in business operations restrains FDI into domestic markets (OECD 2019). Although quality of labor is the most important attribute of Slovenia at attracting FDI, relatively high minimum wages compared to the median wage can be problematic (OECD 2019), especially in the manufacturing sector where wages are relatively low. Figure 4.3 features the breakdown of FDI by statistical region (NUTS3). The highest concentration of cumulative inward FDI over the observation period is in Osrednjeslovenska region (Central Slovenia), which accounts for EUR 7869, or 60.8% of the total. Osrednjeslovenska region is central both in geographic and economic context and contains the national capital of Ljubljana. This city is also situated on the crossroads of international transport corridors linking Germany with Southeastern Europe and the Mediterranean with Central and Eastern Europe. One quarter of Slovenia’s national population lives in this region (537,023 inhabitants). In 2016, the region produced EUR 14,836 million of GDP or 38.8% of the national GDP. It has the highest GDP/capita income in Slovenia (EUR 27,576), which is 41% higher than the national average (EUR 19,547 per capita).

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Fig. 4.3 Inward stock value share of FDI by statistical regions, 2016 and location of selected greenfield and brownfield FDI in Slovenia. Source Bank of Slovenia 2017

The next three regions in order of the value of total FDI inward stock rank are Podravska (10.4%), Obalno-kraška, and Gorenjska (each with 5.9%). The remaining nine regions together account for just 17.0% of the total inward FDI. The least successful statistical regions in Slovenia for attracting FDI are Koroška and Primorsko-notranjska, each with just 0.5% of the total. Jakliˇc et al. (2017) observe that this regional distribution has not changed significantly since it became possible to monitor FDI statistics. MNEs often expect support from local governments, either in the form of awareness of the role of businesses as employers and taxpayers, or more active support in finding solutions to problems they face. However, most enterprises in Slovenia report that they have no experience with local support (Jakliˇc et al. 2017). Local governments in Slovenia (LAU2; 212 municipalities) are relatively limited in the support they can offer foreign investors. Their main responsibilities are with regard to spatial planning. One of their most important tasks is planning the location of industrial zones. Industrial zones are often a precondition for attracting domestic and foreign investors (Kušar 2008). Since 2000, municipalities in Slovenia planned and equipped a number of industrial zones with necessary infrastructure, at locations near highway exits in order to compete against other municipalities. With the absence of the second level of local governance in Slovenia, provincial (pokrajine) mayors often use their political power to influence the decisions of the relevant industrial, regional, and spatial planning bodies at the national level. With the combination of that influence, support from the regional planning agencies, and good cooperation with potential investors, some municipalities are successful in

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attracting not just domestic investors, but also FDI (Kušar 2010). The most successful municipalities are those that developed a proactive business environment at the local level, mainly by linking local industrial or craft traditions with new strategic development documents (Kušar 2011). Kušar (2008, 2010, 2011) cites the example of Germany’s Carthago Reisemobilbau GmBH in the Odranci, Pomurska statistical region. At this location, efforts by the local government in combination with regional and industrial policy on the national level resulted in one of the most successful greenfield FDI projects in Slovenia. Carthago Reisemobilbau GmBH manufactures luxury motor homes. Due to high labor costs and spatial limitations at their original production site in Germany, the management of Carthago decided to relocate production facilities to another country. Although the original intention was to relocate to the Czech Republic, in the end, this MNE selected Odranci in the northeastern part of Slovenia. A number of factors led to this location decision: good transport accessibility (close to the highway), available labor, premises prepared by the Municipality of Odranci, and some personal preferences of the investor. The investment was successfully realized in large part to Slovenia’s national industrial policy: The investor received a direct financial incentive of EUR 1.2 million, which covered approximately one-fifth of the investment costs. The regional development agency helped with technical advice and with coordination between Carthago, the municipality, and national planning organizations. However, the municipality of Odranci had an especially important role in the successful realization of the investment. Unlike other municipalities in the area, Odranci submitted a strategic decision to promote development of manufacturing rather than tourism. Its promotion of manufacturing included upgrading the infrastructure and providing other manufacturing support. After the location decision procedure began, the mayor and the municipal administration were in constant contact with the investor, assisting with every stage of the formal planning system, from obtaining the necessary permits, preparing planning documents for the project, to applying for funding from national planning organizations. The industrial zone of Kamenice was further expanded. The mayor also used his political influence to overcome objections by other organizations (Kušar 2010, 2011). A number of similar Slovenian examples of local interventions can be cited as successfully attracting FDI during the post-GFC period, but describing them in detail would be beyond the scope of this chapter. It might be, however, worthwhile to menition just a few for further inquiry by the reader. With local cooperation, Japanese MNE Yaskawa located in Koˇcevje in order to produce industrial robots. The Swiss manufacturer Lonstroff chose the town of Logatec for the production of medical elastomers after purchasing the firm from Japan’s Sumitomo Rubber Group. In the tourism sector, Hotel Intercontinental in Ljubljana was purchased by a Serbian firm. The Austrian-Canadian automotive firm Magna selected its site in close proximity to Maribor. The latter enjoyed strong support from the national development policy, which adopted a special law enabling the Magna investment to take place in Slovenia (Uradni List 2016).

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To summarize, the above-described approach for attracting FDI to industrial zones relates predominantly to greenfield FDI. These greenfield investments are more characteristic of peripheral regions in Slovenia, while the dominant central region of Osrednjeslovenska has attracted a number of brownfield FDI projects, some of them relatively large in scale.

4.7 Prospects for FDI in Slovenia A number of endogenous and exogenous economic determinants should be considered when discussing prospects for FDI in Slovenia over the next 25 years. One of the main location factors convincing investors to locate their facilities in Slovenia is the workforce, which is relatively well educated and highly trained. However, demographic projections show that due to population decline and emigration, the size of Slovenia’s labor force will begin to decrease. IMAD (2019) estimates that within the next ten years, the contraction of the population in the age group 20–64 will become a limiting factor to economic growth in Slovenia. Slovenia’s unfavorable demographic situation in the future may severely influence the country’s potential for attracting MNEs, while at the time an important structural mismatch exists between the type of labor that is sought after and the type of labor that is available. Economic growth since 2014 has been driven mainly by the export sector, and has already led to labor deficiencies, especially in the manufacturing and construction sectors. Research on satisfaction with Slovenia as an investment location shows that 65% of companies included in the sample have already had difficulty attracting a suitable workforce (Jakliˇc et al. 2017). Companies operating in Slovenia often need to hire workers from other countries, especially from Bosnia & Herzegovina and Kosovo, in order to meet the demand for their products (IMAD 2019). Labor faces some additional disadvantages. Namely, the OECD warns that despite Slovenia’s high levels of education, labor force quality is relatively low compared to other OECD countries (OECD 2019) causing possible difficulties in adopting work philosophy, technology, and skills necessary to follow the Industry 4.0 and 5.0 initiatives. Also problematic is Slovenia’s relatively slow adoption of advanced technology and management practices from FDI to its own economic environment (OECD 2019). Moreover, Slovenia cannot offer a large agglomeration economy. It has limited possibilities regarding the labor market. However, future FDI development in Slovenia can lean on the country’s advantageous geographic location and underutilized potentials for specific economic sectors, mainly in services and high-tech industries. With regard to European traffic corridors and Slovenia’s location at the northernmost position of the Mediterranean and Adriatic Seas’ extension into the European continent, the country offers excellent geographically strategic investing opportunities. Namely, Slovenia is situated at the crossroads between the V. corridor linking Spain, Southern France, and Northern Italy with Hungary, Slovakia, and Ukraine, as well as the X. corridor linking Central European Countries with Southeastern

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Europe, including Croatia, Serbia, Bulgaria, Turkey, North Macedonia, and Greece). Recently, more emphasis is being placed on the TEN-T Mediterranean and BalticAdriatic transport corridors, both of which transect Slovenia, giving excellent opportunities for economic development in the logistics sector. In the future, at least partial privatization of large infrastructure enterprises can be expected, including the national railway company and management company for the motorway network. Slovenia’s strategic location also offers great potential for FDI in tourism and renewable energy production and distribution, areas in which many domestic small and medium-sized enterprises already exist. Growth in these areas and domestic collaboration with MNEs could help them realize their potential to become global players. Because the Slovenian economy is strongly internationalized, especially within the context of the economic space of the EU, any conversation of future FDI dynamics, structure, and spatial characteristics cannot avoid the recent economic and geopolitical issues prevailing in the EU. The economic implications of Brexit, strategic development decisions for the new programming period (2021–2027), transformation of economic structure marked by the de-carbonization, COVID-19, and the role of the EU on the global geopolitical stage cannot be fully understood at this time. All of these events introduce great uncertainty to the EU economic environment. Potential investors to Slovenia might delay their decisions or change plans altogether as a result of this unclear future. They might become more conservative by searching for locations in larger or more traditional business environment countries and regions. Moreover, FDI dynamics in Slovenia could be strongly affected by competition from other countries across Central and East Europe. More optimistically, the COVID-19 pandemic and consequent changes in the global economic structure might actually have some positive implications for Slovenia’s ability to attract new investments. With Slovenia’s proximity to the economic core of the EU, investors might be interested in dispersing their global value chain vulnerability while retaining strategic/specialized suppliers. Taking into account Slovenia’s geographic, economic, and cultural characteristics, it can be expected that the most important countries in the structure of the inward stock will remain Austria, Italy, France, and Germany. However, FDI from some other countries might also accelerate, especially in locations where capital accumulated during the transition and crisis period in Slovenia. Potential investors might now seek the opportunity to return to Slovenia. Chinese capital is also gaining importance globally, but thus far Slovenia has very mixed experiences with the stability and development potential of Chinese FDI. There are also some restrictions at the EU level regarding FDI from China. For all these reasons, it is unlikely that investors from China will take a much stronger initiative in Slovenia in the near future. There is also the question about the future role of US-based MNEs in the current chilly political climate between the Slovenian and US governments. Due to Southeastern Europe’s lagging economic growth rates, a demographic exodus from peripheral and semi-peripheral regions, and delays in EU enlargement, the short-term potential for FDI from the other successor states of Yugoslavia is limited. This might change in the long run, pending more openness of the EU toward West Balkan accession, supported by efforts to reconstruct infrastructure and develop

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Slovenia’s domestic economic base. Since 2010, only MNEs from Croatia play a visible role, as Croatia achieved EU accession in 2013. Croatia’s eventual admission to the Schengen zone is unlikely to have any strong influence on FDI to Slovenia, although Croatia’s potential adoption of the euro will facilitate increased bilateral economic relations (see also Chap. 3 by Tica, Globan, and Levaj). The Slovenian government sees FDI as an important way to bring prosperity to its citizens throughout its regions, although it is expected that the Osrednjeslovenska statistical region, which contains the national capital of Ljubljana, will continue to benefit the most. Until COVID-19 appeared, the government anticipated increased inward cumulative FDI of EUR 15,000 million by the end of 2020. To achieve this goal, even if delayed, a consistent and well-targeted FDI strategy is needed, supported with sufficient promotion and aftercare. Slovenia’s excellent business environment and economic stability are important advantages toward achieving this objective. Additionally, minor changes in management, such as a long-term privatization plan, can help to increase the reputation of Slovenia as an FDI-friendly location. At the same time, the growth of FDI within Slovenia’s economic structure over the past few years has already prompted discourse on the country’s national interest and whether Slovenia is becoming overly dependent upon foreign capital. Instead of pursuing MNEs in its labor-oriented manufacturing sector, Slovenia needs to focus on attracting investments that build new high-quality work facilities in services and high-technology industries. Only this re-orientation and stronger spatial decentralization of FDI across Slovenia will enable the full realization of Slovenia’s advantages vis-à-vis similar competing investment locations. These include its high quality of life, as well as cultural and geographic amenities, and especially an extremely favorable location at Europe’s transportation crossroads offering excellent accessibility to the rest of Europe.

List of Abbreviations AJPES

Agency of the Republic of Slovenia for Public Legal Records and Related Services CEE Central and Eastern Europe EU European Union EUR Euro FDI Foreign Direct Investment GDP Gross Domestic Product GFC Global Financial Crisis GODECP Government Office for Development and European Cohesion Policy ICT Information and Communication Technologies IMAD Institute for Macroeconomic Analysis and Development of the Republic of Slovenia LAU2 Local Administrative Units—Level 2 (Municipalities) MNE Multinational Enterprise

104

NACE NUTS3 OECD R&D ROE SFRY SPIRIT SORS TAM WIIW

S. Kušar

Statistical Classification of Economic Activities in the European Community Subnational Statistical Regions Organization for Economic Co-operation and Development Research and Development Return on Equity Socialist Federal Republic of Yugoslavia Public Agency for Entrepreneurship, Internationalization, Foreign Investments and Technology Statistical Office of the Republic of Slovenia Tovarna Avtomobilov Maribor (Maribor Automobile Factory) Vienna Institute for International Economic Studies

References AJPES (Agencija Republike Slovenije za javnopravne evidence in storitve) (2019) Slovenian business register, Ljubljana. https://www.ajpes.si/prs/. Accessed 3 Aug 2019 Ašanin Gole P, Maˇcek A, Vukasoviˇc T (2016) Strategic communication and marketing of the country as a location for FDI. In: Sustainable organization: proceedings of the 35th international conference on organizational science development. Moderna organizacija, Kranj Bank of Slovenia (2015) Direct investments 2014, Ljubljana. https://bankaslovenije.blob.core.win dows.net/publicationfiles/Neposredne_nalozbe_2014.pdf. Accessed 5 Aug 2019 Bank of Slovenia (2017) Direct investments 2016, Ljubljana. https://bankaslovenije.blob.core.win dows.net/publicationfiles/gdgehbqhggfBGU_neposredne_nalozbe_2016.pdf. Accessed 2 Aug 2019 Burger A, Svetliˇciˇc M (2005) Slovenija na globalnem trgu tujih neposrednih naložb: teoretiˇcni okvir, dileme, perspektive in izzivi. Our economy 51(1–2):3–18 Burger A, Jakliˇc A, Rojec M (2012) Uspešnost programa spodbujanja zaˇcetnih tujih neposrednih investicij v Sloveniji. Fakulteta za družbene vede, Založba FDV, Ljubljana. https://fdvzalozba. shopamine.si/knjige/politologija/analize-cmo-cir-analyses/i_589_uspes-nost-programa-spodbu janja-zac-etnih-tujih-neposrednih-investicij-v-sloveniji. Accessed 25 June 2019 Civic´c C, Stanley P (2010) In search of the Balkan recovery: the political and economic reemergence of South-Eastern Europe. Columbia University Press, New York Damijan J, Rojec M (2004) FDI and catching-up of new eu member states: is there a flying geese pattern? In: Enlarged EU: challenges to international business and management: conference proceedings. EIBA, Brussels Damijan J, Polanec S (2005) Export versus FDI behavior of Slovenian firms: does FDI substitute for trade flows? Medium-sized firms and economic growth. Nova Science Publishers, New York, pp 283–296 Dicken P (2015) Global shift: managing the changing contours of the world economy. Guilford, London Eurostat (2018) https://ec.europa.eu/eurostat/data/database. Accessed 14 Sept 2018 Gal Z, Sass M (2014) Role of financial sector FDI in regional imbalances in visegrad 4 countries and in Slovenia. https://dx.doi.org/10.2139/ssrn.2494171. Accessed 5 Aug 2019 GODECP (Government Office for Development and European Cohesion Policy) (2017) Slovenian development strategy 2030, Ljubljana. https://www.vlada.si/fileadmin/dokumenti/si/pro jekti/2017/srs2030/en/Slovenia_2030.pdf. Accessed 25 Jun 2019

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Gradišnik J (1993) Posledice navzoˇcnosti tujega kapitala v vsakdanjem življenju. Tuji kapital na slovenskem: želje, stanje in posledice, kulturni, socialni in gospodarski vidiki. Slovenska matica, Ljubljana, pp 75–82 Helios dokonˇcno pod okrilje japonske družbe Kansai Paint. https://znanost.sta.si/2373062/heliosdokoncno-pod-okrilje-japonske-druzbe-kansai-paint Accessed 1 Aug 2019 IMAD (Institute of Macroeconomic Analysis and Development) (2019) Development report 2018, Ljubljana Inotai A (2007) Development, features and perspectives of FDIs in Southeastern European countries: A comparison of Central and Eastern European experiences. Our Econ 53(3–4):3–17 Jakliˇc A, Rojec M (2014) Changing patterns in Slovenian inward and outward FDI after EU accession. Stud Hist Slov: Humanit Soc Stud Rev 14(1):157–176 Jakliˇc A, Svetliˇciˇc M (2005) Izhodna internacionalizacija in slovenske multinacionalke. Fakulteta za družbene vede, Ljubljana Jakliˇc A, Burger A, Rojec M (2010) Ali posebnosti slovenskega poslovnega okolja vplivajo na delovanje in širitev podjetij s tujim kapitalom? IB Revija 44(3–4):5–21 Jakliˇc A, Koleša I, Rojec M (2017) Tuji investitorji o slovenskem poslovnem okolju 2017. Rezultati raziskave med podjetji s tujim kapitalom. SPIRIT Slovenia, Univerza v Ljubljani, Fakulteta za družbene vede, Center za mednarodne odnose, Ljubljana Jakliˇc A, Kunˇciˇc A, Burger A (2011) Javnost in tuje neposredne investicije. Javnost—The Public 18:23–44 Jus M, Steinbacher M, Steinbacher M (2006) Subsidizing foreign investments. Our Econ: Rev Curr Probl Econ 52(1–2):96–105 Justinek G (2015) Nepsoredne tuje investicije v porastu. Ocena konuukturnih gibanj za Slovenijo 23(1):20–21 Kamenšek Z (2003) Vpliv neposrednih tujih investicij na kakovost cˇ loveškega kapitala. Novi zunanjetrgovinski koncepti. Ekonomsko-poslovna fakulteta, Institut za ekonomsko diagnozo in prognozo, Maribor, pp 31–61 Kersan-Škabi´c I, Orli´c E (2007) Determinants of FDI inflows in CEE and Western Balkan countries: Is accession to the EU important for attracting FDI? Econo Bus Rev 9(4):333–350 Kos M (1993) Tuji kapital in znanstveno-raziskovalna dejavnost ter politika. Tuji kapital na slovenskem: želje, stanje in posledice, kulturni, socialni in gospodarski vidiki. Slovenska matica, Ljubljana, pp 89–95 ˇ Redek T, Rojec M (2007) Davek na dobiˇcek kot determinanta vhodnih neposrednih tujih Kostevc C, investicij. IB Revija 41(2):17–28 ˇ Redek T, Rojec M (2011) Analiza uˇcinkovitosti ukrepov spodbujanja tujih neposrednih Kostevc C, investicij v Sloveniji in tujini. Ekonomska fakulteta, Ljubljana Kumar A, Zajc Kejžar K (2003) FDI and changing trade patterns: the case of Slovenia. Econo Bus Rev 5(3):201–219 Kumar A, Zajc Kejžar K (2004) FDI and host-country export performance: The case of Slovenia. In: From transition to development: globalisation and political economy of development in transition economies: conference proceedings. Part 1–2. Faculty of Economics, Sarajevo, pp 313–328 Kušar S (2008) Vloga prostorskega planiranja pri lociranju proizvodnih dejavnosti v Sloveniji. Dissertation, Univerza v Ljubljani, Filozofska fakulteta, Oddelek za geografijo Kušar S (2010) Planiranje kot dejavnik lociranja proizvodnih dejavnosti v Sloveniji. Dela 34:61–72 Kušar S (2011) The Institutional approach in economic geography: an applicative view. Hrvatski geografski glasnik 73(1):39–49. https://doi.org/10.21861/hgg.2011.73.01.03 Lapuh L (2016) Measuring the impact of the recession on Slovenian statistical regions. Acta Geog Slov 56(2):247–266. https://doi.org/10.3986/AGS.764 Lindiˇc M (2017) The effects of outsourcing and outward FDI on skill structure in Slovenia: evidence on matched firm-employee data. Econ Bus Rev 19(3):365–413 Maˇcek A, Ovin R (2011) Ali tuji kapital škodi podjetjem v strateških panogah? Banˇcni Vestn 60(9):50–54 Maier J, Beck R (2000) Allgemeine industriegeographie. Klett-Perthes, Gotha, Stuttgart

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Uradni List. 2016. Zakon o zagotavljanju pogojev za izvedbo strateške investicije na razvojnem obmoˇcju v Obˇcini Hoˇce-Slivnica (2016). https://www.uradni-list.si/glasilo-uradni-list-rs/vsebina/ 2016-01-3689?sop=2016-01-3689 Accessed 4 Aug 2019 Uspešen zakljuˇcek Novartisove ponudbe za prijateljski prevzem Leka s pridobljenimi 99% delnic. https://www.lek.si/sl/o-nas/za-medije/sporocila-za-javnost/256/uspesen-zakljucek-novartisoveponudbe-za-prijateljski-prevzem-leka-s-pridobljenimi-99-delnic/. Accessed 31. July 2019 Vrišer I (1992) Industrialization of Slovenia. Geo J 27(4):365–370 Vrišer I (2000) Industrijska geografija. Univerza v Ljubljani, Filozofska fakulteta, Oddelek za geografijo, Ljubljana Vrišer I (2008) Slovenska industrija po osamosvojitvi. Ib Revija 42(2):65–86 WIIW (2019) Database on foreign direct investment (Wiener Institut für Internationale Wirtschaftsvergliche). https://data.wiiw.ac.at/fdi-database.html. Accessed 20 September Zajc Kejžar K (2007) Inward FDI, domestic mergers, and crowding out of domestic firms: the case of a Slovenia. Economic integration prospects and dilemmas. Ekonomska fakulteta, Ljubljana, pp 405–421 Zajc Kejžar K (2008) The effects of foreign firm entry on market structure in a host country: a game theory approach. Our Econ 54(5–6):19–31 Zajc Kejžar K (2011) The role of FDI in the host-country firm selection. process: firm-level evidence from Slovenian manufacturing. Rev World Econ 147(1):169–193 Zajc Kejžar K, Kumar A (2006) Inward FDI and industrial restructuring: micro evidence—the Slovenian firms’ growth model. J Econ Bus 24(2):185–210

Chapter 5

FDI in Bosnia & Herzegovina Almir Peštek, Lejla Lazovi´c-Pita, and Ademir Abdi´c

Abstract Similar to other Western Balkan (WB) countries, Bosnia & Herzegovina (BiH) started its transition toward a market-oriented economy in the mid-1990s. However, unlike most WB countries, BiH entered the transition shock and process with significant economic, human, and infrastructural losses that were a result of the war in BiH that lasted from 1992 to 1995. Following Dunning’s O-L-I framework, this chapter investigates dynamics of foreign direct investment (FDI) flows to BiH including their industrial structure and that led to the current cumulative FDI situation. Because most of the available FDI literature analyzes inflows to BiH together with other WB or Southeastern European (SEE) countries, the purpose of this research is also to make a scholarly contribution that focuses exclusively upon BiH. Like most WB countries, BiH too faced two distinct periods of FDI inflows, which are analyzed here as pre- and post-global financial crisis of 2008. The results of our analysis show that BiH should put more effort into attracting FDI because in most cases foreign capital improves the country’s macroeconomic conditions. In conclusion, prospects are set forth for FDI inflows to BiH over the next decade, along with suggestions and recommendations to achieve greater FDI inflows into BiH. Keywords FDI · BiH · Structure of the investments · Location

1 Even

though Central Bank of BiH (CBBH) started recording FDI to BiH in 2001, in 2004, data were divided into three official categories of FDI: reinvested earnings, equity, and other capital. A. Peštek · L. Lazovi´c-Pita (B) · A. Abdi´c School of Economics and Business, University of Sarajevo, Sarajevo, Bosnia and Herzegovina e-mail: [email protected] A. Peštek e-mail: [email protected] A. Abdi´c e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_5

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5.1 Introduction Although BiH gained its independence from Yugoslavia in 1992, it entered the transition process as late as 1996 due to the devastating war that lasted from 1992 to 1995. The first data on FDI inflows to BiH were recorded as late as 20011 ; thus, the country first started attracting investments during the new millennium. Following Dunning’s O-L-I framework (1980), the purpose of this chapter is to analyze FDI inflows to BiH and to provide insights into context-specific circumstances related to FDI inflows or a lack thereof. Hence, this chapter is organized as follows: In the introduction, the objective is to answer three questions as to “set the stage” for this analysis of FDI inflows since data became available in 2004. After a review of international and domestic literature related to important aspects of FDI in BiH, levels of inflows are analyzed both before and after 2008 and the outbreak of the global financial crisis (GFC). Using Dunning’s (1980, 1991) O-L-I framework, particular attention is paid to the location of the FDI in BiH, specifically, where and in what form do the FDI come from and why and where do they go. In the final section, prospects for future FDI are explored, and a set of recommendations and suggestions is provided that might help BiH attract more FDI in the coming years in order to provide positive effects for the host economy. In order to assess the level of FDI inflows into BiH and the push and pull factors that affect them, it is first necessary to examine the origins, and circumstances in which BiH entered the transition shock (Onaran 2011). Several important questions related to the unique case of BiH remain unanswered in the literature, especially in terms of the country-specific conditions of Bosnia’s location and historical legacies. Specifically, these include • What was the role and status of the economy of BiH during Yugoslav times? • What are the greatest possibilities and needs for FDI inflows in BiH during transition process? • What occurred over the period of nine years (1992–2001) for which no official data on FDI inflows exist? The answers to three questions will provide a better understanding of BiH case and yield insights into the current situation in BiH, its perspectives, and its unutilized potential. Deichmann (2012) provides a salient analysis of the measures of FDI in BiH by developing five models focusing upon the importance of origin-specific enablers defined by Dunning (1980), including historical legacies and cultural proximity. As an explanation, he provides some contextual information related to the country’s economy during Yugoslav times, which briefly introduces the unique circumstances in BiH. The purpose of this chapter is to focus upon the years since the dissolution of Yugoslavia, rather than upon the period of its existence. Nevertheless, as contextual ˇ information it is worth noting Cauševi´ c’s (2013) overview of the BiH economy during the 1945–1991 period and especially its achievements in the manufacturing sector. During the period 1945–1965, BiH was considered to be the natural resources and

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Table 5.1 Bosnia’s total exports and imports from 1986 to 1990 (millions of Yugoslav dinarsa ) Year

1986

1987

1988

1989

1990

1991

Exports

66

128

455

6955

23,271

…

Imports

64.4

113

378

5993

21,130

…

Balance

1.6

15

77

962

2141

…

Source Federal Agency of Statistics (1991, 561) a It is worth noting that the data from Table 5.1 were not converted to US dollars. In fact, it is quite difficult to accurately convert the actual figures due to exchange rate volatility between the US dollar and Yugoslav dinar at the time because the latter was affected by high inflation rates

Table 5.2 BiH GDP levels before and after the war (USD millions) Year

1990

1991

…

1994

1995

1996

1997

Nominal GDP

10,633

8670

…

1254

1867

2741

3423

Sources The World Bank (1997, 100) and EBRD (1999, 201)

ˇ energy base of Yugoslavia (Cauševi´ c 2013, 31). By the mid-1960s, BiH developed relatively quickly from an agricultural country to one where industrial production ˇ dominated. Cauševi´ c (2013) also states that after 1965, Bosnia’s share of manufacturing capacities and processing outputs became increasingly significant as a portion of total Yugoslav exports, which was inevitably reflected on the size of BiH’s GDP.2 In 1990, 43.4% of GDP was derived from industry and mining. Vilogorac (1989) reports that BiH produced more goods of high value-added than the Yugoslav average at the time, based on his analysis of two groups of labor- and capital-intensive production. In addition, the data also show that, at that time, BiH recorded a trade balance surplus, whereas most other republics and Yugoslavia as a whole recorded a trade deficit (OECD 1989, 1990, 14). Table 5.1 provides an overview of the period 1986– 1990, illustrating the extent of trade surplus in BiH. Kreso (2016) provides an in-depth analysis of Yugoslavia’s economic situation during the late 1980s with considerable reference to Bosnia’s strengths in manufacturing. Based upon Kreso’s (2016) analysis, it is clear that the greatest potential for BiH to attract FDI has been in the manufacturing sector. However, as noted already, BiH entered the transition process devastated by war. During this period (1992–1995), the economy suffered tremendous human, capital, and infrastructural losses. Notably, the GDP of BiH fell by 80% (Hadžiahmetovi´c 2005) in a single year (1991–1992). Table 5.2 summarizes the fall in nominal GDP (please see footnote 2). From Table 5.2, we can determine that Bosnia’s nominal GDP in 1990 was five times higher than the nominal GDP in 1995. GDP per capita during the same period dropped from $1980 to around $500 (Kreso 2016).

2 Please

note the methodological change: GDP at the time in Yugoslavia was recorded as gross material product (GMP).

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Fig. 5.1 Constitutional organization of BiH

The unfortunate circumstances in BiH did not end when the new constitution, based upon the Dayton Peace Agreement (DPA),3 was signed in 1995. The DPA’s primary purpose was to end the war in BiH. However, the new constitution organized the country as an asymmetric (con)federation of two administrative entities (Fig. 5.1): The Federation of BiH (FBiH) and Republika Srpska (RS).4 Even at the time of writing, almost twenty-five years after the end of the war in BiH, the country still struggles to overcome political issues and deadlocks resulting from the governance structure set forth by the new constitution. Political instability, together with growing nationalism and the international community’s neglect of BiH remain a threat to the country’s stability and a barrier to its sustainable economic development.

3 The 4 Due

official title of the agreement is ‘The General Framework Agreement for Peace in BiH’. to chapter length constraints, Brˇcko District is not analyzed in detail.

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Figure 5.1 shows the territorial organization of BiH, which acts as a further disincentive for foreign firms to invest in BiH. For example, the city of Mostar has always been the geographic location of the ‘center’ of the Herzegovina basin. Mostar now belongs to FBiH, which under the constitution is in the Herzegovina-Neretva Canton. Trebinje is a city in the eastern Herzegovina that has infrastructure, economic, and historical ties to the ‘center’—city of Mostar. However, under the new constitution, Trebinje belongs to RS, which focuses upon its new ‘center’ of Banja Luka, located in the northwest of BiH. Similar examples can be found in FBiH as well, such as the proximity between Banja Luka and Biha´c, which now belong to different administrative entities. The divergent rules and regulations set by different administrative authorities across BiH have greatly hindered the country’s potential for attracting FDI over the past two decades. After the signing of the Dayton Peace Agreement in 1995, representatives of the international community announced plans to assist BiH with its process of reconstruction and development. The First Donor Conference for reconstruction and development of BiH was held in Brussels in 1995, leading to international aid over the following nine years (1996–2001). The estimated required level of aid was set at USD 5.08 billion. In fact, five donor conferences have been held in order to help implement the reconciliation and reconstruction of the country. What caused so many donor conferences in the first place was the inability of the domestic and international community to determine with certainty the extent of international aid required to achieve the outcomes of reconstruction and stability. At the Fifth Donor Conference, held in May 1999 in Brussels, it was estimated by leading donors that the projected approx. USD 5.1 billion would be insufficient to reach the minimum threshold of sustainable economic development. Additional funding would be required, designated primarily toward addressing accumulated socioeconomic problems, including refugee-displacement problems. This was considered necessary to stabilize this part of Southeastern Europe as a whole. Hence, at that time, BiH was an aid-driven economy where most of the anticipated results targeted under the priority reconstruction program (PRP) were only partially achieved. The increase in production capacities in BiH during the first four post-war years showed that in 1999, which was planned as the final year of the PRP’s implementation, the GDP level reached 41.3% of the pre-war volume, which is a significant deviation from the targeted two-thirds

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Table 5.3 Plans and results of international aid to BiH (1996–2000), measured by the size of GDP Planned GDP according to PRP (USD million)

1996

1997

1998

1999

2000

3260

4500

5900

7300

8500

Actual size of GDP

2779

3340

4134

4394

4540

% achieved to planned

85.25

74.22

70.07

60.19

53.41

Source World Bank (1997)

(Kreso, unpublished). Table 5.35 summarizes planned and actual levels of international aid to BiH from 1996 to 2000, as measured relative to GDP. By comparing these data to Table 5.2, it is clear that the war resulted in tremendously detrimental economic consequences. Even though international assistance promoted the development of BiH during its post-war reconstruction from 1996 to 2001, its GDP reached only about 50% of the pre-war levels. As a result, an unfulfilled plan to rebuild productive capacities left Bosnia’s economy and society unable to achieve a realistic basis for sustainable development. Since most of the international assistance went into reconstruction of basic roads, communal and housing infrastructure, BiH realized little potential for attracting any significant volume of FDI over 1996–2001 period.

5.2 Literature on FDI in Bosnia & Herzegovina Scholarly literature on FDI and BiH has been gaining prominence over the past decade. As noted before, the country has been analyzed together with WB and SEE countries according to different aspects of FDI. Similar to other WB countries, both domestic (pull) and foreign (push) factors affect capital inflows into BiH, and therefore, some academic research focuses upon determinants related to both origin and destination countries, and how these factors impact flows of FDI. Much of the research analyzes the relationship between FDI and macroeconomic factors such as inter alia, unemployment, economic growth, poverty, and public policy. Other work examines the effects of FDI upon the host country with special reference to business performance.

