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A Chill East Wind


At first glance, IBM (IBM)'s computer disk-drive factory in Szekesfehervar, western Hungary, doesn't look the picture of industrial decline. Built just eight years ago, its bright blue, green, and white facade still glows from a hillside overlooking a bustling shopping plaza. But a closer look reveals an unnatural stillness. Loading docks that once were piled high with components lie empty. Turnstiles that admitted 3,700 workers a day are chained.

IBM shut the plant last November, moving the work to China, where wages are 75% cheaper. Dutch electronics maker Royal Philips Electronics (PHG) and Singapore contract manufacturer Flextronics International Ltd. (FLEX) have moved an additional 1,500 Hungarian jobs to China in the past 18 months. Flextronics also has closed a 1,000-worker plant in the Czech Republic. The closings are sending shudders across eight formerly communist countries just as they are gearing up to celebrate their entry into the European Union on May 1.

The most successful of that group -- Hungary, Poland, and the Czech Republic -- have been put on warning even before the party starts that EU membership is no economic panacea. The labor markets of Asia, especially China, are beginning to pull away industrial investments that helped this region rebuild after communism's collapse. "Their whole goal has been to join the EU," says Humphrey W. Porter, president of Flextronics Europe. "The risk is that they don't realize this is a rat race. And it's just the beginning, not the end."

The manufacturing job flight is prompting some governments to look for ways to diversify their economies. "These countries have to make up their minds where they want to be in 10 years' time," says Wim Wielens, Philips regional CEO for Europe, Middle East, and Africa. "If they try to keep attracting [investment based on] cheap labor, they'll have problems. Their real future test will be how well they emphasize knowledge-based jobs."

The competition will be harsh. India, the Philippines, and Russia are rising powers in information technology and customer support. But Eastern Europe has some advantages. EU law prohibits storage of banking data outside the union. So joining the EU will help the region grab back-office financial jobs. EU membership also will increase the feeling of security for foreign investors.

But Eastern Europe's cost advantage is shrinking by the day. Take Hungary. In the past two years, real wages have risen by 20%, according to Vienna-based Erste Bank. That explains why Hungary has seen the worst job losses as foreign manufacturers head for the exits. Czech wages have jumped by 11.5% in two years. Even in Poland, where unemployment is estimated at 20%, wages have risen by 3%.

Despite the recent runup, wages in Eastern Europe's most dynamic economies are still 25% lower than those in Western Europe. But the gap is widening with China, where wages have stayed roughly the same, at about $100 per month for unskilled factory workers. Factor in the greater access to China's vast domestic market as the country dismantles trade and investment barriers, and the case for moving production is more compelling. Even Eastern European companies are shifting work to Asia. Bela Karsai, president of Karsai Plastics Holding in Szekesfehervar, boosted annual revenues from $2.7 million to $37 million since 1995. Now he's keen to be an international player. But rather than expand at home in Hungary, Karsai is opening a plastics plant outside Shanghai. "If you want to be a global supplier, there is no way you cannot be in China," he says.

Wages don't dictate every investment decision. Proximity to Western Europe, not to mention Eastern Europe's blossoming consumer markets, can be an advantage. For large appliances or autos, shipping costs are high. PSA Peugeot-Citro?n and Toyota Motor Corp. will open a joint plant in the Czech Republic in 2005 employing 3,000. PSA will open a 3,500-worker factory in 2006 in Slovakia. And since moving production of Microsoft Corp.'s (MSFT) Xbox game consoles to China, Flextronics has hired more Hungarians to make goods such as TVs for France's Schneider Electric.

Thanks to such investment, the number of overall manufacturing jobs in Hungary and the Czech Republic has remained steady for the last two years, while the two economies are growing at 2.7% and 2.2%, respectively. But that's following years of heady manufacturing growth. And Poland has lost 250,000 manufacturing jobs in two years.

Some of the manufacturing work is being replaced by higher-skilled jobs. Just about three miles from IBM's moth-balled factory in Szekesfehervar, Alcoa (AA) has just hired 210 service workers. Tucked away in quiet offices, two-thirds of these staffers handle finance and administration tasks. The rest, mostly young techies dressed in T-shirts and shorts, run and help design applications for a computer system that serves 10,000 Alcoa Inc. workstations in 14 countries across the continent.

Alcoa isn't alone in pooling information technology and back-office support tasks in the region. Lufthansa and Philips have each recently announced they will centralize accounting operations for Europe in Poland. In the Czech Republic, IBM, Axa, and Honeywell have gotten into the act. ING Group, General Electric, and British distiller Diageo are adding back-office jobs in Hungary. Plano (Tex.)-based Electronic Data Systems Corp. (EDS) has offices in all three countries, including a call center in Budapest where 140 employees handle remote information technology support for companies like General Motors, Coca-Cola (KO), and Sweden's Ericsson (ERICY). "There's going to be a huge wave in the next three to five years in the transition to commoditized back-office services," says Laszlo Szakal, EDS's client sales executive for Hungary. Consultancy A.T. Kearney Inc. forecasts that German, Austrian, and Swiss banks alone could move up to 100,000 back-office jobs from their home countries to cheaper locales by 2008.

To attract these jobs, governments in Eastern Europe are starting to revamp education systems that have been neglected and unreformed since the political changes of 1989-90. In Hungary, a new law allows industry groups to supervise curriculum and teaching materials at vocational schools. "It's not enough anymore just to create a safe legal, financial, and economic environment," says Hungary's Economy & Transport Minister, Istvan Csillag. To keep pace in the global economic race, the new EU members will have to use their heads more than their hands. By Christopher Condon in Budapest, with Rick Butler in Warsaw


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