FDI-Attracting Factors in the Hungarian Food Processing Industry

The Hungarian food industry may be screened for FDI-attracting features by taking the major components of the extended Porter diamond one by one.

4.2.1. Related and Supporting Industries

The segments of the agrifood chain, which were interrelated and linked to each other throughout the central planning era, ali suffered from a severe lack of working capital after 1989, so that the old linkages disintegrated and ownership structures changed dramatically. Agriculture undoubtedly suffered the most in the early years of the transition, primarily due to protracted political debates and inconsistent policies regarding ownership and land restitution.

Foreign investors have not shown equal interest in all components of the agri-food chain (Figure 12), presumably because profitability is usually considered to be higher in processing, wholesaling and retailing than in basic agricultural pro-duction.

Political regulations, such as the prohibition of foreign land ownership, also explain the low interest in agricultural production. In the prevailing economic environment, foreign companies had an opportunity to establish vertical rela-tions and gain a controlling position in the agrifood chain starting from the food processing and trading segments. Experience proves that they did indeed take this opportunity in many cases (Gow and Swinnen 1999).

Food F ood 'VVholesale Processing

and Retail Agricultural

Inputs

Agricultural

< Production level of

foreign

ownership26 low - medium none - low medium-high mediu h igh

Figure 12. Foreign ownership in the Hungarian agrifood chain.27

4.2.2. Factor Conditions

Three production factors, agricultural raw materials, the labour force and the existing production capacity contributed greatly to attracting foreign capital into the Hungarian food sector.

Agricultural raw materials are plentifully available in Hungary, as agricul-tural production is based on favourable climatic conditions and the country' s most notable natural resource, the abundance of fertile arable land.

In terms of human resources, the relatively inexpensive sldlled labour avail-able in the processing industries makes an attractive factor.

Also, the scope of existing food processing capacities was very important among the advantageous production factors. The technical state of fixed assets throughout the food processing industries and among individual companies was rather heterogeneous, but the processing capacity, which was geared largely to-wards western exports, represented reasonable value for investors in technical terms. Some food processing companies constituted a favourable starting point for foreign parent companies entering a new market.

4.2.3. Firm Strategy, Structure and Rivalry

Hungarian companies had been gaining increasing independence from the mid-1980s onward, when the food processing companies had entered first into a

"gentle" state of competition that had later intensified rapidly. A new market situation then emerged in the 1990s, in that corporate restructuring, privatisa-tion, a growing number of bankruptcies, and also a large number of newly estab-lished small and medium-sized enterprises constantly kept the markets and the range of competitors chancy and volatile. The rivalry question was therefore

26 The categories refer to the following ranges of equity: low - 0-20%; medium - 21-50%; high - over 51%.

27 The rate of foreign ownership varies by segments of agri-food chain within the given range and may exceed the boundary values in the case of individual companies.

hard to predict for investors. On the other hand, the investing companies them-selves modified and considerably affected the state of competition. Their most serious competitors often appeared to be the same rivals as on their home markets or in the international arena.

The type of market structure largely influences corporate strategy, and is thus a major determinant in the SCP paradigm (Figure 5, page 54). Four major types of market are distinguished in the international economic literature: pure mono-poly, market dominance, oligopoly and competition. The Hungarian food mar-kets have now assumed a new structure and clear rivalry positions have emerged.

The Hungarian food industries can be classified into the latter three of these four categories (Figure 19, page 115). The corporate strategy of a particular foreign firm is subject to the specific market position it has achieved.

4.2.4. Demand Conditions

The proximity of consumer markets is of crucial importance to foreigners in-vesting in the Central and Eastern European countries. Although investors in most of the manufacturing industries look on the region as one large, homo-genenous market, the motives of food industry investors differ slightly from that approach: their first priority is the market of the target country, while export sales are of secondary importance. The Hungarian market — albeit smaller than that of Poland — still represents considerable sales prospects within the atomising national markets of the region. In terms of purchase power in the 1990s, its rela-tive attracrela-tiveness surpassed that of large food markets such as Russia, the Ukraine and Romania.

4.2.5. Key Public Policy Elements

Governments can give additional impetus to FDI by means of numerous public policy measures, which are examined in two major groups below: policy direc-tions characteristic of the post-socialist economies, and general investment in-centives. This classification of public policy elements is illustrated in Figure 11.

