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REGIONAL DEVELOPMENT IMPLICATIONS OF FOREIGNDIRECT INVESTMENT IN CENTRAL EUROPE

Petr PavlínekUniversity of Nebraska at Omaha, USA

After the collapse of state socialism in Central andEastern Europe (CEE),1 Western liberal economistsand multilateral institutions suggested that asuccessful ‘transition’ from the centrally plannedeconomy to a market-based system could only beachieved with large inflows of foreign directinvestment (FDI) (Fischer and Gelb, 1991; Gowan,1995). FDI was supposed to play a ‘critical role’ inthe economic development of CEE and generateindustrial restructuring that would spreadthroughout the entire economy and ultimately leadto national prosperity (Dunning, 1993a; EBRD,1993; Michalak, 1993; Csáki, 1995; Gorzelak, 1996;Papp, 1996; Lankes and Stern, 1997; Benáček andZemplinerová, 1997; Ozawa, 2000). FDI wasattributed such a critical role because it is oftenviewed as an ‘engine of development’ (Csáki, 1995:112), a vehicle of economic modernization and adriving force of productivity development in CEE(Hunya, 2000a). To attract large FDI inflows, theCEE countries only needed to develop appropriateinstitutional and policy frameworks to positionthemselves within flows of global capital (Dunning,1993a; Rutland, 1995).

In CEE, it is certainly the case that FDI typicallyresults in rapid and profound restructuring offoreign invested enterprises (FIEs – joint venturesand foreign-owned companies) including, amongothers, organizational restructuring, technologytransfer, worker training, the transfer of Westernmanagement structures and practices, and newproduction strategies and organization. It is alsousually the case that such influxes of productioncapital and transfers of Western factory regimes andtechnology result in rapidly increased quality andcompetitiveness of produced goods, productivitygains and expanding production and sales by FIEs,both domestically and abroad (e.g. Zloch-Christy,1995; Bell, 1997; Estrin et al., 1997; 2000; Sharp andBarz, 1997; Dyker, 1999; 2001; Hamar, 1999; Hunya2000a; 2000b; Pavlínek, 2002a) (Table 1).

Yet, the overly optimistic accounts of the role ofFDI during the CEE ‘transition to capitalism’ oftenoverlook several important issues regarding FDIand by doing so they tend to exaggerate its potentialbenefits. The uncritical views of FDI as a ‘ship ofriches that will ensure economic prosperity’(Kojima, 2001: 22) have become quite common

Abstract

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European Urban and Regional Studies 11(1): 47–70 Copyright © 2004 SAGE Publications10.1177/0969776404039142 London, Thousand Oaks, CA and New Delhi, www.sagepublications.com

Foreign direct investment (FDI) has been accorded acentral role in the post-communist economic trans-formation of Central and Eastern Europe.This paperexamines the regional effects of FDI in CentralEurope (Czech Republic, Hungary, Poland andSlovakia) in the 1990s. It challenges uncritical viewsof FDI and its role in regional economic transforma-tions by considering its potentially adverse effectsfor regional economic development, such as theintensification of uneven development, the develop-ment of a dual economy, failure to develop linkageswith local and regional economies, and its contribution

to increased regional economic instability. A case-study of the Czech automotive components industryillustrates the regional economic effects of FDI inCentral Europe in terms of stability of investment, itslinks with the regional economy and its effects ondomestic research and development.

KEY WORDS ★ automobile industry ★ CentralEurope ★ Czech Republic ★ foreign directinvestment ★ regional development ★ research anddevelopment

www.sagepublications.com

among the CEE politicians, especially after failuresof domestic mass privatization schemes in countriessuch as the Czech Republic and Slovakia to generatelarge-scale, radical restructuring of formerly state-owned industrial enterprises. In this context, FDI isgenerally considered to be vastly superior todomestic capital in generating such strategicrestructuring, leading to a long-term successfulsurvival of domestic companies and by doing sobecoming the ‘driving force in economicdevelopment’ in CEE countries (Jelonkiewicz,2001). Attracting greenfield investments to regionswith high unemployment levels is viewed by bothregional and national politicians as a desirablesolution to their economic problems. These views ofFDI contributed to ‘Eastern Europe’s obsessionwith foreign investors’ (The Economist, 1991: 25) andan intense competition among the CEE countriesover FDI inflows in the1990s that continued in theearly 2000s.

Although this paper does not underestimatepotentially positive effects of FDI on affectedcompanies (see Pavlínek, 2002a), industrial sectors(see Pavlínek, 2002b; 2002c; 2003) and on overall

economic development, it argues that uncritical,unbalanced and undiscriminating views of FDI areincorrect. In reality, FDI in CEE has not necessarilyled to an automatic success in all FIEs (see Pavlínek,2000; 2002a), its effects have been very uneven bothsectorally and geographically (see Pavlínek andSmith, 1998; UNCTAD, 2001; Pavlínek, 2002b) andthe generally assumed superior performance of FIEscompared to domestic enterprises has been verydifficult to verify empirically with the exception ofmanufacturing (Szanyi, 2000). Uncritical views ofthe FDI role in the CEE economic transformationsgenerally fail to recognize that there are manydifferent types of FDI and a large diversity of FIEsin all possible respects with various effects onindividual companies, regions and nationaleconomies (Szanyi, 2000).2 Such views also tend tostress the positive effects on national income, jobsand government revenues typically associated withFDI in host countries, while largely ignoring theadverse effects related to FDI, such as those onbalance of payments and loss of sovereignty. It isalso being generally overlooked that impacts of FDIon host developed countries have been regarded as

European Urban and Regional Studies 2004 11(1)

48 EUROPEAN URBAN AND REGIONAL STUDIES 11(1)

Table 1 Potential positive and negative effects of FDI in host countries

Potential positive effects of FDI Potential negative effects of FDI

Enterprise level: Enterprise level:• continued and expanded production • labour shedding• increased labour productivity • disinvestment and downsizing of production• access to investment capital • transfer of R&D abroad• access to worldwide sale and distribution networks• transfer of Western technology and know-how Local and regional economy:• improved competitiveness • local dependency on foreign capital• increased R&D • external control of local economies

• attracting skilled and semi-skilled workers from local Local and regional economy: companies• saving of existing jobs and creation of new jobs • suppression or destruction of local firms unable to• increased wages compete with FIEs supported by generous governmental• growth or real income investment incentives and benefiting from transfer• increased tax base pricing• increased exports • suppression of the development of new indigenous • labour training enterprises• provision of social services to local communities • deskilling• spillovers to local and regional economy • regional specialization in low-skilled, labour-intensive • increased opportunities for local companies to supply production

foreign-owned companies • development of ‘dual economy’• branch plant syndrome• instability of Western investment

more favourable compared to FDI effects in lessdeveloped countries (see Hood and Young, 1993).The high expectations associated with FDI basedupon the past experience of highly developedWestern economies or rapidly growing East Asianeconomies thus tend to overlook the experience ofless developed countries with FDI that may berelevant in the case of CEE.

The goal of this paper is to discuss regionaldevelopment effects of FDI in Central Europe (CE– Czech Republic, Hungary, Poland and Slovakia).It deliberately focuses on ‘problematic’ issuesrelated to FDI. The first part of the paperconcentrates on three interrelated issues: therelationship between FDI, economic growth anduneven regional development; long-term economiceffects of FDI in the host countries; and theintegration of FIEs in local and regional economies.The second part draws on the case-study of theCzech automotive components industry to illustratepotential risks for local and regional economicdevelopment associated with FDI in CE. Inparticular, it briefly investigates the questions ofstability of Western investment, regional economiclinkages of FIEs, and FDI effects on enterpriseresearch and development (R&D).

FDI, economic growth and unevendevelopment

In the early 1990s, Western economists argued thatCEE needed large amounts of FDI to achieve rapideconomic growth and Western levels of labourproductivity.3 Although annual FDI inflows to CEEincreased dramatically in the 1990s, they remainedlow in the global context, well below its 5.4 percentshare of the world’s population (Tables 2 and 3).CEE attracted $166.5b between 1990 and 2001 or2.7 percent of the total compared to $4,404b (71.4percent) invested in the industrialized countries and$1,598b (25.9 percent) invested in the less developedcountries. FDI inflows to CEE were also low in theEuropean context. While CEE accounts for 46percent of Europe’s population, it attracted only 5.7percent of total FDI inflows to Europe between1990 and 2001. For example, the entire CEE(population of 334m) attracted lower cumulativeFDI inflows than Spain, (population of 41m, FDI


PAVLÍNEK: REGIONAL DEVELOPMENT IMPLICATIONS OF FDI 49

Tab

le 2

Ann

ual i

nves

tmen

t inf

low

s, 1

990–

2001

($m

)

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Wor

ld20

3,81

215

7,77

316

8,12

220

7,93

722

5,66

033

1,06

838

8,14

047

8,08

269

4,45

71,

088,

263

1,49

1,93

473

5,14

6D

evel

oped

16

9,77

711

4,00

111

4,00

212

9,30

213

2,75

820

3,46

221

9,90

826

7,94

748

4,23

983

7,76

11,

227,

476

503,

144

econ

omie

sD

evel

opin

g 33

,735

41,3

2450

,376

73,1

3587

,024

113,

338

152,

685

191,

022

187,

611

225,

140

237,

894

204,

801

econ

omie

sC

EE

300

2,44

83,

744

5,50

05,

878

14,2

6813

,547

19,1

1322

,608

25,3

6326

,563

27,2

00

Sour

ce: U

NC

TA

D (1

996;

200

1; 2

002)

.

inflows of $169.5b) during this period (UNCTAD,1996; 2001; 2002; PRB, 2002). Within CEE, FDIinflows were very uneven. Central Europe (CE)accounted for 64.3 percent of all FDI inflowsbetween 1990 and 2001 (UNCTAD 1996; 2001;2002). The highest FDI stock as of 2001 was inPoland, the Czech Republic, Hungary and Russia(Table 4). Highest FDI stock per capita was in theCzech Republic, Hungary and Estonia (Table 5).

