The Impact of Foreign Direct Investment

Greece is a country situated in the southeastern portion of the European continent. It is a known fact that this country has successfully completed the three phases accession requirement of the European Monetary Union (EMU) in December 2004.

It is a known fact that the country has a capitalist economy ever since. Gert-Jan Hogeweg (1996), Head of the Monetary, Economic and Statistics Department of the European Monetary Institute, revealed that the conditions set by the European Union (EU) to be a convergence member involve maintaining budget deficit of less than 3% of their GDP, a debt ratio of less than 6% of GDP, and inflation of less than 2% and interest rates comparable to EU average.

(“Convergence”, 7th par. ) Romania, the neighboring country of Greece has also been acceded to EU and also a convergent member as of January 1, 2007. Turkey is being considered as the first Muslim country to be acceded to the European Union and the earliest date that accession will be completed according to blogger Lucia Kubosova (2007) of EUobserver will be 2013 (1st par. ). Greece and Romania in the light of being convergent members of the European Union can be

hypothesized as having a more stable economy than Turkey who is not yet a member. Having a stable economy is very attractive to FDI which will further strengthen the economy. This paper aims to document the effect of FDI on the financial system of Greece and compare it to the achievements of Romania and Turkey. Furthermore, the paper aim to analyze the determinants of FDI in the light of milestone achievements of Greece in 2004-2008 period compared to Romania and Turkey. Determinants of FDI, Structural Changes in Greece and Impact of FDI on the Financial Sector

The World Fact Book of the US Central Intelligence Agency (2009) reported that the capitalist economy of Greece resulted to public sector controlling 40% of GDP and the per capita GDP of about 75% of the leading countries in the EU. The CIA further revealed that tourism contribute 15% to GDP. Immigrants in Greece represent about 20% of the workforce that is mainly agricultural and unskilled. The Greek economy as reported by CIA grew by about 4% annually during the 2003-2007 period mainly due to infrastructural spending related to hosting of the Athens Olympic Games in 2 2004. In 2008, the growth rate dropped to 2.

8% mainly due to tightening credit condition and the world financial crisis. The government is continuing its effort to reduce government spending, and public sector size and reforming the labor and pension system to make the economy stable and attract FDI (Economy overview, “Greece”) Determinants of FDI a. Geographical location The study of FDI and regional development by Copenhagen Economics in 2006 revealed that geographical location of country which is vital to FDI effect spillover is a prime consideration in attracting inward FDI. (Summary, 4th par. ). Greece has been marketing their country to FDI

prospects as having a strategic geopolitical location (Fact Sheet on the Greek Economy, 2007). The geographical location of Greece made it possible to easily link the east with the west, the Mediterranean and the Balkans thus making the country an ideal location for FDI and trade (“Strategic Geopolitical Location”, 1st par. ). b. Issues related to ownership specific advantage, local knowledge pool and internalization According to Claudio Viezzoli (2006), Director Western Balkans FEMIP Expert Committee, FDI inflows normally consider the possibility of owning and maintaining the patents

and brands that will be introduced to the host country. Under international business ethics, this will give the investor great competitive advantage over other firms, both local and international operating in the host country. Internalization advantage relating to retention of asset under single corporate structure rather than licensing or franchising is also a prime determinant (“What motivates FDI”, p. 7). Related to this, the Ministry of Economy and Finance of Hellenic Republic (2007), reported that they enacted the Investment Incentive Law which guarantee the determinants stated

above and funding up to 55% of the new investments (Investment Incentive Law, 1st par. ) c. Stability and size of the economy The above data also is a requirement for convergent with the EU and this showed that Greece is a worthy accession member which is a determinant of FDI (Viezzoli, “Determinant of FDI to TE’s, 5th line”). In the strict business sense, the country giving the FDI want to ensure that the investment will be profitable and one way of ensuring that is investing in countries which are accession member of the EU. e. Excellent condition of supporting institutions

The supporting institutions which include the government with its general reform program towards trade liberalization, transparency and privatization is essential for deciding to which country the FDI should go. Moreover, Viezzoli (2006) indicated that the financial sector should be in tuned to support and ensure availability of funds for consumption stability and growth and reduced transaction costs by reducing red tape. In addition, there should be level playing field for all players related to regulation and competition policies as well as legal rules of the game with better

enforcements (“Role of supporting institutions in attracting FDI”, 1st to 7th lines). The Ministry of Economy and Finance of Hellenic Republic (2007) has outlined the structural changes of the supporting agencies which made Greece attractive to FDI placements. As a result of structural changes, the FDI to Greece shoot up from 468 million euros in 2005 to 4275 million in 2006 (Ministry of Economy and Finance of Hellenic Republic, “The Greek Economy in Graphs”, p. 6). In 2007, after the structural reforms made by Greece in 2006 to 2007, the Organization for

Economic Cooperation and Development (OECD) reported that the country posted a big decline of inward FDI of 64. 3%. The reason is bureaucracy and changing tax system (grhomeboy, 2008). In 2007, the inward FDI of Greece registered to only $1. 9 billion against $5. 4 billion in 2006. This is against an average of 31% increase in inward FDI in other OECD member states. “The so-called structural changes of the previous Greek governments and the “reforms” of the current one have 4 apparently failed to persuade foreign investors that Greece has a business-friendly environment” (3rd par, lines 1 to 3).

