Poland, by far the largest of the Central European countries entering the European Union in May 2004,¹ is losing the battle for foreign direct investment to its smaller neighbors. Although it could reverse this trend by attracting multinational corporations that offshore services to low-cost destinations, first it will have to intensify its efforts to create a more inviting investment climate, a study has found.²

After the collapse of Communism, in 1989, Poland was the preferred place for foreign direct investment in the region. Throughout the 1990s, the goal was to capitalize on Central Europe’s domestic market. But from 2000 to 2002, foreign investment plummeted in Poland while it soared in the neighboring Czech Republic and Slovakia and rose steadily in other nearby countries (Exhibit 1). Now these regionally oriented foreign investments—90 percent of the total in Poland—are drying up: privatization is largely complete, as are onetime investments by multinationals in assets such as fast-food restaurants, retailing networks for consumer goods, and service station chains.

As a result, Poland and much of the rest of the region must seek new sources of foreign direct investment. The country should target investments for which the size of the domestic market...