The argument that FDI generates economicgrowth and development is widely accepted but ithas never been proven (Nicholls et al., 1998). Hoodand Young (1993: 101) argued, for example, that‘overall, no clear generalisations are possible eitherin regard to the impact of MNEs [multinationalenterprises] on national income in developing hostcountries or in respect of the effects on otherdevelopment goals’. Others have argued thateconomic growth tends to attract FDI rather thanthe opposite way (Gowan, 1995), which is supportedby the fact that about three-quarters of globalannual FDI inflows are invested in the developedcountries (Table 3). Causality tests performed byFabry (2001) to find relationships between FDI,economic growth and trade in CEE in the 1990syielded inconclusive results. The relationshipbetween FDI inflows and economic growth is thusless than clear.


50 EUROPEAN URBAN AND REGIONAL STUDIES 11(1)T

able

3Sh

are

ofgl

obal

FD

I in

flow

s, 1

990–

2001

(%)

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Dev

elop

ed

83.3

72.3

67.8

62.2

58.8

61.5

56.7

56.0

69.7

77.0

82.3

68.4

econ

omie

sD

evel

opin

g 16

.626

.230

.035

.238

.634

.239

.340

.027

.020

.715

.927

.9ec

onom

ies

CE

E0.

11.

62.

22.

62.

64.

33.

54.

03.

32.

31.

83.

7C

E0.

11.

51.

92.

31.

83.

32.

21.

81.

81.

51.

22.

4C

E s

hare

of

CE

E98

.796

.187

.187

.969

.576

.262

.445

.056

.662

.867

.964

.8

Not

e: C

EE

= C

entr

al a

nd E

aste

rn E

urop

e, C

E =

Cen

tral

Eur

ope

(Cze

ch R

epub

lic, H

unga

ry, P

olan

d, S

lova

kia)

.So

urce

: Cal

cula

ted

from

UN

CT

AD

(199

6; 2

001;

200

2).

Table 4 Estimated FDI stock in CEE as of 2001 ($m)

Poland 42,433Czech Republic 26,764Hungary 23,562Russia 21,795Romania 7,636Croatia 6,597Slovakia 6,109Ukraine 4,615Bulgaria 3,850Slovenia 3,250Estonia 3,155Lithuania 2,665Latvia 2,216Serbia and Montenegro 1,484Belarus 1,412Macedonia 919Albania 759Bosnia and Herzegovina 519

Source: UNCTAD (2002: 313).

At the regional level, FDI should ideallycontribute to overall economic growth and regionaleconomic restructuring by increasing competitionand by transferring and diffusing new forms ofproduction organization. These changes thenshould lead to productivity improvements across theregional economy (Florida, 1996). FDI is typicallyattracted to the existing economic clusters to benefitfrom external economies of scale such as markets,existing pools of qualified labour, factors ofproduction, suppliers, infrastructure, institutionsand innovative capabilities (UNCTAD, 2001). Itexplains why FDI contributed to unevendevelopment and regional polarization in CE asmore developed and more industrialized regionsattracted higher volumes of FDI than less developedand less industrialized regions in the 1990s (e.g.Tomeš and Hampl, 1999; Domański 2001a; 2001b;J. P. Kiss, 2001). FDI in the forms of banking,financial and service types of investmentsconcentrated in the capital cities increasing theirprimacy. Other big cities were also the target of FDIinto the service-related activities but expensive urbanareas tended to be less favoured by manufacturinginvestment. In the Czech Republic, for example,Prague and Brno, the two largest cities, attractedover 60 percent of service-oriented foreign-ownedfirms but only 24 percent of manufacturing FDI(Blažek, 1999). However, even greenfield

manufacturing investments are disproportionatelyattracted by metropolitan areas.

In Poland, less than one-fifth of greenfield FDIin industry and mining was located in non-metropolitan areas as of 1998. Overall, FDIcontributed to the reproduction of existing regionaldisparities both between western and eastern Polandand between metropolitan and peripheral areas.About one-third of industrial FDI was invested inthe southern industrialized regions along the borderwith the Czech Republic and Slovakia (LowerSilesia, Silesia and Małopolska provinces accountfor 30 percent of total industrial FDI) and 42percent in central Poland (Mazowiecka,Wielkopolska, Łódzka and Kujawsko-Pomorskaprovinces), while less industrialized eastern Polandand the western border areas attracted low volumesof FDI (Domański, 2001a; 2001b).

In the Czech Republic, in addition to Prague andother large cities, FDI tended to concentrate in themore industrialized central and north-westernBohemia. The regions close to the German andAustrian border benefited from cross-border FDI(Pavlínek, 1998). As of 31 December 2001, Pragueaccounted for 49 percent of all invested FDI in theCzech Republic. Prague with the surroundingregion of Central Bohemia accounted for 60 percentand the share of the four largest Czech cities(Prague, Brno, Ostrava and Plzeň) was 58 percent(CNB, 2003: 34–5).4 In Slovakia, the share of theBratislava region is even higher as it was the host ofover 60 percent of FDI throughout the 1990s and itaccounted for 67.8 percent of the total Slovak FDIstock as of 30 September 2002. The seven remainingSlovak regions received low amounts of FDI (eachbetween 2.2 percent and 4.0 percent of the Slovaktotal). The only exception is the south-easternKošický region (12.7 percent of FDI stock as of2002) dominated by the second largest Slovak city ofKošice.5 Bratislava region’s share is 58.1 percentwhen FDI in the banking sector is excluded (NBS,2003: 44).

In Hungary, in addition to Budapest (56.5percent of FDI stock and 53.5 percent of FIEs in2000) and the historically industrialized NorthWest, the previously little industrialized westernareas along the Austrian border have attracted cross-border FDI by their relative location with respect toWestern Europe (Fazekas, 2000; OECD, 2000;HCSO, 2002).6 Central Hungary, Central and



Table 5 FDI per capita in CEE, 2001 ($)

Czech Republic 2,598Hungary 2,333Estonia 2,254Slovenia 1,625Croatia 1,534Slovakia 1,131Poland 1,099Latvia 963Lithuania 761Bulgaria 494Macedonia 460Romania 341Albania 245Bosnia and Herzegovina 153Russia 152Belarus 143Moldova 142Ukraine 96

Source: Calculated from PRB (2002); UNCTAD (2002: 313).

Western Transdanubia, that account for 49 percentof population and 32 percent of Hungarian territory,accounted for more than three-quarters of industrialFDI in 2000 (84.6 percent of FDI stock and 78.4percent of FIEs).7 At the same time, the lessdeveloped eastern regions saw only limited amountsof FDI in the 1990s. The empirical analysis of theregional distribution of FDI inflows to Hungaryshowed that the three most important explanatoryvariables of FDI distribution at the regional level inthe 1990s included the level of education of labourforce, level of urbanization, and the proximity ofwestern border (Fazekas, 2000). The situationslowly started to change in the late 1990s with moreFDI being located in south-western and easternHungary because of labour shortages and growingproduction costs in the North West. However, thediffusion of FDI outside Budapest and the NorthWest will most likely be very limited because the lessdeveloped eastern regions have a poorly educatedpopulation (Hamar, 1999; J.P. Kiss, 2001; Serenyi,2001a).8

Long-term economic effects of FDI in thehost countries

Although the immediate positive effects of FDI maybe considerable at the company level and for localeconomies, the long-term economic effects of FDIin the host countries are less clear. After the entry ofFDI, local economies may benefit from continuedand often expanded production that saves jobs inFIEs (especially where the privatization agreementobliged foreign investors to maintain currentemployment for a particular period), or new jobs arecreated in greenfield investments (e.g. Hardy, 1998).At the same time, foreign takeovers are oftenassociated with labour shedding, disinvestment anddownsizing of production (Hardy, 1998; Smith andFerenčíková, 1998). Local government budgets maybenefit from increased tax base, and foreigninvestors may provide some social services to localcommunities previously provided by state-ownedenterprises during the state socialist period, such asthe sponsorship of local cultural and sports events.However, the long-term costs for local communities,invisible at the moment, may be substantial in termsof the creation of new forms of local dependency on

foreign capital and external control of localeconomies. Additionally, FDI may have adetrimental effect on local companies by attractingtheir skilled and semi-skilled workers to FIEs.These workers may have been trained by localenterprises. It has been argued that FDI maysuppress or even destroy the existing local firms thatare unable to compete with FIEs supported bygovernmental investment incentives. It may alsosuppress the development of new indigenousenterprises (Foley et al., 1996; Dicken, 1998; Hardy,1998).

