The Contribution of Foreign Direct Investment to Transition Revisited

By its very nature, the systemic impact of privatization through foreign direct investment (FDI) has been unique because it has been part of the transition of Central and Eastern Europe from centrally planned to market economies without historical parallel. On balance, this impact has been positive, and more substantial than was expected at the beginning of the transition process. At the early phases of systemic transformation, the majority of the observers believed that Central and Eastern European countries only needed a formal change in ownership without major qualitative upheaval, and perhaps a dose of macroeconomic stabilization. This led them to conclude that FDI would not need to play a major role in transformation, which would instead be led by a nascent domestic private sector. As a corollary, they believed that FDI needed to be confined to its greenfield type, and was to be avoided in the privatization process. However, with some exceptions most Central and Eastern European economics had been lacking in private business and experience with markets for at least half a century. In retrospect, it is easy to deduct that the rapid switch from public to private ownership would not have been possible without the active involvement of foreign private investment, given the lack of experience and capital available locally. The transition from centrally planned to market economies involved not only an increased role for private enterprise and markets but also the elimination of the inefficiencies inherent in social ownership and planning and the restructuring of the production base and its integration into the international economy. Privatization related FDI has also contributed to the elimination of such macroeconomic and structural distortions inherited from the socialist economies as high degrees of shortages and slacks, soft budget constraints, price distortions and latent inflationary pressures