Central Europe Between an Assembly Shop and Global Success
The V4 countries currently have a broad range of industries from sophisticated production to basic assembly shops. The current trends inspire modest optimism.
The Czech Republic saw a significant growth in imports from Bulgaria and Serbia in the first half of 2018. An examination of detailed data, provided by the Czech Statistical Office, indicates that the growth was driven primarily by cables for car production and other, more basic, electrotechnical components. This gives quite a strong sign that the Czech Republic is gradually ceasing to be a country providing cheap labor, as this role is being assumed by other, poorer, countries.
We are, therefore, moving to a higher level, to use the language of computer games. At present, Slovakia, Slovenia and Estonia are at a stage similar to that of the Czech Republic. These are the four countries that have been most successful in catching up with the original fifteen members of the European Union, with Poland, Hungary and Lithuania lagging slightly behind. Growth in these seven countries has been driven largely by industrial production or rather, to be precise, an investment boom, backed mostly by foreign capital: German, French and American, but also, increasingly, Japanese and Korean.
This boom is an occasion for rejoicing as well as for being cautious about setting up assembly shops that rely on cheap labor (not to mention a massive out ow of revenues in the form of a dividend, an issue that calls for an article in its own right). All this begs the question: have the Visegrad 4 countries turned into an assembly-shop zone? And if so, is there a way out?
How to spot an assembly shop
The term assembly shop usually conjures up the image of a primitive factory with badly paid workers, frenziedly assembling products using imported components. In short, a scene from the opening of Chaplin’s Modern Times, except with better health-and-safety standards and an eight-hour working day. It therefore might be of help to begin by looking at the value added and average wages in the Czech industry.
Only a few manufacturing plants, in contrast, exceeded the 50 per cent mark. This is due to the present-day character of industry, which no longer relies on producing, in a single location.
Data for 2015 indicate that the greatest share of value added in terms of revenues was generated by IT companies (such as Avast Software and Seznam.cz) and hubs of shared services of the kind established in the Czech Republic by IBM, Lufthansa and Accenture. In their case the value added—labor costs, depreciation costs, unit profit and other “internal” items—amounted to 70 to 90 per cent of the revenue. This provides a straightforward guide for politicians: growth in GDP bene ts most from a boom in IT industries and shared services centers.
Only a few manufacturing plants, in contrast, exceeded the 50 per cent mark. This is due to the present-day character of industry, which no longer relies on producing, in a single location, an entire automobile or TV set, from melting metals to final assembly. The clearly dominant trend at present is for purchasing component parts and seminished products from external suppliers, both domestic and foreign.
Even many traditional Czech companies that are regarded as the country’s ‘family silver’, such as Škoda Auto, Tatra Trucks, Škoda Transportation or Agrostroj Pelhřimov—hovered around the 25 per cent mark in terms of value added revenue, while actual assembly shops mostly remained below 15%. These include the automobile plants: Hyundai Motor Manufacturing Czech and TPCA Czech, the TV assembly plant Panasonic AVC Networks Czech and some car component manufacturers.
The assembly plants in the Czech Republic owned by the Taiwan-based concern Foxconn represent an extreme example, assembling as they do computers, notebooks and servers from imported component parts, and subsequently supplying markets across Europe, the Middle East and Africa. Although the annual revenue averaged 120 billion Czech crowns, the value added in the Czech Republic amounted to a paltry two per cent.
Up until the 1980s, three European industrial powers—Germany, France and Italy—seemed to vie for dominance. Germany’s industry clearly dominates at present, while its former competitors have declined.
Foreign companies pay decent wages
As tempting as the image of modern drudges slaving away in gloomy production plants for the benefit of anonymous global capitalists may be, it does not reflect reality. An overview of the payrolls of the largest Czech companies, published by the weekly Euro last November, shows that foreign owners generally pay better than local businesses and industry.
In fact, it was locally-owned companies that came out bottom in the rankings of individual companies. Examples include Brano, SOR Libchavy and Karsit Holding in the auto industry, and plants that form part of Agrofert holding, owned by the billionaire Andrej Babiš, in the chemical and food industry. It is actually quite difficult to find a large manufacturing company with a foreign owner with gross salaries falling below 25,000 Czech crowns per month (including commission and bonuses). Companies whose salaries were just above this threshold include Foxconn, mentioned above.
The payroll survey published by the weekly Euro also highlighted companies that provide exemplary care to their staff. Companies which paid average gross salaries in excess of 40,000 Czech crowns in 2016, including bonuses, include Škoda Auto as well as ABB, the Bosch Group, Doosan Škoda Power, Unipetrol and the car component manufacturer Valeo Autoklimatizace. It is probably no accident that all these companies have, in addition to production, invested heavily in the research and development capacity in the Czech Republic.
In contrast, a number of basic assembly shops relying on cheap labor no longer operate in the Czech Republic. A well-known example is Alcoa Fujikura Czech, a plant that produced wire harnesses for automobiles, employing 3,200 people in the Pilsen region before 2008. Due to labor shortages and rising wages, the investor decided to close the factory down and move production to Romania, where the costs are lower.
A new wave of industrialization
Let us now move from the company level to the macro level. The pace of growth in Central European industries, which has at times almost matched that of China, may have benefited from the boom in assembly shops. Eurostat data also provide, however, a valuable alternative perspective on industrial expansion, i.e. the long-term growth in value added. The comparison is rather favorable for the Visegrád 4 countries.
