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The analysis in this chapter complements the analysis in the previous one: the technological-embeddedness issue introduced in the previous chapter on the determinants of sourcing knowledge and technology from the host innovation system is not uni-directional: embeddedness can also involve the flow of knowledge and technology from the foreign affiliate to other actors in the host innovation system. This is within the most widely researched area of the developmental role of FDI and is best known as spillover literature.

Whereas the previous chapter was concerned with motives and matches between expectations and reality by foreign investments in CEECs as a condition of technology transfer and spillovers, Chapters 4 to 6 separately analyse the conditions for internal (Chapter 4) and external (Chapters 5 and 6) technology transfer and spillovers. Amongst the most widely discussed determinants of the technological role of FDI for host economies is internal, direct technology transfer within the network of the foreign investor (including the intentional contracted, and the unintentional, not accounted for in contracts, that is spillovers).

Having treated spillovers as a positive condition for the technology-accelerating role of inward manufacturing FDI, and having analysed conditions at the firm level, this chapter now approaches the issue of conditions of technology transfer from a different, complementary perspective: now, the ownership advantage aspect a la Dunning of technology and knowledge owned by the foreign investor moves into the limelight. Knowledge and technology constitute firm-specific (ownership) advantages that are increasingly important as a competitive factor between firms in the industrialised world. Knowledge, however, has the particular characteristic that it may be applied by several users at the same time without diminishing its content, possibly even the converse (think, for example, of the accumulative character of an idea). Whilst there is no technical exclusivity for the use of knowledge, the commercial value of knowledge can very well be held to be exclusive: a firm has a competitive advantage over rival firms if it uses a particular piece of knowledge or technology that it exclusively owns and competitors therefore do not have, or cannot, are not allowed to apply1

The analysis in this chapter focuses on the two central aspects of inward FDI: strategic investment motives and locational factors. Their relative importance over host countries in CEE, regions of origin, year of engagement etc. is described to present a more realistic picture of the dominant investment motives prevailing in CEECs. Next, investment motives are compared to locational advantages to test the extent of correspondence at the firm level between what the motives imply in terms of locational factors and the motive itself. This is derived from theory of international production (e.g. Cantwell and Iammarino, 1998, 2003) and the international management literature (e.g. von Zedtwitz and Gassman, 2002; Andersson et al., 2002) that shows that the strategy followed by a foreign investor depends not only on internal considerations but also on the endowment of the host economy or region with locational factors.

Traditionally, research on FDI analyses bilateral country-level aggregate data on FDI flows (in much the same way as in the introduction). However, the empirical analysis of the technological role of FDI for economic development in host countries (technology transfer and spillover effects) usually uses the method of production function analysis, based on aggregate industry-level data on FDI stocks combined with estimates of inter-sectoral linkages derived from national-level input- output tables. Some production function analyses rely on firm-specific data using official databases or field work. The traditional method of analysis does not take firm heterogeneity into account, and hence remains unable to explain large fractions of the variance in resulting technological roles between the various FDI projects that exist in host countries. The latter is, however, typically restricted in its comparative strength, because the methodology behind the firm-specific databases varies between the different countries where such data is available. Moreover, official statistics seldom contain information about the most important determinants of the research issues at hand (determinants of the technological role), because they are typically not easily measured in hard facts, but rather involve subjective valuations of managers of firms to be considered in the analysis.

Before economies that are catching up in terms of technological development can feed the process of technical advance from their own indigenous resources, they will typically depend on the supply of technology from abroad, that is technological diffusion and imitation. FDI is the most important driver of supply of external technology. This is generally assumed for the newly industrialised countries in Asia and other emerging markets, and has also proven to be the case amongst some of the West European countries in their own processes of catching up (see for example Jungmittag, 2005). There is, however, a controversy about whether FDI has in fact had a benign effect for economic development or not. Even if the literature does on average agree that FDI has positively contributed to technological advance and economic growth (for comprehensive overviews see for example Moran et al., 2005; Rugman and Doh, 2008), many important qualifications can be found in the literature that are convincing and appear to be empirically robust. The final word on the developmental role of TNCs is hence not out yet, and may never be due to issues like heterogeneity and context-specificity.