At the national scale, the growth in real incomeresulting from imports of capital, technology andskills is one of the most important potential positivedirect economic effects of FDI (Mišun and Tomšík,2002: 57). Domestic suppliers of FIEs that survivethe rigorous selection process may become morecompetitive internationally (e.g. Pavlínek, 2003).However, direct economic benefits such as in capitalformation, employment, trade and the balance ofpayment may only be short term (Young et al.,1994). FDI’s effects in terms of increasedcompetition and restructuring throughout theeconomies of CE countries have so far been limitedbecause of its concentration and sectoralspecialization.9 Vertical integration of CE branchplants into the networks of transnationalcorporations (TNCs) results in external control andmakes the local plants more dependent on thedestiny of the individual corporations and morevulnerable to international economic fluctuations. Italso limits their integration and linkages with thelocal economy, thus affecting their potentialmultiplier effects. The absence of local linkages hastypified many FDIs to the former East Germanyand Hungary, the two former state socialisteconomies that have witnessed the deepest FDIpenetration so far (see Grabher, 1994).10

In the case of Hungary, some observerssuggested that the country could become ‘Europe’sMexico’, that it could suffer from the ‘Maquiladorasyndrome’ because of its increasing dependence onFDI seeking low-cost labour and governmentalincentives for foreign investors. The primaryfunction of such investments, the argument goes, isto assemble imported Western components intofinished goods that are then re-exported to theWest. Their economic benefits are limited to thecreation of low-skilled jobs and increased exports



(Ellingstad, 1997; Kapoor and Eddy, 1998).Although such a view obviously exaggerates theexisting situation by ignoring the diversity andcomplexity of FIEs in Hungary, it points topotential dangers related to the increaseddependence of CE countries on a strategy of usinglow labour costs to attract FDI; this strategy mayprevent CE from securing a better position in theworld economy by reinforcing its role as a low-costproduction base vulnerable to low-cost competitionfrom less developed countries.

In the case of Poland, and to a lesser extent theCzech Republic, cheap labour was not the primaryreason for FDI in the early 1990s. Market captureinvestments often combined with an export-orientedmotivation were more important by far both interms of overall value of investment and in terms ofeconomic impact (Benáček and Zemplinerová, 1997;Hardy, 1998; Pavlínek, 1998; Domański, 1999). Bythe late 1990s, however, after the initial capture ofdomestic monopoly producers, cost-cutting wasincreasingly becoming the leading reason for FDI inCE, especially in Hungary and the Czech Republic.The Czech Republic, for example, has increasinglybecome the target for mass-production relocationfrom Western Europe to capitalize on its low wages.For example, Matsushita moved its production oftelevision sets including 1,400 jobs from Cardiff toPlzeń in 2000 (Plesl, 2000). In 2001, Compaq moved 700 low-skill assembly jobs from Erskine(Scotland) and Celestica transferred 570 assemblyjobs from its circuit board factory in Ashton-under-Lyne near Manchester to the Czech Republic(Jones, 2001; Nicholson, 2001). In 2002, Black &Decker, the American power tools manufacturer,announced the transfer of assembly and packagingoperations including about 600 jobs fromSpennymoor (United Kingdom) to a new plant inthe Czech Republic (at Trmice) for cost-cuttingreasons (Tran, 2002). This type of transfer andoutsourcing of parts of the production process byWestern TNCs to relatively low-cost low-wage areasof CE has limited regional economic benefits in CEas it leads to very low levels of local valueappropriation (Smith et al., 2002: 51–2).

Mišun and Tomšík (2002) measured the effectsof FDI on capital formation in the Czech Republic,Hungary and Poland. They argue that FDI whichbrings new goods and services into a domesticeconomy usually has more favourable effects on

capital formation than FDI in the existing sectorswhere competing domestic companies may cause the effect of ‘emptying investmentopportunities for domestic investors in favor offoreign investors’ (the so called ‘crowding-out’ ofdomestic investment) (p. 59). FDI which crowds-out domestic investment or does not contribute tocapital formation has negative effects for hostcountries. Based on their theoretical model andempirical testing, Mišun and Tomšík (2002) foundevidence of a crowding-out effect in Poland in theperiod 1990–2000 which they explain by theprimarily market-capture nature of FDI in Polandduring this period and its negative effects on theexisting domestic companies in the sectors targetedby FDI. Contrary to Poland, 1990–2000 FDI inHungary and 1993–2000 FDI in the Czech Republichad positive effects on increasing domesticinvestment as FDI was primarily export-oriented,especially in the case of Hungary (the so-called‘crowding-in’ effect). The crowding-in effect wasmuch stronger in Hungary than in the CzechRepublic.

Development of dual economy?

It has been argued that growing FDI inflows lead tothe development of ‘dual economy’ in CE (Hamar,1999; Mejstřík, 1999; Benáček, 2000; Hunya, 2000b;Kapoor, 2000, Mišun and Tomšík, 2001). On theone hand, a small number of FIEs integrated intoTNC networks undergo rapid restructuring basedon the transfer of modern technology, Westernmanagement and production strategies. Thesecompanies then drive countries’ exports by massproducing goods for Western markets, but theyremain few in number and employ a small numberof people. Their effect on the rest of the economy islimited and their local economic linkages aretruncated or only poorly developed. Such‘cathedrals in the desert’ (Morris, 1992; Grabher,1994; 1997) typically offer low-skilled or narrowlyqualified jobs used to operate modern mass-production technology.

On the other hand, there are domestically ownedfirms employing a vast majority of themanufacturing workforce. Many of these firms arestill dominated by state socialist legacies in terms of



their management, many of them are still owned bythe state, or their ownership is often ambiguous (asin the case of hundreds of companies privatizedthrough voucher privatization in the Czech Republicand Slovakia). These firms have typically been slowto restructure as they lacked capital and managerialskills to do so. Many of them acquired large debtsthrough soft loans, which they are unable to pay off,and further credit is unavailable because of theexisting credit crunch. Many of these firms havebeen negatively affected by asset stripping and rentseeking by their own managers (Pavlínek, 2002d). Inaddition, these companies usually produce fordomestic markets where a large proportion of thelocal population has a low purchasing power andforeign competition is intense. As a result, localcompanies have typically had major difficultiesadjusting to market conditions and foreigncompetition, and most of the time they have justbeen fighting for short-term survival. The emergingdual economy has been reinforced by the fact thatforeign investors tend to invest in domestic firmswith above-average productivity, profitability andcapital. At the same time, FDI was almost non-existent in the traditional backbones of state socialistindustry in the 1990s (such as the steel industry, largemachinery industry, chemicals, coal mining, coke andrefinery) that continued to employ large numbers ofworkers, had excess capacities, and were in dire needof extensive restructuring/modernization(Zemplinerová, 1998; Głębocki and Rogacki, 2002).The end product of these processes has been awidening gap between a few efficient and successfulFIEs and a majority of increasingly impoverishedlocal companies.

It has been argued that the phenomenon of dualeconomy is already well developed in Hungary andincreasingly in the Czech Republic. In Hungary,FIEs employed 15 percent of the workforce,produced 40 percent of output, and accounted for80 percent of exports in 1999 (46.5 percent ofmanufacturing workforce, 88.8 percent ofmanufacturing exports, 73 percent of manufacturingsales) (UNCTAD, 2001; 2002; Mišun and Tomšík,2002). In the Czech Republic, FIEs accounted fornearly half of the exports while employing only 3.2percent of the total workforce in 1998 (60 percent ofmanufacturing exports, 19 percent of industrialproduction and 18 percent of the manufacturingemployment), with Volkswagen (VW)-Škoda JV

alone being responsible for 10 percent of Czechexports while it was employing only 20,400 workers.In 1996, 92 percent of the total gross profit in Czechmanufacturing was produced by FIEs thataccounted for only 23 percent of the totalmanufacturing output (Pomery, 1997; Harris, 1998;Zemplinerová, 1998; UNCTAD, 2001; Mišun andTomšík, 2002).

