FDI in Central Europe: How Companies Organize Production Networks? Applied to a subcontractor to the Automotive Industry

Bachelor Thesis 2005 95 Pages

Business economics - Economic Policy


Table of Contents

List of Abbreviations

List of Figures

List of Tables

1. Introduction
1.1 Key Question and Hypothesis
1.2 Methodology
1.3 Structure of This Thesis

2. Foreign Direct Investment (FDI) in Central Europe
2.1 Definition and Types of
2.2 FDI Development Worldwide With a Closer Look on Central Europe

3. The Attractiveness of Central Europe for Foreign Investors
3.1 Favorable Location Factors in Central Europe
3.2 Description of the Business Environment in Selected Regions

4. Multinational Companies (MNCs)
4.1 Definition of MNCs
4.2 The Importance of FDI for MNCs and their Basis for Decision-making

5. Continental AG as an MNC Operating in Central Europe
5.1 The Development and Character of the Automobile Industry
5.2. Continental AG - Structure and Strategy
5.3 How does Continental Automotive Systems Organize its Production Network with Special Regard on Central European Locations?
5.3.1 Overview on Continental Automotive Systems
5.3.2 How does CAS Organize its International Production Network – The Example of Brake Booster Production
5.3.3 Which Reasons Determine the Location Choice for CAS – The Example of a Greenfield Investment in Slovakia

6. Conclusion

7. References

8. List of Appendix

9. Appendix

List of Abbreviations

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List of Figures

Figure 1: CEE: FDI inflows and their share in gross fixed capital formation,1990- 2003

Figure 2: CEE: Top 10 recipients of FDI inflows, 2002 and 2003 (Bn of USD)

Figure 3: GDP per Capita (2004 est.)

Figure 4: GDP in PPP (2004 est.)

Figure 5: Real GDP Growth (in prices of 1995)

Figure 6: Corporate Tax Rates 2004

Figure 7: Development of ULC in Selected Countries

Figure 8: Czech Republic - Gross Value Added by Activity in 2003 (in constant prices and percentage of GDP)

Figure 9: Slovakia - Gross Value Added by Activity in 2003 (in constant prices and percentage of GDP)

Figure 10: Vertical and Horizontal Networks

Figure 11: The Development of Value Added 2002 to 2015 of Light Vehicles worldwide (development and production of cars)

Figure 12: Favorite Destinations for new Production Sites of German Component Suppliers

Figure 13: Central European Locations

Figure 14: CAS – Products

Figure 15: Production in Low Cost Countries

Figure 16: Automotive Systems Manufacturing Sites

Figure 17: The Production of brake boosters

List of Tables

Table 1: Selected indicators of FDI and international production, 1982 – 2003*

Table 2: Inward FDI Performance Index from Selected Regions

Table 3: Infrastructural Indicators of Central European Countries

Table 4: Labor Costs in the Manufacturing Industry 2002

Table 5: Production of Light vehicles in mill. Units

1. Introduction

1.1 Key Question and Hypothesis

If there is a term which can best subsume current trends in development of politics, society and economics it would be globalization. Major drivers of the globalization process are multinational companies (MNCs). The value of their foreign direct investments (FDI), as part of internationalization strategy, has enormously increased in the last decades. This development allows for their continuous strive for competitiveness through opening up new markets or lowering their costs as a result of economies of scale or a beneficial business environment in the target countries. Thereby the degree of international division of labor shows an upward trend underpinned by the increasing permeability of borders in regard to goods, services, capital and people. Above all lower communication barriers facilitate the operation of cross-border production networks.

As the thesis will state Central European Countries have experienced a tremendous increase in FDI inflows in the last 10 years which definitely contributed to a faster privatization and deregulation process. Their attractiveness to foreign investors has increased in that way that locations in Central Europe take an important part in the production network of MNCs.

The key question of this thesis is: What are the major reasons for multinational companies to invest in Central Europe through foreign direct investment and which role do production networks play for an international company? This question will be examined by regarding the example of Continental AG - a German component supplier to the automotive industry.

The hypothesis is first that Continental AG has established a multinational production network. Secondly it is to be proven that locations in Central Europe play a significant role for Continental AG due to cost-based as well as market-based considerations.

