Eastern Europe a victim of its own successes

VIENNA, Austria — When the communists were ousted across Eastern Europe, the capitalists moved in. For foreign companies from McDonald’s to Microsoft, it was an exciting new frontier — a cheap place to make things, with 70 million potential consumers to buy them.

Now, 18 years after the East embraced economic freedom, come the first tentative signs that an unprecedented boom may be on the verge of going bust.

Although big business is still expanding briskly across the region, wages, real estate and taxes are rising fast. Put simply, for companies looking to outsource manufacturing or services, the newest corner of the European Union just isn’t the bargain it used to be.

Analysts say the shift is subtle — in some places barely perceptible — but they warn that the rapidly prospering nations of Central and Eastern Europe soon could become victims of their own success by pricing themselves out of the market.

“It has happened before — Mexico, Singapore, Thailand — and will continue to happen as long as there are ‘lower cost’ places with the human and political potential to be developed,” said Charlie Barnhart, a senior consultant for Alameda, Calif.-based Technology Forecasters Inc.

Mr. Barnhart thinks there could be a noticeable “sustained softening” of foreign outsourcing to the East in as soon as two or three years.

It’s happening already. Among companies that recently scaled back or pulled out:

• Delphi Corp., a Troy, Mich.-based auto parts supplier that filed for bankruptcy in 2005, shifted some manufacturing from the Czech Republic, where workers earned about $6 an hour, to Ukraine, where the going rate is closer to $1.60.

• Lauma, a lingerie maker based in Latvia, last year started transferring production to Belarus and Ukraine. Now it plans to outsource all new business to the two ex-Soviet republics because it can’t hire enough Latvians to staff its sewing houses.

• Lidl, a discount grocery chain headquartered in Germany, last year sold 50 parcels of land in Estonia and Latvia, where it had planned to open stores, after executives realized the cost of doing business in the Baltics was much higher than they anticipated.

Guntis Strazds, who heads the Latvian Association of Textile and Clothing Industries, says a shortage of workers and high labor costs will prompt textile companies to outsource up to 40 percent of their production to cheaper countries “in the near future.”

“We’re already giving orders to Russia and Belarus, and we’re in the process of making contacts in Ukraine,” he said.

In Hungary, an American company that refused to be identified showed the Associated Press an internal chart it uses to decide where to open new factories. Russia and Ukraine were ranked far cheaper than Poland, Hungary and Romania.

To be sure, there’s no mass exodus of Western companies from those countries. In fact, consulting firm McKinsey & Co. predicts outsourcing activity in the region to triple by the end of 2008, creating more than 130,000 jobs.

The region’s chief advantages, according to McKinsey: Wages comparable to those in India, a skilled, innovative and multilingual labor force, a low-risk profile based on political and economic stability, and a cultural proximity to Western Europe that poses fewer challenges and headaches than places like Southeast Asia.

Story Continues →