Geographic Factors As Determinants of Foreign Direct Investment in Eastern Europe's Transitioning Economies Jovana Trkulja Macalester College

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5-2-2005 Geographic Factors as Determinants of Foreign Direct Investment in Eastern Europe's Transitioning Economies Jovana Trkulja Macalester College

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Recommended Citation Trkulja, Jovana, "Geographic Factors as Determinants of Foreign Direct Investment in Eastern Europe's Transitioning Economies" (2005). Geography Honors Projects. Paper 4. http://digitalcommons.macalester.edu/geography_honors/4

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SeniorHonors Thesis

JovanaTrkulja

Advisor: David Lanegran GeographyDepartment MacalesterCollege

May2,2005 GeographicFactors as Determinants of ForeignDirect Investmentin Eastern Europe'sTransitioning Economies

Absffact

The removalof the "Iron Curtain"epitomizedthe shed of EastemEurope's central planning andthe region's adoptionof the Westemmarket system.To establisha comparativeadvantage in today'smarkets, the transitioningnations need financial assistancethrough Foreign Direct Investment(FDI). While mostresearch focuses on economicand political factorsas determinants of FDI this paperadditionally examinesthe regionsgeography. Results indicate that urbanconcentration, road networksand proximity to surroundingmarkets significantly attract foreign investors. The implicationsof capitalinflows aregeographically altering as the urbanand rural landscapesare modified to reflectthe new marketsystem.

Advisor:David Lanegran

GeographyDepartment MacalesterCollege Acknowledgements

I would like to thank all thosewho supportedme and advisedme on completingmy honorsthesis. Special thanks are further extendedto Dr. David l,anegranfor sparkingthe interestin me to becomea geographerand Dr. Laura Smith, Dr. William Moseley,Carol Gersmehland Laura Kigin for kindling the fire throughmy collegecareer. I would also like to extendmy thanksto Brent Hecht, for his computerprogramming skills that savedme preciousdays in finishing this project. Tableof Contents

ChaDterI Inhoductionto EastemEurope's Transitioning Economies ...... 1

Chapter ? TheTheoryBehindForeipDirectInvestrnent...... 7

Chaoter3 PreviousResearch and Findings...... 1 3

Chaoter4 Methodology...

Chapter5 ModelOutline, Data Sources and Expected Relationsfups...... 23

Chapter 6 AnalysisofObtainedResults...... 32

Chaoter Z The Effects of ForeignInvestrnent of Urban and Rural Landscapes. . ..40

ChapterE Conclusion...... 60 ChapterI Introductionto EasternEurope' s TransitioningEconomies

The removalof the "hon Curtain"in the 1990sepitomized the desireof economicallyand politically distressedEastern European nations to shedtheir central planningand adopt the Westernfree market system.l Prior to decentralizationthese nationsboasted some of the richestagricultural regions and heavy manufacturing plants.The U.S.S.R., with its formulizedproduction plans and long-term goals, was settingthe exampleas'ho othernation of comparablesize has ever experienced such a rapidpace of industrialization"(Alexander,1963;446). The yearsof centralized 'cry' governance,however, left deepscars on the countries'landscapes. The painful of the environment- eventhough heard by some2- remainedsuppressed through strict government"censorship of information,about environmental quality, unresponsiveness to local environmentalhazards and restrictions on formation of independent environmentalgroups" (DeBardeleben and Hannigan, 1995). This degreeof negligence andexpurgation was alsopracticed on issuesconcerning industry, education, and political relations.As a result,Eastern Europe was in dire needof a political and economicreform.

Today,these economies look at the incorporationof an efficient market system as the ticket for entry into the EuropeanUnion, and ultimately to an improvementin the living standardsof the local population.Though the notionof decentralizationis viewedpositively, the costsof undertakingthe necessaryreforms have been

t The removalof the "Iron Curtain" symbolizesgovernment and economicdecenhalization of Eastern Europeanblock. 2French (1990) mentions a publicationby a governmentofficial, Boris Komarov,titled The Destruction of Nature in the Soviet Union. As a result of this publication Boris Komarov had to leavethe country. underestimatedby a numberof nations.The yearsof absenceof meaningfulmarket pricing andthe existenceof considerablegovernment subsidies created little incentive for centrally plannedindustries to conserveand adoptprofit maximizing production schemes.The workforcein the heavymanufacturing industries felt the biggestimpacts of the reforms,since "labor-hoarding had been encouraged under socialism...and had beenestimated in Poland,for example,to makeup almost25 percent of the industrial workforce"(Hamilton,1999;136). Labor-hoarding refers to the over-employmentin the numberof workersrequired to efficientlyoperate of an industry.While this system ensuredlow levelsof regionalunemployment it causeda declinein the marginal productivityof labor.In otherwords having more workers than necessary to operatea productionsystem may causelower outputlevels since the workersare hindering, ratherthan aiding, each other in theproduction process. Consequently the de- industrializationof theseindustries left hundredsunemployed, causing production declinesand shortages. Accordingly, the governmentswere faced with the extreme burdensof budgetdeficits, hyperinflation, and lack of exposureto the competitive world markets.To climb out of the chokingdebt pressures and to establisha comparativeadvantage in today'smarkets, Eastern European nations are in needof financialassistance through Foreign Direct Investment(FDD.

ForeignDirect lnvestment(FDD entailsthe acquisitionof the homecountry's assetsfor the purposeof control.3Ownership can take a numberof forms.Investment cancome inas greenfieldinvestment, where the foreignfirm providesthe necessary capital to establisha new asset,such as an industrial plant. Foreign investmentcan comein is asmerger and/or acquisition of thehome firm. This is a popularform of

3For future referencethe foreign country refersto the countryproviding the FDI while the homecountry is the country acquiringFDI. investmentin countriesundergoing privatization of previouspublicly held entities.

Jointventureso on the otherhand, constitute a partnershipbetween foreign and home companiesfor reciprocalbenefits. Subcontracting and licenses are additional measures foreignfirms canuse to investcapital into the homecountry. In all cases,the home countryobtains the financialresources that act as"an engineof development,a vehicle of economicmodernization and a driving force of productivity development"

(Pavlinek,2004;1).

While westerneconomists and multinational institutions advocate "that successfultransition from centrallyplanned economy to a market-basedsystem could only be achievedwith largeinflows of foreigndirect investment" (Pavlinek,2004;3), theymostly focuson economicand political factorsas determinants of FDI flows.

Concentrationof FDI literatureon the abovestated incentives has createda theoretical frameworkof foreigninvestment called Factor Endowments-Basedtrade theory.

Grantedthat low wages,tax redemptionsand retained eamings are significant aspects in determiningFDI, thereare calls for otherfactors to be takeninto consideration.

Camposand Kinoshita (2003) encourage future research to follow their stepsin establishinga new tradeFDI model.The economistsincorporate institutions in their predictivemultivariable models, but acknowledgethe importanceand lack of inclusion of countries'physicalfactors. Coughlin and Segev (1997) inspect some of China's geographicfeatures in attractingFDI, but call for futureresearch to examinethe effects of transportationand proximity of the economiesto otherworld marketsin determining

FDI flows. This papertakes up thesecalls by statingthe following question:do geographicfactors have a significant effect in determiningFDI flows into Eastem Europe'shansitioning economies,and can hansportationact as an aid to athact filture

FDI?

Map 1.

The paperwill addressthe questionby using panel data for fifteen Eastem

Europeannations, illustrated in the map above,for the years 1995througb 2000.Most of the datahas been extracted and aggregatedfrom the World DevelopmentIndicators

Online (WDI), a data sourceof the World Bank. Furthermorg the definitions of the variablesused in the study are in line with the WDI datadefinitions, usedto construct the explanatoryvariables. In someinstances these definitions were limited and unclear.

The limitations will be addressedfurther in ChapterVI. Additional data sourcesare outlined in ChapterV. Furthermore,the studyrecognizes that that proxies usedto conductthe analysis arenot idealrepresentatives of foreigninvestment determinants. Their shortcomings will be tackledin ChapterVI wherefuture research proposals will be outlined.

As indicatedby themap above,the studysample excludes certain Eastern

Europeannations. The paperrecognizes Russia as a hansitioning economyin Eastern

Europe,however, the division of Russiainto Europeand Asia" as well asthe landsize of Russia,classifies the countryas an outlierin the sample.Russia, therefore, is not includedin the statisticalanalysis, and the sampledoes not representa fully random sample.It shouldbe notedthat evenwith the eliminationof Russiafrom the studythere arestill significantdifferences in landareas of the countriesexamined. These differencesare therefore expected to affectthe final results.Furthermore, ex-Yugoslav countries,with the exceptionof Croatiaand Slovenia,are excludedfrom the study due to lack of dataconsistency and availability.

As previouslystated, the regionhas been chosen as the focusof studydue to the o recenteconomic and political transition. The following sectionof the paperwill provide a theoreticalframework of FDI flows andthe advantagesof FDI. Previous literatureis outlinedin sectionthree in orderto providethe readerwith betterinsight into the theory,effects, and factors that influenceFDI inflows in today'sworld. The methodologyof the researchwill be presentedin sectionfour of the paper.The conceptualmodet andthe difficulties in obtaining accuratedata will be outlined in sectionfive, while sectionsix will examineand discuss the obtainedresults. In section seven,the advantagesand disadvantages of foreigninvestment on the homecountries' populationwill be addressed.Most importantly,the paperwill analyzethe effectsof a The 15 nations chosen are the following: Albania, Belarus, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Lailia, Lit}uania, Republic of Moldova, Polan4 Rornania, Slovakia, Slovenia and Ukraine. FDI on urbanversus rural settingsin the studiedregion. In the end, the study hopesto extrapolatethe extentto which transportationfactors can attract foreign firms to invest in homeeconomies. The conclusionwill touchupon the degreeto which FDI can alleviatesome of the difficultiesthese nations face, in their transitionto the market system. Chapter II The Theorybehind Foreign Direct Investment

Throughoutthe last centuryEastem European nations have witnessed various economicand political instabilities.In particular,this steinmedfrom numerous encountersbetween three major religions, the rise andfall ofmonarchies,two World

Wars,and various dictatorships.t To from the consequencesofthese hardships, "scape the nationswere advisedby major financial institutions to "liberalize the economy, decentralizedecision making, and allow economicagents to assumeresponsibility for their actions"(Camdessus, 1994)6. The advicewas taken, and in the year1989 the destructionof the Berlin wall markedthe end of centrally plannedgovemance in the

EastemEuropean bloc.

Even thoughdecentralization began during the sametime frame for all nations, the transitionhas not beenhomogenous for the countriesin question.The dilficulty in the shift from plannedto market economyhas been attributed to "lack of theoretical guidesto decentralize".TAs a solution,intervention from developedmarket economies throughFDI can aid the transitionprocess for decentralizingnations by providing a theoreticalguideline.

The theoreticalframework behind foreigrrdirect investrnent,as presented by

Pavlinek(2004), suggests that FDI typicallyresults in rapidand profound restructuring, including "organizationalrestructuring, technology transfer, worker training, transferof

Westemmanagement structures and practices, and new ptoduction strategiesand

5By threernain religions the authoris ref€rring to Christian Orthodoxy,Catholicism and Islarn 6 Michel Camdessuswas the ManagingDirector of the Intematiornl Monetary Fund. 7 For firrther information on difficulties facedby ttansitioneconomies see: [4g!9a!!q$9445r. Available oa /ie; hftp:,/encvcloDedia.thefreedictionarv.coIn/centralo%2Oplannins organization"(Pavlinek,2004; 47).In otherwords, accompanying capital, FDI flows providethe resourcesnecessary to improvethe productivityand efficiency of the home country'sprimary, secondary, and tertiary industries.

