Investing in the East Bloc Is a High-Risk Enterprise
The revolutionary events in Eastern Europe have swept away Communist rule and discredited central planning. But if there is certainty about what has been jettisoned, there is great uncertainty about what will take its place. Accordingly, Western investors interested in the region may find the opportunities less attractive than expected.
While there is a ubiquitous tendency toward the creation of parliamentary democracies with market economies, even a cursory glance around the world indicates that there are many varieties of democracy and market economies. As parties with different political agendas take power in Eastern Europe and market forces shape their political and institutional choices, this diversity promises to grow even more pronounced.
Whatever the final destination, the road to freedom will be rocky. Economically, things will get worse in most countries of the region before they get better. They all confront staggering structural problems.
Huge, outmoded industrial complexes producing petrochemicals, steel, chemicals and heavy machinery must be closed or modernized. New exports are needed to pay for continued imports of Soviet energy and raw materials and expanded imports from the West. The Soviets, facing their own economic crisis, have notified the East Europeans that they are no longer willing to accept low-quality manufactured goods in exchange for oil.
The implications are alarming: If the Soviets deliver on their threat, the East Europeans will find themselves with unsalable manufactured goods and a shortage of hard currency.
The restructuring of the East European economies, regardless of how rationally conceived it might be, will require a massive relocation of labor, with high transitional unemployment, and a staggering infusion of new skills, new technologies and new investment. Debt repayment burdens in Hungary, Bulgaria, Yugoslavia and Poland will make the restructuring task even more difficult, as export earnings are absorbed to repay outstanding debt rather than to finance imports for future growth.
Economies straddled with debt can hardly expect to find Western banks clamoring to finance their restructuring plans. Nor can they expect that their populations, which threw off their shackles as much because of material privation as political dissatisfaction, will voluntarily foot the bill with greater sacrifices. In short, the East European countries cannot afford to “go it alone,” using their own savings to rebuild their economies, nor can they rely on long-term borrowing from the international banking community. Not surprisingly, then, they are looking to direct private investment to help them out of their economic difficulties.
But if the East European desire for direct private investment is understandable, the motivation for such investment on the part of Western businesses is less than clear.
After the exhilaration stirred by the East European revolutions fades, why should Western investors rush into countries whose economic and political futures are highly uncertain and whose short-term economic prognosis is poor? Why not opt for investment in countries such as Spain and Portugal, which offer more certain economic and political conditions? Or, if high risk is the goal, why not find appropriate investment opportunities closer to home? Purchase of junk bonds or loans to Texas Air Corp. Chairman Frank Lorenzo come quickly to mind.
Western investors seem to be attracted to Eastern Europe by several considerations. First, the long-run growth potential of most of the East European economies looks favorable. In general, these are not poor economies, they are poorly managed economies. With better management and incentives, they can expect to achieve per-capita incomes comparable to those in Western Europe. Growth potential is especially good in certain sectors--such as telecommunications and personal and business services--which lagged under the skewed priorities of the Communist regimes.
Second, as a result of depressed wages and dramatic currency depreciations, the East European countries are rapidly becoming attractive locations for low-cost labor. These advantages are reinforced by the proximity of Eastern Europe to West European markets, and by a growing indication that at least some of the East European countries will be granted preferential ties with the European Economic Community. This calculation has been reinforced by the Community’s initiative to form a European Bank for Reconstruction and Development to finance modernization in Eastern Europe, and by substantial commitments of credit and aid from West European governments to Hungary, Poland and Czechoslovakia.
Finally, some Western investors are attracted to Eastern Europe by the old-fashioned prospect of a bargain. Newly elected East European governments, hemmed in by debt repayment and populations anxious for more consumption, and unwilling to sell state assets to managers or officials tainted by their previous communist associations, are eager to sell such assets to Western investors even at fire-sale prices. For bargain hunters and turnaround artists, Eastern Europe offers once-in-a-lifetime opportunities. One might expect them to grab their carpet bags and descend on the region in droves.
However, a would-be investor in Eastern Europe must still decide where to invest. In the high-risk, high-stakes game of investing in uncertain economic and political conditions, which countries are likely to be the best bets over the long run?
East Germany is an obvious candidate. The West German checkbook is open to subsidize the costs of rebuilding the East German economy. The East German labor force is hard working and skilled. With unification, East Germany will automatically become part of the European Economic Community. On the other hand, West German investors have a strong head start over American and other foreign investors. And monetary union between the two Germanys is likely to eliminate the cost advantages of East German locations.
Other investment locations in Eastern Europe also have both advantages and disadvantages. Hungary liberalized restrictions on foreign direct investment and private property earlier and more completely than other countries in the region. Like East Germany, it also offers highly skilled labor at a very competitive price. But Hungary has a huge foreign debt, which may necessitate austerity measures that further slow growth and restrict the outflow of profits to foreign investors.
Like Hungary, Yugoslavia will be burdened by debt repayment obligations into the next century. Another troubling constant in the Yugoslav situation is regional and ethnic conflict, which makes the economic policy agenda uncertain and may threaten the nation’s very existence. On the positive side of the ledger, however, Yugoslavia has a history of more extensive trading ties with the West than most of the other East European countries. It also has the managerial experience that comes with such ties.
Although Czechoslovakia lags behind both Hungary and Yugoslavia in reform experience, it has little debt, a sound macroeconomic condition and longstanding industrial expertise. If the best predictor of the East European future turns out to be the pre-Communist past, then Czechoslovakia figures to be the star performer of the region. But for now, the Czech situation is uncertain; major institutional changes are being improvised by a new and untried leadership.
For the would-be investor in Eastern Europe, there is no sure thing. Political and ethnic uncertainties enter the calculus along with economic uncertainties. Future market potential must be weighed against medium-term economic difficulties.
Investment in Eastern Europe is not for the faint-hearted, not for the inflexible, not for the investor after immediate returns. Thus it would not be surprising to find that, after all the media attention, the flow of private direct investment into Eastern Europe, with the obvious exception of East Germany, turns out to be considerably smaller than what the East Europeans need and the pundits anticipate. If this is so, then Europe, Japan and the United States must find alternative means for mobilizing resources to promote political stability and economic prosperity in Eastern Europe.
