FDI and The Restructuring of Industrial Trade Networks

The ancien regime in Eastern Europe was characterized by an almost complete divorce of production from the market. As a result the quality of machinery (with the exception of some military goods) and most consumer goods was usually very poor. One of the main tasks of trade in a market economy, a by-product of its general role of networking producers to customers, is to convey information on market tastes and requirements, and to apply market sanctions for non-compliance. In the centralized socialist economy, trade was to a large extent relieved of this task. Central planning replaced the customer, and “trade” was transformed into a link in rigid supply network with stable ties to the supplying networks of fabricating industry, and subject to constant prices. A crude thermometer of social unrest supplanted finer market signals and coercion was substituted for market sanctions. For an effective transition, all goods and services producing sectors require added resources, new technologies and new management methods, and FDI can be a conduit for all three. The fabricating industries need in addition a complete change in the gamut of goods they produce, and a novel way of using market information to continually adjust offerings to the requirements and tastes of the market, including those of the global market. Trade needs the most radical change: it has to rebuild itself almost from scratch as the flexible conveyor of market information about qualities and prices to the fabricating sector. It has to catalyze new links and marketing networks between producers and customers. The old chain of initiative, from production to distribution has to be reversed, and enable the customer to impose his wants onto the producer. The transformation of trade is thus the most urgent and difficult task and the one where external involvement can be most fruitful. Some examples of FDI were indeed in the phase nearest to the final consumer, which later fanned out and created new networks of modern supplying industries. Our paper first models why the centralized allocation, which placed the planner as an insulating screen between the market and the producing sector, led to the situation described above. It then demonstrates how the aims of trade restructuring can be served by FDI. Empirical evidence from East Europe and Russia supports the theoretical arguments. * Department of Economics, The Hebrew University of Jerusalem. Paper to be presented at the 3 EACES Paris Workshop, “Impact of FDI and Know How Transfer on Restructuring, Spin off and Networking in Central and Eastern Europe and Asian Transition Economies”, at GASI-OEP, University Marne la Vallée, June 8 & 9, 2000.