Foreigncapital flows andrestructuring can saveexisting jobs aswell as aid the creationof new onesin eachindustrial sector. It is expectedthat wagesof the local laborforce - operatingunder foreign employers - would witnessan increasein their hourly wages.This increasein wageswould serveiN an instrumentto boostthe productivityof the workersas well asestablishing a form of tnrstbetween the employer andthe employee.The increasein wagescan further conffibute to the growth of the country'sreal incomeand living standardof the homecountry's population.

Settingup new industriesand enterprises allows the local govemmentsto increasetheir tax baseand reduce some of their outstandingbudget deficits. The boost in productionof a greatervariety of goodswould expandthe home country's export sharein the world markets.More importantly,there would be transferof knowledge andskills asfirms from developednations train the local populationto conductday-today operationsmore dynamically and skillfully. In the long run, the transferof knowledgeand expertise, through foreign training, would createa spill-overeffect to the local andregional economy, as privately-owned indusfies takeup more efficacious meansof production.

Advocatesof foreigndirect investment also make claims that investmentof this form contributesmore to the economicdevelopment of the nation than bank loans.

Bank loansto nationalgovemments are often utilized solelyfor consumptionpurposes ratherthan for the investmentinto local firms. At the sametime, "if foreign firms make a baddecision regarding direct investment expenditure, the lossis sustainedby the foreign firm. If the domesticgovemment uses bank loansinefficiently, the country still facesa repaymentobligation to the banks" (Melvin, 2004; 122)' Lastly, therewould be increasedopportunities for localcompanies to supplynewiy-established, foreign- ownedfirms with necessarygoods and services to conducttheir daily operations.

Additionally,"domestic firms thatare competitive enough to supplymultinationals are alsothe most likely to breakinto globalmarkets on their own".E

On theother hand, foreign-owned firms have a numberof incentivesto direct their capital to newly emergingmarket economiesin EastemEurope. The uniquesite andsituation characteristics, and close proximity to Middle Eastern,Central Asian and

WestemEuropean markets, give the transition economiesan attractiveniche for foreign capitalinflows. The abundanceofprimary resources,relatively low laborcosts, communicationnetworks and attractiveamenities further increasethe appealof these nations.These variables provide an attractiveinvestment to foreigr firms thatare restrictedfrom pursuingcost effectivemethods of productionin their own nationsdue to strictindustrial regulations, resource depletion, worker unions and highly competitivemarkets.

Now thatthe advantagesofFDI inflows into transitioneconomies have been outlinedfor all participants,the question arises how a regionor countryis selectedfor investrnentby theinvestor. To answerthis question,the paper refers the reader to

Ullman's 1956modification of the GravityModel.

In his model,Ullman proposed that movement of labor,goods and services is stimulatedthrough the demandand supply forcesoccurring in space.Ullman cameup

oFor further information on benefitsof dornesticfirms ftom FDI flow see: http:,twww.worldbank.ors,/transihonnewsletter'/s099/Dss5-7.htm with threebases that encourageinteraction in space(Dicken & Lloyed, 1990).Firstly, for interactionto occurbetween sites the characteristicsof the two sitesmust be complimentaryto eachother. In otherwords, for interactionto occurbetween countries

A andB, countryA musthold a specificgood and be willing to supplythe goodto countryB that demandsthe good. EasternEurope's transition economies, unlike

Westerndeveloped nations, have lower laborcosts, lack severepollution restrictions andpromote themselves by issuinglower corporatetanes. On the otherhand, Western economieshold higherlevels of technologyand infrastructure that, at times,can be relativelymore expensive to implementin Westernnations. These factors act as complements,consequently explaining the willingnessof foreignfirms to travellong distancesto minimizetheir productioncosts.

Furthermore,if we examineLoschian's expansion on Christaller'scentral place hierarchy,we cansee its relevanceand application to Ullman's GravityModel. The centralplace hierarchy is'based on conceptsof rangeand threshold" (Yeates, 1998;

166).In the centralplace hierarchy, central places are ranked based on populations' willingnessto travelin orderto obtainhigher order services (range), and through demandrequired to supporta businesstlpe (threshold).According to Loschian's centralplace hierarchy, lower orderedplaces may offer specificgoods that higherorder placesmay lack (Dickenand Lloyd, 1990).An importantpoint is that interaction amongstplaces may not necessarilyoccur only amongstthose ranked within the same orderof the hierarchy.Loschian's more flexible centralplace hierarchy addresses the interactionbefween lower andhigher ordered countries.

Secondbase of the GravityModel investigatesthe possibilityof intenrening opportunities.In perfectlycompetitive world markets,countries that arein close proximity to eachother will be morelikely to interactwith eachother. Imperfections thatresult in lowerprices of goodsmay endthe tradeagreements amongst the countries previouslyinteracting. Thus, proximity of marketsand market size have direct effects on the allocationof investmentamongst countries.

The lastbase of the GravityModel assumesthat if thereare perfect complimentarygoods and services amongst places with no interveningopportunities, interactionamongst countries may be terminatedif costsof movementare extreme.

Moreover,the frictionaleffects of transferringgoods need to be takeninto considerationtogether with distance,since "some products are more sensitiveto distancethan others such as agricultural goods" (Dicken & Lloyed, 1990;75).

Transportation,therefore, plays a crucialrole, as"central places must be highly accessible... andif this accessibilitychanges in someway, throughrail closuresor road improvements,there will be a concomitantimpact on the numberand range of centralfunctions found in centralplaces" (Yeates, 1998; 166). In otherwords, secure andefficient methods of hansportationare essential. The indusfies in the transitioning nationsneed to be accessibleto provideforeign firms with a reliableand continuous flow of resources.At the sametime, reliable transportation is requiredto distributefinal productsto the surroundingmarkets.

Thus,reliable and cost effective forms of transportationare essential in assisting the developmentof all industrialsectors, either directly or indirectly,through FDI. To what extent,however, is transportationimportant in attractingFDI into transition economies? Beforeaddressing the thesisstatement, it is necessaryto delineatethe findingsof previousstudies regarding the main factorsthat attractFDI inflows and the role of transportationinfrastructure. ChapterIII

PreviousResearch and Findings

It is diffrcult to strictly delineatethe main determinantsof foreign direct investmentsince there is no homogeneityin the countries'provision ofresources. The

World Barikstates that the art of attractingFDI inflow lieswith "low-costqualified labor,long term market potential and access to rich naturalresources".e While low labor costsaxe an attractiveincentive for foreigr firms to move their opemtionsto 'brain eastemterritories, the World Bankdirects attention to "long-termfears about the drain' oftechnicalprofessionals and the strongupward trend ofreal wagesfor skilled workers".loThe demographics of thepopulation also play a significantrole for future

FDI flows. The dependencyratio is a vital humangeographic determinant of foreigrt investment.The dependencyratio is an estimateof the economicburden of the working populationin supportingthe non-workingpopulation. It is measuredby dividingthe numberofpeople who aredependent (ages under 19 andover 64) by thenumber of peoplethat areofthe workingage (between 19 and 64).t1 If the dependencymtio is expectedto rise over the years,this will placean escalatingburden on the foreign firms.

The cost oflabor will increasedue to higher payroll taxesinitiated by the aging populationand higher pension bills.

If we look at Figure1, we observethat the dependencyratio in EasternEurope hasbeen in declineover the lastthree decades. While the agingpopulation is increasing

e For firther information on the World Banks determinants on FDI see: htF://www.wo dbank.ore/transitionnewsletter/so99/pss5-7.htm L0For firrther information see:httD://www.worldbank.org/hansitiornewsletter/sogg/Dsss-7.htm tr For firrtber information on dependency ratios see Southern Forest Resowce Assessment. Available on line: htto://www.srs. fs.usda. sov/sustairtdata/authors/slossarv.hftl

t3 'brain the bffi rate has beenfalling at a fasterpace. The drain', at the sametime, has not resultedin a substantialdecrease of the working populationand consequentlyan increasingdependency ratio. At present,these ratio pattemslepresent an attractionto foreign frms sincethey contrastwith the dependencyratio pattemsof the Western world. Changein birth ratesand migration will changethe dependencyratios in the future, as EasternEurope slowly developsto matchthe economiesof the West.

X'igurel. DependencyRatio E tmb ol tu M!b.r or deEd.nb { Bt t 0.6

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o -'' tt o s0.2 o

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1996 1997 1998 1999 2W0 Year Sowce:World Developmentlndicators Online, World Bank.

Expandingon the World Bank's demographicdeterminants of FDI flows,

Dunning (2002) illustratesthat demographicsare particularly vital to the market determinantsof FDI. The demographicsof the home country's population are important to the foreigr firm ifthe goodsthe firm is producingare targeted to a specific age group.The demandpattems stemming from youngerpopulation tend to differ significantly from thoseof elderly. Moreover,younger age goups tend to spendhigher proportionsof their disposableincome on goodsand services while olderage groups

14 tend to be savers.Demographics can alsoprovide us with the information on future availabilityof the laborforce in the areaof study.

Expandingon homecountry's market size, Campos and Kinoshita (2003) introducethe importanceof institutionsin attractingforeign investment.The economiststake into considerationthe qualityof education,trade dependence and createan index to illustrate the degreeof law andorder in the country. In order to examinethe gapin communicationthe numberof telephonelines per 1,000people is usedas a variableto attractforeign capital inflow. The variableis foundto insignificantlycontribute to attractinginvestment. While introducingsome new variablesto the standardFDI determinants,the researchersmake a call for future inclusionof homecounfilr's physical geographic aspects. The call stemsfrom the belief that telephonelines are not the bestindicator of a country's connectivity to the surroundingmarkets.

Accompanyingabove outlined market characteristics, there are resource, efficiencyand asset seeking FDI motives.Each of the outlinedmotives has a fundamentalgeographic component according to Dunning(2002).Transportation, in particular,plays an essentialrole in the effrciencyand asset seeking motives. To elaborate,efficiency-seeking motives encomp:rss production costs. The aim of firms is profit maximizationthrough revenue increases and rnput cost reduction.One of the main input costsis transportationand communication to, from, andwithin the host economy.Asset seeking motives consider physical infrastructure including ports, rail, airportsand roads as well ashuman assets such as educated and skilled population.

Dunning(2002), therefore, calls for researchersto taketransportation variables into considerationwhen determining FDI flows. Coughlinand Segev(1997) take up Dunnig's(2002) call andempirically test the importanceof transportationin the locationdecisions of foreignfirms. The first caseconducted by the researchersis in their homeland,the United Statesof America.

In the 1970s,the U.S. witnesseda shift in its main industryfrom manufacturing to service.The consequenceof the shift wasa rise in blue-collarunemployment.