1.2 Methodology

The methodology to manage the topic involved both classical desk research as well as inquiries at a company to verify the theory. Desk research included reading books, studies, journals and newspaper articles as well as working papers available in the library and in the world wide web. Statistics on common indicators were also provided by recognized internet sources. The content in the practical part, however, is largely based on interviews with responsible persons at Continental AG. This filled the thesis with additional data not available in regular sources originating from interviews face-to-face, via telephone or by emails. An own questionnaire helped to find out relevant information. (see Appendix XXVII) All sources used are listed in references on page 49.

By giving an example of a MNC operating in Central Europe the aim is to emphasize the meaning of FDI for MNCs in Central Europe and prove the hypothesis. Thus the role of Central European countries in the location choice as well as the functioning of international production networks is reflected.

In proving the hypothesis limitations have been set:

First of all industrial clusters have been excluded. These are an additional form of production network, can also occur across borders and are also present in the Central European automobile industry. Clusters, however, include different firms along the industry’s value system and thus a wide range of other factors are crucial in decision-making for FDI.

According to UNCTAD data Central and Eastern European (CEE) countries include Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Russian Federation, Serbia and Montenegro, Ukraine, Albania, Belarus, Bosnia and Herzegovina, Estonia, Latvia, Lithuania, Republic of Moldova, Slovakia, Slovenia, and The former Yugoslav Republic of Macedonia. However, other definitions from other sources may lead to differing results. According to the general public Central Europe equals all EU-8 countries plus Romania, Bulgaria and Croatia but again inconsistencies in data may occur due to definition problems. Usually a limited view is given specifically regarding Poland, Czech Republic, Hungary and Slovakia since these countries are significant FDI recipients for the automotive sector.

In the practical part limitations occurred from the side of Continental AG. Some internal data had to be handled confidentially and are hidden by black beams in the minutes.

1.3 Structure of This Thesis

This thesis provides theoretical background on FDI and MNCs as well as an impression on how theory is applied by a component supplier to car producers operating in Central Europe.

To begin with, chapter two will define the nature of foreign direct investments (FDI). It will also put emphasis on the development of FDI activities worldwide and especially in Central Europe. The reason for the Central European countries’ attractiveness for foreign investors is then discussed in chapter three. First overall conditions for foreign capital will be analyzed and the attractiveness of the production factor labor will be in the focus of this chapter. Above all the second part of the chapter will provide a closer look on the Slovak and Czech business environment already giving implications for the automobile industry. Based on some theoretical models the fourth chapter presents answers to the question on why do multinational companies (MNCs) invest abroad. The role of production networks will be in the center of attention here.

Practical evidences for the described theory will be the content in the fifth chapter. This chapter encompasses three parts. The first part gives an overview of the automobile industry in general, focusing on the relation of car makers and component suppliers to understand the position of component suppliers in this industry. The second part goes further into detail by presenting the Continental AG and especially the Automotive Systems. The third part finally describes two cases: One showing the importance of cross-border value chain activities at the example of brake booster whereas the other case portrays the decision-making process of setting up a new production plant in Slovakia.

The conclusion will end with a summary of the most important information that could be drawn from this thesis to verify the hypothesis stated above.

2. Foreign Direct Investment (FDI) in Central Europe

2.1 Definition and Types of FDI

Foreign direct investment is defined as an investment across national boundaries with the intention of gaining a degree of control over that firm’s operations by either buying a controlling investment or setting up a branch or subsidiary in the host country. Therefore FDI must be distinguished from portfolio investment where investments in the form of purchased shares flow only for financial reasons and the purpose of gaining any control over the other company misses.[1]

Greenfield and brownfield investments distinguish the starting point of FDI: greenfield investment is FDI “in a manufacturing facility that ‘starts from scratch’”[2] whereas brownfield investment refers to purchasing already existing facilities via FDI. Moreover the degree of FDI is determined by independent ventures, such as the establishment of new facilities as an independent company, the complete or partial acquisition of local companies as well as launching joint ventures with local organizations.[3]

2.2 FDI Development Worldwide With a Closer Look on Central Europe

FDI as a major internationalization strategy in companies has boosted since World War II and especially in the last decades where worldwide trade and investment flows grew faster than worldwide production.[4] The role of FDI in the global economy continues to grow, as reflected in increasing sales, total assets, value-added, employment and exports of foreign affiliates shown in the table below.[5]

Table 1: Selected indicators of FDI and international production, 1982 – 2003*

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* Indices are explained in Appendix I

Source: UNCTAD (2004), p.9

Major reasons for this development are the growing number of market oriented economies together with the liberalization and deregulation of markets worldwide. Furthermore technological progress leads to decreasing transportation and communication costs. This resulted in company activities becoming more and more global through integrating production internationally or progressively merge with or purchase foreign companies (M&A)[6] aiming at staying competitive on ubiquitous buyer markets.

