Ralf Wiegert and Kasia Zatorska of Global Insight -

• The pattern of foreign direct investment (FDI) inflows to Poland has been changing. Not so long ago, low labour costs were the main motivation, but Polish workers' technological skills are playing the key role nowadays. Poland has benefited from the global outsourcing boom in recent years through a number of high-profile investments.

• Due to its knowledge base, and despite many infrastructural and bureaucratic shortcomings, Poland enjoys a fairly solid position among foreign investors. Close cooperation between Polish universities and private investors emerged has proved particularly successful.

• Poland's economic success in recent years would have been impossible without foreign investment. With improvement in capital as well as the knowledge base, productivity growth has gained momentum, driven mainly by high value-added growth rather than cost-cutting measures such as dismissing staff. Poland's overall resilience against external shocks has clearly strengthened.

• Given the current rise of the zloty against both the dollar and euro, foreign investment in Poland – particularly from the perspective of the dollar – could remain dampened for the next several years, at least until Poland joins the Eurozone. Other places in Central and Eastern Europe such as Romania or Ukraine, or even Russia, look much more attractive from this point of view.

After a period of restraint at the beginning of the decade, as the Polish economy lingered on the edge of recession, foreign investors and multinational companies discovered Poland as a prime target. Indeed, the country of more than 38m people, which lies in the heart of Europe, has been quite successful in attracting foreign direct investment (FDI) during the past several years, and since it joined the EU in May 2004 in particular. In the wake of its liberation from communism and towards the end of the previous decade, Poland had become a hotspot for foreign investors. But made many would-be investors chose to reconsider their options at the time, either as a result of the slowing economy or uncertainties surrounding emerging markets following the Russian crisis.

That said, Poland has clearly benefited from a globally favourable investment climate in recent years, as the volume of FDI flows worldwide rose amid high capital-market liquidity, reaching out not only to the major OECD (Organisation for Economic Co-operation and Development) countries, but also to emerging markets and even remotely situated developing countries. Poland, being in a group of emerging markets, clearly sucked in the bulk share of foreign investment in Central Europe, and among the new EU member-states, even though the country still lags behind the Czech Republic, Hungary, or Slovakia, when considering FDI inflows and stocks in per capita terms, or relative to GDP.

In any case, for a country of Poland's size and economic history, inflows on the scale seen since 2004 are a great success. They are not only stating the attractiveness of the Polish market itself, but they also fundamentally modify it in terms of technology, labour demand and infrastructure, exerting considerable influence on the country's economic growth. Additionally, these inflows have clearly enhanced Poland's ability to compete on global markets, instilling a self-sustaining nature in the undertaken investments.

Indeed, the extent to which Poland has been benefiting from FDI inflows can hardly be overestimated. High economic growth at an annual average of 5.5% during 2004-07, and fairly resilient exports, leaping ahead even in the face of an appreciating zloty, would have been impossible without foreign financing. Clearly, zloty appreciation in recent years reflects both current and past investment inflows, which have already given a major boost to the competitiveness of Polish external sector. This is what makes it even more interesting to examine the patterns of FDI inflows to Poland, as well as the investors' choice of country.

How wide is the actual investment in Poland?

According to the statistics provided by the National Bank of Poland (NBP), the highest level of FDI inflows to Poland occurred in 2006, reaching almost $19bn. The numbers from 2007 presented a slightly more modest result of $17.6bn, but still very impressive compared to pre-EU accession levels. It should be acknowledged, though, that the FDI surge during 2004-07 seems rather more modest in zloty terms; indeed, the dollar's slide against the zloty during recent years has slightly exaggerated the latest FDI inflows in dollar terms, artificially dampening the levels from the turn of the century, as shown in the table above.

However, there are also technical issues at play that change the overall picture somewhat. Since 2006, the NBP has published a new category of incoming investment, which is known as "capital in transfer" (in Polish, kapital w tranzycie). This refers to investment inflows recorded in the Polish balance of payments, initially raising the capital stock on the balance sheets of foreign-owned companies but later channelled abroad again for other means and are not spent in Poland at all. Since 2006, this term also includes the value of real-estate traded by foreigners in Poland.

The central bank introduced the concept to get a more accurate picture of the size and economic impact of direct investment inflows on the Polish market, because in fact FDI inflows in the form of "capital in transfer" do not have any meaningful impact in Poland in terms exerting influence on the business of local companies; in most cases they merely inflate Poland's financial account and the balance sheets of the firm in question. Foreign investment, which has been "flowing" through Poland this way, accounted for roughly 14% and 20% of all direct investment inflows in Poland in 2005 and 2006, respectively.

