On International Investment Climate in Bulgaria and Strategies for Attracting Foreign Investments

At the December 7 th meeting of the Council for Economic Growth a report entitled “Analysis of international investment climate and Bulgaria foreign direct investment experience and opportunity” was presented . The report was introduced by Deloitte Bulgaria and commissioned by the Bulgarian Ministry of Economics .

The main conclusions of the report can be summarized as follows:

1. Foreign Direct Investments (FDI) are a main factor for economic growth in Bulgaria as they have a direct positive impact on gross domestic product (GDP) in the country and stimulate opening of new work places and transfer of technology innovations, know-how and management and operational knowledge and skills.
2. According to the analysis, few in number but comparatively large investments form the volume of the annual FDI flows in Bulgaria, which makes the economy vulnerable to external economic performance and the investment climate abroad. The creation of new stimuli is necessary for attracting bigger investors in the country.
3. The competitive advantages of the Bulgarian economy in attracting FDI are:

•  Natural resources availability

•  Work force –presence of skilled and affordable workforce as the average wages are low in the country

•  Macroeconomic and political stability as a result of NATO membership and the prospective EU accession

1. The disadvantages of the Bulgarian economy concerning its ability to attract FDI are:

•  Investment climate – the level of the administration services is unsatisfactory and still lacking enough transparency; there are many regulations and bureaucratic procedures for starting and doing business in the country

•  The internal market in Bulgaria is relatively small

•  The country's location is remote from the markets in Central and Western Europe and at the same time the infrastructure is not fully developed

1. Three economic sectors are proposed as being “targeted industries” and should be referred to as priorities in attracting FDI. These are:

•  Mechanical and Electrical Engineering/Machinery

•  Information and Communication Technologies (ICT)

•  Business Process Outsourcing (BPO)

1. The strategies for overcoming the competitive disadvantages should include the following mechanisms:

•  The incentive scheme for investors should be reconsidered and the following mechanisms should be introduced: more subsidies and grants, privilege credits, government guarantees for investment credits, export guarantees and insurance;

•  There should be a compensation of the investors for the disadvantages in Bulgaria and the targeted industries should be stimulated;

•  Education and training should be improved by pre-qualification of the unemployed and stimuli for companies who improve the qualification of their employees and staff.

Our comments

Analysis of the FDI as a factor for economic growth

The attraction of foreign investments is the result of the advances of the economy and the presence of profitable investment opportunities. However, a factor for economic growth is not the money inflows of FDI, which increase the country GDP statistically, but the accumulation and creation of capital – physical, human and institutional – which leads to enhanced labour productivity. Technology renovation and capital accumulation in the economy can be financed by (1) savings in the economy, that is the postponing of present consumption for more in the future and (2) attracting savings from foreign economies which means attracting of FDI.

From this point of view, the privatisation of government assets is a positive phenomenon as long as favourable conditions are being established for the development of entrepreneurship and efficiently managed enterprises while at the same time distribution of income by the central government is lessened. However, cash flows coming from the sale of government enterprises are not a factor for economic advance because in these ways already existing capital is being bought. Of course, the follow-up modernization of the enterprises, the adoption of know-how and innovation and investments in new technological capacity enhance economic growth because they lead to the creation of more factors of production. Therefore the lack of large privatisation deals as a result of the exhaustion of assets for privatisation should not be taken as a threat for the economy, just the opposite. The increase of the private sector share is by itself a prerequisite for the attraction of investors and doing profitable business in the country.

The other types of foreign direct investments – green field investments and mergers and acquisitions are a direct result of the investment opportunities that spring up in the country and unutilised market niches. Their significance for the economy should be evaluated through the prism of factors of production and the potential opportunities for business in the country.

