Foreign direct investment (FDI) is becoming an increasingly interesting topic, especially in transition economies. Several papers, special journal editions, and conferences are devoted, at least in part, to issues such as motivation behind FDI, its impact on the host country's economy, and its impact on marketing, management, and other aspects of enterprise development in the host country. FDI is important because it provides investment necessary for economic growth and development of technology that domestic savings cannot provide. Developing countries, including transition economies, often have very low levels of domestic savings due partially to low income levels coupled with high inflation. FDI brings benefits to developing countries such as knowledge in the form of improved technology and management skills, much-needed financing that could be difficult to come by in the host country due to high borrowing costs, and positive spillover effects that extend beyond the firm receiving the FDI. In transition economies, this is especially important because much of the production during communist rule used older technology, and research and development activities stagnated, especially during the 70's, 80's, and beginning of the 90's, due to lack of incentives (Borsos-Torstila, 1997).

Results of studies done previously indicate that there is still potential for increased FDI in transition economies. These countries have received a relatively small share of total FDI worldwide, especially considering their high growth rates (Hirvensalo and Hazley, 1998). Compared to other groups of emerging markets, many transition economies have lower levels of FDI per capita. Investment to GDP ratios in transition economies are also lower than those in Asia, closer to those of Latin America (Heinrich, 1995). Of the Baltic Rim transition countries (Estonia, Latvia, Lithuania, Poland, and Russia), only Estonia has FDI to gross investments and FDI to GDP ratios that approach those of small open market economies (Hirvensalo and Hazley, 1998). This observation underscores the important role risk assessment plays in an investor's choice of investment location. Risk is difficult to measure accurately and consistently, and investors' sentiments are likely to play a more important role than actual economic conditions. Estonia has a good reputation among former Soviet Union (FSU) and Central and Eastern European (CEE) states as being a country committed to market reform and economic stability. Recent events such as being admitted to the first round of EU accession talks and receiving relatively high credit ratings by international ratings agencies are some indicators of international confidence in Estonia. FDI figures indicate that the cumulative level of FDI per capita in Estonia from 1989 to 1997 was higher than in any other FSU country and below only Hungary and the Czech Republic (EBRD, 1998; see Table 1[2] .

If one assumes that FDI is beneficial to the host country, the next questions that arise are how and why do foreign investors choose one country over another, what are the motivations behind FDI, and how can a host country retain the investment already there. The purpose of this paper is to look at the investment climate in Estonia as evaluated by foreign investors based on motivational factors behind FDI and difficulties encountered and to compare it with that of other transition economies. Using data from the most recent and most extensive survey thus far on FDI in Estonia, the following issues are examined: primary motivations for investors, the difficulties they face, and their overall evaluation of the climate. These results are compared with other studies done on Estonia and other CEE countries that focus on investor motivation and problems encountered. The first section provides a short overview of the literature and methods of studying FDI. The second presents the results of the recent survey and is followed by a review of other studies. The final section concludes with a discussion of possible directions for future research in this field.

Estonia is an interesting case because it is attracting a considerable amount of FDI. Although a small country, when comparing measures such as FDI per capita and FDI as a percentage of GDP with those of other CEE states, Estonia is one of the top FDI-attracting countries, especially among FSU states that had to build up an institutional framework from scratch. Several reasons can be given for this on a general level. First, Estonia has projected a credible, reform-minded image from its earliest days of independence. It was the first FSU country to introduce an independent currency. The subsequent establishment of the currency board system added to its credibility. Estonia adopted a liberal, open economy and a policy of a balanced budget in the early years when other transition economies were running government deficits and protecting some industries. Privatization through tenders rather than vouchers or management/employee buyouts, which are the primary methods in most transition economies, has also facilitated foreign investment as has the rapid development of the banking sector. The level of risk in Estonia is relatively low; looking at country credit risk ratings, Estonia is only behind Slovenia and the Czech Republic. Location is also important; most of the FDI in Estonia comes from Finland and Sweden (see Table 2).


The body of literature on FDI is large and covers a broad range of both theoretical and empirical approaches[3] . Earlier theoretical studies that attempt to explain the existence of FDI focus on cost and demand factors, often assuming perfect markets. In this case, FDI can be explained by the desire to obtain a higher rate of return on investment or by portfolio diversification. In the former case, interest rates, and hence, the marginal product of capital, are higher in developing countries, and therefore it is profitable to engage in FDI. In the latter, FDI serves as a means of decreasing the risk of the corporation's 'portfolio'. When market imperfections are acknowledged, FDI is a means through which a firm can gain if it possesses certain advantages that host country firms lack that outweigh the disadvantages of operating in a foreign environment. The most common advantages include technology, managerial skills, and cheaper financing. More recently, a new approach to FDI has arisen in the field of industrial organization that focuses on strategic action of firms. This method uses game theory and strategic bargaining models to endogenize the comparative advantages of FDI (Konings, 1995).