Nevertheless, even when deducting the "capital in transfer," the size of inflows to Poland remains impressive. Even more so considering the many disadvantages Poland still potentially scares investors away with, not least in comparison to countries like Hungary or the Czech Republic. Indeed, Poland has worse infrastructure and a more outdated road network than its competitors in Central Europe. Meanwhile, investors complain of lengthy and time-consuming administrative processes as well as cumbersome and costly telecommunication services.

During the past two decades, Poland has barely upgraded the number of motorways or express routes, which remains still very small, despite various government initiatives to push ahead with road construction. There is some hope that efforts in preparation for the next European football championship, which (hopefully) Poland will co-host with Ukraine in 2012, will act as a catalyst in this respect.

However, there is some ambiguity surrounding the infrastructure disadvantage, because Poland's geographical location is frequently cited as a major advantage, if not the most important one in some cases. Poland is situated exactly in the middle of Europe, making it a good logistical place for storage and transportation. Indeed, with upgraded transport infrastructure, the country could easily become a major hub for trade between Western and Eastern Europe. This suggests that a large potential for cross-border and transit trade has remained untapped so far.

Another important factor is the support received from central and local governments. In many cases, investors have received grants in the form of public subsidies or profit-tax relief. These measures have been received in cases where investors help in fighting unemployment in the region; in cases of good cooperation with local governments free leases of land have been granted, and, in cases of joint investment with Polish state-owned companies, additional financing is granted from the central government's budget.

Labour force remains key advantage

One of the main reasons why so many foreign companies have been considering Poland is definitely its labour force. Back in the 1990s, Poland was still attractive for low-skilled employment due the fairly low wage level, but the skill level has shifted notably upwards since then, not least because low-skilled workers are cheaper elsewhere around the globe.

Poland has almost 2m students in higher education institutions, ie. half of the population between the ages of 19 and 24 years, and these figures are increasing steadily. In 2003, over 360,000 graduates left universities in search of employment, while in 2006 this number rose to 394,000, according to information and investment agency PAIiIZ. Among the 394,000 students graduating from Polish universities, nearly 30% finished full-time courses with a master's degree, while 45% achieved a first undergraduate degree, in which over 30,000 received polytechnic engineer degree. In addition, Polish students are well prepared to work for foreign companies, with over half of them speaking decent English, as well as several other foreign languages, in most cases German, Russian, French, or Spanish.

Poland's endowment with young and skilled people is well recognised by foreign investors; indeed, the baby boom generation of the 1980s has just joined the labour market. Even though many chose to migrate as the UK, Ireland, or Sweden – where labour markets opened up since May 2004 – a relatively high share of well-educated talent remains.

As a result, the average nominal wage growth has accelerated markedly, partly as a consequence of rising demand during the course of the recent economic recovery, but also because labour supply has become scarcer. Nonetheless, the wage level has retained a reasonable pattern as productivity has compensated for a large chunk of the ensuing labour-cost increase; indeed, Poland's labour cost remains within a competitive range. Also, the rate of wage growth is still slower than in other regional economies, which enhances security for investors over potential cost increases.

Patterns of FDI inflows: geography

Looking into the regional spread of investments, there seems to be a relatively even pattern for investors' favourite choices of location. However, Poland's capital and biggest metropolitan area, Warsaw, has clearly claimed the bulk share of investments, particularly because most of financial-sector investments went there. But investment in other sectors has not only been taking place around Warsaw and its surroundings, but also in Lower and Upper Silesia, at the seaside, and even in very eastern part of Poland, like Podkarpacie with the rather small town of Rzeszow at its heart. This diversity of places is sometimes due to investors trying to use already existing infrastructure, as has been the case of the FSO car factory in Warsaw, which initially saw a venture undertaken by Daewoo and now operates under General Motors; or the investment in Jesionka airport near Rzeszow, where Ryanair has just modernised an existing runway to start its new investment. At the same time, there has been much greenfield investment, with Fiat having built brand-new car plant in Tychy or factory of audio-visual products by LG Electronics in Kobierzyce.

Patterns of FDI inflows: business activities

Given Poland's traditional post-communist role as a workbench for both medium-sized and larger multinational Western companies, it is hardly surprising that the manufacturing sector nowadays accounts for the largest portion in terms of FDI stock in Poland. In 2006, currently the latest available year for sectoral details, manufacturing made up 36.2% of the total FDI stock, with motor vehicles, food, and chemical products standing out as prime targets, but also the sector of electronic goods receiving much recent attention from foreign investors. Another aspect of this trend is reflected in the presence of manufacturing plants of big multinational car companies–for example German Volkswagen, which set up a joint venture in Poznan in 1993, and then converted it into a full-scale subsidiary in 1996 – as well as in the influx of multinational food companies like the Danone Group during the late 1990s.