5 Please

note the volatile exchange rates between BAM and USD at the time. 1996

1997

1998

1999

2000

GDP in BAM

4125

6116

7559

8603

9611

GDP in e (1e = 1.95583 BAM)

2109

3127

3865

4399

4914

1.7614

1.8343

2.1189

Average mean exchange rate (BAM/$) Source Kreso (unpublished)

5 FDI in Bosnia & Herzegovina

115

This brief review of literature related to FDI in BiH is organized around two types of query, namely Web of Science and Elsevier Scopus databases. The research available in the local language is discussed separately. Table 5.4 summarizes the key results of research focusing on the purpose of the research, methods used, and results. Although the FDI literature published in Bosnian/Croatian/Serbian is usefully descriptive, it is also somewhat redundant. Therefore, only the most recent and relevant papers are discussed here. Several papers published prior to 2012 focus on the determinants of FDI inflows as well as on explanations of why the country attracts less foreign capital than its neighbors. Reports from the Directorate of Economic Planning of BiH (DEPBiH 2005) analyze and compare the level of FDI in both administrative entities of BiH. Similar to WB countries, BiH also started its transition shock through the process of voucher privatization. However, the DEPBiH (2005) describes a drawn-out process with only 39% of companies FBiH and 53% in RS having been privatized. Additional research examines the unfinished privatization process and lack of ˇ institutional capacities, together with legal and economic obstacles. Cauševi´ c (2009) provides a macroeconomic overview of the effects of the GFC on the Bosnian economy and hence its modest FDI inflow. Halilbaši´c (2011) summarizes FDI in the context of the country’s competitiveness. Culahovic et al. (2009) analyze the importance of factor endowments in relation to institutional development in explaining the selection of location by MNEs in the manufacturing sectors of SEE countries. Their econometric model uses panel data and includes determinants of FDI at the sectoral level from 1999 to 2006. The results show that institutional changes have enhanced FDI receipts to the manufacturing sector. These changes include the development of privatization process, liberalization of foreign exchange and trade, development of competition policy, and the rebuilding of infrastructure. Other factors that do not seem to be significant include enterprise restructuring, domestic price liberalization, and development of the banking sector. At the time of writing, the most recent research on the manufacturing sector in BiH is that by Kastratovi´c (2018), who evaluates the effects of FDI6 on market concentration. By using the Herfindahl–Hirschman index (HHI), the results for almost 5000 foreign companies operating in BiH in 2016 show that the impact of FDI on market concentration can be described with a quadratic U-shaped functional form. Pejakovi´c (2012) analyzes the inflow of FDI during the peak period of 2007– 2009. Examining the overall structure of FDI inflows he observed that the peak is attributable to the completion of the privatization of the RS telecommunications operator. Kumali´c (2014) argues that BiH is a good location for foreign investors based upon several positive actions such as the signing of bilateral trade agreements with Turkey in 2002, association with CEFTA in 2006 (member since 2007), and Stabilization and Association (SAA) with the EU in 2008. As a result of these agreements, Europe’s market of over 600 million inhabitants is open to BiH’s exports. These

6 FDI

is used as an independent variable and is determined according to OECD and CBBH methodology.

Role of institutions in attracting FDI

Effects of FDI. Evidence from Southeast Firm-level data from the World Bank Europe enterprise survey used in the OLS model

Panel cointegration analysis of FDI and average net wages: the case of four WB states

Effect of FDI on the employment rate in BiH

Competitive advantages of BiH as precondition for FDI

FDI entrance and its impact into countries in transition (case of BiH)

Mari´c and Shukarov (2017)

Apostolov (2016a)

Kurtovi´c et al. (2015a)

Kurtovi´c et al. (2015b)

Starˇcevi´c and Suboti´c (2015)

Mari´c (2009)

Positive effects of FDI to GDP

Results

Analysis of macroeconomic policy and real role of FDI in economic development of BiH

Descriptive analysis of competitive position of BiH in relation to attracting FDI

Econometric analysis of time-series data and multiple regression model

Panel analysis tested for relationship between FDI and average net wages (ANW) in WB countries

N/A

(continued)

BiH competitiveness determined by comparative analysis of the global position of WB countries

FDI, consumption, exports, and unemployment have a positive impact on employment in BiH

Statistically significant long-term relationship between FDI and ANW by most tests

Positive outcomes of FDI tied to movements in the domestic economy

Comparative data analysis between FDI WB countries with lower degree of inflow and corruption perception index institutional development have higher as an institutional proxy transaction costs such as bribery than countries with higher degree of institutional development

Quantitative analysis (linear regression—GDP to FDI). Analysis of FDI inflow with emphasis on joint ventures and free-zones

FDI and its impact on the economic development of BiH

Susic et al. (2017)

Objective, data, and methods

Title/topic

Author(s)

Web of Science search results

Table 5.4 Summary results of available literature related to FDI and BiH

116 A. Peštek et al.

Fiscal decentralization (FD)’s influence Panel analysis of FD’s effect on social Decentralization has a positive impact on on development & economic development aspects FDI, social contributions, GDP, etc.

Impact of FDI on productivity in eight Balkan countries

Post-communist financial and economic development: Cluster analysis of selected countries

Cobb–Douglas production function on FDI in Southeast Europe

Muço et al. (2018)

Reiff and Tokar (2016)

Apostolov (2016b)

Effects of FDI on domestic firms and overall economy of SEE countries. WBa firm-level data analyzed with econometric models and Cobb–Douglas production function

Explain disparities of social and economic development of 28 post-communist countries based on World Bank (WBa) indicators 2000–2014. Cluster analysis to classify countries, Ward’s method, and Kruskal–Wallis rank test employed

Analysis of FDI’s effects on productivity growth, university enrollment and unemployment

(continued)

Foreign ownership has predisposed movements in domestic economies with constant increase in capital base. Low technology and lag in labor force employment are obstacles

Economic trajectory after communism of post-communist countries is far from being identical. Countries differ with respect to their social and economic dynamics and can be grouped into three relatively homogeneous clusters

Positive impact of FDI on productivity growth, university enrollment. Subject to institutional quality and economic development

Emigrants from WB involved in former home economies through FDI, remittances, etc.

Chygryn et al. (2018)

Overview, impact, and perspectives of emigration from WB countries

Emigrants from the Western Balkans: the region’s money sacks?

Results

Koleša (2019)

Objective, data, and methods used

Title/topic

Author(s)

Elsevier Scopus search results

Table 5.4 (continued)

5 FDI in Bosnia & Herzegovina 117

Cyclical properties of workers’ Testing cyclical components and remittances: Evidence from Bosnia and nature of co-movements of Official Herzegovina Development Assistance (ODA) and FDI with output/BiH GDP

Political economy of economic liberalization and competitiveness in BiH (Book chapter)

FDI into transition economies: Are the Balkans different?

Governance and enterprise restructuring in Southeast Europe: Gross domestic product and FDIs

Isakovic and Ilgun (2015)

ˇ Cauševi´ c (2015)

Estrin and Uvali´c (2014)

Apostolov (2013)

Sustainable economic strategy for BiH and its two entities should be based on export-oriented investment

FDI behaves counter-cyclically to BiH output and ODA behaves pro-cyclically to GDP with one-year lead/lag

Corporate governance mechanism’s influence enterprise restructuring in SEE/WB countries. Governance and enterprise restructuring is encouraged by movements in GDP and FDI

(continued)

Variables of interest advance through time due to imposed policies and overall progress of the economies’ GDP and FDI inflows

Determinants of FDI in several Factors driving FDI into WB differ from Balkan countries using gravity model CEE countries. WB received less than from 1990 to 2011 CEE using same determinants

Analysis of interaction of domestic political actors and the international community in BiH in implementing reforms

Motives of Russian state-owned energy Analysis of cooperation using three companies for outward FDI, and their examples of outward FDI (one impact on state-company cooperation includes BiH company- Optima Group). Desk-review analysis

Tepavcevic (2015)

Drivers of outward FDI of Russian state-owned energy companies represent a complex range of commercial considerations

Corruption’s effect on FDI: The case of Using Transparency International Corruption has a negative and significant Bosnia and Herzegovina (Book report, World Bank and National impact on FDI inflows chapter) Banking Statistical data in a cross-sectional setting, the purpose is to re-examine the effects of corruption on FDI

Results

Pupovic (2015)

Objective, data, and methods used

Title/topic

Author(s)

Elsevier Scopus search results

Table 5.4 (continued)

118 A. Peštek et al.

Spatial and national distribution of FDIs in Bosnia and Herzegovina

Convergence of export structure of Romania, Croatia, Serbia, and BiH to structure of import demand in developed countries

Boti´c (2013)

Nikoli´c (2011)

Analysis of trade structure in SEE. Identified factors in the success of advanced transition economies was, inter alia, FDI inflow, imports of modern technology, etc.

Research on spatial and distribution of FDI in BiH through data analysis. Geographic methods used to process data with series of parallel graphics

Objective, data, and methods used

Export structure of BiH recorded more similarity since 2004 with reference import structures. Export structures of BiH correlate with transition process

Positive connection between geopolitical interests of FDI origins and recipients in BiH

Results

N.B. two papers from Rovˇcanin et al. (2007) and Stipanovi´c and Skoko (2007) were not available as full text but rather extended abstracts in the Web of Science database. Three papers [Susic et al. (2017), Apostolov (2016a), and Deichmann (2012)] are cited in the literature review from the Elsevier Scopus database Sources Web of Science (2019) and Elsevier Scopus database (2019), authors

Title/topic

Author(s)

Elsevier Scopus search results

Table 5.4 (continued)

5 FDI in Bosnia & Herzegovina 119

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developments, in turn, could play a role in contributing toward the acceleration of economic growth and development of BiH. In addition to these quantitative papers, other research considers relatively small samples of foreign investors’ opinions and attitudes about the investment climate and other considerations is often cited in academic discourse. For example, Sinanagi´c ˇ c et al. (2017) survey foreign investors about several economic, et al. (2013) and Civi´ legal, and institutional factors and whether they are important for deciding upon locations and operations in BiH. Similarly, reports from the World Bank’s Doing Business Report (2016a) and Competitiveness Reports (Schwab 2017), as well as the Foreign Investors Council in BiH publication ‘Business Barometer’ (2015, 2018) all identify similar legal and economic obstacles requiring improvement to make BiH more investor-friendly. As a specific macroeconomic factor that might affect the FDI inflow into BiH, Damjanovi´c (2015) tests the effect of tax rates, examining both corporate and personal taxes. By using PwC data from 2006 to 2013, the author reports a Pearson’s correlation coefficient that reveals a positive relationship between corporate income tax rate and FDI, as well as a negative relationship between personal income tax rate and FDI. The most recent comprehensive analysis of FDI inflows to BiH over time is provided by Domazet (2016). Using secondary data, the author analyzes and tests four aspects of FDI in BiH. These include achieved results in terms of FDI volume until 2016, theoretical assumptions necessary for FDI inflow, purposes and objectives of support for FDI, and new policies intended to create a more friendly environment for FDI. As a result of the analysis, Domazet (2016) identifies three areas where improvements are required to attract more FDI. These are an improved business environment, greater institutional capacity of organizations such as Foreign Investment Promotion Agency (FIPA) in BiH, and promotional activities of such organizations including the provision of post-investment support and services for investors. Some literature covering the effects of FDI on Bosnia’s macroeconomic parameters has already been mentioned in this brief review. Beyond the literature available in global scientific databases, two additional relevant papers should be considered when analyzing the effects of FDI on macroeconomic indicators. Mehic et al. (2013) analyze FDI’s role in economic growth in seven SEE countries including BiH during the period 1998–2007. Their results unveil positive and statistically significant effects of FDI on economic growth. For the period 2000–2015, Estrin and Uvalic (2016) show that the effects of FDI on poverty reduction are stronger in (poorer) WB countries than in other (wealthier) SEE countries. Overall, the scholarly literature on FDI in BiH tends to emphasize positive impacts over negative.

5.3 FDI in BiH Before and After the Global Financial Crisis When years of intensive international aid for reconstruction and reconciliation in BiH led to a GDP that was merely 50% of pre-war size, the country embarked upon the process of transition. This transition process involved voucher privatization, which is usually accompanied by several macroeconomic challenges. BiH faced high

FDI (milion EUR)

5 FDI in Bosnia & Herzegovina 1600 1400 1200 1000 800 600 400 200 0 -200 -400

2004 Reinvested earnings 26.0 Equity 341.2 Other capital 44.6

2005 26.5 227.2 28.7

2006 93.2 335.2 13.8

2007 130.1 1119.8 79.4

121

2008 11.9 394.9 277.1

2009 -302.3 156.5 325.7

2010 -104.7 216.9 194.5

2011 44.6 204.0 108.6

2012 -15.8 142.5 180.6

2013 -53.9 218.1 43.9

2014 53.1 134.5 227.1

2015 79.4 159.1 87.2

2016 104.5 150.9 60.8

2017 205.3 179.2 14.6

2018 195.8 280.0 -75.3

Fig. 5.2 FDI inflows in BiH (in millions EUR, 2004–2018). Source CBBH (2019), authors

unemployment and sluggish economic growth yet avoided high inflation. Originally intended for economies in Latin America, the Washington Consensus and its ten policies were also advised for BiH (Rodrik 2002). Since it was written much earlier, in 1989, it gave rise to numerous controversies. As a result, it became modified into a new, augmented Washington Consensus (Rodrik 2002) or post-Washington Consensus. Out of the original ten reforms, three are closely related to FDI: trade liberalization, openness to FDI, and privatization (Rodrik 2002). Hence, in ‘a onesize-fits-all’ model under the Washington Consensus, the three policies were intended to be introduced together. In the first years of the privatization process (from 2004 until the outbreak of GFC), FDI inflows were concentrated in the financial and telecommunications sectors, although only one out of three telecom operators in BiH had been privatized. Privatization has shaped the dynamics of FDI inflows into BiH over a period of fifteen years, and it remains an ongoing process. Figure 5.2 depicts the temporal patterns of FDI inflows from 2004 to 2018. Hence, looking at the historical data, as one of the reasons to why foreign investors invested in BiH rather than other WB or CEE countries lies in the process of voucher privatization that started late in comparison with other WB and CEE countries. During the process of privatization, the FDI inflows were recorded by the seat of the privatized company, and therefore, the most FDI inflows at the time were geographically located in the ‘two centers’ of BiH-Sarajevo and Banja Luka. Additionally, Sarajevo and Banja Luka are also the headquarters of the two stock exchanges (The Sarajevo Stock Exchange—SASE and Banja Luka Stock Exchange—BLSE, respectively) which have contributed toward FDI inflows and have speeded up the process of privatization in some sectors (e.g., the privatization of the banking sector in FBiH until the outbreak of GFC). FDI inflows to BiH in 2018 amounted to EUR 400.6 million, which is a slight increase of 0.4% compared to the previous year. FDI inflows in 2018 increased 20.37% compared to their five-year average (2013–2017). Compared with the average FDI during the aftermath of the GFC (2009–2017), 2018 represents an increase of 28.07%. In IBM’s ‘Global Location Trends Report’ (2018, 2019), BiH ranks in the top ten globally in terms of job creation from FDI relative to population size. Regarding global value chains, BiH ranks third among transition countries by foreign value-added share and second among SEE countries behind only North Macedonia (UNCTAD 2019).

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Nominal GDP (in milion EUR) Current Prices

Figure 5.2 shows that BiH experienced its largest annual FDI inflows in 2007, with EUR 1.33 billion. Nearly half of this value can be explained solely by the privatization and sale of RS’s large public telecommunications company Mtel a.d. Banja Luka, at EUR 0.64 billion. During the following year, total FDI inflows declined sharply to EUR 683.8 million. Considering the privatization of this telecommunication operator as a one-time outlier, the level of FDI in 2008 is satisfactory in the absence of any significant privatization, and with a favorable inflow structure dominated by greenfield manufacturing investment. As in other WB and SEE countries, Bosnia’s FDI inflows were reduced significantly by the GFC. The next increase in FDI net values was not registered until 2014 (EUR 414.7 million), which nearly doubled the numbers for 2013. Unfortunately, despite promising estimates, FDI flows in 2015 and 2016 failed to maintain this positive trend, making 2014 the largest recent single year. Overall, FDI inflows continue to fluctuate on an annual basis due to unfinished privatization and other factors highlighted in the literature review, such as legal, institutional, and economic factors. Based on preliminary Central Bank data for the first half of 2019, it was expected that FDI will maintain a growth trend (CBBH 2019). In the first two quarters of 2019, FDI amounted to EUR 333.41 million, with the increase of 50% compared to the same period in 2018 or increase of 87.51% compared to the five-year average (for the same period 2014–2018). The structure of FDI inflows varies during this period. Figure 5.3 reports the dynamics of GDP, FDI inflow as a percentage of GDP, and FDI inward stock as a percentage of GDP from 2004 to 2018. Recently, media reports and scholars such as Domazet (2016) estimate that BiH’s GDP needs to grow at the annual rate of at least 5%. With the help of such growth, BiH can begin to catch up with the levels of development in EU member states. In order to reach such rates of growth, BiH requires better public policies for promoting foreign capital. 18,000

50.0%

16,000

45.0% 40.0%

14,000

35.0%

12,000

30.0% 10,000 25.0% 8,000 20.0% 6,000

15.0%

4,000

10.0%

2,000 0

2004 Nominal GDP BiH 8,180 % FDI inflows share 5.0% % FDI stock share 20.5%

5.0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 9,024 10,255 11,529 13,048 12,680 12,969 13,412 13,407 13,692 13,988 14,617 15,290 16,042 17,081 3.1% 4.3% 11.5% 5.2% 1.4% 2.4% 2.7% 2.3% 1.5% 3.0% 2.2% 2.1% 2.5% 2.3% 21.6% 23.7% 31.8% 33.6% 38.0% 38.7% 41.1% 42.8% 45.0% 44.2% 45.0% 44.3% 44.1% 42.8% Nominal GDP BiH

% FDI inflows share

0.0%

% FDI stock share

Fig. 5.3 Dynamics GDP, % FDI inflow of GDP and % FDI inward stock of GDP in BiH from 2004 to 2018. Source CBBH (2019), authors

5 FDI in Bosnia & Herzegovina

123

The total cumulative value of FDI through 2018 was EUR 7.4 billion, or 42.79% of the country’s GDP (CBBH 2019). The average annual value of FDI as a portion of GDP during the period 2004–2018 was only 3.44%. The compound annual growth rate of FDI inflows in BiH during the period 2004–2008 was 13.53%, declining to 9.3% during the period 2009–2018. Several reasons have been identified that might provide an explanation to this situation. During the ten most recent years and primarily due to the GFC, privatization of the remaining two large telecommunication companies in FBiH was delayed. Since 2008, their market value decreased considerably. In addition, there have been delays in the implementation of large investment projects in the energy sector. In 2010, a lack of interest by international investors is noted, as well as the discontinuation of direct economic support from governments of major economies including the United States (US), Germany, and the United Kingdom. Subsequent economic uncertainty since 2010 in the EU market also reflects negatively on BiH as an investment location. Slow recovery, followed by high budget deficits and problems in the Eurozone, including the 2012 EU crisis combined with increased volatility in the global market, debt crises in Greece and elsewhere, and even Brexit represent a few external factors which might also detract FDI flows. Also, poor credit rating (which is among the worst in the region) can be considered as one of the determining factors of low FDI inflow to BiH. Standard & Poor’s and Moody’s Investors Service estimate that BiH is still lagging behind other WB countries and is one of riskier countries for investment.

5.4 Origins of FDI in BiH Following Dunning’s (1980) framework or ‘O-L-I’ framework, ‘O’ stands for ownership advantages or origin-country assets. In that sense, origin of FDI in BiH is an important factor that is analyzed. Available statistical coverage from the Central Bank of BiH allows us to analyze the origins of FDI in BiH since 2004. Prior to that period, available literature from international financial organizations provides some insights. Hence, Bray (2004) provides, inter alia, a summary of investment environment in BiH, results from the World Bank’s Multilateral Investment Guarantee Agency (MIGA) in the reconstruction of BiH and lessons learned from investments in BiH. Similar to other relevant research related to FDI in transition countries, BiH FDI inflows are compared to its neighboring countries, namely Croatia and Serbia at the time. In the same research, BiH has also been compared to several other SEE countries, and in the cumulative FDI inflow over 1994–2002 period, BiH came last (Bray 2004). These results were expected (primarily due to the war in BiH and late start of transition process in BiH) and are discussed in the introduction section. Bray (2004) also provides a breakdown of FDI by country of origin over 1994– 2003 period. At the time, Croatia was the single largest investor in BiH, followed by

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Kuwait, Slovenia, Germany, Austria, Serbia and Montenegro,7 the Netherlands and Switzerland. Among all stated countries, Kuwait is an obvious outlier. Hence, Bray (2004) states that Kuwait came to the top of the list primarily due to purchase of shares in the steel plant in Zenica and the UNIS buildings in Sarajevo. Since Kuwait did not make further investments on similar scale to BiH as of 2002, it has been overtaken by other countries in the coming years. Interestingly enough, Kuwait investors did not keep their shares in Zenica steel plant because today, Zenica steel plant is owned by AcelorMittal (whose country of origin is Switzerland) and government of FBiH. In its analysis, Bray (2004) also states the significance of historical and economic ties that BiH traditionally has with Austria. At the time, Austria was the fifth largest investor in BiH that invested primarily in wood processing and banking industries. However, Bray (2004) predicts that Austria is expected to become a more serious investor in BiH. In terms of FDI by sector over 1994–2002 period, manufacturing sector had the highest share (55.5%) followed by banking sector (16.5%), services, trade, transport and tourism (Bray 2004). It is interesting to state that Coca-Cola’s investment in a bottling plant came though Coca-Cola’s affiliate from Netherlands. This resulted in the overall score of country of origin—the Netherlands which was seventh largest investor in BiH.8 As Bray (2004) rightly predicted, Austria did become a single most important investor in BiH in the coming years. In terms of cumulative FDI stock during the period 1994–2018, the largest value was invested by companies from Austria, totaling EUR 1.36 billion. If we look at the investments based upon NACE rev. 2 classification, Austrian investors invest mostly in financial and insurance activities (60.4%), followed by manufacturing (25.75%). Prior to the GFC, the privatization of banks in BiH was nearly complete. The second most important origin of investors is Croatia, with a cumulative value of EUR 1.17 billion. Once again, almost 50% of these investments went into the financial sector (46.4%), followed by wholesale, retail trade, and repair of motor vehicles (19%). Serbian MNEs, ranked third by value (EUR 1.04 billion), focus upon information and communication (70%) as well as on wholesale, retail trade, and repair of motor vehicles (11.3%). Next, Slovenian firms are valued at EUR 550.21 million, with activities concentrated in the financial sector (35.6%) and manufacturing (20.1%). Dutch companies have invested EUR 445.20 million mainly in manufacturing (72%), followed by projects in wholesale, retail trade, and repair of motor vehicles (16.2%). Russian investors (EUR 360.61 million) invest mostly in manufacturing (95%) as well as wholesale, retail trade, and repair of motor vehicles (3.7%). The seventh most important origin of investors is Germany, with a cumulative value of EUR 350.89 million. German investors have invested 40.8% of their investments into manufacturing, followed by wholesale, retail trade, and repair of motor vehicles (20.1%) and professional, scientific and technical activities (14.4%). Next, Italian firms with the cumulative value of EUR 326.64 million focus on activities concentrated in manufacturing (55.56%) and other activities not classified elsewhere 7 Serbia

and Montenegro were one country at the time. note that Coca-Cola firstly opened a bottling plant in BiH in 1975, which was then a part of Slovenian bottling company.

8 Please

5 FDI in Bosnia & Herzegovina Austria Croatia Serbia Slovenia Netherlands Russia Germany Italy Great Britain Switzerland

125 1,360 1,172 1,035 550 445

361 351 327 267 245 0

200

400

600

800

1,000

1,200

1,400

1,600

Fig. 5.4 Top ten origins of total FDI stock in BiH (1994–2018). Source CBBH (2019), authors

(37%). United Kingdom companies have invested EUR 267.45 million in electricity, gas, steam, air conditioning supply (74%) and in projects related to wholesale, retail trade, repair of motor vehicles (10.4%), and manufacturing (7.5%). Rounding out the top ten country of origin investors (as in Fig. 5.4), Swiss companies invested EUR 244.72 million, mostly in manufacturing (66%), followed by projects in wholesale, retail trade, repair of motor vehicles (17.7%), and mining and quarrying (11.4%). Figure 5.4 shows the top ten origin countries of MNEs by total value through 2018. Together, the leading five countries account for more than 60% of FDI stock. According to the data from Central Bank of BiH (2019), two-thirds of total FDI stock in BiH come from European Union (EU28) member states (66.25%), while one third (33.75%) comes from non-EU28 countries. The greatest share of nonEU28 country of origin investors pertains to Serbia, Russia, Switzerland, and Turkey. These four countries together make up three quarters (75%) of non-EU28 country of origin investments in BiH. Sectoral investment structure of non-EU28 countries is no different from EU28 investments. Furthermore, the origins of FDI to BiH are roughly similar when examining the most recent year for which data are available. In 2018 alone, the largest contributor of FDI is Russia, with EUR 71.68 million, followed by Croatia with EUR 54.24 million, and the Netherlands with EUR 48.06 million. The following countries have also registered significant capital increases of more than EUR 10 million: Austria (EUR 44.54 million), Germany (EUR 42.81 million), the United Kingdom (EUR 41.63 million), Switzerland (EUR 20.60 million), Slovenia (EUR 16.66 million), and Italy (EUR 11.95 million). However, when comparing the top ten countries in cumulative FDI stocks in BiH before and after the GFC, some countries have become less important as origins of FDI. These include Switzerland, Germany, the Netherlands, and France. Other countries increased the level of FDI in BiH since the GFC, and they include Luxembourg, the UK, Cyprus, and Liechtenstein (Fig. 5.5). As several of these new origins are increasingly popular as offshore tax havens for agile firms, their presence on this list plausibly reflects this growing phenomenon (Haberly and Wójcik 2014). Austria, Serbia, and Croatia all rank among the top five origins during both periods. This finding supports earlier findings on the country’s long historical ties and legacies with its neighbors (Deichmann 2012). Austria remains a

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900 843 800

FDI (in million EUR)

700 600

560 515

500

473

400

377 344

328

325

300 222 200

172

186

179

166 131 98

87 82

100 34

86

121

117 82 33

45

42 2

35

16

12

2

0

Top 10 FDI countries (2004-2008)

Top 10 FDI countries (2009-2018)

Fig. 5.5 FDI in BiH by country-level investments before and after the GFC. Source CBBH (2019), authors

leader in FDI in BiH, while firms from Croatia, Serbia, and Slovenia also continue to invest there for several reasons (see later). Similarly, Boti´c (2013) also argues that ethnic communities in BiH attract investments from neighboring countries such as Croatia and Serbia. Other reasons might include, inter alia, the fact that there are numerous unbreakable linkages such as people, culture, religion, language, and a longstanding tradition of community in single country. Koleša (2019) observes that emigrants from WB countries return to invest in their home countries, and this may apply to BiH, given that nearly 50% of its population currently lives abroad9 (World Bank 2016b). Looking at the firm-level FDI data, additional conclusions can be drawn with the help of earlier findings by Pejakovi´c (2012). During the period 1994–2008, the privatization and sale of the telecommunications company of RS in Banja Luka rank first among all foreign acquisitions. Figure 5.6 shows the ten largest foreign-owned companies in BiH during the period before and in the period after GFC. In both entities, location within BiH of the FDI inflows was primarily determined by the Headquarters of the privatized company. Secondly, most companies listed in Fig. 5.6 are privatized due to their going-concern business potential or further exploitation of the natural resources. Six out of the ten largest FDI projects since the GFC 2009 were made in RS, whereas during the pre-crisis years, FBiH hosted six out of the ten largest MNEs. This might reflect the fact that in 2009, RS introduced more liberalized policy toward FDI. Privatization undoubtedly contributes to the number of projects in each entity. In RS, the privatization process of large publicly owned 9 Estimates

of the World Bank (2016b) which include only the first generation of migrants for the year 2013 were 44.5% of the total population.

5 FDI in Bosnia & Herzegovina 1.400

127

1.263

FDI (in million EUR)

1.200 1.000 800 600

466

407

400 200

210 183 154 147 136 121 118

253 251

184

135 104

98

93

92

69

67

-

Top 10 FDI companies (2004-2008)

Top 10 FDI companies (2009-2018)

RS (Solid fill)

FBiH (Pattern fill)

Fig. 5.6 Top ten companies with foreign capital in BiH (before and after GFC). Source DEPBiH (2009), MFTER (The authors would like to thank MFTER staff for the provided data and their professional help) (2019), authors’ interpretation

companies had been largely concluded by 2009, while the privatization process is still ongoing in FBiH, especially in the telecommunication and energy sector. For these reasons, it is reasonable to assume that in the coming years, FBiH might expect a greater FDI inflow in this area.

5.5 Sectoral Composition of FDI in Bosnia & Herzegovina Figure 5.7 summarizes the structure of FDI stock by industrial sector for the period 1994–2018. As noted earlier in this chapter, BiH boasts a strong manufacturing tradition, especially in metals and military equipment. Accordingly, FDI since 1994 has been concentrated in manufacturing (32%), followed by financial and insurance activities (26%), information and communication (12%), and wholesale and retail trade (12%). These activities roughly mimic the productive activities of the domestic economy. ˇ The sectoral structure of FDI in BiH is explained in research by Cauševi´ c (2009), ˇ Sinanagi´c et al. (2013), Civi´c et al. (2017). Some of the main determinants include institutional, legal, and economic preconditions that favor certain sectors over others. Mari´c and Shukarov (2017), Muço et al. (2018), and Estrin and Uvali´c (2014) discover that institutional capacities and development guide FDI to WB countries. Besides the

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A. Peštek et al. Professional, scientific and technical activities 3% Other not elsewhere classified activities (A-U) 4%

Mining and quarrying 1% Other 4%

Real estate activities 4%

Electricity, gas, steam, air conditioning supply 4%

Accommodation and food service activities 1%

Manufacturing 28%

Wholesale, retail trade, repair of motor vehicles etc. 12%

Information and communication 13%

Financial and insurance activities 26%

Fig. 5.7 Structure of FDI stock status by sectors in the period 1994–2018. Source CBBH (2019), authors

financial sector, other industries that have been successful during this period include telecommunications, trade, tourism, and real estate. Moreover, according to Domazet (2016) and Holzner and Schwarzhappel (2018), sectors that offer the greatest growth potential over the coming years include energy, infrastructure, automotive, food, metal and wood-processing, tourism, and telecommunications. Similar results were obtained through two surveys of the foreign investors in BiH (Foreign Investors Council in BiH 2015, 2018) which also consider the aforementioned sectors as the ones with greatest growth and investment potential. These trends are upheld by the most recent data from 2018 (Table 5.5). The financial sector, manufacturing, and wholesale trade dominate the most recent round of FDI inflows. With regard to the FDI structure, equity accounts for the largest share of EUR 280.04 million, or 69.91% of the inflow in the year 2018. This is followed by retained earnings in the amount of EUR 195.82 million, while other capital amounted to an outflow of EUR 75.29 million. Compared to the previous year, there was an increase in equity of 56.24%, a slight decrease in retained earnings of 4.60%, while other capital had a significant negative amount (possible debt obligations) and resulted in a total FDI growth of only 0.36%. In terms of a structure of either greenfield or brownfield investments, Domazet (2016) has provided an overview of FDI in BiH in the non-financial and nonimmediate sectors, mainly the manufacturing sector (Table 5.6). The classification was made according to two criteria: the foreign investors’ motives and the type of FDI. Based upon Table 5.6, throughout the privatization process, MNEs were interested mainly in companies they considered promising as separate strategic units, and less

5 FDI in Bosnia & Herzegovina Table 5.5 Activities of largest registered new investments in 2018 (>EUR 10 million)

129

Activity Financial service

EUR million activitiesa

74.44

Manufacture of coke and refined petroleum products

69.43

Wholesale tradeb

44.82

Manufacture of basic metals (EUR 26.58 million)

26.58

Manufacture of motor vehicles, trailers and semi-trailers

19.96

Electricity, gas, steam and air conditioning supply

18.82

Real estate activities

17.09

Manufacture of chemicals and chemical products

16.79

Manufacture of beverages

15.69

a Excludes

insurance and pension funds and motorcycles Source CBBH (2019), authors

b Excludes

motor vehicles

interested in integrated companies that functioned as conglomerates with unprofitable units (Domazet 2016). Brownfield investments mainly represent acquisitions of existing facilities made available through the privatization process. We assume that the determinants of location of greenfield investments in BiH are primarily the result of rich natural resources of local community within BiH and secondly, the ability of local community to attract FDI to its business zone. We assume both conclusions since they require an in-depth analysis that surpasses the objectives of this chapter. BiH has attracted most of its FDIs through push factors through the privatization process, but the elimination of obstacles of FDI inflows is linked to the activation of pull factors arising from the quality of the business environment offered to potential investors (Domazet et al. 2008). The increased number of investors from the East (rising markets) in transition countries affects the FDI recipients in terms that they develop specific models of competitive advantage and are better able to meet the needs of FDI recipient countries, predominantly applying a model of market-oriented FDIs (Andrés et al. 2012).