A vast percentage of today’s FDI outflows still originates from developed countries and receiving countries are also to a major part the developed countries. Within theses the triad[7] accounted for 75% of all inflows and 85% of outflows in 2000.[8] However the developing countries gained importance in the worlds FDI activities in the last twenty years since “their share in the global FDI flows rose from less than 6% in the mid-1980s to some 11% during the latter half of the 1990s, before falling to 7% during 2001-2003”[9].

The importance of FDI for a country can be measured by the UNCTAD “Inward FDI Performance Index” calculated as the ratio of a country’s share in global FDI inflows to its share in global GDP as presented in the table below. A value of more than one indicates that the region attracts more FDI in relation to its economic size.[10]

Table 2: Inward FDI Performance Index from Selected Regions

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Source: UNCTAD (2004), p.42

The table very well shows a decreasing importance of FDI for North America whereas for Europe FDI plays a much higher role. The peak for CEE countries between 1993 and 1995 was increasingly due to high investments in restructuring these economies. Today Estonia, Czech Republic and Slovakia are all among the top fifteen of 140 nations in the UNCTAD “Inward FDI Performance Index” ranking from 2001 to 2003[11] indicating a high participation in FDI activities. (see Appendix II)

Historically FDI activity in Central and Eastern European (CEE) countries indeed has grown impressively since there has been a ten-fold increase of the share of the world inward FDI from 1990 to 2% in 2000[12] due to privatization, industrial restructuring and favorable liberalization measures. Especially in the early 1990s the transition process had a high impact on FDI performance as also expressed in a relatively high share of FDI in gross fixed capital formation.[13]

Figure 1: CEE: FDI inflows and their share in gross fixed capital formation,1990-2003

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Source: UNCTAD (2004), p.69

After a steady growth of FDI inflows there has been a decline from $31 billion in 2002 to $21 billion FDI inflows in 2003 due to economic recession in European source countries as well as privatizations coming to an end especially in the Czech Republic and Slovakia. Nevertheless in these two countries new automobile plants (Toyota-PSA in the Czech Republic and PSA and Hyundai in Slovakia) have been established which will not be reflected in the statistics until 2005 or 2006.[14] FDI inflows compared to gross fixed capital formation in the CEE region show a similar development while a decrease of this share can be observed since 2000. This indicates that CEE countries cumulate capital more from internal sources reflecting their increasing economic strength.

Regarding individual countries Poland, Czech Republic and Hungary have been the top FDI recipients of the CEE countries in 2002 and 2003 regarding total FDI inflows.[15]

Figure 2: CEE: Top 10 recipients of FDI inflows, 2002 and 2003 (Bn of USD)

illustration not visible in this excerpt

Source: UNCTAD (2004), p.69

Opposite to inflows, FDI outflows reached a new record in 2003 with $7 billion compared to $5 billion in 2002. The Russian Federation remained the leading source with 59% of the region’s outflow mainly targeted to CIS or other CEE countries. Outward FDI from other countries, however, face higher growth rates. Hungary’s outward FDI rose from $0.3 billion in 2002 to $1.6 billion in 2003.

Effects of FDI inflows in Central Europe positively affected the local economies. First of all FDI as long term capital accumulation helps to develop the capability of export growth and import substitution and thus contributes to economic growth in these countries. Furthermore old state monopolies were broken down and greater market competition was created. In other cases, however, FDI may have reduced competition by the acquisition of local monopolies or foreign MNCs were secured exclusive supply rights and other incentives which competition is distorted often to the damage of domestic companies. Before EU accession big MNCs derived their strong bargaining power from CEE governments which granted them trade concessions such as quotas and tariffs on the competitor’s imports.[16]

3. The Attractiveness of Central Europe for Foreign Investors

3.1 Favorable Location Factors in Central Europe

As proven in the preceding chapter CEE countries have increasingly become attractive to foreign investors. The question arises which factors contribute to a country’s attractiveness and to what extent do CEE countries provide favorable conditions. Thereby location policies, i.e. governmentally set location improvements, play a major role in the background of the globalization of industrial structures and growing location options of MNCs. These urge national governments to pay more attention to a sustainable quality of their location-bound resources and capabilities in respect to other competing countries.[17] Especially in Central European countries location policies such as investment incentives are popular measures to stay attractive for investors, but there are other factors that are determined by local governments rather indirectly and more crucial to investors.

