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Location Determinants of FDI in Transition Regions

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An essential aspect of globalization in past period has been the progressing grows in foreign direct investment (FDI). According to assessments of UNCTAD (2000) expert's estimation, since 1979 to 1999 the volume of the world FDI funds to world's GDP boosted by 16 per cent and relatively the proportion of world FDI streams increased by 14 per cent. Such a progressive expansion explains as the FDI determinant's plays a leading role in development of any country's economy, in terms of macro and micro parameters (Lipsey, 2001).

Most of time FDI is provided with developed country's strong market orientations to emerging countries, where market is weak. To expose most the effective conditions which are attracts FDI determinants in the host regions, a number of researches have been done. As a result of this study has concluded that there is a large impact on a market size, GNP and economic growth rather than investment incentives.

However, the circumstances of FDI are various in each country because all of them have weak and strong markets and therefore have different outcomes of FDI stocks. The transition regions such as CIS and CEE regions have been recently studied comprehensively. There is a large empirical literatures implemented the FDI effects, as an engine machine for the transition regions. Due to advantages that related to the introduction of new technologies and innovations, new managerial techniques, development of additional skills, increased capitals, improvement of working conditions and the development of the industrial sectors in the transition regions (Caves, 1974 and Perez, 1997). Although, several policy makers viewed that FDI activities might provide negative effects on country's economic development. This diversification followed by foreigners' intensity in the host markets.

The traditional debate stands for relationship among FDI and the prospects for economic growth.

The study is divided into six parts. Chapter two will examine the results of several empirical studies of FDI activities, by examining series of positive and negative effects on the transition regions' economies. Chapter three will review the mechanism of FDI activity by exampling its various types. Moreover, this chapter will briefly estimate FDI types' affects on transition companies. Chapter four draws economic overview of the Kazakhstan's market condition and the intensity of economy growth since the country gained its independence, and furthermore, will illustrate foreign direct investment environment. Chapter five contains FDI challenges and problems in the Kazakhstan oil and gas field industries, and will show government strategies against foreign investors. Finally, the last chapter will conclude with the summary and implications of the study.

2. Literature review

Over the past years the endowments of Foreign Direct Investment (FDI) are becoming to be very important issue for transition countries. As the FDI activities contribute certain volume of assistances to the national economic growth. However the issue of FDI activities are often stands to be as the implicit hypothesis, in terms of its flows that transports benefit to the host region's economy. The impact of such disputes generally depends on FDI forms behaviour that it takes. The several evidence of empirical literatures have drawn series of positive and negative features of FDI as a basis of assistance growth for transition regions, some of which are examined below.

The article by Kozima ( ) has expressed a macroeconomic explication of the FDI behaviours. Kozima's observation analysed that FDI ought to operate as channel trade for the productivity goods and thereby its direction should be followed by the market forces rather than the micro level characteristics. The FDI flows transfer and promote productivity level growth in terms of technology, management skills and know-how from the developed industries to the developing industries. As the outcome of such investment types follow by the improvement of the welfare conditions and by the increase of the industries income. The case can describe the Japanese FDI activities in Asian regions. On the other hand, in some terms FDI activities correspond to negative effects of its location decisions. This presents the case of the presence of more technology advantaged foreign company in an emerging country, where domestic industry might not be comparatively competitive and efficient to compete with the advantaged foreign company. Therefore, the presence of more advantaged foreign company under such conditions can simply take over domestic firm's market shares and decrease country's economic welfare growth. The case explains by the United States FDI activities after the second war.

De Gregorio (1992) stated that FDI may bring several benefits that persuade economic development by its advanced technologies and skilled knowledge's, as such factors may promote productivity growth in emerging regions. De Gregorio's studies have estimated several facts on economic growth in Latin America. This followed by increasing investment growth which is approximately implemented 0.6 per cent of GDP growth annually from 1950 to 1985. Likewise, Blomstrom and Lipsey (1992) examined FDI's positive externalities. However, such estimations studied under certain conditions that followed by high performed regions and therefore implemented positive performances. According to their studies, countries that only have attained certain level of returns can benefit from FDI activities. This can be correlated to human capitals that provide different income returns in transition regions. As well educated and skilled labour population can utilize the benefits of advanced technologies to the whole economy.

The model of Malign emphasizes the potential interaction among FDI that realized by foreign company under the imperfectly competitive industry and a host region with imperfectly competitive domestic market. Hence the foreign firms operation in such market faces with several barriers to gain access into a market, and thus this increase market concentration instead of decreasing. (Cardoso and Dornbush 1989; Grieco 1986) In this term the presence of foreign company can simply turn down domestic savings and investment capacities by taking out rents and funds activity. Moreover, such case can basically trough out domestic firms from local business activities. The international firms might reinvest their capital flows to related industries in the host region and expand their market powers. The repatriation of such reinvestment profits may take out capital from the host region. Far from providing an encouraging impact on profits distribution and social environment improvements by foreigners might sustain a small power of local business partners and suppliers. As they utilize inappropriate intensive technology that might generate small number of labour forces, whereas consigning employees to the category of the unemployed, and this turns down them to set up more productive occupations. Their rigid control over advanced technology and skilled management channels may put off the favourable spillovers and externalities.

It is commonly acknowledged that attracting FDI spillovers promote development effects, as the FDI activities symbolize as an essential source of technological spillovers, and as one of the resourceful and practical tools for improvement and upgrading of transition industries. (Dunning and Narula 2004) In fact, FDI spillovers have been enthusiastically supported under the Washington consensus as a universal remedy that leads economic growth and expansion. Because, structural changes highly amalgamate macroeconomic stabilization strategies along with strategies that increase FDI flows. However, the benefit levels are considerably various and the results from FDI assistances procedure are not always positive. (Lall and Narula 2004)

Aitken and Harrison (1999) estimated the spillover effects to domestic companies in Venezuela. They investigated exceptionally limited effects of spillovers level. In addition, this spillover levels were mostly delivered from joint ventures. This suggested that relations among foreign and domestic company produce some amount of spillovers. However, its effects can not capture the whole economy. This can be explained when the foreign company in some way induced productivity growth but its financial sector would not be able to capture the plant stage, although it ought to capture even at the aggregate stage.

