Clare Nuttall in Bucharest -
Southeast Europe is fast becoming the low-cost manufacturing centre for the Continent, a transformation driven as much by changes to the Chinese economic model as by efforts within countries on the fringes of the EU to attract investors.
Workers in countries like Albania, Moldova and Serbia are cheap, well educated and right on the EU’s doorstep. Added to the increasing savviness of most governments in the region in how to attract international investors, this has proved to be an attractive proposition for global manufacturers of products from clothes to auto-parts who have been gradually migrating eastwards in a quest to keep costs down.
But Southeast Europe’s transformation into an emergent manufacturing hub was triggered primarily by changes some 8,000 kilometres away in the industrial heartland of eastern China. Changing demographics are at the root of China’s transition away from a low-cost manufacturing location. As the population ages, China’s labour surplus is disappearing, creating upward pressure on wages. Concerned that a widening income gap could result in social unrest, Beijing is aiding this process by increase the minimum wage and putting pressure on multinationals to raise salaries. Average wages rose by 8.6% in China in 2013, and are expected to increase by a further 8.8% in 2014, according to the China Daily. The government has announced plans to raise minimum wages by an average of 13% a year until 2015.
The upshot of this is that it has eroded the wage gap between China and low-income European countries, several of which now have a lower minimum wages than richer Chinese regions. After increases across most of the country in April, the minimum wage in Shanghai – the highest in China – stood at CNY1,820 (€223) per month. This is well above the MDL1,650 (€89) that the Moldovan government set as its minimum wage in May. While this is the lowest rate in Europe, Albania’s minimum wage is just ALL22,000 (€160), and minimum wages in Bulgaria, Macedonia, Romania and Serbia are all under €200, according to Eurostat data. Consequently, international firms are exploring new manufacturing locations.
Closer to home
Habitex Group, which specialises in producing high-end garments for German clients such as Basler and Gerry Weber, currently carries out the bulk of its production in Romania, where it has built its own factory. The company’s chief financial officer, David Jachir, believes there has been a shift from Asia to Europe. “As Chinese labour costs rise, there are two choices: either you go cheap and move to a region with lower costs – Bangladesh, Indonesia, Vietnam – with all the risks; the second choice is to go local, move production closer to the market to increase responsiveness and speed to market.”
Proximity to Western European consumers is another factor; it takes just days to receive goods from factories in Eastern Europe compared with the two months needed to ship from China. Albania, for example, is just 100km from southern Italy, encouraging a growing number of Italian shoe and clothing retailers to shift their production across the Adriatic, often working with local sub-contractors. EU rules allow goods produced in Albania (or Bosnia-Herzegovina, or Macedonia) to bear the “Made in Italy” label, provided at least part of the manufacturing process takes place within Italy.
Speed has also become the all-important factor for mass-market clothing retailers like H&M and Zara. The spring/summer and autumn/winter seasons are being superseded by fast-changing “micro-trends” designed to get customers into their shops more often and spend more money. To make this possible, Zara produces 80% of its goods within Europe.
Investors also report that Chinese producers have become harder to work with. The legacy of the recent economic crisis has actually been to improve the bargaining position of Chinese manufacturers. Initially, it forced many Chinese factories catering to the international market to close. This reduced the number of players on the market, putting those that remained open in a stronger position when negotiating terms with customers. Others have turned to the increasingly affluent domestic market, where buyers tend to be less picky, rather than “fulfill complicated orders for European customers,” says Jachir.
Elena Baragan, commercial director of Nightserve, which produces specialist garments for the military and services such as the police and fire brigades, acknowledges that while costs are higher in Romania, which has been an EU member since 2007, there are advantages. “Since the crisis in Europe, the size of our orders are not so big and customers have wanted quick turnaround. Going to China for 150 vests is not cost effective,” Baragan says. Given Romania’s background in the textiles industry, quality is also higher, she adds.
