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1 BITZENIS ARISTIDIS, 2003, "The most important barriers underlying limited FDI flows; the case of Bulgaria", Submitted in East Asia Studies Journal The most important barriers underlying limited FDI flows; the case of Bulgaria ARISTIDIS BITZENIS LECTURER AT THE CITY LIBERAL STUDIES, AFFILIATED INSTITUTION OF THE UNIVERSITY OF SHEFFIELD Dr. A. Bitzenis (Words 7800) Abstract (160 Words) Foreign direct investment (FDI) inflows are of crucial importance to the process of transition from a planned to a market economy for the Central and East European (CEE) countries in the global marketplace. This paper explores specific obstacles that foreign investors and foreign multinationals (MNEs) from certain sectors and origin faced during the establishment of their FDI projects in an ex-communist country such as Bulgaria. What is more, the degree to which these barriers have been considered by MNEs is evaluated and special attention is given to the Bulgarian unstable legal framework, corruption, briberies and its bureaucratic procedures. The research data come from the author's questionnaire research, which took place in Bulgaria from the period of mid 1998 until the end of Our questionnaire survey concluded that foreign MNEs looked upon bureaucratic or administrative issues and the regulatory environment together with corruption, political and macroeconomic instability as the most decisive barriers in their decision to undertake FDI projects in a Balkan country. JEL: P2 - Socialist Systems and Transitional Economies, F21 - International Investment; Long-Term Capital Movements, F23 - Multinational Firms; International Business Keywords: Corruption, Bureaucracy, Bulgaria, Unstable Legal Framework, Transition Economies, Foreign Direct Investment, FDI Address correspondence: Aristidis Bitzenis 18 Tavaki Street, Thermi Thessaloniki, GR 57001, Greece Tel. ( ) , fax: ( ) bitzenis@yahoo.com

2 The most important barriers underlying limited FDI flows; the case of Bulgaria Abstract (160 Words) Foreign direct investment (FDI) inflows are of crucial importance to the process of transition from a planned to a market economy for the Central and East European (CEE) countries in the global marketplace. This paper explores specific obstacles that foreign investors and foreign multinationals (MNEs) from certain sectors and origin faced during the establishment of their FDI projects in an ex-communist country such as Bulgaria. What is more, the degree to which these barriers have been considered by MNEs is evaluated and special attention is given to the Bulgarian unstable legal framework, corruption, briberies and its bureaucratic procedures. The research data come from the author's questionnaire research, which took place in Bulgaria from the period of mid 1998 until the end of Our questionnaire survey concluded that foreign MNEs looked upon bureaucratic or administrative issues and the regulatory environment together with corruption, political and macroeconomic instability as the most decisive barriers in their decision to undertake FDI projects in a Balkan country. JEL: P2 - Socialist Systems and Transitional Economies, F21 - International Investment; Long-Term Capital Movements, F23 - Multinational Firms; International Business Keywords: Corruption, Bureaucracy, Bulgaria, Unstable Legal Framework, Transition Economies, Foreign Direct Investment, FDI 1

3 1. Introduction Before we undertake any discussion regarding the determination of foreign direct investment (FDI) for a specific country and examine the important barriers to FDI such as an unstable legal framework, corruption, briberies and bureaucratic procedures, we must outline the difficulties which occurred in the definition of FDI. Moreover, we must consider the legal difficulties of a specific country in defining and viewing FDI flows differently in different time periods. However, we will assist on the conclusions of this paper regarding the determination of the most important barriers responsible for the limited FDI inflows in Bulgaria by presenting significant findings derived from the statistical analysis of our questionnaire survey. These findings are based on primary sources using a significant sample composed of sixty-four MNEs that invested in Bulgaria. In Section 2 we will present the difficulties in defining FDI in general and for the case of Bulgaria. In Section 3 we will consider a literature review regarding the most significant barriers. The latest development of Bulgarian FDI inflows together with the results of our questionnaire survey regarding the determination of barriers for the case of Bulgaria will be presented in Section 4. Finally, in Section 5 we will point out our conclusions. 2.1 Difficulties in defining Foreign Direct Investment Foreign Direct Investment (FDI) came from needs and opportunities present in an imperfect market. There is a lot of literature which analyzes the reasons that encourage firms and entrepreneurs to invests in a foreign country. Ample literature is also available on how to predict the outcome of such an investment and choose the best alternative. Despite the difficulties in defining FDI, there are generally accepted characteristics of FDI that coincide with the following definitions taken from several sources. A definition of Foreign Direct Investment is: FDI is defined in the IMF Balance of Payments Manual (5 th edition) as investment that involves a long-term relationship reflecting a lasting interest of a resident entity in one economy (direct investor) in an entity resident in an economy other than that of the investor. The direct investor s purpose is to exert a significant degree of influence on the management of the enterprise resident in the other economy (1993) [Dunning, 1993, p. 5]. DFI is defined as investment in equity to influence management operations in the partner company [Meyer, 1998, p. 125]. 2