Despitethe "declinein manufacturingemployment since 1979, manufacturing employmentin foreignowned firms [in the U.S.] morethan doubled between 1979 and

1995"(Coughlin and Segev, 1997;1). The increasein manufacturingemployment was experiencedonly in a numberof states.The researchers,as a result,set out to determine an "economicallysound, statistical model to explainthe pattem of new foreignplant location"(Coughlin and Segev, 1997;3). Using countydata, the authorstake into considerationunemployment, education, labor unions, population density and most importantlytransportation. Running three multivariate regression models, the paper illustrateslo/olevel of statisticalsignificance for the highwayvariable concluding that

"transportationinfrastructure affects [foreign] industrial location at the countylevel"

(Coughlinand Segev, 1997; ll).

Expandingtheir studyto the restof theworld, Coughlinand Segev (1999) scrutinizethe importanceof geographicFDI determinantsin China.After decadesof isolation"China began to removesome of thebarriers to inflow of foreigndirect investrnent"(Coughlin and Segev, 1999;1) in the 1970s.Presently, China is the largest recipientof foreigndirect investment among developing nations. Applytng variables similarto thosein their 1997U.S. study,the authorsfind that economicsize, productivityof labor,and coastal location draw foreigninvestrnent into China.The case study,furthermore, takes into accounttwo transportationvariables. Kilometers of highwayremain the main transportationdeterminant, while air staff is the second variabletaken into consideration.l2Due to increasesin air traffic andisolation of some of the study'sprovinces, the authorsbelieve that air staff numberis a goodproxy for changesin China'sair traffic. While both transportationvariables hold positive coefficientsigns they are"not foundto havea statisticallysignificant relationship with the level of FDI inflows acrossprovinces [in China]" (Coughlinand Segev, 1999; l).13

Unlike the rest,Gwartney, Skipton and Lawson (2001) examine factors that influencetrade openness. In particularthe authorsconcentrate on geographic determinantsto illustratethe importanceof proximity andmarket purchasing power for tradeto takeplace between nations. Using the principalsof Ullman's Gravity Model,

Gwartneyet. al createa DistanceAdjusted Demand Scalar(DADS). Insteadof comparingthe populationsamongst the countries,the authorslook at the GDP purchasingpower parity (ppp) as a proxy of marketpower betweencountries. The variableis thenused to establishthe importanceof a country'sdistance from the world's main purchasingpowers. Accordingly, Fiji, Australiaand New Zealandare not favorably locatedwhile Luxembourg Belgium and the Netherlandsare favorably locatedto the strongestdemand nodes.

Accompanyingthe DADS variableGwartney et. al examinethe populationof the countryand the geographicsize advocating that "countriesthat aremore populous andcover a largergeographic area are likely to haveless international trade as a share of their economy''(Gwartneyet. al, 200I;72).In otherwords, countries of greater geographicsize tend to havea greatervariety ofnatural resources.This varietyand

12 Air staffis the number of total staffand workers in state-owned units of airway transportation in a province in China divided by the population of the province (Coughlin and Segev, 1999; 15). 13 A positive coefficient sign indicates that as there is an increase in kilometers of highway and air staff, we should wibress an increase in FDI flows. In this case the study finds no significant causation between the independent variables and FDI.

T7 abundanceof resourcesmay enablethe nationsto be more self-sufficient.The self- sufficiency,in fum, may detractforeign investorssince the homenations may not have strongties of hadeestablished with the marketsof surroundingeconomies. Thus geographicsize of the countryshould be takeninto considerationby investorswhen determiningwhere to allocatetheir funds.

The literatureillustrates varying determinants of FDI flows. Even thoughthe studiesare conducted in differing countries,regions and spatial scales the authors unanimouslyagree that geographicfactors, in particulartransportation, deserve greater attentionin future empirical investigations.This paperis an outgrowth of the above outlinedresearch, as it attemptsto determinethe role of geographicaspects in athacting foreigninvesffnent in EasternEuropean transition economies. The following sectionof thepaper delineates the methodologyused to tacklethe thesisstatement. ChanterIV

Methodology

Oneof the main attractionsof EasternEurope's transition economies is the locationof thesecountries and their proximity to the Middle Eastem,Central Asian and

WestemEuropean markets. While foreignfirms areinterested in exploitingthe lower costsof production,they arealso interested in the easeof importingproduction inputs aswell asexporting the finishedgoods. For tradeto takeplace factors other than trade regulationswill swaythe homecountry's trade sector. For instancecountries that have a lengthycoast line couldhave "lower transportationcosts that will enhancetheir volumeof internationaltrade" (Gwartney et. al,200I;72). As previouslymentioned,

Gwartneyet. al establisha DistanceAdjusted Demand Scalar (DADS) by which they takeinto considerationthe country'slocation in relationto the purchasingpower of othercountries' markets.

While the measurementofpurchasing powers of surroundingmarkets is a vital determinantof FDI we mustnot forgetthe vitality of transportationmodes. Modern and reliabletransportation infrastructure is essentialin orderto distributefinished goods from the areaof productionto the areaof consumption.

To measurethe significanceof transportationin determiningFDI flows into

EasternEuropean transition economies, the paperwill usepanel data for 15 nations, years1995 through 2000. The yearschosen are primarily dueto the availabilityin consistencyof data.It couldbe arguedthat six yearsis too shortof a time spanto identify significantchanges in transportationinfrastructure. If we examinethe raw data, however,we perceivenoteworthy variations in transportationmodes amongst the countriesand within the countriesfor the studiedtime frame (Figure 2).

, Kilometersof Highway Years1995 to 2ooo

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Figure 2 clearly illustrateschanges in highway kilometersfor six of the fifteen countriesresearched.la In this studyhighway kilometers encompass the entire road network including motorways,highways, main aswell asregional roadsand all other roadsin the country.Albania, in this case,shows no changein highway construction overthe studiedperiod while the CzechRepublic illustrates a 148%oincrease. Poland, on the other hand,due to its centrallocation in EastemEurope, holds the highest

In Only 6 countries are graphed since l5 would cause too mucb crowding on the chart and hinder rather than aid the argument. Similar patterns, however, are petceived for the remaining 9 nations.

20 numberof highwaykilometers with a slight declinebetween the years1999 and 2000.rs

The graph,therefore, depicts that for the region thereis variation in road infrastructure both within the countriesand betweenthe countries,for the studiedtime frame.

It is vital to notethat duringthe years1995 through 2000, a numberof the studiednations experiencedslight economicgrowth. Improvements in economic performance,consequently, facilitated constructionof transportationinfrastructure. The economicimprovement can partially explain the roadkilometer jump witnessedfor someof the nationsin the years1997 and 1998.Were the changesin highway constructiona significant factor in attractingforeign investment?

To addressthe thesisquestion the papercreates a numberof modelsthat take into considerationvariables used by previousresearch. The modelsare then examined throughmultivariate regressions in orderto determinethe significanceand the extentto which eachvariable attracts or repelsforeign investment. The sizeof the coeflicient illustratesthe strengthof the variablesin explainingthe flow of foreigninvestment while a p-valueof lessthanl0o/o confirms that thereis significantcausation.

By usingthe models,the paperattempts to depictto what extentwe canexplain the flow of foreigninvestment into transitioneconomies. Coughlin and Segev (1997) usekilometers of highwayto proxy the availabilityof transportationinfrastructure in

U.S.counties. Their methodologyis expandedin the 1999paper, with the inclusionof air staffchangesas a proxy to air transportation.This paperexpands on the numberof variablesused to proxy transportation.The researchwill hold highwaykilometers - that in this caseincorporate the entireroad network of the nation - as a one of the

rsThe declinein highway kilometersin Polandover the studiedtirne frame is unknown. One carq however,speculate that certainroads were closeddown for reconstructionor were simply in a poor condition for use.

2l transportationproxies andwill addrailroad kilometersand aircraft departuresas the two new variables.

It is importantto directour attentionto air transportationsince "air transportationis a directcontributor to a dynamiceconomy and is a leadingtrade facilitator".l6While air transportationis not a main form of transportationfor bulk manufacturedgoods, it is oneof the main facilitatorsin the serviceindustry. Developed nations,as previously mentioned, have been shifting their industryimportance from manufacturingto tertiary. While EasternEuropean countries are not as advancedin this shift, thereremains potential for servicegrowth and vitality of air transit.The continual rise in the importanceof air transportationis verifiedby Figure3. Countriessuch as the

CzechRepublicand Poland have witnessed rapid increases in air transportationsince

1998while countriessuch as Belarus have seen dramatic declines in the numberof air departuresover the studiedtime frame.

Thedramatic decline in air traffic for Belarusis mostlyblamed on political factors.In 1994the first Byelorussianpresident, Alexander Lukashenko, was elected.

Thepresident took numeroussteps to improvethe economic,political andmilitary ties with Russia.This movewas not supportedby the U.S. that viewedthe new referendum asa worseningof humanrights problem and lack of significantmarket reforms.lT On thesebases, the U.S. decidedto removeits fundingto Belarusthus sendinga negative signalto othernations investing in Belarus.These moves set a negativespiral to the

Byelorussianeconomy, in consequenceaffecting inversely air transportation.As a resultwe seea dramaticdecline in Byelorussianair transportationfor the year 1996.

'uFormoreinformationonairtransportationsee:Ir@e4g!!b.AvgiIableonline: http://www.tc.gc.ca/ poU en/ Airpolicy/doc/Airliberalization.hun " For frutherinformation on Belaruseconomic and political policies in the mid 1990ssee: Belarus: Economicand Trade Overview. Available on line: http://www.bisnis.doc.gov/bisnis/country/belcon.hfin

22 Evidently, variationsin air transportation,just like highways,are taking place both within the countriesand amongstthe countriesas indicatedby the graphbelow.

Figure 3. Numberof RegisteredInternational and Domestic Aircraft Departures

Yearsr99S to 2ooo 60ooo

5OOOO

g 4oooo r 3OOOO a) 20000

10000

o 1996 L997 1998 Year Source:World DevelopmentIndicators Online, World Bank

Railroads,on the other hand,have been a static form of transportationin Eastern

Europe.While the railway lines and refrigeratedcars may be one of the most important modesof transportationfor agriculturalgoods, there has been liftle invesfinentin expandingthem over the years.It is thereforepredicted that rail will have a significantlyweak causal relationship with FDL

In summary,kilometers of highway (the entireroad network), numberof registered yearly aircraft depaf,turesand kilometersof railway will be usedas three explanatory transportationvariables. The followingsection outlines the conceptualmodel, data sourcesand expected results,

23 ChanterV

ModelOutline, Data Sources and Expected Relationships

Conceptuallythe empiricalmodels will not digressconsiderably from the modelsapplied in the previouslyoutlined literature. The studyat first examinesall of the main variablesoutlined in the aboveliterature focusing most of the attentionon the geographicdeterminants rather than economicand political. Below is the Foreign

Direct InvestmentModel.

Equation I

ForeignDirect Investment:f (Transportation,Proximity to SurroundingMarkets and their Sizes,Urban Population, Geographic Size of the Country,Population Density, Politicaland Economic Stability, Human Capital, Tax Regulations,Labor Availability andPresence of WorkingPopulation)

The dependentvariable in the modelis the yearlyUS dollar per capitainflow of

FDI into the examinedcountries. The controlvariables have been obtained solely from the literaturereviewed in ChapterIII. The controlsare political andeconomic stability, humancapital, ta,r regulations, labor availability and presence of working population.