The effects of political intensity have been examined by several policymakers and suggested that relationship among FDI inflows and host country firstly based on the political stability. Alesina and Perotti (1996) examined the impact of political vulnerabilities on economic development and investment. They implemented that an increase of the political intensity in the host region leads to decrease of investment flows. By implementing index of political instabilities that stands beyond of political assassinations, corruption and coups. Campos and Nugent (2002) analysed the causal linkages among investment and growth index by utilizing pooled panel statistics. According to their investigation results, it suggested that there are not so many evidences for the negative linkages among political instability and GDP growth. However, in terms of investment facilities, there are strong causalities of political vulnerability to investment decline.

The relation among political volatility and asset markets has been examined by several policymakers. Robin, Liew and Stevens (1996) have examined factors of political volatility in transition regions. According to their analyses the importance of asset returns' stands to be more significant in transition regions than in developing regions. As Bussiere and Mulder (1996) implemented their investigation in the twenty three regions and proposed that political vulnerabilities in economic models broadly explicate economic decline the aptitude of economic model to explicate economic decline of transition region. Moreover, they stated such conditions are vulnerable to economic crises when election consequences under uncertainty.

Kutan and Zhou (1995) investigated that political intensity in Poland during 1990s had introduced economic reforms that influenced foreign exchange returns and bid-ask spreads. According to their investigation, these events reflected by political volatility that seriously harmed the national currency value in international exchange market. This consequently boosted the bid-ask spreads under the foreign exchange transactions that formulated bid-ask spreads to be more expensive for foreign investors. Likewise, Melvin and Tan (1996) examined political volatilities on foreign exchange market by their studies that implemented similar causes.

Ivo Feierabend and Rosalind Feierabend (1966) formulated their Feieraben measure on political instability. This theory based on the country's political vulnerabilities that considered the amount and concentration of political aggressiveness behaviour that takes place within a nation. According to their definition on political instability it is: the amount of Aggression directed by individual or groups within the political system against other groups or against the complex of officeholders and individuals and groups associated with them. Or, conversely, it is the amount of aggression directed by these officeholders against other individuals, groups, or officeholders within the polity.

Using this characterization Feierabend's have examined various indicate scales of political vulnerability that based on the amount and concentration of political actions. Feierabend's have segregated thirty categories of political actions that were given by various weights. As the more destabilise actions, then the higher influences it obtains. For example, during the election of public servants is estimated to be zero, as this was not followed by aggressiveness of political intensity. However, in cases of assassination of high politic figures, corruptions and coups had estimated up to 5 and 7 scales.

In the case of locational decision of foreign companies the political intensity of host regions might lead them out off their domestic market. Aharoni (1960) and Thunell (1977) showed that the intensity of political instability might be very significant measure in the foreign investment activities in the way of location decision. This has been examined that foreign investors in general consider the political vulnerability of the host regions in an unsystematic way. However, a foreign company that operates abroad should put forward its attention on political intensity. This would facilitate in the formulation of tactic for choosing the location and expand further its investment flows. As in some circumstances the host governments might change their political intensity in terms of nationalization.

3. The role of FDI's

The priorities of developing economies are obviously comprise under constant revenue growth for their economies through strengthening technological capabilities, increasing investment rates, and enhancing the competitiveness of their production in the global marketplace. By providing the opportunities to economic growth, creating employment potentialities and conserving the environment for future population. As the globalisation and liberalization of the world economy constrains the developing economies to upgrade abilities and resources of their economies. The modern global can be classified by speedy progress in knowledge and economical capability under competitive circumstances. Therefore, in globalizing world the economic growth can be implemented constantly only if states can promote privileged value-added performances to supply goods and services for their open market strategies. Among these attitudes MNE's and FDI activities can apply for an essential function in complementing their efforts. As their assets is one of the main features of promoting local markets or entire enterprises to the international market.

FDI has been characterized differently by several empirical literatures. The International Monetary Fund (IMF) describes FDI as an investment made to acquire a lasting interest in a foreign enterprise with the purpose of having an effective voice in its management (Bjorvatn, 2000).

Generally, FDI activities are undertaken by Multinational Enterprises (MNEs) that provide a huge capital of investment flows over the world. These investment flows classified as a market seeking, its purpose to serve for an existing market. For instance, owing to a high tariff rates, the company needs to relocate its activities to the emerging country, as firm's activities were previously supplied by exporting. The motivation for such investment in the host economy explains in better serve for a local market through production, market growth and market size. The case of Japanese FDI in vehicle production in the US can be implemented as the market seeking (Duning, 1993).

The efficiency seeking appears with a firm that involves in gaining economic scale and scope activities from the host economy. In this perspective, close relations with the western countries would lead to corporate network linkages and the presence of high transport and communication costs will encourage more of efficiency-seeking FDI.

Finally, the asset seeking or resource seeking occurs when a firm invest into a foreign country to find natural and low cost labour force resources that not available within their country. It might follow by natural resources, cheap labour forces and furthermore, by raw materials. Again the case of the UN and Japan can present the view of asset seeking by searching for a cheap labour force in Asia. In contrast to market seeking, it is able to serve for a home and for a third country's market. This tendency follows particularly by industrialised sectors that subsidized by MNE's. Therefore, such accessibilities in physical infrastructure and skilled and cheap labour forces are the main trends of resource seeking.

3.1. FDI types

In analysing market entry through FDI flows, there two choices such as, greenfield investment and takeover of an existing company. Through greenfield investments a company which invests a small amount of inputs, and afterwards when demand increases it can enlarge that investment. A greenfield investment frequently set's up from building a new company after the governments of host countries would approve that, because of the location perhaps can be in the profitable place and produce a new production capacity. In discussing another type of FDI is the takeover of an existing business through the acquisitions and mergers (M&A). In other words, foreign companies appear in the emerging countries and purchases already existing local business by gaining the packages of the company, as a result, such companies turn out to be an affiliated. In the past years M&A have seen massive surge by reaching more than 50 per cent (Theodore 1998).