Important criteria for companies to assess an economy’s attractiveness are the political, economic, technological, social and ecological environment. Another approach points out the investor’s interests on the country’s overall climate for foreign capital on the one hand and the production considerations and special conditions, regarding e.g. the competitive situation within the industry abroad on, the other hand.[18] Production conditions focus on the availability and cost of production factors, and of employees in particular, whereas favorable conditions for foreign capital highly depends on political, fiscal and economic aspects. Hereby the tax environment and the size and quality of the market play a major role as well as the overall political framework of the relevant country.[19]

Since the fall of the iron curtain around 1990 the political situation in Central Europe improved to democracy and the greatest efforts have been made to successfully adopt features of a market economy. This is reflected in a GDP per capita that has surpassed the pre-reform level by 28% in Poland already in 1999 followed for example by Hungary or Czech Republic.[20] Today a stable political system and a liberalized economy are favorable location factors in Central Europe not only since Poland, Hungary, the Czech Republic, Slovakia and Slovenia entered the EU on May 1, 2004. As a prerequisite for accession these countries showed conformity with the EU Acquis Communautaire (rules, regulations and standards) and the political and economic aims of the union.[21] As EU members, they can now benefit from free movements of goods, services, persons and capital to and from Western Europe, the world’s largest market. Therefore this membership certainly has a positive effect on Central Europe’s attractiveness as a trade and investment partner. Yet competition among countries is likely to intensify due to facilitated exchange opportunities with Western European as well as neighboring countries in Central Europe which bears chances as well as risks for foreign investors.

For firms producing in the secondary and tertiary sector significant variables to asses economic benefits is the size and average growth rate of the market (GDP and GDP-Growth rate) as well as the GDP per capita. With a total population of around 64 mill. and a GDP of more than USD 863 bn Poland, Hungary, Slovakia and the Czech Republic are the largest markets among the 10 new member states of the EU. In 2004 the economies had an average GDP per capita of 13,425.[22]

Figure 3: GDP per Capita (2004 est.)

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Source: own work, data taken from CIA – The World Fact Book (2005)

Figure 4: GDP in PPP (2004 est.)

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Source: own work, data taken from CIA – The World Fact Book (2005)

Despite trends of economic downturn in major European states, which are at the same time major trading partners, the GDP per capita was steadily growing in Central European states in the last decade. But still the country’s GDP per capita are still around 45 to 70% that of EU 25 with the Czech Republic being the most advanced country. (see Appendix III)

The economies’ real GDP growth rates have been above average of the figures in Germany and the average of all EU 25 states that is between 3.8% in Poland and 5.5% in Slovakia in 2004[23] indicating the economic potential of these countries.

Figure 5: Real GDP Growth (in prices of 1995)

illustration not visible in this excerpt

Source: Own graph, data from:

URL: http://europa.eu.int/comm/eurostat/newcronos/reference/display.do?screen=welcomeref&open=/&


Furthermore the degree of openness of these countries is an important factor for foreign investors. FDI as well as import and export activities have grown constantly in the last years (see Appendices IV to VII) reflecting the attractiveness of these countries as investing and trading partners. Since significant FDI has occurred in financial markets after the fall of communism a working financial infrastructure can now be found and is continuously improved facilitating FDI inflows.[24]

Additional economic attractiveness can be derived from a stable monetary system aimed at reducing inflation and providing a strong and convertible national currency. Inflation rates have decreased steadily in recent years although in 2001 they are still above the average consumer price index of the EMU.[25] (see Appendix VIII) These days Central European countries are heading to fulfill the Maastricht criteria in order to join the EMS in 2006 and become a member of the EMU in 2009.