However, this type of classification of enterprisesin two large groups is overly simplistic because itoverlooks the existing diversity in both domesticcompanies and FIEs. There are many examples ofdomestic companies that have successfullyrestructured without FDI and are highlycompetitive today. At the same time, not all FDI hasled to the kind of enterprise success described above(Pavlínek, 2000; 2002a). The dual economyargument also underestimates the extent ofrestructuring in many domestically ownedenterprises after their ownership consolidation inthe late 1990s that followed the initial (typicallyunsuccessful) post-privatization period (Pavlínek,2002d).

Local integration of foreign-ownedcompanies

Linkages of foreign-owned plants with domesticfirms are considered the most important mechanismthrough which technology transfer takes place,additional jobs are generated, and new localenterprises are formed (Dicken, 1998; UNCTAD,2001). The degree of integration of FIEs in localand regional economies of the host countries variesconsiderably because there are large differencesbetween both industrial sectors and in strategiespursued by TNCs within a particular sector (e.g.Pavlínek and Smith, 1998; Pavlínek, 2002c). FIEswith a high degree of local integration can play animportant role in regional economic transformationby encouraging and triggering restructuring ofsupplier networks. This has been the case for someFDI in the CE passenger car industry as typified byVW’s investment in the Czech carmaker Škoda thatled to the transformation of Škoda’s network ofcomponent suppliers with important implicationsfor the national economy as a whole (e.g. Meyer,2000; Pavlínek, 2003). However, not all FDI is likely



to result in the development of supplier linkageswith local companies. Export-oriented, cross-borderinvestments are particularly likely to be isolatedfrom local economies.11 Many Western companiesdevelop no or only few linkages with local firmsbecause they often find it difficult to secure suppliesof components from domestic suppliers at thedesired level of sophistication, quality, and timing ofdeliveries (Grabher, 1994; Ellingstad, 1997;Pavlínek, 1998; Pavlínek and Smith, 1998; Swain,1998). At the same time, direct local competitors ofFIEs are often forced out of business as they cannotcompete; such FIEs have more efficient production,an advantage reinforced by tax holidays and otherfinancial incentives provided by governments toattract them, and they also benefit from transferpricing that is unavailable to domestic companies.Similar effects of FDI have been reported fromperipheral regions in Western Europe, leading to anargument that the truncated nature of FDI activitiesin such regions can actually act to their long-termdisadvantage because it restricts their potentialdevelopment of supplier linkages within thedomestic economy (Ashcroft and Love, 1993;Dicken, 1998).

Even in the cases of some car manufacturers(such as VW-Škoda in the Czech Republic andSuzuki in Hungary) where the degree of localintegration is high, many of their foreign-ownedsuppliers are typical branch plants verticallyintegrated into the TNC supplier networks with nolocal linkages in CE. As one car industry analyst has put it: ‘In most cases, the only thing they[Škoda’s foreign-owned suppliers in the CzechRepublic] manufacture locally is the label. They’rescrewdriver plants where low-wage employees puttogether high-tech products manufactured backhome in the West’ (Harris, 1999: 14). So whileforeign suppliers transfer their new processtechnologies to their plants in the host nations(Fujita and Hill, 1995), the regional economiceffects of such plants are often very limited. In thesystem of lean production of automobiles, suppliersare increasingly expected to design their owncomponents, assemble parts into componentsubsystems at the lowest possible cost and in perfectquality, and deliver them to automobile assemblersjust in time. The surviving local suppliers not takenover by TNCs can rarely meet such conditions and,as a result, are unable to compete with efficient

production of sophisticated parts dominated byTNCs. Consequently, if they survive, they typicallyspecialize in high-volume production of simplecomponents or become second-tier suppliersdelivering simple parts to the foreign-owned first-tier suppliers. Such domestic suppliers are typicallyhighly vulnerable to market fluctuations, theirlinkages with foreign-owned first-tier suppliers orcar assemblers are weak and do not involve muchexchange of information and knowledge(UNCTAD, 2001). As a result, even the few autoinvestments that are generally considered to be verysuccessful and highly integrated in local economies (such as VW-Škoda) can lead todeskilling in the host countries. Additionally, theclosure of uncompetitive domestic suppliers andextremely low or non-existent local content offoreign-owned suppliers may reduce the number ofmanufacturing jobs in the host countries (Fujita andHill, 1995).

The degree of local integration is also importantfor the stability of investments. Foreign-ownedbranch plants set up to assemble large quantities ofgoods for Western European markets from importedcomponents that have no or very weak linkages withlocal firms are not necessarily very stable elementsof local and regional economies because they couldeasily be shut down and their production relocatedif wages were to go up, local currency to appreciateor the investor face economic difficulties at home(Nicholls et al., 1998; Pavlínek, 1998). There havealready been examples of companies moving theirproduction from CE to cheaper locations because ofrising production costs after only a few years ofoperation. Mannesmann (the German-basedproducer of seamless and welded steel tubes andpipes), Shinwa (the Japanese maker of electronicequipment) and Solectron (the American electronicsmanufacturer) have closed their production units inHungary and moved them to China (Mannesmannand Shinwa) and Romania (Solectron). In the caseof Mannesmann, 1,100 jobs were lost in the town ofSarbogard in western Hungary and an additional500 people were laid-off in the city of Miskolc afterMannesman’s supplier Shinwa followedMannesmann to China (J.P. Kiss, 2001; Serenyi,2001b). The Singapore-based FlextronicsInternational, a contract electronics manufacturer,has recently moved its production from Hungaryand the Czech Republic to China, citing lower



labour costs in China as the reason.12 In the case ofHungary, Flextronics produced Xbox computergame consoles for Microsoft. Its assemblyoperations in the city of Sárvár and componentproduction in Zalaegerszeg were moved to theChinese city of Doumen, resulting in the loss of1,200 jobs. In the Czech Republic, Flextronics,which started to produce electronic equipment inthe city of Brno in November 2000 and employedmore than 2,500 workers in 2001, closed its factoryin 2002. Flextronics received governmentalincentives in the form of job-training subsidies, 10-year tax holidays, customs duty exemptions and freeland in return for the promise of creating 3,000 jobsby 2005 and keeping those jobs for five years(Fránek, 2002; UNCTAD, 2002). Other examples ofTNCs moving their recently established productionfrom the Czech Republic include the German VartaAku which announced in November 2002 that itwould move its production of cell phone batteriesfrom Česká Lípa to an unspecified location in Asiato save on labour costs. The company will lay off344 workers in the Czech Republic (MF Dnes,2002). Massive Production, the Belgian maker oflights, is moving its production to China from theCzech city of Litovel, and the Japanese-GermanTakta Petri is moving its steering wheel coverproduction from the town of Kalná to anunspecified location (Klímová, 2002).

While the development of supplier linkagesbetween foreign-owned and domestic companies isgenerally considered to be difficult (UNCTAD,2001), there are two specific problems that helpexplain weak linkages of many FIEs with localeconomies in CE. First, FDI in CE is a recentphenomenon and it takes time for foreign companiesto develop supply linkages to domestic companies.Second, the generally lower level of technologicaland managerial knowledge in CE compared to thedeveloped economies means that many CEcompanies are unable to satisfy the demands offoreign companies. For example, in the case ofautomobile manufacturing, foreign-owned carassemblers and first-tier suppliers often argue thatdomestic suppliers cannot meet their qualitydemands (see Pavlínek, 2002c).

FDI-associated risks for host economies:the evidence from the Czech automotivecomponents industry

To illustrate potential risks associated with FDI forCE countries, the second part of this paper draws ona case-study of the Czech automotive componentsindustry conducted as part of a larger project on theprocesses of car-industry restructuring in CEE (seePavlínek, 2002b; 2002c). The following discussionfocuses on three FDI-related issues: the stability ofinvestment, its local and regional economic effects,and FDI effects on domestic R&D. The primaryinformation presented is based upon in-depthinterviews conducted by the author with directorsor top managers of 20 automobile-industrycomponent suppliers in the Czech Republic in 2000and 2001, and it also draws on interviews conductedat the Czech Ministry of Industry and Trade and atŠkoda Auto in 1996 and at Škoda Auto, Tatra,Daewoo-Avia and Karosa vehicle manufacturers in1999. The goal of the interviews was to collectinformation about the processes of enterprisetransformation in the 1990s and the effects ofdifferent ownership structures on enterpriserestructuring strategies. The component suppliersinterviewed were selected from the three groups ofcompanies based on their different ownershipstructures (domestic, joint venture, foreign). Nine ofthese suppliers were fully or partially foreign-ownedat the time of the interview. However, the topmanagers of Czech-owned suppliers also providedimportant insights and assessments of FIEs becausefour of them formed joint ventures (JVs) with foreignpartners that involved parts of their companies.13

Most of the remaining companies interviewed haveseriously considered forming JVs with foreignpartners in the past or at the time of the interviewand underwent negotiations with potential foreigninvestors (see Pavlínek, 2002a: 362).14 While thistype of qualitative research is not and does not claimto be a fully representative sample of the Czechautomotive industry as a whole, interviews with keyinformants represented by top managers of selectedcompanies provide important insights into theactual processes of FDI-related enterprisetransformation. As such, this research complementsempirical/quantitative studies of enterpriserestructuring and FDI effects at the enterprise level.



