The Role of Technology in Transition Economies of Europe

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The Role of Technology in Transition Economies of Europe









Jon Campbell

MGMT 6730

April 18, 2005


Jon Campbell


MGMT 6730

April 18, 2005


1



Abstract


Fifteen years ago, the world witnessed the breakup of the Soviet Union and its influence on the
countries of Central and Eastern Europ
e (CEE). Relatively “simple” technologies proved to be
key factors in overcoming government propaganda by rapidly publishing free and open
information. In the succeeding years CEE countries began political, economic, and social
reforms to transition from

centrally planned socialist economies to free market capitalist
economies. The improved business climate from these reforms resulted in increased Foreign
Direct Investment (FDI) in various forms, primarily capital, knowledge and technology transfer.
The
se resources and technologies facilitated economic growth in CEE countries by improving
their infrastructures, communication, efficiency, productivity, competitive advantage, and job
creation. As a result, these countries have ultimately seen increases in

their Gross Domestic
Product, decreased unemployment, and accelerated growth and learning.






Thesis


Modern technology in various forms has played the most critical role in Central and Eastern
Europe’s transition from socialist to capitalist economies
by liberating information and
facilitating economic growth.

Jon Campbell


MGMT 6730

April 18, 2005


2

Introduction

Fifteen years ago, the world witnessed the fall of the Berlin wall, the break up of the
Soviet Union and its influence on the Soviet Bloc countries of Central and Eastern Europe
(CEE
). In the succeeding years, these countries began their transition from centrally planned
socialist economies to free market capitalist economies. Despite the varying degrees of
socialism in CEE, from command socialism to market socialism, all transition

economies have
similar objectives and elements.

Privatization, liberalization, and stabilization can be considered the primary objectives of
a country in transition (Meier). Transitions also “entail the creation or reform of institutions


economic, so
cial and political


and organizational change” (Meier, 338). These expansive
reforms created a favorable business climate which allowed FDI to flow in, and with it came an
abundance of technology from the west


not just information and communication tec
hnologies,
but up
-
to
-
date knowledge, management practices, and industry expertise.

In this paper, the role of technology in CEE is examined as a tool for political, social, and
economic reform as well as a vehicle for economic growth. It is clear that th
e Soviet empire
could not have existed without strict information control. However, the enormous task of
controlling information became increasingly difficult with the development of increasingly
sophisticated information technology. Technology allows th
e free flow of information, improves
transparency, communication, transfers knowledge, ideas and expertise. Furthermore,
technology improves a country’s infrastructure and can
strengthen comparative advantage
.
Modern technology in various forms has playe
d the most critical role in Central and Eastern
Europe’s transition from socialist to capitalist economies by liberating information and
facilitating economic growth.

Jon Campbell


MGMT 6730

April 18, 2005


3

Technology as a tool for reform

Socialist economies of the former Soviet Bloc were marked

by inefficiency, poor
economic growth, high unemployment, and experienced a shortage of goods. To maintain social
order, governments needed to control information though an extensive propaganda campaign.

[…] for reasons compellingly articulated by Ludwig

von Mises and Friedrich A. Hayek
during the 1920s and 1930s, socialism doesn’t work; it doesn’t produce goods and
services for the vast majority of people who live under it to nearly the same extent that
free markets do. So, to keep people from being dis
contented and wanting a different
system, what is a socialist government to do? […] the government must lie. It must tell its
people how good they have it (Henderson, 519).


Henderson goes on to say that “In the Soviet Union, the government used a massive

censorship
apparatus to suppress other sources of information, virtually from the beginning of communism
in 1917 until the Gorbachev era starting in the mid
-
1980s […] but the communications
technology employed for spreading the lies can backfire. Lying i
n print is easy; lying with video
footage is much harder” (519).

In the late 80’s, Gorbachev’s glasnost campaign to push his perestroika reforms removed
the lynchpin of fear and allowed information to flow more freely in the Soviet Union. Existing
mass me
dia technology rapidly spread more accurate information about the dismal state of the
Soviet Union as well as everyday “luxuries” average westerners enjoyed. This information
“appeared in the pages of official newspapers, resounded from millions of radios

and televisions,
began to bounce around the country on photocopied leaflets and telefax news services” (Shane,
73). Gorbachev himself did not expect such a revolutionary outcome. Since information had to
be suppressed for socialism to work, the communis
t party and the Soviet Union could not survive
when these technologies freed up information.