4 The IMF s definition emphasizes a lasting interest, a significant degree of influence of the investor over the company outside the home country [Brewer, 1994, p. 117]. There are many different operational definitions of FDI, but all aim to encompass the desire of a home country firm to obtain and manage an asset in a host country [Barrell et al., 1997, p. 64]. A Direct Foreign Investment is the amount invested by residents of a country in a foreign enterprise over which they have effective control [Ragazzi, 1973, p. 471]. The main characteristics are investing / acquiring / obtaining a foreign firm or asset and influencing / controlling the management operations. The essence of FDI is clearly displayed in the objection of MacManus (1972, p. 32) over the name of FDI: Foreign Direct Investment is a rather inappropriate name for the process by which productive activities in different countries come under the control of a single firm. The essence of this phenomenon is not foreign investment, which is an international transfer of capital, but the international extension of managerial control over certain activities. [MacManus 1972, p. 66]. The issue of control and influence is very important in defining FDI, but does need some clarifications. The fact is that, depending on the host country, when an entrepreneur or a company acquires more than 10% or 20% or even 25% of a foreign company, it is considered FDI. But does such a small percentage ensure control for the investor? The ownership rights issue over a company is a very complicated subject nowadays. The person who has control over the decisions affecting the company is determined by the elaborate enactment of each company that varies greatly; enough to forbid assumptions and generalizations. Sometimes a person can have management control owning 10% of the company (if, for example, the given company s shares are divided among many shareholders through the stock market) or have no management control even if he/she owns more than 50% of the company or have both management control and over 50% of the shares and yet not to be able to make important decisions (if the agreement of all parties dictates that in order for a decision to be valid, 2/3 of the owners must agree). Thusly, one must keep in mind that not all investments over 10% or 25% aim and lead to control. 3

5 Some definitions use lasting interest and significant amount of influence to define FDI. This is more accurate in explaining the current status of several FDIs, but still it is vague since it does not specify the target of the influence. Influence management operations is even more accurate, but again not enough. In fact, in order to clarify this issue, one must first specify the amount of control the investing company needs over the company that receives the investment. This differs according to what the investing company expects from the investment. Through the years, many theorists studied the concept of investing abroad, and foreign direct investment in particular. What FDI is cannot be defined in a four-line definition, since it involves much more than a simple money transaction which aims at profit. The complications begin with the very first step economists might take; measuring and comparing FDI flows among several countries. This is because each country may have different standards for a foreign investment to be considered direct. The OECD (1997) has recommended that the minimum equity stake for an investment to qualify as direct should be 10%. The differences, though, among countries are distinct. For example in the USA, Canada and Australia the minimum is 10%, in France and Germany 20% (or 25% according to Brewer (1994) p.117) and in New Zealand 25%. It is obvious that any comparison among the state records of these countries on FDI would be unequal [Dunning, 1993, p. 12]. Another difficulty is to specify the components included in FDI measurement. The following components should be used in FDI when reporting to the IMF: Equity Capital: the value of the initial investment. Reinvested earnings: all earnings of the affiliate company that are reinvested on the initial investment. Other capital: the transfer pricing between the mother company and the affiliate (short and long-term capital). [Barrell et al., 1997, p. 64] A problem arises because many countries in their records leave out at least one if not two of those components. The reinvested earnings component of FDI is particularly problematic. It is the most difficult component to measure because the data are not collected from foreign exchange records, but are based on surveys of the firm [Brewer 1994, p.117]. Consequently, this component is left out in many national FDI records. The problem is also manifest in Bulgaria where the Bulgarian Foreign Investment Agency (BFIA) includes in its official catalogues the reinvested earnings, while the Balance of Payments (BP) of the Bulgarian state, which is the source of data used by official institutes, does not. Although the BP 4

6 projects the apparent foreign capital flows, it excludes the reinvested earnings, investments applied in gray/black/unofficial ways (shadow economy) and/or even individual investments (not derived from a registered company). The clear capital inflows or individual acquisitions appearing in BP is the minimum FDI volume which the country may have, but still the actual investment is usually much higher. The Bulgarian official catalogues (National Statistical Institute -NSI) generally manifest distinct problems, since they often present different data for the same variables for the same time period which are not usually updated properly and on time. Furthermore, some of the companies which have invested in Bulgaria do not appear in the catalogues (BFIA) or appear with smaller investment amounts (see Bitzenis, A. 2002). The author s questionnaire research has revealed at least 20 companies with investments of large amounts of money (over 1 million USD), not recorded in the Bulgarian official lists. Another problem is the manipulation of the economic facts, either intentionally or because of incompetence (for example, companies that have withdrawn their investments through the years, still appear in the catalogues). An example of this problem is Rover which almost immediately withdrew an investment made in the end of 1994 but is still recorded in the official catalogues of Privatisation Agency [Bitzenis, A., 2003a]. 2.2 Difficulties in defining Foreign Direct Investment in Bulgaria Having chosen the road of economic reforms and through the introduction of the market principles in the past several years, Bulgaria has taken a number of steps to introduce a liberal economy and attract foreign investment which are the prerequisites to a modern economy with a developed infrastructure [Bitzenis, A., 2003b]. This is particularly true for the legislative initiatives where many new acts have been adopted and/or old ones have been amended. Currently, there is an acting legal framework for doing business by modem standards which favours inward investment. The conditions for doing business in Bulgaria are quite liberal and there are no restrictions for foreign investors to settle in the country. According to the Encouragement and Protection of Foreign Investments Act (1996) 1 (1) Any foreign person shall have the right to make investments in Bulgaria and to acquire shares or participating interests in commercial partnerships according to the procedure provided for Bulgarian persons, being equal in rights thereto, save as otherwise provided by statute. (2) Save as otherwise provided hereby, partnerships wherein foreign persons hold an interest shall have the same rights as partnerships wherein foreign persons hold no interest. (3) The percentage of a foreign participating interest in newly formed or existing partnerships shall be unrestricted. 5

