Why does (not) Foreign Capital Enter Macedonia, October 30, 2000

INTRODUCTION 

For quite a long time the world has been divided in two parts: a small number of rich countries and a large number of poor countries. As time passes, the gap between these two groups becomes deeper, despite all initiatives, resolutions and similar activities of international organizations, intended for reducing this gap.

The reason for this is that there is a large outflow of capital from undeveloped to developed countries, then the other way around. A small number of developing countries managed to create a climate for more significant inflow of capital from the developed countries in different forms. In the 70’s and the 80’s those where the Far East Tigers, and today, in Europe, from the post-socialist countries, such are Poland, Czech Republic and Hungary. From the countries of former Yugoslavia, Slovenia is added to that group.

Which factors influence the decision of an investor to place its capital outside his own country?

Of course, profit is the main motive. Capital is moved from one place to another, or from one branch to another in order to accomplish higher profit. However, despite the amount of profit, there are other factors, which influence the decision to move the capital from one country to another. I will try to list some of them and simultaneously to explain in which way each of those factors acts in direction of (non) investing the foreign capital in the Republic of Macedonia.

 

Factors for (non) investing foreign capital in a country

1.       Political stability

Political stability of the country has an enormous influence on the foreign investor’s decision to invest in particular country.

In the years after Republic of Macedonia had gained its independence, this factor had a dominant role in discouraging potential foreign investors to invest in the country. The several wars on the territory of former Yugoslavia have had and shall have a huge, long-lasting influence when deciding on the region in which our country belongs, as a region with high political risk.

Also, the occasional internal tensions, especially those between the Macedonian people and the Albanian ethnic minority, are a factor, which adds negative points to the rating lists prepared by the international rating organizations regarding the level of risk for investment.

Potential investors would rather decide to invest in countries in which the possibility for inter ethnic conflict is lower.

Only a short review of the data on foreign investments in the transition countries in the past decade confirms the fore conclusion: Poland, Czech Republic, Hungary and Slovenia are countries with most homogeneous societies from an ethnical aspect, i.e. with a relatively low percentage of minorities in the structure of total population, and with high level of integration of minorities in the society on one hand, and highest inflow of foreign capital on the other.

Of course, it is only one of the factors, which contributed the aforementioned countries to lead with respect to the inflow of foreign investments in comparison with the other transition countries.

The Republic of Macedonia as a one of the smaller countries in the region (or more precisely, the smallest one) could do very little in terms of improving the image of the Balkans as a region with high (or even highest) political risk. Although with its policy it succeeded in avoiding the war in former Yugoslavia, and it maintains a relatively stable interethnic relations, yet as a Balkan country, the Republic of Macedonia shares the destiny of the countries with high political risk for investment, which discourages foreign investors.

2.       Macroeconomic stability

Investors prefer countries, which have established long term macroeconomic stability. Proof of this are the American investors, which in the past thirty years rather invested in the far east Asian countries with achieved macroeconomic stability, than in their “own back yard”, in the countries of South America, which faced macroeconomic instability often accompanied by episodes of hyperinflation. Of course, this is not the only factor, which discouraged American investors from investing in the countries of South and Latin America. Equally important were the unstable political regimes often accompanied by wars, in a certain number of countries of this region.

Regarding this factor, it can be said that the Republic of Macedonia has achieved maximum economic stability, which is the case with very few countries among the countries in transition. Inflation, which has been for several years in the framework of the average inflation of the European Union countries, as well as the stability of the exchange rate, contributed to achieving high rating score among the countries with macroeconomic stability. If we succeeded in maintaining the macroeconomic stability in the years to come (in which I have no doubt) it will be one of the important factors for attracting foreign capital.

3.       Clear legal regulations

This is one of the most important factors, which contribute to the smaller or larger inflow of foreign investments in a country. In that context, it should be stressed that foreign investors do not request to be privileged in advance with relation to domestic investors, nevertheless they expect not to be discriminated, i.e., the same laws to apply both to them and to domestic investors.

In this respect, we cannot say that we have legal regulations, which will attract foreign investors to invest in the Republic of Macedonia due to this factor. On the contrary, the vague, incomplete and very often controversial legal regulations in the Republic of Macedonia discourage potential foreign investors. However, it is a small comfort that we probably have the lowest tax rate on profit, that the investor may freely transfer the profit to his own country (the Republic of Macedonia has accepted Article VIII of the Fund’s Articles of Agreement, according to which it is committed to allow free transfer of profit of the foreign investor on the basis of invested capital). If at the very beginning the investor comes across a huge number of regulations which very often are of a controversial nature, and if he spends months wandering from one ministry to another applying for different types of licenses, if the officers most often do not know the answers to his questions, if they are forced to offer bribe in order to obtain an ordinary decision, the potential investor will soon change his mind and invest in the country where the procedure for acquiring licenses is simpler and quick, where regulations do not change overnight.

We need to do a lot more in this area if we want to be competitive against other transition countries. The worrying fact is that we have all been aware of this for about ten years, however we have done very little in order to improve the situation.

4.       Labor price

Labor price is also a very important factor, which influences the decision of foreign investors in which country they will invest their capital. Labor price was the dominant factor in the decision of the USA to transfer almost all its textile industry in the countries of the Far East.

With that respect, in many labor-intensive branches, we have a relatively cheap and qualified labor. Tolling manufacturing in the textile industry (and in some other branches) where this factor is emphasized (cheap and qualified labor), during all years after the independence, is the most important factor which determines both the size and the type of export. In the forthcoming years, as situation in the Balkans stabilizes, we expect more intensive foreign investments in the labor-intensive branches.