A good case can be made that information technology helped bring down the Soviet
Union. I am not referring to the Internet, which was not in widespread use unti
l the mid
-
1990s. I have in mind instead information technology that had been around a long time,
including television and print media (Henderson, 518).

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MGMT 6730

April 18, 2005


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Scott Shane provides additional evidence of the role that “simple” technologies, such as
fax and photoc
opy machines, played in the collapse of the Soviet Union. Shane was a
correspondent from the Baltimore Sun living in Moscow in the late 80’s. After installing a fax
machine in his office, he reported “it operated around the clock, spewing out political
c
ommuniqués from nationalist groups and infant political parties, advertisements, and news from
the new information services Interfax and Baltfax” (Shane, 205). Once information began
flowing freely in this more transparent environment, there was no stopp
ing the inevitable effect it
would have.

Along with the fall of the Berlin Wall in 1989, a wave of reform swept through the
former Soviet Bloc countries and the Soviet Union was officially dissolved in 1991. With
political and economic reforms taking plac
e, the stage was being set for increased foreign direct
investment and economic growth. Technology plays an important role in this arena as well.
Today, information and communication technologies such as the Internet, satellite TV, and cell
phones play an

important political and business role in CEE. These technologies help to
organize grassroots political parties, promote democracy and reform, as well as facilitate
business and economic growth.

Technology as a vehicle for growth

Technology is an importan
t tool for improving business practices and serves as a vehicle
for economic growth. The positive results are best seen after the necessary reforms have taken
place.

Once the social foundations are in place, all economic growth depends upon
improvements i
n technology. Successful countries go through 3 stages in acquiring
technology. In stage 1 they mobilize human and capital resources to fully exploit existing
technologies. In stage 2 they copy existing technologies from more advanced countries
to catch

up. And in Stage 3 they build new industries based upon the advance in
knowledge that flow from their own research and development (Thurow, 191).

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MGMT 6730

April 18, 2005


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CEE countries started in stage 1 in the early 90’s and have been moving toward stage 2.
So far, investment
in the region has been to take advantage of local resources. The majority of
new technology has been transferred from the west, such as computers, management skills, and
product knowledge. Computerized information systems improve managerial control, faci
litate
accounting, and financial reporting, which results in increased efficiency and productivity. From
a government’s perspective, improved financial reporting also facilitates taxation of revenue.
Latecomers such as Serbia have recently begun introduc
ing computerized cash registers in order
to track sales, thereby allowing better “financial policing” (Biberović).

The effect of economic reforms and technology became evident early on in Central and
Eastern Europe. Privatization and modernization of th
e banking industry increased electronic
transactions and international capital flows. In 1989,
securities exchanges began opening across
CEE, allowing greater investment in the region. By 1995, 13 countries had stock markets.

Figure 1: Stock Exchange
Openings in CEE, 1989


1995 (www.business2.com)

Number of New Stock Exchanges in CEE
0
1
2
3
4
1
2
3
4
5
6
7


1989


1990


1991


1992

199
3


1994

1995

Year

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April 18, 2005


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Additionally, investments from multinational corporations and joint ventures have been the
primary vehicle for technology transfer in the region. As will be discussed further, foreign direct
investment
is considered to be pure technology transfer. The following examples show the effect
that FDI and technology transfer has had:

Case in Point: Škoda



Škoda started as a private Czech car company in 1925 but was nationalized after WWII
in socialist Czech
oslovakia. The company fell victim to central planning and lagged
behind the rest of the world in R&D and production. During privatization efforts in
1991, a 70% stake in the company was sold to Volkswagen/Audi. This was the FDI that
transferred the tec
hnology and expertise Škoda needed to catch up with the rest of the
world. In 4 years, sales increased 21% and productivity increased 30%. (
www.skoda
-
auto.com

and C.I.P.E)


Technology transfer doesn’t have to be

high
-
tech, but can come in the form of knowledge and
expertise, as seen in the East European wine industry.