Stability of Western investment

Many Western car-component suppliers have beenattracted to the Czech Republic not only by thegeographical proximity of Škoda Auto assemblyoperations, but also by the possibilities of low-costproduction for West European vehiclemanufacturers and lately by generous governmentalincentives for foreign investors.15 The average 2000wage in the Czech automotive industry as a wholestood at Kč16,050 (AIA, 2001) which was DM881.5or $415.9. In 2000, the average German labour costwas DM7,835.49 per employee per month in theautomotive industry (VDA, 2001). The averageCzech automotive-industry wages were thus 11.25percent of average automotive industry labour costin Germany in 2000.

Average wages in the Czech automotive-component sector vary significantly but overall theyreflect average wages for a particular sector and aparticular type of work in a particular region andthey are very low compared to those of WesternEurope (Table 6). The differences among thecomponent suppliers interviewed in 2000 and 2001were significant. Barum Continental’s averagemonthly manual wage of Kč21,000 (the highest inthe Czech Republic) was more than three timeshigher than the average wage in the HLF Hajniceplant (Kč6,500). Table 6 also suggests that FIEstend to pay their workers better than domesticCzech ones.

Component suppliers can produce componentsin the Czech Republic and supply various carmakersin Western Europe and even overseas to reap the



Table 6 Average monthly wages in the interviewed component suppliers in the summer of 2000

Average monthly wage,summer 2000

EmploymentComponent supplier Product Ownership (2000) in Kč in DM in $

Barum Continental tyres foreign 3,700 21,000 1,157.4 546.3Hayes Lemmerz wheel assembly foreign 100 17,000 933.5 448.9Lucas Autobrzdy brakes foreign 700 16,500c 918.4 440.9Tanex Plasty Jaroměř polyurethane foam Czech 250 15,000b 826.7 390.2

componentsFederal Mogul brake lining foreign 700 14,000 771.6 364.2Avon Automotive Rudník rubber components foreign 665 13,000a 747.1 343.3Temac Zvěřínek gaskets foreign 250 12,500 688.9 325.2Rubena Hradec Králové rubber components Czech 2,100 12,500b 688.9 325.2Brisk Tábor spark plugs Czech 650 12,500b 688.9 325.2CIEB Kahovec seats Czech 180 12,500b 688.9 325.2Gumárny Zubří moulded technical rubber Czech 250 12,300 677.9 320.0

componentsKarsit Jaroměř car seat frames Czech 500 12,000 661.4 312.2Hanácké Železárny a pérovny hot-formed steel springs Czech 500 12,000 661.4 312.2Draka Kabely cables foreign 320 11,000 606.2 286.2Magneton Kroměříž starters Czech 1,200 11,000 606.2 286.2Almet Hradec Králové pistons Czech 120 10,860 598.5 282.5PAL Praha small electric engines joint venture 1,000 10,000c 556.6 267.2Fezko Strakonice seat covers foreign 700 9,000 496.0 234.1Gumotex Břeclav polyurethane foam Czech 1,600 8,000 440.9 208.1

componentsHLF, Hajnice plant switches Czech 110 6,500 358.2 169.1

Notes: a Summer 2001. b Overall average wage including administrative workers, manual wage was lower. c January 2001. Thefigures above are approximate based upon the interviewees’ accounts. Exchange rate is based upon the average exchange ratepublished by the Czech National Bank for a month in which a particular interview was conducted.Source: Author’s interviews with CEOs in the above companies in 2000 and 2001.

benefits of lower labour costs. Seventy percent ofcomponents production is exported and the value ofexports reached $3.6b in 2000 (CzechInvest,2001a). The geographical proximity of the CzechRepublic to Germany allows some Czechcomponent suppliers to supply German carassemblers in the just-in-time (JIT) system. Forexample, Hayes Lemmerz’s subsidiary located inMladá Boleslav is JIT and in-sequence supplyingassembled wheels and tyres to the VW assemblyplant in Dresden, Germany.16

In those cases where the major concern of theforeign investor is to protect or improve itscompetitive position in the markets outside theCzech Republic through more cost-effective verticalintegration, the cost of production has been thedecisive location factor. In such a situation, theproduction can move to cheaper locations abroadwhen wages and overall production cost increase asthe above mentioned examples from the CzechRepublic and Hungary document. Indeed,attachments of some component suppliers tospecific locations seem to be rather tenuous. Forinstance, the new Hayes Lemmerz assembly plantlaunched in Mladá Boleslav in August 1999 tosupply wheels to Škoda was built according to thespecifications of Hayes Lemmerz but the companydoes not own it. It only owns the machinery andinterior equipment. The director argued that therewere two reasons for this situation. First, thebuilding as such is not part of the core business ofthe company so it does not need to own it. Secondand more important, in his words ‘we could bereplaced anytime as we replaced the previoussuppliers. It is possible to take away the machinerybut impossible to move the building’.17 This casesuggests that some component suppliers areemploying various strategies to minimize their sunkcosts (Clark, 1994) in order to increase their overallflexibility.

Local and regional economic effects

Empirical research focusing on FDI spillover effectsto the domestic economy in the Czech Republic andCE as a whole has so far found them to be weak andstatistically insignificant. For example, Jarolím(2000) found FDI spillover effects to be statistically

insignificant in the Czech Republic, rejecting hishypothesis that foreign presence was positivelyaffecting the productivity growth of domesticallyowned firms. Similarly, Djankov and Hoekman(2000) found a statistically insignificant spillovereffect of FIEs on domestic industrial firms between1992 and 1996. This means that even if FDIpositively affected the performance of FIEs, thesepositive effects did not spill over to the domesticindustry. The authors explain the lack of spillovereffects by a short study-period, and suggest thatknow-how spillovers require a certain minimal levelof technological capacity and effort on the part ofdomestic firms to be absorbed. Kinoshita (2001) alsofound spillovers from FIEs to be insignificant forCzech manufacturing firms. The empirical researchin other CEE countries yielded similar results.Konings (2000), for example, found no evidence ofpositive spillover effects of FDI to domestic firms inBulgaria, Romania and Poland. He found negativespillover effects in Bulgaria and Romania, whilethere were no spillovers to domestic firms in Poland.Similarly, the empirical studies from less developedcountries such as Morocco (Haddad and Harrison,1993) and Venezuela (Aitken and Harrison, 1999)found either statistically insignificant or negativespillover effects from foreign to domestic companiesin terms of impact of FDI on productivity growthof domestic companies. To say the least, theempirical research does not support the overlyoptimistic views of FDI effects on domesticindustry.

FIEs may have a detrimental effect on localcompanies by attracting their skilled and semi-skilled workers. In the Czech Republic, domesticcompanies and regional politicians have increasinglybeen voicing their concerns about the negativeeffects of FIEs on local companies, complaining thatforeign investors build new factories and enticeworkers away from local companies by offeringhigher wages and better work conditions (Dolejší,2001). For example, the mayor of the southBohemian city of Písek argued that not even a newfactory with 1,000 new jobs is necessarily beneficialfor a region if it headhunts the most skilled workersaway from local companies using governmentalfinancial incentives for foreign investors (Kerles,2001). In southern Bohemia, where theunemployment rate stood at 5 percent in 2001, localand foreign companies have been competing over



skilled workers such as locksmiths, turners,toolmakers and welders, with FIEs being muchmore successful. Local companies complain thatthey are unable to increase their production tosatisfy the existing demand for their productsbecause of the acute shortage of skilled workerscaused by increasing competition from newlyestablished FIEs (Dolejší, 2001). Local companiesare forced to increase wages rapidly to keep up withFIEs, which may force them out of business. Thegovernmental support for the development of smalland medium-size local enterprises is extremelysmall or non-existent compared with the incentivesoffered to foreign investors to create new jobs(Kerles, 2001). FIEs can afford to pay higher wagesnot only because they are much strongereconomically than local companies, but also becausethey receive up to $5,000 from the Czechgovernment for each newly created job, whichrepresents the average annual wage in the Czechautomotive sector. The situation at the local levelthus calls for a more critical assessment of FDIeffects on local economies in CE and more realisticexpectations as to its contribution to regionaleconomic development.

FDI effects on domestic research anddevelopment

Large TNCs started to locate sizeable R&Doperations abroad and established significant globalR&D networks only in the mid-1970s (Howard,1990a: 277). The globalization of R&D advancedconsiderably in the 1990s (Dalton and Serapio,1999). The degree of centralization anddecentralization of R&D within the corporatehierarchy is typically related to the type of researchconducted. While basic research as a strategicfunction tends to be localized close to the companyheadquarters, applied research tends to bedecentralized to the individual product divisions.The highest degree of decentralization is typicallyrelated to development work which is conducted atthe plant-level. Such corporate R&D hierarchy inlarge corporations is in turn expressed in a spatialhierarchy of R&D in which basic research, and to alesser extent applied research, tends to be spatiallyconcentrated in core metropolitan regions.