Empirical models that examine reasons for FDI do so at both the micro- and macroeconomic levels. One difficulty that must be noted concerning empirical FDI work is the shortage of good data. Availability of reliable data for several years varies widely among countries, and is of particularly poor quality in the CEE/FSU, relative to other emerging markets[4] . Using panel regression allows researchers to increase the number of observations while at the same time facilitating comparisons among transition economies, but there is no solution for the problem of the less credible data that was collected in the earliest years of transition. Macro-oriented studies try to explain FDI flows between countries or regions or flows into a specific country or region using macroeconomic or country-wide data (for example, Landsbury, Pain and Smidkova, 1996, and Wang and Swain, 1995). These are easier to test empirically because much of the data needed for these types of studies are collected by governments, but because the results are generalized for the entire country, they fail to reveal differences between industries within a country and between different types of firms. Macroeconomic studies of FDI motivation are useful because they can reveal to some extent how important factors such as the perception of macroeconomic stability and GDP growth are to foreign investors in general, but they do not address the issue from the firm's point of view.

The great diversity among theoretical approaches to FDI motivation indicates that there is not yet one single widely-accepted theory of FDI (Konings, 1995). Microeconomic studies have the advantage of being able to identify specific characteristics of groups of firms divided by industry, export orientation, or some other factor. These models can be based on data from firms' balance sheets and income statements or on more subjective data. Some of these theoretical models are difficult to test empirically; for example, it is not easy to quantify firm characteristics such as technical know-how and marketing expertise. Not only is it true that the data itself is difficult to measure, but the data are not generally collected from individual firms on a regular basis in every country. Often micro-level studies turn to surveys and questionnaires as a source of useful firm-specific information. Regarding FDI motivation, this is one of the best ways to find out exactly why firms chose to invest in a foreign country. Surveys can employ both open-ended and ranked-response questions. The former are much more revealing in terms of actual information, but the question arises as to how useful is this type of information when comparing a large number of firms. Ranked-response, yes-no, and other types of quantifiable questions can easily be compared and analysed, although at the expense of providing less-detailed information.


This particular survey of foreign investors is a continuation of a project that was begun last year by a group of researchers at Tartu Ülikool (University of Tartu) and Eesti Välisinvesteeringute Agentuur (the Estonian Investment Agency; EIA). The scope of the survey is extensive, covering topics including transfer effects, financial information, export data, composition of the workforce as well as the items discussed in this paper. Results of last year's survey are published in Varblane, et al (1998), which provides the most extensive study on FDI in Estonia thus far. The survey consists of two parts: a financial section containing questions requiring numerical data on profits, turnover, share capital, etc and a questionnaire requiring subjective answers, usually ranking on a scale of one to five. The 1997 survey follows the same format as in 1996, but a few modifications have been made and some new sections added. The scope extends beyond motivational factors and problems, but discussion in this paper will be limited to these topics. Where possible, last year's data are presented for comparison. Ninety-two foreign firms representing 124 foreign investors responded to at least one part of the survey, and 73 investors responded to at least some of the questionnaire[5] . The figure below represents the origin of respondents to the questionnaire and accurately reflects the large share of FDI coming from Estonia's close neighbours, Finland and Sweden. One difficulty with surveys of this type is consistently obtaining complete responses. Having the survey completed in the presence of the researcher is one way to solve this problem, but this solution is not practical in this case due to time considerations of both the researchers and the respondents, most of which are managing directors or other senior executives (see Figure 1).

We first look at motivational factors which have been divided into two categories to make graphical presentation easier (see Figures 2 and 3). The first can be called economy characteristics and refers to benefits that are due to locational factors, past reforms, and the overall economic situation in Estonia. The second category is resource factors. Participants were asked to rank on a scale of one to five (one is 'none' and five is 'significant') the influence of each factor on their investment decision, and these have been averaged. Market entry is the most important motivational factor with a score of 3.94 followed by market growth potential (3.77) and the Estonian workforce (3.69). The relatively lower scores for access to Russia/CIS and EU markets and the small size of the local market indicate that most firms surveyed are interested in Baltics and CEE states. Surprisingly, access to the EU is the least motivating factor for foreign investors (2.16) followed by raw material availability (2.69) and competitors' activities (2.83). Considering that most of the respondents are from Finland (42%) and Sweden (19%), one possible explanation is that these countries, especially Finland, are motivated primarily by Estonia's close geographical proximity, which was not listed as a choice, and view Estonia as a local market. However, removing these countries does not alter the result for EU access significantly[6] .

The biggest problem faced by foreign investors is with VAT (value-added tax) payments and rebates (3.25) [7] . According to a study done by the Foreign Investment Advisory Service (FIAS, 1997), there are no provisions to defer or eliminate payment of VAT for VAT-exempt items. Although firms do receive a rebate for the VAT paid, it is a slow process, not going into effect until the firm starts exporting, and for expensive equipment, translates into high costs for firms. The quality of labour is also considered to be a problem (3.09) which contrasts with the above results listing the Estonian workforce as one of the chief motivating factors. However, the workforce is certainly not homogenous in terms of required skills; one problem Estonia has is a lack of personnel with managerial skills, although the reputation of skilled technical workers is quite good (Larimo et al, 1998; FIAS, 1997; EIA, 1997). The absence of export and import tariffs is ranked as the least problematic factor (2.10) which lends support for the liberal economic policies Estonia has enacted. Unfortunately, the 1996 survey did not include a section on problems encountered by foreign investors so a comparison of the latest results cannot be made (see Figure 4).

