Studies Eastern European Markets
Eastern European Markets
Tauno Tiusanen

Lappeenranta University of Technology
Northern Dimension Research Centre NORDI
Publication 1

    Some conclusions
    (edited version)

    The first phase of post-communist transition was undoubtedly extremely difficult time for all countries involved. In the mid-1990s it became evident that the first shock of post-commumist stagflation can be overcome. The overall results of the first decade of socio-economic transition were in many senses positive. Economic growth has resumed. Productivity gains were in many TEs impressive.

    Economic trends in those ten TEs, which are EU-candidates, have not been parallel. In the early 1990s it was pointed out that EU membership will be given on merit. In 2002, it was announced that two candidates, Romania and Bulgaria, do not qualify for the EU under present circumstances. Negotations with these two candidates will continue and it is highly likely that the admission will be given in the not too distant future. In the light of several indicators brought up above, Bulgaria and Romania were the most modest performers of the ten candidates to EU.

    Exchange rate deviation index (ERDI) figures actually reflect relative economic strenghts and weaknesses. Relatively high ERDI values in Bulgarian and Romaniam cases indicate that these two countries have an obvious need for high level of undervaluation of their currency units, in other words, there is clear "exchange rate protectionism" both in Romania and Bulgaria.

    ERDI values in TEs under review are still relativcely high with the exception of Slovenia. In 1998, the highest ERDI value (1,35) among the EMU-candidates was in Portugal: when eurobloc was established, ER deviations were thus rather modest. Portugals ERDI in 1998 was more moderate than Slovenian equivalent in 2002. ERDI values of about 2,00 which were observed in TEs in 2002, are too high to allow TEs to enter the monetary union.

    Eastern enlargement of EU brings labour market problems

    Special attention ought to be paid on labour market problems in the framework of Eastern enlargement of EU. Many traditional industries are moving out of Western Europe, especially in labour intensive branches. Therefore, relatively high unemployment in EU-region is structural, not cyclical. Unemployment in Western Europe is a long-term problem: demand for manual work is limited.

    In those eight formally communist countries ready to join EU, the total number of unemployed persons is almost 5 million. Unemployment rate is about 12 % in average. This as a very visible result of the transition: "unemploument on the working place" - or overmanning of production units - cannot be continued under market condition. The enterprise sector must minimize the costs and maximize profits. In this context, all local enterprises - local and foreign owned - must pay attention to productivity improvement. Excessive demand for labour is not to expected.

    There are some very interesting trends in TE wage development. It was shown above how unit labour costs in TEs under review have increased in relative terms (compared with Austria) very rapidly since the mid 1990s. This important indicator skyrocketed especially in Lithuania and Poland in 1995-2002. It is evident that wage explosion in Poland is a very important background factor in the excessive unemployment rate of some 20 %.

    In the transitional period TEs under review have had an impressive growth of FDI. It is often assumed that this boom of outside investment is not yet over. This invasion of foreign companies to TE-region has had a very concrete impact on local economy. Especially productivity gains via foreign-owned companies have been revolutionary, as evidence in the previous chapter shows.

    TE-region offer a relative but no absolute advantage in wages

    It can be assumed that in many, but not all, FDI decisions low labour costs in TEs have played a decisive role. Obvioiusly TE-region has been able to offer a relative but no absolute advantage in wages. Comparative statistics on unit labour costs show that this advantage is eroding.

    There is some empirical evidence that TE-region is not permanently regarded as a cheap production base. "Business Week" (September 1st, 2003) describes, how IBM closed a disc drive factory in Hungary in November 2001 making 3.700 workers redundant. Production was moved to China because of cheaper labour costs. The same source gives more details on competition between TE-region and Asia: Dutch electronics maker Royal Philips Electronics and Singapore contract manufacturer Flextronics International Ltd. have moved an addtional 1.500 Hungarian jobs to China in the past 18 months. Flextronics also has closed a 1.000 worker-plant in the Czech Repiblic. The closings are sending shudders across eight formerly communist countries jus as they gearing up to celebrate their entry into the European Union on May 1st, 2004.

    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 blobal supplier, there is no way you cannot be in China", he says.

    These pieces of information in one of the leading economic weeklies are undoubtedly interesting: it is pointed out that in manual labour relative wage advantage is not enoough any more in a globalised economy, where every opportunity to reduce costs are considered more and more carefully. Flexibility seems to be increasing in the FDI game.

    New TE-phenomenon: local firms must look for internationalisation

    The second part of the article pays attention to rather new phenomenon: some local firms in TEs have reached the decelopment stage, in which they must look for internationalisation options. In this framework, absolute cost advantages must be seriously taken into consideration.

    These pieces of business news certainly do not allow observing any new and clear trend in the FDI scene of TE-region. However, it can be assumed that during the present decade there will be FDI inflow, as well as outflow in the TE-region.

    In the 1990s, there was virtually only an inflow of FDI. It is rather secure to assume that there will still be a net inflow of FDI´s in TE-region for many years to come.

    Obviously, there will be structural changes in FDIs flowing into TE-region. Levelling off or even recuction of manufacturing FDIs in TEs may well take place in relatively near future, while service sector including IT activities has plenty of growth potential in TE-region. In this context it is important to bear in mind that TEs have high educational standards, and thus, able to create human capital.

    In the 1990s it was very commonly assumed that labour-intensive activities will be moved to TE-region in really massive scale, not only in the framework of FDIs but also in the form of "outsourcing": obviously many contract manufacturing deals, via which multilateral companies used TE labour were signed. These deals and their contents can hardly be statistically measured.

    Eroding price and cost competitiveness

    What can be statistically shown is very rapid increase in unit labour costs in TEs under review; numbers given above indicate that the ULC advantage in TE-region (in comparison to Autria and EU in general) has eroded rapidly in recent years (since 1995). This erosion is not the same in all TEs. In Poland the ULC advantage has become very thin, while in Bulgaria ULCs are still very moderate in the comparison brought up in the previous chapter. Bulgaria had the most spectacular growth of FDI in TEs under review. Thus we can assume that there is a link between those two factors, low ULC and Bulgarian growth of FDI by a factor of 13 (1995-2002).

    Decreasing ERDI figures (1995-2002) reflect eroding price and cost competitiveness in TEs. Obviously there is a link between decreasing ERDI values and strong inflow of FDIs. Foreign-owned companies have increased productivity levels and export capabilities in TEs. These two important development trends have obviously had an effect on TEs exchange rates, which are generally speaking much less undervalued than in the mid-1990s. Therefore the previous clear incentive to build up export-oriented cheap cost industries in TE-region is weakening.

    In the first years of the 21st century it has become evident that blue-collar work in TE-region is not in high demand. Unemployment in pan-European framework seems to be very serious problem. Among the EU-newcomers, Poland has the most severe unemployment problem, in absolute and also in relative terms. Hungary and Slovenia seems to have a relative full employment with unemployment rates below 6,5 %.

    In sum, there is a need to make further reaserch on labour market questions in the context of EU enlargement. Discussion on enlargement of the European monetary union ought to start immediately after the inclusion of new EU-members. FDI flows in TE-markets call for permanent updating, These three topics are interlinked and ought to be investigated separately or together.

Professor, Ph.D. Tauno Tiusanen, the director of NORDI, has extensive experience in studying communist and post-communist econonies. He has been professor at the Lappeenranta University of Technology (Department of Industrial Engineering and Management) since 1995. Prior to that Tiusanen held a professorship of Economics and worked as Director of the Institute of Russian and East European Studies at the University of Glasgow.

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