Case in Point: Wine Industry


“Now, little by little, whole wine industries


wineries, vineyards, state cellars


are being
dismantled and hande
d over to private owners who need to sell to the west because
Eastern export markets have dried up. Much needed European and Australian investment
has begun to move in, bringing with it essential expertise to show local winemakers how
wine has to be made
if it is to sell to Western palates.” (Simon, 150).


Similarly, modern information and communication technologies (ICTs) have helped transfer
knowledge and learning in transition economies. “The Internet facilitates education, a
fundamental underpinning o
f economic development.” (Cateora, 249). This points to the
sustainability of technology, social and political reform and economic progress. Cateora
describes additional benefits of ICTs:

The cellular phone, the Internet, and other advances in IT open op
portunities for
emerging economies to catch up with richer ones. […] The Internet accelerates the
process of economic growth by speeding up the diffusion of new technologies to
emerging economies. […] IT can jump
-
start national economies and allow them to
leapfrog from high levels of illiteracy to computer literacy (249).

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MGMT 6730

April 18, 2005


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Realizing the advantages of a modern IT infrastructure, the Czech Republic approved a
comprehensive State Information Policy in 1999 with eight priority areas:

1.

Information Literacy

2.

Inform
ation Democracy

3.

Development of the Public Administration Information Systems

4.

Communications Infrastructure

5.

Reliability and Security of Information Systems and Personal Data Protection

6.

Electronic Commerce

7.

Transparent Economic Environment

8.

The Information Soc
iety, ‘Stable and Safe’

(Czech Republic, 1)


Comparing Progress

During the first decade of transition (1990
-
2000), the efforts of CEE countries resulted in
winners and laggards. Poland, Slovenia, Slovakia, Hungary, and the Baltics fared well with an
avera
ge real GDP growth of 4.5%. On the other hand Ukraine, Romania, Bulgaria and other
Balkan countries lagged behind with growth rates between
-
2.3% and 0.2%. Russia’s growth
varied widely from
-
13% in 1991 to 10% in 2000 (Sources of data: Meier and IMF).

Since
2000, however, all CEE countries have experienced respectable growth. 2004 was a particularly
good year with all GDP growth rates falling between 2.3 and 12.1% (IMF, 209). As Rosser and
Meier both discuss, numerous other metrics are used to compar
e the progress and performance of
transition economies:



Per capita income, PPP, inflation rate, unemployment, debt and debt ratio



Private sector share of GDP; score for privatization, restructuring, prices/competition,
trade/foreign exchange, and banks



Ind
icators for transparency, democratic rights, and regulatory burden; Human
Development Index, and Gini coefficient



Level of Foreign Direct Investment


The last metric is of interest here because
FDI directly translates to the level of
technology use in a tr
ansition economy
. It is not a coincidence that the countries with the most
Jon Campbell


MGMT 6730

April 18, 2005


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FDI have fared the best economically. A study of 25 CEE countries by Campos and Kinoshita
found that “FDI has a positive and significant impact on economic growth” (398). Further
, they
assert that “FDI directly raises the level of technology in the host economy. […] FDI diffuses
knowledge about production methods, product design, and new organizational and managerial
techniques.” (401). Perhaps the most important benefit to host
-
c
ountry recipients is the direct and
indirect creation of jobs that would otherwise not be created there (Hill, 246).

Data on FDI distribution to individual industries in CEE countries is limited. Poland,
however, had some relevant data revealing that FDI
flows to its ICT industry accounted for 25%
and 35% of Poland’s total FDI in 1999 and 2000, which was more than any other industry
(Source: UNTCAD). Conglomerate sectoral data on FDI distribution is more prevalent.

The Center for European Integration St
udies indicates that between 1989 and 2002 the
largest percentage of FDI to CEE was directed to sectors classified as “high tech” and “medium
-
high tech”. The FDI flows to these sectors accounted for 44% to 55% of total FDI in the region
(Resmini, 8). Th
ese sectors included industries such as aerospace, pharmaceuticals, information
& communication technologies, automotive, chemicals and heavy machinery. During that same
period, average annual GDP growth in CEE as a whole improved from 0.9% to 4.4% (IMF,
209).

