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Is the West Still the Best for European Business?

15 11 2007  The economic balance between the two halves of a once-divided continent is shifting, as firms up sticks and head east.

By Bogdan Asaftei in Bucharest, Botevgrad, Azambuja and Belgrade

Azambuja, a small town with 7,000 inhabitants, 35 km north of Lisbon, looks like the perfect place for a tourist seeking a well-deserved break. The small streets and houses are neat and tidy and silence reigns everywhere. But not everyone relishes the silence. On a house in the centre of town, a big red flag with a hammer-and-sickle proclaims that this is a communist-run workers’ club.

But as an old man, standing in front of the building, points out, the name is a misnomer. “Here is a workers’ club, but there is no work in Azambuja,” he says, sadly. “The town has collapsed since Opel left. Our town is like that tower - falling slowly,” he adds, pointing to a leaning spire that resembles the famous tower of Pisa.

Only months ago, Azambuja was the operations centre for one of the most important Opel factories in Western Europe, employing more than a thousand workers. But in December, the automobile plant closed, the workers were dismissed and silence embraced the streets. The firm, part of General Motors, relocated production to several sites, in Gliwice in Poland, St Petersburg in Russia and Zaragoza in Spain. It was another cruel blow to the ailing economy in Portugal, where the unemployment rate was 7.7 per cent last year and 8.4 per cent this year, the highest rate since 1987.

The plight of Azambuja has been replicated in many towns in other countries in Western Europe, as firms, in the wake of globalisation, up sticks and relocate to the old Eastern bloc, lured by the promise of cheaper workforces and lower operating costs.

Peugeot Citroen has moved most of its operations from Britain to Slovakia, for example. The computer producer HP has shifted from France to Bulgaria while the consumer appliance giant Electrolux has shifted from Germany to Poland. They are just a few of the largest corporations that have relocated to Eastern Europe or are planning to do so. Others include the computer manufacturer Dell, British American Tobacco, Volkswagen and IBM.


From black hole to gold rush

A few years back, Eastern Europe was very far from the “El Dorado” it now appears to be for investors. In the early 1990s, few Western companies were interested in moving operations there. The new non-communist governments in the region were preoccupied with trying to sell off their factories, most of which were uncompetitive and dilapidated, stricken by huge debts and oversized workforces.

Without obvious prospects at home, workers left for jobs in Western Europe, creating the now familiar phenomenon of the “Polish plumber”, the Romanian nurse, or the Bulgarian construction worker. This helped Western countries maintain their economic competitiveness but also gave a fillip to the economies the migrants left behind.

Remittances soon become a major source of revenue for their countries of origin. Between 1997 and 2002, Romanians sent back about 8 billion euros in savings, according to the Romanian central bank, BNR. The sum has increased year on year, reducing the country’s current account deficit by 38 per cent in 2005. This year, it is estimated that money from workers abroad will total more than 5 billion euros, more than 4 per cent of GDP.

A recent World Bank study of remittances as a share of Eastern European countries’ GDP, using data from 2004, showed three other countries benefited by similar amounts. Money sent home by migrants from Moldova, for example, was worth almost 503 million euros, equivalent to 27 per cent of the country’s GDP. Migrants from Bosnia and Herzegovina sent home 1.31 billion euros, or 21 per cent of GDP, while Albanians sent home 830 million euros, equivalent to 16 per cent of the country’s GDP.

At the same time, as Eastern European economies started to reform and develop, Western companies became increasingly interested in investing in the region. The movement of workers abroad was matched, therefore, by a counter-flow of investments, acquisitions, green field projects and relocations.


A tale of two towns

Relocation involves companies moving operations partially or totally from one region to another and – normally – closing units and plants in the town and country of origin. It is not just a simple investment, expanding business into another territory. It is a move dictated by economic and logistical arguments. At the same time, it entails a fresh outlay of investment in the new country in production facilities and a new workforce, as well as in the acquisition of property and new headquarters.

The most common and obvious incentive for relocation is, as has been noted, a cheap but skilled workforce and lower production costs. Some countries offer extra incentives to incomers in the form of low or negligible startup taxes. The ageing profile of the workforce in Western Europe has boosted the trend, creating a shortage of skilled and educated young people, according to a 2005 study commissioned by business consultants KPMG of 172 manufacturing companies in Western European industrial nations and presented by the Economist Intelligence Unit, EIU. The expansion of the European Union into the Balkans provided yet another stimulus to the relocation process, with new EU members, Romania and Bulgaria, becoming sought-after destinations for foreign companies seeking to move all or some of their operations out of the West.