In order to fully assess the investment climate, it is important to look at how the government and its policies are perceived by foreign investors. Results for the past two years are fairly consistent with only one category changing more than half a point, the EU Association Agreement, which received one of the most positive evaluations due most likely to the recent decision to include Estonia in the first group of new members. Although access to the EU is not an important motivational factor, it does appear that foreign investors do welcome Estonia's future membership. This factor received an average score of 3.42, between 'acceptable' and 'good'. The ability to repatriate profits was the policy ranked most favourably in 1997 (3.53). Although all of the government's activities listed received scores close to or above the 'acceptable' level (3.0), ease of conducting business received the lowest score (2.82) indicating that there is room for improvement in areas such as bureaucracy, corruption, and the regulatory environment (see Figure 5).

Respondents were asked to evaluate how certain factors had changed since the time of their initial investment. This information is useful because it indicates how policies have changed and whether more adjustments are necessary. Unfortunately, this survey does not ask the time of initial investment which makes it difficult to fully assess the effectiveness of policy changes. Most factors, on average, were between 'unchanged' (3) and 'changed for the better' (4) with the telecommunications system and the banking sector receiving the highest scores (3.88 and 3.65, respectively). These scores indicate that infrastructure is developing in a positive manner which is very important for foreign investors. The only factor to receive a change for the worse rating was access to Russian/CIS/Eastern European markets (2.73), most likely due to double import tariffs imposed by Russia and the lack of a double taxation-avoidance treaty between Russia and Estonia. A similar question was asked in 1996 survey, but due to the use of a three-point scale, they are not directly comparable. However, the results are similar; the banking sector and market growth potential received the two highest average scores, and eastern market access received just below an 'unchanged' score. Questions regarding the impact of potential policy changes were also asked. Lower corporate income tax was the most popular of the four with an average score of 4.2 indicating a change for the better. The remaining three were regarded as having a negative impact on business, these were a customs tariff (2.2), a devaluation (2.86), and a revaluation (2.2).


Several surveys have been done on various aspects of FDI in Estonia and other parts of Central and Eastern Europe. In this section are presented a sample of those that discuss investment motivation and problems encountered by foreign investors. Answers to these questions can shed light on not only why a particular country was chosen in the first place, but also why it was chosen over other countries located nearby with similar cost levels. For each case, the survey is briefly described in terms of both methodology and content. The surveys discussed here do not constitute a complete list of studies done on FDI in transition economies, but do provide a sample of recent work.

The oldest study on FDI in Estonia considered here is Glaros (1996) which focuses on investment coming from the US companies and looks at the motivating factors, advantages of investing in Estonia, and disadvantages of investing in Estonia. This study was done while the author was interning at the Estonian Investment Agency (EIA) in the summer of 1996. He surveys seventeen companies of varied size and business interests using a written questionnaire which is included in the paper along with the data gathered. The questionnaire is divided into four parts: general information, factors motivating investment in Estonia, investment experiences thus far, and how the EIA can better serve foreign investors. After a presentation of general results by topic, detailed information on each of the participant companies is included. Both open-ended and ranked response questions are used, although the latter is the predominant question type[9] . The sample size is quite small (seventeen firms), and case studies of all firms interviewed are included.

Results indicate that market access is the most important reason these firms came to Estonia (1.87) followed by enterprise expansion (2.14) and trade expansion (2.29) [10] . Protection of existing markets (3.45) and lower costs of production (3.08) were the two least important motivating factors. The biggest advantages of investing in Estonia, according to an open-ended question, were market access, a highly educated and skilled workforce, and potential for economic growth. Small market size, excessive bureaucracy, and the possibility of future problems with Russia were the greatest disadvantages. The biggest problems encountered by investors were availability of finance capital (3.89), residency requirements (3.67), and the level of government assistance (3.64) [11] . Labour related factors and market access gave investors the fewest problems: labour productivity (2.07), workforce and labour relations (2.21 each), and market access (2.25). Recommendations for improvements to the investment climate included improving bureaucracy, infrastructure, and access to legal information.

Although the results of Varblane et al (1998) that are directly related to this paper have already been discussed in conjunction with the latest survey results, it is worth expanding on the content of the study since this paper is intended to provide a survey of the literature as well. Chapters in this booklet include patterns of FDI into Estonia, the Estonian investment environment and its influence on FDI, the role of the government influencing FDI, transmission effects accompanying FDI, FDI's influence on exports, and a comparative analysis of domestic- and foreign-majority capital firms' competition[12] . Each chapter contains extensive empirical analysis as well as theoretical discussion of the topics at hand. Where appropriate, results are broken down by industrial sector as well, and relevant data from other transition economies are included for comparison.

This study looks at differences in responses of the surveyed group based on export orientation. Survey results indicate that export-oriented and non-export-oriented firms evaluate certain motivational factors differently. Although for the most part, both groups ranked the seventeen different factors listed similarly, there were some differences. The workforce was the third most important factor among export-oriented firms but ranked eleventh among non-exporting firms. However, looking at the actual scores (3.4 and 3.12, respectively), there is minimal difference in magnitude. A greater discrepancy can be found in responses to availability of ports and infrastructure development, which were ranked fifth (3.47) and seventh (3.41) by non-exporting firms and eleventh (2.95) and twelfth (2.87) by exporting firms.

