Economics & Policy

The Auto Slump Hits Eastern Europe


Zilina, Slovakia - Tractor-trailers hauling shiny Kia compacts or Citroën minivans have been a common sight on Slovakia's D1 highway in recent years. But these days you'll see far fewer big rigs on the road as it follows the Vah river beneath hilltop castle ruins and past seedy truck stops. With car sales plunging worldwide, the heart of "Detroit East"—an automaking corridor that stretches from Poland to Slovakia and the Czech Republic—is suffering woes that echo those in the original Motown. Korea's Kia Motors, which produces cars in Zilina at the foot of the pine-clad Tatra mountains, has trimmed shifts to six hours from eight as it dials back production 15%. Volkswagen ( (VLKAY)) makes SUVs for the U.S. and Europe at a sprawling plant outside Bratislava, the capital, but temporarily shut down assembly lines this spring. France's PSA Peugeot Citroën ( (PEUGY)) has laid off 6% of the 3,500 workers at its factory making compact sedans and minivans in Trnava, 30 miles east of Bratislava. Such cutbacks may seem mild compared with the troubles in Michigan, but they're a big deal for this nation of 5.4 million people. Some 80,000 Slovaks work for the automakers and a dense cluster of suppliers, such as Visteon ( (VC)), Delphi ( (DPHIQ.PK)), and U.S. Steel ( (X)). Last year Slovakia churned out 591,000 vehicles—the highest per capita car production in the world. But this year output is likely to drop below 500,000 and won't grow again until 2011, researcher IHS Global Insight figures. "We are really feeling the impact of the crisis," says Peter Ziga, the No. 2 official in the Slovak Economy Ministry. Unemployment has shot up to 10.5% from 8.7% at the end of 2008, while the economy contracted at an annual rate of 5.4% in the first quarter. Foreign investment has slowed to a trickle. Even as Slovakia's adoption of the euro has eliminated currency risk for many businesses, it has made Slovak workers more expensive than those in Hungary or the Czech Republic, not to mention Romania and Ukraine, countries whose currencies are much weaker than the euro. In 2007 the Slovak Investment & Trade Development Agency attracted 64 foreign projects worth $1.8 billion, mostly auto-related. This year, just two projects have been completed. "Everybody is on hold," says Barbora Mikloskova, head of development at the agency. PUSHING R&DAs the automakers adjust to a shrunken market, Slovaks are realizing it's time to update the national business plan. "Slovakia needs to shift gears," says François Lecavalier, regional director in Bratislava for the European Bank for Reconstruction & Development. Cheap manufacturing takes an emerging economy only so far. To achieve long-term prosperity and growth, developing countries have to create their own innovative products and nurture domestic companies that can compete internationally. The government is doing what it can to reduce Slovakia's dependence on carmaking. Plants built by Sony ( (SNE)) and Samsung Group in recent years were a step in the right direction, though both concentrate on manufacturing. A new law will offer better financial incentives—such as covering half the cost of land in depressed areas—to companies setting up research and development. The crisis has also added urgency to efforts to help the east and south, where the auto-driven prosperity never had much impact. In July construction will begin on a four-lane highway to link Bratislava better with the east. But those measures may not be enough. Slovakia's boom began with economic reforms led by center-right Prime Minister Mikulas Dzurinda, but three years ago he was bounced by voters who hadn't benefited much from the new prosperity, and left-leaning Robert Fico took over. The new government hasn't tampered drastically with the reforms, but it also hasn't moved as quickly as business would like to upgrade education and health care. And while Slovakia is trying to attract more high-paying R&D jobs, particularly in autos, that strategy pits it against China and other countries where costs are lower and the pool of educated workers deeper. It's doubtful whether Slovakia can be as successful at attracting R&D as it was at luring assembly lines. Auto companies gravitated to Slovakia and elsewhere in Central Europe not only for cheap labor but also because the region is close to both Western Europe and growth markets in Eastern Europe and Russia. Geography doesn't matter as much for R&D. After all, the Detroit automakers do much of their design work in California, notes Mary Stokes, an analyst at economic consultancy RGE Monitor. "Slovakia is an ideal location for auto production, but does it have a comparative advantage as it moves up the value chain?" she asks. Indeed, none of the three automakers in Slovakia has significant R&D or design in the country. To change that, executives say, Slovakia needs to upgrade its poorly equipped universities so the country produces more engineers. Despite some well-regarded technical schools, Slovakia ranks at the bottom of the European Union in the number of people employed in R&D. "There is definitely a lack of a high level of education," says Jean Mouro, Peugeot Citroën's Slovakia chief. "That will be a huge drawback." ROBOTIC WELDERSThe auto industry slump is a blow for one of the most successful members of the former Soviet bloc and a model for emerging countries everywhere. In 2004, Slovakia introduced a 19% flat tax on both business and personal income. That and a low-cost, skilled workforce prompted a surge in foreign investment, helping push growth to more than 10% by 2007. Thanks to prudent government spending, Slovakia raced past its neighbors to join the euro common currency this year. The auto industry, which accounts for 8% of gross domestic product and 40% of exports, played a crucial role in the country's success. "We have written the recent history of the auto industry in Slovakia," says Andreas Tostmann, chief executive of Volkswagen Slovakia, which in 1991 took over a state-owned auto factory that now accounts for 10% of the country's overall exports. The modern Slovak plants couldn't be further from the gritty Communist-era combines they replaced. The Kia factory, which makes Sportage SUVs and a compact called the cee'd (pronounced "seed"), looks as clean as a hospital. "Redukujeme Poruchy Na Nulu," implores a banner above the assembly line—Slovak for "Reduce Defects to Zero." Outside, freshly mowed grass surrounds orderly flower beds. Even though the country's workers earn an average of $16,800 annually—or less than half the average manufacturing wage in Western Europe—Kia planners knew salaries would rise. So they designed the plant with plenty of automation, such as robotic welders and computerized trolleys that fetch parts from metal racks as the assembly line needs them. The Kia factory will cut production to 170,000 vehicles this year, from 200,000 in 2008, well below capacity of 300,000 vehicles. But Kia doesn't regret investing in Zilina, says In Kyu Bae, CEO of Kia Motors Slovakia. The location gives the company easy access to both Western Europe and Russia, which has become a larger market for Kia than Germany. And Slovak workers are more productive than Romanians or Ukrainians, even if they are more expensive. "I'm very satisfied with our employees," Bae says over green tea in a room furnished Korean-style, with a low, round table. One of those workers, Robert Ondrejkovic, a 38-year-old senior operator on the Kia assembly line, says he's grateful to management for avoiding layoffs. But he could be speaking for all of Slovakia when he adds, "People need to buy more cars."
Jack_ewing
Ewing is BusinessWeek's European regional editor.

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