7 However, during the transition period there was an unstable legal system in Bulgaria; a fact which our survey confirmed as a barrier for foreign investors. The changes in the content of the Bulgarian laws have been so numerous that they have caused a sense of insecurity to local investors and especially to foreign ones. The radical changes in these laws are reflected by the many names the laws have undertaken through the years. The first Law on the Business Activity of Foreign Persons and on the Protection of Foreign Investments ( ) was adopted by the Parliament of Bulgaria in 1991 and was promulgated in the State Gazette, Issue No. 47 of In 1992, it was revoked and the Bulgarian Parliament adopted the Law on Promotion and Protection of Foreign Investments ( ) or the Encouragement and Protection on Foreign Investment Act, promulgated in the State Gazette, Issue No.8 of From October 1997, the Parliament of Bulgaria adopted the Law on Foreign Investments. These laws and many more that followed brought the legal framework on foreign investment in full compliance with the accepted international standards and provided for an even more attractive investment policy. There are different prerequisites for an investment to be characterized as a direct investment (thus FDI). Moreover, these prerequisites may change at any time in any country. The Bulgarian laws concerning foreign involvement and especially FDI have undergone changes many times. According to the Law on the Business Activity of Foreign Persons and on the Protection of Foreign Investments 2, 1992, Article 9, foreign investment shall mean any investment made by any foreign person acting, inter alia, in a single merchant capacity or through a branch, or by a partnership wherein a foreign person holds an interest exceeding 50 per cent. In keeping with the Encouragement and Protection of Foreign Investments Act [published in the Official Gazette issue No. 109 of December 27th, 1996] Article 9. (1) (Amended, Official Gazette issue No 109 of 1996) foreign investment means any investment to the value of not less than USD 50,000 or the equivalent thereof in Bulgarian lev or in any other foreign currency translated along the central rate of the Bulgarian National Bank as applicable on the date of investment, made by any foreign person, any subsidiary wholly owned by a foreign person, any sole-trader foreign natural person, or any partnership wherein a foreign person holds an interest up to the extent of the said interest The latest Law on Foreign Investments, 1999, Article 3 12 mentions that, a foreign investment shall be any investment by a foreign person or its branch in: 1. shares and 6

8 stakes in commercial companies, 2. ownership title over buildings and limited ownership title over property 3. ownership title and limited ownership title over movable property where considered long-term tangible assets, 4. ownership title over an enterprise, or detached parts thereof, within the stipulations of the Law on Restructuring and Privatisation of State-Owned and Municipal Enterprises, 5. securities, including debentures and Treasury bonds, as well as their derivative instruments issued by the State, by the municipalities or by other Bulgarian legal persons, with a remaining term until maturity not shorter than 6 months, 6. loans, also in the form of financial leasing, for a term not shorter than 12 months, 7. intellectual property title - articles of copyright and kindred rights, patentable inventions, utility models, trade marks, service marks and industrial designs, 8. rights stemming from concession contracts and contracts for the assigning of management. In keeping with the Methodology for Compilation of the Direct Investment in Bulgaria adopted by the Bulgarian National Bank (BNB) 4 the presence of a lasting interest presupposes a long-term relationship between the direct investor and the direct investment enterprise and a considerable degree of influence on the part of the investor in the management of the direct investment enterprises. in the Balance of Payments Manual is adopted the principle that the acquisition of 10% or more of the voting power in the management of the investment enterprise is considered an establishment of a direct investment relationship. 5 The Foreign Exchange Law 6, 1999, Article 1, par. 8, states that a direct investment is: a) the establishment or acquisition of a business enterprise, b) the acquisition of unlimited liability partnership rights or a stake in a business which entitles the investor to more than 20 percent of the votes in the General Assembly of the business, c) the extension of a loan the maturity of which exceeds five years with the purpose of making a direct investment in compliance with letters a and b above, or in connection with an agreement for participating in the distribution of profit, d) additional investments to those already made as per letters a) or b) above. To conclude, it must have become clear by now that the statistical data for FDI in general are not very accurate for comparisons because of the different ways each county uses to define and calculate them. The problem is even worse in Bulgaria, since the prerequisites for FDI 7 have changed five times in the last eleven years. Perhaps this fact explains the differences in the data available from official sources for the same years. 7