The remaining two studies on Estonia discussed here focus on difficulties faced by investors, rather than motivational factors, although these are discussed briefly. This is important to analyse as well because current difficulties directly affect future investment, both from already-established firms and firms coming to Estonia for the first time. 'Estonia: Diagnostic Study of the Environment for Foreign Direct Investment' (FIAS, 1997) was put together for the Estonian Investment Agency (EIA) by the Foreign Investment Advisory Service (FIAS) which is associated with the World Bank and the International Finance Corporation. The focus of this paper is to extensively examine problems foreign investors are having in Estonia and to recommend solutions. The study addresses three types of problems: those that are of immediate concern to the investor, those that are likely to arise over a longer time horizon, and those that emerge while implementing policy or regulations. The FIAS gives a very detailed account of difficulties faced by investors and recommends measures to be taken to remedy the situations. According to the results of the FIAS survey, the problems foreign investors have in Estonia are small compared to the advantages they gain from investing there. The discussion is limited to a brief outline of some of the more general problems and omit a discussion of policies recommended by the agency.

FIAS interviewed twenty-two firms using a series of open-ended questions. FIAS did not use a structured questionnaire, but asked broader open-ended questions about issues including tax policy, land availability, prices, and quality, regulatory controls, and privatization. The firms of the investors they interviewed were from several countries and were of different sizes. Two law firms and two accounting firms were included in the survey primarily because they have had much contact with other foreign investors in a professional capacity and are aware of particular problems these firms have had.

Although the study concentrates on difficulties associated with FDI in Estonia, it does discuss advantages of choosing to locate there and future prospects for FDI in Estonia. First, Estonia is generally regarded as being investor-friendly with relatively few restrictions. Estonia's reputation for economic stability and credible reforms also surpasses those of neighbouring transition economies. Labour costs are low while the education level of the labour force and its productivity are high. Regarding the future of FDI, it is difficult to say whether it will continue at the same level. Privatization was a big influence for some earlier companies and, according to the FIAS, as the number of privatization projects remaining falls, FDI could also decline. However, if studies like this do serve their purpose and result in positive policy reform, then investors who are more risk-averse could be attracted to Estonia. If this effect outweighs other investment-detracting factors such as increasing costs, then FDI could rise.

Immediate problems include land acquisition, work and residence permits, the Commercial Code, licensing, and VAT payments and rebates. Although it is legal for foreigners to own land in Estonia, in practice, it is very difficult to do; often firms own the buildings and structures, but lease the land on which they are located. The root of many of the smaller problems associated with land acquisition is the land restitution process; land cannot be sold until it is returned to its rightful owner, and this process is expensive and time-consuming. Problematic issues surrounding work and residence permits include yearly quotas, extensive health tests required to get the permits, and a complicated and time-consuming application process. It is worth mentioning that partially as a result of this study, a new business visa has been introduced patterned after the US L-1 visa, granted in place of a work permit and designed to be easier to obtain[13] .

Complaints surrounding the Commercial Code, which is patterned after German Commercial Law, include the requirement that at least fifty per cent of the managing directors for both limited liability and joint-stock companies be Estonian residents and the lack of experience of the judges who must settle legal disputes. Many judges are unfamiliar with terms and concepts in the Code and have not received subsequent training. While investors do not object to the need for licensing certain activities for both foreign and domestic investors, the problem lies in the separate procedures for foreign and domestic investors. In some cases, foreign investors are required to produce additional information that would also be pertinent for domestic investors. Exporters entitled to VAT rebates often must wait months before they receive them, which is costly, especially to smaller investors (the Estonian VAT rate is 18 per cent). Another issue often cited is the lack of any means of deferring VAT payment on capital equipment[14] .

Problems that are associated with policy or regulation implementation are chiefly those associated with the tax system and bureaucracy. In sum, the complaints about taxation were primarily due to lack of clarity in specific tax rules, a failure to consider inflation for capital gains taxes, and the requirement that monthly tax payments be based on taxable income from the year before rather than on the current year's estimate. Problems investors have regarding licensing and bureaucracy centre around inconsistent behaviour of civil servants and a lack of communication among various levels of bureaucracy. The licensing process is also extensive; for multiple branches within Estonia, investors are often required to undergo separate licensing procedures for each. Investors would like to know in advance of proposed legislation and, if possible, to be able to discuss it with lawmakers.

Longer-term issues include rising costs, relations with Russia, future EU membership, regional development, and conflict-of-interest legislation. As mentioned before, low costs are an attraction for foreign investors, but with the completion of privatization in the near future and continuing inflation, costs are likely to increase. Energy costs are most often cited, especially due to the energy inefficiency of many structures built during Soviet times. This will harm competitiveness of several foreign enterprises and could lead to relocation. Continuing high inflation at the current exchange rate peg means real appreciation of the kroon which can also harm competitiveness, although many policy makers do not yet consider the kroon to be overvalued. Relations with Russia were also considered to be a problem because many investors came to Estonia because of its location next to Russia. Because of the existing double import tariffs between the two states and other sanctions imposed by Russia, investors are finding it difficult to fulfil their original plans concerning eastward expansion and trade. Potential EU membership brings increased regulations and actual membership will necessitate imposition of a common external tariff.

