Back to the Balkans. Volkswagen’s Relocation Plans and State-led Investment Promotion in Visegrad Countries.

By Michal Trnik, PERG guest author and MA IRES 2006 graduate

A recent news post concerning the alleged move of Volkswagen’s factory from Slovakia to Bosnia triumphantly lifted eyebrows of those who croaked the unstoppable and permanent eastward movement of foreign capital where the costs are irresistibly lower. According to these pessimistic prophets it was only a question of time when Central Europe cease to be interesting for foreign investors, which will result not only in its decreasing influx but also in direct relocations of multinationals’ production facilities.

The noticeable fuzz in Slovakia spurred by the announced VW’s plan to move whole production to Sarajevo was even magnified by citing no reasons for such a move. The ongoing silly season further boosted speculations on all fronts. Exorbitance of these catastrophic scenarios was refuted early on by Reuter’s refining follow-up, which confirmed only the relocation of small line that would have no direct impact on neither of VW’s two plants in Slovakia whether in terms of decreased production capacity or employment.

Panic is not justified. Not yet. Slovakia and other V4 countries in comparison to Bosnia still posses many FDI luring advantages. The decision of Europe’s biggest car manufacturer to start a new line of production in Bosnia rather than in Slovakia, however, sends a specific signal to Slovak government and other Central European countries as well. In particular, it serves as a good case for identifying persisting gaps in long-term investment promotion frameworks across the region.

Several speculative reasons why VW opted for Bosnia can be spelled out. Some argue that fundamental push factors that contributed to VW’s decision dwell in acute lack of skilled labor force, strengthening Slovak currency, sprawling anti-business rhetoric of current populist administration and end of tax holidays for the company. While others stress Bosnia’s pull factors such as incentives not subjected to strict EU limits, previous history of VW car production in Sarajevo and site’s potential to serve as testing grounds for further relocations.

Although none of the abovementioned reasons have to be directly responsible for the restart of VW’s production in the Balkans, they offer a larger picture concerning the state of current strategies to attract foreign investment in Slovakia and Central Europe. The Tatran Tiger’s economic success was largely generated by immense FDI inflows spurred by liberal reforms of Dzurinda’s governments. Most of investments came from at that time desired manufacturing industries, which helped to transform once economic laggard into the world’s biggest carmaker.

New challenges need fresh ideas. The V4 region soaked with manufacturing FDI demands new investment promotion approaches in order to move up the development ladder. Such strategy needs to be dynamic and has to reflect country’s development goals. In Slovakia, however, such scheme seems to be completely missing as can be seen on the country’s excessive and continuous reliance on automobile industry.

VW’s relocation to Bosnia certainly is not the first and will not be the last. Constantly rising wages in Slovakia and soaring world oil prices having detrimental effect on the car industry globally show obsolescence and fragility of country’s auto-industry focused investment promotion framework. Despite some indications of new winds blowing in minds of policymakers nothing like coherent, functioning and future-oriented investment promotion strategy was implemented. Although some minor diversification of FDI inflows into electronic industry occurred recently, Slovakia considerably lags behind in the amount of projects in high-tech, sophisticated services, IT or R&D. These require more brains than heavy machinery, can help transform the country into a modern service-based economy and make it less vulnerable to companies’ relocations. Slovakia’s close neighbors seemed to understand this some time ago.

The main regional leader in this respect is the Czech Republic, which continuously attracts sophisticated investments with high value added. The Hungarian investment strategy registered noticeable successes in form of highest FDI stock per capita in CEE and has a relatively better balanced structure as well. In fierce regional bidding wars for mega-investment projects, however, Hungary often does not hesitate to dig into taxpayers’ pockets in form of extra sweeteners offered to foreign investors. The case of Hankook Tire and speculations about Daimler’s recent investment are good examples of Hungarian generous aid to multinationals.

Daimler’s investment shows that V4 countries are still attractive for investors and can effectively compete with cheaper countries in the East even for large capital intensive investment projects. As Daimler is believed to be one of the last automobile investors in this region it is high time to rethink investment promotion strategy for those who did not do it yet. Czechs, Hungarians and even Poles did their homework on time and not only adjusted but also implemented their strategies oriented towards more perspective type of investments.

The age of massive capital and technology intensive manufacturing FDI inflows to the region is over. Forward looking investment promotion strategy is one of the necessary ingredients for further growth. Attracting investment in cutting edge technologies, services, R&D together with increased effectiveness of current production can become corner stone of its future economic success. Slovakia better learns this lesson quickly in order not to get caught unprepared face to face messages like that announced by VW.

August 28, 2008