Admittedly, there are several trends that foreign firms seek to invest their capitals abroad. These features were partly analysed by Dunning's OLI theory. As Dunning (1993) describes three conditions that firms carry to take FDI activities. Ownership advantages- appears, when the foreign firm is capable to compete with the domestic firm. It can be attained through specific skills or assets that follow by advanced management and technological capabilities. Companies that endowed with ownership advantages basically enlarge their operations in a foreign country to internalize the growing benefits from ownership advantages. Location advantages- aspects as natural and mineral resources, transport costs and low prices, access to the domestic market determine the presence of the investment. Moreover, factors such as social and political stability and business environment that follows by stable prices and sustainable budget deficit determines location. Internalization advantages- occurs, when the foreign firm is able to retain its multiple activities, rather than licensing or franchising technology to local firms. The case can be implemented, when the firm prevents the technology or assets imitation by rival firms. According to OLI theory, all these criterions should be fulfilled for firms to invest in the host economies.

In terms of investment incentives, Dunning (1993) pointed that OLI theory is generally stands for a characteristic of the host country and for the MNE's. This follows by attracted or specific location, skilled or cheap labour forces, infrastructure and political stability. Undoubtedly, these trends are very significant for the location of FDI assets, however, the significance of investment incentives have raised in the past years. Over the world countries have lowered their entry barriers to persuade a massive amount of foreign subsidizes and generated FDI incentives to attract more foreign investment flows. Therefore, operations such as low taxes, attractive tariff regimes, and market preferences, investment in infrastructure, financial grants and loans for the foreign firms took the form of investment incentives. Basically, FDI incentives are similar in developed and developing regions. Regarding to UNSTAD (2001), a small number of regions participate for FDI activities without subsidies nowadays. This report estimates that 95 per cent of adjustments in FDI legislations for the 1990s were encouraging to foreign companies and furthermore, these adjustments followed by FDI promotions and incentives. The motivation of such reasons primarily tended by prospect of seeing positive spillovers inflows into host economies UNSTAD (2001).

In the context of positive spillovers host governments tries to attract foreign subsidizes to their economies as they considers that FDI's spillovers generate positive externalities to the domestic companies by transferring know-how and advanced technology. The following terms can be implemented

  • Domestic companies might benefit from foreign production processes as they diffuse new technologies. It can be implemented through labour turnover and through imitation.
  • As the foreign firms gain access into domestic market equilibrium, it is makes domestic companies to be more an incentive to protect market shares income (Ponomareva, 2000).

These systematic alterations might cause various sorts of spillovers that bring to productivity growth into domestic companies, as the spillovers effects from foreign companies can be significant. On the other hand, several literatures provided that spillovers effects can have negative forms. In article by Aitken and Harrison (1999) the negative impacts of spillovers introduced on the domestic firms' productivity, in terms of market steeling effect. For example, when the foreign company gain access to the foreign market and take over local market shares by its technology advantages. In other words, the MNE's advantages can simply trough out domestic firms' productivities and so, local company's productivity declines.

3.2. Spillover activities and types.

There is a large empirical study that implements the significance of spillover activities in the host economies. According to Blomstrom and Kokko (1997), the importance of the FDI spillovers is not only the investment in a new plant and equipment, but also transfers of technology, skills and capital for the host countries. Consequently, FDI arrives through managerial and financial resources, technical support and strategic assets. This can be company's brand name that takes place by comparative advantage to domestic entrepreneurs. Spillover activities can be taken during foreign companies' presence that provides efficiency and productivity to the domestic firms. The positive spillovers followed by foreign investment enterprises that provide benefits to domestic companies, in terms of productivity technologies that do not exhaust cost for gains (UN-ECE, 2001).

In the perspective of the FDI spillovers, several policymakers have concerned that the presence of foreign firms lead to productivity growth of domestic companies. Whereas, other authors implemented that, there is also a negative impact of FDI spillovers. One of the common explanations of FDI in transition regions is assistance in restructuring domestic firms. As Wallner (1998) suggest that, partly an emerging firm occurs under the soft budget constraint and thereby FDI's activity might provide in a positive way. As the presence of the foreign firms provide various incentives to reduce funds to domestic companies and as a result involves in companies' restructuring. Another positive feature of FDI spillovers importance is transfer of technology and know-how to domestic firms. On the other hand, this can also provide negative spillovers. For instance, in terms of product market under imperfect competition, that can follow by a considerable decrease of the market shares of the local firms and moreover, can trough out domestic firms from the market. The literature by De Gregorio and Lee (1998) and Kokko and Borensztien (1994) stated that FDI spillovers can generate in positive way, if only the technology development among foreign and domestic company is not so great. The trends of positive spillovers were found in the next literatures Blomstrom, Sjoholm (1999) in Indonesia, Caves (1974) in Australia and Globerman (1979) in Canada. In the case of negative spillovers the following studies such as Kornings (1999) in Poland and Romania and Aitken and Harrison (1999) in Venezuela have implemented such effects

Spillover activities determine two approaches such as direct and indirect approach. The direct approach examines through statistical examples, as the spillover activities are directly correlated to presence of foreign firms (Blomstrom et.al.1999). The purpose of the direct approach frequently leads to productivity measure of local firms to the MNE's presences. There is on common method that utilizes evaluation of production functions that estimates through the foreign firms presences upon industry productivities and on its levels. In studies of econometric the spillover activities might expose the total impact of productivity to host firms under the foreign presence. However, the impacts are frequently not specific nor implement its effects (Blomstrom and Kokko 2003). The indirect approach examines through channels in which FDI spillovers may take in, and afterwards estimate the forcefulness of those channels. Likewise direct approach, there is a large studies on its channels, but it can be difficult to implement general conclusion from these studies (Blomstrom et.al.1999).

Another spillover activity in the host industries persuaded by two types such as inter (vertical) and intra (horizontal) industry spillovers. The vertical spillovers appear when foreign company provide impacts to the domestic suppliers. This can be under different industries that engaged in a long term contract among foreign company and a domestic supplier (Smarzynka, 2002). The horizontal spillovers result from the occurrence of the MNE's that brings competition to the host economy. There are five channels that chase horizontal spillover activities such as competition, transfer of technology and R&D, industrial management, demonstration and imitation activities and human capital and labour turnover (Blomstrom et. at. 1999). According to UNECE report (2001), on intra industry spillovers in transition regions have estimated FDI's horizontal and vertical impacts. The following (Table 2) estimated that basically the presences of foreign companies did not perform better and thus, they have not generated the expected positive spillovers to local companies.

