The role of investment environment and incentives in attracting foreign direct investments

Abstract

The objective of this thesis was to analyse investment environment and the incentive schemes in the four transition countries Estonia, Hungary, Romania and Moldova. The outcome of the broad analysis of investment environment was very clear. Estonia possesses the best investment environment in terms of stability, ease of doing business, a highly competitive market, low corruption and freedom. Only in labour market terms, size and with regard to infrastructure was the leading position not in hand. Hungary on the other hand scored highest on infrastructure, although also doing remarkably well in most other categories with the exception of labour market and ease of doing business. Regarding labour market conditions, Moldova had its one victory, otherwise it had to be content with facing less corruption perception than its large neighbour Romania and being slightly bigger in relation to population and area than Estonia. Size was Romania’s largest locational advantage, alongside amazing ease of starting a business, while corruption was Romania’s biggest challenge. The analysis of incentive schemes suggests that the theory regarding the use of fiscal policies as the ultimate focus area in transitional countries is very much reflected in the case countries. All four case countries have a functioning incentive system in place. Hungary has a remarkably well developed and generous incentive scheme, while Estonia seems to have understood the vital importance of a more broad policy approach. Both countries are front-runners in attracting FDI, but both need to keep adjusting and expanding their policy areas, if this is to continue. Hungary could beneficially choose to eliminate the last differences in incentives offered to domestic and foreign investors. This would in turn eliminate bureaucracy and help create transparency in the intricate web of incentives. Romania and Moldova are still somewhat behind Hungary and Estonia in terms of FDI per capita, although Romania has shown an impressive growth rate. It would be beneficial for Romania and Moldova to focus on financial incentives as a supplement to the fiscal ones already in place. All countries have shown a will to reform their systems, which is a positive feature. Estonia deserves praise for its transparent and liberal system. Furthermore, the country has managed to embrace the idea of regional cooperation, while maintaining its own unique policy portfolio. Moldova receives the smallest amount of FDI inflow, also compared to other European countries. Since 2000, the inflow has however begun to pick-up and one most hope that continuous improvements to the policy system will continue to create larger amounts of inflow. A well-developed fiscal incentive is in place with competitive corporate income tax and other generous tax incentives, but the use of financial incentives as well could help development in undeveloped regions. For Moldova, the main challenge in the future will be eliminating macroeconomic imbalances and creating a stable investment environment politically and economically. Focus should be on core policies as well as the macroeconomic environment. Investments into the basic infrastructure will need to be improved and after that, focus on the incentive portfolio can be made. Incentives only seem to be justified if the potential of them can be fully used, this demands that the foreign affiliates attracted are different than the local firms, and that they have some assets which can spill over to the host nation, which than in turn needs to be on a certain level in order to absorb the spillover. An interesting step for Moldova would be trying to attract inflow into the emerging new FDI sectors such as service, but it needs to overcome the other challenges and stop the threatening labour market migration first.