When a company relocates its operations, it has profound social implications for the community. Take the respective cases of Azambuja in Portugal and Dej, a town of almost 40,000 in central Romania.

When Opel closed its gates in Azambuja last December and moved production to Eastern Europe and Spain, the relocation hit Azambuja hard. “Our town was totally dependent on the Opel factory and now there’s nothing to do,” laments Carlos Almoster, who worked in the plant for more than a quarter of a century. “All my life was spent in the Opel factory, starting 25 years ago. But since the plant moved, all I have to show for it is a gold watch,” he adds. “After so many years, I feel useless,” he says, holding out the souvenir.

In Dej, it is a different story. The town is enjoying a boom as more and more companies like Opel relocate their activities there. In 2005, Spain’s ACE Automotive Group, which makes electrical components for vehicles, opened its first Romanian plant. It has since announced plans to relocate all its production from Barcelona and Zaragoza in Spain to Romania by 2011. Half of ACE’s 6,000 employees are already there and the group intends to hire another 1,100 employees for new Romanian units.

Last June, Trelleborg of Sweden also opened a factory in Dej, producing car parts for Renault, Audi, Ford and Peugeot. At the same time, it has cut production in Trowbridge in Britain and Mannheim in Germany, where almost 1,000 jobs have been axed.

Dej’s dilemma is an insufficient number of workers for the newly vacant positions. “We are facing many problems due to the [tight] labour market, which is why we are trying to open new production facilities in those regions where it is easier to find new workers,” says Tatiana Mursa, PR manager for ACE in Romania.

As the main motivation for relocating operations to Central and Eastern Europe is low labour costs, the wages these companies offer Romanian workers are inevitably modest. Despite a rise of about 200 per cent in average salaries in the last four years, analysts estimate it will take years before Romanian salaries - just over 400 euros per month in mid-2007, according to the National Institute of Statistics - match Western counterparts and become uncompetitive.

“Average wages in Romania will attain 60 per cent of Western ones, which is what we call convergence, in about five years,” notes Adriana Iftime, manager of Romania’s Ownership of Romanian Contractors.


Will somebody please relocate here?

While Dej is a showcase for the way in which relocations can transform a town’s fortunes, not everybody in Eastern Europe is optimistic that they can also become a magnet for Western firms. In Botevgrad, a small town in western Bulgaria about 50 km away from the capital, Sofia, while local people pray for a Western company to shift to their town, they are far from hopeful.

The mono-industrial town was totally dependent on Plastchim, a local manufacturer of plastic goods that closed four years ago. Depression, frustration and pessimism now prevail in Botevgrad. The frustration is all the worse because the workers were fired after not having received their salaries for months. They launched a court case to recover some money - and won - but still didn’t get any cash. “The judge said we had a right to receive our money but the judicial decision was not applied because the company had gone bankrupt,” Ivan Nikov, a former Plastchim worker, says.

In the meantime, the townsfolk live without any hope for a better future. “I was dreaming of doing up my house, but after losing my job I had to drop those plans,” Nikov complains. Another worker, grey-haired and grim-faced, describes how he has had to put his life on hold. “My wife and I planned to have another child, but we can’t afford it anymore”, he laments.

In Botevgrad, the mood of pessimism is far worse than it is in Azambuja, where Opel only closed its doors relatively recently, and where the sacked workers at least obtained redundancy payments. “The real problems will come next year when we run out of the money we received from General Motors,” Joao Soares, a former Opel worker, says.

Jose Eduardo, another former company employee, has been luckier. “I found a new job at the town hall,” he says. “But most of these men won’t be able to find another job because they are 50 or older.” Life in the town is already visibly fading. Many houses are for sale or for rent, as the numerous signs reading Venda-se [for sale] or Arenda-se [for rent] indicate.

It’s not all about cheap labour, actually

While local people in Botevgrad complain about the lack of Western companies interested in relocating to their town, analysts note that many crucial but highly subjective reasons come into play when firms decide to relocate eastwards.

Turning to the key motives, cost factors and market acquisition clearly come to the fore, according to a 2006 study commissioned by the finance committee of the French Senate. These are followed by questions concerning the proximity of expanding markets, labour cost differentials, the cost and availability of raw materials and the presence of an attractive local network of production facilities. Taxes, surcharges and subsidies are lesser considerations.

A more subjective element is historical connections. Take Austria, which is among the most important of the new investors in Eastern Europe: many financial analysts say Austrian firms hurried into the region because they had old links with this part of Europe, from when it formed part of the Habsburg Empire. As the economist Eric Frey noted in an article published last April in the Austrian daily newspaper, Der Standard: “In those places where the Habsburgs had reigned, Austrian managers felt at home”.