Virtually, the FDI spillovers turned to be negative in these manufacturing regions. Generally, CEE regions were under negative coefficient performances. The exception was followed with Estonia's and Russia's manufactures which are presented positive coefficients. The results suggested that it is not unexpected as the initial conditions and economic environment was critical during the transition period. Those countries essentially had experienced various shocks and thus, local companies were not capable to react to the challenges that followed by FDI. This however, can be temporary factors and these regions will be more competitive with the next FDI flows.

3.3. FDI flows in transition economies.

Over the decade ago the former Soviet Countries and central and eastern Europe regions have been transferred themselves from centrally planned system to open market economy. This systemic transformation has seen a massive upsurge in FDI inflows that afterwards assisted to recovery their internal economic vulnerabilities. As the initial stages of economy conditions experienced several economic shocks and therefore domestic growth of these regions went down. According to UNECE report (2001) the industrial productivity decreased by 34 per cent over the transition regions. Furthermore, in some regions it even followed by 64 per cent. This economic collapse was stated by macroeconomic imbalances, monetary overhangs, and by external debts. Consequently, these host regions were under extremely necessitate of liberalization, privatization and stabilization reforms that followed with the foreign subsidizes. There are strong evidences that FDI tends to boost the initial stage of economic performances. The following trends were considered such as,

- FDI frequently helps to the host country to amalgamate into the global economy.

- FDI increases the aggregate rate of investment.

- FDI generates transformation of hard technology that process technology and product.

- FDI engenders relocation of soft technology that processes organization, management and sourcing technologies

- FDI tends to encourage networking and subcontracting patterns that conducive for host firms to improve their technologies and productivities. (Dyker 1999)

Thus, the importance of FDI in these regions was not only in supplying funds for the acquisition of new equipment, but also it seen transformation of advanced technology and organisational forms that led from more developed economies. Attracting FDI assets are considerable issue for the transition regions, as it leads to catch up policy with more developed economies by improving their economic efficiency. According to Transition Report (EBRD 2007), in the past decade the former soviet regions and central and eastern European countries have been successfully stabilized their economic circumstances. As their living standards have improved and moreover political, social, economic and legal issues were adopted and improved by state agencies. The transformation processes however implemented in different stage as their initial conditions were varied over all regions. Some of regions have simply been mistreated by foreign investors as the investment inflows directed more toward to some regions. (EBRD, 1999, Henriot, 2003) This discrepancy might be implemented by the high economic dynamism of more advanced transition economies. There are some regions that have been under the greater concern to investors due to of their mineral wealth resources, and close frontiers to the European Union countries. Moreover, in the last 10 years, it was obvious that foreign investors were in favour to a more stable political economy and to a favourable environment that had followed a consistent privatization policy (Henriot, 2003). According to table the following four regions experienced a large amount of FDI flows.

It is clearly seen that Hungary's state was dominant in foreign investment flows. Its economic condition was greater then in other regions and furthermore political relations with the western countries brought attention of foreigners. As the view of Hungary implemented beneficial infrastructure and economical ability to adopt foreign subsidizes. In addition, in its early sophisticated privatization strategy on state owned firms made favourable environment for foreign investors. Likewise FDI flows in Poland and Czech Republic also had experienced a fast growth. This rapid increase was experienced through acquisition of state owned enterprises that had involved foreign investors. The Slovak's FDI inflows entered later in contrast to Hungary, Poland and Czech Republic and therefore had the lowest rate. Although, in most cases its small sized enterprises were privatized by foreign investors. Through the government policy that could proceed with the well managed economic reforms and external relations with the neighbouring regions. The total stock of FDI inflows for country size by population and GDP analysed that Hungary and the Czech Republic have succeeded significantly then Poland and Slovak Republic. Nevertheless, these regions tended to recover faster in contrast to the CIS regions.

In the perspective of CIS regions, FDI stocks remain with low attitudes, despite their performance in accomplishing macroeconomic policy and managing relatively high growth rate. (Table 2.1.) illustrates that regions such as Kazakhstan and Azerbaijan have chased the largest proportion of FDI stocks, whereas Tajikistan demonstrated the lowest amount of FDI stocks.

Similarly, shares of FDI stocks in GDP for Azerbaijan and Kazakhstan have performed better. In terms of per capita of FDI stocks, regions as Kyrgyzstan and Azerbaijan have performed worthily, whereas Uzbekistan and Azerbaijan turned with the lowest rate. In comparing the result of FDI stock levels of Central European to Central Asian regions, the Republic of Kazakhstan, Azerbaijan and Russia were shown with the better perform attitudes. This impact followed with large inflows of FDI stocks in oil and gas fields. Nevertheless, these regions levels of FDI stocks are still smaller then in other central European regions. The case of such underperformance of the some CIS regions can be attributed by the tardiness in privatization, incapability and disinclination in reform strategies and inefficiency in transportation, a high level of corruption and allocation of infrastructures. In addition, much of the FDI assets are coordinated in transportation and extraction of mineral resources, and though this investment flows' offers slightly to the regions economic diversification. In article by Polanec (2004) stated that from the initial stage of transition process the macroeconomic policies were basically not related to economic bases.

On common aspect influencing the transition economies is political instability. This has been considered by assassinations of high ranking figures, authoritarian regime, and ineffective or corrupted governments that were not capable to solve such violences. According to Transition report (2007), its survey has analysed people's attitudes to political conditions, in terms of their satisfaction and dissatisfaction views during the past decade. Thereby, it represented that about 40 per cent of citizens of CEE claimed that the political conditions have been declined since 1989. For example, dissatisfaction was measured in Hungary by 75 per cent, despite to their economic performances. Similar views were presented across SEE regions by more than half per cent due to political deterioration and internal conflicts. This brought a high attitudes of dissatisfaction by it is political system in Serbia, Bosnia and Herzegovina. (Life in transition, 2007).

