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Foreign direct investment in countries of the former Soviet Union: Relationship to governance, economic freedom and corruption perception
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Communist and Post-Communist Studies 41 (2008) 301e316 www.elsevier.com/locate/postcomstud
Foreign direct investment in countries of the former Soviet Union: Relationship to governance, economic freedom and corruption perception Murat M. Kenisarin a, Philip Andrews-Speed b,* a
Academasbob, Uzbekistan Academy of Sciences, Tashkent Akademshaharchasi 700125, Uzbekistan b Centre for Energy, Petroleum and Mineral Law and Policy, University of Dundee, Carnegie Building, DD1 4HN Dundee, United Kingdom
Abstract The modernisation of the economies of the former Soviet Union (FSU) will require substantial levels of foreign direct investment (FDI). The aim of this study is to examine factors which may be instrumental in determining this level of the FDI. It achieves this by establishing quantitative relationships between levels of FDI per capita to the year 2004 and three sets of indicators relating, respectively, to governance, economic freedom, and corruption perception. The paper demonstrates that the level of FDI in FSU states has been determined to a significant extent by the degree of reform from a planned economy towards a market economy. Ó 2008 Published by Elsevier Ltd on behalf of The Regents of the University of California. Keywords: FDI; Governance; Economic freedom; Corruption; Former Soviet Union
* Corresponding author. 0967-067X/$ - see front matter Ó 2008 Published by Elsevier Ltd on behalf of The Regents of the University of California. doi:10.1016/j.postcomstud.2008.06.007
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Introduction Direct foreign investment (FDI) is known to stimulate the development of national economies. Ireland and Hong Kong serve as direct evidence of this phenomenon. For the last 15 years (1990e2004) inward FDI in Ireland has increased from 42 to 223 billion US dollars (US$), and in Hong Kong from 45 to 457 billion US$ (UNCTAD, 2005). FDI in Hong Kong resulted in an increase in gross domestic product (GDP) of 277% and in Ireland 126%. The success of these countries in the development of their economies over this period is indisputable. In both cases, success was achieved due to high quality of governance at all levels, the high level of economic freedom for firms, the availability of skilled labour, favourable environmental conditions and unique geographic location. Over the same period since 1990 the former socialist countries of Europe and of the Former Soviet Union have also been trying to attract FDI, but with varying levels of success. The level of total FDI per capita in the FSU countries is just one-third of that in the former European socialist countries (Table 1). This suggests that the FSU countries have not been able to address the factors responsible for attracting FDI. Further, as will be shown below, the level of FDI varies greatly among the countries of the FSU, and only the three Baltic States, Azerbaijan and Kazakhstan have per capita levels of FDI which match those in the former socialist states of Europe. The purpose of this study is to examine the extent to which the FDI performance of the different FSU countries in recent years matches the expectations that would be generated using certain established indicators of FDI attractiveness. It achieves this by comparing the relationships at a global scale between indicators of governance, the index of economic freedom, and the corruption perception index, and then establishing regression correlations between inward FDI and these indices. These regression correlations are then used to predict the level of FDI in each of the FSU states and these predictions can then be compared with the actual levels of FDI. The paper starts with a brief review of the results of a study of FDI in the former Soviet Union undertaken by the Bleyzer Foundation and a summary of FDI in the FSU up to the end of 2004 before embarking on the quantitative analysis.
The Bleyzer Initiative The many interacting factors which influence the flow of FDI have been well studied by many organisations such as the World Bank, UNCTAD and the OECD, as Table 1 Stock FDI in some groups of transition countries by the end 2004
Former Socialist countries of Europe Countries of Former Soviet Union
Population (million)
FDI (US$ million)
FDI (per capita, US$)
117.8 286.2
244,496 173,002
2075 604
Sources: World Bank (2004); UNCTAD (2005).
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well as by individual researchers (Mallampally and Sauvant, 1999; Meyer and Pind, 1999; Peck, 1999, 2000; Resmini, 2000; Barrell and Holland, 2000; Hewko, 2002; Starr, 2004). Analysis of these issues inside the FSU is complicated by the fact that some local economists (Amonov, 2001; Abdurakhmanov, 2004; Djuraeva et al., 2004) and state bodies appear to restrict themselves to the consideration of only a limited range of factors relating to the investment climate. By considering only a subgroup of factors in isolation and submitting the results of their study as decisive, they tend to mislead policymakers. During 1999, an International Commission founded by the Bleyzer Foundation began investigations in the Ukraine. The commission’s objective was to investigate the factors which determine attractiveness for FDI in the FSU countries. In 2002 the commission published outcomes of the first investigation (Bleyzer Foundation, 2002) and identified a total of nine factors. The three most important were the extent of liberalization and deregulation of business activities, the provision a stable and predictable legal environment, and improved corporate and public governance. The commission found that the following six conditions also contributed to a conducive environment for FDI: Removal of international capital and foreign trade restrictions; Stimulation of the finance sector activity in order to facilitate the financing of business ventures; Reduction of corruption levels; Minimization of political risks; Expanded country promotion and improved image; Rationalization of offered investment incentives. The commission’s report considered the outcome of an analysis of these nine factors over a period of 10 years from 1991 to 2001 for the 15 FSU countries. The study also analysed a number of other developing and transition economies, and established benchmarks of best practice with reference to Chile, Argentina, Hungary and Poland. These results provided the basis for projections to be made for the period up to 2010. These projections took the form of three scenarios which envisage different rates of progress made by each country over a period of five years in closing the policy differential between them and the ‘best-in-class’, as derived from the benchmarking study (Table 2): A pessimistic scenario assuming the continuation of current policy; A mid-case scenario with policy actions to reduce by 50% the policy level differential with the bestdin class; An optimistic scenario with policy actions to reduce by 80% the policy level differential with the bestdin class. Data for actual levels of FDI in the years 2002e2004 show a considerable divergence between these forecasts for the year 2005 and the inward flow of foreign investments over the period 2002e2004. In Russia, Azerbaijan, Estonia, Georgia,
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Table 2 Forecast for FDI attracted into FSU countries up to 2010 Rating Country
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Average annual inward FDI for 2002e 2004
Russia 21,164 Estonia 3171 Azerbaijan 3149 Kazakhstan 2982 Ukraine 1517 Lithuania 1209 Latvia 759 Georgia 334 Belarus 196 Armenia 179 Turkmenistan 117 Moldova 112 Tajikistan 113 Uzbekistan 92 Kyrgyzstan 43
FDI forecast (million US$) 2005
2010
Status quo Mid-case Optimistic Status quo Mid-case Optimistic scenario scenario scenario scenario scenario scenario 5155 395 950 1750 909 598 449 130 300 150 110 52 39 150 50
8500 485 1100 2025 2500 800 547 170 520 200 218 100 54 200 123
12,500 585 1300 2650 4000 1050 715 220 750 265 285 120 70 380 170
6611 475 1100 2250 1387 767 579 170 530 210 145 75 50 300 63
17,500 795 1500 2950 3988 1560 1030 370 1100 340 517 180 120 800 215
25,000 1240 2044 4600 6082 2436 1607 580 1750 530 806 250 190 1200 348
Sources: UNCTAD (2003, 2004a, 2005) for 2002e2004 data; Bleyzer Foundation (2002) for 2005 and 2010 forecasts.
Kazakhstan, Latvia, Lithuania, and Tajikistan FDI was considerably higher than forecast by the modelled optimistic scenario. In the case of Moldova the actual resultant inward flow of FDI lay between the mid-case and optimistic scenarios. The remaining FSU countries experienced FDI flows close to or lower than predicted by the modelled pessimistic scenario. Despite the value of this analysis, the Bleyzer Initiative did not establish the character of the relationship between, on the one hand, the inward flow of foreign investment into a country, and, on the other, integrated indicators characterizing the level of state and corporate governance and economic freedom. The following sections attempt to establish such a relationship.
