FOREIGN CAPITAL INFLOWS – INFLUENCE ON DOMESTIC INVESTMENT AND TRADE STRUCTURE

One of the structural and institutional reforms that transition economies took in the beginning of the 90’s was the liberalization of international trade. Transition countries started with trade liberalization, followed by partial capital and financial account liberalization. The magnitude of foreign capital inflow to transition countries in the 1993-2003 period played significant role. However, countries share different experience concerning the impact on
competitiveness and trade specialization. Some countries managed to increase domestic investments substantially in order to change export structure, while the others were less successful and experienced the rising foreign trade imbalances.
The paper consists of two sections. In the first one we analyze the implication of capital inflows on domestic investment for Croatia and six selected transition countries. A foreign capital inflow comprises FDI, portfolio investments and other foreign investments.
For that purpose, we conducted regression analysis on panel data and used so called fixed effects model with instrumental variables. Our findings point to a positive relation between capital inflows and the level of domestic investment. Other foreign investments (mainly
foreign loans) have the highest impact on domestic investment while FDIs have a positive but less significant influence. Variable foreign portfolio investments have no significant impact on domestic investment activity. The FDI influence on the change in the export trade structure, comparative advantage and trade specialization is explored in the second section. For the group of analyzed
countries there is a positive correlation between FDI, the level of specialization and export trade structure. However, empirical results indicate that Croatia is an exception. Namely, although Croatia has a relatively high level of FDI per capita, it has not recorded a significant
improvement in the structure of international trade and sector specialization. This implies the absence of integration in international technology and value added chains. The structure of Croatian trade has an increasing similarity with less developed transition countries (Poland and Romania) while lagging behind the most developed transition economies (Slovenia, The Czech Republic).