4.2.5.1. Specific Transitional Policy Directions

The post-socialist — or transitional — economies had to introduce substantial changes in order to build up free market economies. Of the political, economic and legislative reforms, three policy directions can be directly related to corpo-rate reforms: restructuring, compensation and privatisation policy. Corpocorpo-rate re-structuring determined the investment environment and opportunities in the CEE countries. The attitude towards restructuring, compensation and privatisation policy varied considerably among the individual CEE countries and resulted in

distinct discrepancies in their attractiveness to FDI. Privatisation policy was un-doubtedly the most important policy element in attracting FDI to the transitional economies. The more liberally and commercially privatisation was carried through, the more foreign capital flowed into that particular country (Holland and Pain 1998).

Hungary was a forerunner in corporate restructuring (Csåld and Nash 1998), as the reform of its legal framework had already started in the late 1980s. At the same time, trusts and monopolies were decentralised. Hungary was among the first countries to enact a law on bankruptcy, which was one of the toughest in the region. A separate investment act covered foreign investments, ensuring the same rights for foreigners to establish companies and pursue business activities that domestic firms enjoyed (Alvincz and Tanka 1997).

Hungary favoured the commercial type of privatisation — the direct sale of companies — as opposed to compensation-based privatisation. Food processing companies were among the very first ones offered for sale. More than 50 percent of the food industry had been privatised by 1994, and privatisation was practic-ally complete by 1997 (Table 8, page 48). Hungary was the most consistent of ali the CEE countries in applying this policy in its food industry.

4.2.5.2. General Policy Incentives

One important step in making Hungarian competition policy compatible with in-ternational standards was the establishment of the Economic Competition Office (ECO) in 1990. The Competition Act (1990), however, allowed supervision only over those companies that were registered in Hungary. This legal nuance re-moved the "redundant obstacles" of competition control from the acquisition thrusts of foreign investors. By the time privatisation of the food industries was complete, foreign firms were allowed to buy Hungarian food companies freely and gain monopolistic or dominant market positions in the course of this privati-sation.28 The Competition Act in its 1990 form was an important contributor to the FDI incentives. On the other hand, once the foreign companies were regis-tered in Hungary, they immediately became subject to strict competition control, and the ECO did in fact intervene in a number of cartel cases even in the early 1990s. The Competition Act served two purposes at a time, it indirectly fostered FDI and facilitated supervision.

Trade policy stimulated FDI in the food industry by means of duties and tar-iffs. Although trade in general was liberalised in the early phase of the reforms, agriculture and the food industries remained highly protected sectors. The high

28 The Competition Act was modified in 1996, when the jurisdiction of the ECO was extended to ali private and legal entities that carried out business activities on the Hungarian market.

import duties on food products were even increased further by means of an extra import duty in 1995, a situation which lasted for an 18-month period. At the same time, imports of technology, including equipment and processing Iines, was enhanced through a general liberalisation of imports. This fact also contrib-uted to the FDI influx and to the modemisation of the Hungarian food industry.

Since the country was badly hit by unemployment in the 1990s, employment policy benefits and subsidies were granted to firms that either created or retained job opportunities. Nearly ali the foreign companies took advantage of these employment incentives.

Taxation policy was designed to encourage the influx of foreign capital investments. Companies established with at least 30 percent foreign ownership enjoyed significant tax concessions —40 to 100 percent of taxes — for a period of up to five years. Consequently, hundreds of foreign-owned companies were registered in the food industry. This benefit was removed for companies established after January 1, 1995. Simultaneously, the corporation tax rate was reduced from 36 percent to 18 percent, which is a very favourable rate even by international standards. The early tax benefits offered to foreigners contributed to the fact that over 90 percent of the present foreign-owned food processing companies were registered before 1995.

Some tax benefits are currently used for the purposes of regional develop-ment policy. Total tax exemptions for up to five years are offered to new invest-ments that target less developed regions or regions that have over 15 percent unemployment. These tax benefits also aim to even out the geographical distri-bution of foreign investments. Budapest and north-west Hungary have received two-thirds of ali FIA, and this regional inequality also applies to food process-ing, although foreign-owned food manufacturers are scattered throughout the country.