Central and Eastern Europe (CEE) A new business environment

2004 enlargement One of most significant events in EU history –10 new member states –Population up 20% –Area increased by 26% –GDP up only 5% What are implications for EU and for business?

Characteristics of CEE –diverse population - culturally and ethnically –low tech and productivity – changing –poor quality infrastructure –low costs and wages –relatively low income/head but skilled labour

Employment costs – annual average full-time male Source: Mercer Human Resource Consulting, Press release 4 April 2005

GDP per capita – 2005 (PPS)

6 Rationale for EU enlargement Cultural/geographical – part of Europe Mutual economic and political gains Internal gains: –Economic: larger SEM, better policy co-ordination –Security: alliance building with former Cold War enemies - containing Russia? –Political: extension of market orientated pluralist democracy into former bastions of communism. External gains: –Enhanced regional role for EU and greater weight in international affairs (eg trade negotiations)

Why join the EU? Alternatives? EU - dominant and successful regional framework - market access and assistance Coincidence of requirements of transition and enlargement - i.e. facilitate the process of modernisation Membership - able to influence EU law and policy Globalisation - membership of world’s largest trading bloc

8 The legacy of communism Micro-economic problems : Absence of market mechanisms – inefficient resource allocations. Sectoral imbalances –over-development of heavy industries – under-development of consumer goods industries. Environmental problems Bureaucratic legal/administrative structures Apathy- absence of competitive forces

9 (continued) Macro-economic problems: Repressed inflation via wage and price controls Monetary policy - often a reliance on foreign debt Inappropriate patterns of investment Hidden/disguised unemployment MASSIVE PROGRESS TO DATE IN OVERCOMING ABOVE PROBLEMS

10 Challenges of enlargement to European business Enlarges SEM –opportunities from supplying a larger market. –CEE fast growing market for consumer and industrial products –CEE share of extra-EU exports in 1983= 7%, by 1997 = 15.3% Competition: Inter-industry or intra-industry trade? –Eg Hungary -intra-industry trade ratio 61% 1994 but only 50% BUT –Growth in inter-industry trade more evident (labour intensive and lower value-added production). Relocation of industry to CEECs ?

What does EU enlargement mean for Growth Trade Investment Jobs For the EU?

Growth After traumatic falls of early 1990s, 2004 accession states growing faster than EU(15) but: –Real GDP in several still below that of 1989 i.e. much catching up to do

Transition period GDP growth (2004 average CEE and Baltics = 5%)

Real GDP in 2003 (1989=100) Source: EBRD, 2004 Transition Report

Trade Growth of intra-industry trade First half of 1990s – massive shift in CEE trade towards the EU –Trend continues albeit at lower rate Opportunities for both eastern and western traders –e.g. capital goods from the West –Untapped markets in the east –Low cost advantages for the east in the west

Evolution of EU-25 shares of trade of major CEE countries

%exports to EU

18 Investment Opportunities: low cost production, privatisations, skilled workforces and emerging local markets. –government incentives to inward investing firms –cumulative FDI inflows $147.5 bn –Est. inflows of $14.8 bn in 2004 –Big difference between countries – e.g. since 2003, Slovenia is net exporter

Cumulative FDI per capita, $US, Source: EBRD, 2005 Transition Report

Trade and investment example The motor industry

Motor industry 1989–9 - CEE companies produced over 3 mn cars for local market – not suitable for export EU motor industry – integrated, transnational industry before SEM Transition and accession – extends transnational European motor industry (econ. of scale and minimum efficient size) eastwards CEE provides –markets –Platform for exports % of EU car imports by volume rose to 7% Mid-2000s - about 15% Since 1990 – all major European automotive investment in CEE - competition for investment

SlovakiaVW300,000 units PSA Peugeot-Citroen300,000 units by 2006 Hyundai Kia200,000 units by 2006 with possible expansion to 300,000 CzechVW ,000 units per annum TPCA Toyota Peugeot Citroen Automobile Production began early 2005 and will rise to 300,000 vehicles per annum RomaniaRenault Dacia95,000 units (2004) 200,000 by 2010 HungarySuzuki200,000 by 2006 and later 270,000 AudiEngine plant and 55,000 vehicles SloveniaRenault132,000 units in 2004 PolandFiat360,000 units in 2004 Opel110,000 units (2004):→150,000 CAR PRODUCTION IN CEE

CEE motor industry benefited from: 1.Qualified and low cost labour force – problems with inflexibility Source: Derived from Revue Elargissement, Dossier 52 – March 2005 Labour costs in the motor industry – end 2004

2.Strong regional demand –Lower car ownership rates –Older stock – years vs8 years (EU15)

3.Proximity to West European markets 4.Links with related industries – e.g. materials and components 5.Slovakia 2006 to become world’s largest car producer in terms of cars per capita At transition – produced no cars – 2006 will produce 800,000 plus Car production – 20% industrial production; 17% GDP and 25% exports Location: market and at centre of emerging auto cluster

VW Skoda - since 1991 Greenfield investment - longer to take root Limited joint venture - brownfield opportunities: VW quickly took advantage – Skoda in Czechoslovakia –Initial reputation for poor quality and reliability –1991 VW took 30% stake in Skoda –2000 VW took last of government’s stake in VW –VW sees Skoda as platform for CEE and Russia and Asia entry –Largest auto producer in CEE - output tripled –Consistent 50-55% of domestic market –Skoda’s image transformed

–Spillovers - within 5 years, VW Skoda had stimulated 52 joint ventures & 38 greenfield suppliers –Largest sales revenue of any Czech company, –Czech number one exporter (10% of all Czech exports - auto components a further 5%) - exports 52% of sales approaching 80%; 64 markets -

–Leading industrial employer - plants and domestic supply chain employ 150,000 (4% Czech workforce) –Helped integrate Czech component manufacturer into global automotive sourcing –Some differentiation from VW cars - but many VW qualities at lower price

Jobs Low wages in CEE leads to competitive advantage over EU-15 –Investment effect –Downward pressure on wages elsewhere in EU Migration effects? Will CEE advantage disappear over time?

For the EU? New balance of power? Institutional pressure Extension of SEM Few policies unaffected

The Future Future members: –Bulgaria and Romania –Turkey - date unknown –Croatia –other former Yugoslav republics? –Others?