9 3. Literature Review regarding the most important barriers which discourage FDI inflows The following discussion attempts to be a literature review of the most relevant and important articles regarding the most important barriers of FDI (see also Bitzenis, 2003e). Their main effort focuses on determining the most significant disincentives of FDI, based on questionnaire analysis (see also table 2). Benacek V., et al., 2000, concluded that the findings of econometric studies tend to support survey results. This suggests [among others] that macroeconomic and political stability are also taken into account. Evidence on the attraction of the skilled labour force in Central Europe has been more variable political stability may influence the distribution of investment across countries, while specific incentives may direct investment towards certain sectors. [conclusions, Benacek V., et al., 2000]. A comparative survey based on the public opinion regarding corruption conducted with the cooperation of Vitosha Research (Center for the Study of Democracy in Bulgaria), Albanian Center for Economic Research and a Forum Center for Strategic Research and Documentation (FYROM). This survey was conducted in Albania, Bulgaria and FYROM in January The survey was based on the Corruption Monitoring System of Coalition which was created by Vitosha Research in 2000 and was an initial step towards implementation of the Regional Corruption Monitoring System. 8 Vitosha Research was extensively engaged in conducting the surveys of the Corruption Monitoring System (CMS) of Coalition The CMS included a comprehensive set of qualitative and quantitative techniques aiming at different target groups (the general public, businessmen, public officials, professionals, etc.). In 2000, a total of five quantitative surveys of population and business elite were conducted. The results of the CMS (Corruption Monitoring System) showed that in terms of values and principles, public opinion essentially remained negative to corruption but at the year end of 2000, a certain public desensitization to the manifestations of corruption were detected. Public opinion perceives corruption as a widespread phenomenon in Bulgarian society and fairly consistently qualifies the sectors of customs, police, ministries, the tax administration, the court system (including judges, lawyers, court officials, prosecutors) as corrupt. The stability of corrupt behavior suggests that the capacity of Bulgarian society to cope with the problem of corruption depends not only on a change in mass attitudes to this phenomenon, but also on the emergence of new social practices. There is a need for essentially new regulatory mechanisms that should be both morally acceptable and practically effective [p.38 Vitosha Research]. The citizens of Albania, FYROM and Bulgaria evaluate in different ways the main problems of their societies, as well as the public significance of the problem corruption. According to 8

10 public opinion in Albania, corruption is the most important public problem at present. In Bulgaria, corruption is among the four most important problems and in FYROM corruption is ranked at seventh place. In Bulgaria, as well as in FYROM, unemployment is ranked as the most important social problem (see Table 1). Table 1: Main problems faced by country Albania -Bulgaria -FYROM % Rank % Rank % Rank Political instability 40,3 4 13,1 8 35,7 4 Ethnic problems 5,2 9 1, ,9 6 Corruption 68,4 1 37,5 4 28,5 7 Low incomes 26,3 5 50,6 2 38,1 2 Crime 54,5 2 27,9 5 32,1 5 Unemployment 44,7 3 65,3 1 69,0 1 Environment pollution 6,4 8 4,3 9 3,8 11 Health Care 22,7 6 18,9 6 10,2 8 High prices 4,9 10 2,9 10 4,2 10 Education 3, ,6 7 6,2 9 Poverty 20,5 7 41,2 3 38,0 3 Comment: Respondents gave up to three answers and the sum total of percentages therefore exceeds 100. Source: Vitosha Research According to public opinion in Albania, doctors are the ones who exert the strongest corruption pressures on citizens. More than two thirds of all the respondents (71%) have declared that such pressure was exerted on them 9. Municipal (20%), tax (15.5%), and police officers (12.5%) also exert substantial corruption pressures on Albanian citizens. In Bulgaria, police (23.5%) and customs officers (20%), doctors (20%), and administrative staff in the judicial system (18.5%) are shown as occupations that most often exert corruption pressures on citizens. In FYROM, the different professional groups that exert corruption pressures on citizens are doctors (36%), municipal officials (25.5%), police (18%), customs (17.8%), and tax officers (16%), as well as the administrative staff from the judicial system (17.7%). Furthermore, according to public opinion in Albania, corruption is most widespread among customs officers (95%) and tax officers (79.5%), as well as among all representatives of the judicial system judges (85%), lawyers (77%), investigators (74%), and public prosecutors (72.5%) 10. In Bulgaria, the leading positions in the ranking are occupied by customs officers (70%), who are far ahead of the other occupational groups such as lawyers (55%), tax (54%) and police officers (52%), and businessmen (48.5%). In FYROM customs officers (66%) are also assigned first place followed by doctors (62%), business people (58%), ministers (53%), members of parliament (52.8%), and ministry administration (52.7%). Furthermore, the data show that the institutional spread of corruption in the three countries largely reproduces public assumptions about common corrupt practices among different 9