Thegeographic variables in this caseare transportation, proximity to surrounding marketsand their sizes,urban population, geographic size of the countryand populationdensity.

It is importantto notethat the variablesin EquationI arenot ideal variablesand will not accountfor all the variationin foreigninvestment. Ideally, the datawould hold no enors in measurement,extraction and aggregationDeBardeleben and Hanning

(1995)emphasize the lack of continuousdata availability due to previouslystrict govemmentcensorship of information.The lack of historicaldata, therefore, makes it diffrcult to form comparisonsof changesin populationand transportation infrastructure overlonger time frames.Further specific shortcomings of the variableswill be addressedin sectionsix with evaluationof the results.

Up to this point, the paperargued for the theoreticalimportance of geographic factorsin determiningFDI flows. Accordingto Ullman's gravitymodel andLoschian's centralplace hierarchy, efficient modes of transportationare necessary to aid the range andthreshold phenomena. While transportation,together with marketsize and distance, remainthe main explanatoryvariables, the controlvariables outlined in the conceptual modelare solely obtained from previousresearch. The paper further analyzes the inadequacyof the data andthe limitations of the time frame. At this point the paper will turn to its empiricalevaluation by statingthe regressionmodel and the data sources.

The following regressionequation is usedto representthe conceptualmodel outlinedearlier.

Equation 2

Y: po+ pr(Transportation)+ p2(DADS)+ p3(UrbanPopulation) + 9o(Country Area) + p5(PopulationDensity) + p6(GDPper capita)+ p7(EducationalAttainment) + Fs(Tax Regulations)+ pe(UnemploymentRate) + Fro(Percentage of LaborForce) + p Table l. Variables, Proxies and Data Sources

ForeignDirect ForeignDirect Investmentinflows in World Development Investment millions US $s per capitaby year IndicatorsOnline (WDI) Transportation Highway (km) World Development Railroad(km) IndicatorsOnline YearlyNumber of Aircraft Domestic (wDI) and InternationalDepartures SurroundingMarket DistanceAdjusted Demand Scalar UnitedNations Sizesand Distances (DADS) EconomicCommission away from the Explained in detailed later in the paper for Europe(UNECE) & Market (WDI) & ESRI UrbanPopulation Percentageof total populationthat World Development livesin citieswith 50,000people or IndicatorsOnline more (WDI) GeographicSize of SurfaceArea of Country in World Development the Country kilometers IndicatorsOnline (WDI) PopulationDensity PopulationDensity Figures : World Development No. of People/Surface Area of IndicatorsOnline Countrvin Kilometers (WDI) Economicand GDPper capitain US $s adjustedfor World Development PoliticalStability inflation year(2000) IndicatorsOnline (WDI) Educational Percentageof the population enrolled World Development Attainment in tertiary education IndicatorsOnline (WDI) Tan Regulations Tares in millions of US $s per capita United Nations PPPs(US) Year2000 as a percentage EconomicCommission of country'sGDP per capitaPPP forEurope (UNECE) Year2000 & IMF LaborAvailability UnemploymentRate World Development IndicatorsOnline (WDI) WorkingPopulation Ratioof WorkingAge Populationto World Development total Populationof the Country IndicatorsOnline (WDI) The datawere collected for all the previouslyoutlined countries and years. It is expectedthat all of the mentionedtransportation modes will havepositive coefficient signsindicating that astransportation infrastructure increases we would expectto obtainhigher levels of FDI. This is dueto the fact that transportation,as previously argued,would be usedby foreignoperated firms, in homecountries, to both bring resourcesto the point of productionas well asdistribute the final productsto the differing markets.Efficient transportationmodes are seenas bridging the communicationgaps amongst nations and within nations.With efficientmodes of transportationforeign owned firms will be ableto obtaininformation on the market demandof their productsin a well-organizedand reliable manner.

To calculatethe marketpower of surroundingnations the distanceadjusted demandscalar (DADS) is applied.The demandscalar is usedzrs aproxy for Ullman's gravitationalmodel theory. To measurethe attractionbetween hlpothetical countriesA andB, Ullman multipliesthe populations of two countriesand divides the productby the distanceof the two countries.Gwartney et. al (2001)expand on this theoretical modelto determinethe attractionamongst nations due to their marketpowers. By multiplyingthe GDP ppp of nationsmaking up 99o/oof the world's total GDP,and dividing the productby the distancebetween nations the authorsfind that countries locatedin centralEurope are more favorablein attractingforeign investmentthan the moreisolated nations, even though the isolatednations might be moreeconomically developed.

Expandingon the theory andthe applicability of the model in previousresearch, this papercalculates the gravitymodel in a slightly differentmanner. The general equationis outlinedbelow. Equalion 3

(GDP A * GDP B) Gravity PPP PPP - Model = (Distancebetween nation capitals)'

In this casethe GDP ppp for eachof the 15 nationsis found fot eachofthe years1995 through 2000. To comparethe marketpower attraction ofthe 15nations to the world markets,100 countrieswith the highestGDP ppp are found for eachstudied year.The product ofGDPs for eachof the 15 studiednations and each nation from the

100 list is found. The productis then divided by the distancesquared between the two nation's capital cities. I squarethe distancein order to accountfor the frictional transportationfactors. The distancebetween the capitalswas calculatedusing the equi distantAzimuthal map projection. The diagrambelow illustratesthe aboveoutlined techniqueI usedto createthe gravity variable.

Gravify Variable Calculation Hypothetical Numbers

GDP ppp 1999 2000

Hungary $125b $ l30b Germany $3s0b $390b Portugal $ l80b $r75b Year1999 g = ''' 6 (125 350)/ 200:: 1.09 tle = = In the caseof Hungary "H & P (125't180)/ 400' 0.la for = : calculationwas repeated 400 km Valueentered 1.09+0.141.23 the remaining98 countries and the previous5 years. Year2000 The summationsofthe * H&G (130 390)I 2002= 1.27 indiceswere then enteredas H &P (130+175)/ 400' = 0.la oanel data. Valueentered = 1.27+0.14=l.4l

28 It shouldbe notedthat the summedvalues entered into the data set are indices portrayingthe relative attractionsof the nationalmarkets. Lastly, the proximity of the

EasternEuropean nations to the Westernmarkets is portrayedusing the gravtty variable.As Hamilton(1999) states "geographic proximity, higheraccessibility and lower costsof transportto and from areasadjacent to the EU stimulatehigher motivationof market-orientedbehavior amongst new firms" (66). Theseissues are encompissedin the gravityvariable. Thus a positivecoefficient sign is expectedas it would indicatethat the higherthe attractionof the marketsthe more foreigninvestment will flow into the homecountry.

Urbanpopulation, on the otherhand, signals the availabilityof servicesin the countryof study.Foreign firms locatingin new countriesneed financial, educational andmarket services to carryout their daily operations.As a result,the higlrerthe urban population,the greaterthe availabilityof servicesand the greaterthe expectedinflow of foreigncapital.

Populationdensity as urban population is expectedto hold a positivecoefficient sign.Population density can be usedas an indicatorof two variables.Increases in populationdensity imply a biggerdomestic market and a higherlabor supply.

Populationdensity, however, can also signal the costof land.If thereis high population density,the cost of land inevitably increases,which would detractprofit maximizing firms from investingin EasternEurope.

The last geographicvariable in the studyis the geographicsize of the country.

As statedin ChapterIII countriesthat cover a greatergeographic area are more likely to be self-sufficient.It is hypothesizedthat a greatergeographic area is associatedwith a greaterdiversity andavulability of resources.Thus larger countries are less likely to

29 engagein tradewith other countries.The lower levels of tradeopenness may deter foreigninvestment. If a countryis not a big importerthen it is likely that the surroundingnations would reciprocateby not importingthat county'sexports. Thus foreignfirms may be lessinclined to investin economiesthat tendto be self-sufficient asthis would lower the foreignfirm's chancesto invadethe surroundingmarkets with its goods.It is thereforeexpected that the coefficientsign for the country'sgeographic sizewould be negative.

Economicand political stabilityis expectedto havea positiverelationship with

FDI, in this casemeasured by GDPper capitain U.S. $s.Improvements in the economicand political stabilityof the countrysignal that the countryis experiencing both economicas well aspolitical restructuring.It shouldbe noted,however, that too high of a GDPper capitamay be a disincentivefor foreignfirms. If the GDP per capita is too higb it would meanthat wages and salaries of the laborare - in relativeterms - higher.Higher labor costs could lower the efficiencymotive anddetract foreign firms.

Educationalattainment is alsoexpected to havea positivesign, since the more skilled and educatedthe populationis the more productivethey are and the lower the reeducationcosts. If the level of education,however, is too high it would imply highly skilled andknowledgeable population that would demandhigher compensations for their work. This, in turn, cancreate a disincentivefor a foreignfirm to setup its operationsin the homecountry.

Tax regulationsare expected to havea negativecorrelation with FDI. Til( regulationsare a costincentive for the firm. The lower the relativetaxes, the lowerthe costsand the more athactivethe homecountry would be to the foreign firms. The unemploymentrate is expectedto havea positivecoefficient sign. An increased unemploynentrate indicates an increasein laboravailability. At the sametime ahigher unemploymentrate means that thepopulation would be willing to work for a lower wage.This factor will further attractforeign investment.

Lastly the working populationis an indicator of the dependencyratio. The workingpopulation is calculatedas a percentageof the populationbetween the agesof

15 to 64. Thegreater the workingpopulation, the lower the dependencyratio andthe morelikely the foreignfirm is to investin the countrysince its costsof supportingthe elderlypopulation through taxes and pension plans are lower. Hence the coefficient sign for the working populationis expectedto be positive.

Whetherthe aboveoutlined expectations are met, anddo geographicfactors contributesignificantly to attractingforeign investment into EasternEurope's transition economies,is addressedin the following section. Chapter VI Analysisof the ObtainedResults

Theresults of the estimatedmodel in ChapterV areoutlined in the tablebelow, Table2.

Table2. GeographicFactors as Determinantsof Foreign Direct Investmentin Eastern European Transition E conomies

t Variable: FDI in millions of US $s

C -rt69.57 -754.765 -730.052 .-1405.46 rc.897)** (0.1266) (0.1591) (0.0232)** Highway 0.00043 0.0006 (road network. Km) (0.0022)* (0.090&*** Air 0.0046 0.0041 Transport (0.0000* rc.0210** Railroads 0.0112 4.0148 (Km) (0.0074* (0.2052) Transportation Index DADS 0.3847 0.2527 0.1856 0.5340 DistanceAdjusted Demand (0.0138)*+ (o.ozt11*** (0.2050) (0.0188)** Scalar GeographicSize of -0.0007 -0.0007 -0.0009 -0.0005 Country (0.0013)* (0.0012)+ (0.001u* (0.1312) Urban 6.2027 4.4176 5.4448 5.6140 Population (0.0000)* (0.0014* rc.0001)t (0.0003)* GDP 0.0074 0.0061 0.0073 0.0061 Per capita (0.0999)*** rc.r628) rc.rr64) (0.1810) Educational -2.166 -0.2779 -r.02t9 -2.8890 Attainment rc.0245)** (0.287) (0.3020) (0.0402)** Tax 4.t46 1.I 835 4.3184 t.2793 Resulations rc.2799) 0.7s64) (0.2683) (0.7449) Unemployment 0.7115 2.265r r.8242 0.61t8 Rate (0.7572) rc3r63) (0.43r4) (0.8012) Working 13.515 8.4577 6.8516 r8.222 Pooulation (0.1219) (0.2738) (0.3923) (0.056u*+ F-Stat$tic 9.781* 10.359* 9.269| . s?890f &1,. 0.su 0.538 0.510 .i;0.55.6 Aaiysgdn' 0.470 0.486 0.455 . ,4494 90 90 90 '90 Notes to Table 2: C representsthe constantterrn The coeflicient of the variable is shown first followed by the p-value in the parenthesesthe star markednext to the t-statistic indicatethe level of significance:* : lo/olevel of significanc€,r* : 5% level of significance,*r* : l0% level of significance.The t- statisticsunmarked by a star are not statistically significant at any of the abovementionedlevels, The n representsthe numberof observations. It shouldbe notedthat the variablePopulation Density proved to have a high degreeof correlationwith the unemploymentrates and working population. The variablewas, therefore, not fully independentof the remainingexplanatory variables andcould not be usedin the multivariateregression.

