Central and eastern Europe faces the end of an economic era.
With employment rates at record highs and workers demanding wages closer to Western levels, the cheap labor model that has driven growth since the fall of communism is on the way out.
The challenge that faces governments and companies in the region over the coming years is to find new avenues to growth.
Photo: Reuters
A walkout at the Volkswagen AG factory in Bratislava last month, the first strike at a major Slovak car plant, led to a staggered 14 percent pay hike in what has become the latest and starkest sign of the shifting economic landscape.
Volkswagen was one of dozens of big Western manufacturers beating a path to Slovakia, the Czech Republic, Poland and Hungary after the fall of communism in search of cheap labor.
The rush eastward marked the birth of an economic model that transformed the region. However, one-quarter of a century down the line, the regional labor market is running dry, with record low unemployment rates of about 3 percent to 7 percent across the region.
As a result, wages are rising faster than in the West — led by Hungary with a 12.8 percent year-on-year leap in March.
Zoroslav Smolinsky, the Volkswagen Slovakia union leader who engineered the strike, had joined the production line in 1992, when the plant had just been taken over by the German firm.
He was paid the equivalent of 75 euros (US$87.31) per month at the time.
“We could live on it,” he said. “We had to.”
Today, Volkswagen’s 12,300 workers in Bratislava earn an average of 1,804 euros per month.
However, such rates remain less than half the average Volkswagen pay packet in Germany, and Smolinsky said such huge disparity can no longer be justified.
“Times have changed,” the 48-year-old said. “We’re in the EU and have to keep up with trends and gradually narrow the gap.”
The strike was resolved with the wage increase phased over more than two years, as well as a 500 euro one-off bonus for each employee and an extra day of vacation.
Volkswagen is not alone in facing rising labor costs and strife.
French automaker Peugeot and South Korea’s Kia Motor Corp have raised wages this year in Slovakia, while Audi and Mercedes-Benz have faced strike threats in Hungary.
The moves by the automakers are particularly significant, because the auto industry represents the lion’s share of foreign investment in central and eastern Europe.
For example, Volkswagen units are the biggest companies in Slovakia and the Czech Republic, while Slovakia has become the world’s top automaker per capita, producing more than 1 million per year.
Moscow-based investment banking group Renaissance Capital said foreign investors would not abandon existing projects in the region, but new investments were likely to go elsewhere.
“Never again is central Europe likely to offer what it did in the 1990s,” it said in a note to investors.
Companies are taking steps to improve productivity via methods such as increased automation in order to offset rising costs, executives, policymakers and analysts have said.
In the longer term, some could go to other countries instead in search of cheaper labor.
Volkswagen signaled it could steer clear of Slovakia for future investments if faced with another costly showdown with workers.
Another sharp rise in wages would “threaten the stability of jobs,” Volkswagen Slovakia spokeswoman Lucia Kovarovic Makayova told reporters. “It could happen that the group gives preference to a factory with lower personnel costs when deciding on sourcing production of the next product.”
Renaissance Capital said investors in search of cheap labor would ultimately look further south and east.
“When European business confidence is high again, we think the next wave of investment expansion will lap the shores of Turkey and the southern Mediterranean,” it said, also singling out Morocco, Tunisia, Egypt and possibly Ukraine and Iran.
Filip Eisenreich, CEO of Czech ventilation and cooling system producer Janka Engineering, a unit of India-based Lloyd Group, said his company was raising wages by 7 percent to 8 percent this year and was “pretty much on the edge” in terms of labor costs.
“Further growth [in wages] without concurrent growth in productivity would not be sustainable for us,” he told reporters.
While productivity has long been lower than in western Europe, “this difference has so far been compensated for by lower wage costs, but those rise faster every year than in western European countries,” he added.
Czech Confederation of Industry vice president Radek Spicar said intensifying wage pressures were forcing firms to automate more, for which his organization trains workers.
Seminars “have been packed to the roof,” he said.
The issue of wage disparity is a highly charged one that is pervading society and politics across the region.
It is at the heart of a perception among Poles, Slovaks, Czechs and Hungarians that they are seen by western Europe as second-class Europeans.
Politicians have seized on such grievances and have taken up the call for better pay.
Slovak Prime Minister Robert Fico backed the Volkswagen strikers, while in the Czech Republic the ruling Social Democrats have erected billboards ahead of an October election declaring the “end of cheap labor.”
However, political and labor leaders aiming to bring wages in line with the West must find alternative paths to economic success. Crucial to this, most agree, is to move industries up the value chain into higher-margin areas.
Big manufacturers share less of their income with employees in central and eastern Europe than they do in western Europe.
In the EU, wages on average account for 47.5 percent of economic output, Eurostat data showed, but while that figure reaches 50.9 percent in Germany, it drops to just 40.4 percent in the Czech Republic.
However, workers in central and eastern Europe are less financially productive.
An hour of work in Germany produces 52.7 euros of German economic output, but just 19.4 euros in the Czech Republic, Organisation for Economic Co-operation Development data showed.
Part of the reason is that many Czech firms produce lower-margin components for global supply chains rather than the finished products that deliver higher margins and profits.
“We are not just a cheaper labor economy, but also a low-cost economy,” Spicar said. “We are also a supplier economy, part of global production chains, with low share of final products.”
Policymakers are looking to invest in higher-margin sectors.
“We have to get ourselves away from the economic model based on being a low-cost economy and switch to production with higher added value,” said Michal Picl, head of analysis in the Czech prime minister’s office.
There are already examples, such as Czech government support for a plan by General Electric Co’s (GE) US aircraft engine subsidiary GE Aviation to build a 350 million euro development and production plant for turboprop engines in Prague.
Peter Stracar, GE’s CEO for central and eastern Europe, said the region’s future industrial success hinges on moving into higher-margin businesses.
“We must find ways to create more value-added technology in CEE [central and eastern Europe] and GE is at the forefront in doing so,” he told reporters.
He said his company had hired more than 2,500 highly qualified employees in Hungary in engineering, finance and software development over the past three years.
The region has much to offer beyond low wages, he said, citing factors including the stability of its legal systems and its geographical proximity to the markets of western Europe.
“It is not just a question of low cost,” he said.
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