Potential technological effects via inward FDI not only emerge from direct, internal technology transfer. The contribution to technological catch-up development is also expected to emanate from the diffusion of knowledge and technology between the host economy and its foreign affiliates (the ‘external’ part of technology transfer and spillovers). This technology transfer may assume the characteristics of a ‘transfer’ of knowledge and technology (that is, intentional, enshrined in contracts, and not giving rise to externalities) and/or can rather be of a ‘spillover’ type, where this diffusion is unintentional and not regulated in contracts, and hence gives rise to externalities. In line with the conceptualisation of research in this work, this distinction does not play a role in the analysis of this chapter (nor in the following one, Chapter 6). The focus in this chapter is rather on the conditions of positive technological effects from the host innovation system for the foreign affiliates hosted by them. Those conditions are deduced from theoretical (or conceptual) and empirical research, and give rise to a set of hypotheses on what drives the role of the host innovation system for technological activity of the foreign affiliate.1 The empirical analysis presented here tests whether empirical support for those hypotheses can be found in the particular case of CEECs. In terms of theories, the analysis mainly draws from Cantwell’s technology accumulation approach within the body of international business literature, assuming that there is a “complex dynamic interaction of the ownership advantage of groups of firms and the locational advantages of the sites in which they produce” (Cantwell, 1989, p. 207).

During the socialist era, companies in East Germany became much weaker than firms in West Germany in terms of technology and competitiveness. In large part, this may be rooted in the different incentive structures of the two systems: whereas in the West, the criterion for companies’ success was their ability to remain in business and generate income in a contestable market environment, firms in the East were required to fulfil a plan to which they were subjected without having their opinions considered.

The second empirical analysis is based on a fieldwork project conducted between 2002 and 2003, which generated a large and unique database on 438 foreign subsidiaries in a selection of CEECs, namely the Czech Republic, Estonia, Hungary, Poland, Slovakia and Slovenia. The field work was done between 2002 and 2003 by the use of a concise, two-page questionnaire, sent out to the largest foreign investment subsidiaries in the countries named. The questionnaire is presented in the Appendix to this book (pp. 160–4).

This introductory chapter to Part II of the book presents a comparative overview of economic development, and the changing conditions for and results of FDI as a mechanism of productivity growth in Estonia, Hungary, Poland, the Slovakia-Republic, Slovenia. By summarising briefly the main similarities and differences between these countries (with a particular focus on Hungary), we try to determine whether differences by countries depend on their different stages in FDI attractiveness, labour productivity,1 economic development levels and restructuring by technology intensity.

On 18 May 1990, the government of the FRG published the ‘Vertrag uber die Schaffung einer Wahrungs-, Wirtschafts- und Sozialunion zwischen der Bundesrepublik Deutschland und der Deutschen Demokratischen Republik’ (unification Treaty) which outlined the conditions of German Monetary Union in general and in particular the rates of conversion between the DM and GDR-mark. As of 1 July 1990, the legal tender of the GDR (the GDR-mark) ceased to exist and was substituted by the West German currency, the DM.

In all PSEs facing the tasks of profound economic restructuring and catch-up development, the establishment of a functioning financial sector is of central importance for the emergence of a stable monetary constitution: unless the financial sector is able to offer credibility despite its inherent instabilities, and unless the institutions this sector is comprised of can fulfil their functions in the new system of economic control and governance, the most immediate obstacles to economic development cannot be removed.

In order to be able to give account of the relevance of the shifts in the regional structure of Hungary’s foreign trade with respect to its perspectives on economic growth (export-oriented development), the following section will outline the most important features of Hungary’s foreign trade during the CMEA era and describe in what direction it developed during the years of transformation. Regional co-operation in the form of a payments union (PU) and a free trade area is seen as a chance for economic growth and development. The concept of a ‘two-tier’ integration is the result of these advantages of regional cooperation and the concept of ‘outward orientation’. This chapter closes with an analysis of the effects of capital imports on catch-up development to conclude that, for Hungary, export surpluses, currency undervaluation and monetary stabilisation form the trinity of a successful process of catch-up development.