The studyused four modelsto determinethe bestset of variablesthat would explainthe variationin FDI flows into transitioneconomies. The modelsdiffer amongsteach other as they look at differentmodes of transportation.Models 1,2 and3 look at eachof the transportationvariables separately. On the otherhand Model4 takes into accountall three forms of transportation(highways, railroads and air transportation).

The coefficientsigns in the modelsare as expected with the exceptionof Tax

Regulationand Educational Attainment in all of the modelsand Railroad kilometers in

Model 4.Tax regulationshows to havea positivecoefficient sign indicatingthat the higherthe tanesas a percentageof GDPppp in a countrythe greaterthe inflow of foreigninvestment. This finding is counterintuitiveto the theory.Theoretically one of the main attractionsof foreigninvestment into transitioningeconomies is the lower governmentalcosts in comparisonto the developedwestern nations. This theorydoes not hold true in this studyas the variableproves to insignificantlycontribute to attractingforeign investrnent into the studiedhansitioning nations.

Themodels prove that educationalattainment has a negativecausation with foreigninvestment. In otherwords, foreign firms arenot looking for highly educated laborforce that would requiregreater compensation in formsof higherwages.

Consequently,a lo/oincrease in the numberof individualsenrolled in tertiary institutionswill leadto an approximate$2.08 decrease in foreigninvestment per capita

33 accordingto models 1 and 4 but a smallerdecrease if we examinemodels 2 and 3. It is suggested,by thesefindings, that when it comesto air transportationand railroads, a moreskilled population is requiredto operatethese more complex forms of transportation.If the foreignfirms aremost likely to requireair transportationthen educationwill deterforeign investment by only $0.28per capita.It shouldbe noted, however,that educationproves to be an insignificantvariable when examining individualmodes of transportation.

While railroadson their own (Model 3) contributesignificantly and positively to foreigninvestment flows, they areshow as substitutesrather than compliments in

Model 4. The finding it surprisingand further investigation is necessary.Itshould be noted,however, that railroadstend to "bundle transportationon a few corridors and largeterminals where they canyield economiesof scale"(Rudel, 2001; 13)tt.While bundlingof transportationcan be desirablefor transportingprimary resources, it is not a desirableform of transportationfor light manufacturedgoods. Unlike railroads,

"trucksoffer a flexible door-to-doorservice" (Rudel, 2001;7). The flexibility of transportingfinished products directly to the marketmakes highways a more desirable modeof transportation.

At the sametime, Europe'srailway freight systemhas faced "failing standards in servicequality, lack of inter-modalinformation systems, development of adapted andstandardized load units, [in this way] contributedto the successof road transportation"(Rudel,20Al;6). Accordingto the aboveinformation, in orderfor

Europeto attractinvestment through rail transport,the countrieswill needto restructure therail freight system.Rudel (2001) suggests the introductionof Cargospintersto

rEFor further information on rail tansport in Europesee: http://www.sfc.chlrudel.pdf

34 increasethe flexibility andefficiency of rail hansit.The flexibility of this systemis within the smallnumber of car setsthat cometogether for long line hauljourneys and canbe brokenup into smallerunits for local delivery.At this point, however,rail transit doesnot appearto be the mostviable form of transportationto attractforeign investment.

Highways (road networks)and air transportationhold the expectedsigns and aresignificant in attractingFDI in all the studiedmodels. These results support the fact thatmost of the foreigncapital that flows into EastemEuropean transition economies is for manufacturingpurposes and servicessuch as tourism or banking. Importing raw mateials and exportingbulk goodsrequires cost-effective means of transportation,and highwaysare more cost effective in this respect.On the otherhand, tourism requires a moreefficient and comfortable means of transportationand in this caseair transportis in greaterdemand and more effective. In its individualmodel a 1 kilometerincrease in highwaysincreases FDI by $0.00043per capita.In the combinedtransportation model, model4, the athactiveforce of highwaysis strengthenedto $0.0006per capita.These resultsindicate that highways act ascompliments to air transportationand railroads ratherthan substitutes.Air transportation,in all countsattracts more foreign investment as 1 increasein departuresof flights per yearwould leadto $0.0046increase in investmentper capita.

The strikingstatistic to notein the abovemodels, however, is the high influence of urbanpopulation on attractingforeign investrnent. In all the modelswith the exceptionof model4, urbanpopulation not only provesto be statisticallysignificant at a l%olevelof significancebut it alsoholds the highestcoefficient value. According to the models,a lYoincrease in urbanpopulation would resultup to a $6.20increase in foreigncapital inflow per person.The resultis expectedsince the greaterthe urban population,thegreater the local threshold(demand) and the morecomplimentary servicesare available for foreignfirms. Also, moredeveloped of the studiednations, inevitably, will have strongurban, financial coreswith the servicesforeign investors require.The interestingfactor to noteis that urbanizationhas been rapid in certain

EasternEurope nations. This is causinga discrepancyirmongst national regions, since nationwidegovernment and foreign firms areneglecting the rural areas.These issues will be addressedin greaterdetail in the following chapter.

The gravity variable,distance adjusted demand scalar, proves to significantly contributeto atfiactingforeign investment in all the modelswith the exceptionof model3. Theseresults show us thatthe proximity of nationsto the top GDP ppp world marketsis a vital factor in attractingforeign investment.Affordability incentive- lower productioncosts - is strongfor locatingproduction units in a ftansitioningEastern

Europeancountry. Moreover,the nations'location - in relationto the strongwestern andcentral European markets - makesthese places even more advantageous sites.

Untike urbanpopulation, proximity to surroundingmarkets and transportation modes,the geographicsize of the countrytends to detractforeign direct investment.

Thoughthe coefficientvalue is low indicatingthat a lkm squaredarea increase leads to an average$0.0007 decrease in foreigninvestrnent, the resultremains significant in mostof the studiedmodels.

The remainingeconomic and political indicators,GDP per capit4 unemploymentrates and working population, hold the expectedcoefficient signs indicatingthat an increasein all threevariables should lead to an increasinginflow of foreigncapital. In otherwords, political andeconomic stability should be an incentive for foreignfirms to investin EasternEurope. An increaseof lo/oin unemploymentrates should,on average,increase FDI by $1.50per capitawhile a 1oloreduction in the dependencyratio, or toh increasein the working population,should lead to the greatest increasein invesfrnentby approximately$10.00 per capita.The variables,however, attestto be insignificantin attractingintemational capital inflow, with the exceptionof

GDPper capitain model I andworking population in model4 thatissignificant at a 5

Yolev el of signifi cance.

It is vital to notethat amongstthe modelsholding the independent transportationvariables, model4 explainsthe greatestvariation in foreigndirect investment.The AdjustedR2 of 0.556,indicates that the includedvariables explain

55.6%of foreigninvestment variation in transitioningeconomies. This resultin turn signifiesthe importanceof maintainingand improving the transportationmodes in orderto attractforeign capital. Furttrermore, supporting urbanization of the countries would atfiactforeign investment but, aswill be addressedin the following section, supportingurbanization comes at a high price of neglectingrural locations.

The importanceof the aboveanalysis is the strongdependence on geographic factorswhen allocating foreign investrnent in EasternEurope. Previous research concentratedmostly on addressingeconomic and political factorsin finding the main determinantsof intemationalcapital venture. The studydoes not refutethe belief that economicfactors are vital drawsof FDI but it doesshow that geographicfactors play an importantrole.

As evident from the table abovefor all the modelsthe F-Statisticis significant provingthat the modelsare statistically viable. Moreover, geographic variables significantlycontribute in attractingforeign investment. The choseneconomic and politicalindicators, on the otherhand, were rarely statistically sigrrifrcant. It is recogrizedthat perhaps the economicand political variables applied in the studyare not the true attractorsof foreign capital.The variableswere, as indicatedin the Chapter

III, solely extractedfrom previousliterature. ln short the analysisproves that geography is a vital componentof foreign investmentin EasternEuropean transitioning economies.

The study further recognizesthat the vaiables chosento representthe geographyof the region arenot ideal. Highwaysrepresent the entire road network of the nations.There is no distinction asto what percentageconsists of efficient highways that can supportthe transportationof freight goodsand what percentageconsists of one-way,narrow town streets.Condition ofthe roadsis alsonot addressed.In Poland

"of 18,000national roads. . .one-thirdrequires immediate attention. . .while the highway systemconstitutes of 394kilometers ofroughly scatteredand uncoffrected roads"le. An increasein highwaykilometers may be a desirablefactor, but if the qualityofroads remainspoor there will be no contributionmade to efficientflow of traffic.

In the caseofair- transportationit is assumedthat the registereddepartures are thoseof only civilian carriers.This may not be the case.The counted departures might alsobe army basedthat may not directly contributeto attractingforeign investment.

TheDADS variablealso holds numerous assumptions. On measuringthe distance befweenthe nationsit is assumedthat the main market force is locatedin the capitzl city. Thusthe distancesare measured between capital cities neglecting, to someextent, the potential distancebarriers o the remainingurban centers.

reFor firther information on the road network in Polandsee Central & EastemEuope Commercial Update(March 2003). Atailable on line: http://www.macdoc so\'/teebic/Pub/CuPDATE/mar03Ddf

38 Lastly, there is ambiguity with the unemploymentrates truly reflecting the percentageofpeople without work. Thereis no indicationwhether the unemployment rateencompasses hidden unemployment. If the variableis measuredas solely the percentageof populationregistered as unemployed and receives unemployment benefits,then the variablemay not be capturingthe truepercentage of population without work. Secondly,there is no informationregarding whether the legalworking ageof the populationdefer amongst the studiednations. There could be a presence,as a result,of an underestimationin unemploymentrates.

While regressionanalysis is a usefulway to examinethe extentto which certain factorsdetermine foreign investment, the readershould take into considerationthe faultsof the outlinedmodels. At first is it importantto notethat thereis multicollinearitypresent amongst the transportationvariables. The study,however, still finds model4 thebest model since previous research, Coughlin and Segev(1999), also usednumerous transportation variables in a singlemodel. Model4 alsoholds the expectedcoefficient signs. Qualitative variables are imperative when examiningthe effectsof FDI on the local population.Multivariate regressions neglect the qualitative factorsin the analysis.

As previouslystated, regression analysis is an applicableresearch tool that placesweights and determines the significanceof variablesthat attractforeign capital.

