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Europe: The Push East


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EUROPE: THE PUSH EAST

France's consumer-electronics giant Thomson makes TV tubes in Poland. Ireland's Waterford Wedgwood PLC turned to the Hungarians for a new lower-priced line of its famous crystal. Peter Littmann, chief executive of men's clothier Hugo Boss, this year slashed German production from 40% to 20%, shifting much of it to Slovakia and Slovenia. He's not happy about dropping several western suppliers and laying off workers but says: "I have no choice."

Manufacturers throughout Europe are reaching the same conclusions. No longer viewing Central Europe as just a potential market, companies are starting to rely on the region as an alternative manufacturing zone to get around high costs and to battle Asian and U.S. rivals. Indeed, Western Europe's backyard has both Philippine-level industrial wages and well-trained engineers. Gunter Baumann sends the mufflers his German auto-parts company makes to Prague for bending and welding. "Our neighbors can now do the job just as well," he says. "This is how we can compete."

What was a tentative trickle of foreign interest after the fall of the Berlin Wall has grown into a steady stream of cross-border acquisitions, partnerships, and supplier networks. Forty thousand Western European companies have offices in Central Europe, and the ties are fast expanding. Direct foreign investment in Hungary, Poland, and the Czech Republic combined will total $15 billion by the end of 1994, two-thirds of it from Western Europe. "We used to see carpetbaggers make windfall profits and disappear," says Bela Kadar, Hungary's former International Economic Relations Minister. "Now, investors are fitting us into their global networks."

NEW CONFIDENCE. These connections are helping to get what were staggering economies on their feet. Pragmatic policymakers and hungry workers eager to learn new skills deserve a lot of credit. So do western companies that provided the training, marketing skills, and awareness of quality. Today, telephones work, restructured banks are pumping capital through their economies, managers focus on profits, and politicians get voted out of office for misguided policies. The Central European countries of Hungary, Poland, the Czech Republic, and even Slovakia have come a long way.

In fact, Central Europe finally appears poised to take off. Its economic output plummeted in the early 1990s as fledgling governments struggled to dismantle statist systems. But now, the Czech Republic is growing at about 5% a year, and Hungary and Poland are heading for 2% growth this year. Nor has the reemergence of former communists at the helm in Hungary and Poland thrown market reforms off course. That, in turn, is giving investors greater confidence. At the same time, the workers in these countries are hitting quality and productivity levels on a par with their western counterparts.

That's good news for the west, which has watched warily to see whether the Soviet Union's former satellites would sign on to free-market democracy or slide toward inchoate politics and economics. A key barometer of the region's stability, says Finland's deputy prime minister, Pertti Salolainen, "is that it stands on its own feet economically."

While western industry increasingly sees opportunity in Central Europe, the region is particularly attractive to Germany, which is carving out an economic zone to the east. German labor rates, at nearly $28 an hour in wages and benefits, are so out of line with the rest of Europe and the world that Central Europe serves as a lifesaver for German companies trying to stay in the global race. The region also provides Germany with entree into what are bound to be growing markets from Warsaw to Moscow.

But some in Western Europe see progress in Poland, Hungary, and the Czech Republic more as a threat than an opportunity. That's especially true in sectors such as steel, coal, and agriculture--Central Europe's top industries--where West Europeans are maintaining trade barriers. With unemployment in the European Union at 10.8% and welfare payments straining budgets, the growing competitiveness of the eastern cousins looms large.

If the EU drags its feet on integration, however, it could not only thwart the east but risk stagnation for all of Europe. Warns Thomas Mayer, chief economist for Goldman, Sachs & Co. in Frankfurt: "If we slip into protectionism, Europe will become an industrial museum." Still, as more and more companies move production and managerial skills east, Central European countries will find their trade, legal, and economic systems increasingly aligned to those of the west--and resistance to eventual membership in the EU will crumble.

Right now, trucks continue to rumble across borders, binding the Continent despite the ambivalence. According to a recent Harris poll, more and more executives see the east as a partner, not a competitor, and 55% want to slash EU import barriers to eastern products. As technology transfers boost the east's competitiveness, its growing purchasing power will also help break down barriers. "We are already integrating at the micro level," says Karel Dyba, Economics Minister of the Czech Republic.

GE'S COUP. Initially, east-west links were chiefly through big companies plunking down tens of millions of dollars for privatized state companies. With its 1990 purchase of Hungary's Tungsram, General Electric Co. was a pioneer. The bet is paying off. Tungsram will turn a profit this year, and quality is so good that GE has shifted European lightbulb production there from Britain and elsewhere in Europe, exporting 90% of the output.

But direct investment into Central Europe doesn't tell the whole story; every dollar of investment goes much further than in, say, China, where there's so little infrastructure. Elisabeth Waelbroeck-Rocha, economist for researcher DRI Europe in Brussels, estimates that fully 55% of west-east business ties are through outsourcing or licensing rather than registered acquisitions, joint ventures, or startups.

Some analysts argue that the region's wage advantage may be fleeting as pay eventually catches up with western levels. But for the next decade or so, there is plenty of room for leaps in productivity. Unit costs may actually be falling, says Vienna's Creditanstalt-Bankverein, because in Hungary and Poland, productivity rose faster than wages last year. And in Bohemia, textile maker Pleas was bought by Switzerland's Schiesser Eminence and has trimmed the workforce and boosted quality. The changes have pushed productivity up, and now 70% of production is exported.

Certainly, there are pitfalls to relying on Central Europe. Marketing and management skills are weak, and training and equipment are expensive. Sharing technical knowhow with suppliers carries the risk that they'll apply it to a competitor. And the habits of a lifetime can be difficult to break. Danube Knitwear, set up in southern Hungary by private western investors to export T-shirts, gives bonuses for attendance to rid its workers of the communist-era penchant for sneaking out to do errands.

But Europe's challenge will be precisely to break old habits, in the east and the west. Central Europe's ongoing need for technology and capital is likely to make it even more dependent on western industry for its industrial transformation. And for Western Europe, where the overarching challenge is to create a globally competitive industrial base, the east will continue to beckon. With their fates thus linked, the economic bridges businesses are building across the old Iron Curtain will only multiply.

WHAT THE BIG PLAYERS ARE DOING IN THE EAST

Western European multinationals are now shifting production to Central Europe, no longer seeing the region just as a market

AUDI

--$195 million in engine plant in Hungary. Additional $280 million investment planned. Plant is open, replacing German production.

SIEMENS

--Latest investment was $50 million for Czech electric-motor plant. Shifting labor-intensive auto-parts production to Poland and Czech Rep.

VOLKSWAGEN

--Paid $332 million for 25% of Czech carmaker Skoda in '91. Despite problems, Skoda remains key part of strategy. New model launch due in November.

GM EUROPE

--$300 million Hungarian engine plant now supplies six plants from Britain

to Turkey. Begins Opel car assembly at Polish plant soon.

CONTINENTAL

--Bought 73% of Czech tiremaker Barum in 1993. Shifting production of

basic tires there, freeing German workers for new technologies.

FIAT

--Paid $640 million in Polish auto maker. Plant is now sole source of

Cinquecento city car. An additional $450 million investment is planned.

GE LIGHTING

--Invested $550 million in Hungarian bulbmaker Tungsram. Transferred all European light production there. Will be profitable this year.

THOMSON

--Launched TV-tube joint venture in Poland in 1991. 70% of production is now exported out of east. Wants to use Poland as a platform to sell eastward.Karen Lowry Miller in Prague, with Bill Javetski in Paris, Peggy Simpson in Warsaw, Tim Smart in Budapest, and bureau reports


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