Besides economic stability investors are of course attracted by low corporate tax rates in Central Europe. In 2004 the average corporate income tax rate of 21.5% in the new Member States is about 10 percentage points lower than in the EU-15 with 31.4%.[26] Slovakia, for example, offers a flat tax rate of 19% for all major income and excise taxes reflecting a transparent tax system.[27]

Figure 6: Corporate Tax Rates 2004

illustration not visible in this excerpt

Source: URL: http://www.imoe.de/deutsch/laenderinfos/OE_allgemein/Wirtschaftliche_


The low share of direct taxes in the new member states, however, is usually compensated by higher shares of indirect taxes and by social contributions. Shown in the graph above Hungary has one of the lowest corporate tax rates in the EU at 16% but one of Europe’s highest VAT at 25% and they faced a higher overall tax burden than the Britain’s of 39,3% of GDP.[28] This might on the one hand attract foreign investors but hinder domestic consumption and thus diminish the country’s attractiveness for market-seeking investments. However, the burden for investors depends not just on the tax rate but also on the tax base. The Implicit Tax Rates measures “the average effective tax burden on the different types of income or activity in the economy”[29] e.g. taking into account the statutory tax rate as well as tax deductions or tax credits (see Appendix IX) and thus serves as a good indicator to compare tax systems.[30] Except for Hungary effective corporate tax rates in Central European countries do not differ from statutory rates. Thus the relevant corporate tax rates are good calculation bases for investors and are well below most incumbent EU members. (see Appendix X)

FDI, notably in manufacturing, requires good transportation networks and a functioning infrastructure. Building up infrastructure, however, still takes an important part in the transition process in Central Europe. And this does not only include the renewal and maintenance due to a lack of investments before the 1990s but today it also revolves around adjusting to European standards.[31] Under EU structural funds, EU-8 countries can expect total transfers of EUR 21.5 bn for the years 2004 to 2006 from the common EU budget. These funds are, besides human resource development or competitiveness and enterprise development, intended to build up infrastructure, including transportation nets.[32] Hereby road construction makes up a significant part since truck traffic as well as the stock of vehicles has dramatically increased in these countries. In Poland e.g. the number of cars has more than doubled from 1990 to 12 mill. in 2000.[33] In Slovakia the government provides doubled funds for highway construction in the budget 2005 with further augmentations envisaged in the following years.[34]

Investments should especially eliminate the lack of motorways as a share of total roads in Hungary, Poland, Czech Republic and Slovakia. The table below indicates that the overall infrastructural situation is best in the Czech Republic, yet, the table does allow interpretations on the quality of the road, rail, waterway or air freight system.

Table 3: Infrastructural Indicators of Central European Countries

illustration not visible in this excerpt

Source: Statistisches Bundesamt 2005

As outlined political, economic and fiscal conditions are attractive but rather similar between individual Central European countries. Infrastructure shows a different picture and especially promoting policies by the individual government are set as a tool to compete. Central European governments support especially large scale investments through incentives such as tax holidays or subsidies for every new job. Since their accession to the EU the new members receive grants from EU funds aimed at balancing economic disparities within the EU.[35] But even before accession promoting policies have been a major tool to attract MNCs. As, for example, VW purchased 31% of Skoda Auto from the Czech government for $900m in 1991 with some concessions on VW’s side, the government in return “wrote off Skoda’s debts, offered tax concessions and gave VW virtually monopoly protection in the domestic market”[36]. Similar incentives have been offered by the Slovak government in 2002 when VW decided to expand its facility in Bratislava.[37]

Besides the overall climate for foreign capital the foreign investors’ decisions depend on the availability and costs of production factors and thereby labor costs and working conditions are of particular interest.

Regarding the employment in most Central European accession countries unemployment rates hardly differ from those of other EU countries and the average unemployment rate of all EU-8 countries have always balanced between 10 and 13 percent since 1993.[38] However an imbalance in the distribution of labor can be observed. “Warsaw, for example, is near full employment, while adjacent regions may have as much as 30% unemployment.”[39] The same picture is revealed in Hungary. In the western part of the country and around Budapest infrastructure is very well developed and thus a high business density occurs. Here the availability of qualified labor becomes problematic.

Labor costs[40] are an important factor in favor of Central Europe. According to the OECD, labor costs in some of the most advanced Central European countries Poland, the Czech Republic and Hungary are around 20% of those in Germany. In Slovakia, e.g., component suppliers to the automotive industry can produce 22% cheaper than in Western Germany, e.g., to a large extent due to low labor costs and tax burden. The average wage in the VW plant in Bratislava is EUR 900 a month which is still three times higher than the country’s average wage level and allows them to recruit the best and most productive workers.[41] Moreover producers in Central Europe must be aware of a relatively big spreading of wages. Managers in a leading position are gradually approaching the level of their western European colleagues and for instance in Hungary they earn 200 to 290% more than the country’s average.[42]