FDI in FSU countries until 2004 The rate of economic reform in the FSU countries has not been uniform. Differences in levels of pre-existing economic development, in historical experience of independent development and in prevalent education levels are among the factors which have controlled the nature and extent of the reform process. The former Baltic republics of the USSR have completely reformed their economies in a short time. Acceptance of these states into the European Community in May 2004 is interpreted as recognition of the successful reforms undertaken by these countries. The former FSU countries outside the Baltic States, except for Russia herself, appear to have had more difficulty in achieving reform, possibly due to the longer period of time spent under the administration of
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a communist regime. These countries did not have any experience of independent development. This would imply that rates of economic reform are significantly affected by economic, political and social experience, as a nation’s ability to drive independent development and to effectively exploit its natural resources. Many factors affect the ability to attract inward FDI; some of the selected integrated indicators may also reflect conditions which restrict the FDI flows. Tables 3 and 4 present the UNCTAD data on FDI flows in the FSU countries. By 2004 the stock of FDI exceeded US$ 3 billion in seven countries. The majority of FDI inflow went to Russia. However, if outward Russian capital is taken into account the net FDI inflow into Russia is approximately US$ 16.7 billion (UNCTAD, 2005). The major flow of FDI to a country other than Russia itself has been to the petroleum-rich states of Kazakhstan and Azerbaijan. Despite its enormous reserves of oil and gas, Russia did not experience similar growth in FDI. Table 4 presents data for FDI and GDP on a per capita basis. These values reflect not only the natural resource endowment and the market capacity for foreign investors, but also the progress of transition towards market economies. Estonia has attracted levels of FDI three times greater than its nearest competitors, Lithuania, Latvia, Azerbaijan, and Kazakhstan. This suggests that, it is not necessary to have huge natural resource endowments like Kazakhstan and Azerbaijan in order to be successful in attracting FDI. The remaining countries have performed significantly less well, with Kyrgystan, Uzbekistan and Tajikistan at the bottom of the list with FDI less than US$ 100 per capita. Armenia, Georgia, Belarus, Ukraine and Moldova have been more successful in attracting FDI than the Central Asian countries. A considerable proportion of the funds included in statements of current levels of FDI in these countries comprises payments owed to Russia for electricity, oil, and gas. It also includes proceeds from the sale of some state enterprises due to the untenable levels of debt accrued by them. Table 3 Stock of inward FDI in FSU countries, million US$ Rank
Country
1995
2000
2002
2003
2004
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Russia Kazakhstan Azerbaijan Ukraine Estonia Lithuania Latvia Belarus Turkmenistan Georgia Uzbekistan Armenia Moldova Kyrgyzstan Tajikistan
5465 2895 352 910 688 352 615 50 415 32 106 34 93 144 40
32,204 10,078 3735 3875 2645 2334 2084 1306 944 423 699 513 459 439 146
51,374 15,464 5354 5529 4226 3981 2751 1648 1214 679 847 867 727 476 192
86,772 17,586 8639 7502 6511 4960 3282 1899 1314 1036 917 1024 789 491 223
98,444 22,399 13,408 9217 9530 6389 4493 2057 1464 1536 1057 1004 940 568 495
Sources: UNCTAD (2003, 2004a, 2005).
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Table 4 Specific values of FDI in FSU Countries for 2004 Rank Country
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Population GDP in GDP per by the 2004 capita in end 2004 (US$ billion) 2004 (US$) (million)
Estonia 1.3 Latvia 2.3 Lithuania 3.4 Azerbaijan 8.4 Kazakhstan 15.4 Russia 142.4 Armenia 3.1 Georgia 5.1 Turkmenistan 4.9 Belarus 9.9 Moldova 4.3 Ukraine 48.2 Kyrgyzstan 5.2 Uzbekistan 26.5 Tajikistan 6.4
11.6 13.6 22.3 8.5 40.7 573.0 3.1 5.2 6.2 22.9 2.6 64.8 2.2 12.0 2.1
8923 5913 6559 1012 2643 4024 1000 1020 1265 2313 605 1344 423 453 328
Stock inward FDI by the end 2004 (billion US$)
Stock inward Stock inward FDI per FDI/GDP in capita by 2004 (%) the end 2004 (US$)
9.5 4.5 6.4 13.4 22.4 98.4 1.0 1.5 1.5 2.1 0.9 9.2 0.6 1.1 0.5
7308 1957 1882 1595 1455 691 323 294 306 212 209 191 115 41 78
82 33 29 158 55 17 32 29 24 9 35 14 27 9 24
Source: UNCTAD (2005).
Establishing correlations with FDI In this section, we examine for each country in the FSU the nature of the correlation between the level of FDI and three selected indicators relating to governance, economic freedom and corruption. These specific indicators have been chosen on account on their widespread availability and acceptance. For each indicator we first tabulate the values of the component indices and the aggregate scores for each of the FSU countries drawing on formal published sources. We then establish the nature of the regression equation linking the indicator with the level of FDI per capita for all countries around the world for which data are available. From this we derive the approximate level of the indicator which would be required in order to attract the FDI in the order of thousands of US dollars per capita and identify those countries which would be predicted to achieve this level of FDI. FDI and governance indicator (GI) Systematic methods of qualitative assessment relating to issues of governance have only recently been developed. Kaufmann et al. (2000, 2003, 2005) defined governance as ‘the traditions and institutions that determine how authority is exercised in a particular country’ and include: 1. The process by which governments are selected, held accountable, monitored and replaced;
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2. The capacity of governments to manage resources efficiently and to formulate, implement and enforce sound policies and regulations; 3. The respect of citizens and the state for the institutions that govern economic and social interactions among them. The different aspects of governance are commonly described by the use of a set of international indexes. The World Bank identifies and uses a large number of such indexes. Generally speaking the quality of governance can be qualitatively expressed by using six key criteria expressed as indexes: voice and accountability, political instability and violence, government efficiency, regulatory burden, rule of law, and control of corruption. Kaufmann et al. (2003) prepared a study analyzing 27 international indices of governance for the period 1996e2002 for all the countries referred to in this paper. Table 5 summarizes these governance indicators for the FSU countries. Six factors were ranked from 2.5 up to þ2.5 points. The governance indicators for the Baltic countries are higher than for the other FSU countries. All members of the FSU receive negative scores. Belarus, Tajikistan, Uzbekistan and Turkmenistan score lowest of all. Comparison of scores for the years 1998 and 2004 demonstrates that governance quality shows different patterns of change in different countries. Only the three Baltic countries and Tajikistan improved their indicators, the latter having just emerged from a civil war in 1997. Russia, Armenia, and Ukraine maintained their previous scores and the remaining countries saw their governance indices decline. Fig. 1 presents FDI data for 153 countries plotted against the governance indicator. Countries with a population less than one million have been excluded from consideration. A regression equation relating the natural logarithm of FDI and a governance indicator has the form: lnðFDIÞ ¼ 6:33 þ 1:85 ðGIÞ
ð1Þ
The correlation coefficient is 0.78, and standard deviation is 1.41. Thus the obtained equation allows us to calculate a probable level of FDI based upon a governance indicator. According to Eq. (1) FDI levels in the order of thousands of US$ per capita can be reached only when the governance indicator is positive and exceeds 0.31. Only the three Baltic States reached this threshold by 2004. FDI and index of economic freedom (IEF) The Heritage Foundation and Wall Street Journal refer to an index of economic freedom (IEF; Heritage Foundation, 2004). This integrated indicator consists of 10 separate indexes. The weight of each component index is the same. The index is estimated on a five-mark scale.1 Table 6 shows the IEF obtained by the Heritage 1 In the period since our own calculations were carried out, The Heritage Foundation has changed its scale to one based on percentages.
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Rating (Among 153 countries)
Country
1 (1) 2 (29) 3 (34) 4 (82) 5 (98) 6 (100) 7 (101) 8 (112) 9 (113) 10 (115) 11(116) 12 (133) 13 (136) 14 (143) 15 (146)
Estonia Lithuania Latvia Armenia Russia Ukraine Moldova Georgia Kyrgyzstan Kazakhstan Azerbaijan Belarus Tajikistan Uzbekistan Turkmenistan
Voice and accountability
Political stability and absence of violence
Government effectiveness
Regulatory quality
Rule of law
1.13 0.97 0.96 0.66 0.81 0.62 0.47 0.34 1.06 1.21 0.97 1.54 1.12 1.75 1.90
0.92 0.85 0.95 0.51 0.85 0.27 0.62 1.26 0.91 0.11 1.52 0.24 1.19 1.37 0.92
0.99 0.70 0.60 0.34 0.21 0.67 0.73 0.80 0.83 0.63 0.81 0.93 1.05 1.04 1.37
1.61 0.70 0.60 0.05 0.51 0.48 0.49 0.64 0.06 0.89 0.57 1.78 1.16 2.10 2.22
0.91 0.60 0.48 0.58 0.70 0.83 0.65 0.87 1.04 0.98 0.85 1.31 1.18 1.30 1.43
Sources: Kaufmann et al. (2000, 2005).