Development activity is more geographicallydispersed, even though it also tends to favour morecentral regions. For TNCs, this typically means thatthe most important R&D centres are located inhome countries where the leading-edge R&D onTNCs’ core technologies is conducted, while R&Doperations abroad involve smaller-scale appliedresearch and development activities (Howard,1990b: 135–8; Dalton and Serapio, 1999: 7–9).Consequently, the vast majority of R&Dexpenditures by TNCs are realized in homecountries and the location of R&D facilities abroadhas been almost exclusively the core phenomenon.18

FDI generally, and export-oriented FDIparticularly, tends to vertically integrate domesticproducers into large TNCs in which basic R&D istypically concentrated in the TNC’s home countryin the developed world (Howard, 1990b; Grabher,1994; 1997; Gowan, 1995; Pavlínek, 1998; Pavlínekand Smith, 1998).19

Two groups of reasons for R&D investmentsabroad by TNCs can be identified: demand-drivenand supply-oriented (Howard, 1990a: 277; 1990c:496–7; Dalton and Serapio, 1999: 38). The demandreasons include the TNCs’ needs to customize anddevelop their products for foreign markets and tosupport their manufacturing, sales, or serviceactivities in host countries in order to gain andmaintain market power. The supply-orientedreasons involve the need to tap pools of foreignR&D labour and expertise and to develop newproducts that could be sold globally based on theideas and innovations generated in foreignsubsidiaries. Two general scenarios of FDI effectson R&D in host regions are recognized in theliterature. The first possibility is the transfer ofR&D by TNCs from host country’s FIEs to theirhome countries. The second scenario leads to anupgrading of host country’s R&D through thelocation of home-base-augmenting laboratories inhost regions to exploit specialized local expertise(Dunning, 1992; Hotz-Hart, 2000).

In the context of CE generally and the CzechRepublic specifically, it has been argued that FDIcan undermine the abilities of recipient countries todevelop their own domestic industrial innovationand R&D sector, and therefore diminish their abilityto produce more value-added goods and services(e.g. Jindra, 1996).20 According to this view, FDImay lead to a reduction in domestic technological



capacity as uncompetitive local companies sharplyreduce their R&D expenditures (see also Young etal., 1994). At the same time, many foreign TNCsmay transfer the existing R&D to their R&D centreslocated abroad after their takeover of domesticcompanies. Empirical analysis of the determinantsof the R&D expenditures of 241 Czech and 186Hungarian firms in chemical and mechanicalengineering industries concluded that foreignownership ‘adversely affects the chances ofinvestment in R&D’ (Urem, 1999: 179).

In the case of Hungary, for example, R&Dexpenditures declined from 2.3 percent of GDP in1988 to 0.6 percent in 1997 (Kapoor and Eddy,1998). Similar declines in R&D spending wererecorded in Poland, Slovakia and the CzechRepublic, which spent only 0.7 percent, 1.0 percentand 1.2 percent of their GDP on R&D respectivelyin 1995. Declines in absolute terms were even largerbecause of sharp drops in GDP in the early 1990s(Knell and Hanzl, 1999; Radosevic and Auriol,1999). Between 1989 and 1995, R&D expendituresdeclined by 80 percent in Slovakia, 67 percent inHungary, 64 percent in the Czech Republic and 35percent in Poland (Gokhberg, 1999). It is not clear,however, to what extent R&D expenditures havedeclined due to collapsed governmental demand,economic difficulties of domestic firms, or changedmethodology to assess R&D.21 It is also unclearwhether TNCs’ transfer of R&D abroad, if any,played a role in this decline in the 1990s.

According to the survey conducted byCzechInvest in 1998, 22 percent of foreign investorsin manufacturing conduct ‘significant’ R&D in theirCzech subsidiaries and 53 percent conduct productdevelopment work on exported goods. The OECDreported that 33 percent of Czech corporate R&Dexpenditures were made in the automotive sectorand 63 percent of overall R&D expenditures werefinanced by industry compared to 43 percent inHungary and 31 percent in Poland (CzechInvest,2001b). According to the Czech AutomotiveAssociation, 65 percent of companies in the Czechautomotive industry conduct R&D, and on averagethe companies spend 4 percent of their annualturnover on R&D.22

Interviews with 20 Czech component suppliersand Škoda Auto conducted in 2000 and 2001revealed three major R&D location strategiespursued by foreign investors in the Czechautomotive sector in the 1990s (Table 7). All threestrategies are seeking cost-effective R&D and two ofthem are related to the different spatial structures ofTNCs and the position of Czech subsidiaries in thecorporate hierarchy (Massey, 1995).

Transfer of R&D abroad (global strategy) The firststrategy is linked to the part-process spatial modelof TNCs in which Czech component suppliers arepredominantly assembly operations verticallyintegrated into Western TNCs with no or extremelylimited R&D functions. The existing R&D,



Table 7 R&D location strategies by TNCs in the Czech automotive industry

Global strategy Multi-local strategy Supply-oriented strategy

TNC’s spatial structure part-process conglomerate varies

Type of production assembly of standardized assembly of specialized varies, not necessarily linked to products at different locations products at different locations production

R&D location R&D concentrated outside CE R&D decentralized to Routine R&D decentralized to factories, local R&D for CE, higher R&D centralized globally marketed products outside CE

Reasons R&D quality, efficiency specialized local expertise cost-cutting, highly skilled andinexpensive R&D labour,product customization for thelocal market

Examples Barum Continental Draka PAL Praha, Temac Zvěřínek Škoda-Auto, Lucas Autobrzdy, Kabely, Hayes Lemmerz, Bosch, DaimlerChrysler, Avon Rubber Rockwell Automation, Siemens

including selected experienced and talented Czechengineers and designers, tends to be transferredfrom Czech suppliers to the specialized R&D centres,typically located in the TNC’s home country. TNCspreferring such a concentration of R&D aretypically those specialized in the production of alimited number of automotive components ormodules and servicing car assemblers in variousmarkets worldwide (so called ‘global sourcing’).This is a cost-efficient approach that assures a high-quality R&D and avoids overlapping R&D indifferent subsidiaries of the same TNC.

The elite group of first-tier multinationalautomotive component suppliers that emerged inthe past 10–15 years built specialized R&D centreswhere they have concentrated R&D for theirworldwide operations. These R&D centres aretypically concentrated in the core areas ofautomobile production of the United States,Western Europe and Japan (Bordenave and Lung,1996). In the Czech context, it usually means thatthere is no or very limited development of newproducts in foreign branch plants and the existingR&D (basic R&D in particular) has been transferredto specialized R&D centres after the acquisition ofCzech suppliers. For instance, Barum Otrokoviceused to develop its new products in-house and itsbasic R&D used to be done at the nearby researchinstitute. After its acquisition by Continental, allproduct development including testing of productswas transferred to Continental’s central R&Dfacility. Several of Barum’s researchers work in thecentre. Barum has kept a construction office, andabout 35–40 workers are engaged in tasks associatedwith applied product development.23 Similarly,R&D was centralized after Federal Mogul mergedwith T&N and the existing R&D was largelytransferred from its Kostelec nad Orlicí subsidiaryto research centres in Germany, France and theUnited Kingdom. In 2000, 18 workers were engagedin the product development, some of them workingon projects not related to on-site production.24

Draka Kabely, a greenfield factory built to produceindustrial cables and cable harnesses, has no R&D.R&D is conducted at Draka’s factories in theNetherlands and Germany.25 Avon Rubber has anR&D centre in Westbury (Wiltshire, UK) and,subsequently, its Czech subsidiary Avon Automotivea.s. Rudník has retained only limited R&Dfunctions, such as cooperation with its suppliers’

designers on the shape of supplied components,their pilot production, and durability tests.26 Itremains to be seen what the long-term effects ofsuch R&D transfers abroad will be in terms ofinnovation and research capacities and the overalleconomic development of the Czech Republic(Jindra, 1996). The transfer of strategic functionssuch as R&D, decision-making powers, globalmarketing and management functions to parentWestern companies not only increases thedependency of local component suppliers onWestern companies, but it also makes them morevulnerable at times of economic difficulty.

Local R&D promotion based on specialized expertise(multi-local strategy) The second strategy is relatedto the conglomerate model of TNCs in which theproduction of different commodities is under thesame financial control. In such a case, a TNC tendsto leave the R&D functions in its specializedsubsidiaries that concentrate on the production ofone class of automotive components exportedworldwide. The pressure to concentrate R&D fromvarious companies producing different products toone site is lower than in the case of several branchplants producing the same component in differentlocations (markets). The individual subsidiaries thatpossess specialized expertise within a particularTNC and produce a unique product are likely to beresponsible for product development. Thisapproach then stresses the development of R&Dfunctions along with the production function insubsidiaries. In such a scenario there are no attemptsto transfer the existing R&D abroad, and somecompanies have experienced growth in R&Dconducted in the Czech Republic after foreignacquisition.