As already touched earlier non-wage labor costs and most importantly social security contributions make up a rather high share of total labor costs in Central Europe. In Hungary, e.g., the ratio of non-wage labor costs in total labor costs amounted to 78% in 2002[43]. Nevertheless the average wage per hour is still very low compared for example to Germany’s as outlined in the next table.[44]

Table 4: Labor Costs in the Manufacturing Industry 2002

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** Proxy value

Source: Institut der Deutschen Wirtschaft (2004), p.2

However low labor cost levels to tend to converge towards western standards as high labor cost growth rates of Central European countries indicate. (see Appendix XI)

Similarly to labor costs labor productivity, measured by the value added per employee, also display differences to developed countries. Figures lag far behind those in OECD countries and in the private sector Czech workers were only 12% and Hungarians only 10% as productive as US Americans in 2000.[45] (see Appendix XII)

But again there is a tendency towards productivity levels converging in Western and Central European economies since partly double digit growth rates in labor productivity in the manufacturing sector of new EU member states could be observed.[46] (see Appendix XIII) An important measure for companies are unit labor costs (ULC) giving a comprehensive view on the actual costs to employers by taking productivity into consideration as well.

Unit labor costs are defined as compensations per employee at current prices as a share of labor productivity at constant prices.[47] Regarding the whole economy ULC in all selected Central European economies are declining since 1996 as depicted in the graph below. This indicates that growth in productivity is higher than the increase in labor costs.

Figure 7: Development of ULC in Selected Countries

illustration not visible in this excerpt

Source: ECB, Convergence Report 2004 i n Lipská, E./ Vinková, M./ Macková I. (2005), p.13

However costs for employees are also coherent with soft factors. As far as the population’s skill level is concerned it can be claimed to be similar to other EU countries. The Czech Republic for example is higher ranked in the PISA survey than Germany.[48] In Poland from 1990 to 2000 the percentage of students of total population increased from 13.1% in 1990 to 38.2% in 2000 and many have high technical skills and above all are proficient in English and German. Yet technical dominance in schools and universities creates a disadvantage in business skills.[49] Still attractive but rather different than in most Western European countries is the corporate governance in Central Europe. Compared to communist times unions are more or less unheard today. Wage negotiations usually take place on the company level and working times are usually handled flexibly.[50] An additional favorable aspect is that labor mobility measured by the change of work stations of employees in Central Europe is very high along with the fact that people are very motivated.[51]

To sum up, Central European countries provide a good investment climate through a stable political environment, attractive economic indicators, low corporate tax rates and several promoting policies. Above all favorable employment conditions compared to Western European standards and a good infrastructure make Central European countries attractive for foreign investors. Nevertheless, according to a survey conducted in 1999 by the Institute of German Economy[52] in Cologne (Institut der Deutschen Wirtschaft) CEE countries are still considered as risky investment environments by 77% of the investigated. Major obstacles mentioned were bureaucratic lacks (60%), unfavorable economic conditions (49%) or lack of managerial expertise or infrastructure (both 47%).[53]

3.2 Description of the Business Environment in Selected Regions

As mentioned above CEE countries have experienced more then a ten-fold increase in FDI inflows since the early 1990s due to favorable political, economic and labor conditions. The biggest investments thereby occurred in the automobile industry (e.g. Fiat SPA in Poland, GM in Hungary, VW AG in Czech Republic and Slovakia) or in the electrical sector (e.g. Electrolux and GE in Hungary) and involved substantial capital imports[54] supposing long term plans of western companies in Central Europe. Czech Republic and Slovakia are of special interest regarding the automobile sector. Czech Republic has a long-standing tradition in car and truck manufacturing[55] and Slovakia currently experiences a boom of its automobile sector attracting major international investors.

By the end of 2003 the Czech Republic was the main recipient of FDI per capita with 4,100 US dollars in Central Europe (see Appendix XIV).[56] This confirms the country’s high attractiveness for foreign investors especially in sectors like energy, construction, and property development, chemicals, pharmaceuticals, metals, and management consultancy. Since the beginning of transition the entire banking sector has seen large inward investments in equity for instance the Citibank Praha operates with American capital, Banka Haná with Belgium capital or Volksbank with Austrian capital.[57] The largest value added, however, is created by the industry of 33% followed by trade, hotels and restaurants, as well as transport activities making up 25% of gross value added.[58]

Figure 8: Czech Republic - Gross Value Added by Activity in 2003 (in constant prices and percentage of GDP)

illustration not visible in this excerpt

Source: URL: http://www.czechinvest.org/web/pwci.nsf/pages/7C92B97BE46CFEFCC1256EBC0058E2BF?