Likewise, in the CIS regions some of interviews stated their negative views on political system, but positive views were predominantly high particularly in Kazakhstan, Azerbaijan, and Belarus since the beginning of transition while, Ukraine and Kyrgyzstan responded negatively. For example, majority of Ukraine's citizens reported that their living standards declined since the political revolution took place in the country. In the way of foreign capitals, it is obvious that investors' activity based on future proceeds and the assurance that investors can place on their further investment. Therefore, the FDI nature requires estimation on political stability of host economies. Two principal threats of political instabilities can be considered that the investors mostly collide. The first one is domestic instability of host country that decrease profit ability of operating company. This follows by domestic sale and export reduction and production disruptiveness. The second circumstance follows by affection of the domestic currency that reduces the value of the foreign assets in the host economy. Consequently, FDI inflows in these regions are dissimilar from the similar host market economies owing to the effect of transition process. In article by Bennett and Green (1972), Singh and Jun (1995) and Cho (2003) have considered that reflect the political instability as an explanatory variable to economic characteristics of host regions. Deichman (2003) examined the implementations of the law regulations and general investment climate, either of these reflects political constancy and therefore, there are important aspects in the determinants of FDI activities into Eurasian transition regions.

4. Kazakhstan's Economic overview

The Republic of Kazakhstan is located in Central Asia and Europe, which is ninth largest country in the world. The territory of Kazakhstan covers a total area of 2, 7 million sq. km and it is bordered by Russia, Turkmenistan, Uzbekistan, and China and also landlocked by the Caspian Sea. Kazakhstan's south and centre areas are predominantly steppe with desert landscapes and the southeast regions covered by mountains. It is the second largest country of the Commonwealth of Independence States (SIC) after the Russian Federation and forth by population density. The population density is about 16 million and admittedly one of the sparsely inhabited territories in the world with a 5.8 population density per square kilometre. The country dominated by Islamic, Orthodox and other religions. According to the embassy of the Republic of Kazakhstan in the United Kingdom data's about 57 per cent of the population are Kazakh, 40 per cent of Russian and 3 per cent of other small ethnic groups (Bureau of South and Central Asian Affairs, 2008)

In context of the history Kazakhstan was initially inhabited as the nomadic tribes and at the end of 15th century was united as the Kazakh Khanat. Although by the 17th Kazakh Khanat was forcedly pushed under the control of the Russian Empire. In the yearly of 1936, the Russian Federation has declared that the formerly Kazakh Autonomous Soviet Socialist Republic became as the Kazakh Soviet Socialist Republic. After the collapse of former Soviet Union, in December 1991 Kazakhstan declared its independence and became member of the CIS. Since then Kazakhstan has chased the determined aim of transforming itself to a mixed economy from a centrally planned economy. Kazakhstan is a constitutional republic with a strong presidency and with a bicameral parliament such as lower house and upper house. Its president is the head of state and furthermore the commander in chief of the military forces (Baker&Mc Kenzie, 1999).

In the stage of economy, Kazakhstan is an extraordinarily growing economy with the well-managed macroeconomic and monetary policy. Admittedly management and market policy of the economy growth have been highly prosperous in the past few years. In the year of 2002 the United States Department of Commerce acknowledged Kazakh state with market economy status which is recognized by several reforms such as wage rate determination, state control over the all allocation and production resources and currency convertibility under the United States Law. Its GDP increased at the phenomenal and stable rate of 8-14 per cent annually over the last several years. The Kazakh government's aims to double percentage of GDP by 2008 and triple it by 2015 (???)

Its territory possesses plentiful natural resources such as fossil fuel reserves and other mineral and metal resources. For example, the state of Kazakhstan forecasts that they will be one of the largest world's producers of uranium by 2010. The agricultural sector also has great potentiality of the economic growth as its lands largely accommodate livestock and grain production. For instance, during the Soviet time, its territory has exported one fifth of the grain production, and about a fifth of the coal and iron industry. In addition, it was the sole producer of important sources such as chrome, lead, copper, zinc and tungsten over the Soviet Republics. Relatively machinery sector of construction equipment, agricultural machinery and building machinery supplied the Soviet market. The coal industry also supplied about a fifth of soviet production.

Nevertheless, the break up of the former Soviet Republics in1991 heavily affected to the economic growth, especially to the living standards, monetary system and industry sectors. Perhaps, more than any other states in the former Soviet Republics, Kazakhstan was under extreme requirements of foreign subsidizes to assist in restructuring internal economy. As the situation into country turned to be worse, for example, the net material product (NMP) declined by 37 % among 1991 and 1993. Inflation considerably grew up by 1,200 per cent. Another example demonstrates by (Table 3), where industrial output fell by 27.2%. ( Kalyuzhnova 1998)

More then half of industry units have occurred in the 1960th and therefore were in require of substantial subsidizes and upgrading. Inasmuch as the facility of operation and production productivities were under capacity rate. For instance, three Kazakh oil refineries were set up in the middle of 1970th, and average production level of heavier fuel was taken by 31 per cent in 1991 (Terterov, 2004).

Moreover, predicaments with the Russia's Nacbank banks led to leave the official currency of the Russian Federation in 1993, and this brought into Kazakh currency tenge which is consequently devalued approximately by 85 per cent by the following years. Its manufacturing industries were poorly confined, as the large inflows of subsidizes were arriving from the Soviet Union. Nevertheless, after assistances of several agencies such as the WB, IMF, ADB and USAID, it brought down inflation rate by persuaded macroeconomic stabilization policies. A number of national institutions were set up as the National Bank which is afterwards received regards from international investment agencies for its capability to flight inflation. The Republic of Kazakhstan was capable to attract massive amount of FDI inflows predominantly in the fossil fuel and energy resources. Therefore, foreign capital and trade have been demonstrated an influential portion of the country development. According to report of the Kazakhstan Republic president Nursultan Nazarbayev has claimed that, Kazakhstan continues to attract major of foreign investments per capita in CIS. From 1993 to up to current time the volume of direct foreign investments reached almost $ 40 billion. Moreover, $4 - $4.5 billion of FDI since 2001 and in 2004 their volume reached $8.4 billion (Kazakhstan Today 2005). Its government has established economic reform policies to privatize the small and medium sized enterprises into private and foreign hands that afterwards had been success of transferring state enterprises. The privatizations of state enterprises were divided into three classes:

-Small scale privatization of enterprises was issued through auction and tender

-Medium size enterprise shares were sold by voucher funds to all citizens

- Privatization of large enterprises was followed step by step

Reforms of banking and financial sectors were introduced simultaneously price liberalisation policies were completed. Its financial cooperation has been expanded with many financial organisations, such as the EBRD, ABD, ICF, IBD and so forth (Offices-Kazakhstan, 2007). According to EBRD's report agricultural production has increased by 2.2 per cent, however, productivity of livestock was lower comparing to pre-independence period.