Although a detailed analysis would need to be done to be conclusive, this evidence lends weight
to the idea that FDI in high
-
tech industries in particular contributed to growth in Central and
Eastern Europe. Another correlation can be seen in FDI fl
ows to individual CEE countries. The
countries that received more FDI tended to fare better than others during the first decade of
transition.



Jon Campbell


MGMT 6730

April 18, 2005


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Figure 2: Foreign Direct Investment in Eastern Europe, US$ millions (Meier, 365)


Country

1990
-
1995

1996
-
2000

Hungary

11,200

12,968

Slovakia

7,555

2,150

Poland

7,148

21,969

Czech Republic

5,666

15,466

Russia

4,400

26,960

Other CIS

2,300

5,085

Baltics

1,280

1,890

Romania

933

4,017

Ukraine

574

1,400

Slovenia

501

3,052

Bulgaria

412

1,428

Other Balkans

30
0

2,210

Albania

205

583


It is important to note that the reasons some countries receive more foreign investment than
others can vary substantially.

Determinants of FDI

A higher level of Foreign Direct Investment generally means reforms have been
impleme
nted, business climate is improving, and investor confidence is rising. Tihanyi and
Roath concluded “…the adoption of essential market institutions and the specific norms of
regional integration with the European Union [are the] most important determinant
s.” (188). On
the other hand, Campos and Kinoshita maintain “…the determinants of FDI are rather different
across transition economies.” (414). They agree that economic policies worked well in Hungary
and Poland, but it was the initial favorable condition
s in the Czech Republic and the abundance
of natural resources in Russia that determined FDI flows (Campos, 414). Regardless of the
reason, their study found that:

…in the context of the transition economies FDI has a positive impact on the annual rates
o
f economic growth. This finding is robust after we instrument FDI in order to account for
the variety of determinants in different transition economies. Irrespective of whether FDI
is attracted by good policies or favorable initial conditions, the positi
ve effect on growth
rates seems to hold. (Campos, 414)


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MGMT 6730

April 18, 2005


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Furthermore, Campos and Kinoshita tested for “reverse causality” or the possibility that fast
growing countries attract more FDI. They found that this was not the case in CEE transition
economies (4
11). But FDI alone does not guarantee a successful transition.

The amount of investment by itself does not explain the success of Slovenia with modest FDI
and the mixed results in Russia with heavy FDI, especially in the last decade. This is likely due
t
o the fact that
there are many other factors that affect economic growth and transition status.
The relative success of transitions has also been influenced by the following:



State of the economy before the transition.

o

Type of socialist economy


command,

worker
-
managed, market, etc.



Stability

o

Internal politics, legal system, corruption, mafia, security/law enforcement.

o

Pace and effectiveness of political, social, and economic reforms


Poland
(“shock therapy”), Hungary (gradual).

o

Business and investment
climate, level of IP protection

o

War and/or economic sanctions



Geography, history and culture (proximity to Western Europe).



Regional Alliances

o

Visegrád Group “V4”: Poland, Czech Republic, Slovakia, and Hungary. 1991
cooperation to move toward free market

reforms.

o

OMX Group: Estonia, Latvia, and Lithuania joined Denmark, Sweden and
Finland in Baltic Sea regional securities exchange.

o

Free trade agreements among various CEE countries.



Factor Endowments/Comparative advantage.



State of the Western European an
d world economies due to interdependence and
availability of cash for investment in CEE.


Given the difficulty and complexity of transforming a country’s economic system, it is
not surprising that transitions have taken well over a decade and will continue

for years.
However, it begs the question, “When is a transition complete?” Different economists have had
varying responses to this question. János Kornai “declared it completed if a country is no longer
a one
-
party state, most of its enterprises are pr
ivately owned, and the market is the dominant
force in decision
-
making” (Rosser, 76). Marie Lavigne believes it is complete when a country
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April 18, 2005


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joins the EU while others believe this is an unanswerable question and transitions will never be
completed (Rosser,
76). Depending on the point of view, the transitions of some CEE countries
can be considered over, especially the ones that were admitted to the EU on May 1, 2004


the
Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia.

O
bstacles to reform

Several things have hindered CEE countries in their efforts to transition to market
economies. Remnants of the Communist party still exist throughout CEE and work to subvert
reform efforts. This may have been more true in countries tha
t implemented gradual transitions.
Governments “that took the slow road permitted the bureaucrats from communist days to
organize effectively to delay and even derail the transition to a market economy” (Cateora, 263).
(Although the slow road didn’t seem
ed to slow down Hungary’s success).

