Slovakia worries cars won't drive it through global recession

By bne IntelliNews September 24, 2008

Jan Cienski in Bratislava -

Slovakia's icon is the Tatra mountains, whose snowbound peaks adorn the country's flag. But a better symbol of Slovakia today might be the futuristic ski lift outside Bratislava that hoists finished cars from the Volkswagen factory to the test track on the other side of a highway.

That's because Slovakia has become the world's leading car producer on a per capita basis with about 106 cars produced for every 1,000 Slovaks, and cars already make up about a third of Slovakia's exports. Cars have turned Slovakia from a rusting also-ran economy reliant on a creaking arms industry for much of its exports into the fastest growing economy in Europe. But there is now a growing danger that Slovakia has become over-reliant on a cyclical industry that's now entering a potentially severe downturn.

"We are nervous that a huge proportion of investments are in car production," Robert Fico, Slovakia's prime minister, tells bne. "We are now concentrating on other investments." He is echoed by his finance minister, Jan Pociatek, who warns that not only is the country's dependence on the car industry already too big, the situation could even be "dangerous" for Slovakia, which last year enjoyed growth of 10.4%.

And it's not just politicians who are apprehensive about the health of the overall economy if western Europeans dramatically slow their car purchases. Even car factory bosses are worried about the dominance of their sector. "Until now, the expansion of the car sector has been positive, but three big players in the country are enough," says Andreas Tostmann, head of the Volkswagen factory.

In addition to Volkswagen, PSA Peugeot Citroen has a factory in Trnava, about 50 kilometres north of Bratislava, and Korean car maker Kia is building cars and SUVs in its factory in Zilina in the north, near the border with Poland and the Czech Republic. Last year, Slovakia's big-three car factories produced 572,000 units, almost double the production in 2006. This year, production is expected to be about 675,000 before reaching full capacity of close to 1m by 2009.

Until now the arrival of each additional car plants has been positive, attracting a host of smaller suppliers who have ended up supplying other parts of the car industry in central Europe. Last year, for the first time more of Volkswagen's parts came from supplier factories in Slovakia than from Germany. The problem is that the car plants and suppliers have soaked up most of the available labour in western Slovakia, the most advanced part of the country. "It's not easy to find workers, unemployment is too low in this area," complains In-Kyu Bae, president and CEO of Kia in Slovakia, a unit of Korea's Hyundai.

Volkswagen has shifted some of its production to the more depressed east of the country, but has run into troubles because of the lack of a decent highway or fast railway link between the two halves of Slovakia. "We need an improved road and rail network to the east," says Tostmann.

Carmakers were initially lured to Slovakia by a combination of low labour costs, steeply rising productivity and a skilled workforce honed by a long industrial tradition. Volkswagen opened its factory in 1991, before Slovakia split off from the Czech Republic. "We found good skills and trained workers. Czechoslovakia was a country with a tradition of producing cars," says Tostmann.

Kia is also thrilled with its workers. Bae says their productivity is higher than their counterparts in Korea. Kia was also attracted by Slovakia's 19% flat tax. "It's one of the biggest advantages of the country, it's really like a tax have for us," says Bae. "We can more easily invest and expand our factory here."

However, both of those advantages are fast being eroded. Most of the rest of central Europe has also introduced flat corporate taxes, and labour costs are now even cheaper in new EU members Romania and Bulgaria.

The government is now scouring around for other types of investments to balance the car sector. Recently, it announced that Slovakia had attracted flat screen television plants from Sony and Samsung. But as Slovakia tries to balance its economy by looking for other forms of investment, it is running into the limitations imposed by its underwhelming education system, which does not produce enough specialized graduates to interest investors looking for much more than assembly plants. The carmakers have not transferred much of the research and development to Slovakia, preferring to keep those functions closer to head office. And even the flat screen TV plants being touted by the government need much lower skilled workers than car factories.

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Slovakia worries cars won't drive it through global recession

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