Control of corruption
Total rank 2004
1998
Rank change
0.82 0.36 0.23 0.53 0.72 0.89 0.86 0.91 0.92 1.10 1.04 0.91 1.11 1.21 1.34
1.06 0.29 0.77 0.28 0.71 0.32 0.43 0.26 0.63 0.24 0.63 0.23 0.64 0.15 0.80 0.31 0.80 0.37 0.82 0.40 0.83 0.48 1.12 0.55 1.14 0.05 1.46 0.39 1.53 0.46
0.52 0.19 0.15 0.37 0.58 0.52 0.12 0.51 0.34 0.53 0.74 0.74 1.68 0.89 1.22
þ0.54 þ0.58 þ0.56 0.06 0.05 0.11 0.52 0.29 0.46 0.29 0.09 0.38 þ0.54 0.57 0.31
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Table 5 Aggregated governance indicators for 2004 in FSU countries
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ln (FDI per capita US$)
10 8
309
y = 6.33 + 1.85 x R = 0.78 SD = 1.41 N = 153
6 4 2 0 -2
-2
-1 0 1 Integrated Governance Indicator
2
Fig. 1. FDI versus integrated governance indicator.
Foundation’s experts for the FSU countries. The Baltic countries achieve high scores on this IEF index. The majority of FSU countries fall into the group of countries categorized as largely not free. Belarus, Tajikistan, Uzbekistan and Turkmenistan are referred to as repressed economically, and close the list of the countries in which monitoring is carried out. Azerbaijan has made substantial progress in improving its IEF over the six years until 2004. Estonia, Armenia, Kyrgyzstan, Kazakhstan and Ukraine improved over the same period. Russia, Belarus, Tajikistan, and Turkmenistan recorded the least improvement. Fig. 2 plots the natural logarithm of FDI versus the index of economic freedom obtained for 140 countries. The regression equation has a linear form: lnðFDIÞ ¼ 12:85 2:15 ðIEFÞ
ð2Þ
The correlation coefficient is 0.71, and standard deviation is 1.5. From this equation an IEF with a value of 2.81 points would be required to achieve an annual flow of FDI of thousands of US dollars per year, which includes only countries falling in the category of ‘economically mostly free’. Apart from the group of Baltic countries, only Armenia meets this requirement. These results suggest that in order to attract FDI, all countries of the FSU must improve their economic performance with respect to the areas of trade policy, fiscal burden of government, government intervention in the economy, monetary policy, capital flows, foreign investment, banking and finance, wages and prices, property rights, and elimination of the black market. FDI and corruption perception index (CPI) In the previous sections we have considered integrated indicators and the capacity to attract FDI. Factors such as transparency and the control of corruption should
310
Country Rating (Among 140 countries)
Trade Fiscal policy burden of government
Government Monetary Capital Banking Wages Property Regula- Black Total rank Rank and and rights tion market 2004 intervention policy flows 1998 change in the and finance prices economy foreign investment
1 (4) 2 (18) 3 (27) 4 (35) 5 (67) 6 (75) 7 (94) 8 (98) 9 (101) 10 (105) 11 (116) 12 (129) 13 (131) 14 (133) 15 (134)
1 2 2 2 2 4 4 3 3 3 4 4 3 5 5
2 2.5 2.5 3 2.5 1.5 2 3 2 3 2.4 3.5 4 4 5
Estonia Lithuania Latvia Armenia Moldova Georgia Kyrgyzstan Azerbaijan Russia Ukraine Kazakhstan Belarus Tajikistan Uzbekistan Turkmenistan
2.1 2.4 2.6 2.3 2.4 2.4 2.5 3.4 2.6 3.9 3.5 3.4 3.5 2.9 3.1
2 1 1 2 3 3 4 1 5 3 3 5 5 5 4
1 2 2 2 4 3 3 4 3 4 5 4 4 4 4
Accepted Scores: 1e1.99, free; 2.00e2.99, mostly free; 3.0e3.99, mostly unfree. Source: Heritage Foundation (2004).
1 1 2 1 3 3 3 4 4 3 4 4 5 5 5
2 2 2 3 3 3 3 3 3 3 3 5 4 4 4
2 3 3 3 3 4 4 4 4 4 4 4 4 4 4
2 3 3 4 4 4 4 4 4 4 4 5 4 5 4
2.5 3 3.5 4 4 4 4 4.5 4 4 4 3 5 4 5
1.76 0.55 2.19 0.79 2.36 0.70 2.63 0.95 3.09 0.79 3.19 0.79 3.35 0.65 3.39 0.98 3.46 0.87 3.49 0.52 3.70 0.71 4.09 0.79 4.15 0.59 4.29 0.70 4.31 0.65
2.43 2.98 2.84 3.50 3.48 3.78 4.00 4.35 3.54 3.83 4.23 4.15 4.30 4.68 4.50
þ0.67 þ0.79 þ0.48 þ0.87 þ0.39 þ0.59 þ0.65 þ0.96 þ0.08 þ0.34 þ0.53 þ0.06 þ0.15 þ0.39 þ0.19
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Table 6 Index of economic freedom in FSU countries in 2004
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12
ln (FDI per capita US$)
10 8 6 4 2
y = 12.85 - 2.15 x R = - 0.71 SD = 1.50
0
N = 140 1
2
3
4
5
Heritage Index of Economic Freedom Fig. 2. FDI versus heritage index of economic freedom.
fundamentally impact the governance indicator. Research suggests that transnational corporations prefer countries with well developed market legislation and regulation which they consider favourable for investment, as a certain degree of security is essential in order to attract investment of departure between existing legislative acts and international norms (UNCTAD, 2007). Since 1993 the international non-government, non-commercial organisation, Transparency International has been monitoring the perceived level of corruption and other economic developmental factors in many countries. Table 7 presents data on the situation in FSU countries. All FSU countries, except Estonia, Latvia, Lithuania and Moldova, score 2.8 out of 10 or lower, and rank below the top 100 countries in terms of global performance. The correlation between FDI and CPI is plotted in Fig. 3 and this suggests that the perception of a high level of corruption in the majority of the FSU countries may be one of key factors limiting inward FDI. Using the available data from 146 countries the linear regression correlation is computed to be lnðFDIÞ ¼ 3:17 þ 0:76 ðCPIÞ
ð3Þ
According to Eq. (3), in order to attract per capita FDI in the range of thousands of US$ it is necessary to reach a score of at least 4.92 in the corruption perception index. Only the Baltic States match or exceed this standard.
Comparison of real and calculated FDI The actual values of FDI and the calculated values using Eqs. (1)e(3) are given in Table 8. In many cases there is a degree of relative congruence between the actual levels of FDI and those predicted by two or more of the equations. In nearly all cases Eq. (2), which relates to economic freedom, gives higher scores than Eqs. (1) and (3)
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Table 7 Corruption perception indexes for FSU countries Rank (among 163 countries)
Country
CPI 2006
CPI 2000
Rank change
1 (25) 2 (48) 3 (49) 4 (81) 5 (94) 6 (100) 7 (104) 8 (113) 9 (127) 10 (130) 11 (145) 12 (149) 13 (150) 14 (151) 15 (155)
Estonia Lithuania Latvia Moldova Armenia Georgia Ukraine Kazakhstan Russia Azerbaijan Kyrgyzstan Tajikistan Turkmenistan Belarus Uzbekistan
6.7 4.8 4.7 3.2 2.8 2.8 2.8 2.6 2.5 2.4 2.2 2.2 2.1 2.1 2.1
Not 4.1 3.4 2.6 Not Not 1.5 3.0 2.1 1.5 Not Not Not Not 2.4
Not available þ0.7 þ1.3 þ0.6 Not available Not available þ1.3 0.4 þ0.4 þ1.1 Not available Not available Not available Not available 0.3
available
available available
available available available available
Source: Transparency International (2006).
which relate to governance and corruption perception, respectively. The index of economic freedom is a derivative of governance quality, and does not reflect political stability directly but is a partial component of the integrated governance indicator. The political stability in many countries of the FSU is estimated to be very low (Kaufmann et al., 2000, 2003, 2005) and this instability results in over-estimates of FDI using purely economic measures. The continuing friction caused by the existence of ethnic and religious enclaves such as Nagorno-Karabakh (International Crisis Group, 2006a,b) contributes to 12
ln (FDI per capita US$)
10 8 6 4 y = 3.17 + 0.76 x R = 0.76 SD = 1.39 N = 146
2 0 2
4
6
8
Corruption Perception Index Fig. 3. FDI versus corruption perception index.