5.6 Location of FDI in Bosnia & Herzegovina According to Dunning’s O-L-I theory (1980, 1991), location advantages vary depending on the motives causing the MNE to go abroad. The four categories include market seeking, resource seeking, efficiency seeking, and strategic-resource seeking

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Table 5.6 Type of FDI and motives of foreign investors Type of FDI Greenfield

Brownfield

Motives of foreign investors Market-seeking FDI ˇ Ledo Citluk, Grudska Pivovara, Globtour Medugorje, Vino Domanovi´ci ˇ Capljina, MI Inmer Gradaˇcac, Centar za srce Tuzla, Organika Sarajevo, Mlijekoprodukt Koz. Dubica, Dallas Sarajevo, Telemach Sarajevo, Messer Mostar Plin, ALFE-MI Živinice, Austrotherm BH Biha´c, Mlijeˇcni put Gradaˇcac, CIBOS Sarajevo, KIT BH Telekomunikacije, Anex Telekomunikacije BL, Perutnina Breza, Alba Zenica

Resource-seeking FDI

FC Kakanj, FC Lukavac, Bimal Brˇcko, Vitaminka BL, Sarajevski kiseljak, Jelšingrad FMD Prnjavor, Tvornica opeke Sarajevo, Banjoluˇcka pivara BL, Meggle Biha´c, RAOP IS, Arcelor Mittal Prijedor, Messer Sarajevo Plin, Xella BH (Ex Siporex) Tuzla

Rafinerija nafte Brod, Rafinerija ulja Modriˇca, Olip- Bosna Travnik, Kabine Krupa, Prevent Sarajevo, Unico filter Jelah, TMD Gradaˇcac, SHP-Celex ˇ BL, CIMOS Prijedor, Jelšingrad LC Casting Zenica, Arcelor Mittal Zenica, Natron-Hayat Maglaj, GIKIL Lukavac, SISECAM Soda Lukavac

Acquisitions Coca-Cola BH, HT Mostar, EP Sarajevo, Telekomunikacije RS, Rudnik kreˇcnjaka Vijenac, Lukavac; Gazprom petrol stations

Studen Agrana Brˇcko, RS Silikon Mrkonji´cgrad, Bekto Preciza Goražde, EFT Rudnik i TE Stanari, FE-AL Mostar, Devi´c tekstil Tesli´c, Presal Extrusion Š. Brijeg, Alloy Wheels Jajce, Argeta Sarajevo, Strolit Odžak, Bema BL, Hemofarm BL, Swisslion Trebinje, Dubicotton Koz. Dubica (predionica), Sportek Kotor Varoš, Al Jazeera, CIMOS TMD Casting Zenica, Henkel Ceresit Bile´ca; Napco Beds Factory Petrovo, Mreža Network Derventa

VW Sarajevo, Unic Valjˇci´ci Konjic, Kapis TG; Kraš Mira ad Prijedor

Source Domazet (2016), 137

firms. Table 5.6 provides a summary of two fundamental types of MNEs who invest in BiH, categorized by their motives: market and resource seeking.10 Boti´c (2013) examines the pre-crisis period until 2008, considering the projects of more than BAM 1.0 million (approx. 0.5 mil EUR11 ), which was analyzed in order to understand why firms from neighboring countries invest in BiH. Another reason for examining the location advantages over the most recent ten years relates to the fact that there has been methodological change in the records of FDI in BiH greater than BAM 1.0 million (MFTER 2019). As of 2009, MFTER records are based on FDI valued at more than 1 mil BAM that have been recorded in official court records in BiH. The possible limitation of such data is the inability to determine if a given company that is registered with the court is operational or not. Additionally, in order to overcome this issue, future research needs to include the analysis of financial data from business registers in both FBiH and RS.

10 The

remaining two—efficiency and strategic FDI are not analyzed in detail. exchange rate 1 EUR = 1.95583 BAM, so the amount is 511,292 EUR.

11 Fixed

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Fig. 5.8 Location of FDI in BiH, 2009–2018. Sources MFTER (2019), authors’ interpretation

Figure 5.8 depicts the location of FDI valued at more than BAM 1.0 million. The data were collected over the period 2009–2018 and are shown as a share of FDI received in local communities relative to total FDI. These data are aggregated at the county or region level and depicted in only a single local community. These communities represent the center of a county in FBiH or a regional center in RS, depending on the location. As indicated earlier in Fig. 5.1, FBiH is administratively organized as ten cantons. The spatial plan of RS through 2025 identifies five regions and five regional centers. Figure 5.8 indicates that traditionally, entity and county centers attract the greatest levels of FDI. Consider Sarajevo and Banja Luka, which hosted over 50% of all major FDI projects in BiH between 2009 and 2018. The Bijeljina-Zvornik region in RS attracted the second-largest inflow of FDI, mainly in the manufacturing sector. Following O-L-I framework, we further investigated two important points: the reasons behind FDI inflows to BiH in comparison with other WB or CEE countries and specific locations of FDI within BiH. The reasons include both, initial investments, and reinvestments. The results of two rounds of Business Barometer

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surveys conducted in 2014 and 2017 by the Foreign Investors Council in BiH (Foreign Investors Council in BiH 2015, 2018) provide interesting insights and answers. In 2015, foreign investors in BiH stated the following four main reasons for investing in BiH (by percentage of responses): potential of the domestic market (21%), the geographic and strategic position of BiH (16%), existing resources and logistics in BiH (13%), and access to raw materials and other inputs (10%). The previous experience of investors in a particular industry, i.e., the existing tradition in a particular sector, and cheap workforce were factors that account for 8% of the reasons for investing in BiH. Overall, the foreign investors agree that the proximity to EU markets, educated and skilled workforce, as well as low costs of labor were among the top reasons for investing and reinvesting in BiH (Foreign Investors Council in BiH 2015). Similar results were obtained in the 2018 survey. Even though the 2018 survey shows some methodological changes compared to 2015 survey, we managed to compare the results of the two surveys given to the same statements. As the reasons in 2018 stayed the same as in 2015 survey (BiH’s geographic and strategic position, the domestic market potentials, the available resources and logistics, and the experience and tradition BiH have certain industries, cheap workforce and easy access to raw materials and other inputs), the difference can be only be seen in the ranking of the reasons.12 Overall conclusions related to proximity to EU markets, qualified and professional workforce, low labor cost and low tax rates, and adequate local support services were among the top reasons for investing and reinvesting in BiH (Foreign Investors Council in BiH 2018). Table 5.7 illustrates the structure of cumulative FDI by sectors, summarizing projects greater than BAM 1 million, comparing the values before and after GFC according to NACE Rev. 2 economic activities. According to CBBH data reported in Table 5.7, the relative percentages of FDI in both manufacturing and information & communication fell following the GFC, concurrent with growth in other sectors. Namely, these include electricity, gas, steam, and air conditioning supply, as well as wholesale, retail trade, and repair of motor vehicles, in addition to finance, insurance, and real estate (FIRE). It is important to remember that the pre-GFC period includes only five years, whereas post-GFC spans a ten-year period. It is necessary to bear in mind some limitations of the post-GFC data. Since 2008, companies can be registered as limited liability companies with the FBiH legally set minimum capital of approx. EUR 511. In RS, the legally set minimum capital for limited liability companies is EUR 0.5. Hence, the first limitation relates to the inclusion of only those companies with investments greater than EUR 0.5 million EUR. All companies registered in BiH regardless of the amount of capital invested can be registered for more than one economic activity. The statistical office requires 12 Please

note that the 2018 survey did not provide percentage points per answer, but rather the overall score per statement (e.g., BiH geographic and strategic position received the mean weighted value of all responses for the given category of 5.9 on a scale of one to seven, seven being the highest value and top priority, Foreign Investors Council in BiH 2018).

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Table 5.7 Structure of FDI stock status by sectors (before and after GFC) Economic activities Agriculture, forestry, and fishing Mining and quarrying Manufacturing Electricity, gas, steam, air conditioning supply

2004–2008 (%) 0.17

2009–2018 (%) 0.00

0.77

2.68

32.11

24.94

0.48

4.73

Construction

0.44

0.00

Wholesale, retail trade, repair of motor vehicles, etc.

9.35

20.52

Accommodation and food service activities

1.61

1.34

Transportation and storage

0.70

0.00

Information and communication

29.98

3.91

Financial and insurance activities

18.32

30.80

Real estate activities

2.24

9.10

Professional, scientific and technical activities

0.00

3.83

Others

3.84

3.54

Source CBBH (2019), authors

that, prior to registration, companies state their primary economic activity but does not prevent them from listing several additional economic activities. Hence, in order to provide an in-depth analysis of the FDI inflow to BiH, it would be necessary to examine the financial reports of companies over time to determine whether their primary registered economic activity corresponds to their revenue structure over time. Another limitation relates to the fact that since much of the population of BiH lives abroad, some projects initiated by BiH’s diaspora investments might be recorded as FDI. In the last two years, there have been several projects supported by the international community in BiH that try to ‘catch’ the effects that diaspora investments have on BiH economy (other than traditional remittances).

5.7 Prospects for FDI in Bosnia & Herzegovina According to the World Investment Report, total global FDI at the end of 2018 stood at USD 1.3 trillion, a decline of 13% compared to 2017 (UNCTAD 2019). This organization projects the global FDI to increase to USD 1.5 trillion, up 10%, over the next years. However, these projections will most certainly be affected by the global outbreak of COVID-19 virus in 2020 and might result in a decline in global FDI. FDI to transition economies in general continues to increase (UNCTAD 2017). These countries are composed of two groups: The Commonwealth of Independent States (CIS) and SEE (Albania, BiH, Montenegro, North Macedonia, and Serbia). Optimistic forecasts for FDI inflows to BiH in 2019 were based on expected investments in major energy and infrastructure projects, as well as the planned remaining privatization process of companies in BiH. This was primarily related to two major sectors: telecommunications (two publicly-owned telecom operators) and energy.

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However, the dynamics of privatization depends heavily on the political will and the resolution of current and ongoing political deadlock faced by the leaders of BiH. As noted earlier, preliminary reporting of FDI data for the year of 2019 showed an upward trend even though the entire year thus far has been marked by political deadlock that began in October 2018 with general elections in BiH. This observation is a positive sign that FDI can occur even in the absence of an ideal political environment. Based upon the most recent 15 years of FDI inflows, it is noteworthy to observe that privatization and FDI began at different times in the two administrative entities of BiH. In the first period (until GFC 2008), FBiH recorded significantly higher FDI inflows than RS. Since 2009, the reverse is true, with RS attracting more. In terms of FDI country of origin, a decline in participation by European MNEs can be observed, for example, from France and the Netherlands. At the same time, increased capital inflow has occurred from the east, for example from Russia and Turkey. It is reasonable to expect that in the years to come worldwide FDI inflow and hence FDI inflow into BiH would be heavily influenced by political and economic dynamics in the EU countries (e.g., the effects of most recent Brexit still remain unclear for other EU members) or a rise of nationalism in Europe and worldwide. All these factors will most certainly affect BiH economy and FDI inflow into BiH economy. BiH must put additional effort in political stabilization of the country together with significant improvements in institutional, economic and fiscal factors. Along those lines, what could be a potential BiH safety net in the turbulent and uncertain times ahead are BiH citizens that emigrated from BiH but still have strong ties to its homeland and have already proven to be a significant factor in terms of FDI inflow in WB countries (Koleša 2019). In addition, since BiH financial market is currently bank oriented, BiH should put more efforts into building stronger and more stable financial sector, which could be a precondition for stronger FDI investments in BiH. In terms of the increase of the number of new potential investors in BiH from the East, literature suggests that such scenarios are happening and are expected to occur in the future. Hence, switches in the dominance of the country of origin in WB and SEE countries are to be expected in the coming years. Most recently, Holzner and Schwarzhappel (2018) and Richet (2019) analyzed the volume of Chinese FDI into Western European and SEE countries and WB countries. The conclusions of the paper are very interesting and relevant for the possible forecasts of FDI inflows in BiH in the years to come. Chinese capital found its way into the CEE and WB countries but to a lesser extent than in mature Western European countries (since the total volume of FDI in SEE countries is lower than in Western European countries). Richet (2019) also concludes that the presence of Chinese capital is WB countries is less direct than in Western European countries due to smaller markets. However, Chinese companies are building WB infrastructure, railways, invest in energy projects. This is very true in the case of BiH, where Chinese companies have already taken part in the projects related to energy sector. These include Stanari thermal power plant as well as the planned construction of a new thermal block in Tuzla thermal power plant. Chinese infrastructure projects include construction of section of motorway through BiH. It is important to note that most of these investments are financed through government loans rather than Chinese FDI into BiH.

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As in previous years, the likelihood of global FDI growth beyond 2020 is tempered by a series of factors such as geopolitical risks, trade tensions, a general shift toward more protectionist policies and most recently the outbreak of COVID-19 virus across the world. As BiH exports depend heavily on fluctuations in the EU’s economy, an expected slowdown in the EU economies such as Slovenia, Austria, Germany, or Italy will affect BiH’s economy through exports and FDI. Since we are currently facing times of great uncertainty, it remains very difficult to predict the FDI movements across the world and hence FDI inflow to BiH as a small transition economy. The FDI inflow to BiH will most certainly decline similar to other WB countries (The World Bank 2020) which will put additional pressure on current account deficits. Most recently, the international community in BiH (The World Bank 2020) predicts a slowdown of the world’s economy in 2020 due to the COVID-19 and therefore negative GDP figures for 2020 (for BiH, GDP is expected to fall by −3.2% in 2020). The process of recovery is expected to last at least two years (based upon the results and predictions from the last GFC of 2008), or even longer. Therefore, it is reasonable to expect a fall in FDI inflows to BiH at least in 2020 or even by 2022. However, BiH should, following Domazet (2016), use the current situation to put forth a clear strategy to enhance the country’s attractiveness toward FDI inflows, protect existing FDI and domestic capital in BiH, and adopt a strategy favoring the accumulation and protection of domestic capital in the future.

List of Abbreviations BiH CBBH CEE CIS EU FBiH FDI FIPA GCI GDP GFC HHI MFTER MNE OLI RS SEE SFRY SMEs UK

Bosnia & Herzegovina Central Bank of Bosnia & Herzegovina Central and Eastern Europe Commonwealth of Independent States European Union Federation of Bosnia and Herzegovina Foreign Direct Investment Foreign Investment Promotion Agency Global Competitiveness Index Gross Domestic Product Global Financial Crisis Herfindahl–Hirschman Index Ministry of Economic Trade and Foreign Relations of BiH Multinational Enterprise Origins-Location-Internalization Republika Srpska Southeastern Europe Socialist Federal Republic of Yugoslavia Small and Medium-Sized Enterprises United Kingdom

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US WB WIIW

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United States Western Balkans Vienna Institute for International Economic Studies

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Mari´c Z (2009) The FDIs entrance and its impact into countries in transition (Case of Bosnia and Herzegovina). In: 5th interdisciplinary management research meeting, Josip Juraj Strossmayer University of Osijek, Faculty of Economics, Umag, 08–10 May 2009 Mari´c Z, Shukarov M (2017) The role of institutions in attracting FDIs. In: Conference on economies of Balkan and Eastern Europe countries in the changed world (EBEEC), KnE Social Sciences, Split, 06–08 May 2016 Mehic E, Silajdzic S, Babic-Hodovic V (2013) The impact of FDI on economic growth: some evidence from Southeast Europe. Emerg Mark Finan Trade 49(sup1):5–20 MFTER (2019) Ministry of Foreign Trade and Economic Relations of BiH. FDI in BiH over 1 million BAM over 2009–2018 period (database) Muço K, Valentini E, Lucarelli S (2018) The impact of FDI on the productivity of the Balkan countries. J Trans Stud Rev 25(2):37–54 Nikoli´c G (2011) Convergence of the export structure of Romania, Croatia, Serbia and BosniaHerzegovina to the structure of import demand in developed countries. Panoeconomicus 58(3):393–406 OECD (1989/1990) Yugoslavia. OECD Economic surveys, Paris Onaran Ö (2011) From transition crisis to the global crisis: Twenty years of capitalism and labour in the Central and Eastern EU new member states. Capital & Class 35(2):213–231 Pejakovi´c G (2012) Analiza priliva direktnih stranih investicija u Bosni i Hercegovini. Zbornik radova Ekonomskog fakulteta u Istoˇcnom Sarajevu 6:339–350 Pupovi´c E (2015) Corruption’s effect on FDI: the case of Bosnia and Herzegovina. In: KhosrowPour M (ed) Banking, finance, and accounting: concepts, methodologies, tools, and applications. IGI Global, Hershey, pp 850–865 Reiff M, Tokar V (2016) Post-communist financial and economic development: cluster analysis of selected countries. Ekonomiqni qacopic-XXI 161:12–17 Richet X (2019) Geographical and strategic factors in Chinese FDI in Europe. Asian Econ Papers 18(2):102–119 Rodrik D (2002) After neoliberalism, what? In: Remarks at the BNDES seminar on New Paths of Development, Rio de Janeiro, 12–13 September 2002 Rovˇcanin A, Halilbaši´c M, Tati´c K (2007) The role of FDI in raising national competitiveness (extended abstract). In: 4th international conference on global challenges for competitiveness: business and government perspective location. University of Pula, Pula, 27–29 September 2007 Schwab K (2017) The global competitiveness report 2018. World Economic Forum ˇ c B, Kamari´c A (2013) Pokretaˇcki faktori i determinante stranog direktnog Sinanagi´c M, Civi´ investiranja u Bosni i Hercegovini. Tranzicija 15(31):107–124 Starˇcevi´c V, Subotic S (2015) Competitive advantages of the economy of Bosnia and Herzegovina as precondition for attracting FDIs. Strateg Manag 20(1):17–25 Stipanovi´c S, Skoko B (2007) FDI as a determinant of economic development in Bosnia & Herzegovina (extended abstract). In: 4th international conference on global challenges for competitiveness: business and government perspective location. University of Pula, Pula, 27–29 September 2007 Susic I, Stojanovic-Trivanovic M, Susic M (2017). FDIs and their impact on the economic development of Bosnia and Herzegovina. In: IOP conference series: materials science and engineering. IOP Publishing, Baia Mare, 10–11 November 2016 Tepavcevic S (2015) The motives of Russian state-owned companies for outward FDI and its impact on state-company cooperation: observations concerning the energy sector. Trans Corp 23(1):29–58 The Central Bank of Bosnia and Herzegovina (CBBH) (2019) https://statistics.cbbh.ba/Panorama/ novaview/SimpleLogin_bs_html.aspx. Accessed 4 Oct 2019 UNCTAD (2017) World Investment Report 2017: Investment and the Digital Economy, New York and Geneva UNCTAD (2019) World Investment Report 2019: Special Economic Zones, New York and Geneva

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Vilogorac E (1989) Uporedne prednosti i privreda Bosne i Hercegovine. Ekonomski institut Sarajevo, Sarajevo Web of Science (2019) Results from a literature search. WoS database World Bank (1997) Bosnia and Herzegovina—from recovery to sustainable growth (Country Study). Washington, DC World Bank (2016a) Doing business 2017: equal opportunity for all. Washington, DC World Bank (2016b) Migration and remittances Factbook 2016, 3rd edn. Washington, DC World Bank (2020) The economic and social impact of COVID-19. Western Balkans Regular Economic Report No. 17 (Spring 2020). https://documents.worldbank.org/curated/en/301261 588088338100/pdf/The-Economic-and-Social-Impact-of-COVID-19-Setting-the-Stage.pdf. Accessed 2 May 2020

Chapter 6

FDI in North Macedonia Rufi Osmani and Lorik Ahmeti

Abstract In 1991, North Macedonia became an independent state and began its political and economic transformation. The country has set forth the goal of European Union (EU) accession as a symbolic achievement marking the completion of its transition. Among the Copenhagen criteria that remain to be met is macroeconomic stability. Given its small market of just over two million and limited domestic savings opportunities, foreign direct investment (FDI) is viewed as a means to achieving economic growth. The first decade after the independence was marked by symbolic levels of FDI inflows, mainly due to the privatization process of state-owned enterprises. These came mostly in the form of mergers and acquisitions (M&As) in the services sector, by companies in a position to exploit their monopoly positions in the domestic market. During the second decade, the government drafted a new model for attracting greenfield FDI through Technological Industrial Development Zones (TIDZs). In TIDZs, foreign investors enjoy a range of tax holidays and other forms of financial concessions. This program is also intended to increase exports and stimulate reindustrialization. Despite these efforts, the level of FDI remains modest. After nearly two decades, a solution to the name dispute with Greece brings new optimism to North Macedonia regarding membership in Euro-Atlantic organizations and growth through accelerated attraction of FDI. Keywords FDI · North Macedonia · Former Yugoslavia · Balkans · Southeastern Europe

6.1 Introduction Since its independence in 1991, North Macedonia has encountered severe economic and political challenges. Like its neighboring countries during the transition, the R. Osmani · L. Ahmeti (B) Southeast European University, Tetovo, North Macedonia e-mail: [email protected] R. Osmani e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_6

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country inherited debt from the previous system and faced a high level of unemployment and inflation as well as other problems, as measured by macroeconomic indicators (Cvii´c and Sanfey 2010). In order to improve business opportunities for foreign investors and guarantee their rights, the North Macedonian government has passed more than 40 different laws (Kikerkova 2013). With the assistance of international institutions like the World Bank and International Monetary Fund (IMF), the government has implemented a range of economic policies toward achieving economic stabilization and growth, thus affecting a successful economic and political transition process. The main goals of the government in economic terms were achieving macroeconomic stabilization, which means low unemployment rates, low levels of inflation, and sustainable economic growth. Toward achieving these objectives, it was necessary to complete a successful privatization process and transform state-owned enterprises into private companies. Moreover, the process of privatization is among the Copenhagen economic criteria, which North Macedonia is required to meet as an aspiring candidate for European Union membership. During the period from 1993 to 1996, the government applied new laws to facilitate the process of transition. In 1993, it passed the Law on the Transformation of Enterprises with Social Capital.1 Three years later, the Law of Privatization of State Capital in Enterprises2 was passed. Because most privatized enterprises needed high levels of capital, they were financially impossible for domestic companies to afford; this situation led their purchase by foreign companies, which then injected capital into the country. FDI is among the drivers of economic growth and development, especially for small countries such as North Macedonia (Kikerkova 2013). Recognizing limited internal opportunities and resources for economic growth, policymakers have viewed the attraction of FDI as necessary. During the period 1996–2006, the level of FDI in North Macedonia has generally grown consistently, though not at a satisfactory level vis-à-vis some larger neighboring transition countries such as Serbia or Bulgaria. FDI to North Macedonia was negligible during the first years after independence. The country faced obstacles such as its name dispute with Greece, which later lead to an embargo with dire economic consequences for the country. Other reasons for low inflows of FDI include the political instability of the Balkan region due to the wars elsewhere in former Yugoslavia, which caused potential foreign investors to view the entire region as unsafe. In 2006, this situation led the right-wing government to compile a new strategy for attracting foreign investors. Accordingly, the Law of Free Economic Zones was passed, later to be renamed the Law of Technological Industrial Development Zones (TIDZs), with the intention of using the areas as incubators for the development of

1 The Law on the Transformation of Enterprises with Social Capital—“Official Gazette of Republic

Macedonia” nr. 38/93. Law of Privatization of State Capital in Enterprises—“Official Gazette of Republic of Macedonia” nr. 37/96.

2 The

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new technology and industries. To attract investors, the government formed institutions designated to promote the country as an ideal location for multinational enterprises (MNEs) through various advertisements and roadshows. According to the model of TIDZs, the company that invests in TIDZs benefits from a range of financial incentives. Specifically, fiscal enticements include exemptions from profit tax, personal income tax, property tax, and value-added tax (VAT), as well as subsidies for business parcels, grants for building business facilities, VAT exemptions, customs payment releases, and subsidies in the form of state aid up to 50% of the eligible investment costs. Despite this strategy’s benefits for foreign investors, the level of FDI inflows remains low one decade after its introduction. Moreover, the government’s model for promoting inward FDI is a subject of criticism by public opinion, and particularly by domestic business representatives. They argue that taxpayers bear the cost of the incentives, which in turn discriminate against local businesses to the benefit of foreign companies. Although the inflow of FDI is essential for sustaining economic growth and decreasing unemployment rates in small countries like North Macedonia, the government needs to find alternative ways to attract MNEs, rather than tax cuts and other concessions that can have negative implications toward local taxpayers and local businesses. The structure of this chapter is based upon Dunning’s (1980, 2009) eclectic approach, a three-part set of analytical tools that engage a broad range of theories to help understand FDI national origins, location choice, and degree of internalization. This “O-L-I” framework is useful for analyzing FDI decisions and can be helpful to MNEs when considering an FDI opportunity.

6.2 Existing Literature In recent years, issues surrounding FDI in North Macedonia have generated research opportunities in the academic sphere while sparking public debate. Most of the scholarly works analyze the impact of FDI on North Macedonia’s economic growth, focusing mainly upon its effects on exports and employment. Another target of research by local experts has been the correlation between the country’s ranking in the World Bank’s Doing Business Report (2019a) and the level of FDI. Specifically, North Macedonia’s business climate is ranked very highly compared to its former Yugoslav counterparts as well as the other Western Balkan countries. After the implementation of the strategy of TIDZs in the past decade, decision-makers and scholars have analyzed the costs and benefits of FDI in North Macedonia, as well the effects of fiscal and economic incentives toward foreign investors. The Center for Economic Analysis in North Macedonia (Garvalieva et al. 2016) measures the costs and benefits for the country caused by incentives presented to foreign companies that invested in TIDZs or industrial zones. The agency analyses the net economic benefits to any foreign investor within each zone. They also estimate opportunity costs of investment incentives to MNEs, examining the non-payment of profit and personal income taxes, as well as related implications for the budget

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of North Macedonia. Results show that the presence of foreign investors in TIDZs has led to more costs than benefits, with detrimental implications for the national budget (Garvalieva et al. 2016). Karajkov et al. (2016) also criticize North Macedonia’s use of costly policies to offer such generous aid, subsidies, and fiscal incentives to foreign investors. The authors acknowledge that leaders feel obliged to compete with other transition states as an investment destination, but they argue the meager returns on these policies are detrimental. Their conclusions corroborate the Garvalieva et al (2016) report’s findings that overly assertive investment policies exhaust public finances, reducing the fiscal capacity for the fulfillment of public services. The Association of Young Analysts and Researchers (AYAR 2016) analyzes the impact of government subsidies and concessions upon FDI in the context of economic growth. The authors focus upon foreign companies that have invested in TIDZs or industrial zones, estimating the benefits created at the national level and comparing the direct, indirect, and opportunity costs for the budget. Using data provided by state institutions such as the Central Register of North Macedonia, AYAR measures financial results of the foreign companies, the impact on the level of national exports, the number of employees and wage level in these companies, as well as the level of financial aid they have received from the government. The results show that FDI leads to high costs for the national budget. Although FDI helps ameliorate unemployment, the wages received by employees are generally insufficient. With the notable exception of British investor Johnson Matthey, a manufacturer of automobile emissions control equipment near Skopje, most investors contributed very little to local well-being. Moreover, many of them leave the country after their incentive packages expire, including the US company Visteon, which left after ten years. Following AYAR, Jovanovic (2017) analyzes FDI policy during the period 2007– 2015. The results show that the total costs for attracting FDI during these years approach EUR 160 million. The author examines firms that received fiscal incentives and other types of economic aid. He finds that an increase in the level of employment is evident until 2015, although the average salary at these foreign-owned companies is below the average national salary. The contribution of these companies toward GDP in 2015 was merely 2.1%, although it is increasing. In addition, Jovanovic examines working conditions and workers’ rights at these firms, concluding that employees are often exploited and lack basic workplace rights. Kikerkova (2012) attributes North Macedonia’s high scores in the World Bank’s Doing Business (DB) report to reforms introduced for easy entry by foreign firms, as well as guarantees for foreign investors’ rights. Over the past decade, the country has experienced further improvement of its business climate. However, the ratio of FDI inflow as a percentage of GDP remains insufficient and lags behind many other transition economies in Central and Eastern Europe (CEE). Osmani (2015a, b) later discovers a negative correlation between the DB ranking and the level of FDI inflows to Macedonia. Regardless of improvements achieved by the origin country, investors in North Macedonia highlight its high level of corruption, the poor quality of public administration, insufficient infrastructure, and the enormous political influence on the judicial system.

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A major deterrent for potential investors, especially export-oriented firms, is the lack of efficient road and railroad infrastructure to connect North Macedonia with its neighbors. There are also problems with the full implementation of the rule of law, as well as securing investors’ rights. Kikerkova (2013) finds that most European Commission reports on North Macedonia criticize the inefficiency of its courts and call for judicial reform and more effective deterrents to corruption. Scholars researching the costs and benefits of FDI have faced difficulties and obstacles due to the lack of transparency in state institutions (Osmani and Ahmeti 2017). Many state offices refuse to provide data on the value of state aid, subsidies, grants, and other incentives given to foreign investors. This failure to disclose such payments calls into question the fairness of FDI policy. Osmani and Ahmeti (2017) examine the incentives foreign investors receive in comparison to domestic businesses in North Macedonia. With the help of internal corporate data for companies submitted as financial reports, they find that foreign investors receive preference over domestic companies. The study shows that through the non-payment of profit and personal taxes, as well as construction grants, foreign companies in TIDZ Skopje 1 have received EUR 28 million in cost reduction benefits. Moreover, this figure represents only three of the many types of incentives. In sum, the authors demonstrate that North Macedonian incentives for FDI have created an unequal investment environment to the detriment of domestic investors that result in less domestic investment. Collectively, the FDI research reviewed above draws attention to North Macedonia’s low level of investment inflows despite many benefits offered to foreign investors, which in turn result in high costs for the country’s central budget. Despite attractive incentives, a consensus prevails that North Macedonia has thus far suffered from its limited market scope, poor infrastructure, and political instability both domestically and throughout the Balkans, as well as its inefficient judiciary system and the high level of corruption. In order for FDI to take place in the former Yugoslavia, properties needed to be privatized, or transferred from public ownership to private ownership. Privatization also represents one of the main requirements for fulfilling the Copenhagen economic criteria for EU accession, another goal of North Macedonia. The selling of formerly nationalized Yugoslav properties has been a complex and extended process that marked the start of the investment process by foreign companies. Unfortunately, throughout the first five years of the 1990s, FDI inflows were negligible throughout the region as the privatization process began to take place and the region experienced multiple wars of dissolution of the former Socialist Federal Republic of Yugoslavia (SFRY).

6.3 Temporal Dynamics of FDI in North Macedonia The National Bank of Republic of North Macedonia (NBRNM) first began reporting FDI data in 1998. At that time, the country faced a refugee crisis of Kosovars while

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conflict continued next door. This political instability in the region represents an additional obstacle for the country in attracting FDI after its independence from the SFRY. In fact, not only did conflict and the resulting destruction in former Yugoslavia dissuade investors from coming in, but in some cases, it led to the withdrawal of most existing FDI. In the early years of the transition process, the aftermath of war continued to impact every successor state of Yugoslavia even further by causing enduring uncertainty for foreign investors. Figure 6.1 shows the annual inflows of FDI to North Macedonia since 1997, with the linear average increase superimposed on the diagram. Three peaks are clear: in 2001, 2007, and 2018. During the first decade, the highest inflow was realized in 2001 when the Hungarian giant MATAV purchased half of the shares of the country’s telecommunication company Makedonski Telekomunikacii. In 2006, the national electricity supplier Elektrosponastvo Makedonija was privatized and its shares were purchased by the well-known Austrian energy supplier EVN group for EUR 202.5 million. In 2007, Telekom Austria Group entered the Macedonian market by acquiring mobile communications firm AEK for approximately EUR 10 million, as just one of the major projects that year. The effects of the global financial crisis (GFC) are reflected in the abrupt decline and anemic inflows during 2009 and 2010. The third major spike was achieved in 2018, when the name dispute with Greece was resolved, opening new opportunities for integration into Euro-Atlantic agreements. At the outset of the new millennium, North Macedonia began to stabilize its macroeconomic situation. As the privatization process moved forward, major MNEs such as Austria’s EVN took over in the energy sector and Magyar Telekom acquired the monopoly Makedonski Telecom to reach the domestic market. Since the country’s 700 624.5

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6 FDI in North Macedonia Fig. 6.2 Leading Cumulative Origins of FDI North Macedonia (percent of total). Source NBRNM and authors’ calculations

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4%

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independence in 2001, more than 5.42 billion EUR in cumulative foreign capital has been invested in North Macedonia (NBRNM 2019). This represents an average of EUR 217 million per year.

6.4 The Origins of FDI in North Macedonia North Macedonia’s cumulative investment stock through 2018 is dominated by European firms, as indicated by Fig. 6.2. Countries with firms contributing more than five percent of total investment stock include Austria, the United Kingdom (UK), Greece, the Netherlands, Slovenia, Germany, Turkey, and Hungary. All of these leading origins are located in continental Europe, and all but Turkey are EU members. This structure of origins is highly concentrated, as MNEs from the top five origins account for more than 68% of cumulative FDI. It is worthwhile to highlight FDI from each of these leading countries briefly in this section. Already in 2000, Austrian companies had invested around EUR 40 million in cumulative FDI. FDI from Austria grew slowly until 2006, when 90% of the shares of the corporate monopoly for the distribution and supply of electricity Elektrostopanstvo Makedonija were sold by the state to Austrian EVN Group. The total value of investment was EUR 202.5 million, but it was met by public dissatisfaction due to the high electricity prices charged by the foreign monopoly. Moreover, the firm failed to fulfill its obligation to reinvest more than EUR 96 million within three years after its initial venture according to the State Audit Office. (Ministry of Finance 2009). EVN defends itself, having invested more than EUR 200 million from 2006 to 2013, including 11 small hydropower plants that are revitalized and fully automated.3 According to financial reports for 2015, EVN Macedonia was ranked second 3 EVN

Official Website. The history of the company. https://evn.mk/Za-nas.aspx.

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in terms of revenues and fifth in terms of profitability at the national level. Austria Telekom Group also made a major investment in 2007, followed by subsequent reinvestments. Austrian companies have high also made major investments in insurance companies, as well as rebuilding and revitalizing several small hydropower plants. Indeed, Austria has retained primacy as the largest source of foreign capital in North Macedonia with an average of EUR 27 million being invested by its firms each year. Second to Austrian firms, investors from the United Kingdom have invested EUR 520 million. Most of this British investment has been recorded only in recent years. In 2009, total UK FDI amounted to merely EUR 80 million. At the firm level, Energy Financing Team Holding (EFT Macedonia) was the largest venture, operating mainly in CEE.4 EFT Macedonia is considered as one of the largest exporters of foreignowned companies in the country. Imperial Tobacco, another important British MNE, celebrated its 15th anniversary in Macedonia in 2017 with a new investment of EUR 23 million. British FDI in North Macedonia began to accelerate in 2010 with the British behemoth Johnson Matthey, the world-leading catalyst manufacturer for vehicle and stationary exhaust emission control. Johnson Matthey invested EUR 80 million to build a manufacturing plant in TIDZ Skopje 1. Two years later, they expanded their investment by building the second plant in the same TIDZ worth EUR 65 million.5 During its years of operation in the market, Johnson Matthey has achieved extraordinary financial results, helped by many financial incentives. In 2015, according to Kapital (2016a), Johnson Matthey was the most profitable company in North Macedonia with a net profit of EUR 91.2 million and the largest firm in terms of revenue, with revenue value of EUR 1.2 billion. It is notable that this investor has had a significant positive impact on North Macedonia’s balance of payments, with 28% of the country’s total exports in 2015. Enabling its profitability and positive economic impacts, Osmani and Ahmeti (2017) point out Johnson Matthey benefitted from more than EUR 23 million in tax relief. An additional notable increase in British FDI occurred in 2016 when JV Hystead paid EUR 92 million to Balfin Group of the Netherlands for shares in Skopje City Mall.6 Ranked third with 13% of the cumulative total, Greek investors have also been very active in North Macedonia, despite the political conflict surrounding the country’s two-decade name dispute. Greek investments are distributed across nearly all sectors of the economy. In 2000, the National Bank of Greek purchased 93.4% of the newly privatized Stopanska Banka Skopje, the country’s oldest bank. In 2015, this bank was the most profitable financial institution in the country with net profits of EUR 36.4 million. In addition, the biggest oil refinery OKTA was sold to the Greek Hellenic Petroleum, attracting public attention following a secretive sale process and allegations of corruption (Transparency International Macedonia 2007). Other important Greek investments include a joint venture by Coca Cola Hellenic and Heineken, 4 EFT Group, Official Website. History of the company in North Macedonia. https://www.eft-group. net/makedonija/. 5 Directorate for TIDZ, Official Website, Tenants: Johnson Matthey. https://fez.gov.mk/mgt_clients. 6 Europe Real Estate "JV Hysted buys Skopje City Mall for EUR 92 million (2016). http://europere.com/jv-hystead-limited-buys-skopje-city-mall-for-92m-mk.

