Abstract
This essay focuses on the various macroeconomic opportunities and challenges created by the foreign direct investment (FDI) inflows in the new Member States. We question whether the macroeconomic performance of the new Member States is furthered through the overall positive impact of FDI on the trade balance or whether FDI can actually worsen the performance. Our findings suggest that in some new Member States the positive impact, foreseen by the financial markets, may be reflected in a sustainable appreciation of the real exchange rate. Such real appreciation is in most cases moderate enough to allow for smooth nominal convergence required for euro adoption. In some cases, however, this appreciation is very fast, especially in the new Member States with an initial low net external debt and massive inflows, making it challenging to fulfill the Maastricht criteria. The Maastricht criteria may be difficult to meet also in those new Member States where FDI has been channeled predominantly into services, housing construction, or non-tradable sectors in general, and where it might be required to depreciate currencies in real terms to sustain the external balance. In these countries we observe increasing net external debt without a corresponding improvement in the trade balance.
During our work we benefited from comments by Ignazio Angeloni, Martin Cincibuch, Zdeněk Čech, Carsten Detken, Balázs Égert, Vítor Gaspar, László Halpern, Katarina Juselius, Jan Kodera, Louis Kuijs, Kirsten Lommatzsch, Martin Mandel, Alessandro Rebucci, István P. Székely, Corina Weidinger Sosdean, and participants at seminars at the European Commission, European University Institute, International Monetary Fund, Prague University of Economics, Czech National Bank, and European Central Bank.
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- 1.
NiGEM is the large-scale quarterly macroeconomic model of the world economy created and maintained by the London-based National Institute of Economic and Social Research (http://www.niesr.ac.uk). For a description, see National Institute Global Econometric Model (NiGEM 2008).
- 2.
Detailed description of the data and additional graphs, tables and results are available in the working paper version of this essay (see Babecký et al. 2009).
- 3.
As argued earlier, the Balassa–Samuelson effect and its resulting impact on the productivity growth are not enough to explain the appreciation phenomenon.
- 4.
Note that the decision to borrow has been optimal under the existing circumstances: with much higher steady-state output and consumption, the firms and households attempt to smooth their investment and consumption profiles.
- 5.
This period has been known as the Great Moderation (Giannone et al. 2008).
- 6.
This finding is akin to the so-called “Rybczynski effect,” according to which an increase in a country’s endowment of a factor will cause an increase in output of the good which uses that factor intensively (Rybczynski 1955). In other words, if a country has specialized in tradable output, FDI is likely to continue to flow into these sectors.
- 7.
In both cases the upper band of the misalignment corridor is touching the zero horizontal line, thus suggesting that the domestic currency was not misaligned under some scenarios.
- 8.
See Babecký et al. 2009 for more details.
- 9.
Nevertheless, in case of productivity enhancing FDI inflows into services there could be integration gain as well (Blanchard 2007). The mechanism is the following: an increase in productivity in services causes a decrease in prices, which in turn pushes down nominal wages in tradables, leading to an improvement in competitiveness in tradables and thus to higher activity and an improvement in the trade balance.
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Babecký, J., Bulíř, A., Šmídková, K. (2010). Sustainable Real Exchange Rates in the New EU Member States: Is FDI a Mixed Blessing?. In: Keereman, F., Szekely, I. (eds) Five Years of an Enlarged EU. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-12516-4_9
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