OpenDocument with reference on Czech Statistical Office (2004)

The Czech manufacturing sector is heavily influenced by the automobile industry. Investors are provided with support programs by the Czech government and can benefit from the country’s long industrial heritage - of vehicle manufacturing in particular. Laurin & Klement, the forerunner of Skoda Auto, was already founded in 1895.[59] and finds itself under the roof of VW today. Low labor costs in this sector are of special interest for investing car makers. In 2002 330 automobile design and manufacturing companies made up 20% of total manufacturing output and 21% of total Czech export volume. Between 2002 and 2003 the automotive industry served as the major source of FDI with a volume of EUR 747 mil.[60] The Czech Republic is hereby profiting from its geographical position close to Western European markets.

Slovakia counts to one of the latecomers regarding large scale reforms and FDI attraction. This has kept wages lower than in other CEE countries, that have traditionally been catching FD,I while at the same time competitive labor skills can be expected.[61] A rough display of distribution of gross value added shows that the producing sector makes up more than a third in Slovakia, reflecting a similar share like in Poland, Hungary and Czech Republic.

Figure 9: Slovakia - Gross Value Added by Activity in 2003 (in constant prices and percentage of GDP)

illustration not visible in this excerpt

Source: Statistisches Bundesamt (2005)

Even more interesting to the automotive industry than the Czech Republic is Slovakia today which was recently described as “a new hub for European automobile production”[62] by UNCTAD in its World Investment Report 2004. Hereby the organization refers to a future production capacity of 850,000 cars per year by 2006 in a country with only 5 mill. inhabitants. Volkswagen, PSA Peugeot-Citroën and Hyundai are major investors here. The three main sites are located in the western part of Slovakia “in the middle of an emerging cross-border cluster of 13 plants, 10 power train factories and hundreds of suppliers in 500-km circle”[63] comprising the Czech Republic, Hungary, Poland, Slovenia, and Slovakia.[64] (see Appendix XV) The automobile industry makes up 70% of revenues of Slovak engineering and app. 25% of Slovak exports.[65]

The World Bank ranked Slovakia as the worlds leading reformer in 2003 lifting it among the global top 20 of best business environments. Slovakia especially scored in the field of working conditions by e.g. introducing flexible working hours, and administration by cutting the time to launch a business in half.[66] The popularity of the country for doing business is expressed in the FDI development which has almost tripled from 2003 to almost 1.5 mill. In 2004.[67]

However, the Slovak government should have a look on a balanced development of its industry portfolio since other industries suffer from the dominance of automobile companies. Vocational Training for other industries like the leather and textile industry is hardly provided. Yet, Slovakia is fond of the negative effects of economies being largely dependent on one industry and now tries to attract more foreign service companies through aimed investment incentives.[68]

In a nutshell, CEE countries are especially attractive for the automotive industry while Czech Republic has long found its place and Slovakia is a rising star on the automobile industry screen. Besides European car makers the Asians are increasingly attracted to new EU accession countries. Apart from the proximity to major European customers and the known location benefits, Asian companies benefit from EU duty exemptions on cars from the transition states (even if produced by Asian companies) if they have a local content of at least 60% of their manufactured value. This provides a significant advantage given the 10% duty on direct motor vehicle imports into the EU.[69]

This has explained the attractiveness of Central European countries. The stated country specific indicators are decisive when selecting favorable production locations out of a choice of different countries by MNCs. However, the next chapter rather gives an answer on the initial drivers for MNCs to go abroad.


[1] Cf. Dicken, P. (2003), p. 51f

[2] Albaum, G./ Strandskov, J./ Duerr, E. (2002), p.550

[3] Cf. Mercado, S./ Welford, R./ Prescott, K. (2001), p.304

[4] Cf. Kloth, H. (2001), p.5

[5] Cf. UNCTAD (2004), p.8

[6] Cf. H. Dunning, J.H. (ed.) (2002b), p.223-225

[7] The Triad is formed by the United States, Japan and European Union (UNCTAD)