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which in 2012 purchased shares of the beverage company Pivara Skopje. In addition, less valuable but notable Greek investments in North Macedonia include Titan Group (cement and building materials), and the supermarket chain Vero. The Netherlands ranks fourth as an origin of FDI in North Macedonia, with 12% of total cumulative value. In fact, Dutch firms led as a source of FDI until 2016, when EUR 536 million was withdrawn. Dutch Heineken’s joint venture with Coca Cola Hellenic, mentioned earlier, is one of the major foreign projects in North Macedonia. Another sizeable project is Beny Steinzmetz Group’s investment in Feni Industri, the largest ferro-nickel producer in the country. Rounding out the top five origins of FDI is Slovenia, the only major source among the successor states of Yugoslavia. The two major players are Telekom Slovenia, which purchased 45% of the shares in the One&VIP telephone operator (the rest belonging to Telekom Austria), and Nova Ljublanska Banka, the main financial interest in NLB Banka AD Skopje. The latter represents one of North Macedonia’s largest banks, as well as one of the most longstanding major FDI projects in the country. To summarize the other origins of FDI in Fig. 6.2, German companies (collectively representing sixth rank) have shown particular interest in the TIDZs, and it is notable that Germany is North Macedonia’s top export recipient. Accordingly, German firms Dräxelmaier and Kromerg & Schubert have major investments in the automobile industry and made a positive impact on North Macedonia’s employment and export statistics alike. Other significant origins of foreign firms in North Macedonia since independence include Turkey, Hungary, Cyprus, and Bulgaria. From these countries, the Hungarian MNE Matav is particularly noteworthy, as it purchased 51% of the country’s telecommunications monopoly Makedonski Telekomunikacii for EUR 300.5 million in 2001. It is also worth mentioning that MNEs from the USA and Russia are relatively less prominent in North Macedonia, although they have been very active elsewhere in the Balkans. The promotion of TIDZs at roadshows in the USA resulted in some interest in the TIDZs, led by Johnson Controls, the largest US investor in the country. Johnson Controls invested in factories to produce circuit boards (2007), car seats (2011), and seat covers (2017) for automobiles. These projects were valued at EUR 30 million, EUR 20 million, and EUR 20 million, respectively.7 Other US investments located in TIDZs include Lear Corporation, Delphi, Joyson Safety Systems, Gentherm, ARC Automotive, and Kemet. Most of this FDI is greenfield, focused on the automobile industry, and is export oriented. Sasa, an extractor of zinc and tin, is considered the most successful Russian investment in North Macedonia. During 2006, long-dormant ore production resumed with this purchase by the firm Solvej. In 2015, Sasa was ranked as the second most profitable company in the country with a net income of EUR 37.6 million (Kapital 2016a). At the same time, the mine has been identified as one of the five largest lead and zinc mines in Europe and as one of the largest net exporters to the EU (Sitel

7 https://fez.gov.mk/mgt_clients_reviews/johnson-controls/.

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2016). Sasa’s Russian parent Solvej is also the owner of the Bucim mine, which produces cuprum. Based on the data for the past twenty years, in North Macedonia, the biggest investors are the giant companies of the developed countries of Western Europe and members of the European Union. Because of the erratic nature of annual inflows (Fig. 6.1), and the magnitude of occasional transactions from a few national actors (Fig. 6.2), it is difficult to summarize the trends of firms from each origin, let alone project them into the future. It is, however, possible to identify some key explanations for the FDI. These include privatized firms’ monopoly positions in the market, as exemplified by the purchase of EVN, Pivara Skopje, and Makedonski Telekom. In addition, FDI has been encouraged substantively by North Macedonia’s inexpensive labor force and many incentives provided by the government, as illustrated by the many cases of operations that have been established in TIDZs. Moreover, geographic proximity and knowledge of the regional market may explain the volume of Greek investments in North Macedonia, despite the political skirmishes between the countries. Similarly, Bulgarian and Albanian firms enjoy both geographic and linguistic advantages for operating in the country. Bulgarian firms have doubled values of FDI since that country’s EU accession in 2013, and Albanian FDI totaled EUR 40 million by 2016. Furthermore, cultural and historical linkages throughout the region have likely contributed to a large number of Turkish investments.

6.5 Mode of Entry and Composition of FDI in North Macedonia The National Bank of the Republic of North Macedonia (NBRNM) is the most authoritative institution for the publication of data on many aspects of FDI, including the mode of entry and composition. The mode of entry includes two possibilities: mergers and acquisitions (M&As) or greenfield investments. Based on the 19 years of data, except for 2001, M&As have prevailed over greenfield investments. This is due to the prevalence of the existing productive capacity that was privatized from state ownership and sold to foreign firms since the dissolution of Yugoslavia. Kikerkova (2012) finds that foreign firms have been especially interested in opportunities related to natural or state monopolies. As shown in Fig. 6.3, the prevalence of M&As is especially obvious during the first decade of FDI inflows considered in this chapter. By 2000, greenfield investments were modest, ranging from 20 to 34% of total FDI value. Most of the greenfield investments that occurred were made in the food processing and textile industries. Most of the investments in large firms were M&As, including the beverage firm Skopska Pivara and the refinery OKTA, purchased from the North Macedonian government. According to Kapital (2016b), investors frequently complained that the acquired operations suffered from inefficiencies. Although many of the acquisitions represented monopolies, in order to cut costs and

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increase profits, the investors often responded with layoffs. The mismanaged privatization process and lack of greenfield investments triggered unemployment growth during the first decade of transition. At its peak in 2005, unemployment reached 37.3%. These alarming numbers forced the new government in 2006 to change the national strategy for attracting foreign investors. As part of its strategy to attract more FDI, the government created the model of free economic zones, which were latter renamed to Technological Industrial Development Zones (TIDZs). Investing companies would benefit from a range of fiscal incentives and other economic benefits. One of the goals of the new program was the stimulation of greenfield investments, because of the greater employment benefits that this mode of entry generally offers for the host country. Benefits and tax holidays attracted some high-value investments such as Johnson Matthey, Johnson Controls, Van Hool, Lear Corporation, Key Safety Systems, and other investments. However, this strategy did not yield the intended results, as over the next 10 years, the proportion of greenfield investments became even lower and less in terms of value compared to M&As. The failure to attract greenfield projects can be blamed on North Macedonia’s limited market size, weak infrastructure, high level of corruption, and ineffective public administration. Moreover, its geographic location is viewed as being less favorable vis-à-vis that of many neighboring countries. In short, to avoid these obstacles, most of investors to the country prefer to buy domestic firms or merge with them, making use of their local knowledge and favorable market position to increase profits while the county’s benefits are symbolic at best. Figure 6.4 depicts the breakdown of FDI in North Macedonia by broad industrial category. More than one-third (35%) of cumulative FDI is concentrated in manufacturing, which first began to grow in 2000. The largest recorded FDI inflows in this

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A - Manufacturing A, € 1,686

E, € 338

B - Financial and insurance activities C - Wholesale, retail trade, repair of motor vehicles etc. D - Electricity, gas, steam, air conditioning supply E - Construction F - Information and communication

D, € 365

G - Mining and quarrying H - Real estate activities I - Administrative and support service activities J - Arts, entertainment and recreation K - Other C, € 666

B, € 925

Fig. 6.4 Cumulative FDI in North Macedonia by activity through 2018. Source NBRNM (2019)

sector were recorded in 2004, when more than the half of the year’s inflows took place in manufacturing. Given North Macedonia’s modest FDI position, even a single large investment can change the sectoral structure of FDI. The creation of TIDZs helped shift cumulative composition toward manufacturing, due to the types of incentives offered to companies that operate in them. Specifically, Johnson Matthey, Jonson Controls, and Dräxelmeier, Kromberg & Schubert produce automobile components, mainly to be exported German market. Although these exports help North Macedonai’s trade balance, most of the inputs for the products are imported from abroad. Therefore, benefits to the host economy beyond immediate employment are negligible. The second most important type of activity by investors is in the financial and insurance sector. By 2016, foreign companies have shown great interest in investing in banks and insurance companies. Three out of the four largest banks in North Macedonia are almost entirely owned by foreign banks. These include Stopanska Banka (Greece), NLB Banka (Slovenia), and Ohridska Banka (France). The insurance sector has been attractive to foreign investors, including the enormous Austrian firm Winner, which is part of Vienna Insurance Group. Wholesale and retail trade has also been an attractive sector for MNEs in North Macedonia. Of cumulative FDI value, 14% falls into this category, while seven percent of total FDI value has been invested in the sector of electricity, gas, steam, and air conditioning supplies. A large portion of this value is composed of the single largest investment made in North Macedonia thus far. Specifically, in 2008 Austrian EVN bought Macedonian ESM Makedonija. As indicated in Fig. 6.4, it is worth noting that the construction sector represents seven percent of cumulative FDI value.

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The aforementioned activities are alternatively classified as tradable and nontradable sectors. The tradable sector includes agriculture, fishing, manufacturing, and construction. The non-tradable sector includes mining and quarrying, electricity, gas, steam and air conditioning supplies, and other services. In a comparative analysis using data from 2003 to 2008, Bezovska (2014) identified a significant shift between these sectors. During this period, 34.2% of FDIs were invested in the tradable sectors, while 64.8% in the non-tradable sector. In contrast, during the period 2009–2013, the creation of TIDZs attracted more FDI in tradable sectors such as manufacturing, at the same time affecting the growth of exports. During this period, 50.6% of FDI was in tradable goods, while 49.4% was in the non-tradable sector. Another trend in recent FDI inflows to North Macedonia is a clear preference for joint ventures. The tendency to seek partnerships with the government was common during the privatization process of state-owned enterprises. However, there are also joint ventures between well-known foreign investors on the domestic market. A notable example is Pivara Skopje, a joint venture between Heineken (Netherlands) and Coca-Cola Hellenic Group (Greece). This partnership has been a profitable success story, with Pivara Skopje producing both beer and non-alcoholic drinks. Pivara Skopje benefits from each foreign partner’s core production competency as well as marketing skills and distribution channels, among other advantages. In contrast, Porsche Makedonija is an example of FDI operating as a wholly owned subsidiary (WOS). The company represents car brands Volkswagen, Audi, Skoda, SEAT, and Porsche. Having established its presence in the Macedonian market in 2005, this automobile importer is directly owned by German Volkswagen AG. As evidence of its success, Porsche Makedonija is the leader in the domestic automotive market. Consistent with Dunning’s taxonomy of (1980) corporate motivations to engage in FDI, the main objective for foreign companies in North Macedonia is profit maximization. Therefore, low wages and tax rates attract them by lowering production costs. As of 2015, nearly all (eight out of ten) of the most profitable companies in North Macedonia are under foreign ownership (Kapital 2016b). At the same time, the creation of TIDZs has led to an increase in employment in the localities where they have been established, many of which were targeted by policy to correct joblessness. However, foreign firms can be transient (Dicken 2015), and in the absence of long-term prospects at a given location, they often leave when incentives run out. For example, the US company Visteon, the very first company that invested in a TIDZ left North Macedonia ten years after it arrived, and shortly after the fiscal benefits expired. In addition, there have been examples of foreign firms investing in North Macedonia only for the purpose of money laundering. According to Transparency International Macedonia (TIM 2013), millions of dollars in FDI has arrived over the past decade with dubiously documented origins such as Cyprus, the Netherlands Antilles, the British Virgin Islands, and Saint Vincent and the Grenadines. Scholars argue that such transactions are not real FDI (Haberly and Wójcik 2014). This “FDI” often represents actions by opportunist tycoons and politicians from the host county who dispatch money collected illegally during the transition process to offshore company

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schemes, thus buying shares in overseas MNEs operating in their own home country, in this case North Macedonia.

6.6 Location Choices of Foreign Investors In line with Dunning’s (1980) original eclectic FDI framework and supported by his (2009) reiteration that scholars should include location as an important component of a robust understanding of FDI, this section examines North Macedonia’s geographic advantages at the national level, with reference to sub-national variation. Dunning’s framework posits that location decisions of MNEs are determined in part by the relative location advantages of countries for certain activities. Geographically small with a population of merely 2.1 million, North Macedonia requires full utilization of its location-specific advantages to compete with its neighbors. Situated in the middle of the Balkan Peninsula, the country has a favorable geographic position, as it represents a connecting bridge between the north and the south of peninsula, as well as between the east and the west of the Balkans. Despite its small territory, North Macedonia is rich in natural resources, one of its comparative advantages. The vast majority of FDI is spatially concentrated in the capital city of Skopje and smaller cities. Following categories set forth by Dunning (2009), most of the MNEs present can be thought of as market-seeking, efficiency-seeking, and strategic-asset seeking. However, as would be expected from observations of North Macedonia’s post-Yugoslavia neighbors, the motivations and locations vary by industry. For example, FDI in the service sector is highly clustered in larger cities, especially Skopje. North Macedonia’s capital of Skopje has 610,000 inhabitants, more than one-third of the country’s total. Skopje’s population is significantly larger due to the presence of thousands of students and workers from other parts of the country. The activities of service sector companies—especially those in high technology—lead to much higher wages compared to other regions of the country, affecting massive concentration of the labor force in Skopje. As shown in Fig. 6.5, half of all greenfield FDI in TIDZs or IZs is concentrated in the region of Skopje, mainly made by companies that apply sophisticated technologies. Most of these are associated with the manufacturing sector, making the Skopje region attractive to domestic manufacturing companies as well. It is clear from Fig. 6.5 that some companies are willing to pay a wage premium (average of EUR 628 in 2016) to maintain the presence near the capital city. In contrast, following Dunning’s (2009) typology, resource-seeking MNEs involved in natural resource extraction are dispersed in other areas in the country, mainly in the east along the border with Bulgaria. Examples of raw material mining and metal processing include Sasa and Bucim ores in the Eastern Region and Feni Industri in the Vardar Region. In line with its strategy for equal regional development, the government has been promoting these other regions far from Skopje for greenfield investments. MNEs that have large numbers of employees have invested mainly in such peripheral regions, where gross wages are the lowest. When MNEs are not

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Region Skopje Northeast Southeast Polog Pelagonia Southwest East Vardar National Level

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Average Gross Wage for 2016 in EUR

Foreign Active Companies in TIDZ or IZ

628 404 417 513 494 478 397 421 469

12 0 1 1 4 3 3 2 26

Population in 2012 609,140 175,442 173,187 317,003 232,959 220,840 178,814 153,659 2,061,044

Fig. 6.5 Gross wage, foreign active companies in TIDZ and IZ and population by region. Source State Statistical Office (2018), Directorate for TIDZ and authors calculations

constrained by the amenities of major cities, they instead seek to exploit cheap labor to reduce their costs. Examples of these investments are Adient or former Johnson Controls in the Eastern Region, Dräxelmeier in the Vardar Region, and Kromberg & Schubert in the Southwest Region. Despite a slight increase in wages compared to previous years, North Macedonia is ranked among Europe’s lowest-wage countries. As discussed earlier, this feature may make it more attractive to some investors, while simultaneously signaling the presence of a relatively weak market that is less attractive to what Dunning (1980, 2009) considers market-seeking firms. According to the State Statistical Office (2018), North Macedonia’s gross average wage was EUR 593 as of October 2018. The government’s agency Invest North Macedonia8 does its best to showcase the country’s educated, high-qualified, and ethical workforce. The quality of education continue to increase with obligatory primary and secondary education, including mandatory English language training from the first grade. However, the level of education quality remains low by European standards. Currently, there are only five public universities operating in North Macedonia, along with a considerable number of private universities. North Macedonia also presents several disadvantages as a potential FDI location. According to the Shanghai Ranking (2018), none of the Top 1000 universities globally are located in North Macedonia. By comparison, former Yugoslav cities of Belgrade, Zagreb, Ljubljana, and Maribor are all home to universities included in this ranking. The number of scientific papers published in international journals by North Macedonian universities is also low. Moreover, the quality of practical teaching at universities lags behind competitor countries, which makes it difficult for graduates to enter the labor market. According to Invest North Macedonia, the national investment agency, 45% of the population in North Macedonia is under the age of 30. The level of emigration from the coutry is alarming, especially among the population with higher education levels. Even more problematic is the fact that every third educated person wants to leave the country, according to the government research (Zinzirova and Vancov 2017). The authors argue that such documents tend 8 Official

website: https://www.investinmacedonia.com.

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to underestimate the problems, and further assert that the remaining younger generation lacks motivation. Finally, the government has been reluctant to invest in its own population. While the rate of total social contributions was 32.5% in 2008, ten years later it had been reduced to 27%. After North Macedonia’s separation from former Yugoslavia, rates of personal income tax changed several times. From 1994 to 2006, the government applied a progressive taxation system regarding personal income tax. During this period, changes have been observed in tax rates as well as the restrictive values. In 2007, the government replaced its progressive income tax system with a proportional income tax rate regardless of income. Since January 2019, a progressive taxation of personal income is again being applied.9 According to the law, income from work up to 90,000 MKD is taxed at 10%, while every additional value up to 90,001 MKD is taxed at 18%. However, because after one year the change in the tax system didn’t bring the intended result, in 2020 the proportional change was reversed. In line with EU standards, North Macedonia adopted a Law on Labor.10 This law provides increased flexibility of the labor market by offering and promoting flexible and different employment contracts and flexibility of working time. The employment rights and obligations as well their responsibilities are regulated by collective agreements. It is also worth mentioning The Law on Establishment of Employment Relations with Foreign Persons, which regulates the employment of non-resident persons in North Macedonia. According to this law, foreign persons can be employed in the country upon obtaining a work permit. The work permits are issued by The Employment Agency of North Macedonia upon the employer’s request. Good infrastructure implies lower costs for business development in a given country. The government agency Invest in North Macedonia promotes the country as a good location with excellent infrastructure. Situated centrally in Southeastern Europe, North Macedonia provides an ideal transit and distribution position for products intended to reach the European market. Considering the small geographic size of the country, the extensive road and railway infrastructure enable access to every portion of the country in less than three hours. The road network alone is 13,278 km in length, although most of these roads are in need of modernization and improvement. The backbone of the country’s highway network consists of the Pan-European Corridors V and VIII. Due to the lack of public finances and the high level of corruption, most of the major road projects have either been stalled or their construction has yet to commence. North Macedonia connects via Serbia and Greece through the “Friendship Highway.” At the time of writing, no highways connect the country with its remaining neighbors Albania, Kosovo, and Bulgaria. Kosovo recently launched the new highway that connects Kosovo with North Macedonia, while Albania began building the “Arber Road” to the border of North Macedonia. An EU member since

9 The

Law on Personal Income Tax-Official Gazette of Republic of Macedonia no. 241/2018. Relations Law—Official Gazette of Republic of Macedonia no. 80/93–2007.

10 Labor

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2007, Bulgaria has an excellent road network, and passing through the Macedonian border is straightforward at all border crossing points. North Macedonia has two international airports, in Skopje and Ohrid. The operator of the North Macedonian airport system since 2008 is the Turkish investor TAV which possesses a 20-year concession. These airports offer connections with several European hubs for low prices, especially following the initiation of the government’s cooperation with Hungary’s Wizz Air and Ireland’s Ryanair. Considering its landlocked position, North Macedonia uses ports in neighboring countries, enabled through roads and railway links. The closest port to the west is Durres, Albania, 150 km away from the border crossing at Struga, while to the south, the closest port is Thessaloniki, Greece, approximately 100 km away from the crossing at Gevgelija. The railway network is about 900 km of single-track standard gauge lines and is integrated with the railway systems of Greece and Serbia.11 North Macedonia also boasts an extensive network for the distribution and supply of electricity. The Austrian company EVN has run the electricity grid since 2006, and its contract has been extended by the North Macedonian government through 2024. The bid of 11.5% offered by this MNE was the main reason why it was selected. North Macedonia has a 98 km gas pipeline system, which connects to the Southern Gas Corridor. Further development of the gas pipeline network of North Macedonia is centered on constructing new facilities for electric power production, as well as this gas pipeline network’s upgrade. Figure 6.6 features the locations of the TIDZs, set forth by a set of specific and unique laws designed to entice MNEs. Dunning (1980, 2009) considers government incentives and taxes as powerful attractions for efficiency-seeking firms. At the time of writing, the general level of profit tax is 10% and is arguably unrealistic. As examined by Osmani and Xhila (2019), the actual tax rates prior to 2014 were lower. The authors believe that a shift to a progressive tax system would provide a more equitable burden, and at the same time, the economic performance of businesses would be affected less. Moreover, they recommend revising and harmonizing accounting and fiscal regulations by eliminating differential treatment of accounting profits and fiscal profits. Such harmonization can be achieved through the elimination of the taxation of most (26 types) operating expenses that are important for corporate business activity (Osmani and Xhila 2019). Following the 2005 decentralization of government, the responsibility of tax collection is shared with local authorities. Taxes vary dramatically by location and therefore represent an important sub-national consideration for MNEs. The customs rate applied to imports generally ranges from 5 to 20%, depending on the type of goods. Within TIDZs, companies are exempt from customs on equipment, machines, and spare parts. Excise taxes ranging from 5% to 62% are applied on luxury goods such as automobiles and cigarettes, depending on the item. MNEs operating within TIDZs are exempt from excise taxes. Apart from fiscal incentives, MNEs that invest in TIDZs benefit from other economic advantages, including a state grant of up to EUR 500,000 for construction. 11 Official

website of Invest in Macedonia: https://www.investinmacedonia.com

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Fig. 6.6 Locations of TIDZs in North Macedonia. Source Directorate for TIDZ (2020), Cartography by Joel I. Deichmann

In addition, the government finances up to 50% of expenses for training employees. Its agencies also subsidize foreign companies in TIDZs up to 50% of the gross wage expenses for the period of two years or cover 50% of the estimated investment costs for projects valued up to EUR 50 million. Another positive factor for attracting foreign investment in North Macedonia is the country’s very strong ranking of #10 in the World Bank’s (2019a) Doing Business Report. The Doing Business (DB) index features the following criteria: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency (World Bank 2019a). The country is ranked highly based on the following indicators: Dealing with construction permits, it is ranked at 13th position, getting credit ranked at 12th position, and protecting minority investors ranked at the 7th position. The index Ease of Doing Business (EDB) indicates the country has satisfactory results in the following indicators: starting a business with a score of 92.08/100, obtaining credit with 85/100, and trading across borders with 93.87/100. The country has further managed to significantly improve its business climate by making quality reforms in the function of reducing the procedures and costs of establishing a business (Jovanovic and

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Jovanovic 2018). Still the EDB Index and DB Report do not consider many of the main factors that attract FDIs. In spite of these strong scores, FDI to North Macedonia is constrained by the country’s small market, poor infrastructure, high levels of corruption, inefficient administration, politicized institutions, a non-independent judiciary system. Since its independence in 1991, (North) Macedonia has been characterized by a turbulent political environment. The political conflict with Greece regarding the name issue has had serious consequences. In the economic sphere until 1995, North Macedonia had trade difficulties with Greece including embargoes. In the political sphere, as a result of the Greek veto, the country remained outside of Euro-Atlantic integration initiatives, even though the country enjoyed EU candidate status since 2005. It would take 17 years to finally resolve the name issue with Greece, accomplished through the signature by both sides of the 2018 Prespa agreement. After the agreement, the constitutional name was changed and approved by the parliament. After solving this issue, the county became a NATO member on 27 March 2020, while a major obstacle remains initiating EU membership negotiations, delayed by the need for major reforms prior to EU membership. It is worth pointing out that North Macedonia has faced very difficult political situations after its independence. In 2001, there was an internal armed conflict between the two largest ethnic groups, Macedonians and Albanians, causing negative economic and social consequences. The conflict was resolved by the signing of the Ohrid Framework Agreement. Also, since 2001 the country has faced ethnic clashes between the two major ethnicities. Additional negative political factors include crises in numerous early parliamentary elections, causing high financial cost, uncertainty, and obstacles in implementing reforms. From 1990 to 2020, cabinet instability prevailed as ten parliamentary elections were held, of which five of them were premature.

6.7 Prospects for FDI in North Macedonia At the time of writing, the global economy faces financial fallout from COVID19 at a level that has not been seen since the GFC that began in 2007, and it may take even longer to recover from the present crisis. The true financial cost of this pandemic remains to be seen, but it is likely that global FDI flows will continue their recent decline, which was already evident prior to the 2020 spread of COVID-19 (UNCTAD 2019). Due to budgetary constraints, it can be expected that MNEs will be more reluctant to engage in new opportunities across borders, and the competition between host countries for evermore scarce FDI is likely to increase. As articulated in this chapter, leaders should proceed with caution and avoid selling themselves short as destinations for FDI projects that jeopardize the local economy, civilians, and the environment (UNCTAD 2020).

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Like other Western Balkan countries, North Macedonia has experienced a difficult period of economic and political transition. Still, one of North Macedonia’s advantages compared to some other portions of former Yugoslavia like Croatia, BiH, and Kosovo has been its non-involvement in external conflict during its separation from Yugoslavia. This relatively peaceful separation led to accelerated early development vis-à-vis the other former republics. Following Alfaro (2017), given the limited possibilities for domestic savings in this small country, FDI is considered a crucial source of capital that can affect economic growth. The first decade after independence from Yugoslavia was marked by modest levels of FDI. Most of the FDI at that time resulted from the privatization of state-owned enterprises in the services sector. Despite changes in the legal framework and the creation of special economic zones (TIDZs) during the beginning of the second decade, the level of FDI inflows continued to be modest. Prospects for FDI in North Macedonia depend most fundamentally on EU membership. Since North Macedonia’s independence, EU accession has been defined as the government’s highest strategic priority. Unfortunately, at the time of writing, North Macedonia has not yet been able to initiate accession negotiations with the EU. Solving the name dispute with Greece helped to overcome one of the major remaining obstacles for this to take place until October 2019, when French President Macron exercised his veto against accession negotiations by North Macedonia and Albania. The process of EU accession began in 2000 with negotiations about the EU’s Stabilization and Association Agreement (SAA) and as the first post-Yugoslav country to sign this agreement. The country submitted its application for EU membership in March 2004. During that year, the government adopted a National Strategy for European integration, and the start of negotiations was vetoed in several subsequent years by member states (notably Greece), despite recommendations by EU government bodies based upon the country having satisfied the political criteria12 The breakthrough was made in 2018 when the “Prespa Agreement” was signed by the government of North Macedonia and Greece, by which the constitutional name of the country was changed, and Greece withdrew its veto, overcoming the biggest obstacle blocking the Euro-Atlantic integration path. The delay in EU accession has had a significant impact on the low volume of FDI to North Macedonia so far. This fact is also reinforced by empirical research that examines the relationship between EU membership and FDI. Bruno (2016) estimates that EU membership has increased FDI inflows to the New Member States (NMS) of Europe by 28%. EU accession provides prospects for legal stability via adoption of the EU’s Acquis Communautaire and improved infrastructure through the strategic use the EU structural funds (Jirasavetakul and Rahman 2018). These authors have proved empirically a strong positive correlation between EU accession and FDI inflows, both leading up to and following accession. Currently, North Macedonia in on track to receive approximately EUR 1.3 billion of development aid through 2022 through the Instrument for Pre-Accession Assistance. EU membership would 12 IBNA (Independent Balkan News Agency), 2014. “European Parliament passes the Resolution on FYR Macedonia”. Independent Balkan News Agency. 6 February 2014. Retrieved 22 March 2014.

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provide many additional economic advantages, especially for infrastructure, which is crucial for the attraction of FDI. Even though North Macedonia is considered an open country with trade at 94% of GDP, it lags behind the EU new member state average of trade at 137% of GDP. EU integration will create new markets and lead to FDI in the WB economies as it has in the NMS countries (Besimi 2017), which offer an excellent model of how to attract FDI. However, the differences between CEE and SEE are noticeable in the length of the accession process, the size of the economies, and the quality of infrastructure between the two regions. First, most of NMSs were on a fast track to EU membership. The number of years taken to move from EU membership application to accession ranges from eight years (Czech Republic and Slovenia) to 12 years (Romania and Bulgaria) (Jirasavetakul and Rahman 2018). More than 15 years after its application, North Macedonia continues to wait for the initiation of negotiations with the EU. Leaders have grown frustrated because North Macedonia was the second country from former Yugoslavia (after Slovenia) that had ideal predispositions for the EU membership, and it was the first WB country to sign the SAA. Indeed, the isolation and often nationalistic policies by governments refusing to solve the name issue still bear negative consequences today with regard to EU integration and economic performance. These policies have also led the country to multiple conflicts between its two largest ethnicities. The consequences on FDI have been reflected though the present time as the level of FDI per capita in North Macedonia remains the lowest compared to all other former Yugoslav countries. Even though a large part of the country’s citizens is skeptical about EU integration, there is no doubt that for economic benefits (including those realized through FDI inflows), the only way forward is through the EU. Rapid EU accession in the coming years would have a positive impact on FDI growth, based upon the past experiences of other CEE countries, notably Croatia. Second, the geographical size of the CEE countries varies significantly. NMS countries like Poland, Hungary, and the Czech Republic are countries which have much larger populations than WB states. Their own large markets offer greater opportunities for market-seeking and labor-seeking MNEs. Not surprisingly, these countries have achieved a very high level of FDI per capita compared to WB countries. Unlike them, North Macedonia’s market of two million inhabitants is limited in scope and potential. This exogenous factor has a significant impact on FDI attraction. Third, the state of infrastructure in the WB region is much worse than it was in the NMS. Indeed, North Macedonia has inadequate road and railway infrastructure, with its old, deteriorated roads as well as numerous unscheduled and delayed projects. A big problem for potential foreign investors that are export-oriented is the lack of good motorways and railroad infrastructure that would connect the county with its neighboring countries and link them to Western markets. Related to the poor infrastructure quality, empirical studies find that well-developed infrastructure increases potential returns to investment and hence can attract FDI inflows (Ancharaz 2003; Demirhan and Masca 2008). EU membership would mean improvement of North Macedonia’s infrastructure through additional EU funding instruments. To attract higher levels of FDI, North

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Macedonia requires an independent judiciary system. North Macedonia is considered as only “moderately prepared” in terms of the EU’s judiciary and fundamental rights requirements. Crucial improvements must also be made in the following areas: Freedom of Movement for Workers, Environment, Financial and Budgetary Provisions. (EU Commission 2018). The Commission’s observations indicate that significant changes need to be done in some of the current government policies on how foreign investors are attracted. The model of TIDZs applied after 2006 by offering multiple financial and fiscal benefits has caused excessive real costs which, due to the lack of transparency of government institutions, are difficult to measure. The state has paid more than EUR 159 million to attract foreign companies that have invested in TIDZs, while the sum of salaries paid by MNEs is only EUR 92.1 million (Jovanovic 2017). The government spends a great deal of money on the attraction of FDI, yet MNEs are mainly motivated by the country’s inexpensive labor force. According to the Law on TIDZs, 100% of the final products of foreign companies in the zones should be exported, leading to economic growth. However, in 2015, only 36% of exports on came from companies within TIDZs, of which 90% of exports were produced by the single MNE Johnson Matthey (Osmani and Ahmeti 2017). It is reasonable to question whether such exports lead to economic growth. Cooperation between MNEs and domestic firms is rare. According to Tumanovska (2018), only 10% of the total liabilities of MNEs are toward domestic enterprises, while about 37% of domestic companies said that they cooperate or have cooperated with MNEs. Most of this cooperation takes place in the form of providing ancilliary services. According to Nova Makedonija (2018), approximately 61% of MNEs purchase services from domestic companies, while only 30% of them can find raw materials necessary for production within North Macedonia. Considering that all MNEs in TIDZs are involved in manufacturing rather than services, the cooperation of foreign companies with domestic ones is very low, implying that exports of foreign companies in TIDZs have only a minor impact on the growth of the host economy. The government should be more transparent about the financial aid received by MNEs in TIDZs, allowing cost–benefit analyses to ascertain whether this way of attracting FDI is worthwhile. The lack of employee skills remains a serious problem in the labor market. Since 2009, the Government of North Macedonia spent less than three percent of its GDP on education, averaging 2.1% since 2009, while each year prior to that, education averaged 4.3% (World Bank 2019b). In contrast, EU-15 countries spend approximately 5.5% of their GDP in education. The EU Progress Report for FYR of Macedonia in 2015 identifies large differences in the technological levels of domestic and foreign firms as an explanation for foreign companies being unable to source inputs from the domestic economy (European Commission 2013; Trajkovska and Petreski 2018). Despite the changes in government, the new left-oriented party has not resolved this issue. Among other things, government officials have warned that as a condition for obtaining financial aid, the foreign companies must cooperate with domestic companies. However, as noted above, many domestic companies do not have the right background, knowledge, and technological skills for cooperation with foreign companies, especially the ones in TIDZs that use sophisticated technologies.