The analysis,however, does not examinethe long term implicationsof foreign investment.In particular,the manifestationof foreign investmenton the rural and urban landscapeis not scrutinized.The next sectionof the paperwill addressseveral repercussionsforeign investment may haveon the homecountry's landscape, populationand economy. Chapter VII

The Effectsof ForeignInvestment on Urbanand Rural Landscapes

Previoussections introduced the fundamentalbenefits of foreigninvestrnent to

EasternEurope's transitioning economies. It is arguedthat foreigninvestment is a more effectiveform of aidingthe transitionof EasternEurope's nations to marketeconomies asoppose to intemationalloans. While economicand political factorsare essential in attractingforeign investment, studies have neglect the uniquenessand importance of the regions'geography. Ullman's modificationof the gravitymodel is usedas the theoreticalbase. The explanatoryvariables are extracted from previousresearch and additionaltransportation variables (air flight departuresand railway kilometers)are incorporated.The studyfinds geographicfactors to significantlycontribute in attracting foreigninvestment. In particular,percentage of urbanpopulation, transportation modes, geographicsize of the nationas well assize and distance from the surroundingpotential marketsinfluence the allocationof foreigncapital.

Whatthe statisticalanalysis fails to encompassare the characteristicsof the urbanand rural settingsof theselocations, how theybenefit the foreigninvestors and how theymight changewith economic,social and political restructuring.This section of the paperwill address,in particularnthe changesforeign investment may generateto rural and urban landscapes.At first it is importantto introducethe readerto the structureof urbanand agricultural sites of plannedeconomies in the studiedregion.

The centralsystern of planningeconomies commanded a uniquestructure of urbansettings making these cities identifiable nodes in the Europeanlandscape. Unlike the urbancores of freemarket nations, these cities were shaped to promotea

40 compositionof "neighborhoodequality and self sufficiency''(Fellmannet. al, 2001;

432).In otherwords, market demands for residential,economic and industrial use were overlookedand land wasallocated according to legislativeplans. Thepure govenrmentalcontrol of land createdcities with centersdesignated forpublic use namedCentral Cultural Districts (Fellamanet. al, 2001).The Red Squarein Moscowis usedas the exceptionalexample of public spaceutilized by the Sovietsfor peopleto gatherand celebratestate events such as the May parade.2o

Theurban population mostly lived in microdistricts"assemblages of uniform apartmentblocks housing perhaps 10,000 to 15,000persons, surrounded by broad boulevards,and containing centrally sited nursery and grade schools, similar neighborhoodnecessities and amenities" (Fellaman et. al, 2001;433)(see Appendix 1 for an imageof a microdistrict). The needto journey, in order to obtain everyday householdgoods, was minimized through provision of first ordergoods and services within the residentialareas, frequently found on basefloors of the high rises.The cities wereplanned to be compact,dense and highly dependenton public transportation.

Moreover,the administrationregulated the housingsupply creating a limitation on housingconsumption -one housing unit per family- andon the sizeand development of majorcities by regulatingthe inflow of populationand industry growth (Tosics, 2004).

The abovementioned characteristics of urbanlandscapes, in plannedeconomies, createdan urbanpopulation density curve widely differing from the Westernnations.

Theoreticallythe urbanpopulation density curve of Westernnations should be skewedpositively, or awayfrom the centralbusiness district as indicatedby Figure4 below.Competition between residential and commercial activities - for limited spacein

20It should be noted that the Red Square was in place prior to the communist regime,

4l the centralbusiness district - drivesup theprices ofland resultingin peopleresiding in either high densrtyluxury apartrnentsor poorerinner city neighborhoods.In Western nationsmoving up the economicladder is followed by a move out of the city into easily accessiblesuburban areas. It shouldbe notedthat recentdevelopments in transportation andthe emergenceof suburbanbusiness districts haveflattened the populationdensity graphcausing the urbanpopulation distribution to becomemore uniform. Planned economies,as previously mentioned, do not holdthe samepopulation density distributionpattem in urbanareas. The city centerswere primarily designedfor public and administrativeuse.

Figure 4.

Population Marketsvstem Density I PlannedSystem Multistory aparfinents Single-

, Packed LOmmerclal

Distance from cify center

As onemoves away from the city center,in plannedeconomies, the population densitiestend to increase.Microdistricts were easier to constructin openspaces that were usually found in the outskirtsofthe city. Moreover,the pulposeof the districts was to keepthe working populationclose to the factoryjobs that were locatedat the

42 fringesof the city. In short,the uniquenessof EastEurope's planned cities lies with the structuresthat do not reflectthe demandsof the economybutare pulled together"in accordanceto the socialistideology and planning principles'n (Brunn et. al, 2003;233).

Away from the dominatingurban centers, numerous towns in ffansition economieswere governed by specificindustries. While in somecities the industrywas developeddue to the availability of naturalresources, in others"cultural forces outweigh[ed]the naturalhandicaps for industry"(Alexander,1963;447). These developmentsof industries,at locationsthat lackedthe necessaryinputs for the industry to operateefficiently, were common in EasternEurope. To regulatethese cities andthe allocationof resources,oblasts were formed.

Theoblasts allowed for concentrationof industrialinvestment to be spread acrossthe countrythus restricting the growthof the major cities (Brururet. al, 2003).In doing this the central governmentaimed to provide the populationwith work - evenif it meantinefficient methods of productionand distribution - andto spreadeconomic growthto all the regionsnot solelythe mosturbanized areas. In the caseof Russiathe

"IndustrialCenter" stretching from Smolenskto Gorki - a region450 miles long and

200 mileswide - that hadno strongphysical base for manufacturing.Yet the region developedinto an industrialone due to the fact that it is a populouspart of Russia.

Underthe centralizedplanning system, the over-employmentof theseindustries led to unprofitableproduction. Once the transitionset in, a numberof theseindustries were hit the hardestand the towns with them, leavingnumerous families with no supportiveincome since the closingdown of theplants resulted in both parentslosing theirjobs. The lossofjobs pushedsome families to leavetheir homesin pursuitof work in the major cities. If we look at the rural areasof the commandsystem economy we find that similarpatterns of ownershipwere occurring. Collective and state farms were a cofilmonphenomenon in the rural landscapetaking over thousands of small individuallyowned farms. The statefarms were managed by stateemployees that were obtaininga fixed salaryfor their work. This systemaltered the countrysideof Eastem

Europedramatically. In caseof the U.S.S.R."state farms transformed the Soviet countrysidefrom millions of smallpeasant holdings to a consolidatedpattern of fewer than50,000 centrally controlled operating units" (Fellmanet. al, 2001;289).It should be notedthat personal plots wereallowed and these plots wereknown to producea significantproportion of the grossagricultural output. Personal plots madeup a diminutive 5Yoof the total farmlandbut contributed25%oto the overall agricultural outputin Russia(Alexander, 1963). This indicatesthat the lack of motivation, inefficiencyand outdated capital were leading to outputsbelow the potentialof the farmland,causing shortages in food supplies.

Now that the structuresof urbanand rural areasin centralplanning systems havebeen outlined, the paperwill examinethe transformationforeign capital has broughtto theseregions, addressing both the shortand the long term consequences. Section7.1

Changes in the Urban Landscape

The initial stagesof privatizationin EasternEurope were mostly associatedwith smallerservice industries rather than large-scale privatization of hansportation,utilities andtelecommunications. The fastpace transformation of consumergoods into privately ownedinstitutions and the lag in pivatization of large-scaleindustries has createda mosaiclike landscapein urbanareas (Hamilton, 1999). Modern shopping centers are emergingnext to run down andneglected public institutionscreating an aesthetically non-uniformlandscape. The distinctionbetween state owned, partially pivatized and fully privatizedinstitutions is becomingmore and more apparent. As evident,the urban coresand the housingmarkets are facing the biggestvisual alteration as a causeof decentralization.

Thetransition into the marketsystem created modifications in the locationof economicactivity within the city. With the collapseof centralgovernment planning the land-useneeded to be reallocatedso that it would reflectthe demandsof the market.

Previouslygovernment owned stores and spaceswere tumed into private retail stores.

Oneof the first citiesto experiencethis conversionwas Budapest. Series of new developmentsstruck the capitalcity of Hungarystarting with the centralbusiness districtthat'\vas allowedto be convertedinto an areaof internationalhotels, extended with the first pedestrianstreet" (Tosics, 2004;3). Shopping centers, new office buildingsand international retail storeswere opening in the downtown.Rundown administrativebuildings were taken by privateinvestors, renovated and restored to serveas an aesthetictrademark for the city aswell asmeet the needsof the population. ln termsof the housingunits, the reformallowed the elite to moveout of the microdistrictsand purchase private dwellings closer to the centerof the city or in areas with high amenitiespreviously unattainable to the local population.While the elite benefited,in this regardthrough increasing their private assetsand wealth, the lower incomeclasses were at a disadvantage.The microdistricts,previously maintained by the state,were now left in the handsof its residents.With the moveof the elite from the rayons(microdistricts), the availability of incometo preservethe buildings was significantlyreduced forcing the projectsto slowly deteriorate.For the first time the citiesof socialistgovernance were witnessing socio-spatial disparities such as those presentin the capitalistWestern world.

The aboveoccrurences have lead to a numberof conflictsamongst the differing residentialclasses in urbanareils. The population of the transitioneconomies has gone throughdecades of living in an economythat was governedby national authorities.

Consequentlysignificant portions of the population"never experienced a market economy,had been subjugated into stateand party dependency,and subjected to sustainedanti-capitalistic propaganda under a commandeconomy run by a totalitarian regime"(Hamilton, 1999;139). The adaptationto the marketsystem was not only met with increasingdiscrepancies in incomeand competitionwithin the labor market,but alsowith decreasein governmentexpenditure on public goodsand divergence in land allocation.As statedpreviously, the elite werenow freeto moveto otherareas of the city formerly prohibited from private ownership.In the caseof Zvglo (Hungary)- a high- prestigegreen-belt area - therewas densification taking place with the moveof the elite to the region(Hamilton, 1999). This densificationis the resultof the free marketexploited by the local developersthat set forth to profit from constructingsingle family units (Hamilton,1999). The consequences of this newly emergingdevelopment with little planningwere increased traffic congestions,clearance of public parksand lack ofparking space.

Therestructuring of the urbanlandscape in Hungary,however, is unique.

Hungarywas one of the nationsthat adaptedto the market economyfastest and at the lowestcost. This is mostlydue to Hungary'sslow introductionto the marketeconomy from the late 1970s.Hungary, even:N acentralizedeconomy, was slowly allowing for local pricesto inflateto the world levels.This moveof world price adaptabilityallowed

Hungaryto smoothlytransition into a marketeconomy in the 1990swith lower costsin comparisonto its eastwardneighbors. Furthermore, the locationand the country's historyaided it in its transitionphase due to "the Germanicenterprise culture being moredeeply embedded in areassuch as west-central Poland, the Czechlands and

Sloveniathan in areasfurther east." (Hamilton, 1999;142).In otherwords, the cultural associationof Hungary,CzechRepublic and Slovenia to the Germaniclifestyle has led to greaterproportions of FDI, stemmingfrom the Westernworld, to be directedto these countries.This pattemof foreigninvestrnent inflow is evidentfrom the map below indicatingthat in 1995foreign direct investrnent, in dollars,per capitawas the highest amongstcountries closer to the WesternEuropean economies with the exceptionof

Estoniaand Latvia. Map 2.