The author further reported that bureaucracy and corruption as well as inflexibilities of the labor market and the unstable institutional environment have placed the country in the last spot among the OECD countries related to FDI attractiveness and competitiveness. Impact of FDI to the Financial Sector of Greece The 2005 IMF Country Report on Greece revealed that the commercial banking system is the predominant component of the Greek financial sector controlling 76% of the country asset. Despite the privatizations and mergers, the state still controls indirectly close to half of the banking sector assets (p. 1).

The IMF further revealed that as of 2004, the insurance segment is relatively small, controlling only 4% of the country’s financial asset. The stock exchange is in a depressed state. As of 2004, the Country Report on financial sector indicated that with regard to soundness of banks in Greece, with scale of 1 as insolvent and 7 as generally healthy, Greece banks scored at 5. 5 vs. 6. 1 for Germany. For the category of access to credit, at scale of 1 as difficult and 7 as easy, Greece scored 4. 8 vs. Germany’s 3. 5. On financial market sophistication with 1 lower than international norm and 7 higher than international norm, Greece scored 4.

1 vs. Germany’s 5. 7 (p. 24). On the basis of this unfavorable image of the financial sector, the banking sector of Greece underwent a major overhaul in order to attract more inward FDI. The Ministry of Economic and Finance of the Hellenic republic in 2007 revealed that Greek banks increased its network to over 1000 branches with 16,000 employees and controlling 16% market share of banking in SEE (The banking hub, 1st to 3rd lines). In Greece, the bank assets amounted to 266 billion euros or 156% of its GDP. Greek banks became one of the top performers in European banking (the banking hub, 5th and 6th lines).

Considering the positive developments, we can conclude that FDI awaken the Greece banking sector to streamline and expand their operations in line with increasing inward FDI. In close analysis, the determinants of FDI with respect to strength of supporting agencies like the privatization implemented by Greek government, strengthening of the banking system, attractive incentive scheme and taxation for investors as well as level playing field were all in placed. The Greek economy being stable with fairly high GDP, low inflation and unemployment is ready for FDI 5 infusion.

Despite this, continues decline of inward FDI was experienced since 2007. Bureaucracy and changing tax system are the major reasons behind the unattractiveness (grhomeboy, 1st par. ). The other reason as pointed out by the IMF in 2005 Country Report is the stagnant labor force with relatively high wages discourage new entrants (p31,1st par. ). ). Based from this, we can conclude that there is no positive correlation between performance of the financial system and flow of inward FDI in Greece. Romania and its Attractiveness to FDI The banking system in Romania has no direct connection with inward FDI.

The National Bank of Romania serves as the depository entity of the investment. The only government agency in charge of attracting FDI is the Romanian Agency for Foreign Investments ( Larive Romania, page 2, right column, 10th par. ). The agency offer professional services to investors throughout the period of investment cycle. Similar to Greece, patent and brand name ownership is guaranteed in Romania and the investor has the right to choose where in the economy the investment will be placed. Income tax is only 25% compared to 30% in Greece. A 50% off on income tax from re-invested profit within the

country is also guaranteed (Larive Romania, page 2, left column. ) For those investing $1 million or more, the government is offering 20% off of investment figure for tax purposes to be applied in the first month of investment completion plus the use of 50% depreciation for equipments only for the first year of operation and the government can opt to exonerate the land tax during the period of entering the investment but not over 3 years (page 2, right column,4th to 7th par. ) The most attractive condition to FDI in Romania is the availability of cheap and highly skilled labor and the stable developing economy.

In 2003, Romania attracted $10 billion worth of FDI (“top investing country…” page 3). This is a proof that the condition in Romania is more attractive to FDI placement than Greece despite the absence of an active banking sector leading into conclusion that the stable economy of the country, geographical location, cheap and highly skilled labor availability plus attractive incentives related to tax and proprietary brand ownership are the effective attractants to inward FDI. 6 Inward FDI of Romania Turkey and its Attractiveness to FDI The Sundayzaman. com in 2008 revealed that the IMF is continuously financially assisting Turkey