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Even though the government offers subsidies for training for foreign companies operating within the zones at the expense of the state budget, it would be more effective to increase the spending within the sphere of education sphere and improve the quality of education. An increase in the quality of education is a prerequisite for North Macedonia to develop a more highly-skilled workforce. The final issue to be mentioned in which North Macedonia should make drastic changes is improving its political stability. According to the World Bank (2017), political stability is among the most important factors impacting FDI inflows. Based on the Global Investment Competitiveness Report, a survey that covered 754 MNEs spanning manufacturing and services sectors, it is reported that more than 80% of respondents consider political stability and legal environment as a “critically important” or “important” factor (World Bank 2017). For more than two decades, North Macedonia has had a turbulent political environment, with detrimental implications for the attraction of FDI. Moreover, additional problems are the politicization of institutions, the high level of corruption, and a widespread shadow economy. According to Osmani (2015a, b), during the period 2003–2012, the average level of the shadow (or gray) economy has been 30.6% of the entire economy, while the corruption perceptions index score was 43/100 (“more corrupt”) as recently as 2012 (TIM 2013). The 2018 resolution of the name dispute between North Macedonia and Greece will prevent further vetoes on EU and NATO membership on that basis and has the potential to increase interest among MNEs. The end of this disagreement has introduced a positive spirit of friendship with Greece. However, the resumption of EU membership negotiations has been postponed due to objections by France. This is an important obstacle for North Macedonia to overcome, as potential membership in the EU represents its greatest hope in the next decade to increase the level and quality of inward FDI. In 2018, FDI inflows stood at EUR 624 million, the highest total for any single year thus far. This fact supports assessments by political and economic experts that the elimination of political and security risk alongside promotion of an appropriate business environment and keeping taxes low are preconditions for accelerating FDI in the future. Nevertheless, challenges remain that will have an impact on FDI inflows. According to Osmani (2015a, b), in the case of SEE countries including North Macedonia, ineffective and selective implementation of tax laws and government regulations creates favorable preconditions for the shadow economy to flourish, and tax evasion is associated with high levels of institutional corruption. The quality fulfillment of Copenhagen criteria for EU integration is a precondition for successfully fighting the shadow economy, tax evasion, and corruption and enhancing North Macedonia’s environment for FDI.

List of Abbreviations AYAR CEA

Association of Young Analysts and Researchers Center for Economic Analysis for North Macedonia

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DB EDB EU FDI FYR GFC IMF M&A MKD MNE NBG NBRNM NLB NMS SAA SFRYSEE TIDZ TIM VAT WB WOS

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Doing Business Ease of Doing Business European Union Foreign Direct Investment Former Yugoslav Republic Global Financial Crisis International Monetary Fund Mergers & Acquisitions Macedonian Denar Multinational Enterprise National Bank of Greece National Bank of the Republic of North Macedonia Nova Ljublanska Banka New Member States Stabilization and Association Agreement Socialist Federal Republic of Yugoslavia Southeastern Europe Technological Industrial Development Zones Transparency International Macedonia Value-Added Tax Western Balkans Wholly Owned Subsidiary

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European Commission (2013) Key findings of the 2013 progress report on the former Yugoslav Republic of Macedonia, Brussels. https://europa.eu/rapid/press-release. Accessed 16 Oct 2013 European Commission (2018) The former Yugoslav Republic of Macedonia 2018 report. Strasbourg www.sobranie.mk/content/republic-of-macedonia-report. Accessed 20 Mar 2019 Garvalieva V, Nikolov M, Dimovska G Mitevski I (2016) Benefits and costs from foreign direct investments at Technological Industrial Development Zones, case-study: Macedonia for the period 2007–2014. The Centre for Economic Analysis, Skopje Haberly D, Wójcik D (2014) Tax havens and the production of offshore FDI: an empirical analysis. J Econ Geogr 15(1):75–101 Jirasevetakul L, Rahman, J (2018) Foreign direct investment in new member states of the EU and Western Balkans: taking stock and assessing prospects, IMF Paper Jovanovic B (2017) The real price of the cheap labor force: policies for attracting foreign investment in Macedonia 2007–2015. Institute of Social Sciences and Humanities Skopje, Policy Brief, Skopje Jovanovic B, Jovanovic B (2018) Ease of doing business and FDI in the ex-socialist countries. International economics and economic policy, vol 15(3). Springer, pp 587–627 Kapital (2016a) 50 most profitable companies in Macedonia. Accessed 21 Feb 2019 Kapital (2016b) Top 200 most profitable companies in Macedonia. Accessed 10 Jan 2019 Karajkov R, Despotovski L, Suncevska M (2016) Incentives for the FDI and the unequal treatment for domestic investors in Macedonia: causes and consequences. Institute for European Politics, Skopje Kikerkova I (2013) Empirical evidence on foreign direct investment impact upon the economic growth of the Republic of Macedonia. Dubrovnik International Economic Meeting. 2013, Dubrovnik Ministry of Finance (2009) Contractual obligations. https://www.finance.gov.mk/mk/node/1115. Accessed 29 Nov 2019 Nova Makedonija (2018) Only 37 percent of companies cooperate with foreign companies. https:// www.novamakedonija.com.mk/ekonomija. Accessed 14 July 2019 Osmani R (2015a) Improved business climate and FDI in the Western Balkans ICESS. Sarajevo, Bosnia and Herzegovina Osmani R (2015b) The level of shadow economy, tax evasion and corruption: the empirical evidence of SEE countries. De Gruyter, SEEU Review Volume, Tetovo Osmani R, Ahmeti L (2017) Fiscal and economic incentives for foreign investors at technological industrial development zones in Macedonia, empirical analysis of TIDZ Skopje 1’. In: ISCBE’17, Tetovo Osmani R, Xhila V (2019) The changes in profit tax policies has had a negative impact on the economic performance in the regions of Struga. In: ISCBE18, Tetovo Shanghai Ranking (2018) Academic Ranking of World Universities. https://www.shanghairanking. com/ARWU2018. Accessed 17 Jan 2019 Sitel (2016) Ten years after the restart of the mine “Sasa”. https://sitel.com.mk/deset-godini-od-res tartot-na-rudnikot-sasa. Accessed 19 Dec 2018 State Statistical Office of the Republic of Macedonia (2018) Average monthly net wage paid per employee, October 2018, Skopje TIM (Transparency International Macedonia) (2007) The case OKTA. https://www.transparentnostmk.org.mk/Upload/slucai/20070921_microsoft-word-slucaj-okta.pdf. Accessed 20 Dec 2018 TIM (Transparency International Macedonia) (2013) Buying influence: money and politics in the Republic of Macedonia Skopje Trajkovska I, Petreski B (2018) Bridging gaps and seizing potential: Domestic SMEs in the supply chain of multinational companies in the country. Finance Think Policy Studies. Skopje UNCTAD (2019) Global investment trends monitor. https://unctad.org/en/PublicationChapters/tds tat43_FS09_en.pdf. (United Nations Conference on Trade and Development). Accessed 7 Oct 2019

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UNCTAD (2020) Investment policy monitor: special issue- investment policy responses to the COVID-19 pandemic. https://unctad.org/en/pages/PulblicationsLibrary/diaepcbin2020d3_ en.pdf. Accessed 20 May 2020 World Bank (2017) Global investment competitiveness report. Foreign investor perspectives and policy implications. https://documents.worldbank.org/curated/en/169531510741671962/ pdf/121404-PUB-PUBLIC-PUBDATE-10-25-2017.pdf. Accessed 30 Nov 2019 World Bank (2019a) Doing business 2019, training for reform—economy profile. Macedonia, FYR. www.worldbank.org/content/dam/doingBusiness/media/Annual-Reports. Accessed 30 Mar 2019 World Bank (2019b). World Bank Open Data-North Macedonia. Education expenditure as a percentage of GDP. https://www.worldbank.org/en/country/northmacedonia. Accessed 30 Nov 2019 Zinzirova S, Vancov D (2017) Public policy paper how to reduce the youth emigration from the Republic of Macedonia. Originally published in Macedonian, Skopje

Chapter 7

FDI in Montenegro Danijela Ja´cimovi´c, Maja Ivanovi´c, and Sunˇcica Rogi´c

Abstract Like its Western Balkan neighbors following the destructive events of the 1990s, Montenegro has engaged in political, economic, and social rehabilitation. With the outset of the new millennium, worldwide expansionary monetary conditions fueled international liquidity, boosting asset markets and directing capital flows toward emerging markets, including those in the Balkans. Within this new favorable external environment, Montenegro opened up its economy, deepened its EU orientation, underwent large-scale privatization, and began creating a more attractive environment for foreign direct investment (FDI). The ensuing significant increase of capital inflows had positive effects on Montenegro’s economic and political environment. Driven by privatization, investments were mainly oriented toward the service sectors (banking, telecommunication, and real state) rather than primary and manufacturing sectors. The first effects of direct capital inflow have been positive, leading to high growth rates, low inflation, increased employment rates, and stability in Montenegro’s fiscal balance. In the wake of the financial crisis, inflows of FDI to Montenegro became significantly lower. Since its recovery, the country has experienced a new wave of investments from origin countries different than before. These have been characterized by various industrial structures and directed toward a previously underutilized set of locations. Keywords Foreign direct investment · Montenegro · Structure of investments · Location

D. Ja´cimovi´c (B) · S. Rogi´c Faculty of Economics, University of Montenegro, Podgorica, Montenegro e-mail: [email protected] S. Rogi´c e-mail: [email protected] M. Ivanovi´c Central Bank of Montenegro, Podgorica, Montenegro e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_7

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7.1 Introduction The Western Balkan (WB) countries set out on the process of transition later than most of Central and Eastern European (CEE) and continue to face more daunting challenges than other post-communist states. The breakup of Yugoslavia and associated challenges left a mark on these countries’ political, institutional, economic, and social environments. In this position, these countries have required urgent rehabilitation through the infusion of capital, and in the absence of domestic sources, they have sought it from abroad. The role of foreign direct investment (FDI) in the process of transformation elsewhere in CEE has been crucial, but Southeastern Europe (SEE) lags far behind in the volume of foreign capital. As they aspire toward European Union (EU) membership, many CEE countries, including Montenegro, require radical reforms. Domestic savings in the region are insufficient to finance the necessary changes, so foreign capital is particularly important. This is especially true in Montenegro, a small and relatively low-income country where cumulative FDI represents 99.6% of the country’s 2018 gross domestic product (GDP; WIIW 2019). Like most of former Yugoslavia, Montenegro experienced high political and economic instability during the 1990s. During that time, each of the successor states began the process of transition toward a market economy. The processes of globalization and liberalization with their related growth in international capital flows influenced the economic system of Montenegro. In accordance with widely accepted theory and practice, many countries liberalized their markets in terms of trade in goods and services, and through successive reforms. During the early 1990s, FDI in Montenegro was nearly non-existent, in part due to political issues and economic sanctions, and the informal economy emerged. Despite Montenegro’s isolation in the wake of regional conflict, its first sizeable foreign investment was registered in 1996 when Telenor and European Telecom Luxembourg established the greenfield venture Pro Monte. Džanki´c (2008) estimates that the total value of FDI at that time was only EUR 75 million. Another successful early project occurred in November 1997, when the Belgium Company Interbrew purchased Montenegro’s brewery Trebjesa. As the political climate began to change after Miloševi´c’s regime ended in 2000, foreign capital slowly began to flow in, thanks to conditions of high international liquidity. Governments competed for foreign capital, attempting to replicate the examples of successful FDI throughout the region, with the expectation of multinational enterprises (MNEs) for ever-higher profitability of their investments in Montenegro (Ja´cimovi´c 2012). The Montenegrin Investment Promotion Agency1 (MIPA) was founded in 2005. This agency plays a central role in promoting opportunities and specific projects of interest. Upon gaining its independence in 2006, Montenegro introduced significant privatization and other measures associated with increased flows of FDI. First, the euro was adopted as the country’s official currency. Next, Montenegro introduced a flat rate tax system and low (9.0%) corporate and personal income taxes, as well as 1 https://www.mipa.co.me/.

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the lowest value-added tax (VAT) in the region. In addition, Montenegro set low entry barriers to businesses and permits MNEs to remit their profits, dividends, and interest earnings without restriction. To further increase its attractiveness, Montenegro also created a liberal legal framework for foreign investors. According to Montenegro’s Foreign Investment Law of 2002, foreign investors in Montenegro are guaranteed identical legal treatment to domestic investors (MIPA 2019). Other benefits set forth by the law include the ability for a foreign investor to operate as a legal entity or as an individual. Furthermore, Montenegro places no limit on the amount of capital investment. MNEs are encouraged to invest freely within any industry, and they have the right to purchase real estate under the same conditions as domestic entities. Integration into the international community has also accelerated since independence, motivated by strong support for Europeanization and Atlanticism. In this regard, Montenegro signed a Stabilization and Association Agreement (SAA) with the EU and joined the Central European Free Trade Agreement (CEFTA) in 2007. In 2012, Montenegro joined the European Free Trade Agreement (EFTA) and World Trade Organization (WTO), reflecting its open trade regime. Montenegro started accession negotiations with the EU in 2012,2 and became a full NATO member in 2017, which has further strengthened its attractiveness to foreign MNEs, as evidenced by recent increases in FDI. By creating a stable and reliable economic environment, Mongtenegro became one of the most attractive FDI destinations in Europe. This small, open economy experienced a substantial increase in capital flows from 2005 to 2009, which were among the highest per capita anywhere in Europe, not only in the Balkans. FDI during this period was significant, resulting in positive effects on the entire economic and political environment of country (Fabris et al. 2010). Like most of its neighbors, Montenegro experienced a decrease in FDI inflows following the Global Financial Crisis (GFC). During the crisis, many MNEs canceled new projects and some even withdrew existing capital they had invested in short-term projects. Moreover, Montenegro delayed and even terminated the privatization of large, state-owned enterprises, because they were unable to obtain investors willing to pay a reasonable price during the crisis. During this period, only smaller amounts of FDI were realized in order to sustain existing long-term projects (Gligorov et al. 2010). As the international flow of capital decreased, the countries that were more exposed to and dependent upon the inflow of foreign capital experienced many problems. In Montenegro, this resulted in a slowdown in the country’s transition and, therefore, in its socio-economic convergence with the EU. The experience of the GFC and its negative effect on FDI, which in turn impacts host economies detrimentally, underscores the need for countries to promote investment from a wide range of origins and in a cross section of industries. To protect itself from such events, Montenegro has more recently sought to diversify its FDI stock from “nontraditional” (non-EU) origins such as China, the Arab states, Turkey, Azerbaijan, and elsewhere. 2 As of November 2019, 32 chapters of negotiation have been opened, with three provisionaly closed.

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This analysis begins at the outset of the new millennium, excluding the early transition period of the 1990s. This is because prior to 2000, data for Serbia and Montenegro did not exist separately as the two entities represented a single state (see also Ratkaj, Sibinovi´c, and Mani´c, Chap. 2). From 1992, they remained united as the Federal Socialist Republic of Yugoslavia. The Federal Republic of Yugoslavia (FRY) was transformed into the State Union of Serbia and Montenegro in 2003. Moreover, FDI was negligible before 2000 as a consequence of regional conflict and isolation resulting from international sanctions. In June 2006, Serbia and Montenegro became two independent states. Given the complex recent history and resulting data challenges, the present chapter focuses mainly on the period 2001–2017.

7.2 Empirical Literature on FDI in Montenegro After the end of World War II (WWII) in 1945, Montenegro became an integral part of the Federal People’s Republic of Yugoslavia (FPRY), and later in 1963, one of six republics in the Socialist Federal Republic of Yugoslavia (SFRY), which existed until 1992. Yugoslavia adopted the economic principles of a planned economy; that is, the model of socialist self-management. The Communist Party of Yugoslavia alone formed the political framework and set national economic policy, and heavy industrialization was chosen as the model of development. This led to radical changes in Yugoslavia’s existing economic structure with a new orientation toward the construction of capacities for energy, black metallurgy, wood processing, and infrastructure projects (Kosti´c 2000a, b). Despite its focus on industrial development, this economic structure negatively influenced the accumulation and reproductive capacity of the economy itself, which significantly hindered the progress and development of the Montenegrin economy. The development strategy for Montenegro’s coastal region was based on intensive investments, with values exceeding the size of the Montenegrin GDP (Petranovi´c 2000). Investments on the coast were 37.5% higher per capita than total investments in Montenegro, which were also generally 55% higher than the Yugoslav average. The ratio of economic and service investments for the period from 1947 to 1965 was 87.1–12.9%, with the largest share recorded in the sectors of transport, tourism, industry, and trade (Petranovi´c 2000). Yugoslavia’s initial dissolution process lasted from 1991 to 1992 and ended with the creation of five new states. Montenegro, along with Serbia, became a part of the Federal Republic of Yugoslavia (FRY) on April 27, 1992. Montenegro represented merely 13.5% of the territory of the new state, only 6.1% of the population, 6% of total employment, and just 5% of GDP. (Marseni´c 1992). The early months of FRY were accompanied by intense military conflicts leading to open civil war, hyperinflation, rising unemployment, international isolation, and an embargo by the United Nations that lasted until 1995. Sanctions by the UN Security Council toward the FRY dramatically affected all sectors of Montenegro’s economy and industry, and in particular international

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economic relations, specifically the export and import of goods and services. Montenegro, with coastal access and a limited domestic market, depends upon external markets, and its economic structure makes it particularly dependent on imports (Bjeleti´c 1995). The sanctions led to the loss of market segments of domestic exporters in the EU, taken over by exporters from other countries, primarily other CEE countries in transition, which would pose an additional obstacle to the return of domestic exporters to this market (Kovaˇcevi´c et al. 1997). During the ten-year blockade of the country that started in 1992, the FRY was restricted from FDI, its access to the international capital market was blocked, and cooperation with international financial organizations was suspended. Access to the international capital market was restored after 2000 (Mrdakovi´cCvetkovi´c 2006). However, more widespread FDI could not be expected before the resolution of the political crisis in the region and the settlement of the macroeconomic situation. In addition, the competition for foreign capital was merciless, especially considering that in many industries, Yugoslavia already lagged behind its direct CEE competitors (Dimitrijevi´c 2001). The suspension of sanctions only partially mitigated the challenges associated with the Yugoslav economy’s non-competitiveness (Kovaˇcevi´c 2001a, b). Kovaˇcevi´c (2001a, b) identifies several location-specific advantages with the potential to stimulate foreign companies to invest in FRY as it emerged from this crisis. These include its favorable geographical position, an abundance of natural resources, low-cost labor, and relatively relaxed regulations for environmental protection vis-à-vis developed countries. In addition to its geographical position and inexpensive labor, Gorˇci´c (2001) emphasizes the advantage of Yugoslavia’s specific form of communism, which enabled the country to gain experience with the market economy earlier than most other former communist countries in transition. The challenges presented in the aftermath of the dissolution of the SFRY, combined with an undefined constitutional system and association between Serbia and Montenegro, resulted in a modest inflow of FDI during the period 2000–2002. At the same time, one of the unique characteristics of the Montenegrin economy from 1992 to 2002 was the implementation of transformation and privatization, whose final phase was “massive voucher privatization” (MVP). Privatization is a key element of economic and political reform, which aims at faster development of the economy as a whole and the improvement of conditions for economic efficiency as well as securing development capital (Ðurovi´c 1992; Vukoti´c 1995). From a legal standpoint, the process of Montenegrin economic transformation was launched with the adoption of the Federal Law on Social Capital in 1989, then continued with the Law on Property and Management Transformation in 1992, followed much later by the Law on Privatization of Economy in 1999 (Žugi´c 2010). However, the transition was interrupted early by the introduction of sanctions against the FRY in 1992, which were accompanied by a decline in living standards, an increase in unemployment, and an expansion of the informal economy. The formation of the Privatization Council in 1998 bolstered the privatization process. Although Montenegrin Law offered a model for transformation supporting capital investment both from both domestic and foreign individuals and companies,

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it was not applied in practice, except in 1998, with Montenegro’s postal service, telegraph, and telephone (PTT). The Greek-Norwegian European Telecom established a joint venture in Promonte LLC for the introduction and exploitation of mobile telephone service in the territory of Montenegro in 1996 (Ðurovi´c 1997). The improvement in privatization procedures ushered in a much stronger presence of the private sector in the structure of Montenegrin GDP (Bajec 2008). As of 2020, more than 90% of the total value of capital in Montenegrin companies has been privatized, with the private capital in the financial structure of every major company. Around 410,000 citizens hold shares in companies or privatization funds. According to EBRD assessments, the privatization process in Montenegro is considered to have been very successful (MIPA 2019). In Montenegro, as in other transition states, the transformation from a planned economy to a market economy is lauded as a crucial instrument toward prosperity, with FDI playing a strong role in this process (Gavrilovi´c-Gagovi´c and Gagovi´c 2002; Kaplanovi´c 2002). In the process of creating a market economy and more favorable ground for integrational trade and investments, several changes took place in the Montenegrin legal framework after 2000. Montenegro adopted the euro as the single official currency in January 2002, followed by a four-year Economic Reform Agenda in March 2003 (Ivanovi´c 2004). The Law on Foreign Investments and the Law on Concessions were adopted in 2002 (Official Gazette of FRY 2002), which was the driving force behind the development of an export-oriented economy through FDI and private sector development (Labovi´c 2004). During the following year, the Montenegrin Investment Promotion Agency (MIPA) was established and given the responsibility for promoting Montenegro as an investment destination. This agency is also charged with supporting targeted projects with service before, during, and after the initiation of investments. Concerning foreign trade regulation, another initiative was launched to harmonize rules with WTO and EU standards. After this point, very few restrictions remained against foreign investments in most private sectors. In addition, Montenegro’s income tax rate was deliberately established to be among the lowest in the SEE region (Golubovi´c and Golubovi´c 2001). The experience of eight former socialist countries that became EU members in 2004 demonstrated that a significant inflow of FDI was among the main factors leading to a successful transition. In these countries, FDI had driven economic growth through high revenues from privatization, transfer of know-how, application of developed management strategies, and distribution channels (Golubovi´c and Golubovi´c 2001; Labovi´c 2005). Foreign investors are of significant interest to policymakers as a means of maximizing domestic investment (Jude 2014). Analyzing FDI in CEE, Mileva (2008) finds that foreign capital stimulates domestic investment, particularly in countries with weak institutional development and underdeveloped financial markets. This is also in line with Gray and Jarosz’s (1993) argument that an immense need exists in transition countries for foreign capital and knowhow to repair economies and stimulate growth. Namely, in cases where the extent of domestic savings is negligible, the recovery of the domestic economy depends heavily on attracting foreign investments (Gliševi´c and Rakoˇcevi´c 2000). Based upon these

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observations, expectations for FDI were high, especially taking into account the lack of domestic capital accumulation (Maksimovi´c 2002). Even though the political situation in Montenegro was already stable at the beginning of the new millennium, investors continued their reluctance to engage, remembering the instability of the near past and projecting their concerns to the uncertain future (Dragaševi´c 1992; Ivanovi´c 2004). Cumulative investment value from 1997 to 2004 amounted to merely EUR 420 million, mostly composed of mergers & acquisitions (M&As), with far fewer greenfield investments (Ðikanovi´c 2000). The following section explains fluctuations of FDI inflows over time, with additional insights from previously published empirical work.

7.3 Temporal Dynamics of FDI to Montenegro Given Montenegro’s size, its inflows of FDI have been significant, and in fact the largest of any former SFRY republic relative to GDP. After renewing its independence in 2006, Montenegro recorded an unprecedented inflow of FDI, becoming one of the top recipients among European transition economies. As the smallest country in SEE, Montenegro ranked first in FDI per capita 2010 (UNCTAD 2008; Zait et al. 2014) and has retained this position for years (Estrin and Uvali´c 2014; Ja´cimovi´c et al. 2014). As highlighted by Deichmann (Chap. 1), among the former states of Yugoslavia, it also remains the leading country measured by cumulative FDI value relative to GDP through the end of 2018. Montenegro’s average annual inflow since 2000 is EUR 412.6 million. This number alone does not appear to be very high, but given Montenegro’s population, it represents an annual average of EUR 710 per person, and 13.9% of GDP. The strongest years for inflows thus far were 2007 (EUR 496 million), 2008 (EUR 655.7 million), and 2009 (1.1 billion), after which point the full effects of the GFC reached Montenegro. Figure 7.1 features the annual inflows measured by value in euros and as a proportion of GDP. These generous investment inflows were unable to introduce new, internationally competitive products to production in Montenegro (Ja´cimovi´c 2012; Žugi´c and Jakši´c-Stojanovi´c 2013). FDI is mainly concentrated in the real estate, banking, telecommunications, and retail sectors. None of these affect Montenegrin exports directly, with the exception of investments related to tourism (Fabris et al. 2010). Veliˇckovi´c and Tomka (2017) express concern that investment boom relects greater personal consumption in Montenegro through higher quality services for the domestic market. The problem of export revenue and correcting the balance of payment deficits became extremely evident during the crisis time, especially starting in 2009. Despite Montenegro’s large inflows relative to GDP, the tasks of diversifying the Montenegrin economy and sustaining export revenues remain a challenge for building sustainable development in the medium and long term. Montenegro has attracted mainly market-seeking companies related to the real estate sector, banking, telecommunications, and retail. Given that Montenegro’s

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2000 1800 1600 1400 1200 1000 800 600 400 200 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 EUR mn

EUR per capita

Fig. 7.1 FDI inflows in Montenegro 2000–2018 (in EUR million and as % of GDP). Source Authors’ calculation based on WIIW data (2019)

economy alone is small, these MNEs are probably more interested in nearby regional markets of the EU. According to Dunning (2009), this type of MNE might also be seeking the availability of affordable highly skilled labor, the presence of related firms, infrastructure quality, and institutional competence. As outlined earlier, they might be further attracted by the type of macroeconomic policies created by liberalizing reforms, as well as promotional incentives by development agencies such as MIPA. Following this book’s adapted structure of Dunning’s (1980) eclectic framework for the analysis of FDI, the next three sections of this chapter provide a thorough overview of the origins, composition, and location of FDI in Montenegro.

7.4 National Origins of FDI in Montenegro After a relatively low GDP growth rate at the outset of the new millennium, Montenegro saw remarkably accelerating economic growth averaging 8.7% in the three years leading up to the economic crisis. The main factors contributing to this rapid economic growth were the introduction of the euro as the country’s official currency, trade liberalization, and large inflows of FDIs. Over the past 18 years, FDI in Montenegro has increased dramatically, with cumulative inflows amounting to EUR 4.6 billion (WIIW 2019). Fabris et al. (2010) attribute much of this growth to the successful privatization process and the amenities of the Montenegrin coast. During these years, the share of FDI in Montenegro’s GDP ranged from 0.4% to a peak of 36.7% in 2009, averaging more than 20% from

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2005 to 2009. According to Fabris et al. (2010), FDI inflow is considered “high” if its share in a country’s GDP is greater than 10%. Therefore, during the years preceding the GFC, Montenegro was a leader in the group of the European countries in transition (Montenegro Securities Comission 2009). Furthermore, as the smallest Southeastern European country, with just over 622,000 inhabitants, Montenegro leads all the others in FDI per capita terms. These robust FDI statistics reflect in part the country’s successful convergence policies. FDI in Montenegro represents a large and diverse set of origin countries. This is fortunate for Montenegro because a diversified inventory should be less susceptible to adverse movements in specific markets. Given that FDI has come from 107 countries since 2001 (Fabris et al. 2010), one might conclude that the current situation is favorable. However, half of these cumulative flows are from only five dominant origins: Russia, Switzerland, Italy, Austria, and Hungary. This group of origins is unsurprising, as it confirms the importance of geographic, historical, and cultural explanations of FDI. Also notable is the fact that only 3.8% of the total gross inflow of FDI from 2001 to 2018 came through known intermediate off-shore countries such as Panama and the Virgin Islands (Fig. 7.2). EU-based firms represent 52% of FDI inflows through 2018, with the largest shares coming from Italy (9%), followed by Austria (8%), Hungary (6%), Cyprus (6%), and the UK (5%). Leading non-EU origins include the Russian Federation Russia 17%

Other 30%

Germany 3% Azerbaijan 3% UAE 4% United Kingdom Cyprus 5% 6%

Switzerland 9%

Italy 9%

Austria 8% Hungary 6%

Fig. 7.2 Origins of FDI in Montenegro (by percent of cumulative value through 2018) (Note The section “Other” includes countries whose MNEs collectively contribute less than three percent of the total. Listed in descending order, these include Slovenia, Netherlands, Panama, Turkey, Luxembourg, Latvia, British Virgin Islands, USA, Greece, France, Lithuania, Ireland, Poland, Malta, Estonia, Belgium, Bosnia & Herzegovina, Liechtenstein, Sweden, Norway, Ukraine, Spain, Hong Kong, Japan, Czechia, Israel, South Africa, Australia, Kosovo, China, Jersey, Canada, Romania, Bulgaria, Kazakhstan, Belarus, Albania, Slovakia, Macedonia, Moldova, Serbia, Croatia, Denmark). Source Authors’ calculations based on data provided by the WIIW (2019)

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(17%) as the most important origin overall, and Switzerland (9%). The fact that the majority of FDI originates from EU countries reflects Montenegro’s political and economic orientation toward Europe. Namely, Montenegro has been a candidate for EU membership since 2010, with accession negotiations beginning in 2012. Furthermore, Montenegro became a NATO member in 2017, strengthening its macroeconomic stability and certifying it as a safe destination. Effectively, NATO membership lends credence to Montenegro’s international reputation, as evidenced already by an increase in FDI from other NATO countries. FDI from Italy is most widespread in Montenegro’s energy industry, while Austrian and Hungarian firms are concentrated in the banking sector. More detailed data on individual investments is not readily available, as MNEs typically treat the specifics as confidential data. During the period of study since 2000, a significant level of economic engagement is evident by Russian companies and individuals in Montenegro. In contrast to most other origins, Russian investors focus heavily upon the tourism industry, as well as the related real estate sector. The majority of Russian assets in the country are reportedly real estate holdings, hotels, and restaurants. As of 2007, Russian companies represented 31% of the country’s total FDI, while by late 2018, Russian FDI constituted just 12% of FDI. This heavy reliance upon Russian investment raises some concern that further deterioration in bilateral relations could pose a risk to Montenegro’s economy. Political relations between Montenegro and Russia have deteriorated since 2013, with Montenegro’s efforts to pursue membership in NATO, a military alliance that Russia perceives as a threat. Nevertheless, Russia remains among the leading origins of investors in Montenegro. One of the most notable features of FDI in Montenegro over time is the enormous shift in FDI origins between the periods prior to and after the global financial crisis (GFC) as a defining moment in the global economy. Figure 7.3 depicts the origins of FDI through 2008, with Fig. 7.4 covering the decade thereafter. Again, it is notable that investors from Russia represent the largest share in both periods, although it has diminished relative to others after the GFC. Hungarian FDI is positioned second as a source of FDI, with 12% of the cumulative today through 2008. Furthermore, Austria maintained its strong role as an origin, as explained earlier in terms of its geographic proximity as well as historical and cultural linkages. By comparing these figures, it is noticeable that the relative percentage of total FDI from Hungary, Cyprus, and the UK declined after the crisis. In the post-crisis period, Russia remained Montenegro’s top investment origin, and the second-largest amount (12%) can be traced to Italian MNEs (Fig. 7.4). Notably, Italy had been only the 22nd most important source of FDI in the precrisis period. This Italian FDI reflects an enormous interest in the energy sector, and specifically reflects the Adriatic underwater power cable project. Other leading origins of MNEs during the post-crisis period are shown in Fig. 7.4 and include Austria (8%), Switzerland (8%), and the United Arab Emirates (UAE, 5%). To facilitate further comparison in the pre and post-crisis period, Table 7.1 lists the top ten origins in descending order, with non-EU members in boldface. Compared to the pre-crisis period, when eight of the top ten origins were EU countries, in the latter period, investors from outside the EU (Russia, Switzerland, UAE, Azerbaijan,

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Russia 18%

Ireland 2% Latvia 3% Germany 4%

Hungary 12%

Slovenia 4%

Austria 9%

Switzerland 11%

United Kingdom 10%

Cyprus 11%

Fig. 7.3 Origins of FDI in Montenegro during the pre-crisis period (percent of value, 2001–2008) (Note The section “Other” represents all other countries that collectively contribute less than two percent of the total). Source Authors’ calculations based on data provided by the WIIW FDI database (2019)

Serbia, and Turkey) gained importance. During this most recent period, only four of the top ten origins are in the EU. In total, 28% of FDI value during the pre-GFC period originated in the EU, while 38% of the value following the GFC comes from these countries. After the crisis, Italy became one of Montenegro’s most important EU foreign partners, while participants from some new countries have shown a significant presence in the international financial market. These countries include the UAE, Azerbaijan, and Turkey. In this period, Montenegro’s government entered into several bilateral economic agreements. Subsequently, Italian enterprises have made investments in the Montenegrin energy sector, primarily through the participation by the Italian company A2A in the capital increase of the Electric Company of Montenegro in 2009, with EUR 436 million (A2A 2009). Furthermore, they financed the project for an underwater electricity transmission cable between Italy and Montenegro, allowing for Montenegrin-generated electricity exports to Italy. This project is expected to enable Montenegro to act as a regional hub for energy, transporting electricity generated in Western Balkan countries to customers in Italy and other European countries. Although European MNEs remain the most important and most sought-after by MIPA, it is evident from these graphics that Montenegro has been successful at diversifying FDI origins. Due to the GFC, many EU investors have withdrawn from many

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Other 31%

Italy 12%

United Kingdom 3% Turkey 3% Hungary 4%

Austria 8%

Serbia 4%

Switzerland 8% Azerbaijan 5%

UAE 5%

Fig. 7.4 Origins of FDI in Montenegro during Post-Crisis Period (percent of value, 2009–2018) (Note The section “Other” represents all other countries that collectively contribute less than three percent of the total). Source Authors’ calculations based on data provided by the WIIW FDI database (2019) Table 7.1 Top 10 FDI origins pre-crisis and post-crisis (non-EU in boldface)

Rank

2001–2008

2009–2017

1

Russia

Russia

2

Hungary

Italy

3

Switzerland

Austria

4

Cyprus

Switzerland

5

United Kingdom

United Arab Emirates

6

Austria

Azerbaijan

7

Slovenia

Serbia

8

Germany

Hungary

9

Latvia

Turkey

10

Ireland

United Kingdom

Source Authors’ analysis of WIIW data (2019)

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large projects, especially those in infrastructure. This presented an opportunity for investors from other origins to enter the market. With intensive EU-based FDI flows mostly absent since the GFC and some new business opportunities on the horizon, MNEs from the UAE and Turkey are becoming more interested. Montenegro’s status as a potential future EU member makes it particularly appealing for MNEs in these countries, which see their investment as a gateway to the EU market. Investors from the UAE are attracting particular attention with increased investment during 2016 and 2017, as the largest source of inflows in each of those years. This was enabled by several economic agreements signed between the two countries (Ministry of Finance 2011). The most important is the 2011 Treaty between Montenegro and the UAE for the Avoidance of Double Taxation, which created the legal and fiscal security required for conducting international business activities (Ministry of Finance 2011). Investors from the UAE have been interested in investing in the tourism, manufacturing, and banking sectors. Capital Plaza in Podgorica, a luxury commercial and residential complex, was the first UAE-based FDI in Montenegro. It was followed by Porto Montenegro in Tivat, a large nautical resort that was bought by the Investment Corporation of Dubai (ICD) in 2016. This investment includes a yacht marina and a luxury residential complex. In the same year, BMJ Industries of the UAE began construction of the New Tobacco Plant in Podgorica, which opened in 2018 to employ 53 workers over three shifts. In recent years, Turkish firms have dramatically increased their country’s volume of FDI in Montenegro. This can be explained by the favorable investment environment, the fact that Montenegro has advanced in the process of European integration, and most importantly, by Turkey’s historical links with the countries on the Balkan peninsula. Turkish companies show a particular interest in tourism, the banking sector, agriculture, energy, and manufacturing, as well as the use of the Port of Bar for transshipment of goods from Turkey and distribution to other countries in the region. Significant investors from Turkey include the company Toscelik, which operates the Zeljezara ironworks in Niksic, and the Global Ports company, which operates container terminals and general cargo at the Port of Bar. Total FDI from Turkey to Montenegro from 2010 to 2018 stands at EUR 181.7 million. The inflow of FDI from Turkey has been increasing steadily, with EUR 53 million in 2018 alone. This fact is attributable to the sheer increasing number of Turkish companies now doing business in Montenegro. According to the Tax Authority, there have been more than 2000 Turkish companies operating in Montenegro (CBM 2019). Most of these companies are concentrated on the Montenegrin coast, especially in Budva, as well as in the inland national capital city of Podgorica. The largest share of Turkish FDI in 2018 went to the real estate sector. According to the Central Bank of Montenegro (2019), 47% of total FDI from Turkey represents investment in real estate. The reason for that might be that in Montenegro, real estate prices remain low, especially in Podgorica, where apartment prices are significantly lower than in other European capital cities. (Property Guide 2019). The Turkish FDI wave reached a peak in 2018 when numerous Turkish companies opened representative offices in Montenegro, including retail stores LC Waikiki and Dogtaš.