In the case of Temac Zvěřínek, owned by theRoyal Econosto N.V., the Dutch owner did not limitthe existing R&D and there were no attempts totransfer it abroad. One reason is that the EconostoGroup specializes in the production of industrialsealing products, while Temac also produces theautomobile gaskets in which the Econosto Grouphas no expertise. However, the existing R&D wasand is very small and its automotive section has onlyfour workers.27 In the case of PAL Praha, thecompany was already spending 7 percent of itsturnover on R&D in the early 1990s, long before itsJV agreement with the Canadian firm Magna. After



the JV was formed, PAL Praha built a new R&Dcentre which was planned before the JV formationand was finished in December 2000. The centreincludes the development of new products, aprototype workshop, laboratories, testing rooms anda measurement centre. It employs 70 workers, whichis more than its R&D employment before 1989.PAL Praha is fully responsible for R&D of itsproducts. There is no transfer of R&D results fromMagna to PAL because Magna has no expertise inthe production of small electric engines (the corebusiness of PAL).28

Local R&D promotion based on skilled and inexpensiveR&D labour (supply-oriented strategy) Finally, thethird approach minimizes the cost of R&D forTNCs by developing R&D in the Czech Republic,capitalizing on its highly educated and experienceddesigners and engineers who are much cheaper thancomparatively skilled and educated workers in theWest. This approach depends on the existence of ahighly skilled workforce fully compatible with itsWestern counterparts and is not necessarily relatedto the production function.

This is the case for Lucas Autobrzdy, one of twoLucas European braking systems subsidiaries, whereR&D is conducted despite the initial efforts toconcentrate all R&D in the other R&D site inGermany. R&D is more important at LucasAutobrzdy today than before its foreign acquisitiondespite the approximately same number of workersemployed in R&D compared to the early 1990s.R&D at Lucas Autobrzdy was integrated intoLucas’s worldwide R&D operations. About 90percent of new products developed at LucasAutobrzdy are not produced on-site but aredeveloped for other Lucas factories. Recently, therehave been efforts to further expand local R&Dbecause ‘a highly skilled and experienced engineercosts much less [in the Czech Republic] thanabroad’.29

Škoda Auto used to employ 600 workers in itsR&D centre before the acquisition by VW. In 2000,the company employed 1,229 workers in R&D(Škoda Auto, 2001). Between 1998 and 1999, Škodabuilt a new designer centre in its R&D complex forKč200m (about $5.5m) for 160 ‘top-classconstructors and designers’ (Škoda Mobil, 1998: 1).This particular R&D expansion will save Škoda$12m annually for external services (Němec, 1997).

Although after the acquisition of Škoda by VW itwas originally assumed that R&D would betransferred to Germany, the quality and experienceof Škoda’s engineers, combined with their low costcompared to German ones, have not only savedR&D at Škoda but led to its substantial expansion.30

Still, higher engineering functions related toplatform development have been transferred toGermany and Škoda’s R&D has focused on theadjustment of VW Group’s platforms to use Czech-sourced components. At the same time, someroutine R&D functions (such as CAD operations)have been moved from Germany to Mladá Boleslavto exploit the benefits of low-cost labour(CzechInvest, 1997).31

Similar developments could be seen across CE.The German-based Audi AG (part of the VWgroup) has recently built a new $13.7m R&D centreat its Hungarian subsidiary Audi Motor HungáriaKft in the city of Györ. The R&D centre wasfinished at the end of 2001 and employs 80Hungarian engineers concentrating on thedevelopment of VW Group engines (T.S. Kiss,2001). Knorr-Bremse, the German manufacturer ofbrake systems for trucks and buses, opened its R&Dcentre in Budapest in 1999 where more than 80engineers conduct R&D on strategic electronicsystems and pneumatic products (ITD, 2001). R&Dexpenditures of FIEs as a percentage of R&Dexpenditures of all enterprises increased from 22.6percent to 78.5 percent between 1994 and 1998 inHungary and from 1.3 percent in 1997 to 6.4percent in 1999 in the Czech Republic (UNCTAD,2002), suggesting increased importance of R&Dconducted by FIEs in CE.

It remains to be seen whether the cases of LucasAutobrzdy, Škoda Auto, PAL Praha, Audi Hungáriaand others signal a new trend of allocating moreR&D responsibilities to CE by TNCs. It seemshighly unlikely that any main automotive R&Dcentres will be transferred from the WesternEuropean automobile production core to its CEEperiphery. In fact, the recent restructuring of theEuropean automobile industry tended to reinforcestrategic activities in the core, represented mainly byGermany, at the same time as some productionactivities were decentralized to the Europeanperiphery to take advantage of lower productioncosts. This led to increased domination of theEuropean automobile production core over other



European regions (Bordenave and Lung, 1996). Itseems more likely that only some car manufacturersand component suppliers that have large-scaleproduction in CE will set up R&D subsidiaries inthe region to take advantage of local skills and lowwages to minimize the purchasing of externalservices from Western Europe, thus furtherminimizing the cost of production in CE. It is alsolikely that such R&D centres will concentrate onroutine R&D activities while the core R&Dfunctions will remain concentrated in WesternEurope, the United States and Japan.

The situation in the Czech automotive industrythus suggests that FDI effects on domestic R&Ddepend on particular cost-cutting strategies pursuedby different types of TNCs. In other words, in somecases TNCs prefer cost-effective concentration ofR&D in the developed countries, while in othercases the development of particular R&D functionsin the Czech Republic and CE as a whole could be acheaper alternative to R&D concentration in high-wage countries. It remains to be seen which of thesecontrasting approaches will become more importantand what its effects will be on the Czech R&Dsector.

Conclusion

This paper has sought to provide an overview ofregional economic effects of FDI in CE. AlthoughFDI inflows to CEE as a whole increaseddramatically in the 1990s, they remained very lowcompared to Western Europe and within global FDIflows. While FDI has played an increasinglyimportant role in the region, its effects have so farbeen very uneven both sectorally and geographically.The Czech Republic, Hungary, Poland and Slovakiareceived almost two-thirds of total FDI inflows toCEE. Compared to the rest of the region, thesecountries benefited from their favourable relativelocation with respect to Western Europe, higherlevels of socio-economic development, higher speedof economic transformation, skilled and inexpensivelabour, relative political stability, and the prospect ofearly EU membership. In addition to market captureinvestments, which dominated FDI inflows in thefirst half of the 1990s, these countries became afavourable location of cross-border export-oriented

investments by Western TNCs in the second half ofthe 1990s. Within these four countries, FDI remainshighly concentrated in capital cities and othermetropolitan areas. Those industrial sectors targetedby Western investors, such as the passenger carindustry, underwent profound transformations andwere integrated into the periphery of WesternEuropean production systems.

However, the evidence so far from CE does notsupport overly optimistic views of FDI and its roleduring the post-communist economictransformations in the region. In the rush for FDIas a quick and efficient fix of CE economies, it hasoften been overlooked that FDI potentially has bothpositive and negative effects on regional economicdevelopment, depending on the type of economicactivities and strategies pursued by particular TNCsin different local and regional conditions. Let us notforget that the investment by foreign TNCs isdriven by their profit-seeking strategies that do notnecessarily coincide with the long-term economicwell-being of host regions and localities. The long-term economic effects of FDI in CE are uncertain atthe moment, and it remains to be seen whetherpositive FDI effects will outweigh potentiallynegative impacts. This paper identified severalpotentially negative effects of FDI on local andregional economic development. The CE economiesincreasingly dependent on FDI, which isspecifically looking for low-cost locations, arebecoming more vulnerable to plant closures if localcurrencies appreciate rapidly or local wages increasesubstantially. Economic vulnerability iscompounded by the fact that countries such as theCzech Republic and Slovakia have becomeeconomically quite dependent on the fortunes andmisfortunes of a single TNC (Volkswagen).32 Thistype of economic vulnerability has recentlymaterialized in Poland after South Korean Daewoocollapsed and Italian Fiat experienced seriouseconomic difficulties at home resulting in plantclosures, lay-offs and rapidly declining passengercar production. Weak local and regional economiclinkages of many foreign-owned enterprises not onlymean that their overall regional economic impactand spillovers are limited, but they also make itrelatively easy to move such production to lower-cost locations, should the need arise. As such,foreign-owned enterprises are not necessarily verystable elements of local and regional economies.



Additionally, FIEs generously supported bygovernmental incentives can negatively affect localcompanies by headhunting their best workers.

