Introduction

1. Foundation for the Advancement of Economics and Friedrich Ebert Stiftung (Belgrade) lecture series The impact of European FDI in the EU 'neighbourhood': relative size, geographical scale and spatial selectivity VassilisMonastiriotis (with MireiaBorrell) LSEE – LSE Research on South Eastern EuropeEuropean Institute, London School of Economics(Contact: v.monastiriotis@lse.ac.uk) Faculty of Economics, University of Belgrade, 10 September 2013

2. Introduction • General motivation / context • EU “approximation” a ‘policy distortion’ • Preferential trade, trade re-orientation, institutional convergence • But is the “EU influence” good? •  Often, these advantages are assumed (‘given’), even in the context of ‘conditionality without accession’ (!) • Here, we examine one only aspect of the ‘economic’: FDI spillovers • One aspect but not a side-issue: impacts on domestic productivityand thus on industrial structure and international competitiveness • Because of FDI’s contribution to political transition (Grabbe, 2006; Bevan/Estrin, 2004) • Because of its contribution to economic development (Markusen/Venables,1999) • Why should we care? • Iff the ‘EU influence’ is not unidirectional, then there is a role (and responsibility) for the EU to correct and/or compensate Institutional (capacities) Political (democratisation) Economic (modernisation/growth)

3. Introduction • FDI in ENP (vs in CEE) • In CEE, prospect of accession paramount in mobilising foreign investments • Part of changing geographical organisation of production (spatial DoL) • Part of a wider process of restructuring for the European industry • Deeper integration process, stronger / more organic linkages => stronger technology transfers to domestic firms • In ENP (and SEE?) less FDI and with different motives • Less integration, more market capture & resource ‘expropriation’ • Still, pref’l framework a motive for more organic / less speculative FDI

4. Introduction • Research questions • Does EU FDI have positive productivity spillovers? • To justify the FDI attraction policies • Does EU FDI have a spillover advantage over FDI of other origins? • To justify the ‘approximation’ policies • Does (EU) FDI have different impacts in ENP than in CEE? • Would suggest need to combine openness w/ deeper/political integration… • Does (EU) FDI create spatial distortions despite its overall +ve effects? • Would necessitate corrective policy interventions • Empirical analysis • Firm-level data (10k+) from BEEPS (28 countries, 2002-2009) • Production-function approach to estimate direct and intra-industry productivity spillovers, looking in particular at: • How these vary across country groups • How they vary by origin • The geographical scale of spillovers (nat’l/sectoral v reg’l/localised) • The spatial selectivity of spillovers (capitals v the rest)

5. Introduction • Structure • Introduction • Considerations for the analysis • Empirics – theoretical considerations – data & model • Empirical analysis I: impact of FDI by origin and recipient group • European vs non-European spillovers in ENP, SEE & CEE • Empirical analysis II: scale and location of FDI impacts • Examining localisation of spillovers and capital-city effects • Conclusions and policy discussion

6. Considerations for the analysis • What we know (empirics) • Vertical / inter-industry spillovers / stronger / more positive • Damijan et al, 2003; Gorodnichenko et al, 2007; Nicolini/Resmini, 2010 • Horizontal often non-significant or negative (also in LDCs) • Konings, 2001; Javorcik, 2004; Sabirianova et al, 2005 • Horizontal (and vertical) conditional / contextual • Firm/sector characteristics (firm size – Pojar, 2012; absorptive capacity / technological distance – Halpern/Murakozy, 2007; sector/region – Monastiriotis/Jordaan, 2010) • Recipient country characteristics (level of development, corruption, political regime – Tytell/Yodaeva, 2005) • Characteristics related to the foreign investors (origin, extent of ownership, export-orientation – Javorcik/Spatareanou, 2011) • Significant selection (Jordaan, 2013) & hysterisis(Monastiriotis/Alegria, 2011) Damijan et al, 2013: an extensive study of effects and conditioning factors Here, interest is in the geography of spillovers, within a context of political-institutional-economic approximation

7. Considerations for the analysis • On origin and geography • Origin • Existing research: different processes and conceptions of ‘proximity’ • J&S: distance => local sourcing => vertical spillovers • M&A: cultural-technological proximity => more ‘embeddedness’, greater scope for / more absorbable spillovers (vertical – horizontal) • Here: political-inst’l proximity (‘approximation’); more productive due to: • FDI part of ‘strategy’ to strengthen local capacities/markets local links/synergies • Local firms more keen to ‘engage’/compete with EU investors more ‘learning’ • Institutional approximation (transposition) facilitating/forging such links  larger / more absorbable spillovers • Scale and space • FDI literature not particularly ‘theoretical’ on this – nor too ‘empirical’ either • Focus on sectors and the nature of spillovers (eg, pecuniary – technological) • ‘Spatial’ theory directly from ‘economics of agglomeration’ literature • Knowledge spillovers are localised; MAR & Jacobs externalities / economies • Some work on impact of agglomeration (‘local capacities’ / absorption) • Driffield/Hughes, 2003; Haskel et al, 2007; Girma/Wakelin, 2009 (UK); Mullen/Williams, 2007 (USA); Sgard, 2001 (HU); Jordaan, 2008 (MEX); Monastiriotis/Jordaan, 2010 (GR)