The ramificationsofthese unevencapital inllows havecaused the urban areasin 'hrosaic" the studiednations to changerapidly creating,what lfumilton describesas a landscape.

This mosaicpattem was fitrther enhancedby the relaxationof the administative regulationson the housingsupply and developmentofcities. With the closing of inefficient industriesa numbero f oblastswerc left without an economicbase to support the local population.The freedomto enter the cities and lack of opportmity in the oblasts, createdan inflow of rural immigrantsto the main cities that generat€da shortageof affordablehousing. The microdistrictswere becoming over crowdedwith the inflow of thesenew immigrantscausing state owned corrmercial spacesto be convertedinto housingunits for the incomingrural families. The urbanrefonn,

48 therefore,added to the socialpolarization and spatial segregation of the population(Gu and Shen,2002).

The spatialsegregation was furtherenhanced by the creationof the housing market.Previously families obtained housing units through the state.The housing allocationwas based on the family sizeand years household heads were active in the labor force. With pivatization the housingwas left to the marketmechanism with minimal allowancefor governmentintervention. While the developersgrasped at this opportunity,the housingunits they were providing to the public were thoseaffordable to the upperclasses such as the onesin the greenbeltarcaof Zugloin Hungary.The availabilityof housingunits to lower incomeclasses remain very limited resultingin overcrowding of apartmentunits and educational institutions, thus impacting adversely the humancapital of lower incomegroups.

The abovefactors are mostly being stemmed by the lack of coherencein market andinstitutional reform. While the housingmarket has established itself swiftly it is not beingfollowed by a swift reformof financialinstitutions. For the housingmarket to reflectthe truedemands of the local populationfinancial institutions need to restructure themselvesand develop a mortgagefinancial system. The lack of long term loans,a mortgagesystem and financial incentives(such as tax redemptions)means that the housingmarket is servingonly thosethat areable to afford the housingunits on an immediatebasis, thus there is a shortageof affordablehousing.

The lack of affordablehousing has, to someextent, prohibited the potential inflow of immigrantsinto the urbancores. Deichmann and Henderson find low levels of urbanizationtaking place in Polandin recentye.rs. The argumentthe authorsmake is that the lack of affordablehousing, for the middle classworking population,is deterringthe rural populationfrom coming to urban coresto take up the employment positionsprovided by foreign investors.The occurrenceof slowly increasinglevels of urbanizationis indicatedin the map below. The readershould, however, examine both of the mapssince the levels ofurban populationdiffer significantly arnongstnations.

Map 3.

50 Map 4.

It is important to examineboth mapsto detemine the changein urbanization over the studiedperiod. While the PercentageChange in Urban Population map indicatesthat Albania witressed the greatestincrease in urbanpopulation, Albania had the lowesturban population in 1995(only 39% ofihe populationresided in urban cores).On the other handthe CzechRepublic witnessed a decreasein urbanpopulation over the last 5 years,though its urbanpopulation constituted 7 5%o of the natton's total populationin 1995.In relative termsthese differences are not extremebut they ar€ worthy to note.

It is interestingto seethat the natiors whosehansition into the market system was smootherfor the most part are experiencinglower increasein urbanpopulation if

51 not evena decrease.Estonia, Latvia andthe CzechRepublic were the nationspraised for the swift adaptationto the marketeconomy, yet the adaptationdid not seemto complywith the housingmarket reform. At the sametime, the lower increasesin urbanizationin thesenations may alsobe dueto the dispersionof foreigninvestment into the rural areasin searchof naturalresources or heavymanufacturing that is not foundin urbancenters. It appearsthat the localpopulation is encouragedto stay,if not also move,to the rural areas.Thus theremight not be as much pressureto move to the cities.

The lessdeveloped nations such as Albania and Belarus, on the otherhand, are seeingincreases in urbanpopulation immigration. This occrurencemay be dueto the harsheconomic circumstances in rural areasforcing the populationto move evenat the expenseof not beingable to find affordablehousing.

It is apparentfrom this sectionthat transitioningeconomies are not only experiencingtransformations in their economicand political systemsbut also in their urbanlandscape. Foreign investment, even though it is providing opportunitiesto the localpopulation, is mostlyaimed at the urbanlocations, as proven in ChapterVI. While the investrnenthas positive effects of restoringthe urbanarchitecture and meeting the demandsof the local population,it is creatingan aestheticallyuneven landscape. New shoppingmalls arenot in line with the old public administrativebuildings. New houses attainableby the higherincome groups are emerging in previouslypublicly held lands, while the affordablehousing market is neglected.These forces are impacting the movementsof the localpopulation that arenot only havingrepercussions on the cities but on the rural areilsils the following sectionwill porhay. Section7.2

Changes in the Rural Landscape

It hasbeen proven that foreigninvestment is directed,for the mostpart, towards urbancores neglecting the rural areasof transitioningeconomies in EastemEurope.

The dependenceof oblartson a limited numberof industrieshas resulted in a high level of emigrationfrom theseregions with the closingof factories.The emigration, however,has been limited dueto the lack of availabilityof affordablehousing, as mentionedin the previoussection.

Whendiscussing the rural landscapein EasternEurope, the main featureto consideris the agriculturalindustry. Thesetransitioning nations boasted some of the richestsoils. The abundanceof the fertile black soil -- chemozemin Ukraine-- has giventhe nationthe title of "Europe'sbreadbasket", wheat being its main crop.2t

Despitethe abundanceof fruitful soils, the nationswere averagingrelatively low outputs,such as in the 1980swhen "Soviet farmers averaged about 10 percent of the outputof their counterpartsin the UnitedStates".22 The main reasonfor the low levels of agriculturalproduction is the policies associatedwith centralgovernment planning.

Undercentral governance, agriculture was socialized through collectivization.

This meansthat any land,machinery and livestock was confiscated and redistributed to communalfarms. The workforcejointly producedthe crops,and was not motivatedby self-profit,but by reachingthe annuallytargeted output levels. Under this plan, discriminationlevels between the agriculturaland the manufacturinglabor force were

2rFor furtherinformation on Ulcraine'sagribusiness see: AeriMarket. Available on line: http://www. a grimarket. info/wonderland.php 22For further information on Soviet agriculturalproduction see: Country Studies.Available on line: http://www.country-studies.com/russia/agriculture.htnl

53 to be reduced.Consequently, "the work forceof the statefarm receivedwages and socialbenefits comparable to thoseenjoyed by the industrialworkers".23

The advantagesof collectivefarming were mostly administrativeas opposed to economic.The regulationswere uniform andwere used "to addressexternality related agriculturaloperations by forcinglandowners to useless fertilizer, spray less toxic chemicals,keep a certainproportion of their landin trees, producefree-range meat and poultryproducts, and so on, thussaving the treasurymoney'' (Suchanek et. al, 2001;5).

Therefore,enforcement of policy changesand new laws,as well asregulation of agriculfurallabor force,was more manageable under the centralsystem.

The weaknessesof the system,however, outweighed the advantages.There was a perpetuallack of incentivesamongst the agriculturallabor force. With the guarantee of fixed wagesand social security,it was in the interestof workers to contributethe daily minimumof their labor.There was no needto strivefor higheryields sincethere wasno form of monetarycompensations. The systemalso lacked flexibility; oncethe specificproduction techniques were set for a particularcrop, the systemwould be subjectto little change.There was also a lbck of diversity. Certain areasand labor were designatedto the productionof a specificcrop. The limited selectioncreated a narrow assortmentof agriculturalproduce in the local market.Lastly, centralizedgovernment planningdid not encourageexperimentation in agriculturalproduction. The laborwas expectedto take ordersand to carry out its daily routine as set by the administration.

This lack of creativityand experimentation limited progressin productionschemes from takingplace. Furthermore, byprohibiting experimentationthe laborforce was directlyprevented from developingexpertise in its line of work. Thesenegative factors

23Country Studies. Available on line: http://www.country-studies.com/russia/agriculture.htnl

54 on agriculturalproduction were further exacerbatedby "administratorswho were unawareof the needsand capabilities of the individualfarms [who] decidedinput allocationand output levels".24

ln an attemptto remedyagricultural production schemes, a numberof countries tried to slowly reformthis vital sectorof their economies.One of the betterknown set of reformswas that of PresidentGorbachev, who "sought to increaseagricultural productivity by forming contractbrigades of ten to thirty farm workers who manageda pieceof land leasedfrom a stateor collective1i*r.,25 The ten - to thirty - member groupswere responsible for the crop yieldsthat directlyinfluenced the group's monetarycompensation. The ideaof the systemwas to encourageteamwork, rather thanself profit, andat the sametime increasethe incentiveof the workersto be more efficientand productive.

By 1987,family brigadeswere legalized as well aslong-term land leasing.By allowingfor long-termfamily land leasingthe governmentwas directly "removingthe restrictionof the sizeof theprivate agricultural plots andcutting into state'sholdings of arableland."26 The reformwas met with outputincreases, but the lack of market freedomstill hinderedthe trueproduction capabilities of Russia'sarable lands. As in the restof EasternEurope, farmers still lackedinterest to improvethe production methodssince prices of produceand capital investment allocation remained in direct controlof the government.

On the otherhand, in the Westernregions of Europe,there was a reconstruction of agriculturalmethods of productionsince the 1950s.In France,"[the] government

24 CountrvStudies . Availsble on line: http://www.country-studies.com/russia/agriculture.htnl 2s CountryStudies. Available on line: http://www.country-studies.com/russia/agriculture.htrnl 26Countrv Studies. Available on line: htp://www.country-studies.cony'russia/agriculture.htnl

55 madegreat efforts to developproduction and productivity; agriculturalmachinery and fertilizerswere among the priority sectorsin the first modernizationplan"(Vial,

2001;l). Unlike Russi4 which facedconsistent shortages of food supplies,France saw constantsurpluses. In orderto meetthe agriculturalproduction standards of Western nations- andto makea biggerclaim in the world markets- the transitionalso needed to encompassthe rural agriculturalsector.

The transition to the market systemwas met with greaterhardship in the rural areasthan in the urbancores. Rather than increasing production, privatization caused

"fragmentationand low efficiencyof agriculturalproduction, which in unstablemarket conditions[can lead to] essentialagricultural land abandonment" (Busmanis et. al,

2001;1).As in the urbancores, the rural areaswere also faced with an unsystematic transitionof institutions.Ukraine's lack of coherenceamongst financial and political institutionshas drawn the attentionof academia.

Ukraine,Eastern Europe's main producerof wheat,has leaned towards pivatization of its agriculturallands since the early90s. The country,however, is not makingstrong steps towards improving the legalsystem that would allow for enforcementof bindingcontracts and property rights. As with the restof the studied nations,"officials in Ukraineare poorly paid andtake advantage of their positionsin a way that enftepreneurshave to make'unofficial payment'for gettingan official permit to receivea loan in a bankor to registeran enterprise."(Nijnik, 2001;10).The degree of comrptionamongst the employeesin the administrativesector is directlyhindering the transitionprocess and the establishmentof freemarkets that would reflectthe demandsand needs of the local population.The existenceof this asymmetric informationbetween the legal institutions andpotential property ownersis inversely affectingthe marketizationof agriculturalland.