10
313
M.M. Kenisarin, P. Andrews-Speed / Communist and Post-Communist Studies 41 (2008) 301e316 Table 8 Comparison of actual and calculation inward FDI in FSU countries Country
Estonia Latvia Lithuania Azerbaijan Kazakhstan Russia Armenia Georgia Turkmenistan Moldova Belarus Ukraine Kyrgyzstan Tajikistan Uzbekistan
Actual stock inward FDI per capita by the end 2004, US$
Available stock inward FDI per capita according to, US$ Eq. (1)
Eq. (2)
Eq. (3)
7308 1957 1882 1595 1455 691 323 294 306 212 209 191 115 41 78
4000 2090 2330 120 120 180 250 130 30 170 70 180 130 70 40
8740 2140 3470 150 240 200 1,350 450 40 500 70 210 250 50 40
3866 845 898 147 172 159 215 200 126 270 118 200 126 126 118
political instability in Azerbaijan and Armenia. Similarly tension in Abkhazia and South Ossetia (International Crisis Group, 2004a,b, 2006c) contributes significantly to the political instability in Georgia as does the Transdnestria issue in Moldova (International Crisis Group, 2004c). Thus Armenia and Moldova have failed to attract the levels of FDI predicted by the index of economic freedom. Actual FDI in Azerbaijan, Kazakhstan, Russia and Turkmenistan exceeds significantly the scores obtained using the three equations. This is interpreted to be due, at least in part, to FDI directly related to the oil, gas, and mineral sectors of their economies. In Azerbaijan it is estimated that foreign investment during 2004 in the oil and gas industries represented 97% of all FDI (Baku Interbank Currency Exchange of Azerbaijan, 2004). Approximately 85% of all FDI in Kazakhstan for the period from 1993 to 2004 was directly in the oil gas and metallurgy industries (Zelepukhin, 2006). Exclusion of this large volume of FDI in these specific sectors of the economies of Azerbaijan and Kazakhstan results in figures close to that calculated by the regression equations. Likewise nearly all the investment flowing in to Turkmenistan took the form of production sharing contracts for oil and gas, though precise statistics are not available (Shiells, 2003). Oil and gas have also played a significant role in FDI into Russia, but to a much lesser extent than in Azerbaijan and Kazakhstan. The stock of FDI within Russia which related to oil and gas extraction ranged between 15% and 20% of the total stock of FDI over this period (UNCTAD, 2004b; Federal State Statistics Service, 2008). This relatively low proportion is too low to account for the more than a proportion of the large difference between actual and predicted levels of FDI in Russia. Other factors specific to conditions in Russia would need to be sought to satisfactorily explain this discrepancy.
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In respect to the Baltic countries of the FSU, the results from Eqs. (1) and (2) give a relatively good match with actual FDI flows, but Eq. (3) significantly under-estimates the level of FDI. This suggests that perceptions of corruption may be a less important determinant of FDI in countries with relatively high measures for governance and economic freedom. Conclusions This study builds on the approach of the Bleyzer Initiative and examines some of the issues raised by that report. The analysis presented in this paper shows that, in relative terms, the actual levels of FDI flowing into individual FSU countries up to 2004 are broadly consistent with what would be predicted using regression correlations based on global data sets for three measures of investment attractiveness relating to governance, economic freedom and corruption perception. Major exceptions relate to the resource-rich countries in Central Asia which attract more investment than predicted. If investment related to oil and gas is removed from aggregate FDI in Azerbaijan, Kazakhstan and Turkmenistan, the actual level of investment lies close to that predicted by the correlations. In contrast, states which are affected by deep political instability fail to achieve their predicted potential, for example Armenia and Moldova. The three Baltic States consistently outperform the other FSU countries in terms of their FDI, and this is predicted by all three sets of indicators. Likewise, Tajikistan, Kyrgystan and Uzbekistan are consistently in the lowest rank for both actual and predicted levels of FDI. The index of economic freedom tends to over-estimate the level of FDI relative to both actual levels and to those predicted by governance and corruption indicators. There is a further tension between the improvement in index of economic freedom for all the FSU states and the deterioration in the governance indicators for all but the Baltic States between 1998 and 2004. Though there are undoubtedly other factors which determine the level of FDI, such as geographic location, the analysis has shown that for most of the FSU states, the path to improving levels of FDI does indeed lie in improving governance, economic freedom and perceptions of corruption. Failure to address these issues will result in continued economic stagnation and isolation. Acknowledgments The authors are grateful to the anonymous reviewers for their helpful observations, and to Trevor Bradley and Diana Byzakova for their research and editorial assistance. References Abdurakhmanov, M., 2004. Factors in attracting foreign direct investments. Ekonomicheskoe Obozrenie (Tashkent) 11, 28e29 (in Russian).
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Amonov, Kh., 2001. Investment climate for foreign investors in Uzbekistan. Ekonomicheskii Vestnik Uzbekistana (Tashkent) 6, 25e27 (in Russian). Baku Interbank Currency Exchange of Azerbaijan, 2004. Investments d institutionalization replaces a lack of system (in Russian). Available at: http://www.bbvb.org/Illik_2004PDF/investments.pdf. Barrell, R., Holland, D., 2000. Foreign direct investment and enterprise restructuring in Central Europe. Economics of Transitions 8 (2), 477e504. Bleyzer Foundation, 2002. The Bleyzer Initiative: Completing the Economic Transition in FSU Countries. The Bleyzer Foundation, Kiev. Available at: www.sigmableyzer.com/files/Bleyzer_Initiative.pdf. Djuraeva, K., Muradova, K., Yusupov, Yu., 2004. Economic reforms and attracting foreign investment: lessons of the past and perspectives of development. Ekonomicheskoe Obozrenie (Tashkent) 2, 33e36 (in Russian). Federal State Statistics Service, 2008. Russia in Figures. Available at: http://www.gks.ru/wps/portal/!ut/p/. cmd/cs/.ce/7_0_A/.s/7_0_3S2/_th/J_0_9D/_s.7_0_A/7_0_2BD/_me/7_0_2BC-7_0_A/_s.7_0_A/7_0_3S2. Heritage Foundation, 2004. Index of Economic Freedom 2004. The Heritage Foundation. Hewko, J., 2002. Foreign direct investment in transitional economies: does the rule of law matter? Centre for Energy, Petroleum and Mineral Law and Policy, Online Journal 11 (9) Available at: http:// www.dundee.ac.uk/cepmlp/journal/html/vol11/vol11-9.html. International Crisis Group, 2004a. Georgia: avoiding war in South Osetia November 2004. ICG Report 159 Available at: http://www.crisisgroup.org. International Crisis Group, 2004b. Saakashvili’s Ajara success: repeatable elsewhere in Georgia? 3 December 2004. ICG Briefing 34 Available at: http://www.crisisgroup.org. International Crisis Group, 2004c. Moldova tensions Over Transdnestria 17 June 2004. ICG Report 157 Available at: http://www.crisisgroup.org. International Crisis Group, 2006a. Nagorno-Karabakh: viewing the conflict from the ground 14 September 2006. ICG Report 166 Available at: http://www.crisisgroup.org. International Crisis Group, 2006b. Nagorno-Karabakh: a plan for peace 11 October 2006. ICG Report 167 Available at: http://www.crisisgroup.org. International Crisis Group, 2006c. Abkhazia today 15 September 2006. ICG Report 176 Available at: http://www.crisisgroup.org. Kaufmann, D., Kraay, A., Zoido-Lobaton, P., 2000. Governance matters: from measurement to action. Finance and Development 37 (2) Available at: http://www.imf.org/external/pubs/ft/fandd/2000/06/ kauf.htm. Kaufmann, D., Kraay, A., Mastruzzi, M., 2003. Governance Matters III: Governance Indicators for 1996e2002. The World Bank, Washington, DC. Kaufmann, D., Kraay, A., Mastruzzi, M., 2005. Governance Matters IV: Governance Indicators for 1996e2004. The World Bank, Washington, DC. Mallampally, P., Sauvant, K., 1999. Foreign direct investment in developing countries. Finance and Development 36 (1) Available at: http://www.imf.org/external/pubs/ft/fandd/1999/03/mallampa.htm. Meyer, K.E., Pind, C., 1999. The slow growth of foreign direct investment in the Soviet Union successor states. Economics of Transitions 7 (1), 201e214. Peck, A., 1999. Foreign investment in Kazakhstan mineral industries. Post-Soviet Geography and Economics 40 (7), 471e518. Peck, A., 2000. Privatization and foreign investment in the utilities industries of Kazakhstan. Post-Soviet Geography and Economics 41 (6), 418e447. Resmini, L., 2000. The determinants of foreign direct investment in the CEECs: new evidence from sectoral patterns. Economics of Transition 8 (3), 665e689. Shiells, C.R., 2003. FDI and the Investment Climate in the CIS Countries. IMF Policy Discussion Paper, PDP/03/5. International Monetary Fund, Washington, DC. Starr, S.F., 2004. The investment climate in Central Asia and the Caucasus, 2004. Available at: http:// www.cacianalyst.org/Publications/Starr_invest.htm. Transparency International, 2006. Corruption Perceptions Index 2006. Available at: http:// transparency.org. UNCTAD, 2003. World Investment Report 2003. United Nations, New York and Geneva.