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Lastly, FDI from China must be mentioned, not so much as a current origin, but rather as one of the future. Montenegro’s first motorway, currently under construction, has been financed by the Chinese EXIM Bank. This infrastructure project is being completed by two Chinese companies: the CCCC International (China Communications Construction Company) and the CRBC (China Road and Bridge Corporation). The value of the project is approximately EUR 809.6 million, with the EXIM Bank providing 85% and Montenegro the remainder. This project is associated with China’s 16 + 1 program, an outreach initiative by the Chinese government toward sixteen post-communist countries of CEE. It is enormous relative to the size of the Montenegrin economy, and it will certainly challenge public finances for the future. European partners are concerned that if the debt burden becomes unmanageable for Montenegro in the future, China will attempt to swap the financial debt for political capital. Naturally, with the start of this highway’s construction, interest by entities from the People’s Republic of China is increasing in other sectors of the economy as well.

7.5 Industrial Composition of FDI in Montenegro Montenegro has traveled a long road over the past two decades from ex-Yugoslav republic to its current status as an independent state, NATO member, and potential EU member. The political and economic structure of the country has changed, both due to the new international environment and new domestic circumstances. Its economy had historically been designed for industrial development based on energy, black metallurgy, and wood processing sector, as part of the SFRY. In contrast, today it represents a small open economy, oriented mainly toward service industries. At the beginning of the period under investigation (2001–2018), the predominant form of FDI was a result of the privatization process; at that time, greenfield investments remained small in number and size. That few greenfield investments occurred in Montenegro during the early 2000s is unsurprising, as it reflects the similar experience of other transition economies in the region. According to the IMF (2008), greenfield investments accounted for only 10% of total FDI, even in the pre-crisis boom period, when FDI exceeded 20% of GDP. At this time, privatization prevailed in the banking, telecommunications, tourism, and energy sectors (Fabris et al. 2010). Aluminum and steel production were the strongest pillars of the economy until the 1990s, contributing dominantly to the GDP and employment in Montenegro. These activities were represented by only two enormous companies, with 4000 employees combined. The IMF (2015) notes that in all WB countries, large public enterprises in historically important industries proved particularly challenging to privatize. While many WB countries had already initiated privatizations in the late 1990s and early 2000s, Montenegro joined the process much later (IMF 2015). Postponement and cancellation of privatizations often resulted from social opposition, high short-run costs, and a shortage of serious bidders.

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Montenegro has also faced difficulties with management issues by MNEs. Russian investors Rusmont Steel Corporation (2002) and Midlend (2004), as well as British off-shore company MNSS (2006), all generated problematic levels of debts. Similarly, the Turkish steel firm Tosjali entered Montenegro in 2012, then was quickly replaced by Toschelik, another Turkish investor. Toschelik continued to struggle and was forced to reduce production by 30%. Privatized steel and aluminum enterprises have drained Montenegro’s public finances for years, and until 2014 they remained a significant burden in the form of non-paid taxes, direct cash transfers, and loan guarantees (IMF 2015). In addition, closer enforcement of EU legislation has made it challenging to retain and upgrade many factories in Montenegro, especially with regard to environmental protection laws. The Montenegrin economy is dominated by service industries now, with the share of services in GDP exceeding 70%, followed by manufacturing and agriculture (NTOM 2018). Tourism is the dominant and growing sector that will contribute the most in the future development of export revenues. The National Tourism Organization of Montenegro (NTOM 2018) reports that direct and indirect travel and tourism account for about 22% of GDP. The World Travel & Tourism Council (WTTC 2018) reports that Montenegro is among the leading three countries for growth in tourism over the next decade. They expect that by 2026, the total contribution of tourism to GDP will be around 30%. The tourism sector has been the dominant recipient of FDI in Montenegro thus far, due to the privatization of several Montenegrin hotels through 2018. Greenfield investment in luxury hotels totaled EUR 3 billion in 2018 (MIPA 2019), including the construction of Porto Montenegro, the first Montenegrin marina for mega yachts in the Mediterranean. Other luxury hotels, such as the One & Only luxury resort in Kumbor, a prime real estate development on the Luštica Peninsula, a luxury five-star hotel complex at the Beyond Horizon site, will have dramatic impacts on the local economy. This FDI, in turn, will certainly have spillover effects on other sectors of the economy, including transportation, trade, energy, agriculture, and construction. The underwater electricity transmission cable is one of the largest FDI projects in Montenegro, estimated at a value of EUR 1 billion. The undertaking is a joint venture by the Italian transmission system operator Terna S.p.A and the Montenegrin transmission system operator. The Underwater Cable Project includes three components. First, a 415-km undersea electricity transmission line will be constructed between Montenegro and Italy, financed by the Italian company Terna. Second, the Montenegrin Electric Transmission System (CGES) will finance a substation and transmission infrastructure from the north of Montenegro to the coast. Third, pending approval, an electricity transmission line will be constructed from Montenegro to Serbia and/or Bowillsnia and Herzegovina to transport electricity between these countries. Montenegro will also realize its potential in renewable energy through FDI. Two examples include wind farms in Krnovo and Mozura. Montenegro’s first wind farm was established in 2015 and is one of the largest in the region. Located in Krnovo, this project is a subsidiary of Akuo Energy, the leading French IPP in renewable energy. In January 2018, UAE’s Masdar completed its acquisition of 49% of Krnovo Green Energy.

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Montenegro’s banking sector has also been completely reformed by FDI, facilitating a more efficient allocation of capital. Foreign investment into the banking sector, combined with increased deposit bases, boosted private sector credit. In fact, with deposits and credit rising by more than 100% of pre-crisis GDP, financial sectors in WB have deepened more than those in the EU’s new member states at comparable stages of transition (IMF 2015). FDI had significant impact on the growth of deposits and thus the development of the banking system, as well as the capital market. This impact was two-sided: on one hand, as the result of property and real estate sales, part of the money was deposited in the banking system; on the other hand, through FDI, credible foreign companies have arrived on the Montenegrin market and became important clients of the banking system, both as depositors and loan users. Today, 13 banks are operating in Montenegro and foreign capital dominates in the ownership structure at over 85% of total value (CBM 2019). Capital from EU members accounts for the largest share, while the share of capital from NATO countries is over 50% (CBM 2019). FDI has also completely transformed Montenegro’s telecommunication sector. As already mentioned, the very first major greenfield investment in Montenegro occurred in this sector in 1996, when mobile operator Pro Monte (founded by Telenor and European Telecom Luxembourg) entered the Montenegrin market. Until that investment, the state-owned company Telekom had a monopoly. The telecommunications sector in Montenegro is currently owned by four foreign companies. Since the privatization of state-owned company Telekom in 2005 total investments by 2018 reached EUR 424 million, according to data from the Montenegrin Agency for Electronic Communication and Postal Services. Montenegro does not report FDI statistics at the sectoral level. However, an overview of major projects suggests that the most successful sectors for attracting FDI to Montenegro include banking, tourism, telecommunications, energy, and manufacturing. FDI inflows significantly contributed to the change in Montenegro’s GDP structure. Specifically, large investments in real estate, tourism, transport, retail sales, and construction have emerged as drivers of the Montenegrin economy. With FDI favoring services over manufacturing, it has been less successful at generating industrial output. As shown in Fig. 7.5, several periods are distinguishable with regard to the structure of FDI. During the 2001–2005 period, most FDI inflows represent investments in banks and companies, resulting from the privatization of hotels, companies, and banks. According to CBM (2003, 2004 and 2005) data, most FDI was in services, followed by financial institutions, while the least was in manufacturing. A second distinct pre-crisis period occurred from 2006 to 2008 (Fig. 7.5). In the years preceding the GFC when global venture capital was abundant, the structure of FDI became dominated by the real estate sector. This increased interest in real estate was partially a response to the Law of Investments, which was put into effect in 2007. The new law allowed individual foreigners to purchase all types of real estate, including land, under the same conditions as Montenegrin citizens. The specific characteristics of Montenegro as a small, open economy with a limited production base lead to current account volatility. For example, if any large project

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1400

1200

1000

800

600

400

200

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Banks & Companies

Intercompany Debt

Real Estate

Other

Fig. 7.5 Structure of FDI inflow in Montenegro for the period 2001–2018 (EUR millions). Source Authors’ calculation based on data provided by CBM (2019)

(e.g., a luxury hotel) requires the importation of goods that are not available locally, the investment becomes detrimental to the current account. Thus, high import content implies correspondingly high current account deficits, a small contemporaneous impact on output, and a lagged increase in potential output, or a “time-to-build” effect. Because real estate—especially in the tourism industry—is a large part of Montenegro’s FDI portfolio, it is important to take precautions. The IMF (2008) warns that dramatic increases in real estate development might actually impair the host economy. Their report suggests that overdevelopment without appropriate infrastructure, along with environment carelessness, could generate strong negative externalities, irreversibly change the landscape, and undermine further real estate and tourist development. Furthermore, a fast pace of development, well above the capacity of the construction sector, will confer limited macroeconomic benefits as it will rely disproportionately on imported inputs, including labor. The report further cautions that FDI targeted primarily the tourism and financial sectors, triggering a cycle of wealth effects, as real estate became more valuable it was used as loan collateral, with loans in turn again funding construction activities. The current account in the post-crisis period is lower than in the period before the crisis (IMF 2010). The next time period from 2008 to 2009 highlights the reality that large accumulations of FDI are not always used optimally. Namely, the largest FDI in the previous years was registered from privatization and the sale of real estate. The structure of FDI began diversifying in 2008, with a decrease in real estate’s share and an increase in the real economy. The decline of real estate in 2008–2009 was highly related to

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the GFC. There were fewer qualified buyers from abroad, a reduced supply of credit funds, and difficulties in registering land that emerged as available. In 2009, the structure of FDI improved, meaning that there was a substantial increase of investments in companies and banks, amounting to 72% of total FDI inflow. Despite the financial crisis, Montenegro’s inflow growth continued in 2009 due to a substantial inflow of funds from privatization and recapitalization of the Electric Company of Montenegro (ECM) (41%), as well as recapitalisation of investments in the banking sector (10%). Fortunately for Montenegro, capital inflows have been more stable in Montenegro than in many other European transition economies in the post-crisis period. Notably, FDI inflows declined in 2009 in all of the other former republics of SFRY. FDI continued to flow into Montenegro for the next few years, albeit at a lower level. Figure 7.5 shows a rebound of FDI since 2014, and these recovering inflows help finance the current account deficit. In 2014, FDI increased by 11%, while net FDI in 2015 was at its highest level since 2009 at EUR 630 million. This represents 17% of GDP and is 68% higher than 2014. Nevertheless, FDI inflow values typically fluctuate on an annual basis, especially in small economies like Montenegro. Therefore, it is not concerning that after a large inflow in 2015, FDI moderated in 2016, followed by another increase in 2017 and slight decrease in 2018. Overall, during the period 2014–2018, the share of FDI inflow in Montenegro’s GDP was approximately 14%, on average.

7.6 Subnational Location of FDI Within Montenegro Dunning et al. (2001) find that classical location factors found in the theoretical literature are helpful for explaining the location of FDI in CEE countries between 1996 and 2000. Specifically, they cite the quality of business environment and the availability of privatized facilities to be highly significant. These, along with market size, labor costs, and natural resources, are shown to be valie for explaining the location of FDI in Montenegro from 2000 to 2018. Although Montenegro is a small country of only 13,812 km2 , it is characterized by significant regional differences. Figure 7.6 delineates the country into three sections: the Coastal Region, the Central Region, and the North Region, as designated by the Law on Regional Development. Several of the most important FDI activities are superimposed on the map. Thus far, the Coastal Region received the largest amount (61%) of FDI. The dominant sector is tourism. New resorts such as Porto Montenegro, Porto Novi, Lustica Bay, and Dukley Gardens have been established by MNEs. In addition, foreign firms have been especially active in this region’s real estate and energy sector, the latter including the energy transfer cable under the Adriatic Sea, and the wind farm Mozura. The coastal region’s FDI has been mostly greenfield investments. Acquisitions of existing facilities include Jugopetrol in Kotor and Port of Adria in Bar, and the privatization of several hotels.

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Fig. 7.6 Name and location of major investments in Montenegro since 2001. (Source authors’ interpretation. North, Central, and Coastal regions designated by Law on Regional Development)

The Central Region includes the capital Podgorica and municipalities Niksic, Cetinje, and Danilovgrad. It has attracted about 32% of Montenegro’s FDI, which is heavily concentrated in the capital city. Most of this FDI is related to banking, with foreign owners controlling over 85% of the bankng sector. The next important sector is telecommunications, with ownership of large projects by Pro-MonteTelenor, Deutsche Telecom, M-tel, and Telemach. Finally, the tourism and hospitality and real estate sectors are major attractions to foreign firms. Additional minor investments in Podgorica have taken place in the manufacturing industry. These investments include an aluminum factory and the New Tobacco company in Novi Duvanski. The other sizable city in the Central Region is Niksic, a former industrial center of Yugoslavia. The investments in Niksic are primarily brownfield projects. They include the privatization of the Trebjesa brewery and Zeljezara ironworks, and privatization and recapitalization of the Electric Company of Montenegro. Another project in the region that is the source of major pride near Niksic is a greenfield investment in Krnovo, where Montenegro’s first wind farm was constructed in 2015. The least developed region in Montenegro is the North Region, and its share of total FDI is relatively small at about seven percent. As pointed out by Fabris and Zugi´c (2012), a characteristic of underdeveloped regions is a significant share of agricultural production on fragmented land, along with a particularly small share of underdeveloped industry. These authors described this region as “anemic,” lacking basic principles concerning the market economy and positive momentum either induced from the inside or the outside. Thus, this region suffers from high unemployment and migration toward developed regions (Fabris and Zugi´c 2012).

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During the observed period, the value of FDI in the North Region is relatively small in comparison with the other regions. As highlighted by Dimitrijevi´c and Fabris (2010), it is common for a country’s capital, industrial centers, and coastal regions to grow at much faster pace than the rest of the country. The few investments existing in the North Region are dominated by the privatization of old factories such as Šuplja Stijena, as well as the lead and zinc mine in Pljevlja and the Tara weapons factory in Mojkovac. In addition, real estate investments were made in Zabljak and Kolasin, which are popular Montenegrin ski resorts with considerable growth potential for tourism. Zabljak, located in the Durmitor Mountains, is a tourist hotspot because it features attractions such as skiing, rafting, mountaineering, and hiking during all seasons. Furthermore, it is located within a national park and listed as a UNESCO World Heritage Site. Nevertheless, the North Region remains relatively undiscovered by investors. It requires better visibility and promotion to encourage foreign investors to build hotels and other supporting tourism facilities in this area. Dimitrijevi´c and Fabris (2007) suggest that government may contribute with fiscal measures to reduce regional disparities through tax relief for investments in underdeveloped parts of a country, improving quality of life in these areas through infrastructure, direct government investments, and various forms of social benefits. According to Bleˇci´c and Kosti´c (2016) and as discussed earlier in this chapter, through MIPA Montenegro offers FDI incentives, including corporate and personal tax exemptions for investing in undeveloped parts of the country for balancing development more evenly across the three regions of the country. However, full realization of these incentives’ positive results is overdue. In spite of policy efforts to spread FDI across the country, incentives have thus far resulted in additional FDI in the South and Central Regions, reinforcing the spatial disparities of Montenegro.

7.7 Prospects for FDI in Montenegro Montenegro became a part of the Federal People’s Republic of Yugoslavia in 1945, following the end of WWII. In 1963, the country was renamed the Socialist Federal Republic of Yugoslavia and it adopted the principles of a planned economy. During this period, an economic transformation was carried out as industrialization became the country’s model of development. Yugoslavia’s dissolution took place in 1991– 1992, resulting in the creation of five new countries. Together with Serbia, Montenegro became a part of the Federal Republic of Yugoslavia in April, 1992. As the significantly smaller partner in this union, Montenegro represented only five percent of the total GDP. Starting in 1992, UN Security Council sanctions dramatically affected Montenegro’s economy and industry, especially in terms of international economic relations. The sanctions pushed the country into high inflation and brought manufacturing to a standstill, with negative implications for all of Yugoslavia’s financial dealings and trade (New York Times 1992). The embargo prevented Yugoslavia from receiving any potential

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FDI, setting it back years behind other CEE countries. Access to foreign markets was only restored starting in 2002, when the State Union of Serbia and Montenegro was allowed to return to the world capital market (Mrdakovi´c-Cvetkovi´c 2006). Besides the sanctions, one of the main characteristics of the Montenegrin economy during the same period was the introduction of the process of privatization and transformation. Similar to other transition states, Montenegro’s transformation from a planned economy to a market economy relied on FDI, which were expected to play a significant role in the process. In Montenegro, this was especially important, taking into account the lack of domestic capital accumulation (Maksimovi´c 2002). However, the challenges in attracting a higher amount of FDI included uncertainty regarding relations between Serbia and Montenegro, as well as the issue of Kosovo and the high level of corruption and crime throughout the region. As a result of these unresolved political and economic issues, Montenegro’s level of FDI in the early 2000s remained insignificant. With independence in 2006, Montenegro quickly become the recipient of significant FDI inflows, as highlighted earlier in this chapter. This injection of foreign capital resulted in economic growth, increasing competitiveness, and new jobs, all of which contributed to Montenegro’s overall macroeconomic stability and credibility. The intense inflow of FDI relative to the country’s size helped Montenegro gain recognition in global economic and financial circles. At the same time, FDI is associated with significant risks, which are especially great when it comes to newly liberalized markets. The first MNEs came from origins with historically good cultural, political, and economic relations with Montenegro because they already had some familiarity and/or experience with this market and the region in general. Modes of international business such as trade and FDI have greater potential to flourish between countries that are geographically proximate and share historical and cultural connections (Dunning 1980; Dicken 2015). Therefore, it is unsurprising that MNEs from Russia, Italy, Austria, and Hungary were among the first and remain the most significant investors in Montenegro. Risks are mitigated for companies operating in familiar markets that share mentalities, culture, and historical experiences, such as those realized during the existence of the Austro-Hungarian Empire and the former SFRY. Montenegro, as a unilaterally “euro-ized” economy, attracted FDI by offering relatively low, flat tax rates, and by allowing overseas investors to remit profits, dividends, and interest freely. As mentioned earlier, Montenegro received EUR 4.6 billion in FDI over the past 18 years (WIIW 2019), the highest level among CEE transition states when measured relative to its GDP. Analyzing the largest foreign investments, once can conclude that the most successful sectors for attracting FDI have been the following: banking, tourism, telecommunications, energy, and manufacturing. Those FDI inflows have significantly contributed to change in Montenegro’s GDP structure. At the beginning of the period under consideration, the dominant forms of FDI were privatized facilities, while greenfield investments at that time were relatively few and small. Privatization of the telecommunications and banking companies was conducted in 2005, while privatization in the tourism industry was mainly carried out between 2001 and 2008. Privatizations in the manufacturing industry had already

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been completed prior to the GFC. Based on MIPA (2019) data, at the time of writing the major results of the process are 100% private ownership in sectors of telecommunication, banking, capital markets (including stock exchange companies and brokerage houses), agriculture, services, oil import and distribution, tourism, and energy. Following the privatization of several Montenegrin hotels during the pre-crisis period, significant greenfield investment in the tourism industry continues, which is expected to further improve existing Montenegrin tourism offerings. Furthermore, it is important to point out new greenfield investments in the energy sector, which may position Montenegro as a regional hub for exporting electricity. Montenegro possesses an enormous potential to develop hydro and thermal power plants given the abundance of rivers and streams, as well as newer types of green energy production such as solar and wind energy. Considering Montenegro’s favorable geographic location and abundant natural resources, it has great potential in the energy sector that is further enhanced by constraints faced by other countries due to continuous legislated reduction of carbon dioxide emissions. In last four years, Montenegro has registered several projects for the construction of new energy facilities linked with renewable energy sources. Montenegro’s FDI promotion efforts have been effective in the previously mentioned projects, as well as the construction of Italy-Montenegro cable underneath the Adriatic Sea. Since 2000, FDI inflows to Montenegro have been stable, averaging EUR 412 million annually. Despite the financial crisis, FDI inflows continued to grow through 2009, reaching a peak of EUR 1100 million, an outlier among SEE countries during the post-crisis period. Nevertheless, the GFC can be blamed for a 50% reduction of FDI in 2010. Since then, FDI has been relatively stable, averaging EUR 432 million annually, a slight increase vis-à-vis the pre-crisis period. For further development in Montenegro, more intensive investments are both necessary and likely in the future, especially given the goal of EU accession. Montenegro’s regions are characterized by geographic, economic, and social diversity. Accordingly, the accumulation and activities of FDI differs across the landscape, with the country’s Central and Coastal Regions receiving the largest inflows of FDI. The Central Region is the main destination for MNEs in the banking sector, telecommunications, real state, and wholesale. The Coastal Region attracted mostly tourism, real estate, and energy investments. The Coastal Region received the largest amount of greenfield investments, followed by the Central Region. Montenegro’s North Region, in contrast, is the country’s least developed, and received much lower FDI inflows thus far. However, this region is rich with natural resources and offers the potential for MNEs to invest in the tourism and energy sectors, which can be achieved through much stronger promotion through agencies such as MIPA. For Montenegro, a small, open economy that uses the euro as its currency, it is vital to attract outside sources of capital. However, attracting FDI from “traditional” (European) sources has become more challenging over the past decade. In response to the GFC, MNEs from the EU and NATO members have been affected by a wave of anti-globalization since 2008. Numerous additional domestic and international issues have affected these countries, resulting in the neglect of SEE. While the EU works to

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create a credible strategy for the Balkan region, its main member states fail to reach a consensus regarding future enlargement. EU opinions about enlargement range from no interest to enthusiastic interest. At the same time, other non-European countries are beginning to capitalize upon this window of opportunity to make themselves vital partners of Montenegro, and participants in its development. New financial opportunities are emerging in Montenegro from countries like the UAE, Azerbaijan and, most recently Turkey. In addition, significant financial flows in the form of loans have arrived from China. After years of attempts to obtain a suitable investor from the EU, Montenegro’s most significant infrastructure project thus far will be financed by China. Different countries are becoming the new global players, and Montenegro has the potential to benefit from their initiatives. In particular, China has asserted itself by expanding its FDI investment activity globally. Since 2000, China has evolved from being the largest recipient of FDI to one of the biggest sources of FDI globally (Ja´cimovi´c et al. 2018). China’s rise increases pressure on “traditional” origins of investors such as the EU and NATO. In the meantime, as China develops its One Belt One Road (OBOR) initiative, it has offered new partnership opportunities for CEE and SEE countries through the 16 + 1 initiative. In particular, WB countries represent a growing area of interest for Chinese investors because their EU prospects provide a potential opportunity for market access to larger markets. The Balkan region can play an important role for Chinese firms to adapt to a completely new business environment and rules, enabling further penetration of Chinese products and investments into the European market (Ja´cimovi´c et al. 2018). The positive effects of Montenegro’s NATO membership are already evident. In the first six months of 2018, FDI inflow from other NATO member countries reached EUR 215.2 million, compared with merely EUR 96.6 million during the same period in 2017 (CBM 2019). As a favorite tourist destination for multitudes of EU citizens and an important energy hub, Montenegro will certainly continue to serve as an important location for EU-based FDI. This openness to FDI is of utmost importance for the sustained economic development of Montenegro and will most likely continue to be supported by policymakers throughout the foreseeable future. The challenge for Montenegro will be to continue attracting advantageous FDI during a very uncertain period in the global economy. The international system is changing, and this will lead to a new hierarchy of ˇ economic, political, military, and ideological powers (Ceško 2019). It is increasingly evident that China is establishing the new balance of power in the world and that it is willing and able to support countries seeking assistance in the form of loans and development capital, positioning it to better achieve its own strategic goals. At the time of writing and in the context of COVID-19, it would be difficult to confidently attempt to predict future FDI inflows, let alone possible outcomes of FDI for Montenegro and the other former republics of Yugoslavia. It is apparent, however, that the global liberal order was already in crisis before COVID-19 (Grizold and Svetliˇci´c 2019) and the pandemic will undoubtedly continue to affect all aspects of FDI flows, including amounts, directions, and composition (UNCTAD 2020). Nevertheless, the only certainty is uncertainty, and a new group of countries has

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demonstrated strategic interest in Southeastern Europe that will impact the region’s future. Notably, the first countries to offer medical equipment and advice to Montenegro in response to this global crisis included Russia, China, and the UAE. Fortunately, in May 2020, the EU also reaffirmed its commitment to Montenegro (EEAS 2020) and its Western Balkan neighbors through the Zagreb Declaration (European Council 2020) and the allocation of EUR 3.3 billion in COVID-19 emergency relief for the region (European Commission 2020). This package includes EUR 53 for Montenegro’s health system, plus an additional EUR 60 intended to help alleviate the economic impact of the pandemic. Irrespective of the eventual economic effects of COVID-19, the long-term prospects for FDI in Montenegro look positive due to the country’s location and its affiliation with the EU. The EU is the final destination for Montenegro, as demonstrated by its long accession negotiations, de facto use of the euro currency since 2002, and as confirmed by the Zagreb Declaration of May 2020 (European Council 2020). This declaration reaffirms “unequivocal support for the European perspective of the Western Balkans.” While the declaration makes no specific mention of “enlargement,” “new membership,” nor “EU integration” for any specific countries, for the first time it emphasizes formally and explicitly the geopolitical importance of the region to the EU. EU membership represents the most important policy goal of the Government of Montenegro, and that of most of its political parties, supported broadly by public opinion. As has been the case in other transition countries, further European integration for Montenegro is perhaps the greatest assurance for attracting and sustaining a stable and favorable FDI portfolio.

List of Abbreviations CBCG CCCC CEE CEFTA CGES CRBC ECM EFTA EU FDI FRY GCI GDP GFC JV

Central Bank of Montenegro China Communications Construction Company Central and Eastern Europe Central European Free Trade Agreement Montenegrin Electric Transmission System China Road and Bridge Corporation Electric Company of Montenegro European Free Trade Agreement European Union Foreign Direct Investment Federal Republic of Yugoslavia Global Competitiveness Index Gross Domestic Product Global Financial Crisis Joint Venture

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MNE MVP OBOR OLI SFRY SMEs UAE UK US WB WIIW WOS WWII

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Multinational Enterprise Massive Voucher Privatization One Belt One Road Origins-Location-Internalization Socialist Federal Republic of Yugoslavia Small and Medium-Sized Enterprises United Arab Emirates United Kingdom United States Western Balkans Vienna Institute for International Economic Studies Wholly Owned Subsidiary World War II

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Danijela Ja´cimovi´c is a full professor at the University of Montenegro, Faculty of Economics. Her fields of interest include International Economics and European Integration. She participated in several EU projects and programmes, including being the holder of a Jean Monnet Module 2012–2015. Maja Ivanovi´c, PhD, is Advisor to the Vice Governor at the Central Bank of Montenegro, responsible for analysis, forecasting, and research of Montenegrin economic activity, inflation, and real estate market. Sunˇcica Rogi´c is a teaching assistant and PhD candidate at the University of Montenegro, Faculty of Economics in Podgorica.

Chapter 8

FDI in Kosovo Kyle Conahan, Joel I. Deichmann, Besnik A. Krasniqi, and Florin Peci

Abstract This chapter surveys the empirical literature on foreign direct investment (FDI) in Kosovo and then examines the inflows, origins, sectoral composition, and geographic distribution of FDI. Kosovo’s relative location, demographics, and investment laws provide positive conditions for attracting FDI. Many industries are available for investors under Kosovo’s privatization program, and several economic zones (EZs) have been established to further attract the attention of MNEs. FDI in sectors such as energy, agriculture, tourism, and telecommunications have particularly favorable implications for Kosovo’s development prospects through job creation and technology transfer. Nevertheless, inflows of capital have been disappointing thus far due to poor infrastructure, corruption, and unreliable institutions. The political situation remains unclear and variability remains in the enforcement of contracts and the protection of property. Prospects for FDI remain uncertain due to domestic and international political challenges and the economic consequences of the COVID-19 pandemic, which has hit many of Kosovo’s leading FDI origin countries particularly hard.