Indeed, while Romania is a centre of mass-market production, the country’s rising costs have been accompanied by an increase in skills – largely thanks to the influx of investors in the mid-2000s. This has seen the country gradually segue from a low-cost factory to a producer of higher end goods and other activities such as IT and services outsourcing. James Hyslop, director for Romania at the European Bank for Reconstruction and Development (EBRD), highlights the impact of knowledge transfer and investment into human capital.
Notable investors in Romania include Universal Alloy Corporation Europe, which set up production of aerospace components and supplies customers such as Boeing from a plant in northwest Romania. Deutsche Bank also endorsed the skills of the Romanian workforce when in May it opened a Global Technology Centre in Bucharest. One of just four worldwide, the Bucharest centre will hire 500 people by the end of 2016 to develop software applications.
Bulgaria has also seen significant interest from foreign investors into high-tech sectors, according to the InvestBulgaria agency. Business process outsourcing has become one of the fastest growing areas of the economy, while the automotive and components sector is also growing.
However it has taken years of investment to come this far, and other countries in the region such as Albania and Moldova are as yet much further down the value chain.
Cut from different cloth
Spurred on by the trend towards fast, disposable fashion, clothing production tends to be a frontrunner in relocating to low-cost destinations in Emerging Europe.
A large share of this production is on “lohn” contracts, also known as CMT (cut, make and trim), under which materials are processed to exact technical specifications. Often the materials are delivered by the customer then re-exported. As a result, opportunities for wider development, by improving skills or creating opportunities for local suppliers, are low, say critics.
There is also a darker side to the clothing and textiles industry across the region, revealed in a June report from the Clean Clothes Campaign. The report says that international brands including Hugo Boss, Zara and H&M are paying “poverty wages” to workers in Southeast Europe and Turkey. “[P]ost-socialist European countries function as the cheap labour sewing backyard for Western European fashion brands and retailers,” says the report entitled "Stitched Up".
Another industry that has been moving steadily eastwards since the 1990s is the automotive sector. Both car assembly plants and components manufacturers are increasingly moving further east to take advantage of lower labour costs; the high costs of transporting cars and car parts give the eastern part of the continent a further advantage over East Asia.
Poland, the Czech Republic and Slovenia became auto manufacturing centres in the first wave of migration eastwards. Ten years on from their entry to the EU, costs there are looking less competitive than in the would-be EU member states further south.
Serbia, like other Southeast European countries, saw FDI drop with the onset of the crisis and it has failed, as yet, to recover to pre-crisis levels. However, the Fiat factory in Kragujevac has not only lifted FDI and exports, but also helped spawn an army of suppliers to the Italian automaker. After taking over the old Zastava plant, which once produced Yugo cars, Fiat opened a brand new plant with an investment of €1.2bn. Fiat has now become Serbia’s top exporter. “By far the most intensive sector is [the] automotive industry, propelled by the capital investment by Fiat in the city of Kragujevac, central Serbia,” says Jovan Miljkovic, senior investment advisor at the Serbia Investment and Export Promotion Agency (SIEPA).
Today, Serbia has more than 150 companies in the automotive sector, boosting both GDP and exports. Other international investors in this sector include Cooper Standard, Magnetti Marelli, Johnson Controls, Leoni and Yura. “There is decades-long commercial cooperation with a large number of foreign companies stemming from Western Europe, which consequently evolves into the natural outcome that those companies open their production facilities here in Serbia,” Miljkovic says. “Moreover, the Serbian labour force is very technically skilled and informed about the latest Western technologies, which facilitates the adoption of new technological processes.”
It is a similar situation in Romania, where Renault took a majority stake in local carmaker Automobile Dacia back in 1999. Since then, Renault has invested in €1.2bn in Dacia.
There are now signs of a tentative move even further east as Moldova starts attracting auto-parts producers. Major investors include Draxlmaier and Lear Corporation, which according to USAID employ a combined total of over 4,000 people. They were followed by Gebauer & Griller, which in April opened a cable manufacturing plant mainly serving the automotive industry, with support from the EBRD. “Increasingly... the automotive industry is looking for ways to reduce its costs of production, motivating shifting of production from Poland, the Czech Republic, and Romania to countries with lower costs such as Moldova, which has an opportunity to secure more of this business,” according to a USAID presentation.