Other, more intangible, subjective reasons have also to be taken into consideration. According to Klara Floti of the Budapest-based ARC Relocation Hungary, a company that facilitates workforce mobility, “the Czech Republic is preferred for its ‘Western’ traditions and Hungary for its central location, beautiful capital and the number and quality of IT professionals. Romania comes top for low labour costs.”

There are also downsides that companies need to weigh up before moving. Investors still face serious hurdles when relocating to Eastern Europe, despite improvements in recent years. Recent European Commission reports on Eastern Europe continue to stress high levels of corruption, weak judicial systems and inadequate and unstable legislation as challenges facing investors - not to mention the tremendous amount of red tape. “Let’s also not forget the old, run-down infrastructure that impedes competitiveness with Western demand,” adds Katalin Varga, managing director of Settlers Kft, another Budapest-based firm working in the relocation industry.

Isamar van Hilten, of Partners in Relocation Group, Pirgroup, notes other negative aspects that companies need to factor into their calculations. Many relate to the temperament of the labour force in Eastern European countries. “Most of these people are characterised by an old-fashioned approach to paperwork, a fear of new events and an unwillingness to work together,” she claims. “They [also] refuse to become accountable.”

Certain countries are already emerging as centres for particular fields of industry that have relocated eastwards. Krzysztof Piech, associate professor at the Warsaw School of Economics, says Slovakia’s good infrastructure hasbrought success in attracting relocating automobile companies. “Slovakia was in a privileged situation because of its good infrastructure, which has positively influenced the circulation of goods and people,” Piech maintains. Slovakia now manufactures over 225,000 cars a year with a potential annual production of 850,000 cars by 2010, according to STAT-USA, the statistical service of the US Department of Commerce.

Volkswagen is currently the largest carmaker assembling vehicles in Slovakia. As has been mentioned, big investments have come also from Peugeot Citroen, which closed its factory in Britain and relocated to Trnava, 45 km northeast of Bratislava, investing more than 700 million euros in the new site. A third car producer in the country is KIA Motors, an affiliate of the South Korean carmaker Hyundai Motor Company, which has a plant in Zilina, in northern Slovakia.

Other Eastern European states have become centres for other types of relocated industry. According to van Hilten, from Pirgroup, Slovenia is becoming the region’s “headquarters” for pharmaceuticals, while Poland attracts firms working in food supply and agricultural products. It is also an administrative centre for large multinational corporations. Belarus and Ukraine are increasingly interesting on account of their cheap but skilled IT staff.


Where to next?

Relocation is taking place not only from Western to Eastern Europe but also within the Balkans. Some countries are becoming magnets for relocation precisely because they are near - but outside - the EU. “When Romania joined the EU, one Romanian company decided to relocate operations in Serbia,” says Patricia Gannon, of Karanović & Nikolić, a Belgrade law firm working in commercial banking, privatisation and taxation.

“Because Romania now has to respect European legislation, it will become a state where the law will be strengthened,” she adds. The Romanian firm relocated to Serbia not only because legislation over the border remains more permissive than in the EU, but also because the Serbian economy is improving overall.

“The economy of the country is growing, industry is developing and privatisation is proceeding fast,” Gannon adds. “But this country still has an enormous disadvantage compared to the other countries from the region; Western states have a very strict visa regime with Serbia, for example, so Serbs cannot go there easily.”

Some economists believe the boom in investment and relocation in Eastern Europe has already passed its peak, as other, cheaper, parts of the world nudge their way into the market. Eastern Europe has not proved an overall match for the booming Asian economies and is rapidly losing out in investment terms to those countries, according to Ernst & Young’s European Investment Monitor, which examines inward and outside investment in Europe in 2006.

The rate of foreign investment in Poland, the Czech Republic and Hungary fell considerably last year and the trend was led by a “declining ability to attract low cost manufacturing investment, which appears more likely to invest in Asia,” the Ernst & Young report noted.

Even if this is true, investment in the region is not about to halt altogether, and the debate goes on over which Eastern European country will become most attractive to foreign relocating companies in the next few years. “I bet on Macedonia and Poland,” says Katalin Varga, of Settlers Kft. “Macedonia, because the corporate tax is very low and Poland, because it has a big market.”

This article was produced as part of the Balkan Fellowship for Journalistic Excellence, an initiative of the Robert Bosch Stiftung and ERSTE Foundation, in cooperation with the Balkan Investigative Reporting Network, BIRN.