Poles and Slovaks have been the top achievers, having made the best use of the opportunities arising from membership in the single European market. Eurostat figures indicate that between 2005 and 2017 these two countries increased value added in industry by a full 90 per cent. The Czech Republic lagged behind in third place with 52.5 per cent. Growth in Romania, Bulgaria, Lithuania and Estonia amounted to some 40 per cent. The only other countries of the original members of the European single market to have done well over the past twelve years are Germany and Austria with roughly 26 per cent growth in value added.
The pace of growth in Central European industries, which has at times almost matched that of China, may have benefited from the boom in assembly shops.
In contrast, quite a few countries in western and southern Europe have been affected by deindustrialization. Company owners have been curtailing production or even shutting down completely because of diminishing competitiveness. Greece has been worst hit, losing a quarter of the value added in industry over the period under scrutiny while Italy, Great Britain and Finland have slipped around six per cent into the red.
Up until the 1980s, three European industrial powers—Germany, France and Italy—seemed to vie for dominance. Germany’s industry clearly dominates at present, while its former competitors have declined. Industrial output has gravitated towards the center of Europe, with a tendency to disappear from the countries on the edges of the continent. The close intertwining of the V4 countries’ economies with that of Germany has proved to be an advantage we ought to maintain and nurture.
The first years following the Czech Republic’s EU accession were marked by a spirit of optimism.
An escape from the middle-income trap
The current prospects for the Czech economy are much rosier than they were four years ago. At that time it almost seemed as if the Czech Republic might get stuck in the middle-income trap, which would have been very difficult to dig its way out of. Stagnant wages and the controversial decision by the Czech National Bank to artificially weaken the currency’s exchange rate also contributed to this state of affairs.
The first years following the Czech Republic’s EU accession were marked by a spirit of optimism. There was a significant growth in wages, and the Czech crown strengthened vis-à-vis the euro. It seemed that we were fast approaching the EU average. The global economic crisis of 2008 brought about, however, a change for the worse. In the period from 2009 to 2015, growth in average annual wages amounted to a mere 3 per cent, and the actual final figure, adjusted for inflation, was close to stagnation.
The first indication of a changing trend came in 2016, when the growth in average salaries jumped up to 4.2 per cent. The year-on-year growth amounted to 7 per cent by 2017 and in the first quarter of 2018 as much as 8.6 per cent. Average gross salaries in the first quarter exceeded 30,000 crowns (1,150 EUR). Nevertheless, the median (“an average Czech’s salary”) is actually lower, i.e. 25,674 crowns (roughly 990 EUR). A substantial gender imbalance in terms of incomes also persists, with the median men’s salary being slightly above 28 thousand crowns, while the median for women is just 23 thousand crowns.
The only way the label of a country providing relatively cheap labor can be shed is by outpacing Germany’s growth in economy and wages. The fact that the Czech National Bank relaxed the local currency’s exchange rate in April 2017, leaving it once more to market forces, might also help. After a period of strengthening against the euro, the crown has weakened in recent months; the uncertainties arising from Donald Trump’s tariff wars, Brexit and the developments in Turkey, have not been beneficial to Central European currencies.
Three basic scenarios
Three basic scenarios are conceivable over the next decade: an optimistic one, a pessimistic one and one that is worse than pessimistic, which we might dub the Italian scenario. The optimistic scenario envisages the Czech Republic, Slovakia, Poland and Hungary gradually catching up with Germany. A precondition of this would be a sustained, though not excessive, growth in wages, a high level of investment in research and development, a boom in domestic brands and also (except for Slovakia) a moderate strengthening of the currency vis-à-vis the euro and US dollar.
Although Germany, with its perfectionism, may represent an unattainable goal, Central European countries have a chance to overtake at least some other EU members. In terms of GDP as an indicator of purchasing power parity, the Czechs, Slovaks and Slovenes are already better off than the Greeks and the Portuguese. These three countries could overtake Italy by 2022 and 2023 and, soon afterwards, also Greece. Within a further five years, the Hungarians and Poles might also succeed in reaching this goal. Over the longer term it is conceivable that they might draw level with Great Britain and France.
The global economic crisis of 2008 brought about, however, a change for the worse.
The pessimistic scenario is just as likely. The new EU member states’ key economic weakness consists in the fact that their industry is, to a large extent, controlled by foreign (predominantly, West European) capital. Multinationals often comprise the main share of individual countries’ value added, be it in the form of research and development or in the area of sales and related services. New member countries can often boast ‘only’ production plants or companies supplying component parts.
Provided this model continues over the long term, the Visegrad 4 group countries could become stuck in the middle-income trap, and the pronounced gap between their economies and Germany’s will not decrease over time. A possible solution might be a shift of investment stimuli and European subsidies for small and medium-size companies towards those that have established within the country a complete chain of activities from development to sales of the final product. This is a key factor in achieving success. And as long as it is achieved, it does not matter whether a company is owned by a Czech, a German or a foreign investment fund.
The worst thing that could possibly happen would be following in the footsteps of Italy or Greece, that is to say, stifling homegrown industry through a combination of a high tax burden, poor technical and university education, overheated growth and wasteful social policies. This inevitably creates an environment in which industry slows down and unemployment rises precipitously. And while assembly shops cannot survive in this kind of environment, nor is it conducive to sophisticated, world-class production.
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