11 occupational groups 11. Among the first five institutions determined by the respondents as centers of high levels pf corruption in Albania, Bulgaria, and FYROM are customs and tax officers, and the judicial system. According to public opinion in the three countries, the Army, the National Institute of Statistics and the Presidency are institutions where corruption is the least widespread. In the Global Corruption Report (2003) prepared by Transparency International, Dejan Jovic examined Southeast European countries 12 and concluded that The countries of Southeast Europe witnessed high levels of corruption in the past 12 months, much of it attributable to ineffectual state institutions and the weak implementation of legislation. Nevertheless, many countries in the region are consolidating state institutions as they proceed with the transition to liberal democracy. The transition is being accelerated by international pressure, which continues to be a major force behind anti-corruption efforts. Yet corruption continues to be widespread in Southeast Europe: old networks of influence and parallel systems offer a semi-legal or illegal way of gaining access to services or products (p.190). On the other hand, Meyer (1996) in his research reported that the purchasing power of consumers is important to the investment decision for market oriented investors. Furthermore, market oriented investors in Hungary regard political and economic stability as a crucial factor in the location decision when at the same time factor-price oriented investors are less concerned with stability. Moreover, Arthur Andersen (OECD, 1994) in an OECD survey 13 found that the main barriers or constraints regarding FDI and according to their importance were the following: bureaucratic or administrative issues, legislative issues, the economic climate, business infrastructure, political volatility and cultural considerations. In addition, Hans-Peter Lankes and A.J. Venables (1997) 14 mentioned in their research that political stability was the first investor motivation for the Czech Republic and Hungary when political stability was the second investor motivation for Poland. Furthermore, the stability of macroeconomic policy was the second investor motivation for Hungary and the Czech Republic. At the same time, the stability of macroeconomic policy was the third investor motivation for Poland while the regulatory environment was the third investor motivation for the Czech Republic and Hungary. Lankes and Venables (1997), also found that the attraction of a skilled labour force was of significant importance only in Hungary and the Czech Republic. Trade barriers are not considered as an impediment to investment in Hungary and the Czech Republic, although import tariffs from the EU are thought to deter investment in 10

12 Poland and other Central European countries. Moreover, Hungary, the Czech Republic, Poland, Slovenia and Slovakia are thought to be considerably less risky than other transitional economies. The Czech Republic and Hungary are popular partly owing to the low inflation throughout much of their transition period. In another survey 15, Simona Iammarino and Christos Pitelis (2000) found that the constraints and risks faced by investors in undertaking production activities were: bureaucracy and administrative constraints, general uncertainties of rules, business infrastructure, and legislative and economic climate constraints. Furthermore, custom tariffs, technological backwardness, foreign indebtedness and local currency strength seem not to be so influential. Bureaucracy and administrative constraints are at the top for all three categories. On the whole, it emerges that general uncertainties of rules are perceived as the most discouraging factors, as shown by the high scores attached to business infrastructure, legislative and economic climate constraints in all three categories. Cultural considerations are again perceived as relatively more important for local suppliers and distributors, as well as custom tariffs, while technological backwardness, foreign indebtedness and local currency strength seem not to be so influential (Pitelis et al., 2000, p.12). In another questionnaire survey, Pye (1998) found that the attraction of a skilled labour force was of significant value only in Slovakia. The overall stability of the host country for investment is thought to be somewhat influential, especially in the Czech Republic. A survey conducted by Southeast European Cooperative Initiative (SECI) 16 in 1998, revealed that the most discouraging disincentive to development in all the countries under examination was found to be political and economic instability, followed by crime, lack of transparency, corruption (especially in Bosnia and Herzegovina, Bulgaria, Hungary), deficient infrastructure (especially in Croatia, Slovenia), insufficient legal and administrative framework (especially in FYROM) and finally bureaucracy. Lastly, in April 1998, KPMG International (a consultant company) 17 initiated a survey of foreign investors in Bulgaria in order to identify key factors such as major incentives and barriers to foreign investment, to present business opportunities and to further investment considerations. They found that a skilled labour force has been one of the driving considerations for more than a third (36%) of the investors. They also mentioned that the majority of foreign investors (84%) have pointed out that the incoherent and unstable legal system was one of the most serious problems for their operations, followed by bureaucracy at 11

13 80% and limited purchasing power at 71%. Next came excessive taxation at 57%, lack of infrastructure at 55%, high investment risk at 32% and lastly crime and corruption at 8%. Table 2: Barriers of FDI according to the literature review; Survey based approach SURVEYS 1 Benacek V., et al., (2000) «The findings of econometric studies tend to support survey results» 2 Arthur Andersen (OECD, 1994) Poland, CIS, Hungary, Czech Republic 3 Simona Iammarino and Christos Pitelis (2000) Romania, Bulgaria BARRIERS THIS IS A LITERATURE REVIEW bureaucratic or administrating issues, legislative issues, economic climate, business infrastructure, political volatility cultural considerations Bureaucracy/administrative constraint Business infrastructure constraint Legislative constraint General economic climate constraint Incoherent and unstable legal system High investment risk Slow pace transition Uncertain or imprecise property rights Undervalued local currency Political uncertainty 4 KPMG International (1998) Bulgaria incoherent and unstable legal system, bureaucracy, limited purchasing power excessive taxation, lack of infrastructure high investment risk, crime and corruption 5 Southeast European Cooperative Initiative (SECI) (1998) Balkan Region Political and economic instability Crime - lack of transparency corruption Deficient infrastructure Insufficient legal and administrative framework Inadequate policy towards foreign investments (Bureaucracy, Difficulties in land ownership) Negative business environment (Inexistent financial and banking systems, Black market) 6 Bitzenis, A. (1999) Bulgaria unstable legal system, bureaucracy, corruption, crime and mafia high investment risk limited purchase power lack of infrastructure macroeconomic instability 7 Vitosha Research (Center for the Study of Democracy in Bulgaria), Albanian Center for Economic Research and a Forum Center for Strategic Research and Documentation (FYROM) (2000) Albania, Bulgaria and FYROM 8 Hans-Peter Lankes and A.J. Venables (1997) Poland, Slovakia, Slovenia, Hungary, Czech Republic 9 Klaus E. Meyer (1995, 96) Czech Republic, Hungary, Poland, Romania, Russia 10 Pye (1998) Poland, Slovakia, Hungary, Czech Republic, Romania Source: Bitzenis, A, 2003 Corruption Crime Low incomes Unemployment Political instability Poverty Political instability Macroeconomic instability Lack of skilled labour force Risky environment High inflation rates Limited purchasing power of consumers overall instability unskilled labour force political and economic instability 12