Stimulation of FDI Inflow in Bulgaria

The attraction of investments in Bulgaria should not be an end in itself. In particular, non-market incentives distort the market signals and lead to non-equilibrium in the economy that turns into recessions in the middle-run. Optimal utilization of the competitive advantages of the economy can be accomplished through private initiative, voluntary exchange, and observance of property rights. Only the free laissez-faire market can “determine” which are the most profitable industries through coordination between the economic actors and via the information signals of the prices and the market processes.

The proposed measures in the report for the stimulation of investments in Bulgaria (giving of subsidies and all kinds of preferences from the government to specified “targeted” industries) will have a negative impact on the economy and undesirable effects on the business environment. Preferences distribution and the lack of equal treatment of investors will lead to the following results:

1. Some of the investors will draw back as they, not being among the targeted industries investors, will not receive equal treatment. This creates a certain degree of unpredictability in the investment environment as a result of the government intervention;
2. Some investors will be attracted to the selected industry not for economic reasons but as a result of the implementation of the proposed incentives. The eyes of some businessmen will be redirected from seeking of good business ideas to seeking of opportunities for preferences (rent-seeking);
3. The increase of income redistribution and an attempt to plan and regulate the development path and economic activity in the country.
4. Resources taken out from taxpayers for distribution of grants and privileges have an opportunity cost. The missed opportunities for economical and cost-efficient utilization of the means should be calculated and considered as a cost and missed benefits for the economy.
5. Increase of bureaucracy and thus more resources will be needed for its maintenance and at the same time conditions for increased corruption will be established.
6. The preferred sector is such that the government treats it as a priority for the sake of the other industries. In fact the proposition of several targeted industries supposes that the other ones are considered non-preferred – and thus their development should not be stimulated only because the “state” and its consultants think that they are not important enough.

The market is a process of the coordination of entrepreneurial efforts to fulfil the needs of consumers at most with the scarce resources that are available to them. Planning should happen only on a firm level and defining of targeted industries by the state is a senseless exercise and even harmful one when it is followed by attempts to change the economic policy in the country.

Measures that should be undertaken in order to stimulate foreign direct investments and the economic activity in the country should be directed towards more economic freedom:

1. Lowering of the tax and social security burden in the economy.

It is pointed out in the report that Bulgaria has one of the lowest tax rates on corporate income in Europe (15%) so incentives different than fiscal ones should be created in order to attract foreign investors. In fact, the overall tax and social security burden in the country is higher than the direct competitors of the state – Romania and Croatia. The share of the redistribution of income via the government budget (about 43%) is also among the highest ratios. For example, the ratio for Romania is under 35%. This clearly shows that fiscal incentives are one of the fair means for equal treatment of the entrepreneurs – Bulgarians as well as foreigners.

A concrete measure that would stimulate investment inflows is the introduction of the promised zero rate on reinvested income. Estonia is already doing well with this fiscal incentive.

1. Decreasing of bureaucratic obstacles and implementation of a “ single counter“ administration, lessening of the licence regimes from 39 (their number at present) to 5. Also, the silent consent principle should be well established for all registration regimes. The procedures of opening a firm should be eased and the whole process should become available through the Internet.
2. Privatisation of the state-owned companies and other government assets such as forests, land, etc.; liberalization of the markets and abolishment of all kinds of obstacles on free trade.
3. Reformation in the education system via the introduction of vouchers and fostering of competition among schools. The proposed measures for education improvements in the country in the report sound as abstract as good wishes but fail to give a full picture of the situation and propose a sound solution to the existing problems. Through greater competition among schools and universities, people will become better prepared in the sphere of languages learning and will become more familiar with new technologies and management skills that are being evaluated as a prerequisite for FDI inflow. Only through the private establishment of the supply of education can a more reliable connection between schools and employers be established.

It is neither logically based nor economically proven that the increase of FDI should become for the sake of the local business and as such targeted industries cannot be defined for attracting investments. Marketing of industries is not in the usual scope of government operations and the proposed strategy contradicts to the main purpose of the state – to protect property rights and assure equality among all citizens before the law and the legitimately established rules.