Other major fields of FDI activity include financial intermediation, trade and repairs, as well as real-estate and other business activities, and, to a lesser albeit growing extent, the sector transport and communications. Many foreign banks set up branches in the Polish market, while takeovers of Polish banks have been the preferred method for gaining access. Nearly 60% of assets of the Polish banking sector were under foreign ownership at the end of 2007, with the major two players being Italy's UniCredit group and Germany's Commerzbank.

Clearly, the prime motivation for foreign investors in the manufacturing sector during the 1990s was to exploit the fairly low wage level of Polish blue-collar workers, a mechanism that apparently worked well until the end of the previous decade, but has come under pressure more recently with the emergence of even lower-paid workers, mainly from developing Asian countries. As the Polish wage level is rising fast nowadays, this first wave of FDI inflows is abating, having weakened substantially already at the turn of the century.

Colour of the collar changes

However, since then, a second wave of FDI inflows gained momentum, bringing about the record highs noted in the recent past. Indeed, Poland benefited from the global boom in outsourcing business processes, as call centres, research outlets, software development centres, business-data units, and other similar facilities mushroomed. In the global area, India is more commonly associated with this pattern of foreign investment, yet Poland and other Eastern European countries have attracted this type of foreign investment on a comparable scale, which is notable, particularly when taking into account the much smaller size of Poland's admittedly skilled workforce.

The latter factor was a key prerequisite for the second wave of investment, of course. Indeed, the country's strong endowment with graduates in IT, engineering, but also business administration made Poland a fairly attractive place as the outsourcing boom accelerated. While the first wave of foreign investment in Poland was perhaps more blue-collar-related (disregarding banking-sector investment), the colour of the collar has thus changed more to white with the approach of the second wave.

In order to illustrate the discussion, we have singled out two foreign investment projects, which could be seen as either part of the second wave of FDI in Poland but also indicate how important technological skills have become. These are the Motorola software development centre in Krakow, Poland's second largest city in the southern part of the country, and the Ryanair Boeing Servicing centre in Rzeszow, located in a more remote town in the south-eastern part, close to the Ukrainian border.

Motorola Software Development Centre in Krakow

Motorola, the US IT equipment and services company, operates one of its 17 software development centres in the Krakow Technology Park. This site is one of two software centres from Motorola in this part of Europe, the other being located in St Petersburg (Russia). The centre in Krakow was opened in 1998, and has quickly become the third-largest centre within the Motorola Global Centre Group. Motorola has invested more than $110m in the Krakow centre and currently employs more than 800 people there, focusing mainly on software production for public safety and wireless-networks infrastructure production. A landmark project of the Krakow centre was the development of the Warsaw's city police command and control system software.

Motorola's centre is located in a so-called Special Economic Zone, which were founded all over the country by the Polish government back in the 1990s in order to nurture foreign greenfield investment. These zones sport improved infrastructure and attractive land-leasing arrangements, but perhaps their biggest asset is their tax-exemption schemes. In the Krakow case, foreign companies investing more than €2m benefited from a 100% tax exemption on profits for the first six years of the zone's operating activities, which started in 1998. For the remaining six years of the zone's initial 12-year lifetime, at least a 50% tax exemption applies; that said, the closure of the zone has meanwhile been postponed to 2017.

Apart from tax exemptions, the zone's close connection with local academies, including Krakow's University for Technology as well as the Jagiellonian University, both of which now have an excellent reputation for educating engineers, IT specialists, and business and administration students, also played a significant role in attracting Motorola. Both universities are among the shareholders of the zone's holding company, and close cooperation is present between the companies in the zone and the academies. Indeed, the high skill level of local talents in combination with a fairly low wage level was perhaps the ultimate trigger for Motorola's investment decision.

However, it is not only Motorola that has invested in Krakow. Other major IT and business-services multinationals have followed suit, such as IBM, which employs about 1,000 workers there; moreover, KPMG and Cap Gemini are also present with software-development and business centres.

Ryanair Boeing Servicing Centre in Rzeszow

In 2004, Irish budget airline Ryanair, which is the investment partner for Singapore Technology, started its investment in the Jesionka airport near Rzeszow in the region of Podkarpacie, where the first plane-servicing base in this part of Europe will be created. The seemingly odd choice of this remote eastern Polish town was driven by its location. The airport, Jesionka, which is situated 10 km from the city boundaries, has a very long runway, which could mean that even large jumbo jets can be safely landed there, according to Ryanair. Also, Rzeszow University's polytechnic faculty is one of the few places in Europe where civil aircrafts pilots are trained; also the Podkarpacie region is connected to the aviation industry, with a factory in the nearby town of Swidnik producing helicopters and another publicly owned Polish aircraft-construction plant located in Mielec, another small town close to the airport.