14 4. Presentation of the data and interpretation of the results FDI Progress in Bulgaria The cumulative value of all foreign direct investments in Bulgaria reached 5,3 billion USD in April 2003 (Table 3). More than 80% of them had been generated during the period FDI through green-field, joint ventures, reinvestments and additional investments in acquired enterprises exceed the FDI flows through privatization, which had been the main source only in Bulgaria lost its chance in the period due to adverse initial conditions, a slow transition process, and political and macroeconomic instability (see also Bitzenis 2003b), when the developed countries extensively invested in the Czech Republic, Hungary, Poland, Slovakia and Slovenia. Table3: FOREIGN DIRECT INVESTMENT INFLOWS IN BULGARIA BY YEARS VOLUME IN MILLION USD YEAR Privatization Other Total by years NUMBER (P) I-Q Total 1, , , Source: BFIA, 2003, Non-privatization - Greenfield investment + additional investment in companies with foreign participation + Reinvestment + Joint ventures, (P) = Preliminary, (I-Q) = First Quarter In the period , the amount of FDI inflows was more than 4 billion US$ while in the first six years of transition it was less than 800 million US$. Around 40% of the total FDI inflows were derived from privatisation deals when at the same time only 4% were acquisitions of shares through the stock market (indirect investment portfolio investment). 55% of the total FDI inflows were concluded in the industrial sector, followed by the trade sector with 20% and the financial sector with 10% (BFIA, 2003). The most important foreign investors in Bulgaria came mainly from Greece, Germany and Italy (Table 4). Important investments have also been made through the offshore center of 13

15 Cyprus. These investments have been exploited from Greek, Turkish and Russian entrepreneurs (see Bitzenis, A. 2003c). Table 4: FOREIGN DIRECT INVESTMENT INFLOWS IN BULGARIA BY EACH COUNTRY BY YEARS In USD$ Nr. Country Jan- June 2002 Total by countries 1 GREECE GERMANY ITALY BELGIUM AUSTRIA USA CYPRUS RUSSIA NETHERLANDS UK TURKEY SPAIN SWITZERLAND FRANCE CZECH REP LUXEMBURG SWEDEN IRELAND HUNGARY ISRAEL KOREA LIECHTENSTEIN JAPAN MALTA DENMARK Source: Bulgarian Foreign Investment Agency, The most important barriers of FDI; A questionnaire survey for the case of Bulgaria The questionnaire was originally based on the author s knowledge of the ample literature regarding FDI theories and following the Dunning theory regarding the possible reasons and entry barriers for foreign investment in Bulgaria. Moreover, it was enriched and updated according to the answers, received in the course of time from the investors. Our questionnaire survey has been based on a population such as the foreign companies (MNEs) that entered to the Bulgarian business environment up to mid We have excluded firstly the companies that did not participate in Bulgaria and secondly public organizations, state owned enterprises (SOEs), local citizens and local companies. We have done this in order to avoid biased results (we searched for the most important FDI incentives and barriers for the case of Bulgaria). Moreover, we introduced a criterion in order to choose the sample from the population. Thus, we have selected all the foreign companies that have invested, each of them, more than 1 million USD$ in Bulgaria. An official list has been received from the Bulgarian Foreign Investment Agency (BFIA) with 110 companies, and another 21 companies have been added to the above catalogue from our own research (thus 131 was the total sample). 14