Nevertheless, by 1998 the Russian national currency turned into fiscal crisis, and at the same time Asian crisis came down with the economic instability of the Asian regions, its consequences affected economic situation of Kazakhstan. As the fuel prices were slumped and supply demand of oil commodities were reduced from Asian regions. For instance, the country's GDP rate went down by 2.5 per cent. In spite of this, foreign subsidizes and high fuel prices led Kazakhstan to a speedy economic recovery (Terterov, 2004). The modest growth was attained among 1997 and 2003 as the total value of FDI reached $21.2 billion, and since 2000 to 2008 the GDP growth attained stable growth and increased by 9.1 per cent. This has offered an important prospect for the Kazakhstan economy to expand its infrastructure sectors and to create further sustained country's growth.

4.1. Investment environment

Attracting FDI activities basically generated conditions for improvement of industrial structure of economy of Kazakhstan. These enhancements followed by creation of new hi-tech technologies, modernization of a fixed capital and modernisation of local enterprises, an effective utilization of labour force, and by introducing the advanced field of management and marketing sector. During the transition period of the Republic of Kazakhstan to open market attitudes several legislative reforms were established. On February, 28th, 1997 the Republic of Kazakhstan has launched a legal law on a state support for FDI, in which foreign investment regulations authorized by Kazakhstan state. In addition, by the president decree statement about attraction of direct domestic and foreign subsidizes the list of priorities were established. This had approved by the rules of granting privileges and preferences for realization investment activity.

The trend followed by realization investment activities in manufacturing sector, agriculture, habitation objects of social sphere and tourism, and in oil and gas sectors. According to Kazakhstan today, the leading investment flows were arriving from the United States by 24.7 per cent, the United Kingdom 15.3 per cent, Switzerland 12.8 per cent, Italy 11.5 per cent and the Netherlands by 9.9 per cent. Yet, in most cases foreign subsidize has been in the type of loans by joint venture agreements. Another review considered by international expert's research that, the Kazakhstan State obtained approximately 80% of FDI among transition countries. The WB's report stated that Kazakhstan is number 20 of the countries of the world attracting the greatest volumes of the investments (Offices Kazakhstan, 2007). The table below illustrates the receipt of the FDI from different countries

Due to its oil and gas sectors extraction that directed such a largest amount of foreign capital. Regarding to the most recent estimation Kazakhstan's holds 23 billion tons of oil and gas reserves and 13 billion of those reserves gathered in the Caspian shelf. Its National Bank issued that for the first half year of 2002 exports of crude resources reached $800 million. In other words, exports of oil and gas stocks counted 53.2 per cent of the total economy value (Investment Guide for Kazakhstan, 1998).

To create such a positive environment the government has implemented a high priority of legal law that attracted foreign investment. The new law regulation considered the benefit of certain guarantees, protection for long term investment, and furthermore favourable tax privileges for the foreign investors. It was placed by to laws such as the FIL and the LSSDI. The FIL applies for fundamental legal structure of protections and privileges that presented obligations of foreign investors supplying their direct or portfolio subsidizes in Kazakhstan and Kazakh enterprises joining with foreign companies. The LSSDI executes the certain privileges for investors concluding contracts with the Kazakhstan Investment Committee. It offers three policies such as:

- a system of privileges and preferences for investors

- a system of legislative guarantees for investment activity

- the establishment of a single state agency authorised to

represent Kazakhstan in its relations with investors

(Investment Guide for Kazakhstan, pp44, 1998)

As was mentioned above several international agencies have been participated into Kazakhstan market that brought sufficient amount of investment founds. Some of these investment agencies were implemented, as their involvements have been shown with the high attitudes to domestic markets. Admittedly, the EBRD stands as one of the largest investors in Kazakhstan field. Its strategic policies are to promote the transition regions to an open market, and furthermore to support private and entrepreneurial sector across transition regions. By providing infrastructure development and economic diversification through maintaining small and medium sized enterprises (Terterov, 2004).

According to EBRD's report, by the 2002 its investment had loaned 818 million euros to Kazakhstan entrepreneurs. These investment flows have been participated in offering assistance programmes for warehouse, leasing brokers and to other trading sectors. In addition, its investment funds have been played significant role in the development of two programmes such as the Eagle Kazakhstan Fund (supporting newly privatized firms) and the American International Group's Silk Road Fund (assisting domestic sector). The International Finance Corporation (IFC) agency presents itself in development supporting of private sector of the Kazakhstan Republic. Its investment funds had reached 400 million of US dollars by the 2003. The IFC forms of investment activities followed by loans and credits to Kazakhstan's domestic banks, and furthermore, it has supplied loans and purchased equities in oil and gas fields. This follows by Lukoil's share of Karachaganak, Kazgermunay's Akshabulak and FIOC's Sazankurak (Terterov, 2004). Another investment agency was established by Andromeda Financial Services that involved in investment advice services to local and foreign business clients in Kazakhstan. Its investment funds have been participated in medium sized industry sectors. Surely, there are several local agencies that also involved in the domestic investments. One of these agencies named as the Kazinvest that promotes investment activities within Kazakhstan. Its policy primarily stands on non oil and gas sectors and moreover assists domestic companies to attract foreign capitals. Another Kazakhstan's largest domestic investment agency is Kazakhstan Development Bank. Its attitudes in Kazakh market are to invest medium and long term projects. The bank promotes its investment funds over the all domestic sectors by providing 5 million of US dollars investment in any local companies. In general the environment of investment activities in Kazakhstan market seems to have potential development that promotes economic growth of domestic sectors (Terterov, 2004). The total amount of investment inflows have been obtained 42 billion of US dollars, in terms of FDI 23.2 billion, in portfolio 2 billion and in other terms 16.6 billion of US dollars. However, more than half of the FDI funds promote Kazakhstan's oil and gas field. As the country implements itself as the resource-based economy in the energy world, and thus its natural resources play's an important role. The next chapter will implement Kazakhstan's natural resource fields.