However, it should be emphasized that there is a strong competition coming from some neighboring countries such as Yugoslavia and Bulgaria, which in the same branches (textile, leather industry, etc.) also have qualified, but cheaper labor. That competition will be especially emphasized after the sanctions against our northern neighbor are lifted. Therefore the intention of the Macedonian Government for decreasing the rates of some taxes related to wages should be welcomed, and if it is realized, we will have a possibility to maintain competitiveness in export on this basis.

There is another area, which today and even more in future will represent an important factor for attracting foreign investments. That is the relatively large number of highly educated HI-TECH staff.

Very often foreign companies open their business units in the Republic of Macedonia, where they employ young computer engineers who are paid relatively well compared to the wages paid in our country, which in comparison with the same type of employees in their countries is four or five times cheaper. These employees prepare computer programs, i.e. conduct activities with the same quality, productivity and efficiency as the appropriate employees in the highly developed countries.

In future, this will help the relatively large number of highly educated persons, instead of working as taxi drivers or shop assistants, or requesting a visa for New Zealand, to “find their future” here, at home which will be of mutual benefit both for them and for the country.

5.       Market size

Foreign capital prefers countries with larger markets. That is why western investors are mostly interested in investing in countries such as Russian Federation, Ukraine, Poland, Romania, etc.

Republic of Macedonia both in absolute and relative sense is a small market, which discourages foreign investors. Therefore, the policy that the Republic of Macedonia has been conducting for quite some time with respect to concluding free trade agreements with the neighboring countries and other countries of the region and even wider, could contribute to mitigate this handicap of a small market.

By concluding free trade agreements, it is not possible to fully overcome the problem of a small market due to the well-known clause for the origin of the exported product, which is required by almost all countries in the international trading arrangements.

However, such a policy significantly mitigates the problem of the small Macedonian market.

6.       Privatization of state-owned, i.e. social capital

That transformation of state owned i.e. social capital into a private capital is one of the channels for attracting foreign capital in transitional economies. Basically there are two main methods through which the state (social) ownership was transformed into a private ownership:

·          Mass (voucher) privatization

·          Individual (case by case) privatization

Former countries with state-owned capital, i.e. centrally planned socialism countries chose mainly the method of voucher privatization. The Republic of Macedonia chose the second method - individual (case by case) privatization. Both methods have their advantages and disadvantages. There is no perfect method of privatization.

Characteristic of the privatization of the Macedonian economy is that before the Law on Privatization was passed, a large part of the economy had been privatized according to the so-called Markovic Law, a Law according to which the employees of the enterprises, became shareholders at almost no cost. That was the main reason why after the Law on Privatization was passed, most widely used model of privatization was employees' buy-out.

Actually, this meant a sort of continuation of self-management. Similar was the situation with the second in the row-practiced model - management buy-out. Since in almost all cases privatized by this model, the buyers were the existing management teams from the period of the self-management, they were engaged in discouraging the inflow of foreign capital in order to maintain their position, being afraid that the new investors will bring new management teams. So, it could be concluded that during the past ten years our enterprises were closed for the foreign capital.

 

Which were the enterprises that admitted foreign capital?

Foreign capital first entered the most attractive enterprises, which were previously privatized according to one of the aforementioned models, where new domestic owners could not resist the price offered by foreign investors for the relatively cheaply purchased shares.

The second group of enterprises where an inflow of foreign capital is expected is the so-called group of loss-making enterprises. Those are mainly large enterprises in which privatization commenced, but due to the financial situation it was terminated and the state is a dominant owner. Quite a successful model of this type of privatization of enterprises, with an inflow of foreign capital is the Steel Plant. If we have in mind that the World Bank proposed, and even insisted that the Steel Plant should go under bankruptcy and be sold as scrap iron the fact that it was sold at a relatively good price and nowadays operates with profit, is an example which should be followed.

7.      Concluding arrangements with the IMF and the World Bank

For a developing country, for a small country, for a country, which is situated in a turbulent region, one of the manners for attracting foreign capital is the conclusion and realization of arrangements primarily with the IMF. The arrangements concluded with the IMF give confidence to foreign investors that the country in which they intend to invest will conduct a consistent macroeconomic policy, i.e. their invested capital is safe. Empirical research has shown that for each Dollar received from the IMF there are 3 - 4 Dollars inflow of foreign investments. Republic of Macedonia belongs to the group of countries in transition, which have concluded and realized largest number of arrangements with the IMF and the World Bank. This successful cooperation with the IMF and the World Bank and the disciplined implementation of the agreed economic policy led to a macroeconomic stability which also puts the Republic of Macedonia on the top among the countries in transition.

The new forthcoming three-year arrangement with the IMF and its successful realization is expected to encourage new foreign investors in the Macedonian economy.

Conclusion

The analyzed factors which influence the decisions of the investors to invest or not, show that some of them, such as the market size could not be influenced at all, or the influence will be insignificant. However, most of the factors could be influenced, and it is necessary to build a strategy for attracting foreign capital. Advantage should be given to direct investments and the joint venture arrangements. Although the Republic of Macedonia has not reached the ceiling in credit indebtedness and does belong to the group of moderately indebted countries, we should be cautious not to repeat the mistakes from the past, to invest credits in projects that are not economically justified. Thus, wishing to use some credit lines as soon as possible, there are still some attempts to extend credits, which the supervision very soon classifies in the category of problematic ones. This means that since the Government is the guarantor, these credits will eventually be repaid by the Government, instead by the ultimate user.