16 The survey lasted 18 months (time period January 1998 June 1999), but most of the questionnaires were completed in the period January June The response size was 64 out of 131, and it formed the sample size. Literature has shown that this response rate in the subject area is extremely large and according to statistics a sample size (response rate) of 10% of the population of interest is regarded big enough to allow secure inferences about the population of interest. Our response rate was 48.9% of the updated catalogue. The sample is very representative since it comprises companies that have invested a very significant amount of US $ especially when considering a small and weak economy such as Bulgaria. Moreover, the sample is also representative because there was a proportional distribution of MNEs in various sectors of economic activities (thus we avoided biased results such as importance of skilled labor force needed for services sector or low cost of unskilled labour force needed for textiles and trade companies). In our questionnaire survey the services sector accounted 28% and the FDI inflows in Bulgaria in the same sector were 18% (Finance 11,4% + Tourism 5,1% + Telecommunications 1,8% =18.3%). Furthermore, trade sector in the questionnaire survey accounted 36% and the FDI inflows in Bulgaria in the same sector were 19,2%. Finally, the answers from the industrial sector were 22% and textiles 14% (total 36%) and at the same time the FDI inflows in Bulgaria in the whole industrial sector were 55% of the total (BFIA). The total invested amount for the 110 foreign companies was 1,283,419,173 USD$ and for the 21 enterprises 47,6 million USD$. The invested volume of the 131 companies adds to 70% of the total foreign invested capital in Bulgaria (Total FDI inflows in Bulgaria: 1.7 billion US$ in mid 1998). The statistical sample with 64 companies consists of a total investment amount equal to 863 million USD$, which is 64.7% of the total investments of these 131 companies or 50.7% of the total Bulgarian FDI inflows (BFIA catalogue, as of 30 June 1998). We examined the survey using the statistical analysis and we concluded not only a specific general ranking according to the importance of incentives and barriers mentioned by all the 64 MNEs, but also we examined if the specific sector (see Bitzenis, 2004) that an MNE belongs to or the origin of the MNE (see Bitzenis 2003c) or even the chosen way (see Bitzenis 2003a) of making an investment (entry mode) in Bulgaria played a role. Therefore, we came up to various rankings for determining FDI when considering specific MNEs that invested in Bulgaria and belonged to the same industry/sector or were coming from the same home country. Moreover, we searched for the interrelation among different variables (see Bitzenis 2003f; Bitzenis 2004a; Bitzenis 2003d) such as if the MNEs, as locational hunters, are considering as incentives the low labour cost and the geographical proximity in order to 15

17 establish an export base in the host country taking into consideration the low transportation cost, the favourable bilateral trade agreements and the knowledge of the market, without considering at the same time the barriers of low GDP per capita, low local demand and low consumption rate because they did not prefer to serve the local market. Finally, our experience in the international business and transition economic research field (see Bitzenis 2003), the duration of 18 months spent for the conduction of this questionnaire survey, the preparation of an excessive number of interviews, the two years that were spent to analyze the results using statistical approaches, experience and theory, and the fact that we produced innovative and critical discussions and made significant comparisons with other similar surveys done for Central and East European countries (see Bitzenis 2004b), are all valuable and lead us to think that we have contributed significantly in our research field. In this paper we have analyzed the most important barriers mentioned by the 64 MNEs and special attention has been given to bureaucracy, corruption and unstable legal framework. These barriers have been examined on the basis of a different MNEs origin, sector and entry mode Legal framework as a barrier In order to determine the incentives and barriers of inward FDI in Bulgaria and to divide them into several groups 19 according to the FDI theory, a research was carried out using a questionnaire and the results were analyzed and studied with the help of statistics 20 [for more see Bitzenis, A., 2002, 2003a, c, d, e]. We searched if there is any difference in the consideration of MNEs regarding the barriers for Bulgarian FDI inflows. Therefore, we examined whether the investments have been made by neighbor investors (Greek MNEs) or other MNEs (thus we included the variable Origin). Moreover, we searched whether there is any relation of the sector that each MNE belongs to with the consideration of specific barriers which discourage MNEs to undertake FDI projects in Bulgaria (thus we included the variable Sector). The most important barriers that the investors had to deal with in the Bulgarian market are shown in Figure 1. The biggest obstacle was the unstable legal system in Bulgaria (74%), followed by bureaucracy (58%) and corruption, crime and mafia (53%). 16

18 Figure 1. The Most Important Barriers, Obstacles or Disincentives for Bulgarian FDI Inflows (Research from 64 MNEs) unstable legal system 73,44% bureaucracy corruption, crime, mafia high investment risk limited purchase power lack of infrastructure macroeconomic instability high vat, high taxation behaviour against consumption, labour lack of managerial skills low progress in transition political instability 57,81% 53,13% 51,56% 50,00% 42,19% 31,25% 29,69% 26,56% 20,31% 15,63% 6,25% Source: Author s Questionnaire Research From Table 5, it can be argued that the Bulgarian unstable legal framework which was profound from the above theoretical analysis, was also another essential barrier for establishing an FDI project in Bulgaria. 47/64 MNEs (73.4%) informed the author that this barrier was also the most significant barrier (see Figure 1). Moreover, another significant finding of this paper is that foreign MNEs, other than Greek MNEs, mentioned the above barrier at an extremely high percentage of 92.6% (25/27). At the same time, only 22/37 (59.5%) Greek MNEs investing in Bulgaria have also made reference to this as a barrier. The reason behind this is that the western foreign investors are not familiar with constant changes in the legal framework. At the same time, Greek MNEs are used to living in such an environment with constant changes in the legal framework, inadequate enforcement of the laws which leave space for corruption, bribery and bureaucracy. Greek MNEs did not reject the above barrier, but referred to it at a significant lower percentage. From the statistical point of view, the p-value (continuity correction, 2x2 Table) is 0,007 and thus <0.01. Therefore, we accept the Ha hypothesis, implying that there is a strong association between the two variables (it is worth noticing the origin of MNEs if they consider the Bulgarian unstable legal environment as a significant barrier or not) at a 1% level of significance. 17

