Outsourcing Chasing Cheap Labor to the East

Talk about investment flows. A decade ago, foreign investment began to pour into Poland, the Czech Republic and Hungary as West European and U.S. companies looked for a low-cost manufacturing base close to the European Union. Today, as these and seven other countries join the E.U., the East and Central Europeans themselves are looking east for low-cost manufacturing. As rising wages force them to find ways to become more competitive, some are setting up plants or outsourcing their production to subcontractors in places like Bosnia, Romania, Russia and Ukraine. The investment farther east isn’t yet a flood, but economists and trade experts expect it to increase substantially in the next few years as living standards — and manufacturing costs — continue to rise. “It’s a sign of maturity,” says Willem Buiter, chief economist at the European Bank for Reconstruction and Development.

Hungary is leading the charge. Between 1998 and 2003, Hungarian companies invested $2.9 billion abroad, mostly in other East and Central European nations. Much of it went toward acquisitions, but some involved outsourcing. There are roughly 4,000 Hungarian firms in Romania and up to 30% of them are outsourcing related, according to Péter Spányik, CEO of the Hungarian Investment and Trade Development Agency.

Companies elsewhere are following suit. Poland’s Forte Group, a big furniture manufacturer, has acquired a factory in Ukraine and recently decided to build a plant in Russia. Forte vice president Andrzej Korzeb says Russia has attractive tax rates (as low as 13%) but “cheaper labor is also a factor.” Zygmunt Berdychowski from the Institute of Eastern Studies in Warsaw says that small- and medium-sized firms along the new E.U. border are investing modest amounts — often less than $1 million — in facilities in Russia and Ukraine.

One Czech company, Moravan-Safety Belts, has been producing safety belts in Russia since 2001. The production was originally for the Russian market, but the firm now imports Russian-made components for assembly in the Czech Republic. The next step will be to move all assembly to Russia, where costs are 15% to 20% less than at home. “The pressure of the market is constantly on lowering prices and that cannot be achieved in our environment, where costs are rising,” says deputy chairman Tomás Stefánek. But outsourcing can be as controversial in the East as it is in the West. When Ceská zbrojovka, a major Czech gun manufacturer, decided last year to move its air-gun production to Slovakia and upped domestic production quotas, it had to work hard to avert a strike by labor unions.

Some companies are already looking far beyond their immediate neighbors — to China and other parts of Asia, where labor costs are lower still. Hungary’s Budmil, which makes sports and leisure gear, now sources 70-80% of its production in China, India, Taiwan, Turkey and Vietnam. It still uses Hungarian manufacturers, but only for sophisticated products and small orders that would be uneconomical to produce in Asia. “We moved toward the Far East because we wanted to keep our ability to compete,” says András Hegedus, a board member. As production costs in the new member states start to approach those in Western Europe, more and more firms could be eastward bound.