The analysis of Hungary’s ‘twin deficit problem’ (Erdos 1995) in 1993–94 serves in this book to highlight the effects of a violation of the monetary condition of catch-up development for a small and open transitional economy (economic policies which are conducive to the fulfilment of this overriding condition were illustrated in Figure 7.6). In light of the results drawn from the analysis into the constraints and pportunities of monetary stabilisation and integration with respect to economic development, it was not surprising (and indeed was inevitable) that the Hungarian policies of public expenditure well in excess of tax revenues (deficit spending), administered capital imports (rooted in the adherence to the ‘two-gap’ approach) and premature integration (effecting import substitution) gave rise to a severe destabilisation of Hungary’s monetary constitution.

Hungary prides itself on being one of the ‘hottest’ candidates for EU membership in the next round of EU enlargement. It bases this on the fact that, amongst all post-socialist economies, the Visegrad-four have proceeded comparatively further in systemic transformation and economic development than other post-socialist economies. Moreover, in 1992/93, Hungary, together with Poland and the then CSFR, had signed ‘Europa Agreements’, which can be interpreted as a preliminary step to accession agreements. In fact, Hungary is the country which started as the earliest with systemic reforms in some form of a ‘third way’. This can be highlighted not least by the introduction of a two-tier banking system already in 1987, which envisaged, but failed to achieve at this early stage, the hardening of Hungary’s ‘soft budget constraint’ (Kornai, 1986).

German unification commonly raised expectations of a relatively ‘easier’ process of transformation and catch-up in the new Bundeslander in comparison to other PSEs: with monetary stability being guaranteed by the Bundesbank, coherent institutions set up and functioning right from the start, unrestricted access to Western markets and, not least, immense financial aid from West Germany and the EU, the conditions for a rapid convergence to Western levels of economic welfare appeared to be very promising indeed. Furthermore, within the former CMEA, the GDR used to rank among the most advanced economies.

German economic integration, in one step, completely removed all barriers to the free movement of products and factors between the economies of East and West Germany. Whilst this granted the economic region of East Germany full membership in the European Single Market with its several regional and structural development funds as well as the Common Agricultural Policy, it also exposed all productive entities in the joining region to unprotected competition from West Germany and to some degree from the world market (West Germany and the European Union, or EU, still retained some protection for part of its domestic economy). This instant and complete exposure to foreign competition was executed before the economy of the new Bundeslander could adjust to the different structure of demand and the new price regime, i.e., the new ‘rules of the game’ and mechanisms in the successor system. Upon integration, the economy of East Germany still had to deal with the removal of its socialist legacies.

Whereas the breaking-up of the monobank into a two-tier banking system was primarily aimed at establishing coherent institutional conditions for financial management and intermediation under a hard budget constraint, subsequent reforms were aimed at gradually exposing the Hungarian economy to (international) competition via integration: price and import liberalisation, as well as the reduction of all kinds of subsidies effected a gradual shift of the economy to the new price regime which was governed by the conditions of supply and demand on the world market. Inflation and exchange rate instability therefore became the most obvious and immediate fields of concern for economic reform policy.

The phrase, a ‘German model’, is adopted in the title although the existence of such a model is highly doubtful. The German economic post-war success story can be understood as a result of economic policy in a peculiar internal and external market constellation, whatever model is stylised (see Holscher 1994). This paper argues that the market constellations faded away, but economic policy remained as if nothing happened at all. The process of changing market constellations began in the early 1970s with the breakdown of the Bretton-Woods system of fixed exchange rates, continued with ‘eurosclerosis’ and stagnation in the 1980s, and found its preliminary last stage in the new constellation of a unified German economy. The obvious signal of the new constellation is the coincidence of a record export performance and mass unemployment, reaching figures comparable to the world economic crises of 1933.