Foreign investment law in Central and Eastern Europe

One of the most remarkable developments in Central and Eastern Europe (CEE) has been the region's opening to foreign direct investment. CEE states saw foreign investment climb from minuscule amounts in 1989 to more than $7 billion in 1992. All CEE states have enacted new laws on foreign investment as well as related legislation in areas such as taxation and company and environmental law. The authors describe these efforts at legal reform and assess their impact on foreign investment in light of what is known about investor motivation. They concentrate on the role of foreign investment law, referring occasionally to other aspects of law that apply to domestic and foreign investors. They find that specialized foreign investment laws can play a useful role during the transition to a market economy. Of particular importance is their role in sending a strong signal to foreign entrepreneurs that the host country is serious about economic reform and is willing to work with investors to establish mutually beneficial arrangements. Foreign investment laws are also often used to target special incentives to foreigners and create an island of legal development that may differ from -- and sometimes outpace -- other legal development. In such ways they tend to create investment"enclaves."But to the extent that an enclave separates foreign from domestic investors, it can quickly outlive its usefulness. The incentives it fosters may not only bleed domestic treasuries, but may also lead to bureaucratic structures that complicate the investment environment and elevate information and transaction costs for foreign investors. As quickly as possible, the transforming economies should dismantle the enclave and put domestic and foreign investors on an equal footing. This may well mean that foreign investment laws are no longer needed. The Czech and Slovak Federal Republic was the first CEE country to abolish specific foreign investment legislation in favor of a broad commercial code covering all investors. If an enclave does exist, policymakers should focus on the concerns critical to foreign firms. In the design of investment laws to date, the CEE countries have perhaps paid too much attention to preferential tax schemes, ignoring other costs foreign investors face. Policymakers should focus on reducing uncertainty and transaction costs through clear and simple legislation, contract enforcement, arbitration and other alternative dispute resolution mechanisms, stronger protection of property rights, dissemination of information on laws and on business opportunities, and an end to unnecessary bureaucratic intervention. Complex regulations not only increase investor uncertainty but divert bureaucratic resources that the host country cannot afford to squander.