Hirvensalo and Hazley's paper (1997), which was written for ETLA (Research Institute of the Finnish Economy) is not Estonia-specific in its concentration, but looks at all economies in transition in the Baltic Sea Region (Estonia, Latvia, Lithuania, Poland, and Russia[15] . The authors interviewed representatives from forty-four foreign companies operating in the Baltic Rim using an open-ended questionnaire. A copy of the questionnaire and a list of companies interviewed is included in the paper. Detailed response data are provided categorically by industrial sectors within each country. Respondents are predominately from Finnish firms although the sample also includes firms from other industrialized countries. The authors interviewed executives and managers in both the home and host countries, and in some cases for the former, firms had multiple investments in the Baltic region.

The results indicate that problems each country faces are similar, although the degree of seriousness varies. Barriers cited most often by participants include uncertain and inconsistent implementation of legislation, slowness of land restitution and privatization processes, burdensome tax regulations, favouritism towards local companies, entry restrictions in the form of inability to own land, lack of privatization in certain sectors, limits on types of companies permitted to operate, slowness of VAT rebates, difficulty obtaining project finance, shortage of sufficient management skills, Soviet mindset of employees, crime, corruption, and lack of infrastructure. After a discussion of the general problems, the situation in each country is addressed.

For Estonia, the problem cited most often by firms (80%) was the lack of employees with management skills, especially at the middle-management level. Firms mentioned the trade-off between hiring an older, more experienced manager who is more likely to retain views of the old Soviet system and hiring a younger person who has little experience. The second most frequently mentioned difficulty (73%) was the lack of consistency in legislation. Other significant problems are fears concerning the liquidity of the banking system, infrastructure, particularly a lag in technology, difficulty obtaining work and/or residence permits, slowness of land reforms, bad debt, and customs delays.

As far as the other Baltic region states go, there seems to be several common problems among investors in Latvia, Lithuania, and Russia while problems faced by investors in Poland are different. This could be due to two factors; first, Poland began its economic reform earlier than the other states in the survey and, secondly, Poland is the only country in the survey that was not part of the Soviet Union. Lack of management skills were among major problems cited by investors in Latvia (75%) and Russia (91%). Uncertainly about legislation and its implementation was also a great concern, listed by 82% of investors in Russia, 75% of those in Latvia, and 58% of those in Lithuania. Investors in Russia also listed bureaucracy, banking risk, and difficulty obtaining information. In Latvia and Lithuania, customs procedures and relations with officials are problematic as well as obtaining financing. Poland's biggest deterrents are access to capital, bribes and corruption, customs difficulties, and reliability of local suppliers.

The authors conclude that the Baltic Rim has much economic potential, but requires more FDI to fully reach it. Of the five, Estonia is the only one with a level of FDI relative to GDP and to gross investment that approaches levels commonly found in small open economies. According to foreign investors, barriers have not changed substantially since the earlier studies were completed; this is most likely due to a lack of reforms that would reduce the barriers rather than due to a lack of change in the perception of the investors themselves. The authors recommend stronger support for measures that would make legislation clearer and more consistently implemented and increased FDI promotion in order to further management training and skills.

Larimo et al (1998) provides a good overview of FDI in Estonia at both the macro and micro levels. Included are comprehensive lists of legal and policy developments in Estonia from 1987, when Estonia was still part of the Soviet Union, until the present as well as data for several transition economies on issues such as FDI incentives, progress in transition, and FDI inflows. The authors present an overview of several studies on FDI in CEE states and Estonia, although at the time of writing, few studies on Estonia were available. They present a table with probable motivational factors by country of origin: Finland and Sweden, non-EU (the USA, Canada, Japan, and Korea), and other EU (the United Kingdom, Germany, Ireland). According to this table, market access factors are important to all investors despite locational differences. Finland and Sweden are motivated by the possibility to extend to neighbouring markets, while the others want to gain footholds in other regional markets including the EU for those non-EU countries.

Four case studies of Estonian firms, which give deeper insight into motivation and problems of specific firms are also included at the end of the paper. Of these four, all have a Finnish foreign investor, and two have Swedish investors as well. In all cases, market access was the primary motivating factor, although in the case of Elcoteq, an electronics subcontractor, prices and location were also important. Problems mentioned by investors include bureaucracy, infrastructure, and specific problems related to their products.

Pye's (1997) survey of FDI in Central and Eastern Europe is quite extensive, covering 334 firms in Hungary, Poland, Romania, the Czech Republic, and Slovakia with foreign investment from Western industrialized countries in excess of USD 1,000,000. The scope of his paper is broad, covering motivational and locational factors of FDI, evolution of ownership modes among foreign firms, performance criteria and evaluation, and geographic and functional strategies of Western investors. Pye uses both open-ended and ranked response questions in his survey. Pye uses two approaches to determine investor motivation; in the first, he asks participants to list the primary and secondary motivating factors behind their investments. In the second, he asks participants to rank a detailed list of factors on a scale of one to four. The specific factors are grouped into seven general categories.