However, in lagging transition economies lingering socialist institutions have been a
problem. “…the socialist past, especially the separation of research and development from
production, is an important obstacle to tech
nological progress […] In order to integrate research
and production, socialist institutions need to be transformed or abolished while new ones have to
be created.” (Lankhuizen, 9) In addition, crime and corruption increased in some CEE countries
during t
heir transition due to the power vacuum that was created when the government collapsed.
This environment inherently encouraged growth in the “informal sector.”

Black market “informal economies” existed before the transition period to circumvent a
non
-
func
tional economic system, but likely increased later out of desperation. “The informal
sector has grown fast in transition economies to the point that it accounts for more than half of
national output in the most extreme cases.” (Campos, 406). This repres
ents a significant loss of
tax revenue for governments


money that could have been used for development.

Jon Campbell


MGMT 6730

April 18, 2005


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Another problem has been the lack of intellectual property (IP) protection in some CEE
countries, which has had a negative impact on FDI: “…weak [IP
] protection deters foreign
investors in technology
-
intensive sectors that rely heavily on intellectual property rights”
(Javorcik, 39). It is safe to say that the countries that do more to protect IP should receive more
FDI. All of these obstacles creat
e unfavorable conditions for business and economic growth, but
some countries worry that FDI itself may have a negative impact on their economies.

As Hill points out, FDI may have adverse effects on the host country. “Three costs of
FDI concern host coun
tries. They arise from possible adverse effects on competition within the
host nation, adverse effects on the balance of payments, and the perceived loss of national
sovereignty and autonomy” (Hill, 251). These concerns could eventually be alleviated if
investment and technology begins to come from the home country instead of the west.

In the future: Technology as a revenue source

Even though the former Eastern Bloc countries were industrialized before the transition,
they are not at the top rung of the
“Ladder of Comparative Advantage” (Meier, 49). They have
what Meier refers to as a “natural comparative advantage [which] is related to Ricardian and H
-
O
-
type of goods that have a cost
-
based type of advantage.” (Meier, 49). Multinational
Corporations hav
e been investing in CEE to capitalize on the region’s resources and
endowments. The factor endowments of CEE countries include natural resources, low
-
cost but
educated/skilled workforce, and an existing industrial/supplier base.

Much of the industrial eq
uipment and infrastructure in CEE countries was outdated by
the early 90’s. “Technological progress has been extremely limited, and much of the productive
technology is internationally noncompetitive” (Meier, 339). FDI to upgrade infrastructure and
typic
al capital equipment with modern computer
-
controlled mills and lathes would improve the
Jon Campbell


MGMT 6730

April 18, 2005


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quality and efficiency in manufacturing. In addition to low labor costs, this makes the prospect
of sourcing manufacturing work in CEE countries more attractive to wes
tern companies. In this
way, technology transfer can strengthen existing comparative advantage.

Furthermore, as FDI and subsequent technology transfer increases, so will learning and
domestic research and development. This
“home
-
grown” indigenous techn
ology will eventually
help
CEE countries move up the ladder to

“the higher rungs of ‘acquired’ comparative advantage
related to Porter
-

and Krugman
-
type of goods that have a product
-
based type of advantage. A
good example of this is the up
-
and
-
coming Roma
nian software industry.

Conclusion

Technology in various forms has played a critical role in the Central and Eastern
Europe’s transition from socialist to capitalist economies. “Simple” technologies helped bring
down the Soviet Union by increasing governm
ent transparency and spreading information
rapidly. Once political, economic, and social reforms began to take place across CEE, foreign
direct investment and the transfer of modern technologies facilitated economic growth in the
region. Initial transiti
on efforts resulted in winners and laggards throughout CEE, but today all
countries seem to be progressing. Thus far, technology transferred from the west has diffused
knowledge and expertise, increased efficiency and productivity, and strengthened compar
ative
advantage. In time however, CEE countries will begin to develop their own technology, which
can lead to a sustainable and prosperous future.

Jon Campbell


MGMT 6730

April 18, 2005


14

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