8. Considerations for the analysis • Data • Business Environment and Enterprise Performance Survey (BEEPS) • EBRD/World Bank survey on firms / business environment • Unbalanced panel from three waves – 2002, 2005 and 2009 • Survey contains 28k obs (22k/10k after cleaning); 28 transition countries • Sample sizes b/w 82 (MG) and 1,000+ (BG, UK, RU, TK, PL, RO, CR) • Info on sales, employment, fixed assets, share & nationality of foreign ownership, share of exports, sector (2-digit NACE), region, etc (info on foreign presence/nationality in cases projected from x-sectional survey) • Independent variable – Foreign share within sector (horizontal) • Based on firm-level foreign shares: share of output attributable to foreign ownership (within sector-year or sector-region-year) • Output-based measure, favoured over E-based due to pvity diffs • Using 10% threshold for decision not to include to group of domestic firms – other thresholds (min, maj, full) similar results • Descriptive statistics (next slide)

9. Considerations for the analysis

10. Considerations for the analysis Table 2. Sample sizes by country (group) and year

11. Considerations for the analysis Table 3. Foreign ownership shares by country (group) and year

12. Considerations for the analysis Table 4. FDI inflows as share of GDP (UNDP data)

13. Considerations for the analysis • Method • Production-function approach – total factor productivity effects • Sales (Y) a function of labour (E) and capital (FA) • Policy variable (spillovers): share of foreign presence (sector/region) • Controls (selection etc): sector and country dummies; firm FEs • Estimating model • where y is output (sales) of firm i in sector s of country c in year t; k is capital (fixed assets); l is employment; h is our measure of horizontal FDI; Dc and Dt are vectors of binary dummies for countries and years; e is a normally distributed error; and the b’s are parameters to be estimated • Estimation considerations • Clustered standard errors, OLS and FE (within) estimations • FEs reduce sample and heterogeneity: only indicatively here • No correction for selectivity of capital – little sectoral differences

14. Empirical results But significant non-linearity (also with firm-FEs) hump-shaped effect, positive for low FDI concentrations, negative for high ones Either way, external (horizontal) effect negative and non-significant But significant with interactive country-year FEs (national trends / country-specific temporal effects) Effect smaller with sector-FEs, suggesting, if anything, selection into low-productivity sectors Aggregate effects Direct (own) effect strong and positive But not when controlling for selection

15. Empirical results Predicted total effects on firm productivity (vertical axis) for different values of sectoral shares of foreign presence (horizontal axis) based on alternative estimation equations Non-linearity Col. 6 Col. 5

16. Empirical results • Stock-taking – aggregate analysis • Overall, in our sample countries, foreign investments offer little benefits to the sectors in which they locate (in terms of spillovers) • There is a direct positive effect for the firms that receive the foreign investment – although, still, this may be subject to self-selection • Some evidence of positive spillovers in sectors where foreign presence is (positive but) at rather low levels – although country differences in temporal dynamics may exaggerate this effect • Firms in sectors that are dominated by foreign-owned production (well above 50%) show in fact lower productivity • When restricting the sample to surviving domestic firms only (FE estimation) the effect becomes more negative • This suggests that this effect is not compositional (e.g., creaming-off via take-overs or crowding-out via exit) but a pure negative externality

17. Hypothesis 2: destination matters Hypothesis 3: EU role by destination Hypothesis 1: origin matters / EU advantage Empirical results In all cases productivity advantage for EU FDI:- significantly positive in the SEE and ENP, where non-EU is non-significant (but +ve in SEE) - EU negative non-significant in CEE, compares favourably to non-EU (significant negative) But very strongly hump-shaped (essentially always positive) in SEE: lack of domestic capital/technology base? In ENP the effect highly insignificant: suggesting perhaps a capacity (absorption) issue? Difference remains also in FE & non-linear specifications (EU FDI has hump-shaped effect, non-EU linear negative) Although insignificant with country-specific time effects, difference from non-EU FDI remains (and is significant) Impact of origin / destination H1 confirmed: EU FDI significantly more advantageous Impact negative insignificant in CEE: benefits exhausted?