The Podkarpacie region is also known for high unemployment rates, much lower-than-average wages, and lack of public infrastructure investments. This is why local authorities were keen to convince Singapore Technology and Ryanair to choose Rzeszow for their centre. Local government has already created a corporate partnership scheme with over 50% belonging to the local authorities, and the rest to the Polish Airport State Enterprise, an arrangement that allows the newly created company to apply for funds from the central government and the EU.

Krakow's special economic zone and the Ryanair Boeing Servicing centre in Rzeszow are but two examples of a trend that began in the late 1990s and gained traction particularly in the run-up to Poland's 2004 EU accession, capitalising specifically on Poland's own endowment in terms of technological skills. Early forerunners of this trend include Lucent Technologies, which already in 1992 spotted the potential of Polish academic graduates when the company launched a software-development site in Bydgoszcz. Other, later examples include Intel in Gdansk (1999), Siemens in Wroclaw (2000), and of course Motorola as described above.

Outlook and Implications

Despite its often-criticised infrastructural disadvantages, complicated tax system and bureaucratic burden, Poland enjoys a favourable position with many foreign investors. It has benefited from high direct investment inflows in the second half of the 1990s, and also, following a weaker period at the beginning of the current decade, since EU accession in 2004.

Foreign investors have transformed the Polish economic landscape significantly, while employing a large chunk of the many young graduates entering the labour market for the first time. Poland nowadays resembles much more of a mature market economy than it did 10 years ago, mostly because the service sector performed extremely well during that period, not least due to FDI. The resilience of Polish exports is very much a result of productivity enhancements effected by foreign investment, with foreign technological knowledge being transferred and cost-cutting measures implemented.

However, there are ramifications that go beyond these fairly direct growth and efficiency-enhancing effects. Firstly, if not most importantly, there is the Polish zloty's tremendous appreciation against the dollar since the beginning of 2004. In fact this trend began early, albeit hesitantly, in the current decade following the zloty's trough against the dollar during the recession at the turn of the century. The appreciation against the euro was slightly less pronounced, but nonetheless the zloty reached a new all-time high against the euro, at 3.32 zloty/euro on July 4, according to National Bank of Poland's official exchange rate. Meanwhile, the zloty/dollar rate, which levelled at 2.11 zloty/ dollar in early July, reached a 14-year-high.

This appreciation reflects not only fairly strong productivity growth, which today is driven mainly by high value-added growth rather than cost-cutting measures like firing staff, but also by Poland's attractiveness as a place to invest. This holds regardless of a likely pre-euro effect on the exchange rate, as Poland is visibly approaching the fulfilment of Maastricht criteria for euro adoption.

As Slovakia's example has shown, European authorities prefer to let the candidate's currency appreciate nominally before it is eventually allowed to join. But this is surely no common rule and could play out differently for other countries. In the Polish case, the European Commission might just urge a similar exchange-rate adjustment as it did in the case of Slovakia, given the still comparably low level of labour costs and other price indicators. Global Insight, however, does not think that the zloty will appreciate much further from the current level as the Polish current-account deficit is widening steadily, and might just return to the current level following a temporary phase of mild weakening in the meantime.

There are two major consequences derived from the zloty's recent performance, as well as from its outlook. Firstly, Poland's households and companies are now much better off than they were a few years ago in terms of their purchasing power, which has been enormously strengthened compared to most other countries in Europe, and Western Europe in particular. Therefore, Polish households' sensitivity to the sky-high oil prices and the rising costs of food staples is perhaps lower than elsewhere in Europe, and they seem relatively well-prepared for a weaker patch of the global economy, although it should be acknowledged that food and energy expenses in Central and Eastern Europe still account for a higher share in household expenditures than in Western Europe. Nevertheless, the resilience of the Polish economy against external shocks has surely improved.

At the same time, though, the influx of foreign investment could slow down markedly as the attractiveness for investing in Poland has deteriorated for Eurozone-based companies, but even more so for dollar-based investors. It is both the price of Polish assets as well as recurring costs such as the wage bill–which has risen markedly by virtue of the appreciating zloty. Other places like Romania, or Ukraine, or even Russia, seem much more attractive from this point of view.

Still, this is not to say that foreign investment inflows will stall in the medium term; they will nevertheless remain somewhat dampened, at least until Poland finally converts to the euro and the nominal exchange-rate level will is fixed. Probably the opposite could be said for Poland's investment flows abroad, as they are likely to gain further traction, though from a much lower level than inflows.

On the other hand, if expectations exist for a further zloty appreciation, foreign investors might consider acting sooner rather than later; however, the uncertainty about levels of cost will surely divert some investment away from Poland. This holds, of course, only unless a third wave of investment is to roll over the country, but the new colour of the collar has not been spotted in Poland so far.

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