"You are the CEO of a car manufacturing company and want to set a subsidiary in central and Eastern Europe. What economic and political factors should you be aware of when you make such a decision?
Topic 4: “You are the CEO of a car manufacturing company and want to set a subsidiary in central and Eastern Europe. What economic and political factors should you be aware of when you make such a decision?
“Our major market is Western Europe, and we have chosen this region primarily because of its location, its cheap labour force and profitable government incentives.”
Tokuichini Uranishi, managing director, Toyota Motor Corporation. (Werner, 2004)
Mr Urashini made this statement in 2002 when Toyota just built a new plant in Poland. His comment, made about ten years after the fall of the communism in Central Europe, insinuates the reasoning that most automakers have decided to locate their production plant in Eastern and Central Europe. The restructuring of governments and economies in Central and Eastern Europe has created enormous opportunities for enterprises throughout the world. The most common reason companies go international to manufacture their products is to lower their production costs. Central and Eastern Europe have proven to be able to provide the making of automobile many advantages, especially their experience in auto making, and, their abundance in cheap, skilled and productive labour force. Our company have narrowed down the research to three countries, Poland, Hungary and Czech Republic. They will be compared, and we will choose the most suitable one.
This essay is going to describe a brief history of the automotive industry in the central and Eastern Europe countries, and, explore what economic and political factors need to be evaluated before establishing our subsidiary.
The Automotive industry in Central Eastern Europe from 1903.
The Automotive industry started to expand in central Europe in Hungary in 1903. Then the Czech Republic started to design and build their cars a few years later. But the industry really started to kick off in this region about twenty years later when the Italian car maker Fiat established a joint venture to import cars, Polski Fiat, in Poland. Then Ford began manufacturing their products in Hungary. But the Second World War affected the industry, and soon, all economic sectors, in central and Eastern Europe, were controlled from Moscow under a communist regime by the Council for Mutual Economic Assistance. During the Communist era, the automobile industry was very controlled with a basic division of labour. But in 1989 when the communist system and its generous support for the industry fall, it brought about a dramatic decline in the sector. For example, by the end of 1991, Poland’ automotive industry had reduced their workforce by 19% and were functioning at only 48% of their capacity. (Werner, 2004)
This is a preview of the whole essay
In the early 1990’s, the automotive industry was characterized by a decline in production in North America, Europe and Japan and an increase in production in the emerging markets.(Lung, 2000, 17) So auto maker started to adopt an increasingly popular strategy which was to “ focus on production expansion in integrated peripheral markets”(Werner, 2004, 3) which are usually countries that offer comparative advantages in production of cars and are located close to large markets and more often than not present vertical Foreign Direct Investment opportunities. So firms would make cars within those countries and sell the output to the nearby markets. And Poland, Czech Republic, Hungary and Slovakia were recognised to be perfect candidates for an integrated peripheral market given their location next to the European Union and their cheap skilled labour. And in view of the fact that these countries were making cars since the beginning of the twentieth century, they acquired experience and knowledge in making cars which give them an advantage against the others. They also facilitated foreign investment by selling the plants they already had. (Werner, 2004) Although the historical background is encouraging to build our subsidiary, we also need to analyse the economic situation and the political factors in order to make the right decision.
The Economic factors
When a company wants to invest abroad, it ideally seeks for a stable economic environment. And these countries, to create this attractive environment for foreign investors, have associated themselves with the European Union. (Werner, 2004) Though, there are several economic factors that must be evaluated in order to judge of the country’s attractiveness for our business. As we want to establish a plant to assemble cars, we need to be next to big markets, in order to reduce transportation costs. As mentioned above, central and eastern Europe is very close to Western Europe.
We then need to know the economic system of our targeted countries. After the communist era, the economy in Central Eastern Europe was declining but the countries slowly returned to constant growth based on the driving forces of the market economy. (). Most central and Eastern Europe countries have reached mostly free level of economic freedom. (Daniels, et all., 2004) When investing abroad, it is important to know how much the government is interfering in the economy and how much control it has over the economic activity.
There are many different macroeconomic issues that affect business strategy. To invest into a country, economic growth is an important factor in order to make plans for the future. The ideal will be to have a high economic growth in the country it will invest since the company, without expanding, will be able to make revenues at the same rate as the general growth of the economy. (Daniels, et all., 2004) The growth rate of Czech Republic is 2.9%, Poland’s is 3.7% and Hungary is 2.9%. (www.cia.gov).These rate of growth are quite high but as these are emerging countries there are more risks for the growth to fall involved.