[8] Cf. UNCTAD (2001), p.9

[9] UNCTAD (2004), p. xviii

[10] Cf. UNCTAD (2004), p.12

[11] Cf. UNCTAD (2004), p.14

[12] Cf. Dicken, P. (2003), p. 59

[13] Cf. Lönnborg, M./ Olsson, M./ Rafferty, M. (2004), p.325

[14] Cf. UNCTAD (2004), p.70

[15] Cf. UNCTAD (2004), p.69

[16] Cf. Mercado, S./ Welford, R./ Prescott, K. (2001), p.293

[17] Cf. Dunning, J.H. (ed.) (2002b), p.223-225

[18] Cf. Albaum, G./ Strandskov, J./ Duerr, E. (2002), p.265

[19] Cf. Albaum, G./ Strandskov, J./ Duerr, E. (2002), p.265

[20] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H. (2002), p.5

[21] URL: http://www.bfai.de/?uid=dff23c24aac0ba2de608ebfec1c7aeca&id=Seite1207

[22] Cf. CIA – The World Fact Book (2005)

[23] URL: http://europa.eu.int/comm/eurostat/newcronos/reference/display.do?screen=welcomeref&open=


[24] Cf. Lönnborg, M./ Olsson, M./ Rafferty, M (2004), p.347f.

[25] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H. (2002), p.X

[26] European Commission Directorate – General Taxation and Customs Union (2004), p.46

[27] Cf. Schweickert, R./Šikulová, I. (2004) in URL: http://www.uni-kiel.de/ifw/pub/kkb/2005/


[28] Cf. Without Editor (2005) in The Economist, p.28

[29] European Commission Directorate – General Taxation and Customs Union (2004), p.10

[30] European Commission Directorate – General Taxation and Customs Union (2004), p.67

[31] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.51

[32] Cf. European Commission (2004), in: UNCTAD (2004), p.77

[33] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.52

[34] World Bank (2004), p.16

[35] URL: http://www.bfai.de/?uid=dff23c24aac0ba2de608ebfec1c7aeca&id=Seite1207

[36] Lönnborg, M./ Olsson, M./ Rafferty, M. (2004), p.334

[37] Cf. Lönnborg, M./ Olsson, M./ Rafferty, M. (2004), p.338

[38] Cf. EBRD (2004), p. 3

[39] URL: http://www.weforum.org/site/knowledgenavigator.nsf/Content/_S11958?open&topic_id=


[40] The term labor costs will synonymously be used for gross wage plus non-wage labor costs like social

security contributions of the employer

[41] Kosch, S. (2004) in Die Tageszeitung, p.9

[42] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.21

[43] URL: http://www.imoe.de/deutsch/laenderinfos/OE_allgemein/Wirtschaftliche_Rahmenbedingungen/


[44] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.22

[45] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.25

[46] CF. Bellak Ch. (2004), p.308

[47] ECB, Convergence Report 2004 i n Lipská, E./ Vinková, M./ Macková I. (2005), p.13

[48] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.40f with reference on OECD 2001

[49] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.56f

[50] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.44

[51] Cf. Gerstenberger, W./ Jungfer, J./ Schmalholz, H.(2002), p.35f.

[52] In commission by BDI and Gesellschaft zur Förderung des Schutzes von Auslandsinvestitionen, partly

published in Byfuß, J./ Eggert, J. (4/2000)

[53] Cf. Byfuß, J./ Eggert, J. (4/2000), p.32

[54] Cf. Agarwal, J.P. (1996) in International Journal of Social Economics, p. 150-163

[55] Cf. Czech Invest (2003)

[56] URL: http://www.czechinvest.org/web/pwci.nsf/pages/613B9BD9480357F2C1256EC300254074?


[57] Cf. Mercado, S./ Welford, R./ Prescott, K. (2001), p.300

[58] URL: http://www.czechinvest.org/web/pwci.nsf/pages/7C92B97BE46CFEFCC1256EBC0058E2BF?


[59] Cf. Czech Invest (2003)

[60] Cf. Czech Invest (2003)

[61] UNCTAD (2004), p.71

[62] UNCTAD (2004), p.70

[63] Wright (2004), p.26P. in: UNCTAD (2004)

[64] Cf. Wright (2004), p.26P. in: UNCTAD (2004)

[65] Cf. Schaudwet, C.(2005), p.34

[66] Cf. World Bank (2004), p.8

[67] Cf. Schaudwet, C.(2005), p..34

[68] Cf. Schaudwet, C.(2005), p.35

[69] Cf. Mercado, S./ Welford, R./ Prescott, K. (2001), p.300


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Central Europe Companies Organize Production Networks Applied Automotive Industry European Integration




Title: FDI in Central Europe: How Companies Organize Production Networks? Applied to a subcontractor to the Automotive Industry