The lack of bindingcontracts and property rights is consideredto be oneof the main factorshindering the flow of foreigninvestment into the agriculturalregions.

"Insufficient developmentof infrastructureand banking systemsin rural areas,aging of the rural populationand inadequate social security" (Nrjnik, 20011'I l) arefurther ailmentsin attractingforeign capital.

Themain consequenceof communismwas the undervaluationof natural resources.This lack of true landvalue, in the caseof Ukraine,resulted in over 2 million acresof landbeing abandoned (Nijnik, 2001).Instead of the transitiontransforming those2 million acresback into productiveland, lack of propertyrights that would allow firms to investin the land'simprovement is prohibitingthe advancementof agricultural production.Consequently the productionof staples,such as sugar, has decreased in

Ukrainefrom 6.8million tonsto 1.2million tonsover the lastdecade (Nijnik,2001).

Thereform did not seemto bring the expectedresults of successand prosperity. With the openingof the countriesto the world markets,the agriculturalindustry was faced with the needto updateits outdatedmachinery in orderto keepup with modern productionschemes.

Trustwas decliningamongst the workers,and comrption was on the rise amongstprivate investors. This resultedin unfair landallocation. After decadesof dependenceon the state,farmers were now left to adaptto the new marketconditions on their own. For somethis was the first time that they had to personallytake up the risks associatedwith a failing crop.Unfortunately, "many of themhave lost managerial skills and entrepreneurialabilities and arenot able to work independentlyand to competewith eachother" (Nrjnik, 2001;7).With limited educationand insuflicient monitoring and guidance,numerous farmers were left unemployed.In Ukraine the

"ruralunemployment... today exceeds 16 million people...[thereis] outflowof labor from rural areasand degradation of villages(about 8,000)n'(Nijnik, 2AAl;3). Theonce vibrantvillages and oblasts of EasternEurope are slowly loosingtheir vigor asthe youngmove to the urbancores in pursuitof work.

For thosewho remainedon farms,the lack of guidancehas resulted in their primaryconcem being revenue maximization with little considerationof the strains outdatedmachinery is havingon the soil andits futurequality. The slow destructionof soil quality,while not in the immediateinterest of the local farmers,is a repellingfactor for foreigninvestors. If foreignfirms seearapid depletionof resourcesdue to careless management,they may loseinterest in settingup long-termrural projectssince there is gteaterrisk in themincurring a futureloss.

To aid the rural communities,the main focus appearsto be on establishing institutionsthat would guidethe laborforce through the marketizationprocess. It is arguedthat "institutionsmust protect farmers against the political whims of unstable governmentwhile enablingfull participationin domesticand international markets"

(Suchaneket. alo2001;4). The naissance property rights need to be backedby legal institutionsthat protect contractual agreements and are not subjectto staff comrption.

Oncethis barrieris broken,foreign firms would be in greaterease to investtheir funds in rural areas.

Furthermore,it is inevitablethat adaptationto the new world marketswill result in an increasein unemployment,since technological advances in agricultureare demandingless manual labor. Since the housingmarket in the urbancores cannot providefor the inflow of rural immigrants,it is advisedthat foreigninvestment should be indirectlygeared towards rural communitiesrather than being solely focusedin the urbancores.

It was proven in Chapter6 that transportationis a vital factor in attracting foreigninvestnent. Instead of focusingthe expansionof roadson leastcost to build motive- wherethe roadsare expanded on the pathof leastresistance - the government caninstead construct routes that leadthrough rural populationnodes.

Theoblasts would be ableto increasetheir servicerevenues as well as local governmentrevenue through tolls. This actioncan liven up the neglectedrural cities of

EastemEurope, aiding in theprevention of furtherdepopulation. The lengtheningof transportationroutes would allow for dispersionof FDI throughoutthe nationrather thanconcentrating the capitalin a selectednumber of urbancenters. The negativeeffect of the lengtheningof transportationroutes is higherconstruction costs and a longer timeframefor completionof the roads.The most economicalway to improve highway transportationnetworks is throughundeveloped land. Construction of roadsthrough agriculturalland andrural nodeswould lead to short term costssuch as reallocationof the localpopulation and changes in zoningregulations. Therefore, connecting many townsand villages may not achievethe best net benefits unless the futurelong term benefits- measuredby changein the level of economicactivity - outweighedthe high shortterm costs. Chapter VIII

Conclusion

Throughthe lastdecade, the studiedfifteen nations of EasternEurope have been adaptingtheir economiesto the marketsystem. High budgetdeficits forced the nations to attractcapital from foreigninvestors instead of basingtheir reconstructionsolely on bankand intemational government loans. Foreign investrnent, unlike loans,directs capitalto the local firms. Throughforeign investment firms canbe modernized organizationallyand technologically (Pavlinek, 2004). Thesefactors contribute to makingproduction methods more efficient, as well asmaking the finishedproducts marketableto surroundingnations. There are, however, disadvantages associated with foreigninvestment.

As previouslymentioned, foreign firms investingin EasternEurope are seeking to minimizetheir costsand maximize their profits.The minimizationof costsmay entaila decreasein worker safety,lack of insurancepremiums and relatively poor workerconditions. The expansionof the manufacturingindustries and lack ofpollution regulationsmay contributeto local environmentaldegradation that in turn can affect the healthof the local population.

While inflow of foreigncapital may stimulatehome country's industries it may alsoincrease the dependencyof the industryon foreigngovernance and investment.

The firms may exploit the availablenatural resources of the nation to the point of full depletion.Once the resourcesare no longeravailable the firms may abandonthe industry,cutting the inflow of foreign capitalto the homenation. Foreignfirms locatingin homeeconomies tend to attractskilled andsemi- skilled laborfrom the local companies.This, in turn, reducesthe marketcompetition and increasesthe relative labor quality of foreign owned firms in the home country.

Thereis a potentialthreatof regionalspecialization in low skilled laborintensive productionmethods. In thesecases, once the foreignfirm losesinterest in the region,it will both cut the flow of capitalinto the regionand leave the working population specializedin a particularskill thatthey might find hardto reapplyin otherindustries.

As evidentfrom the multivariateregressions, foreign capital is highly attracted to urbanizedregions of the homecountry. This factorleads to an unevenflow of investmentinto urbanizedareas of the homecountry, neglecting the primary industry and the rural population.The lack of foreign investmentinto agricultural regionshas resultedin a migrationof the localpopulation from rural to urbanareas placing housing andemployment pressure on the local cities.

Theknowledge of the negativeside effects associated with foreigninvestment, hasnot deterredthe studiednations from focusingon factorsthat would attract internationalcapital. While economicand political factorsare vital determinantsof foreign capital this study additionallyconfirms the importanceof geographicvariables.

Thevariables examined are concentration of urbanpopulation, geographical size of the country,the marketpower and distance of surroundingtop GDP ppp nationsand transportationinfrastructure. By usingmultivariate regressions the studyfinds all of the variablesto contributesignificantly to attractingforeign investment with the exception of country's geographicsize. It is arguedthat the larger the country is the more likely it will be self-sufficientand may not engagein asan extensivetrade as a smallernation would. Foreignfirms, asa result,may be lessinclined to investin economiesthat tend to be self-sufficientas this would lowerthe foreignfirm's chancesto invadethe surroundingmarkets with its goods.

In caseof transportationall threemodes prove to be statisticallysignificant their separatemodels. According to theseresults, home country's government that wishesfor foreigncapital to play a greaterrole in the marketizationof the home economyshould focus on expandingtransportation modes. A modemand efficient road network can aid foreign firms in two ways. It providesa safeand fast transportof productioninput materialsas well asa secureand efficient distribution of the final productsto the local andsurrounding international markets. Thus governments should focuson expandingthe roadnetwork whilst improvingthe quality of the existingone as well astaking carefully into considerationthe regionsthe networkwill cover.As discussedin ChapterVII, Section7.2,a networkthat passesthrough previously highly industrial and rural regionsmay contributeto reviving the oblasts.Through road tolls aswell as formationof servicesalong the roads,the economicstanding of the local populationmay improve.This in turn will contractthe level of rural depopulationas well asreduce pressrue on largercities from providinghousing and employment opportunitiesto immigrantsfrom rural regions.

Urban populationproved to havethe strongesteffect in attractingFDI. The coefficientvalue averaged 6 meaningthat a loloincrease in urbanpopulation should resultin a $6 per capitaincrease in foreigninvestment. High levelsof urbanpopulation indicatea developednation that canprovide complimentary services to the foreign investors.Increasing the urbanpopulation in orderto attractinternational capital, however,is a difficult taskas covered in ChapterVII. The non-homogenoustransition is reflectedin the lagginglegal and banking institutions. Contractual agreements are still lacking, propertyrights are still vague,and mortgages are not availableto aid the localpopulation in purchasinga house.Thus there is comrptionand over crowding takingplace in urbanregions.

This non-homogenoushansition is clearlyreflected in nations'landscapes.

Cities arebecoming "mosaic" structures of old, socialist,administrative buildings and new privateinvestment. There is overcrowdingwith the constructionof upperincome housingunits anddistribution of previouslypublicly held landsto privateinvestors.

The lack of planningis clearlyvisible in traffic congestionsand insufficient parking space.Agricultural regions,on the other hand,are facing abandonmentand negligence from both govemmentand international investors. There is depopulation,especially amongstthe youngergenerations as they leavetheir landsand move to cities in search of employment.

Macroeconomicperformance and cost reducing policies are necessary in attractingforeign investment. The study,however, substantiates that macroeconomic factorsmay not be sufficientin solelyattracting FDI. Thepaper concludes that urban population,transportation, distance and market power of surroundingnations as well as geographicsize, all play a significantrole in attractingforeign capital. The variables, however,are not ideal.The shortcomingsof the studywere outline in ChapterV and the papercalls for futureresearch to recognizethe limitationsof this studyand expand on it.

In particularfuture research should analyze the conditionsof the roadnetwork andthe proportionsof the networkthat belong to motorways,highways, main andside roads.Future research should also examine the distributionof the roadnetworks and wherethey lead.This will provide greaterinsight to local governmentsas to what sectionsof the nefwork are in gyeaterneed of immediateattention. Moreover,future studiescan expand on the transportationvariables used. Danube, Dnieper and Vistual arethe threemajor rivers flowing troughthe studiedregion. Water is oneof the most economicalmodes of transportation.By expandingthe studyto encompasswater transportationthe govemmentcan obtain some insight on the conditionof local ports.

The changesin the urbanand rural landscapesshould continue to be monitored.

Throughtime it is expectedthat theselandscapes will be transformedeven further as legalinstitutions transition to reflectthose of the Westernworld.

Yearsof centralgovemance have left deepscars on EasternEurope's landscapes,economies and political institutions.At this point the fifteenexamined nationsare seeking individual paths to recovery.As a part of their recoverythey are tuming to internationalinstitutions and govemments for capitaland investment. The competitionfor limited foreignfunds, however, has been continually increasing betweenEastern European and East Asian nations. While foreigninvestment has its advantagesit alsohas its costs.I endthis paperwith thehope that the nationsseeking foreigninvestment will useit in futuredevelopment and long-term benefit of the local population. Aopendix I

Banjica

Belgrade,Serbia

This microdistrict was constructedin the 1950sto house World War II veterans.

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