According to the open-ended question results, market factors and strategic position factors were the primary and secondary motivational factors respectively in all cases but Slovakia and Romania. In these countries, strategic position factors were also the primary motivation. These results are supported by the ranked response results, although not completely. For example, in Slovakia, 'availability of a skilled workforce' received the highest score. Investors in Romania found first mover advantages most important while in Hungary, Poland, and the Czech Republic, market access and growth factors scored the highest. Gaining access to raw materials and other needed inputs also received low importance scores. The overall results do corroborate findings from Estonian surveys; market access is one of the most important factors to foreign investors.

Results of this study indicate that reasons for investing in the CEE states are similar to those for investing in Estonia; market access is important in both cases. Costs of production, however, are considered to be more important among investors in the CEE states than in Estonia. This could be due to the fact that these countries border directly on the EU and may therefore be more popular FDI destinations for those EU countries in close geographic proximity. Indeed Germany and Austria account for fifteen and eight per cent respectively. The greatest percentage of respondents, however, comes not from a neighbouring country, but from the USA (21%). France, Sweden, and the UK also have large shares (12%, 8%, and 8%). These results differ somewhat from the breakdown of the 'Foreign Investor 1997' survey; which indicates that the majority of respondents are Finland and Sweden (62% in total); the USA only had eight per cent of respondents. Unfortunately, Pye's study does not examine specific problems faced by investors so a comparison with problems in Estonia is impossible.

Éltetö and Sass (1998) look at motivation behind and deterrents to FDI in Hungary with an emphasis on how the investment environment affects export activity of firms. They group 123 respondent firms into three categories: non-exporting firms, firms that assemble or produce components for re-export to the home country, and export-oriented firms. Additionally, they examine how specific factors affect export activity of the three groups. Obtaining local market share and stable legal framework were both ranked as 'very important' by 61 per cent of all participants and as 'important' by 24 per cent. Lower labour costs was considered to be only the seventh most important factor with only 36% ranking it as very important. The three groups ranked motivational factors differently; non-exporters considered access to local markets and prospects for economic development to be the two most important factors, while a stable political environment and quality of workforce were most important to re-exporters and a stable legal framework and quality of workforce for exporters. Labour costs ranked sixth and eighth by non-exporters and re-exporters, respectively. Export-oriented firms did not rank labour costs in the top eight at all. All three groups ranked inflation as one of the biggest detriments to FDI; export-oriented firms ranked it first, while non-exporters and re-exporters put the tax system and social security contributions and investment risk ahead, respectively. Exporters rated the tax system and social security contributions as the second most detrimental factor. The authors provide a comparative analysis of their survey against other similar works and discuss the impact of the investment climate on firms' export activities.

The paper by Lankes and Venables (1996) examines how patterns of investment in the CEE/FSU states are changing in relation to choice of project function and control mode and how these choices are influenced by level of country development using data from a survey of western investors investing in the region. To analyse their survey results, the authors divide respondents into three groups: distributors, local suppliers, and export suppliers. Among the first two groups, access to local markets received the highest average score of importance and ranked third among export suppliers. Production costs were most important to this group. Having first-mover advantage is very important to distributors, somewhat less so to local suppliers, and relatively unimportant to export suppliers. They also found that the importance of country risk to investors is directly related to a country's riskiness and does not function as a deterrent to investment for those countries perceived to be less risky. Additionally, the EBRD's transition indicator was found to be the most important country characteristic considered when choosing an investment location.

Also included in the article is a summary of results from other surveys done on FDI in the region. The surveys mentioned in this study date from 1990 to 1995 and are varied in their target countries, origin of foreign investor, and industries. In all seven cases, market access in some form was cited as a primary motivation. Low costs were not a great impetus. Obstacles were largely associated with political and/or economic uncertainty, bureaucracy, and changing legislation and regulations.

Rojec (1998) examines the impact of FDI on restructuring and improvement of efficiency in the Czech Republic, Hungary, Slovakia, and Slovenia, but his paper contains several references to survey-type studies done recently and in the earlier stages of transition. Looking at these studies, he finds that there has been a shift in motivational factors over the years; initially, market access was the predominant reason foreign investors came to Central and Eastern Europe, but now cost factors are more important. He explains this shift, which is accompanied by an increase in export-orientation of foreign firms, as a result of increased integration of CEE enterprises into both the EU market and the structure of multinational corporations (MNC's). The latter is important because generally MNC's shift production to host country locations because they can gain some kind of advantage such as being the only producer in the market or reducing costs by producing in the host country. This cost factor issue does seem to be echoed in Estonia. While market access is still the most important factor in Estonia, costs are gaining in importance.

The tables on page 21 provide a summary of the results of the surveys discussed in this paper. Market access is the chief motivational factor among foreign investors coming to Estonia and the CEE states according to empirical works reviewed in this paper. EU access is not overwhelmingly important, and costs of production are increasing in importance. It is difficult to assess whether Estonia's foreign investors are facing problems similar to investors in other transition economies because this issue was not addressed in all cases. Lack of management skills and gaps in legislation are significant among Baltic Rim countries. The problems Hungary is facing are also present in Estonia, but these are not Estonia's largest ones. Bureaucracy, for example, was one of the major problems cited among investors in Estonia in earlier studies, but not in the more recent works indicating it is not as great a difficulty as earlier (see Tables 3 and 4).