Labour costs, however, “are a factor, but not a decisive one”, says Peter Sanfey, deputy director in the EBRD’s office of the chief economist. “Investors look at broader political stability, macro stability and the stability of the operating environment.”
The welcome mat
One of the most important signals is EU candidate status. “Especially for a country like Serbia with a troubled history, tying itself to the EU mast and committing to EU norms is very important,” Sanfey tells bne. “Some of the advantages of the EU accrue to countries well before they actually become members. The whole region seems to be moving in that direction.”
The importance of creating a welcoming environment has helped less obvious investment destinations to redress the balance against EU-established countries like Romania and Bulgaria, which were two of the region’s earlier entrants to the bloc.
Romania saw FDI drop 10.3% on year in the first half of 2014, according to central bank data. This follows changes to the tax regime and retroactive changes to incentives to renewable energy generators that have unnerved investors. Mariana Gheorghe, CEO of Romania’s largest company OMV Petrom, said in a recent interview with Agerpres that the company might cut investments if the government fails to create a more favourable fiscal framework.
The fall in FDI comes despite Romania’s natural attractions for investors. “When investors started moving into Southeast Europe just over a decade ago, Romania was one of the most obvious investment destinations in the region. The country promoted itself naturally, given its geographic location, its large population, natural resources and its low-cost, well-educated and plentiful workforce,” says the EBRD’s Hyslop.
However, he adds that, “Today there is less FDI going around, and countries are competing fiercely for investment. To better compete for these scarcer investments Romania needs a coherent policy framework for attracting FDI.”
Bulgaria has also experienced a flow of investment into high value sectors such as auto-parts manufacturing and business process outsourcing. However, FDI inflows slowed in the first half of 2014, dropping by 33.8% on year. The fall is most likely due to political uncertainty; Bulgaria is currently heading for general elections following the second government collapse within 18 months.
As countries from the region compete for a smaller pool of cash post-crisis, aggressive efforts to bring in new investment are paying off.
Macedonia, a tiny country of just 2.1m, has made FDI a priority under long-time Prime Minister Nikola Gruevski, who was re-elected in April. While FDI inflows have not yet returned to their 2007 peak of €506m, at €251.2m in 2013 and a forecast €300m-350m this year, they are already beating the pre-crisis average of €241m a year.
Kliment Sekerovski, deputy CEO of the Agency for Foreign Investments and Export Promotion of the Republic of Macedonia, puts this largely down to the government’s efforts. Following numerous reforms, Macedonia was in 25th place in the World Bank’s "Doing Business 2014" survey. Skopje has sought to draw in investors with incentives such as low tax rates, a much-reduced regulatory burden, and free trade agreements with the EU and neighbouring countries. The EBRD wrote in its 2013 transition report that Macedonia is “vigorously pursuing new foreign direct investment... actively marketing itself as an investment destination.”
This has paid off in commitments from the likes of Turkish-Chinese clothing manufacturer Weibo, which announced in April that it will invest $400m to build Europe’s largest integrated textile factory in a new industrial zone in northern Macedonia. Weibo’s statement says it picked Macedonia after a “thorough analysis of various region and investment opportunities.”
Macedonia is by no means the only country in the region to have set up a proactive investment agency and seized on the special economic zone model to attract more investors. In Serbia’s second city of Novi Sad, the centre of the Vojvodina autonomous region, the Vojvodina Investment Promotion agency has brought in around 50 foreign companies that have invested a total of $2bn in the region, bne reported. The Foreign Investment Promotion Agency of Bosnia-Herzegovina says it is promoting the country’s low tax rates and “price competitive labour force” to draw in more investors. Across, the region, numerous hothouses – all offering tax breaks, new infrastructure and an educated, low-cost workforce – are competing with each other, as potential investors consider it as a manufacturing destination.
Whether this trend will continue in the longer term hinges on how effectively the countries on the southeastern fringe of Europe can leverage the current wave of investments, and in future offer highly skilled workforces and a conducive business environment that will see them remain attractive after they can no longer compete effectively on cost.
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