to its road to economic prosperity. In 2004, the IMF provided the country the final standby fund of $10 billion dollar. The amount was used for the stopping the “country’s deep, underlying structural problems and focuses on the more well-rounded development of an international, competitive economic market” (“Turkish economy prospects and EU accession”, 2nd par. ). With the fund, Turkey successfully eradicated the structural inflation and tamed the out-of control budget deficits and public debt due to weak state sector. Moreover, the country was successful in repairing the

previously dysfunctional banking system and managed the investment environment by promoting stability and capitalization. This made the banks capable of long term lending and borrowing to finance the economic activities brought in by FDI. The ongoing privatization efforts of major business entities by the country and its effort to improve its macroeconomic climate coupled with positive political stabilization yielded confidence from investors leading to increased inward FDI. Inward FDI of Turkey The country is hoping that its achieved government and economic stability since 2004 to date will

give them the very much sought accession into the European Economic Union. The case of Turkey which is basically a crisis-sensitive government in the years prior to 2004 and its effort to overturn this condition with aid of IMF in 2004 only proved that a stable government, skilled and low cost labor availability, and well-developed financial sector devoid of bureaucracy and red tape are the effective determinants of FDI. Reliable sources revealed that what is happening in Romania and Turkey with regard to positive FDI attractiveness is also happening in other SECI countries. Summary and Conclusion

The sources consulted on the determinants of FDI point to political and socio-economic stability as the primary determinant. Regional diffusion of technology innovation effect coupled with proprietary brand protection and attractive incentives for investment is also a prime consideration. It is an accepted fact that investors view the market in wider perspective. Regional similarity of culture, language and economic stability of adjoining countries to the host FDI country is a prime consideration as it was proven already that market expansion in this type of scenario will entail

lesser time and expense thus ensuring a greater return on investment per unit time. Modernization of the financial sector and its stability is also a prime concern in FDI placements to a certain country. It is a natural tendency of investors to ensure that their investments are well protected in the country through a well secured and liquid financial sector. It was shown that Greece has modernized its financial sector in tune with the needs of foreign investors. However, in the processing of their investments, foreign investors were not attracted due

to bureaucracy and red tape in the agencies related to foreign investments. In addition, the high wage required and lesser skilled labor available in the country further discouraged investments. In the case of Romania and Turkey, which attracted more inward FDI during the period 2004 to 2008 than Greece, the financial sector is not as modern as Greece but cheap and skilled labor is readily available coupled with a stable government and economy and attractive investment incentives. It is now therefore conclusive that a streamlined and modern financial sector is not the only determinant to inward FDI placements.

The ease in investment processing, devoid of too much bureaucracy and red tape, coupled with a stable economy and government and availability of cheap skilled labor together with good potential for expansion in the neighboring countries altogether can attract FDI. Moreover, due to more attractive investment incentive of 25% off on profit tax in Romania compared to 30% in Greece and other attractive incentives, it is more profitable to invest in Romania. The availability of cheap and skilled labor in Romania and Turkey made it more profitable to invest in these countries than in Greece.

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homeboy. gr/? p=1830 [Accessed 6 April 2009] Hogoweg, G (1996). General Aspects of European Monetary Integration [on line]. Available from: http://www. ecu-activities. be/documents/publications/publication/1996_3/hogeweg. htm [Accessed 5 April 2009]. International Monetary Fund. February 2005. Greece: Selected Issues. Washington, DC . IMF Country Report No. 05/38. Kubosova, L. (2007). Brussels declines to endorse 2013 date for Turkey’s EU entry [on line]. Available from: http://euobserver. com/9/23881 [Accessed 5 April 2009]. Larive Romania. Direct Investments in Romania.

2004 Romanian Business Digest, 8pp. Ministry of Economy and Finance of Hellenic Republic (2007). Fact Sheet on the Greek Economy [on line]. Available from http://www. mnec. gr/export/sites/mnec/en/economics/ greek_economy_prospects/ FactSheet_January07_Eng. pdf [Accessed 5 April 2009] Ministry of Economy and Finance of Hellenic Republic (ca 2007). The Greek economy in graphs [on line]. Available from: http://www. mnec. gr/export/sites/mnec/en/economics/ greek_economy_prospects/GreekEconomy_Results. pdf [Accessed 5 April 2009] Ministry of Economy and Finance of Hellenic Republic (2008).

Info on Main Structural Reforms in 2004-2008 [on line]. Available from: http://www. mnec. gr/export/sites/mnec/en/ economics/greek_economy_prospects/FactSheet_Reforms_May_08. pdf [Accessed 5 April 2009] 9 Sunday Zaman (2008). Global investment flows and climate: How can Turkey perform better? [on line]. Available from: http://www. sundayszaman. com/sunday/detaylar. do? load=detay&link=2852 [Accessed 9 April 2009]. Viezzoli, C. (2006). Foreign Direct Investment in Transition Economies. Paper Presented at the Conference of European Bank for Reconstruction and Development. Vienna, March 20-21, 2006.

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