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UNCTAD, 2004a. World Investment Report 2004. United Nations, New York and Geneva. UNCTAD, 2004b. FDI Profile. Russian Federation. United Nations, New York and Geneva. UNCTAD, 2005. World Investment Report 2005. United Nations, New York and Geneva. UNCTAD, 2007. World Investment Report 2007. United Nations, New York and Geneva. World Bank, 2004. World Development Indicators Database 2004. World Bank, Washington, DC. Zelepukhin, S., 2006. Crisis of neoliberal economic policy of Republic of Kazakhstan and analysis of alternative models and programs in country’s development (in Russian). Available at: http://www. turkestan.comunist.ru/chronic/2006/04/20/Kazakhstan.html.
Communist and Post-Communist Studies 41 (2008) 301e316 www.elsevier.com/locate/postcomstud
Foreign direct investment in countries of the former Soviet Union: Relationship to governance, economic freedom and corruption perception Murat M. Kenisarin a, Philip Andrews-Speed b,* a
Academasbob, Uzbekistan Academy of Sciences, Tashkent Akademshaharchasi 700125, Uzbekistan b Centre for Energy, Petroleum and Mineral Law and Policy, University of Dundee, Carnegie Building, DD1 4HN Dundee, United Kingdom
Abstract The modernisation of the economies of the former Soviet Union (FSU) will require substantial levels of foreign direct investment (FDI). The aim of this study is to examine factors which may be instrumental in determining this level of the FDI. It achieves this by establishing quantitative relationships between levels of FDI per capita to the year 2004 and three sets of indicators relating, respectively, to governance, economic freedom, and corruption perception. The paper demonstrates that the level of FDI in FSU states has been determined to a significant extent by the degree of reform from a planned economy towards a market economy. Ó 2008 Published by Elsevier Ltd on behalf of The Regents of the University of California. Keywords: FDI; Governance; Economic freedom; Corruption; Former Soviet Union
* Corresponding author. 0967-067X/$ - see front matter Ó 2008 Published by Elsevier Ltd on behalf of The Regents of the University of California. doi:10.1016/j.postcomstud.2008.06.007
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Introduction Direct foreign investment (FDI) is known to stimulate the development of national economies. Ireland and Hong Kong serve as direct evidence of this phenomenon. For the last 15 years (1990e2004) inward FDI in Ireland has increased from 42 to 223 billion US dollars (US$), and in Hong Kong from 45 to 457 billion US$ (UNCTAD, 2005). FDI in Hong Kong resulted in an increase in gross domestic product (GDP) of 277% and in Ireland 126%. The success of these countries in the development of their economies over this period is indisputable. In both cases, success was achieved due to high quality of governance at all levels, the high level of economic freedom for firms, the availability of skilled labour, favourable environmental conditions and unique geographic location. Over the same period since 1990 the former socialist countries of Europe and of the Former Soviet Union have also been trying to attract FDI, but with varying levels of success. The level of total FDI per capita in the FSU countries is just one-third of that in the former European socialist countries (Table 1). This suggests that the FSU countries have not been able to address the factors responsible for attracting FDI. Further, as will be shown below, the level of FDI varies greatly among the countries of the FSU, and only the three Baltic States, Azerbaijan and Kazakhstan have per capita levels of FDI which match those in the former socialist states of Europe. The purpose of this study is to examine the extent to which the FDI performance of the different FSU countries in recent years matches the expectations that would be generated using certain established indicators of FDI attractiveness. It achieves this by comparing the relationships at a global scale between indicators of governance, the index of economic freedom, and the corruption perception index, and then establishing regression correlations between inward FDI and these indices. These regression correlations are then used to predict the level of FDI in each of the FSU states and these predictions can then be compared with the actual levels of FDI. The paper starts with a brief review of the results of a study of FDI in the former Soviet Union undertaken by the Bleyzer Foundation and a summary of FDI in the FSU up to the end of 2004 before embarking on the quantitative analysis.
The Bleyzer Initiative The many interacting factors which influence the flow of FDI have been well studied by many organisations such as the World Bank, UNCTAD and the OECD, as Table 1 Stock FDI in some groups of transition countries by the end 2004
Former Socialist countries of Europe Countries of Former Soviet Union
Population (million)
FDI (US$ million)
FDI (per capita, US$)
117.8 286.2
244,496 173,002
2075 604
Sources: World Bank (2004); UNCTAD (2005).
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well as by individual researchers (Mallampally and Sauvant, 1999; Meyer and Pind, 1999; Peck, 1999, 2000; Resmini, 2000; Barrell and Holland, 2000; Hewko, 2002; Starr, 2004). Analysis of these issues inside the FSU is complicated by the fact that some local economists (Amonov, 2001; Abdurakhmanov, 2004; Djuraeva et al., 2004) and state bodies appear to restrict themselves to the consideration of only a limited range of factors relating to the investment climate. By considering only a subgroup of factors in isolation and submitting the results of their study as decisive, they tend to mislead policymakers. During 1999, an International Commission founded by the Bleyzer Foundation began investigations in the Ukraine. The commission’s objective was to investigate the factors which determine attractiveness for FDI in the FSU countries. In 2002 the commission published outcomes of the first investigation (Bleyzer Foundation, 2002) and identified a total of nine factors. The three most important were the extent of liberalization and deregulation of business activities, the provision a stable and predictable legal environment, and improved corporate and public governance. The commission found that the following six conditions also contributed to a conducive environment for FDI: Removal of international capital and foreign trade restrictions; Stimulation of the finance sector activity in order to facilitate the financing of business ventures; Reduction of corruption levels; Minimization of political risks; Expanded country promotion and improved image; Rationalization of offered investment incentives. The commission’s report considered the outcome of an analysis of these nine factors over a period of 10 years from 1991 to 2001 for the 15 FSU countries. The study also analysed a number of other developing and transition economies, and established benchmarks of best practice with reference to Chile, Argentina, Hungary and Poland. These results provided the basis for projections to be made for the period up to 2010. These projections took the form of three scenarios which envisage different rates of progress made by each country over a period of five years in closing the policy differential between them and the ‘best-in-class’, as derived from the benchmarking study (Table 2): A pessimistic scenario assuming the continuation of current policy; A mid-case scenario with policy actions to reduce by 50% the policy level differential with the bestdin class; An optimistic scenario with policy actions to reduce by 80% the policy level differential with the bestdin class. Data for actual levels of FDI in the years 2002e2004 show a considerable divergence between these forecasts for the year 2005 and the inward flow of foreign investments over the period 2002e2004. In Russia, Azerbaijan, Estonia, Georgia,
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Table 2 Forecast for FDI attracted into FSU countries up to 2010 Rating Country
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Average annual inward FDI for 2002e 2004
Russia 21,164 Estonia 3171 Azerbaijan 3149 Kazakhstan 2982 Ukraine 1517 Lithuania 1209 Latvia 759 Georgia 334 Belarus 196 Armenia 179 Turkmenistan 117 Moldova 112 Tajikistan 113 Uzbekistan 92 Kyrgyzstan 43
FDI forecast (million US$) 2005
2010
Status quo Mid-case Optimistic Status quo Mid-case Optimistic scenario scenario scenario scenario scenario scenario 5155 395 950 1750 909 598 449 130 300 150 110 52 39 150 50
8500 485 1100 2025 2500 800 547 170 520 200 218 100 54 200 123
12,500 585 1300 2650 4000 1050 715 220 750 265 285 120 70 380 170
6611 475 1100 2250 1387 767 579 170 530 210 145 75 50 300 63
17,500 795 1500 2950 3988 1560 1030 370 1100 340 517 180 120 800 215
25,000 1240 2044 4600 6082 2436 1607 580 1750 530 806 250 190 1200 348
Sources: UNCTAD (2003, 2004a, 2005) for 2002e2004 data; Bleyzer Foundation (2002) for 2005 and 2010 forecasts.