The studies surveyed in this paper do not represent everything that has been written about FDI in Estonia thus far but do comprise a good part of the literature. According to the results of these studies, investors, in general, have similar motives for coming to Estonia and are facing similar problems with several issues including residency requirements, land ownership, and legislation. The most and least important motivating factors among investors in Estonia and other CEE states are also closely related. Regarding work done on Estonia, there are still some questions that must be asked when looking at this data. First, how representative are the respondents for each of the studies? Most of the studies done on CEE states have larger sample sizes. Second, how can the information gathered be analysed and put to use?

There is a need for quantifiable data from both a large number of firms and from firms in all industrial sectors in order to get enough data to be able to draw both general conclusions and industry- or size-specific conclusions about what firms prefer. No matter how data is gathered, responses are subjective and might differ within a firm depending on who answers the question. Open-ended questions are useful because from these come a more vivid picture of the circumstances surrounding decisions to invest in Estonia. However, because these responses can vary widely, it is important to also gather data that are comparable across respondents, data that can be statistically analysed. Ranking and yes/no questions serve this purpose well. Choice of question type also depends on the objective of the study. Open-ended question surveys are more appropriate for those studies that want to give a broad overview of a situation; studies that aim to make more detailed analyses and draw comparisons between different groups should also use questions that provide quantifiable data.

Two problems with the surveys done in Estonia are that the sample sizes are small and the samples are biased toward one or two investor groups, usually Finnish firms. The 'Foreign Investor 97' survey and Varblane et al (1998) have the largest and most varied sample sizes (73 and 59 firms, respectively, with investors from many different countries) [16] , while Glaros' (1996) is limited to seventeen from the United States. The FIAS (1997) sample is also small - twenty-two firms from several countries. Hirvensalo and Hazley (1998) interview sixty-five people from forty-four firms; twenty-seven of these have parent companies based in Finland. Additionally, the low response rate and incomplete responses make it difficult to get an accurate picture of the actual investment climate. However, it seems for this type of study, the average response rate is close to twenty per cent (Éltetö and Sass, 1998), and while the responses could be more complete, understanding of the investment situation is increased through the ones that are available.

The focus thus far has been on what investors like and do not like - an evaluation of the overall investment climate with limited focus on policy impact. If the survey continues as planned on an annual basis, at least as far as evaluating investment experiences, valuable information will be obtained regarding effectiveness and popularity of policies. This information is not only useful to the government and other policy makers, but also to investors already in Estonia and those considering investment because it provides them with information about the investment climate, and it could aid them in further business matters and help avoid other regulatory difficulties. Now would be a good time to analyse the policy situation to determine what changes, if any, have been made and what impact these studies have had on the policy situation. The usefulness of these studies is determined by policy action that follows them. It would be a good idea to evaluate policy changes and their connection with investor sentiment and lobbying efforts by foreign entities (Chambers of Commerce, trade councils, investors). An easily accessible chronicle of policy development in Estonia (and for that matter, in other transition economies) is definitely needed. The author of this paper found it surprisingly difficult to get straightforward information on basic policies, both recent and older, affecting foreign investors from sources such as the Estonian Investment Agency, the Ministry of Finance, and Citizenship and Immigration Board. It seems that much of this information is not universally known throughout institutions and can only be obtained if one is fortunate enough to locate the correct person. Knowledge of Estonian language is definitely an asset as well.

Estonia's development comes at a very crucial time. Results of earlier transition economies' efforts at market reform and whether they have been successful are already evident. These provide a point of comparison for Estonia as it achieves similar levels of progress in transition. More can be learned by comparing the policy reform process in these countries with that of Estonia and trying to assess the impact of reforms on inflows. Estonia is more advanced than most other former Soviet countries so Estonia's experience provides these countries with guidance on how to conduct reforms.

Another area requiring further study is the impact of capital flows on transition economies. If these studies are successful in determining which factors are most important to encourage capital inflows and governments follow their recommendations, these countries could see a sharp rise in inflows. Much research has been done on other developing countries, particularly Latin America, but it remains to be seen whether transition economies behave in a significantly different manner from other emerging markets. Additionally, several transition economies have implemented or are considering implementing currency boards. This area of research has potential for development because the monetary authority is limited in actions it can take against speculative capital inflows. Argentina and Hong Kong have already proven that this system can withstand large-scale speculative attacks, and in October 1997, Estonia held off a smaller one, but there is still a need to determine whether transition economies would behave differently from other emerging markets with currency board systems.