Inflation is also a useful factor to analyse especially for the price of natural resources involved in the production. It also modifies the export prices since it affects currency and exchange rate. (Daniels, et all., 2004) Czech Republic and Poland have both a low inflation rate with respectively 0.1% and 0.9% which indicate a stable currency and economic and political environment. Hungary has an inflation rate of 4.7% which is higher but still reasonable in an emerging country. ()
A major factor affecting all foreign investment is labour force and wages. Labour cost is a main expenditure in production and, usually, company manufacture in Central and Eastern Europe because of its cheap skilled labour force. (Werner, 2004) () Researches have shown that labour cost in the auto industry in Central European countries were about 25%lower than in Germany (Wagstyl, 2002) and as the industrial labour activity has been in sustained growth, the region has become a low-cost labour base for the industry.
For a firm to build a subsidiary abroad, the infrastructure of a country is capital inters of access and cost. To operate effectively, a subsidiary needs easy access for transportation and good communication channels; it needs access to power and water supply. The materials and outputs need to be transported in and out the country through safe and reliable channels. Most of the countries of central Europe being a region where there have been significant production in many industries, years of substantial public investment in utilities, roads and other infrastructure as well as the rapid construction of natural gas networks and power generation and transmission facilities during the 1970s and 1980s provided the capacity for large-scale supply of energy and infrastructure services to the economy. () Czech Republic moves to complete telecommunications, and energy privatization is encouraging foreign investment. While Poland still has problems adjusting but their entry in the European Union have made them readjusting many economic issues. But Hungary been used a lot by Germany and hosting many foreign investments have a good infrastructure and economic position. (www.cia.gov)
Appropriate technology in the chosen country is also very important. But as discussed above, those countries have a long experience in auto making and they have the physical technology and the appropriate knowledge of it to meet our expectation.
Next this essay will explore the political factors to take into account in order to invest in a foreign country.
No matter how attractive the economic environment in a region is, a company looking into doing foreign investment might find it not effective to do business in that area, if there are too many substantial political risks, and if the host government inflict heavy penalties upon the firm’s activity. (Globerman, 1986) Central and Eastern Europe have had dramatic political changes in the past thirty years, going, for most countries, from dictatorship, with communism, to democracy. So there have been major adjustment to do, bringing instability because of possible internal divisions, corruptions, militaries and oligarchies. (Daniels, et all., 2004) Consequently there are risks arising for businesses.
Political risks may occur for different reasons: it can be caused by a change in opinion of political leadership and the new government may have views less positive about business and foreign investment and apply limits on allowance or biased taxes. It can also occur because of civil disorders within the country and negative external relations with the country of origin of the business looking into investing. (Daniels, et all., 2004) Political risks can be divided into macro risks which are when politically stimulated environment changes affect all foreign enterprises and micro risk which are related to changes in the sector in which the firm operate or in the company itself. An example of macro risk is political stability and political party attitude toward foreign investors. (Globerman, 1986) But Czech Republic, Poland and Hungary need foreign investment in order to reduce their debts and encourage it. And since May 2004, these countries have joined the European Union and have been bound to change and to adapt. This incorporation in the EU will directly and indirectly regulate the risks.
Other factors worth considering are the foreign investment climate in the host country, taxation, expropriation, and labour strike and unrest. (Globerman, 1986) In the three countries targeted, as said above, the government is favourable to foreign investment.
Central and Eastern Europe countries have had drastic political changes over the past decades and they are considered as unstable political countries but their recent incorporation into the European union have made them adjust their political environment in favour of foreign investment and their move towards the west give them greater stability. ()
This essay shows how the automobile industry has evolved in Czech Republic, Poland and Hungary. The industry started at the beginning of the twentieth century, went through World War 1 and 2. Those countries then were under the communism regime and the auto industry was prosperous but at the fall of the regime, the industry collapsed and needed foreign investment to come in. Then it describes the economical factors that would affect our company such as labour costs, infrastructure, technology, growth and inflation in those particular countries. Then it analysed potential political risks that could occur in such region of the world.
Being the CEO of this company and after having read the information in this essay, I would recommend investing in Czech Republic because of its experience in the industry and because of the skilled and cheap labour force. Its incorporation in the European Union will stabilise the economic and politic difficulties that they have encountered.
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