Portions of this chapter were presented by Kyle Conahan at the Transatlantic Students’ Conference Addressing Diplomatic, Economic, and Migration Challenges in Southeastern Europe, Florence, South Carolina, USA 23–27 April 2018. K. Conahan James Madison University, Harrisonburg, VA, USA e-mail: [email protected] J. I. Deichmann (B) Bentley University, Waltham, MA, USA e-mail: [email protected] B. A. Krasniqi University of Prishtina, Prishtina, Kosovo e-mail: [email protected] F. Peci University of Peja, Peja, Kosovo e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_8

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8.1 Introduction As predicted one-quarter century ago by Dunning (1994), foreign direct investment (FDI) has resulted in noticeable progress for the transition countries of Central and Eastern Europe (CEE). As a small, landlocked economy in Southeastern Europe (SEE), Kosovo stands to benefit greatly from inflows of foreign capital as it continues to restructure following the dissolution of Yugoslavia, and in the aftermath of its war of independence, which resulted in devastating physical and human losses. Moreover, the wars that took place during the breakup of Yugoslavia also resulted in isolation from the global community, both as a result of international sanctions placed upon Serbia and Montenegro, as well as pressure placed upon Kosovo by Serbia, Russia, China, and several EU members in objection to Kosovo’s sovereignty. FDI can benefit transition countries through the transfer of capital, technology, and know-how, and can increase the productivity of domestic firms (Javorcik 2004; Mavraj 2014, Alfaro 2017; Pavlínek 2017). The positive contributions of FDI can be seen in spillover effects, employment creation, and the availability of investment capital. Horizontal transfers include technology from MNEs to local firms at the same level of operation but at a different technological level. Vertical spillovers can take the form of increased competition and cooperation in domestic markets, as MNEs often seek inputs from the local market instead of shipping them from other locations (Magomberi and Odhiambo 2017). Employment effects are quite straightforward to measure. Foreign firms require local labor to complete necessary tasks, which reduces unemployment, and their wages result in new money in the host country’s economy, which also typically generates tax revenue. Because Kosovo has a small, low-income economy by European standards, its potential benefits from FDI are especially important. However, cumulative investment value through 2018 remains low at EUR 3.598 billion, compared to EUR 34.7 billion in Serbia (WIIW 2019). Kosovo continues to lack European-standard infrastructure as well as major clusters of population with the exception of its capital Prishtina. Leading up to and throughout Kosovo’s history as part of Yugoslavia, agriculture dominated the economic landscape. Kosovo’s war with Serbia resulted in a massive loss of life (approximately 13,000 deaths) and widespread displacement, reducing the population noticeably and devastating the economy (Domanovic 2014). Most property records were destroyed during the conflict of 1998–1999, making the process of determining ownership extremely difficult. Even today, it is common for multiple claims of ownership to be made based upon partial paperwork (ITA 2017b). As part of former Yugoslavia, then later because of its war-stymied transition, Kosovo’s population lacks experience with democratic and market participation. Yugoslavia’s unique approach to communism was more relaxed than many states under the Soviet sphere of influence, but still featured a centralized authoritarian state. Upon Yugoslavia’s collapse, Serbia under Milosevic was also highly centralized. Because Kosovo first held open elections in 2001, its democracy remains fragile in the midst of internal and external challenges to its legitimacy. At the time of writing,

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Kosovo is recognized by approximately half the members of the United Nations (UN) and most EU states, but not by the UN or EU as organizations. Kosovo remains mired in the longstanding Albanian-Serbian cleavage, and the related uncertainty deters risk-adverse MNEs from investing. While Kosovo and Serbia have begun to normalize relations, the war remains a very politically sensitive issue, even within the EU.1 Most countries that are reluctant to recognize Kosovo’s sovereignty also face their own challenges of large ethnic minorities and secessionist movements. In addition to Serbia, these include Russia, China, Spain, Romania, Slovakia, to name just a few. Naturally, MNEs from countries that do not recognize Kosovo face additional obstacles when considering FDI in Kosovo. Moreover, outsiders hold concerns regarding Kosovo’s rule of law and remain uncertain whether contracts will be ignored or enforced and protected. According to Hajrizi and Hasani (2013), uncertainty alone is the biggest concern for MNEs in Kosovo, fearing their investments will be not be protected. Another consequence of Kosovo’s conflict and economic hardship is the emigration of hundreds of thousands of Kosovars. As a result, Kosovo’s economy relies heavily on remittances sent from family members who live and work abroad. Domestic economic activity financed through these remittances is a vital lifeline for consumption in Kosovo. The International Organization for Migration (IOM 2012) estimates that about 800,000 Kosovars live abroad and send money back to Kosovo. According to the World Bank (2017a), Kosovo’s 2016 gross domestic product per capita of USD 3661 USD dramatically underestimates the real income level in the country because it excludes these remittances from abroad. Morina (2017) estimates that the yearly income from the diaspora is approximately EUR 1.5 billion, or roughly 22% of Kosovo’s economy. Most of this diaspora can be found in Switzerland and Germany, notably two of the leading origin countries for FDI in Kosovo. It is important to consider the likelihood that as Kosovo’s economic conditions improve the reliance on remittances will wane, ideally to be replaced by FDI. Krasniqi and Williams (2019) discover that the entrepreneurial intentions of Kosovo’s returning diaspora are affected by their level of trust and perceptions of risk in institutions at home. They advance the necessity of guiding the diaspora’s FDI into opportunities that are productive for Kosovo’s economy. Kosovo offers many potential advantages for MNEs. Aside from its location, it features low taxes, low labor costs, and project support through the Kosovo Investment and Enterprise Support Agency (KIESA)2 . Perhaps Kosovo’s greatest attraction is its corporate tax rate of 10 percent, one quarter lower than that of Ireland, which is considered a corporate tax heaven. Businesses investing in Kosovo are permitted to keep substantial portions of their earnings. Municipalities in Kosovo are allowed to lease property to foreign investors on ten-year contracts. Potential investors are assertively pursued by KIESA, which promotes Kosovo’s competitive advantages (ITA 2017a). The population is among the 1 For EU policy regarding Kosovo, please see https://ec.europa.eu/neighbourhood-enlargement/cou

ntries/detailed-country-information/kosovo_en. 2 https://kiesa.rks-gov.net/.

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youngest in Europe, with the age group of under-18 representing 46% of the total. Nevertheless, more than half of Kosovo’s population lives in rural areas, and 60% of its citizens have no formal qualifications or skills (Osmani et al. 2013). These demographic and educational challenges represent a labor problem whereby Kosovo has more entrants to the job market than positions. As a result, young people emigrate from Kosovo or remain on family farms, contributing minimally to economic growth. Finally, Kosovo has attempted to provide safeguards against uncertainty among potential investors by authorizing two investment insurance providers. The USbased international institution Multilateral Investment Guarantee Agency (MIGA) insures investments up to EUR 20 million. In addition, the US International Development Finance Corportation (DFC) specializes in political risk insurance for foreign investors, including those in Kosovo.

8.2 Literature on FDI in Kosovo The literature on FDI in Kosovo is relatively small, due in part to the recency of the country’s separation from Serbia, but also because inflows of foreign capital have themselves been small, even by Balkan standards. Compared to its six newlyindependent neighbor states, Kosovo has attracted the least FDI, despite the fact that its population is three times that of Montenegro. Since 2014, the literature addressing FDI in Kosovo is composed of two parts: analysis of factors attracting foreign capital (Dobranja 2014; Mavraj 2014; Kukaj and Ahmeti 2016; Beqiri 2017; Jensen 2018; Haliti et al. 2019) and impacts of FDI upon Kosovo (Mustafa 2014; Badivuku and Zogiani 2015; Xhemajli and Kalac 2015; Kukaj and Alishani 2017a, b; Brava 2019). The main findings are summarized in Table 8.1. Overall, a consensus prevails among scholars that FDI into Kosovo is insufficient, and this can be attributed to domestic political instability as well as Kosovo’s disputed status, which impedes investment from countries that recognize its independence, and virtually prevents capital flows from MNEs based in others that do not, such as Russia, China, Romania, and Spain. According to Alfaro (2017), FDI is considered to be a crucial driver of economic growth for the host country through a wide range of positive spillovers. This is also the overarching theme of research in the context of Kosovo, and scholars such as Dobranja (2014) urge policy actors to cooperate in order to build a more favorable environment to entice MNEs. Mavraj (2014) argues that private FDI is a much more effective engine for economic development than loans and grants, which have been relatively abundant in Kosovo. Mustafa (2014) finds that FDI should be encouraged as a driving force for increasing exports, as well as an instrument for increasing other positive spillovers. In contrast, empirical analysis by Islami et al. (2016) reveals that some FDI in Kosovo actually works to the detriment of the country’s trade balance through the importation of production components. To help compensate for Kosovo’s negative image abroad as described by Beqiri (2017), policymakers go to extreme measures to establish a favorable investment climate (Brava 2019). Given the importance of FDI to developing economies such as

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Table 8.1 Results of available literature related to FDI and Kosovo Author(s)

Topic

Objective and methods

Results

Dobranja (2014)

Investment policy design, process, and implementation in Kosovo

Democratic process, weak rule of law, and widespread corruption continue to operate as strong barriers to FDI

Cooperation among policy actors necessary to improve policy design and FDI environment in Kosovo

Mustafa (2014)

Role of investment and Descriptive analysis Investments are trade on Kosovo’s of data presented in considered drivers of economic development graphs and tables growth and exports exploring fluctuations of FDI over time, and effects on development

Badivuku and Zogjani (2015)

FDI and economic growth (case study of Kosovo)

Descriptive statistics, linear regression, and correlation of variables

FDI has a positive impact in economic growth in Kosovo

Mavraj (2014)

Importance of FDI for Kosovo’s economy development

Descriptive analysis (through secondary data) to analyze factors that effect FDI in Kosovo

FDI leads to long-term economic development, in contrast to loans, grants, and other subsidies

Xhemajli and Kalac (2015)

Impact of FDI on the Quantitative data economic transition collection to analyze development in Kosovo the current state of knowledge and the practical implementation of FDI strategies in Kosovo

Legal system in Kosovo since 1999 built in accordance with EU legislation; MNEs enjoy national treatment

Islami et al. (2016)

Relationship between FDI inflow and economic growth in Kosovo

Empirical analysis with Pearson’s correlation technique

Positive relationship between FDI inflow and GDP growth; negative relationship between FDI and trade balance of Kosovo

Kukaj and Ahmeti (2016)

Importance of FDI on economic development in transition countries: A Case Study of Kosovo

Qualitative and quantitative methods are used to evaluate causes of failure of FDI projects in Kosovo

Human capital accumulation and a significant increase in infrastructure provision are the crucial drivers of FDI (continued)

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Table 8.1 (continued) Author(s)

Topic

Objective and methods

Results

Beqiri (2017)

FDI in Kosovo: factor analysis and business profile from a Swiss perspective

Qualitative approach based on literature review and expert interviews

Political and legal factors as well as negative image are the primary reasons why MNEs avoid Kosovo

Kukaj and Alishani (2017a, b)

Evaluation of FDI and its impact on economies of transition countries, including Kosovo

Descriptive analysis of main causes of FDI failure, revealing importance of indicators that are mainly of institutional nature

Human capital accumulation and infrastructure improvement are the most important determinants of FDI in Kosovo

Jensen (2018)

Analysis of FDI in Kosovo

Literature review of key indicators such as production factors, labor costs, and competitive advantage opportunities

Economic and political factors reflect both opportunities and risks for investing in Kosovo

Brava (2019)

Importance of FDI in Descriptive analysis Kosovo; justification of of current policies to attract it institutional policies related to FDI

Haliti et al. (2019)

Investment environment’s role in FDI attraction to Kosovo

Institutions of Kosovo take unusually serious steps to create a favorable climate and provide conditions for attracting FDI

IV-GMM times series Political stability and estimator control of corruption and violence have positive effect on FDI flows; distance is a deterrent

Kosovo that lack domestic sources of capital, Brava (2019) argues for less-restrictive monopoly policies and fiscal policies. Xhemajli and Kalac (2015) focus upon Kosovo’s newly-adopted legal system, which treats MNEs identically to domestic firms. Kukaj and Alishani (2017a, b) assess reasons for failure of FDI projects in Kosovo. They present their results as a basis for further development of human capital and infrastructure. Jensen (2018) provides a thorough review of these and other economic and political factors representing both opportunities and barriers for investing in Kosovo. For many MNEs, geographic distance and Kosovo’s reputation for political instability and corruption remain significant challenges, so Haliti et al. (2019) urge government policy to focus on controlling the latter in order to increase inflows of FDI.

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8.3 Origins, Sectoral Composition, and Location of FDI in Kosovo This section provides a descriptive overview of FDI flows into Kosovo over time, noting annual fluctuations, and well as the origins and activities of MNEs. Figure 8.1 illustrates the inflows of FDI to Kosovo, which peaked at EUR 440 million in 2007 with the announcement of the privatization of many state-owned enterprises. At that time, MNEs became aware of new opportunities to revitalize outdated facilities and public discourse centered around preparations for Kosovo’s independence. Most of this initial burst of FDI came from the diaspora of Kosovars living abroad, optimistic about the transfer of state powers to local institutions under the supervision of the United Nations Mission in Kosovo (UNMIK). The impact of the global financial crisis (GFC) is clear in Fig. 8.1, as inflows began to drop off in 2008, followed by subsequent partial rebounds. This situation is not unique to Kosovo, as most of Yugoslavia’s successor states discussed in this volume experienced a similar inflow reduction during the period 2008–2009. What is different about flows of FDI to Kosovo is their inability to recover following the GFC. International concerns surrounding the Government of Kosovo (GOK) escalated. The business environment became considered weak as reflected by the failed telecom privatization and other problems at the Privatization Agency of Kosovo (AKP). At the same time, uncertainty grew in the midst of delays in the passing of Kosovo’s new constitution. Kosovo’s large inflow of EUR 308 in 2015 was the result of the GOK announcement that corporate and personal income taxes would be reduced. The 2016 introduction of the Law on Strategic Investment was intended to streamline FDI in specific sectors of national interest. As Kosovo’s economy experienced gradual 500.0 450.0 400.0 350.0 300.0 250.0 200.0 150.0 100.0 50.0 0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Fig. 8.1 Annual inflows of FDI to Kosovo, 2004–2018 (EUR mil). Source Central Bank of Kosovo (as reported by WIIW 2019)

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growth, inflows of FDI decreased as measured by their value relative to GDP (Table 8.2). This is not necessarily problematic during periods when economic growth is robust. However, the net inflow of investment value to Kosovo has also diminished over time. In 2007, FDI was valued at EUR 450 million, but by 2016, it had dropped to EUR 150 million due to several significant withdrawals of projects (World Bank 2017a). Declining FDI suggests that MNEs have become pessimistic about the domestic business climate in Kosovo and are increasingly unsure of its future prospects. In 2018, the most significant withdrawal of foreign capital from Kosovo returned to the Netherlands, totaling EUR 39.7 million. According to WIIW (2019) data, divestment from Kosovo also occurred by MNEs based in Slovenia (EUR 8.7 million), Romania (EUR 2.6 million), and UAE (EUR 2.5 million). Another variable that provides an excellent yardstick for the potential impact of FDI on the host society is cumulative FDI per capita (Fig. 8.2). Measured this way, relative inflows grew most quickly in the run-up to independence as significant privatizations took place. FDI as a percentage of GDP remained strong in the years immediately following the GFC, a time period when GDP growth halted. According to the World Bank (2019), GDP growth in Kosovo from 2007 to 2017 averaged 3.73 annually. As shown in Fig. 8.2, while the annual inflows of FDI fluctuate over time and their values as a percentage of GDP diminish, the cumulative value continues to increase on an annual basis, albeit at a slower rate since 2015. In response to sluggish inflows, in 2016 the GOK adopted its “Law on Strategic Investment” in hopes of encouraging more FDI. The law’s primary focus is to transfer ownership of state-owned enterprises to investors in strategic industries. What makes the law unique from other privatization schemes is that in special cases, the law permits the GOK to negotiate directly with potential investors, bypassing traditional bidding procedures. Normally, when governments sell off public assets, they must announce a public tender for bids and begin negotiating the proposed offers. This new law allows Kosovo’s government to expedite the process, thereby encouraging business activity by removing the often-despised red tape of the public procurement process. To probe more deeply into possible explanations for Kosovo’s slowing pace of foreign capital accumulation, it is worthwhile to examine the leading origins of MNEs (Fig. 8.3), while bearing in mind the withdrawal of EUR 35.8 million in Dutch-registered projects since 2012. Since 2008, the leading origins of Kosovo’s investment are Germany and Switzerland followed by Turkey, the UK, Albania, and Austria (WIIW 2019). The United States, Slovenia, Sweden, and Italy round out the top ten. Turkish MNEs have been especially active with infrastructure projects, including Prishtina International Airport and the improvement of Kosovo’s highway network, as well as energy production. The Kosovo Energy Corporation J. S. C. (KEK) is a monopoly that was privatized in 2012 and purchased by Turkey’s Calik Holding & Limak. KEK’s two thermal power plants named Kosova A and Kosova B produce 97% of Kosovo’s energy from coal. Collectively, EU member states represent about half of the total value of FDI into Kosovo. MNEs from non-member states have seen Kosovo as a gateway to the

FDI/GDP

3.6

2005

9.4

2006

12.7

2007 9.4

2008

Source Central Bank of Kosovo (as reported by WIIW 2019)

2004

1.5

Year

Table 8.2 Annual FDI inflows as a percentage of GDP 7.1

2009 8.3

2010 8.2

2011 4.5

2012 5.3

2013

2.7

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5.3

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3.6

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4.0

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2000.0

1500.0

1000.0

500.0

0.0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Fig. 8.2 Cumulative inflow of FDI per capita (EUR mil) to Kosovo, 2007–2018. Source Central Bank of Kosovo (as reported by WIIW 2019)

Fig. 8.3 Cumulative FDI in Kosovo 2008–2018 by origin (EUR mil). Source Central Bank of Kosovo (as reported by WIIW 2019)

EU market since 2015, when Kosovo signed the EU’s Stabilization and Association Agreement (SAA), which among other things creates a free trade area subject to EU standards and laws. The objective of the agreement is to integrate Kosovo more closely with the EU, while promoting sustainable economic growth in Kosovo (Council of the EU 2015). The US corporate presence in Kosovo is largely associated with NATO’s military presence (KFOR). Kukaj and Alishani (2017a, b) consider the significant flows of FDI from Albania to Kosovo as a positive sign of regional cooperation between two culturally-similar countries. Strong flows of FDI from Albania are unsurprising given its shared border

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as well as linguistic and religious similarities with Kosovo. These investment flows are especially noteworthy because Albania itself struggles to attract sufficient foreign capital to support its own domestic growth. It is also worth pointing out that the USA ranks seventh as an origin of FDI in Kosovo, with approximately EUR 180 million through 2018. Notably, US firms are relatively less active else where in former Yugoslavia. Among other major US-based MNEs, Federal Express and United Parcel Service are active in Kosovo. Non-core EU origins of note include Slovenia (EUR 442 million), which joined the EU in 2004, and Bulgaria (EUR 126 million), a new member in 2007. Among other major investments, Slovenia is home to Telekom Slovenia, a main competitor in Kosovo’s information technology and communications (ITC) market that offers mobile communications, fixed telephony, digital cable television, Internet services, and media. Telekom Slovenia was the first operator to offer 3.75G network speed in Kosovo. It is also worth mentioning several countries with MNEs that are active elsewhere in former Yugoslavia, but virtually absent from the list of FDI origins in Kosovo. These include Spain with merely EUR 4.1 million, as well as Russia and China, each registering less than EUR 250,000. Kosovo began the process of privatization in the early 2000s, resulting in the extensive sale of real estate. The strategic process of privatization is important for understanding the composition of FDI in the country, as it determines the facilities in each industry that are available for purchase. The Privatization Agency of Kosovo (PAK) oversees the privatization of public assets, including agriculture, mining, and hospitality services. Given Kosovo’s absence of domestic capital and the resulting need for funding from abroad, a sizeable portion of state-owned enterprises (SOEs) either have been purchased by foreign investors or are available for purchase. Figure 8.4 shows the breakdown of FDI in Kosovo by industry. Kosovo’s FDI inflows are heavily concentrated in the real estate sector (58.2%) and the financial sector (13.5%), followed by support services (7.6%), energy (7.0%), and manufacturing (6.1%). Fig. 8.4 Breakdown of cumulative FDI by industry 2012–2018 (percent of total). Source Central Bank of Kosovo (as reported by WIIW 2019)

Wholesale & Retail, 5.6

Professional Services , 2.0

Manufacturing, 6.1

Electricity & Gas, 7.0

Support Services, 7.6 Finance & Insurance, 13.5

Real Estate, 58.2

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Kosovo’s most widely-privatized state asset has been real estate, and much of it has been sold at a discount. The impact of these sales on FDI composition is reflected in Fig. 8.4. Additionally, this real estate was already developed in most cases. For this reason, very little infrastructure and greenfield investment has been generated thus far by privatization. Moreover, profits from privatization have been repatriated abroad and are seldom reinvested into the Kosovo economy. Kukaj and Alishani (2017a, b) estimate that 559 EUR million in profits are being held in offshore accounts. The primacy of the real estate sector in Kosovo’s cumulative FDI can be explained simply by the fact that since 2007, property was the government’s choice of stateowned assets to sell. As one important example, in April 2015, Kosovo’s Trade and Industry Ministry signed a contract with a French-led consortium of international and local companies for the development of Brezovica, a mountain resort for skiing and outdoor sports. The investment is valued at EUR 410 million, to be spent by 2032. Many privatizations are much smaller but nevertheless important. Hajrizi and Hasani (2013) categorize such companies as “micro” enterprises because they often have fewer than ten employees. At the time of their analysis, 4032 of 4295 foreign MNEs (approximately 90%) fit this description. Among these, many enterprises register only a single employee because they are new entrants in Kosovo, and their operations remain at the stages of market research and analysis or business development. Finance is also a popular sector for MNEs in Kosovo (KPMG 2017). By law, all banks must be established in the legal form of a joint-stock company issuing shares with a minimum of seven million euros in registered capital. Banks— both foreign and domestic—are also required to obtain a license from the Central Bank of Kosovo before conducting operations. As of 2019, ten banks operate in Kosovo, and most of them are foreign. They include Bank for Business, Banka Kombetare, Tregtare-Kosovo Branch, Economic Bank, Komercijalna Banka ad Beograd-Mitrovica Branch, NLB Prishtina, Procredit Bank, Raiffeisen Bank, Turkiye Is Bankasi, Turkiye Cumhuriyeti Ziraat Bankasi A. S. Kosovo Branch, and TEB Sh. A. Kosovo is divided administratively into seven districts and 38 municipalities. With regard to spatial distribution, FDI in Kosovo is heavily concentrated in the capital city of Prishtina. This city has a population just over 200,000, or slightly more than ten percent of the national total, and its surrounding district contains nearly 480,000 citizens, almost one quarter of the national total. Outside of this urban agglomeration, additional industrial clusters have emerged through the establishment of Economic Zones (EZs), which are intended to target MNEs for greenfield investment. The GOK set up these EZs in compliance with EU and World Customs Organization standards. Kosovo offers four types of EZs: industrial parks for heavy industry, business parks for light industry and office buildings, technology parks for research and development, and economic zones for the production of export goods. Kosovo also designated three business parks, which are located in the municipalities of Mitrovica, Gjakove-Djakovica, and Drenas. Their specific purpose is to facilitate trade and export growth through specific rules facilitating warehouse construction, goods processing, goods transit, and free trade (Ministry of Foreign Affairs 2015). Foreign firms are permitted to import their factors of production for

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the manufacture of export goods without paying taxes or customs duties. Of these EZs, however, only Mitrovica has completed the necessary legal and administrative procedures for building new infrastructure. Additional initiatives are underway to establish EZs across the country, all outside of the capital district. The intention is to distribute foreign capital more evenly. The new EZs include the following: • • • • • •

Industrial Zone in Suhareka Dutch Industrial Park in Prizern Business Park in Vushtrri Technology Park in Shtime Economic Zone in Gjilan/Kamernica Economic Zone in Ferizaj

Also near the municipality of Mitrovica, the Kosovo-German-Israeli interest SOWI Kosovo committed to building a 30-turbine wind farm that will go online by the end of 2020, valued at EUR 169 million. This green energy joint venture was negotiated by the GOK under the Law on Strategic Investment discussed earlier (German Embassy in Prishtina 2019). Kukaj and Alishani (2017a, b) argue that some foreign firms are attracted by Kosovo’s low labor costs, but at the same time others are inhibited by the enormous expense of training employees to international standards in certain industrial sectors. Nevertheless, many ICT firms have committed to FDI projects seeking young, highlytrained software technicians. Two recent examples from Germany include Imbus AG, which opened a software testing center in Peja (So-Co-It 2016), and ABIDAT, a contractor for Siemens, which will develop software in the country (Explaining Albania 2019). Among the constraints limiting the further diffusion of FDI throughout Kosovo is internal accessibility. With regard to infrastructure, Kosovo lacks an efficient interconnected road network. Poor roads between Kosovo and its neighbor North Macedonia cripple otherwise natural bilateral trade flows, which dropped by EUR 200 million in 2015 (Marusic 2016). Hajrizi and Hasani (2013) point out that road links with Serbia are somewhat better, with improvements planned for connections to North Macedonia, Albania, and Montenegro. Improved infrastructure will not only help MNEs stay connected to their headquarters and customers; it will also help domestic businesses establish better supply chains and expand their markets. According to KPMG (2017), other sectors of Kosovo’s economy with strong potential for FDI include agriculture, tourism, banking, and telecommunications. Kosovo’s large but antiquated agriculture sector has been virtually ignored by MNEs, but it could easily benefit from foreign know-how to facilitate modernization and increased productivity through vertical integration into food processing. FDI in tourism flourished throughout the Western Balkans region until the COVID-19 pandemic crippled travel. With regard to tourist amenities, Kosovo is endowed with diverse geography and a rich history, although it lags behind in terms of modern infrastructure for mobility and accommodation. Finally, it is worth mentioning

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Kosovo’s ITC sector, because one of the largest remaining fully state-owned enterprises is Kosovo Telecom (KT) with 2400 employees (KPMG 2017). This company competes with IPKO Telecommunications LLC, a subsidiary of Telekom Slovenia and is a potential target for investors. With regard to FDI in the power sector, KPMG (2017) suggests that Kosovo’s outdated and coal-dependent energy sector has great potential through further foreign participation. Hydropower also has potential in Kosovo, but thus far is much more limited in scale. Two challenges plague the energy sector in Kosovo: insufficient production, and widespread technical and commercial losses. These problems are particularly daunting as Kosovo’s demand for electricity increases. Kosovo represents a largely underutilized destination for FDI due to a delayed transition as well as political and institutional handicaps. Its declaration of independence in 2008 hastened the processes of institutional transition and convergence with much of Europe. Despite Kosovo’s decentralized mode of governance under Yugoslavia’s communist political framework, its people remain relatively unaccustomed to democratic practices and market economics. These features make Kosovo less appealing as an investment location. Notwithstanding considerable progress (Wilson 2006), the informal economy and corruption continue to pervade business in Kosovo. In light of these challenges, Boettke et al. (2008) argue that elected officials need to be held publicly responsible for completing promised institutional reforms and building a more transparent environment for business.

8.4 Conclusions and Prospects for FDI in Kosovo FDI in Kosovo remains constrained by a landlocked location in Southeastern Europe, small market of approximately two million, and troubled recent past. However, Kosovo’s geographic position can be leveraged, as with the development of infrastruucture it will provide excellent access to European and Balkan markets, and its young and inexpensive labor force offers greater potential for the future. Kosovo ranks 44th globally in ease of doing business (World Bank 2019), notably ahead of Belgium, China, and Serbia. This ranking is attributable to Kosovo’s deliberate reduction of administrative burdens on businesses, guided by the World Bank (2017a). The vast majority of FDI into Kosovo originates in Central Europe, Turkey, and elsewhere in the Balkans, in sectors where Kosovo offers comparative advantages, including real estate, finance, and other services. Kosovo promotes itself on the basis of its location, its physical geography, and youthful population in its efforts to target FDI projects in strategic economic sectors, with two examples being renewable wind energy (SOWI Kosovo) in Mitrovica and ICT (German Imbus AG) in Peja. Nevertheless, Kosovo has thus far failed to reach its potential in attracting FDI for a number of reasons. Although replete with arable land, within Yugoslavia it was considered a poor and peripheral agricultural region. As Yugoslavia began to break up, Kosovo was handicapped by conflict and international isolation as part of a truncated Yugoslavia. As other regions of former Yugoslavia courted EU and NATO membership, the territory of Kosovo was devastated during its own war of secession, resulting in loss of life and property at a crippling scale. As a result of all these events,

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Kosovo lags significantly behind other transition regions of Europe, including other portions of former Yugoslavia. Today, Kosovo’s status remains disputed by half of the global community, including its neighbor Serbia as well as Russia, China, and other powerful countries. In sum, Kosovo’s current state of affairs presents an array of challenges in attracting FDI. Furthermore, post-COVID-19 global economic uncertainly will introduce new constraints on the availability of capital, which may be especially difficult for small economies like Kosovo to overcome (Economist 2020). As a landlocked entity, Kosovo is unlikely to benefit as fully as its neighbors that enjoy sea access through the realization of China’s Belt and Road Initiative (CBI). To help Kosovo catch up economically with its neighbors by attracting more FDI, the GOK has introduced economic zones and legal changes to encourage a more favorable environment for FDI. Nevertheless, even within the government itself, corruption remains a deterrent to MNEs. Reforming institutions is especially difficult because of Kosovo’s lack of experience with transparency and democracy. Over the next decades, policymakers in Kosovo should play an active role in FDI, not just by maximizing inflows of capital to the country, but by strategically targeting certain MNEs and sectors. Although historically weak in manufacturing, Kosovo would benefit from more FDI in this sector, which, in the absence of existing factories, would require the introduction of greenfield projects. Manufacturing FDI usually entails constructing plants, as well as labor and management to oversee operations, and it can therefore result in the creation of infrastructure, job training, and other multiplier effects. FDI in banking reinforces the financial sector, making further capital available through lending, which can then be used by domestic actors to buy houses, start or expand their own businesses, or invest in others. FDI in the energy sector can be instrumental if renewable and sustainable (e.g., see Chap. 7 on Montenegro), but non-renewable energy projects would remove scarce resources from Kosovo and contribute to environmental degradation. Across industries, each project should be assessed on a case-by-case basis, with the goal being promotion of FDI that contributes to Kosovo’s sustained economic development. Kosovo’s leadership seeks to work with international partners to improve its investment environment for foreign capital. Recent initiatives have been launched with the EU, the World Bank, and Kosovo’s WB neighbors. Kosovo signed the EU’s Stabilization and Association Agreement (SAA) in 2015 to promote trade, adding credibility to Kosovo as a legitimate EU partner. Kosovo is included in the Zagreb Declaration of 2020, which affirms the strategic importance of the WB region to Europe, as well as the region’s political and economic orientation toward the EU (European Western Balkans 2020). As a gesture of the EU’s commitment to the region, Kosovo is already the recipient of EUR 100 million in EU funds to ameliorate the economic detriment caused by COVID-19 (Euronews 2020). Kosovo embraced the World Bank’s (2019) strategy to build its financial system and promote economic stability, as well as policy reforms to target strategic FDI with greater spillovers. Kosovo’s “Competitiveness and Export Readiness Project,3 ” guided by the World Bank, strives to promote export industries to improve its balance of payments. 3 https://documents.worldbank.org/curated/en/619361495332051749/Kosovo-Competitiveness-

and-Export-Readiness-Project.

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A crucial part of this latter initiative is to secure a more reliable energy supply by promoting efficiency and new sources including renewable energy, as well as integration into regional power markets (World Bank 2017b). Finally, Kosovo is a participant in an EU initiative to create a Western Balkan Regional Economic Area (WBREA) with Albania, BiH, Montenegro, North Macedonia, and Serbia. The WBREA stipulates free trade comparable to the EU common market with the aim of integrating participants and potentially preparing them for EU membership by stimulating private sector growth (European Commission 2017). Notwithstanding the immediate challenges of COVID-19 and concomitant economic fallout, Kosovo’s ongoing integration with the EU as well as diplomatic and economic cooperation with other neighbors enhance its prospects for growth, supported by a more selective maintenance of its FDI portfolio.