Terri L. Ziacik
July, 1998

  Borsos-Torstila, Julianna (1997), 'Foreign Direct Investment and Technology Transfer: Results of a Survey in Selected Branches in Estonia', ETLA Discussion Papers, no 580, January 27.
  Coopers and Lybrand (1998), Estonian Taxation Newsletter, no 8, February.
  Estonian Investment Agency (EIA; 1997), 'A High-Skill but Low-Cost Workforce', info.htm#anchor287483.
  Éltetö and Sass (1998), 'Motivations and Behaviour By Hungary's Foreign Investors in Relation to Exports', Institute for World Economics of the Hungarian Academy of Sciences, Working Paper no 88.
  Foreign Investment Advisory Service (FIAS; 1997), 'Estonia: Diagnostic Study of the Environment for Foreign Direct Investment', February.
  Glaros, Chris (1996), 'American Investment Survey', mimeo, Estonian Investment Agency, July 26.
  Heinrich, Ralph (1996), 'Central Europe's Place in Global Capital Movements', in Cs?ki, György et al, eds, Foreign Direct Investment and Transition: The Case of the Visegrad Countries, (Budapest: Institute for World Economics of the Hungarian Academy of Sciences), pp 31-56.
  Hirvensalo, Inkeri and Hazley, Colin (1998), 'Barriers to Foreign Direct Investments in the Baltic Sea Region', ETLA, January.
  Konings, Josef (1995), 'Foreign Direct Investment in Transition Economies', mimeo, Catholic University of Leuven, December.
  Lankes, Hans-Peter and Venables A. J. (1996), 'Foreign Direct Investment in Economic Transition: The Changing Pattern of Investments', Economies of Transition, 4(2), 331-374.
  Lansbury, Melanie; Pain, Nigel and Smidkova Katarina (1996), 'The Determinants of Foreign Direct Investment in Central Europe by OECD Countries: An Econometric Analysis', in Cs?ki, György et al, eds, Foreign Direct Investment and Transition: The Case of the Visegr?d Countries, (Budapest: Institute for World Economics of the Hungarian Academy of Sciences), pp 137-159.
  Larimo, Jorma; Miljan, Mait; Sepp, Jüri; Sõrg, Mart (1998), 'Foreign Direct Investments in Estonia', HWWA-Report 172, HWWA-Institut für Wirtschaftsforschung, Hamburg.
  Lizondo, J. Sa?l (1991), 'Foreign Direct Investment', Determinants and Systemic Consequences of International Capital Flows, (IMF: Washington DC), pp 68-82.
  Pye, Robert K. (1997), 'Foreign Direct Investment in Central Europe (the Czech Republic, Hungary, Poland, Romania, and Slovakia): Results from a Survey of Major Western Investors', Finance Working Paper A.97/1, Department of Banking and Finance, City University, London, April.
  Rojec, Matija (1998), 'Restructuring and Efficiency Upgrading with Foreign Direct Investment', draft, University of Ljubljana, May.
  Varblane, Urmas, et al (1998), 'Otsesed välisinvesteeringud Eesti majanduses', (Tallinn: Estonian Investment Agency and Tartu University).
  Wang, Zhen Quan and Swain, Nigel J. (1995), 'The Determinants of Foreign Direct Investment in Transforming Economies: Empirical Evidence from Hungary and China', Weltwirtschaftliches Archiv, pp 359-382.

[1] The author, TerriL. Ziacik is a PhD candidate in the Department of Economics at Indiana University, Bloomington, Indiana, USA. She spent ten months (September 1997 - July 1998) in the Central Bank Policy Department of Eesti Pank (the Bank of Estonia) on a Fulbright Grant.
[2] 1997 FDI data is estimated.
[3] See Konings (1995) and Lizondo (1991) for a thorough review of models that explain why FDI exists. Much of this section draws on Konings' paper. There is also much written in trade theory and industrial organization literature that examines the question of why multinational enterprises arise in the first place. See Caves (1996) for an overview.
[4] UNCTAD (1996) provides a list of countries for which certain economic indicators are not available in its World Investment Report, and this list is quite long.
[5] Several firms have more than one foreign investor.
[6] Removing Finland yields a score of 2.2, and removing Finland and Sweden yields a score of 2.13.
[7] Here one indicates 'no problem', and five indicates 'a big problem'.
[8] All information in the paragraphs discussing empirical works should be considered to come from the paper being discussed unless otherwise cited.
[9] Ranked response questions refer to questions asking the participant to rank an item on a scale, usually one to five.
[10] In the scale used here, one is 'very important' and five is 'unimportant'. These results were obtained by averaging all responses.
[11] Five is the most negative score.
[12] This data comes from a data set compiled by the State Statistical Office of Estonia and is looks at six industries: food processing, chemical, furniture, textiles, machinery, and electronics.
[13] However, initial experience indicates that is has complicated situations of some foreigners, particularly Americans, who are now required to have a visa or residence permit for stays longer than 90 days within 6 months. Not all qualify for the new visa, and these people may not be able to get a residence or work permit because of a different set of restrictions, even if they own property and contribute to the Estonian economy. Implementation of the new policy has not been smooth either; officials were not well-informed prior to its introduction, and even in the first few months of operation, there is much confusion as to which documents are required. People currently living in Estonia are required to apply for the visa at an embassy in a foreign country.
[14] Regarding the VAT, an amendment was passed in November 1997 which exempted written off goods from VAT. Previously, these were considered to be taxable supply and subject to VAT (Coopers and Lybrand, 1998).
[15] Russia refers to the St Petersburg area only.
[16] Sample sizes are derived in both cases from the number of firms who participated, at least in part, in the questionnaire portion of the survey.