19 Table 5: Unstable Legal Framework (Y62) as a barrier for FDI and the origin of MNEs ORIGIN OF MNES TOTAL Greece Europe & Other Unstable Legal Framework (Y62) No Count % within Y62 88,2% 11,8% 100,0% % within Origin 40,5% 7,4% 26,6% Yes Count % within Y62 46,8% 53,2% 100,0% % within Origin 59,5% 92,6% 73,4% Total Count % within Y62 57,8% 42,2% 100,0% % within Origin 100,0% 100,0% 100,0% Source: Author s Statistical Research From Table 6 we can argue that MNEs belonging to the services/bank sector were totally affected by the unstable legal environment (18/18, 100%) (see also Bitzenis, A., 2004). Moreover, MNEs belonging to the trade or food sector also mentioned (16/23, 69.6%) the above barrier as a significant one. The percentage was lower (13/23, 56.5%) in the industrial and textile sectors compared to other sectors. It can be said that the unstable legal framework affects mostly MNEs which belong to the services sector. From the statistical point of view, according to the Pearson chi-square test, the p-value is and thus <0.01. Therefore, we accept the Ha hypothesis, and so, there is a strong association between the two variables (there is association between the sector that an MNE belongs to and the unstable legal environment) at a 1% level of significance. Table 6: Unstable Legal Framework (Y62) as a barrier for FDI and the sector that an MNE belongs to SECTOR TOTAL Productive/Industry+Textiles Services/ Banks Trade/ Food Unstable Legal Framework No Count (Y62) % within Y62 58,8% 41,2% 100,0% % within Sector 43,5% 30,4% 26,6% Yes Count % within Y62 27,7% 38,3% 34,0% 100,0% % within Sector 56,5% 100,0% 69,6% 73,4% Total Count % within Y62 35,9% 28,1% 35,9% 100,0% % within Sector 100,0% 100,0% 100,0% 100,0% Source: Author s Statistical Research Finally, it was not only the unstable legal environment in Bulgaria that created problems to foreign investors together with the constant changes in this legal framework, but also the inadequate enforcement of the laws which left space for corruption, bribery and bureaucracy (see Figure 1 and Table 10) Bureaucracy as a barrier The high percentage of 57,8% (37/64) of the interviewed companies which mentioned bureaucracy (Y72) as an important barrier for their FDI in Bulgaria was expected (Table 7). 18

20 Table 7: Bureaucracy (Y72) as a barrier for FDI and the origin of MNEs ORIGIN OF MNEs TOTAL Greece Europe & Other Bureaucracy (Y72) No Count % within Y72 59,3% 40,7% 100,0% % within Origin 43,2% 40,7% 42,2% Yes Count % within Y72 56,8% 43,2% 100,0% % within Origin 56,8% 59,3% 57,8% Total Count % within Y72 57,8% 42,2% 100,0% % within Origin 100,0% 100,0% 100,0% Source: Author s Statistical Research On the other hand, the high percentage of Greek MNEs (21/37 56,8%) that gave mention to bureaucracy as a decisive barrier for them was unanticipated and characterized as a surprise due to the fact that Greek entrepreneurs were familiar with Greek bureaucracy and many managers from other western MNEs have acknowledged the experience and the ability of Greek entrepreneurs to cope with great success in economic environments with a high percentage of bureaucracy. An explanation of this outcome may be that bureaucracy in Bulgaria is at higher levels than in Greece and that bureaucracy is an obstacle and a difficult task to cope with, even for experienced entrepreneurs. Finally, the origin of MNEs did not play any role whatsoever in the consideration of bureaucracy as a barrier. From a statistical point of view, we can point out the same when the continuity correction (2X2 Table) was 1. Thus, we concluded that there is no association between the origin of MNEs and the barrier of bureaucracy. Although from Table 7 it was apparent that the origin of MNEs did not play any role in the consideration of bureaucracy as a barrier, on the other hand from Table 8 we can argue that the sector in which MNEs belong to, played a significant role. Table 8: Bureaucracy (Y72) as a barrier for FDI and the sector that each MNE belongs to SECTOR TOTAL Productive/Industry+Textiles Services/ Banks Trade/ Food Bureaucracy (Y72) No Count % within Y72 22,2% 18,5% 59,3% 100,0% % within Sector 26,1% 27,8% 69,6% 42,2% Yes Count % within Y72 45,9% 35,1% 18,9% 100,0% % within Sector 73,9% 72,2% 30,4% 57,8% Total Count % within Y72 35,9% 28,1% 35,9% 100,0% % within Sector 100,0% 100,0% 100,0% 100,0% Source: Author s Statistical Research In other words, over 70% of MNEs which belong to the industrial/textile or services sector looked upon bureaucracy as an important barrier, when at the same time only 30% (7/23) of MNEs which belong to the trade/food sector mentioned the above as a crucial barrier. From a statistical point of view, we assume the same, when the Pearson Chi-Square was 0,004 and 19