Kazakhstan, Latvia, Lithuania, and Tajikistan FDI was considerably higher than forecast by the modelled optimistic scenario. In the case of Moldova the actual resultant inward flow of FDI lay between the mid-case and optimistic scenarios. The remaining FSU countries experienced FDI flows close to or lower than predicted by the modelled pessimistic scenario. Despite the value of this analysis, the Bleyzer Initiative did not establish the character of the relationship between, on the one hand, the inward flow of foreign investment into a country, and, on the other, integrated indicators characterizing the level of state and corporate governance and economic freedom. The following sections attempt to establish such a relationship.
FDI in FSU countries until 2004 The rate of economic reform in the FSU countries has not been uniform. Differences in levels of pre-existing economic development, in historical experience of independent development and in prevalent education levels are among the factors which have controlled the nature and extent of the reform process. The former Baltic republics of the USSR have completely reformed their economies in a short time. Acceptance of these states into the European Community in May 2004 is interpreted as recognition of the successful reforms undertaken by these countries. The former FSU countries outside the Baltic States, except for Russia herself, appear to have had more difficulty in achieving reform, possibly due to the longer period of time spent under the administration of
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a communist regime. These countries did not have any experience of independent development. This would imply that rates of economic reform are significantly affected by economic, political and social experience, as a nation’s ability to drive independent development and to effectively exploit its natural resources. Many factors affect the ability to attract inward FDI; some of the selected integrated indicators may also reflect conditions which restrict the FDI flows. Tables 3 and 4 present the UNCTAD data on FDI flows in the FSU countries. By 2004 the stock of FDI exceeded US$ 3 billion in seven countries. The majority of FDI inflow went to Russia. However, if outward Russian capital is taken into account the net FDI inflow into Russia is approximately US$ 16.7 billion (UNCTAD, 2005). The major flow of FDI to a country other than Russia itself has been to the petroleum-rich states of Kazakhstan and Azerbaijan. Despite its enormous reserves of oil and gas, Russia did not experience similar growth in FDI. Table 4 presents data for FDI and GDP on a per capita basis. These values reflect not only the natural resource endowment and the market capacity for foreign investors, but also the progress of transition towards market economies. Estonia has attracted levels of FDI three times greater than its nearest competitors, Lithuania, Latvia, Azerbaijan, and Kazakhstan. This suggests that, it is not necessary to have huge natural resource endowments like Kazakhstan and Azerbaijan in order to be successful in attracting FDI. The remaining countries have performed significantly less well, with Kyrgystan, Uzbekistan and Tajikistan at the bottom of the list with FDI less than US$ 100 per capita. Armenia, Georgia, Belarus, Ukraine and Moldova have been more successful in attracting FDI than the Central Asian countries. A considerable proportion of the funds included in statements of current levels of FDI in these countries comprises payments owed to Russia for electricity, oil, and gas. It also includes proceeds from the sale of some state enterprises due to the untenable levels of debt accrued by them. Table 3 Stock of inward FDI in FSU countries, million US$ Rank
Country
1995
2000
2002
2003
2004
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Russia Kazakhstan Azerbaijan Ukraine Estonia Lithuania Latvia Belarus Turkmenistan Georgia Uzbekistan Armenia Moldova Kyrgyzstan Tajikistan
5465 2895 352 910 688 352 615 50 415 32 106 34 93 144 40
32,204 10,078 3735 3875 2645 2334 2084 1306 944 423 699 513 459 439 146
51,374 15,464 5354 5529 4226 3981 2751 1648 1214 679 847 867 727 476 192
86,772 17,586 8639 7502 6511 4960 3282 1899 1314 1036 917 1024 789 491 223
98,444 22,399 13,408 9217 9530 6389 4493 2057 1464 1536 1057 1004 940 568 495
Sources: UNCTAD (2003, 2004a, 2005).
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Table 4 Specific values of FDI in FSU Countries for 2004 Rank Country
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Population GDP in GDP per by the 2004 capita in end 2004 (US$ billion) 2004 (US$) (million)
Estonia 1.3 Latvia 2.3 Lithuania 3.4 Azerbaijan 8.4 Kazakhstan 15.4 Russia 142.4 Armenia 3.1 Georgia 5.1 Turkmenistan 4.9 Belarus 9.9 Moldova 4.3 Ukraine 48.2 Kyrgyzstan 5.2 Uzbekistan 26.5 Tajikistan 6.4
11.6 13.6 22.3 8.5 40.7 573.0 3.1 5.2 6.2 22.9 2.6 64.8 2.2 12.0 2.1
8923 5913 6559 1012 2643 4024 1000 1020 1265 2313 605 1344 423 453 328
Stock inward FDI by the end 2004 (billion US$)
Stock inward Stock inward FDI per FDI/GDP in capita by 2004 (%) the end 2004 (US$)
9.5 4.5 6.4 13.4 22.4 98.4 1.0 1.5 1.5 2.1 0.9 9.2 0.6 1.1 0.5
7308 1957 1882 1595 1455 691 323 294 306 212 209 191 115 41 78
82 33 29 158 55 17 32 29 24 9 35 14 27 9 24
Source: UNCTAD (2005).