The short case-study of FDI effects on domesticR&D in the Czech passenger car industry hasrevealed that the fears of potential large-scaletransfers of industrial R&D abroad by TNCs maybe exaggerated. Foreign TNCs pursue three distinctR&D strategies in the Czech passenger car industryrelated to the globalization of R&D. The transfer ofindustrial R&D abroad is likely in what I called the‘global R&D strategy’; this is linked to the part-process spatial model of TNC and global sourcingstrategies in which foreign subsidiaries produce alimited number of standardized automotivecomponents in different markets. The conglomeratemodel of TNC is related to the multi-localindustrial R&D strategy; in this, local R&D, basedupon specialized expertise within a TNC, ismaintained and further developed to serve theTNC’s needs in a particular class of products. Thethird industrial R&D strategy is linked neither to aparticular spatial structure of TNCs nor to aparticular type of production but is rather supply-oriented. In this strategy, foreign-owned R&Dfacilities are attracted to the Czech Republic forcost-cutting reasons to tap into skilled andinexpensive R&D personnel. These facilitiestypically concentrate on routine applied anddevelopment types of research while basic researchremains concentrated in the core areas of globalpassenger car production.

There is no doubt that the importance of FDIand TNCs in the economies of CE will increase inthe future. A sober assessment of FDI’scontribution to economic development in the lessdeveloped regions such as CE, and realisticexpectations about its overall economic and regionaleffects combined with well-defined governmentalpolicies towards FDI, can become an importantcomponent of forward-looking and successfuleconomic development policies in CE.

Acknowledgements

Support for field work was provided by two grantsfrom the University Committee on Research at theUniversity of Nebraska at Omaha. The author also

wishes to thank Adrian Smith and anonymousreferees for their helpful comments on earlierversions of this paper.

Notes

1 In this paper, CEE denotes the former state socialistcountries of Central and Eastern Europe includingRussia and the European part of the former Soviet Union(FSU).

2 See, for example, Dunning (1993b) and Young et al.(1994) for different types of FDI.

3 Estimates of average annual investment ‘needs’ in CEE inthe 1990s ranged between $103b and $260b (EBRD,1993: 83). Colins and Rodrik (1991, cited in EBRD, 1993)estimated that CEE (excluding the FSU) would require$421b annually for 10 years to achieve the averageWestern levels of labour productivity and $344b to reachannual growth rates of 7%.

4 Prague together with the top nine FDI-recipient districts(out of 76 districts) received 71% of all FDI, while thebottom 43 districts received only 10% by the end of1999.

5 Košice benefited from the purchase of its steelworks byUS Steel in 2000. The purchase price was $500m and USSteel promised to invest an additional $700m over a 10-year period (The Economist, 2001a).

6 According to the Hungarian Central Statistical Office,Budapest and Pest county accounted for 64% of FDIstock in 1998 (OECD, 2000). This high figureexaggerates the position of Budapest because it is basedupon the location of company headquarters rather thanactual production units. Many foreign companiesmaintain their headquarters in Budapest while actuallyproducing elsewhere in Hungary (Hamar, 1999; Fazekas,2000; OECD, 2000). The figures of FDI stock andemployment concentrated in Budapest reported byFazekas (2000) are based upon the National LabourCentre’s Wage Tariff Survey that provides a moreaccurate measurement of FDI distribution in Hungary.Based on these data, Budapest accounted for 48.8% ofindustrial FDI stock and 40.5% of FIE employment in1998.

7 The corresponding numbers are 78.1% of FDI stock and72.1% of FIE employment in 1998 using the NationalLabour Centre’s Wage Tariff Survey (calculated fromFazekas, 2000).

8 In 1998, the eastern half of Hungary still accounted foronly 15% of annual FDI inflows. By 2001, its shareincreased to 30–40%. However, the East has attractedFDI looking for a less skilled and lower-paid labour forcecompared to the North West (Serenyi, 2001a).



9 In the Czech Republic, the 10 largest investmentsaccounted for 28% of FDI stock in 2000 (CNB, 2001).

10 However, the tight vertical integration is not cost-effective in cases of resource-oriented investments wherethe production depends on local resources, such asagricultural products for the food industry, constructionmaterials and natural resources for a number ofindustries such as furniture, paper, wood and glass (seePavlínek and Smith, 1998; Domański, 1999).

11 VW Slovakia is a good example of such an investment inthe car industry. Out of 1,200 of its suppliers only twowere Slovak suppliers supplying the Bratislava plantdirectly in 2000 (Weidokal and Stagles, 2001). Almost allcars assembled by VW Slovakia are exported (98.6% in1999 and 100% in 2000) (AIA SR, 2001).

12 Wages for low-skilled factory workers are about $2 anhour in Hungary and the Czech Republic.

13 These included Rubena Hradec Králové, GumotexBřeclav, Tanex Plasty Jaroměř and Karsit Jaroměř.

14 Other forms of cooperation with foreign partners exist.For example, CIEB Kahovec has a licensing agreementwith a German partner to produce car seats.

15 As of 2001, automotive-industry projects accounted for28% of all projects receiving investment incentives, thehighest share among different industries (CzechInvest,2001a).

16 Interview with Radovan Podskalský, Managing Directorof Hayes Lemmerz, Mladá Boleslav, 12 July 2000.

17 See Note 16.18 For example, US companies spent nearly 90% of R&D

expenditures in the United States in 1997. Out of 186US R&D facilities abroad, 164 were located in thedeveloped countries. Most of the US R&D expendituresabroad are concentrated in five core countries: Germany,the United Kingdom, Canada, France and Japan,followed by Italy, the Netherlands, Brazil, Sweden andAustralia. There was only one US R&D facility locatedin CEE: Honeywell’s Technical Centre in Prague, CzechRepublic. The largest R&D expenditures by foreign-owned businesses in the US come from Switzerland,Germany, the United Kingdom and Japan, followed byFrance, Canada, the Netherlands and Sweden (Daltonand Serapio, 1999: 9, 17, 35, 39, 83).

19 One survey of 621 FIEs conducted in the CzechRepublic found that 21% of surveyed firms conducted‘significant R&D inside their Czech companies’ and 56%of firms did some R&D or product development in theCzech Republic (Pomery, 1997). The results must beinterpreted with caution, however, because the responserate of the survey was only 26% (163 companies).

20 Interview with Tomáš Jindra, general director of PALPraha, Prague, 14 February 2001.

21 The 1988 data were based on a UNESCO methodologywhich tended to overstate the R&D expenditurescompared to the current OECD methodology.

22 Interview with Zdeněk Novák, Czech AutomotiveIndustry Association, Prague, 10 July 2000.

23 Interview with Pavel Pravec, Executive Board Chairmanand Plant Manager of Barum Otrokovice, Otrokovice, 26July 2000.

24 Interview with Pavel Dusil, general director of Federal-Mogul Friction Products a.s., Kostelec nad Orlicí, 17 July2000.

25 Interview with Stanislav Tvarůžek, executive director ofDraka Kabely and former director of Kablo VelkéMeziříčí, Velké Meziříčí, 27 July 2000.

26 Interview with Prokop Kirchhof, former director andexecutive board member, and Martin Vávra, AvonAutomotive a.s., Rudník, 10 August 2001.

27 Interview with Petr Nádvorník, general director ofTemac a.s. Zvěřínek, 19 July 2000.

28 Interview with Tomáš Jindra, general director of PALPraha, 14 February 2001.

29 Interview with Ervin Appelfeld, general director of LucasAutobrzdy, s.r.o., Jablonec nad Nisou, 8 February 2001.

30 Interview with Václav Říčář, Public Relations Manager,Škoda Auto, 14 June 1999.

31 Other examples of automotive TNCs conductingsubstantial R&D in the Czech Republic include Bosch,with 146 employees involved in R&D on fuel injectionsystems in České Budějovice and Jihlava. DaimlerChryslerestablished a design subsidiary for automotivecomponents in Prague in 1996. The subsidiary, whichemployed 50 Czech designers in 2001, designs specialparts for new cars and trucks, and componentadaptations for the main design centre located inStuttgart, Germany. Edscha transferred the design ofhinge systems from Germany to Kamenice. Visteon isconducting R&D for lighting systems in its Autopalsubsidiary in Nový Jičín. Additional foreign componentsuppliers that established R&D/design centres in theCzech Republic include Rockwell Automation andSiemens (CzechInvest, 2001a; 2001c; 2001d).

32 VW Slovakia-dominated car industry of Slovakiaaccounted for 19% of Slovakia’s GDP in 1999. VWSlovakia accounts for 16% of total Slovak exports. In thecase of the Czech Republic, 14% of Czech exports areattributable to VW-Škoda and its suppliers and some 4%of the Czech workforce are employed directly orindirectly by VW-Škoda (Klimentová, 2000; TheEconomist, 2001b: 60).

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Correspondence to:

Petr Pavlínek, Department of Geography andGeology, University of Nebraska at Omaha, Omaha, NE 68182-0199, USA. [email:[email protected]]



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