Foreign investment leads to increased tensions on the labor market

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The decrease of FDIs in the countries of the Central and Southeast Europe was accompanied by a recovery in the so-called greenfield investment. FDI inflow may increase but it will not return to the levels recorded before the global financial crisis.

According to a report published by the Vienna Institute for International Economic Studies (Wiener Institut für Internationale Wirtschaftsvergleiche, WIIW), in 2017 the countries of Central and Southeast Europe (CSE) received direct foreign investments worth EUR72bn, that is, one-quarter less than in the previous year. A decline of 20 per cent was recorded in the case of EU Member States from the region of CSE, while in Poland the decline reached 55 per cent.

The main reason behind the decrease in the value of FDI in this region was the large-scale disinvestment resulting from the acquisition of foreign-owned entities by domestic capital. The process of “repolonization”, whose flagship example was the acquisition of UniCredit’s 32.8 per cent stake in the Pekao Bank (worth EUR2.4bn) by PZU (the state-owned insurer) and the Polish Development Fund, was not a uniquely Polish phenomenon, and similar processes also occurred in the other countries of the region. In Hungary, the state took over foreign investors’ stakes in the energy industry, telecommunications and the banking sector, while in the Czech Republic domestic investors bought out foreign-owned assets in the media and telecommunication sectors.

New projects are absorbing workers

The disinvestment and the general decline in the inflow of FDIs in the countries of the CSE region were accompanied by a clear recovery in new investment (so-called greenfield investment). The number of announced projects increased by 11 per cent in relation to 2016, while their value rose by 27 percent. Poland was by far the most important location for these new investments.

Due to the strong economic growth, the countries of CSE may still look forward to rising inflows of FDIs in 2018. However, because of the subdued investment appetite of multinational companies, FDI activity will not return to the levels recorded before the global financial crisis.

Labor shortages could also become an important obstacle to new investments in the CSE region. Foreign greenfield projects announced in this region in 2017 provide for the creation of 220,000 new jobs. According to estimates presented by the WIIW, these greenfield projects absorb as much as 90 per cent of the potential new entrants to the labor market in Hungary and about 50 per cent of the new entrants in Poland and the Czech Republic. The percentage of new labor market entrants absorbed by these greenfield projects is lower, although still significant, in Slovakia (25 per cent) and Romania (20 per cent).

This is the reason why the further inflow of FDIs will likely be redirected further to the east or to the south. According to the WIIW, only the latter direction provides a viable alternative in the short term. The Western Balkans offer an underutilized pool of labor and improving infrastructure, while the inferior business conditions and infrastructure still discourage investment in countries located to the east of Poland, such as Ukraine.

In the longer term, industry 4.0, automation and digitization of production and services will reduce the role of labor costs in the splitting and location of value chains. This will inevitably lead to a reduction of investment attractiveness of CSE countries, including Poland — at least in relation their previous strengths.

Since the beginning of the economic transformation in Poland, the ruling elites and the experts have seen the creation of new jobs as one of the most important benefits resulting from the inflow of foreign direct investment. This approach was understandable in conditions of deep restructuring processes, resulting in double-digit unemployment. At the same time, for potential and actual investors, Poland’s broad resources of relatively cheap and relatively well-qualified workers were one of the key location assets and constituted the basis for the process of relocation of production from Western European countries.

Today the situation is fundamentally different. Due to demographic changes, the labor resources which were once seen as a severe societal problem but also an important development factor have become an increasingly important obstacle to the development of the Polish economy, especially in conditions of a continued strong economic growth.

Foreign investors are also aware of this phenomenon. This is confirmed by the results of the surveys which have been systematically conducted for many years at the request of the Polish Investment and Trade Agency and by the Polish-German Chamber of Commerce and Industry. These surveys indicate a systematic deterioration in the entrepreneurs’ assessments regarding the availability of qualified employees and the labor costs.

The data and estimates in the WIIW report indicate that these assessments do not fully translate into investment decisions. The decline in the importance of labor costs is seen as a factor in the location of investment projects, alongside the shrinking labor supply in Poland. Thus, it is important to change our approach towards foreign investors, providing priority to projects aimed at improving the level of technical advancement and innovativeness of the economy.

The data published by the Statistics Poland indicate, that in 2017 people working in companies with majority foreign ownership accounted for about one-third of all employees in Poland (excluding the financial sector and the micro-enterprises). The role of such companies as employers was relatively limited in the case of small enterprises (where they provided employment for every tenth employee), but it was higher in the case of medium-sized enterprises (where almost every fifth employee was employed by foreign-owned companies), while in large enterprises almost every other employee was employed in a company with majority foreign ownership.

These figures, along with WIIW’s estimates of the percentage of new labor market entrants absorbed by foreign greenfield projects, indicate that companies with foreign capital exhibit greater demand for new employees than companies with Polish capital. The competitive advantage of companies with foreign capital on the labor market could exacerbate the problems of Polish companies with recruiting new employees, especially in the most sought-after specializations.

Foreign direct investment falling across the world

The global financial crisis has brought a clear weakening of the global flows of FDI. In 2017, the strong decline in FDI flows was accompanied by a very good condition of the global economy (read more). According to UNCTAD, the value of the global flows of FDI decreased from USD1.87 trillion in 2016 to USD1.43 trillion in 2017 (i.e. a decrease of 23 per cent).

The experts at UNCTAD mainly attribute this decline to the significant decline in cross-border mergers and acquisitions, as well as the decrease in the profitability of FDIs observed in all regions (the average global rate of return for FDIs is estimated at 6.7 per cent compared to 8.1 per cent in 2012). The reduced FDI activity resulted in a slowdown in the development of global value chains. Nevertheless, for developing countries these investments remain the most important external source of financing (accounting for 39 per cent of total incoming finance).

The assessments of the prospects for the FDI market are very cautious. According to UNCTAD, this year the global inflows of FDIs will increase to USD1.45-1.57 trillion, i.e. by 1 to 10 per cent. However, they will remain well below the average value for the last 10 years. The current escalation of trade tensions is not conducive to increased investment in global value chains; and the tax reforms introduced in the United States in December 2017 may lead to a significant reduction in the value of foreign investments of American transnational corporations (from the current level of USD6.4 trillion to USD4.5 trillion).

Professor Janusz Chojna is an analyst at the Institute for Market, Consumption and Business Cycles Research.

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