Establishing correlations with FDI In this section, we examine for each country in the FSU the nature of the correlation between the level of FDI and three selected indicators relating to governance, economic freedom and corruption. These specific indicators have been chosen on account on their widespread availability and acceptance. For each indicator we first tabulate the values of the component indices and the aggregate scores for each of the FSU countries drawing on formal published sources. We then establish the nature of the regression equation linking the indicator with the level of FDI per capita for all countries around the world for which data are available. From this we derive the approximate level of the indicator which would be required in order to attract the FDI in the order of thousands of US dollars per capita and identify those countries which would be predicted to achieve this level of FDI. FDI and governance indicator (GI) Systematic methods of qualitative assessment relating to issues of governance have only recently been developed. Kaufmann et al. (2000, 2003, 2005) defined governance as ‘the traditions and institutions that determine how authority is exercised in a particular country’ and include: 1. The process by which governments are selected, held accountable, monitored and replaced;
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2. The capacity of governments to manage resources efficiently and to formulate, implement and enforce sound policies and regulations; 3. The respect of citizens and the state for the institutions that govern economic and social interactions among them. The different aspects of governance are commonly described by the use of a set of international indexes. The World Bank identifies and uses a large number of such indexes. Generally speaking the quality of governance can be qualitatively expressed by using six key criteria expressed as indexes: voice and accountability, political instability and violence, government efficiency, regulatory burden, rule of law, and control of corruption. Kaufmann et al. (2003) prepared a study analyzing 27 international indices of governance for the period 1996e2002 for all the countries referred to in this paper. Table 5 summarizes these governance indicators for the FSU countries. Six factors were ranked from 2.5 up to þ2.5 points. The governance indicators for the Baltic countries are higher than for the other FSU countries. All members of the FSU receive negative scores. Belarus, Tajikistan, Uzbekistan and Turkmenistan score lowest of all. Comparison of scores for the years 1998 and 2004 demonstrates that governance quality shows different patterns of change in different countries. Only the three Baltic countries and Tajikistan improved their indicators, the latter having just emerged from a civil war in 1997. Russia, Armenia, and Ukraine maintained their previous scores and the remaining countries saw their governance indices decline. Fig. 1 presents FDI data for 153 countries plotted against the governance indicator. Countries with a population less than one million have been excluded from consideration. A regression equation relating the natural logarithm of FDI and a governance indicator has the form: lnðFDIÞ ¼ 6:33 þ 1:85 ðGIÞ
ð1Þ
The correlation coefficient is 0.78, and standard deviation is 1.41. Thus the obtained equation allows us to calculate a probable level of FDI based upon a governance indicator. According to Eq. (1) FDI levels in the order of thousands of US$ per capita can be reached only when the governance indicator is positive and exceeds 0.31. Only the three Baltic States reached this threshold by 2004. FDI and index of economic freedom (IEF) The Heritage Foundation and Wall Street Journal refer to an index of economic freedom (IEF; Heritage Foundation, 2004). This integrated indicator consists of 10 separate indexes. The weight of each component index is the same. The index is estimated on a five-mark scale.1 Table 6 shows the IEF obtained by the Heritage 1 In the period since our own calculations were carried out, The Heritage Foundation has changed its scale to one based on percentages.
308
Rating (Among 153 countries)
Country
1 (1) 2 (29) 3 (34) 4 (82) 5 (98) 6 (100) 7 (101) 8 (112) 9 (113) 10 (115) 11(116) 12 (133) 13 (136) 14 (143) 15 (146)
Estonia Lithuania Latvia Armenia Russia Ukraine Moldova Georgia Kyrgyzstan Kazakhstan Azerbaijan Belarus Tajikistan Uzbekistan Turkmenistan
Voice and accountability
Political stability and absence of violence
Government effectiveness
Regulatory quality
Rule of law
1.13 0.97 0.96 0.66 0.81 0.62 0.47 0.34 1.06 1.21 0.97 1.54 1.12 1.75 1.90
0.92 0.85 0.95 0.51 0.85 0.27 0.62 1.26 0.91 0.11 1.52 0.24 1.19 1.37 0.92
0.99 0.70 0.60 0.34 0.21 0.67 0.73 0.80 0.83 0.63 0.81 0.93 1.05 1.04 1.37
1.61 0.70 0.60 0.05 0.51 0.48 0.49 0.64 0.06 0.89 0.57 1.78 1.16 2.10 2.22
0.91 0.60 0.48 0.58 0.70 0.83 0.65 0.87 1.04 0.98 0.85 1.31 1.18 1.30 1.43
Sources: Kaufmann et al. (2000, 2005).
Control of corruption
Total rank 2004
1998
Rank change
0.82 0.36 0.23 0.53 0.72 0.89 0.86 0.91 0.92 1.10 1.04 0.91 1.11 1.21 1.34
1.06 0.29 0.77 0.28 0.71 0.32 0.43 0.26 0.63 0.24 0.63 0.23 0.64 0.15 0.80 0.31 0.80 0.37 0.82 0.40 0.83 0.48 1.12 0.55 1.14 0.05 1.46 0.39 1.53 0.46
0.52 0.19 0.15 0.37 0.58 0.52 0.12 0.51 0.34 0.53 0.74 0.74 1.68 0.89 1.22
þ0.54 þ0.58 þ0.56 0.06 0.05 0.11 0.52 0.29 0.46 0.29 0.09 0.38 þ0.54 0.57 0.31
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Table 5 Aggregated governance indicators for 2004 in FSU countries
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ln (FDI per capita US$)
10 8
309
y = 6.33 + 1.85 x R = 0.78 SD = 1.41 N = 153
6 4 2 0 -2
-2
-1 0 1 Integrated Governance Indicator
2
Fig. 1. FDI versus integrated governance indicator.
Foundation’s experts for the FSU countries. The Baltic countries achieve high scores on this IEF index. The majority of FSU countries fall into the group of countries categorized as largely not free. Belarus, Tajikistan, Uzbekistan and Turkmenistan are referred to as repressed economically, and close the list of the countries in which monitoring is carried out. Azerbaijan has made substantial progress in improving its IEF over the six years until 2004. Estonia, Armenia, Kyrgyzstan, Kazakhstan and Ukraine improved over the same period. Russia, Belarus, Tajikistan, and Turkmenistan recorded the least improvement. Fig. 2 plots the natural logarithm of FDI versus the index of economic freedom obtained for 140 countries. The regression equation has a linear form: lnðFDIÞ ¼ 12:85 2:15 ðIEFÞ
ð2Þ
The correlation coefficient is 0.71, and standard deviation is 1.5. From this equation an IEF with a value of 2.81 points would be required to achieve an annual flow of FDI of thousands of US dollars per year, which includes only countries falling in the category of ‘economically mostly free’. Apart from the group of Baltic countries, only Armenia meets this requirement. These results suggest that in order to attract FDI, all countries of the FSU must improve their economic performance with respect to the areas of trade policy, fiscal burden of government, government intervention in the economy, monetary policy, capital flows, foreign investment, banking and finance, wages and prices, property rights, and elimination of the black market. FDI and corruption perception index (CPI) In the previous sections we have considered integrated indicators and the capacity to attract FDI. Factors such as transparency and the control of corruption should
310
Country Rating (Among 140 countries)
Trade Fiscal policy burden of government
Government Monetary Capital Banking Wages Property Regula- Black Total rank Rank and and rights tion market 2004 intervention policy flows 1998 change in the and finance prices economy foreign investment
1 (4) 2 (18) 3 (27) 4 (35) 5 (67) 6 (75) 7 (94) 8 (98) 9 (101) 10 (105) 11 (116) 12 (129) 13 (131) 14 (133) 15 (134)
1 2 2 2 2 4 4 3 3 3 4 4 3 5 5
2 2.5 2.5 3 2.5 1.5 2 3 2 3 2.4 3.5 4 4 5
Estonia Lithuania Latvia Armenia Moldova Georgia Kyrgyzstan Azerbaijan Russia Ukraine Kazakhstan Belarus Tajikistan Uzbekistan Turkmenistan
2.1 2.4 2.6 2.3 2.4 2.4 2.5 3.4 2.6 3.9 3.5 3.4 3.5 2.9 3.1
2 1 1 2 3 3 4 1 5 3 3 5 5 5 4
1 2 2 2 4 3 3 4 3 4 5 4 4 4 4
Accepted Scores: 1e1.99, free; 2.00e2.99, mostly free; 3.0e3.99, mostly unfree. Source: Heritage Foundation (2004).