18. Empirical results • Stock-taking – role of European FDI • Overall, the results offer support to the underlying hypothesis that the origin of FDI matters, not only in itself but also in relation to the recipient country • In the CEECs, where levels of development are comparatively high and where economic openness happened earlier / faster, the benefits from FDI, in an intra-industry sense, seem to have been exhausted – for both EU and non-EU FDI • Instead, in the SEECs, where the EU has been playing a pivotal role for political-economic stabilisation and development, the productivity effects of European FDI are exceptionally strong and much more significant than spillovers from FDI of other origins • Finally, in the ENP region, where EU’s involvement is also preferential but much less significant, or influential, European FDI produces smaller spillovers, albeit still more beneficial ones compared to FDI from other regions

19. Empirical results Impact of geography / scale Impact of geography / scale Is the absence of strong results due to our focus at the national-sectoral level? Are spillovers (more) localised? Counter to expectations, no localised effects either Effect (at least) positive, but insignificant(also with firm-FEs, non-interactive dummies, etc) As before, strong evidence of non-linearity (across specifications): concentration matters (adversely) But the effect is flatter, suggesting little localisation and probably evidence of spatial heterogeneity The hump-shaped effect is also consistently flatter for the three country blocks (and only significant in SEE) EU FDI still more beneficial, but effect non-significant: by all evidence, intra-industry (horizontal) spillovers are not localised EU FDI still more beneficial, but effect non-significant: by all evidence, intra-industry (horizontal) spillovers are not localised But note that the region-wide measure (not region-sector) returns strong positive spillovers Spillovers are inter-industry (region-wide): urbanisation, not localisation, effects These patterns appear to be strongest in CEE and weakest in SEE (not shown): Especially in the CEECs, negative spillovers / exhaustion of benefits comes from the peripheral regions But for intra-industry at least, the effects appear to be heterogeneous in space: the negative effect is driven by domestic firms in the periphery The picture is similar when we examine non-linearities: For capital regions, strong hump-shaped spillovers and stronger with co-location (spillovers are localised) The picture is similar when we examine non-linearities: For capital regions, strong hump-shaped spillovers and stronger with co-location (spillovers are localised) For other regions, spillovers are insignificant / negative (although still less so with co-location) Concerning the origin distinction: EU FDI more advantageous in both types of regions FDI of any origin more advantageous in capital regions EU FDI in capital regions produces clear positive spillovers In the case of the region-specific measure, FDI returns a positive spillover in capital regions Spillover effect more positive everywhere, suggesting that localisation matters, but rather differently in different types of regions

20. Empirical results • Stock-taking – geography of spillovers • Evidence of localised spillovers particularly weak – e.g., in quadratic model hump-shaped curve much flatter than in sectoral analysis • Region-wide FDI, however, produces strong positive spillovers (vertical / inter-industry spillovers; urbanisation effects) • But these effects are conditional on space / heterogenous: • capital regions consistently benefit more / suffer less (esp. in CEE) • hump-shaped non-linearity essentially only in capital regions • conditioning on space, localisation effect becomes larger • Implication: even when overall effect is positive (moderate concentration, European origin, etc), foreign presence has a detrimental spatial effect as it tends to increase productivity differences b/w capital-city regions (which already possess development/agglomeration advantages) and the rest • Effect not due to concentration of FDI in capitals (see result stability in cols.6 & 7) • But given this concentration, the spillover advantage observed in capital regions implies necessarily that foreign-frim presence magnifies regional disparities in the host economies (at least those of our sample)

21. Summary and conclusions • Starting points • Knowledge/empirics of FDI spillovers extensive/consolidated – but little emphasis on supra- and sub-national geographies and political contexts • Here, examined the ‘origin & geography’ issue within context of EU external relations (neigh/hood policy): inst’l approximation – enhanced econ flows • Research questions: Is it good? Is it worth it? Is it cost-free (or distortive)? • Main findings / key highlights (more, in the paper…) • EU FDI has ‘productivity advantage’ in ‘neighbourhood’ (more +ve / less –ve) • If EU MNCs not systematically more productive, policy a likely source of advantage • FDI spillovers in ENP not maximised (countries not sufficiently ‘developed’?) • More ‘approximation’ can bring benefits as in CEE (past) and SEE (today) • Spillovers not too localised but stronger in capital regions • Agglomeration matters; but spatially distortive / enhancing regional disparities • Conclusions for policy • Approximation process and ‘gravitational pull’ create an inadvertent reorientation of trade and economic / production structures • With it, come costs: productivity spillovers that are often negative; spatial distortions producing more inequality / geographical differentiation • Role for (EU) policy to correct/compensate : existing policies and assistance instruments to obtain spatial focus; new ones to address spatial imbalances

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