List of Abbreviations AKP BiH BRI CEE EU EZ FDI GCI GDP GFC GOK IOM KFOR KIESA MIGA MNE NATO OLI SAA SFRY SME SOE UNMIK UK US WB WBREA WIIW

Privatization Agency of Kosovo Bosnia & Herzegovina Belt and Road Initiative Central and Eastern Europe European Union Economic Zone Foreign Direct Investment Global Competitiveness Index Gross Domestic Product Global Financial Crisis Government of Kosovo International Organization for Migration Kosovo Force (NATO Mission in Kosovo) Kosovo Investment and Enterprise Support Agency Multilateral Investment Guarantee Agency Multinational Enterprise North Atlantic Treaty Organization Origins-Location-Internalization Stabilization and Association Agreement Socialist Federal Republic of Yugoslavia Small and Medium-Sized Enterprise State-Owned Enterprise United Nations Mission in Kosovo United Kingdom United States Western Balkans Western Balkan Regional Economic Area Vienna Institute for International Economic Studies

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References Alfaro L (2017) Gains from FDI: macro and micro approaches. World Bank Econ Rev 30(Supplement 1):S2–S15 Badivuku-Pantina M, Zogjani J (2015) The FDI and economic growth: case study for Kosovo. Iliria Int Rev 5(2). https://www.iliriapublications.org/index.php/iir/article/view/77 Beqiri A (2017) FDI in Kosovo: factor analysis and business profile from a Swiss perspective, Master thesis, 10.21256/zhaw-2092. https://digitalcollection.zhaw.ch/handle/11475/7690 Boettke P, Coyne C, Leeson P (2008) Institutional stickiness and the new development economics. Am J Econ Sociol 67(2):332–358. Accessed 5 Apr 2018 Brava F (2019) Importance of FDIs (FDI) in Kosovo and creation of favorable policies in attracting them. KNOWLEDGE—Int J 30(6). https://ikm.mk/ojs/index.php/KIJ/article/download/975/407 Central Intelligence Agency (CIA) (2017) Kosovo. Central intelligence agency. https://www.cia. gov/library/publications/the-world-factbook/geos/kv.html. Accessed 11 Dec 2017 Council of the European Union (EU) (2015) Stabilisation and association agreement (SAA) between the European Union and Kosovo signed. Consilium Europa. https://www.consilium.europa.eu/ en/press/press-releases/2015/10/27/kosovo-eu-stabilisation-association-agreement/. Accessed 4 Apr 2018 Dobranja D (2014) Investment policy design, process and implementation in Kosovo, Public Policy Making in the Western Balkans, pp 133–149. https://doi.org/10.1007/978-94-017-9346-9_7 Domanovic M (2014) List of Kosovo war victims published. Balkans insight. https://www.balkan insight.com/en/article/kosovo-war-victims-list-published. Accessed 4 Apr Dunning JH (1994) The prospects for foreign direct investment in central and Eastern Europe. In: The economics of change in east and central Europe, pp 15–47 Economist (2020) Has COVID-19 killed globalization? The flow of people, trade and capital will be slowed. Online leader. https://www.economist.com/leaders/2020/05/14/has-covid-19-killedglobalisation. Accessed 10 May 2020 Euronews (2020) ‘The Western Balkans belong in the EU’, says Ursula von der Leyen. https://www.euronews.com/2020/05/06/the-western-balkans-belong-in-the-eu-says-urs ula-von-der-leyen. Accessed 13 May 2020 European Commission (2017) Western Balkans: regional economic area, European commission— fact sheet. Accessed 11 Mar 2018 European Western Balkans (2020) Zagreb declaration in shadow of COVID-19: WB has an EU perspective, EU assistance deserves public acknowledgement. https://europeanwesternbalkans. com/2020/05/05/zagreb-declaration-in-shadow-of-covid-19-wb-has-an-eu-perspective-eu-assist ance-deserves-public-acknowledgement/. Accessed 5 June 2020 Explaining Albania (2019) Kosovo attracts e169 million FDI in wind energy. Available at https://exit.al/en/2019/02/04/kosovo-attracts-e169-million-direct-investment-in-windfarm/ExIt 2 April. Accessed 23 Nov German Embassy in Prishtina (2019) German ICT companies seeking youth potential in Kosovo. https://Prishtina.diplo.de/xk-sq/themen/wirtschaft/seite-it-unternehmen/1754158. Accessed 7 Nov Hajrizi E, Hasani M (2013) Kosovo investment climate and foreign investors’ perception. The International Federation of Automatic Control. Accessed 11 Mar 2018 Haliti B, Merovci S, Rexha D (2019) Impact of investment environment on FDI (FDI): Case of the Republic of Kosovo. Res J Finance Account 10(10). https://doi.org/10.7176/RJFA/10-10-07 International Organization for Migration (2012) Kosovo diaspora. International Organization for Migration: The UN migration Agency in Kosovo. https://kosovo.iom.int/kosovo-diaspora-0. Accessed 4 Apr International Trade Administration (ITA) (2017a) Kosovo- foreign investment. Export.gov. https:// www.export.gov/article?id=Kosovo-Openness-to-Foreign-Investment. Accessed 11 Mar 2018 International Trade Administration (ITA) (2017b) Kosovo- executive summary. Export.gov. https:// www.export.gov/article?id=Kosovo-Executive-Summary. Accessed 11 Mar 2018

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Javorcik B (2004) Does foreign direct investment increase the productivity of domestic firms? In search of spillovers through backward linkages. Am Ec Rev 94(3):605–627 Jensen J (2018) An analysis and evaluation of FDI in Kosovo. Int J Bus Adm 9(5). https://doi.org/ 10.5430/ijba.v9n5p88 KIESA (2019) Kosovo Investment and Enterprise Support Agency. https://kiesa.rks-gov.net/. Accessed 27 Nov 2019 KPMG (2017) Investment in Kosovo 2017. KPMG in Kosovo. Edition March 2017. Accessed 11 Mar 2018 Krasniqi B, Williams N (2019) Migration and intention to return: entrepreneurial intentions of the diaspora in post-conflict economies. Post-Communist Econ 31(4):464–483 Kukaj H, Ahmeti F (2016) The Importance of FDI on economic development in transition countries: a case study of Kosovo. Eur Sci J 12(7). https://dx.doi.org/10.19044/esj.2016.v12n7p288 Kukaj H, Alishani A (2017a) The evaluation of FDIs and their impact in the economics of some transitions countries: the case of Kosovo. Acad J Bus Adm Law Soc Sci 3(1). Accessed 11 Mar 2018 Kukaj H, Alishani A (2017b) The evaluation of FDIs and their impact in the economics of some transition countries: the case of Kosovo. Acad J Bus Adm Law Soc Sci 3(1). https://iipccl.org/ wp-content/uploads/2017/03/326-336.pdf Magomberi MT, Odhiambo NM (2017) FDI and poverty reduction. Comp Econ Res 20(2):74–88. Accessed 11 Dec 2017 Marusic SJ (2016) Bad roads blamed for Macedonia-Kosovo trade decrease. Balkan insight. https://www.balkaninsight.com/en/article/bad-roads-blamed-for-macedonia-kosovo-trade-dec rease-08-19-2016. Accessed 11 Mar 2018 Mavraj A (2014) The importance of FDI for Kosovo’s economy development. Eur J Res Reflection Manag Sci 3(4). https://www.idpublications.org/wp-content/uploads/2015/05/Abstract.pdf Ministry of Foreign Affairs: Republic of Kosovo (2015) Economic zones. Republic of Kosovo Ministry of Foreign Affairs. https://www.mfa-ks.net/?page=2,198. Accessed 11 Mar 2018 Morina D (2017) Kosovo awaits summer’s return of cash-rich diaspora. Balkan insight. July 13th. https://www.balkaninsight.com/en/article/kosovo-awaits-summer-s-return-of-cashrich-diaspora-07-12-2017. Accessed 4 Apr Mustafa L (2014) Role of the investment and trade exchange on Kosovo’s economic development. Int J Econ Commer Manag 2(11). https://ijecm.co.uk/ Osmani F, Gorton M, White J (2013) Agricultural households, poverty and the rural labour market in Kosovo. Post-Commun Econ 25(2):241–252. https://dx.doi.org/10.1080/14631377. 2013.787756. Accessed 11 Dec 2017 Pavlínek P (2017) Dependent growth: foreign investment and the development of the automotive industry in East-Central Europe. Springer, Berlin So-Co-It (2016) Kickoff for Imbis Peja. https://www.so-co-it.com/post/481467/kickoff-for-imbuspeja-new-near-shore-site-in-kosovo-for-software-development-and-testing.html Wilson JM (2006) Law and order in an emerging democracy: lessons from the reconstruction of Kosovo’s police and justice systems. Annals Am Acad Political Soc Sci 605: 152–177. Democracy, Crime, and Justice World Bank (2017a) World development indicators. Kosovo. https://data.worldbank.org/country/ kosovo. Accessed 11 Dec 2017 World Bank (2017b) World bank group’s new strategy in Kosovo spurs investment and exportoriented growth. The World Bank. https://www.worldbank.org/en/news/press-release/2017/05/ 24/kosovo-country-partnership-framework. Accessed 11 Mar 2018 World Bank (2019). Doing Business 2019: training for Reform. https://www.doingbusiness.org/ content/dam/doingBusiness/media/Annual-Reports/English/DB2019-report_print-version.pdf. Accessed 10 Nov 2019 Xhemajli A, Kalac M (2015) The impact of FDI on the economic transition and economic development in Kosovo. Acad J Interdiscip Stud 4(2). https://www.mcser.org/journal/index.php/ajis/ article/download/7224/6914

Chapter 9

Conclusions and Prospects for the Next Quarter Century Joel I. Deichmann

Abstract This concluding chapter reflects briefly upon the overarching themes surrounding the economic geography of foreign direct investment (FDI) in former Yugoslavia. In doing so, it examines common issues across the region of study and sets forth some plausible scenarios for FDI over the upcoming decades. Most of the countries in this volume lost at least one decade vis-à-vis other Central and Eastern European (CEE) states due to military conflict followed by various degrees of political and economic isolation. In the wake of the global financial crisis (GFC), they continue to struggle to converge socioeconomically with the core of Europe. Policymakers throughout the region view FDI as a means to help provide necessary capital to overcome this gap. FDI to the former Yugoslavia continues to be affected differentially by recent events, as well as country-specific prospects for EU integration and a shift toward new origins of FDI such as China and Turkey. These developments will continue to shape the landscape, composition, and impact of FDI in the region over the next quarter century. Keywords FDI · Transition economies · Former Yugoslavia · Southeastern Europe

9.1 Changing Times, Changing FDI The chapters of this book provide seven distinct geographic case studies, guided by a framework based upon Dunning’s (1980) eclectic approach for understanding FDI. Each of these Southeastern European territories is relatively small in terms of geographic area and population, but together they comprise a region of enormous geostrategic and economic importance. They share several attributes in common beyond their historical political union as Yugoslavia. Lacking advantages associated with large market size and abundant domestic capital, leaders from each entity have courted MNEs from abroad with the intention of attracting foreign capital to enhance employment and other positive spillovers for the betterment of their societies. As J. I. Deichmann (B) Global Studies Department, Bentley University, Waltham, MA, USA e-mail: [email protected] © Springer Nature Switzerland AG 2021 J. I. Deichmann (ed.), Foreign Direct Investment in the Successor States of Yugoslavia, Economic Geography, https://doi.org/10.1007/978-3-030-55739-3_9

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addressed by contributing authors, the geographic distribution of FDI in former Yugoslavia varies widely both between and within these successor countries, and it can be explained by specific location-specific advantages as well as linkages with the origin countries. This concluding chapter summarizes some of the most salient findings from the chapters of this volume. As scholars at leading universities across the former Yugoslavia, the authors’ insights are grounded in their respective academic disciplines (in most cases geography or economics), a thorough review of the international and regional FDI literature, and their first-hand observations of MNEs that are present in their countries. On this basis, the contributing authors have been able to tease out many features of FDI that may evade outside scholars. The authors frame their descriptive analyses around the structure of Dunning’s (1980) eclectic “OLI” paradigm, examining the flows, origins, composition, and location of FDI in their respective countries. In the next section, key findings from each author team are highlighted in the interest of extracting common themes to conclude this volume, followed by a recap of some of the overarching prospects for the region as a whole.

9.2 Summary of Contributions Ratkaj et al. (Chap. 2) provide a geographic perspective on FDI in the Republic of Serbia, the largest and most populous of the republics of the former Yugoslavia. Serbia represented Yugoslavia’s geographic and political core, containing its administrative capital Belgrade. The authors pay special attention to the turbulent history of the region, setting FDI in the context of Serbia’s changing economic and political situation over time. They highlight the difficulties inherited by democratically elected Serbian governments since the dissolution of Yugoslavia, such as the legacy of human and material destruction, and the lingering effects of international sanctions. As the largest market in the Western Balkans, Serbia has also been the most successful at attracting FDI, which is dominated by MNEs from Western Europe. The authors also examine FDI from “new” origins since the GFC, such as the United Arab Emirates as well as Turkey, realized through recent formal integration arrangements. They strongly caution decision-makers against the indiscriminate disbursement of incentives to MNEs that are likely to exploit short-term cost savings in Serbia without contributing to the country’s long-term economic development. In Chap. 3, Tica et al. examine the geographic and structural characteristics of inflows to Croatia since independence in 1991. Ranked second among successor states in cumulative FDI value, Croatia benefits from its favorable geographic position and diverse landscapes, which include the bulk of former SFRY’s Adriatic coastline. Nevertheless, the capital of Zagreb and its surroundings dominate the distribution of FDI, 84.7% of which is from MNEs based in other EU member states. Croatia’s FDI composition is concentrated in financial services, insurance, and pension funding, largely attributable to the privatization of large banks. Overall, the authors consider the sectoral composition of FDI in their country to be unfavorable, and like most of the

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other contributors, they lament the lack of greenfield projects that would result in the construction of new productive capacity. In conclusion, Tica et al. offer an optimistic forecast for FDI in Croatia during the mid-2020s, as the country continues with privatization efforts, completes EU-funded infrastructure projects, and takes further steps toward the adoption of the euro as its currency, a measure they argue will reduce the current exchange rate risk and facilitate new FDI inflows. In Chap. 4, Kušar offers a spatial perspective of FDI in the Republic of Slovenia, the former SFRY republic located at Southeastern Europe’s land and sea transportation crossroads. Among successor states, Slovenia was the first to gain independence and realize benefits from its central location in Europe and proximity to major economies such as Austria, Switzerland, Germany, Italy, and its other leading origins of investment. As a new EU member already in 2004, Slovenia joined the eurozone in 2007 and is consequently most deeply integrated with its currency and global production chains. With FDI representing merely 32.1% of GDP, this small, open economy is relatively less dependent upon foreign capital than the other countries examined in this volume. Even at this low level, Kušar argues that policymakers are concerned about overdependence on MNEs that may become problematic in the future. He urges government to promote new investment opportunities in services and high-tech industries rather than focusing on labor-oriented manufacturing, which has been a longstanding pillar of Slovenia’s economy and remains a strategic niche for MNEs there. Examining Bosnia and Herzegovina (BiH), Peštek et al. (Chap. 5) set the national context by explaining a disadvantaged position in attracting FDI due to the protracted war of independence that lasted from 1992–1995. Even long after that point, MNEs remained reluctant to invest due to the war’s consequent devastation and enduring political uncertainty in the new state. The privatization process has been handicapped by contentious claims of ownership, non-transparent processes, and the asymmetrical federal administrative structure of BiH. Nevertheless, advantages of BiH include its historical economic status within the former SFRY as a core manufacturing region. The authors pay special attention to FDI inflows before and after the GFC of 2008– 2009, revealing an increase in non-EU MNE participation over the past ten years. They also examine contrasts in the privatization process between the Federation of BiH and Republika Srpska, with implications of accelerated FDI in the latter since the GFC. They call for more assertive government efforts in improving institutional, economic, and fiscal conditions in order to promote more FDI and beneficial spillovers. They discuss potential future large investments in major energy and infrastructure projects, enabled by privatizations and capital from new sources such as China. In Chap. 6, Osmani and Ahmeti consider the case of FDI in North Macedonia, a landlocked country that is already highly integrated with existing EU economies, which represent all of its top six origins of FDI. The authors emphasize their concerns about the lack of transparency that has been demonstrated by imprudent concessions to attract MNEs toward its TIDZs and other privatized investment facilities. As the first Balkan country to begin the EU accession process as a candidate in 2005 and following the resolution of its name disagreement with Greece in 2018, North

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Macedonia signed the NATO protocol in February 2019 and became a full member in March 2020. In November 2019, the next steps for its EU membership were delayed by vetoes from other members, but the EU reaffirmed its commitment to Skopje and other candidates in May 2020. The authors argue that FDI’s prospects depend largely upon the symbolic validation of North Macedonia by EU and NATO through full membership in these organizations, as well as government’s ability to control the country’s problematic shadow economy. Jacimovi´c et al. (Chap. 7) examine the origins and activities of MNEs in Montenegro, the former republic that has achieved the highest level of cumulative FDI as a percentage of GDP. Having already adopted the euro as its official currency, Montenegro’s small, open economy ranks tenth globally for the ease of doing business1 and boasts the lowest corruption perceptions index2 among successor states of SFRY. The origins of FDI in Montenegro are predictably different than those of other successor states, with a strong presence of MNEs from Italy, Russia, Cyprus, Serbia, and the UAE. The authors highlight the detrimental impact of the GFC on FDI in flows, which are concentrated mainly in the financial sector of the economy. As is the case in North Macedonia, the authors regret reluctance by core EU states to move forward with the accession process for Montenegro, expressing a detrimental impact to FDI flows. They argue that the delay in EU accession, reaffirmed in November 2019, has caused frustration among Montenegrin leaders and citizens alike and encouraged more openness toward MNEs from non-EU sources, notably China, Turkey, Azerbaijan, and several Arab states. FDI in the Kosovo is explored by Conahan et al. in Chap. 9. Not only was FDI to this mainly agricultural region inhibited by Yugoslavia’s wars of dissolution from 1991–1995 and the international embargo against Serbia, but shortly thereafter in 1999 Kosovo experienced direct conflict during its own independence movement. The protracted timeline of war in the region and reluctance of foreign firms to locate and remain there have been extremely problematic for Kosovo’s economy. Since Kosovo declared independence in 1999, FDI flows in Kosovo have been anemic at best, and its economy continues to rely heavily on foreign aid as well as remittances from emigres who fled the country for safety or economic opportunity. Moreover, during several years, outflows of FDI returning to other countries have exceeded inflows to Kosovo (WIIW 2019). MNE presence in Kosovo remains strongest from German, Swiss, and Turkish MNEs, followed by those from several other EU countries as well as the United States. Also noteworthy is greater-than-average participation by firms from Albania and several Arab states, which is plausibly attributable to cultural affinities as discussed by the authors. Given Kosovo’s unresolved political status as set forth by UN resolution 1244/1999 and reluctance by risk-averse MNEs from some countries to operate there, it will continue to struggle to attract FDI, despite the injection of significant international aid and the continued presence of NATO’s Kosovo Force (KFOR) in the territory.

1 World

Bank (2019a). International (2019).

2 Transparency

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9.3 Trends Determining Regional Prospects for FDI This volume concludes with a brief discussion of some common themes that have been identified throughout the chapters. It is worth keeping in mind that the most likely trends to impact FDI in the region over the next quarter century are not mutually exclusive: The development of new infrastructure is being funded by both the EU (Gabrisch et al. 2016; Holzner and Schwarzhappel 2018; Lachert and Kami´nski 2019) and China (Jakliˇc and Svetliˇciˇc, (2019); Richet (2019) and will most certainly facilitate further FDI from both of these origins as China seeks better access to the European market. Nevertheless, as was made abundantly clear by the war of dissolution and the GFC, and is currently being witnessed during the COVID-19 pandemic, major disruptions in flows of international capital can be both unpredictable and devastating. Countries are increasingly interconnected through technology and infrastructure that facilitate commerce through trade and FDI. While the activities of MNEs can bring great opportunity for host countries, they can also leave them dependent on foreign capital and susceptible to events beyond their control.

9.3.1 European Integration Throughout these chapters, integration with the European Union has been discussed as the primary enabler of FDI, but also as a means for economic development and convergence. As was the case in most new EU member states of 2004, 2007, and 2013, arguably the single most important consideration that will determine future flows of FDI to these countries is their formal relationship with other European countries. With Slovenia an EU member since 2004, and Croatia since 2013, the remaining countries find themselves at various stages on the pathway to membership. North Macedonia has been an official EU candidate since 2005,3 and its name dispute with Greece, one of the main barriers to entry, was resolved in 2018. Montenegro and Serbia became candidates in 2010 and 2012, respectively. Through the Stabilization and Association Agreement (SAA) process, even BiH and Kosovo enjoy considerable trade privileges with the EU as potential candidates, receive substantial EU aid, and are linked with the EU through use of the euro, either formally (Montenegro and Kosovo) or informally (BiH). In its Zagreb Declaration of May 2020, the European Union reaffirmed its commitment to the Western Balkans (European Council 2020). Notwithstanding the ongoing fallout from Brexit and recent objections to enlargement by France and others, given their transition trajectories, it is reasonable to expect that most, if not all of these seven states could have full EU membership in the not-too-distant future. Of course, the obstacles to this eventuality should not be overlooked. These include resolving the leadership gridlock that plagues the government structure in BiH, set up by the Dayton Accords to cease conflict, but 3 As of May 2020. For updated information about EU enlargement, please see https://ec.europa.eu/ environment/enlarg/candidates.htm.

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thus far less than ideal for political and economic efficacy. In the case of Kosovo, Serbia’s protestations aside, even if it succeeds at meeting EU accession criteria, its disputed status will doubtlessly remain as a barrier to membership over enduring objections by Cyprus, Greece, Romania, Slovakia, and Spain, none of which recognizes its sovereignty. In all of the non-EU countries, as illustrated by Transparency International’s (2019) corruption perceptions indices for 2018 ranging from 37/100 (Montenegro and Kosovo) to 45/100 (North Macedonia), a great deal of work remains to be done to improve institutions and make business environments more transparent and competitive. With the exception of Slovenia, most of former Yugoslavia struggled along the journey of political and economic transformation that was realized much more rapidly by several post-Communist states of East Central Europe. These include wars in Croatia (1991) and BiH (1992–1995), along with economic sanctions isolating Serbia and Montenegro (including Kosovo), war in Kosovo (1999), and trade embargos on (North) Macedonia by Greece. As a result of these events, the region experienced a lost decade; it was deprived of the global economy’s benefits yet left susceptible to its downsides such as the GFC, just as it began to recover. Full integration into the EU would offer these countries a measure of economic security, including increased FDI inflows, expanded trade within the EU market, and more opportunity for domestic businesses to participate in international supply networks (Bartlett 2009). EU structural funds will result in better infrastructure and technology, while ameliorating regional disparities. Although EU membership is no guarantee of success, it certainly enhances prospects in the former SFRY, and it is therefore strongly advocated by all of the authors of this volume.

9.3.2 Transportation Infrastructure Development Economics and geography scholars alike emphasize the role of accessibility as a determinant of FDI flows (Blonigen 2005; Blonigen and Piger 2014; Koepke 2019). Infrastructure in this book’s region of study lags far behind the rest of Europe, with the partial exceptions of Slovenia and Croatia. Nevertheless, the situation is being improved dramatically through a series of projects supported by the EU, as well as other countries such as China and the UAE, along with private investors. Following the 2014 Berlin Conference of WB States, the Western Balkans Investment Framework (WBIF)4 began providing increasing financial and technical assistance for strategic investment to help countries in the region on their road to EU membership, mainly focusing upon infrastructure projects. EU structural funds support the improvement of existing infrastructure and the creation of new accessibility projects (Holzner and Schwarzhappel 2018). The main current transportation initiative supported by the EU is completion of the Balkan portion of Europe’s TransEuropean Transport (TEN-T) road network. This network will link the larger cities 4 For

more information on the Western Balkans Investment Framework, please see https://wbif.eu/.

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of the region together and enhance accessibility with EU member states. The main beneficiaries of these new corridors will be Serbia, Montenegro, BiH, and Kosovo, through grants, loans, and investments totaling approximately EUR one billion. As mentioned throughout several chapters of this volume, China’s chief infrastructure initiative for global accessibility is the “Belt and Road Initiative” (BRI), also known as the “One Belt, One Road” (OBOR) project, and it potentially has very positive implications for SEE (Cosentino et al. 2018). Upon its completion, this infrastructure venture will have a differential effect on the countries examined in the book. The most direct beneficiaries may be countries with access to the Adriatic Coast, where ports are being developed to facilitate trade along a route extending from Koper, Slovenia to Piraeus, Greece. Related to this enormous project, additional port infrastructure will be developed in Croatia and Montenegro, with road spokes extending into BiH, Serbia, Kosovo, and North Macedonia. Finally, other infrastructure projects have been introduced as public–private ventures, such as the 445-kilometer Italy–Montenegro submarine energy cable project valued at EUR 1.15 billion, signed in 2019. Already a leading FDI recipient relative to its economic size, Montenegro will be positioned as an energy hub, with benefits for development throughout the countries of the Western Balkans.

9.3.3 Shifts in Foreign Participation: The Rise of the East Natural (predictable) trade and FDI partners for WB states can be found throughout the rest of Europe due to its geographic and cultural proximity and shared history (Deichmann et al. 2020). However, it is worthwhile noting that over the past decade, most economic growth at the global scale has occurred in Asian countries (Dicken 2015; World Bank 2019b). Moreover, China is deliberately asserting itself as a global economic player, while European MNEs face uncertainty due to deliberations over Brexit and enlargement. At the same time, many MNEs from the USA that are very active at a global scale continue to play only a minor role in SEE. As China emerges in the region, it is also worth mentioning an increased presence in the region by Russian MNEs (Panagiotou 2020). Turkish firms have also become much more active, as highlighted in detail in several chapters (e.g. Chap. 2 by Ratkaj et al. Chap. 6 by Osmani and Ahmeti). Table 9.1 shows the ranks of leading global and regional economic economies based upon the value of FDI from MNEs from these countries. As the world’s two largest economies, the USA and China are important as origins of FDI in the former SFRY, yet the total value of their projects continues to pale in comparison with smaller European countries. Although this table is based on cumulative data and therefore cannot reflect an increase over time, a cursory examination of WIIW (2019) data confirms a recent acceleration of interest from these countries, as well as Turkey. It is reasonable to expect that given the more rapid growth of China’s economy vis-à-vis that of the USA (approximately ten percent annually over the past three decades) and China’s nascent BRI/OBOR, Chinese MNEs will show a much stronger presence

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Table 9.1 Ranks of selected major global and regional origin country in MNE activity based upon total cumulative FDI value through 2018 Origin Bosnia and Croatia Kosovo North Montenegro Serbia Slovenia Average Herzegovina Macedonia rank China

31

28

42

15

20

16

37

27.0

Russia

6

14

41

26

2

7

13

15.6

Turkey 11

16

1

7

19

27

32

16.1

USA

11

7

19

14

18

16

14.7

18

Source WIIW (2019)

in the region over the coming years. Specifically impacting the Western Balkans, the “Maritime Silk Road” portion of the BRI passes along the Adriatic coasts of Montenegro, BiH, Croatia, and Slovenia. Furthermore, major motorway corridor projects already under construction will better connect non-coastal cities such as Sarajevo and Belgrade to this maritime link between Athens and the core of the EU (Cosentino et al. 2018; Richet 2019). It is also worth noting the anticipated introduction of direct flights between China and the region, notably Croatia Airlines service to and from Zagreb’s new international airport, which was completed in 2017 (Bradbury 2018). Increased Chinese interest in Europe has been met by commensurate scholarly attention (Karreman et al. 2016; Jakliˇc and Svetliˇciˇc 2019; Richet 2019; Vangeli and Pavli´cevi´c 2019). These papers examine Chinese FDI in Europe, the volume of which has reached the level of European FDI in China. Richet (2019) analyzes Chinese FDI in three regions: Europe’s core (EU-15), the new member states, and the WB region, which is viewed as an alternate gateway to Europe through the 16 + 1 outreach program, intended to bring Chinese products to the mature markets of the EU through the BRI. Jakliˇc and Svetliˇciˇc (2019) monitor increasing trade and FDI between China and the countries of CEE, while highlighting considerable European suspicion toward the 16 + 1 initiative as a means to undermine its continental cohesiveness. Pavli´cevi´c (2018) and Vangeli and Pavli´cevi´c (2019) argue that through the 16 + 1 initiative, China will emerge in an unprecedented way, with prospects for its relationship with CEE developing and deepening in the future. With China’s emergence as a regional player in CEE, it is likely that at least some countries will welcome its gestures of closer relations. To the extent that FDI reflects this, thus far, these include North Macedonia, Serbia, and Montenegro. Examining data from 2003–2010, Karreman et al. (2016) point out that the overseas Chinese community has already been particularly effective in facilitating the expansion of Chinese business networks throughout Europe. Investors from Turkey, Saudi Arabia, Kuwait, and the UAE have also taken a much greater interest in Southeastern Europe over recent years, and this trend is likely to continue. Cultural proximity between Turkey, Arab states, and the Yugoslav successor states that have sizable Muslim populations such as BiH, Kosovo, and North Macedonia may help to overcome the friction of geographic distance to SEE.

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By cumulative value. Turkey is the largest origin of FDI in Kosovo and seventh in North Macedonia. Turkey also recently signed a free trade agreement with Serbia. Another example can be drawn from WIIW (2019) cumulative values in BiH, where Turkey ranks 14th as an origin, followed by Saudi Arabia (16th), Kuwait (17th), UAE (18th), and Malaysia (23rd). FDI from Muslim countries may suggest a growing market for Islamic finance and related businesses (Komorowski and Kubiszewska 2016), as the population of BiH is more than fifty percent Muslim. In addition, heritage tourism in the former Ottoman space of Southeastern Europe has recently expanded from predominantly Muslim countries, ushering in new business opportunities (Adie 2019). MNEs based in Arab states have also been increasingly active in North Macedonia (Chap. 6) and Kosovo (Chap. 8), both of which have significant Muslim populations. Even in Serbia where cultural similarities are absent, evidence exists of heightened activity by MNEs from the Middle East, including three recent large UAE projects (Ratkaj et al. Chap. 2). The rise of divestment is another noticeable and unpredictable trend in some of the countries examined in this volume. Policymakers and investors alike have learned from the GFC that even the best laid plans can go awry, completely beyond their control. Nearly every chapter in this volume highlights the impact of unexpected events such as the global financial crisis of 2008–2009 and COVID-19 upon the WB region. In many cases, MNEs from wealthy countries face the choice of protecting their assets either at home or abroad. During periods of waning demand in overseas markets, productive facilities owned by MNEs routinely get reduced in capacity, as was done in 2012 by the French automaker Renault at its Revoz production plant in Slovenia. Of course, such corporate transience can leave devastating impacts on the host countries that have come to rely upon the presence of foreign capital and its economic spillovers, especially the employment that MNEs provide (Pavlinek 2017). Arte and Larimo’s (2019) review of the divestment literature highlights the reasons behind the acceleration of this phenomenon, especially since the GFC of 2008–2009. The GFC resulted in the withdrawal of EUR billions in FDI throughout countries of the former Yugoslavia, with Slovenia being impacted almost immediately in overall value (e.g. Kušar, Chap. 4), and BiH experiencing noticeable changes in origins as MNEs from particular countries were more inclined than others to return home (e.g. Peštek et al. Chap. 5). Still other places such as Kosovo have witnessed divestment at a relative scale that has thus far not been recovered in the form of new FDI.

9.3.4 Uncertain Economic Impacts of Unpredictable Events The authors contributing to this volume have addressed two major unforeseen international events that have had a major economic impact on the states of the former Yugoslavia: the political conflict that led to the dissolution of the Socialist Federal Republic during the 1990s and the Global Financial Crisis that began in 2007. At the time of writing, the world is in the clutches of the COVID-19 pandemic. As citizens of every country seek to understand and respond to this pandemic, the weekly

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news magazine The Economist (2020) raises the question of whether COVID-19 has already “killed globalization” and with it FDI. The health crisis has only recently peaked in some countries but continues to accelerate in others. Many economies have already been devastated by the financial aftermath. Long after the health crisis comes under control, the ensuing “economic pandemic” will continue to have severe detrimental impacts on global FDI flows, which had already been declining in recent years (World Bank 2019b). As acknowledged by The Economist, it remains impossible to predict the full impact of COVID-19 on FDI and other aspects of globalization. However, given the pandemic’s enormous economic cost already, the eventual emergence of data will lead to a plethora of research opportunities that may help firms and host countries prepare for future setbacks to globalization. More optimistically, the COVID-19 pandemic may also result in new opportunities in certain FDI sectors such as healthcare and manufacturing of personal protective equipment. Global demand for health-related products and services could result in new opportunities for MNEs, as highlighted in Chap. 4 by Simon Kušar. Moreover, there will certainly be potential for new international activity in transportation, accommodation, and hospitality, as these industries become retrofitted in response to this highly contagious pandemic. UNCTAD (2020) urges national governments to pursue prudent policies to support investment and protect critical domestic industries until the crisis passes. Specifically, their suggestions include making investment approval procedures more efficient, expanding e-platforms for investment promotion agencies, offering incentive schemes for medical industries, and providing state support for struggling domestic firms within essential value chains. In the context of already-diminishing FDI prior to COVID-19, UNCTAD (2020) predicts FDI flow declines of up to 40% in 2020–2021 and calls for policy measures to alleviate this trend. However, the organization estimates that the pandemic may cause host governments to become even more restrictive toward foreign firms in order to safeguard against threats to public health. These forecasts are based upon events that are merely months old, and they relate differentially to specific MNEs, different industries, and various host countries. As discussed in Chap. 7 by Jacimovic et al. countries such as Montenegro have virtually been passed over by the pandemic itself with no new cases reported as recently as June 2020, but will nevertheless be impacted by its extended economic fallout as MNEs withdraw, delay, or cancel plans for projects.

9.4 Policy Suggestions The chapters highlight cases where FDI has resulted in positive impacts such as Johnson Matthey in Skopje, North Macedonia, which contributes enormously toward exports and maintenance of the national balance of payments. On the other hand, some host governments have also offered generous and non-transparent concessions without sufficient safeguards, resulting in enormous costs to the domestic economy as highlighted in Chap. 6 by Osmani and Ahmeti. In yet another instance, female

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employees of a South Korean firm in Serbia claimed they were denied break time and required to wear diapers rather than leave the production line to relieve themselves. This report was combined with other accusations of beatings, sexual harassment, and wage denials (Balkan Insight 2016). From these and other examples, it is in order to urge policymakers to proceed with caution before offering untenable incentives to foreign firms. Other institutions and the public must hold leaders accountable for hasty negotiations and over-generous concessions to MNEs. Of course, in a region where corruption often continues to hold sway over transparency, further reforms and public vigilance are more easily said than done. The governments of former SFRY territories included in this volume maintain offices that are charged with promoting investment from abroad, and many of them hold events abroad to market opportunities at home. Just a few examples include the Serbian Investment and Export Promotion Agency (SIEPA), Invest North Macedonia, and Bosnia’s Foreign Investment Promotion Agency (FIPA). It is both common and reasonable for elected leaders of government to seek public approval and recognition for attracting high profile MNEs to their countries while serving, but they must also be held responsible for their stewardship of national budgets, as well as protection of their workforces and natural environments. Moreover, FDI should not be promoted at the expense of support for domestic firms. Accountability occurs through transparency, and many governments have been less than forthright about the extent of concessions made to multinational corporations and the detrimental results of some FDI projects (Osmani and Ahmeti 2017). Given FDI’s demonstrated potential to promote growth (DeMello 1999, Javorcik 2004), MNEs should be supported just- like domestic firms on a level playing field. They should be judged on the basis of their capacity to enhance national accounts and produce positive spillovers. This means that FDI unlikely to do so should not be permitted to take place, and by all means, such MNEs should not enjoy incentives such as grants and loans, tax breaks, and subsidized infrastructure. Moreover, transparent investment environments should be established by governments to discourage corrupt insider practices. The type and origins of investment that should be encouraged are also important considerations. First and foremost, FDI should represent a cross section of productive industries. According to Pavlinek (2017, 47–73), host countries often leave themselves susceptible by allowing unbalanced FDI in a single industry. Second, following Ford et al. (2008), firms from different origins tend to behave differently depending upon conditions at home, so it makes sense for a host government to build a portfolio of FDI from a range of source countries to protect itself from crises and currency fluctuations. Third, government policy should encourage FDI in the form of joint ventures with domestic firms to enable greater linkages with and spillovers into the host economy. Finally, host societies should favor high value-added activities that provide employment opportunities as well as greater transfers of know-how and technology. The global economy continues to change, and the relatively small, newly independent countries of Southeastern Europe are particularly susceptible to global events

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such as the GFC and COVID-19 that lie beyond their control. At the same time, sentiment toward economic protectionism grows within many major economic players such as the United States and some European countries Emerging powers such as China and Russia have made strategic political and economic advances toward many of the countries covered in this volume that are more than symbolic. As flows of FDI from traditional North Atlantic origins decline, the vacuum is being filled by MNEs from Asia, in line with a general eastward shift of global economic gravity (Dicken 2015). As governments of these Southeastern European states continue to seek foreign capital to meet their domestic needs and advance their convergence with the EU core over the next quarter century, divergence from the FDI patterns that followed Yugoslavia’s dissolution is already evident. Drivers of these changes include further integration with the European Union, the continuing development of infrastructure, an increased interest by firms from Asia, and continued susceptibility to unanticipated events such as the GFC and COVID-19.

List of Abbreviations BiH BRI CEE EU FDI FIPA FSRY GDP GFC KFOR MNE OBOR OECD OLI SAA SFRY SIEPA TEN-T TIDZ UAE WB WBIF WIIW

Bosnia & Herzegovina Belt and Road Initiative Central and Eastern Europe European Union Foreign Direct Investment Foreign Investment Promotion Agency Federal Socialist Republic of Yugoslavia Gross Domestic Product Global Financial Crisis Kosovo Force Multinational Enterprise One Belt One Road Organization for Economic Cooperation and Development Origins-Location-Internalization Stabilization and Association Agreement Socialist Federal Republic of Yugoslavia Serbian Investment and Export Promotion Agency Trans-European Transport Network Technological Industrial Development Zone United Arab Emirates Western Balkans Western Balkan Investment Framework Vienna Institute for International Economic Studies

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