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EASTERN EUROPE
From Site Selection magazine, July 2010
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Taking Stock

As Western European economies falter, is Eastern Europe a safer bet?
A local expert takes a mid-year look at a region full of promises and pitfalls.

EASTERN EUROPE
by VALERIU POPOVICI
E
Valeriu Popovici is a Senior Consultant with IBM-Plant Location International, Brussels, and coordinator of IBM-PLI’s Global Investment Locations Database (GILD). Valeriu has been involved in numerous corporate location projects for major multinational clients in the Eastern European region.
Valeriu Popovici is a Senior Consultant with IBM-Plant Location International, Brussels, and coordinator of IBM-PLI’s Global Investment Locations Database (GILD). Valeriu has been involved in numerous corporate location projects for major multinational clients in the Eastern European region.

Eastern Europe's 22 countries have always been at different stages of development and levels of attractiveness for foreign investors. How do they stack up in mid-2010? To better understand their differences, this analysis discusses three distinct sub-regions — Central Europe, the Balkans, and the Western CIS (Commonwealth of Independent States) and Caucasus.

Central Europe is Poland, Czech Republic, Hungary, Slovakia, Slovenia and the Baltic states of Estonia, Latvia and Lithuania. This group of countries is the most prosperous (GDP per capita), stable and developed sub-region of Eastern Europe. All of the countries from this sub-region are members of the European Union (EU), and some of them are, or soon will be, members of the Eurozone, such as Slovenia (since 2007), Slovakia (since 2009) and Estonia (from 2011).

The fact that the Central European countries are members of the EU has helped them eliminate any trade barriers with Western European countries and thus reduce the operating costs of manufacturing companies exporting to Western Europe. In addition to this, EU membership has allowed many of the regions within Central Europe to benefit from EU regional development aid in the form of grants for companies setting up operations in these countries.

From a sector perspective, Czech Republic and Poland were the main destinations in larger Eastern Europe for projects in transport equipment and electronics sectors, and Hungary was the main destination for life sciences projects, from 2003 through 2009.

The success of Central European countries in attracting investment has benefited greatly the development and modernization of this sub-region. However, this success has had its downside, notably by stressing the relatively small labor markets of the principal cities of these countries. This has led to increasing shortages in specific areas and types of profiles, as well as an increase in labor costs. Foreign companies wishing to locate in Central Europe are looking for alternative solutions in second- and third-tier locations in these countries. This allows them to retain the relatively good level of stability and quality provided by the business environments of Central European countries and tap into pools of underutilized resources at lower costs.

The Balkan region is represented by Romania, Bulgaria, Albania and the former Yugoslav states of Serbia, Croatia, Bosnia and Herzegovina, Macedonia and Montenegro. This region is characterized by relatively poorer and smaller countries. Only Romania and Bulgaria are members of the EU, and have comparatively more stable business environments than their peers. Romania, Bulgaria and Serbia are the main destinations of foreign investment in this region. Romania is also one of the main destinations for investment in the larger Eastern European region for R&D projects, which also include software development and product development.

From a sector perspective, Romania is also the key destination for transport equipment, electronics and ICT projects in the Balkan sub-region, while Bulgaria is an important destination for life sciences projects. As is the case with the Central European EU member states, Romania and Bulgaria also benefit from similar conditions available to the EU member states, notably free market access to the EU market, and regional aid programs. These conditions together with their lowest labor costs (among EU countries) have facilitated the intensification of foreign investment after their 2007 accession to the EU.

The foreign investment is likely to increase in the coming years in other Balkan states as well, especially as their EU accession prospects start materializing. Since 2000, all of the non-EU Balkan states can export nearly all of their goods without customs duties or limits on quantities to the EU. With increasing pressure on labor markets in Central European countries, certain companies will be seeking alternatives in the neighboring Balkan countries. Opportunities exist in countries like Serbia and Albania for shared services projects, and Macedonia and Bosnia for production projects.

The Western CIS and Caucasus region is represented by Russia and the former Soviet Union republics of Ukraine, Belarus, Moldova, Georgia, Armenia and Azerbaijan. Most of the countries in this group represent relatively higher operating risks because of their weaker economies, and business and political environments. Russia and Ukraine are the main destinations for foreign investment in this sub-region because of their large markets and relatively low-cost labor force. In Russia, foreign investment is mostly driven by access to its domestic market, while investments in Ukraine were mainly destined for exports to Russia and the EU.

From a sector perspective, Russia was one of the top destinations in the larger Eastern Europe for transport equipment and life sciences sector projects, and it is very likely that it will increase its share in these sectors in the near future with resumption of growth in domestic demand and tighter import restrictions in these sectors. Western CIS countries are well positioned to serve as a platform for foreign companies interested in accessing the Russian market because of these countries' proximity, special economic relations and historical links to Russia.

Foreign companies are also beginning to consider Ukraine and Moldova as potential locations to serve the EU markets. Moldova has an unlimited and duty free access to the EU market for all products originating from Moldova (except a number of agricultural goods), while Ukraine has a special trade agreement with the EU which allows it to export on a preferential basis to the EU chemicals, plant oils, minerals, base metals, machinery and mechanical appliances. These two countries are likely to see foreign investment in production projects in the near future, especially from cost sensitive and market driven sectors.

The chart below is a general overview of Eastern European regions summarizes the strengths and weaknesses of each group of countries.

Central European locations have started to lose some of their cost competitiveness for production activities as other Eastern European countries have become an option for corporate expansion projects. In addition to this, recent inflow of shared services and R&D projects in Central European countries has put pressure on their labor markets. Companies preferring locations in Central Europe for stability reasons will likely locate in second- or third-tier locations in this region, running the risk of labor shortage in the long term and lower quality of infrastructure.

A similar situation is likely to repeat in the currently lower-cost countries of Romania and Bulgaria. In these cases, currently less preferred locations from the Western CIS and Balkans will likely emerge as potential candidates due to their still untapped local human resources and lower labor costs. Similarly, the next wave of foreign production projects in the region will further advance to the east and south in riskier operating environments which offer very low cost resources, such as Albania, Macedonia and Serbia for companies targeting the EU market, and Moldova and Ukraine for companies targeting the Russian and EU markets.



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