1 1 2 1 3 3 3 4 4 3 4 4 5 5 5
2 2 2 3 3 3 3 3 3 3 3 5 4 4 4
2 3 3 3 3 4 4 4 4 4 4 4 4 4 4
2 3 3 4 4 4 4 4 4 4 4 5 4 5 4
2.5 3 3.5 4 4 4 4 4.5 4 4 4 3 5 4 5
1.76 0.55 2.19 0.79 2.36 0.70 2.63 0.95 3.09 0.79 3.19 0.79 3.35 0.65 3.39 0.98 3.46 0.87 3.49 0.52 3.70 0.71 4.09 0.79 4.15 0.59 4.29 0.70 4.31 0.65
2.43 2.98 2.84 3.50 3.48 3.78 4.00 4.35 3.54 3.83 4.23 4.15 4.30 4.68 4.50
þ0.67 þ0.79 þ0.48 þ0.87 þ0.39 þ0.59 þ0.65 þ0.96 þ0.08 þ0.34 þ0.53 þ0.06 þ0.15 þ0.39 þ0.19
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Table 6 Index of economic freedom in FSU countries in 2004
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12
ln (FDI per capita US$)
10 8 6 4 2
y = 12.85 - 2.15 x R = - 0.71 SD = 1.50
0
N = 140 1
2
3
4
5
Heritage Index of Economic Freedom Fig. 2. FDI versus heritage index of economic freedom.
fundamentally impact the governance indicator. Research suggests that transnational corporations prefer countries with well developed market legislation and regulation which they consider favourable for investment, as a certain degree of security is essential in order to attract investment of departure between existing legislative acts and international norms (UNCTAD, 2007). Since 1993 the international non-government, non-commercial organisation, Transparency International has been monitoring the perceived level of corruption and other economic developmental factors in many countries. Table 7 presents data on the situation in FSU countries. All FSU countries, except Estonia, Latvia, Lithuania and Moldova, score 2.8 out of 10 or lower, and rank below the top 100 countries in terms of global performance. The correlation between FDI and CPI is plotted in Fig. 3 and this suggests that the perception of a high level of corruption in the majority of the FSU countries may be one of key factors limiting inward FDI. Using the available data from 146 countries the linear regression correlation is computed to be lnðFDIÞ ¼ 3:17 þ 0:76 ðCPIÞ
ð3Þ
According to Eq. (3), in order to attract per capita FDI in the range of thousands of US$ it is necessary to reach a score of at least 4.92 in the corruption perception index. Only the Baltic States match or exceed this standard.
Comparison of real and calculated FDI The actual values of FDI and the calculated values using Eqs. (1)e(3) are given in Table 8. In many cases there is a degree of relative congruence between the actual levels of FDI and those predicted by two or more of the equations. In nearly all cases Eq. (2), which relates to economic freedom, gives higher scores than Eqs. (1) and (3)
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Table 7 Corruption perception indexes for FSU countries Rank (among 163 countries)
Country
CPI 2006
CPI 2000
Rank change
1 (25) 2 (48) 3 (49) 4 (81) 5 (94) 6 (100) 7 (104) 8 (113) 9 (127) 10 (130) 11 (145) 12 (149) 13 (150) 14 (151) 15 (155)
Estonia Lithuania Latvia Moldova Armenia Georgia Ukraine Kazakhstan Russia Azerbaijan Kyrgyzstan Tajikistan Turkmenistan Belarus Uzbekistan
6.7 4.8 4.7 3.2 2.8 2.8 2.8 2.6 2.5 2.4 2.2 2.2 2.1 2.1 2.1
Not 4.1 3.4 2.6 Not Not 1.5 3.0 2.1 1.5 Not Not Not Not 2.4
Not available þ0.7 þ1.3 þ0.6 Not available Not available þ1.3 0.4 þ0.4 þ1.1 Not available Not available Not available Not available 0.3
available
available available
available available available available
Source: Transparency International (2006).
which relate to governance and corruption perception, respectively. The index of economic freedom is a derivative of governance quality, and does not reflect political stability directly but is a partial component of the integrated governance indicator. The political stability in many countries of the FSU is estimated to be very low (Kaufmann et al., 2000, 2003, 2005) and this instability results in over-estimates of FDI using purely economic measures. The continuing friction caused by the existence of ethnic and religious enclaves such as Nagorno-Karabakh (International Crisis Group, 2006a,b) contributes to 12
ln (FDI per capita US$)
10 8 6 4 y = 3.17 + 0.76 x R = 0.76 SD = 1.39 N = 146
2 0 2
4
6
8
Corruption Perception Index Fig. 3. FDI versus corruption perception index.
10
313
M.M. Kenisarin, P. Andrews-Speed / Communist and Post-Communist Studies 41 (2008) 301e316 Table 8 Comparison of actual and calculation inward FDI in FSU countries Country
Estonia Latvia Lithuania Azerbaijan Kazakhstan Russia Armenia Georgia Turkmenistan Moldova Belarus Ukraine Kyrgyzstan Tajikistan Uzbekistan
Actual stock inward FDI per capita by the end 2004, US$
Available stock inward FDI per capita according to, US$ Eq. (1)
Eq. (2)
Eq. (3)
7308 1957 1882 1595 1455 691 323 294 306 212 209 191 115 41 78
4000 2090 2330 120 120 180 250 130 30 170 70 180 130 70 40
8740 2140 3470 150 240 200 1,350 450 40 500 70 210 250 50 40
3866 845 898 147 172 159 215 200 126 270 118 200 126 126 118
political instability in Azerbaijan and Armenia. Similarly tension in Abkhazia and South Ossetia (International Crisis Group, 2004a,b, 2006c) contributes significantly to the political instability in Georgia as does the Transdnestria issue in Moldova (International Crisis Group, 2004c). Thus Armenia and Moldova have failed to attract the levels of FDI predicted by the index of economic freedom. Actual FDI in Azerbaijan, Kazakhstan, Russia and Turkmenistan exceeds significantly the scores obtained using the three equations. This is interpreted to be due, at least in part, to FDI directly related to the oil, gas, and mineral sectors of their economies. In Azerbaijan it is estimated that foreign investment during 2004 in the oil and gas industries represented 97% of all FDI (Baku Interbank Currency Exchange of Azerbaijan, 2004). Approximately 85% of all FDI in Kazakhstan for the period from 1993 to 2004 was directly in the oil gas and metallurgy industries (Zelepukhin, 2006). Exclusion of this large volume of FDI in these specific sectors of the economies of Azerbaijan and Kazakhstan results in figures close to that calculated by the regression equations. Likewise nearly all the investment flowing in to Turkmenistan took the form of production sharing contracts for oil and gas, though precise statistics are not available (Shiells, 2003). Oil and gas have also played a significant role in FDI into Russia, but to a much lesser extent than in Azerbaijan and Kazakhstan. The stock of FDI within Russia which related to oil and gas extraction ranged between 15% and 20% of the total stock of FDI over this period (UNCTAD, 2004b; Federal State Statistics Service, 2008). This relatively low proportion is too low to account for the more than a proportion of the large difference between actual and predicted levels of FDI in Russia. Other factors specific to conditions in Russia would need to be sought to satisfactorily explain this discrepancy.
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In respect to the Baltic countries of the FSU, the results from Eqs. (1) and (2) give a relatively good match with actual FDI flows, but Eq. (3) significantly under-estimates the level of FDI. This suggests that perceptions of corruption may be a less important determinant of FDI in countries with relatively high measures for governance and economic freedom. Conclusions This study builds on the approach of the Bleyzer Initiative and examines some of the issues raised by that report. The analysis presented in this paper shows that, in relative terms, the actual levels of FDI flowing into individual FSU countries up to 2004 are broadly consistent with what would be predicted using regression correlations based on global data sets for three measures of investment attractiveness relating to governance, economic freedom and corruption perception. Major exceptions relate to the resource-rich countries in Central Asia which attract more investment than predicted. If investment related to oil and gas is removed from aggregate FDI in Azerbaijan, Kazakhstan and Turkmenistan, the actual level of investment lies close to that predicted by the correlations. In contrast, states which are affected by deep political instability fail to achieve their predicted potential, for example Armenia and Moldova. The three Baltic States consistently outperform the other FSU countries in terms of their FDI, and this is predicted by all three sets of indicators. Likewise, Tajikistan, Kyrgystan and Uzbekistan are consistently in the lowest rank for both actual and predicted levels of FDI. The index of economic freedom tends to over-estimate the level of FDI relative to both actual levels and to those predicted by governance and corruption indicators. There is a further tension between the improvement in index of economic freedom for all the FSU states and the deterioration in the governance indicators for all but the Baltic States between 1998 and 2004. Though there are undoubtedly other factors which determine the level of FDI, such as geographic location, the analysis has shown that for most of the FSU states, the path to improving levels of FDI does indeed lie in improving governance, economic freedom and perceptions of corruption. Failure to address these issues will result in continued economic stagnation and isolation. Acknowledgments The authors are grateful to the anonymous reviewers for their helpful observations, and to Trevor Bradley and Diana Byzakova for their research and editorial assistance. References Abdurakhmanov, M., 2004. Factors in attracting foreign direct investments. Ekonomicheskoe Obozrenie (Tashkent) 11, 28e29 (in Russian).
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