5. FDI's problems and challenges.

5.1 FDI's in oil and gas sector.

With regards to the natural resource wealth, perhaps Kazakhstan is famous state in the worldwide arena by its natural resources. It sits close to the northern part of the Caspian Sea and maintains a large proportion of oil and gas fields. According to statistical review of the world energy, it has estimated overall Kazakh proven reserves by 79.6 billions barrels of oil, which is equivalent to 3.3% of world reserves and furthermore, its gas filed estimated by 1.7 per cent of world gas reserves in 2005. (The Economist 2006) Kazakhstan's oil production was approximately equivalent to 1.45 million barrels per day in 2007. Its consumption has reached 250.000 barrels per day by respectively increasing net exports by 1.2 million barrels per day. Likewise, production of natural gas and coal has been shown with the great attitudes, while consumption of these sectors has seen declines since 1992. However, according to recent updates consumption of those products has been increased particularly in oil field. Table 4.1 and 4.2 illustrates Kazakhstan's energy production and consumption since 1992 to 2005. According to table from the early transition period Kazakhstan's oil and gas sectors production and consumption has been increased significantly, due to its FDI inflows. As Ahrend (2006) pointed out that Kazakhstan stands for natural resource based country. Generally is characterized as one where mineral possessions estimate more than 10 per cent of GDP and 40 per cent of exports.

The FDI inflows in oil and gas fields have brought more than 22 billion of US dollars, and subsequently several joint projects were established with foreign investors. There are three largest consortiums such as Tengis, Kashagan and Karachaganak fields that jointly operated with the foreign investors (EIA, 2008).

The Tengiz is one of the largest oil fields in the world industry and consequently the largest producer of Kazakhstan's oil industry. It is located in the western part of Kazakhstan along to the Caspian Sea. The Tengis field was the first joint venture contract with the Chevron that brought into consortium in 1993 and since that time has been developed under the TCO. Companies such as, the Lukoil (Russia), Exonmobile (US) and Kazmunaigas (local company) have joined to this consortium. Its production coefficient has estimated 280.000 barrel per day in the 2007, and its consortium partners had estimated 9 billion barrels of oil crude in recoverable reserves. Regarding to Chevron's report the Tengiz field could possibly turn out to 700.000 barrels per day with the sour gas insertion project (EIA, 2008).

The second largest consortium stands behind the Kashagan field. In terms of oil crude, it is the fifth largest field in the world oil industry. The Kashagan field sits near the northern site of the Caspian Sea. This field mainly operates with the AGIP KCO. The field has estimated 13 billion barrels of oil crude in recoverable reserves. According to official spokesman of Kashagan consortium the production of oil crude would produce 300.000 barrels per day by the 2011. The field considers other foreign companies that have been participated in this consortium. The list follows by ExxonMobil, Inpex (Japan), Philips Petroleum (US), Shell (UK), and Total France (EIA, 2008).

Another Kazakhstan's largest oil and gas field is Karachaganak, which is located in northern part. The production of natural gas turned out to produce 250.000 barrels per day in 2007, and it reserves approximately 9 billion barrels of gas and oil. The field operates under the KPO consortium. The company's policy is to triple its productivity investment by 10 billion of US dollars within 7 years. The following table 4.3 demonstrates the foreign investor's shares in the Kazakhstan consortiums field (EIA, 2008).

5.2. Kazakhstan's oil boom.

In recent years Kazakhstan's economic growth has been remarkably increased. Due to its natural resource fields that has been seen massive funds by foreign investors. It's catching up policy with high income countries primarily based on the prospects of its natural reserves through booming its production exports. As the country's economic growth heavily depends on mineral resources, and thus the mainstream of FDI stocks mainly exists in oil and gas fields. Economic studies suggested that such circumstances propose macroeconomic stability, which boosts and accelerates economic growth of the hydrocarbon countries. As the possession of such large natural resources is perhaps a most important advantage to rapid economic growth of any country. (Auty 2006) On the other hand, along with prosperity growth there are also threats. It can be implemented by socio-political aspects that influence development strategy of the country. In terms of political inability to sustain stability of economic policy, that leads to concentration on a specific market. (World Bank, 2005)

In the Kazakhstan market, the existing structure of FDI inflows, in fact has fixed oil and gas fields orientation of its economy. For instance, if the mineral sector in 1998 had received 41.6 per cent of the total amount of investment funds, in 2000 it's already had received 61 per cent. (Foreign Investment in the Republic of Kazakhstan 2006) This undoubtedly, highlights Kazakhstan's concentration on oil products consumption. In such perspective country's growth might turn down to fluctuations in world commodity prices. If the Kazakh government will continue such a narrow oil boom policy further without developing consumption of other industrial sectors, then it might bring to a highly volatile growth, as in the pass Venezuela's economy had faced with such predicaments. In the case of Venezuela's economy its income per capita had been tripled within eight years. (Table 5.1)

Owing to, the upsurge of production exports that caused by high oil crude prices and undoubtedly this led to an increase in domestic spending. In retrospection, it is clearly seen that such boost in income was vulnerable fluctuated. As the other sectors of Venezuela's industries basically were implemented to serve the oil field consumption, and therefore, productivity growth in domestic sectors were not achieved. Certainly, the government of Venezuela had been persuaded several policies to diversify its economy, and this led them to utilize their oil capitals to industrialize its large scale infrastructure projects, while human capital was not taken into account. Therefore, afterwards Venezuela's social indication had been declined significantly and the country could not attain its diversification purposes. Such consequences brought to difficult periods when the costs of oil crude had declined remarkably and thus by 1990s Venezuela's income per capita deeply went down, and it accounted about 2500 of US dollars (World Bank, 2005).

According to Karl's book about The Paradox of Plenty: Oil Booms and Petro-States, it has examined Venezuela as a classic example of a state that found oil booms holding it captive to a particular path of underdevelopment, rather than providing the hoped-for resources that would serve as an engine for wider development (Karl, pp 63, 1997). Even so, by the time it has been improved its economy condition with the new oil bonanza. Likewise, Kazakhstan's government persuades such strategy by tripling its income in a short period, and certainly concern such vulnerabilities of oil prices that might badly cause their economy. Its economic policymakers claimed that they would avoid such adversity cases that happened in Venezuela's oil boom period. However, if the country will continue to base on its high volume of oil consumption, then further process of Kazakhstan economy might be harmful to sustain its economy through low oil price period, which undoubtedly will come. As the changes in oil prices lead to the variation of GDP rates. For instance, in 2002 the oil price fluctuations in Kazakhstan economy had made changes in budget revenue by 100 million of US dollars (Tsalik and Ebel, 2003). To turn away from such process some economic theorists have been analysed the competitiveness of the non oil domestic sectors. Their observation analyses implemented that initial conditions of domestic sectors are far behind from its oil and gas sectors, in terms of the competitiveness and diversification index of non oil industrial sectors. In comparison the non oil sectors the table bellow implements investment funds composition.

In addition, their observation analysed that Kazakhstan's dependence on oil and gas field will inevitably rise in the following years. This however might lead to Dutch Disease phenomena, which provides unfavourable impacts on non oil industrial sectors (IMF, 2004). The article by Luong (Kazakhstan: The Long-Term Costs of Short-Term Gains, pp 80, 2005) noted that:

if current trends continue, Kazakhstan will emerge as a quasi-state

- that is, one with international legitimacy but without the domestic

capacity to generate sufficient revenue, address basic social

problems, and promote even minimum levels of economic growth.

In fact, reach oil nations are admittedly more volatile, and therefore, it is not so easy to create an encouraging atmosphere for investment and development in tradable sectors. Nonetheless, such unfavourable circumstances can be vanquishes with well managed structural strategies, in terms of, the stable macroeconomic environment, skilled labour force, suitable cost and quality of infrastructures, innovations and R&D, sustainable government institutions and sector policies. The diagram below implements more detailed examples of structural strategies. (World Bank, 2005)

According to Kazakh policymakers several government institutions were established to fight against volatility of oil prices. The Kazakhstan National Fund (NF) was built in 2001 to assist in reducing the impact of the fluctuation of market prices on the country and to improve the dispensation of oil and gas wealth productivities (Tsalik and Ebel, 2003). The NF stands to exemplify it task as stabilizing the socio-economic development of the country, accumulating savings for future generations, and reducing the country's vulnerability to external factors (Kazakhstan National Fund). Its policies attempt's to provide stable savings and stabilization intentions. In the perspective of savings objective, it proposed to support steady incomes for future generations in the case of price decline of oil products. In the outlook of stabilization objective, it turns to stabilize the income of oil and gas field productions by compensating difficult periods with the funds from the high oil performed productivity years. The NF's investment funds operate in two portfolios such as, saving portfolio with the 75 per cent of assets and stabilization portfolio with the 25 per cent. Its strategies have been rationalized, since the institution was established and by the 2005 it has accumulated $5.2 billion of funds (Kaizer and Pulsipher, 2006).

5.3. Political intensity upon foreign investors.

Since the independence of Kazakhstan state the national natural fields have seen the first flows of FDI in the oil and gas sectors. This led to presence of multinational oil companies to develop initial stages of oil and gas fields, as the country was lacked in terms of finance, technology and experience to expand its natural production fields. To sustain and improve economic condition the Kazakh government have sold large-scale oil enterprises by providing favourable conditions to foreign companies. The results afterwards had an impressive reflection approximately 85 per cent of the Kazakh oil shares were partially controlled by foreigners. However, these investment conditions gradually started to change as the country's economy became more efficient (EBRD, 2004). The government's pressure on foreign companies has been increased and its policies persuaded foreigners to participate in the oil and gas fields to insure and to gain control over all mineral profits for the domestic economy. Subsequently, most of previous PSA contracts with foreign companies were reconsidered with purpose to amend initial conditions of the very favourable oil contracts that were created in the early of 1990s. The government's amendments to petroleum and mining regulations were issued in 1999. Since, then has been pushed forward foreign companies to utilize local technologies and services.

A number of legislative reforms were issued one of them stands beyond a new tax regulation, which had introduced a progressive rent tax agreement on exports, as the tax percentage coefficient increases as the price for oil rise, and moreover, proposed significant changes on foreign investors guaranteeing tax rate legislations. The new regulation on PSA considered the state oil companies participation with the 50 per cent sharing over all projects. Moreover, as a component of the reform regulations, the government has implemented the national oil company Kazmunaigaz (Schofield, 2002).

According to Oxford Analytic Brief (2002), the president of the Kazakhstan Republic issued about the unification of state's oil and gas production companies such as Kazakhhoil and Transneftegas into a single concern to implement as a new national state owned enterprise Kazmunaigaz (KMG). The state company was established in 1997 as the inheritor of Kazakhstan's Ministry of oil and gas, and has estimated more then $2 billion assets of its total value. The initial strategy of the KMG is to provide efficient development of hydrocarbon sectors, and to expand income savings of the Kazakhstan national budget. As the KMG was unified by two state holding companies, it has been amalgamated all affiliated units of Kazakhoil and Transneftegas (Table). Since the company was established, it has been taken a significant role in the offshore zones of Caspian basin to develop Kazakh oilfields, and thus, its exploration and production channels expanded remarkably. Admittedly, the establishment of KMG was focussed to boost national control in the hydrocarbon sector by making it more enable to interact with international oil companies on an equivalent basis.

In recent years, president of the Republic of Kazakhstan, Nursultan Nazarbaev has passed governmental amendments to the Subsurface Law that allows the government to make changes or annul the oil and gas project contracts, if there is critical situation that threats the country's national safety (Cutler 2007). This was partially explained by the KSO consortium delays. In 2001 the president of Kazakhstan declared four conditions for the KSO as company was main operator in the Kashagan field. The conditions followed in terms of, first oil crude output by 2005, local labour f

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