A case Study on the Car Industry of the Czech Republic



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A Case Study on the Car Industry of the Czech Republic

Tracing FDI Trends in Central and Eastern Europe after the 1990s

Maria Beatrice Guidote

Core fields of European Culture III

Socioeconomic Geography of the Central European Countries

December 2008



What is FDI?
The United Nations Conference on Trade and Development (UNCTAD) defines foreign direct investment (FDI) as “an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor.”1 The main purpose of the investor, in cases of FDI, is to gain a powerful foothold on the management of the enterprise.2
FDI is generally regarded as a vital engine of growth and a powerful catalyst for market transition.3 And thus, when state socialism collapsed in Central and Eastern Europe (CEE), liberal economists and international institutions declared that only a large influx of FDI in the region would open the doors to a successful transformation from command economy to market economy.4
It was expected that FDI would “play a critical role in the economic development of CEE and generate industrial restructuring that would spread throughout the entire economy and ultimately lead to national prosperity.”5
Politicians and economists in the CEE themselves saw FDI as a panacea for economic revival.6 FDI was seen as a key to establishing dynamic national and regional economies, a catalyst for regional learning, and a basis for social upgrading.7
But after tracing the development of CEE economies in the succeeding years, economists today are more cautious in describing FDI as such a powerful instrument for economic growth. They are now careful to point out that FDI affects host countries both positively and negatively.
Potential Positive and Negative Effects of FDI in Host Countries8


Positive


Negative

Enterprise level

Enterprise level

- continued and expanded production

- labour shedding

- increased labour productivity

- disinvestment and downsizing of production

- access to investment capital

- transfer of R & D abroad

-access to worldwide sales and distribution networks




- transfer of Western technology and know-how




- improved competitiveness and increased R&D










Local and Regional Economy

Local and Regional Economy

- saving of existing jobs and creation of new jobs

- local dependency on foreign capital and external control of local economies

- growth or real income

- attracting skilled and semi-skilled workers from local companies

- increased tax base

- suppression or destruction of local firms unable to compete with FIEs supported by generous governmental investment incentives and benefiting from transfer pricing

- increased exports

- suppression of the development of new indigenous enterprises

- labour training

- deskilling

- provision of social services to local communities

- regional specialization in low-skilled, labour-intensive production

- spillovers to local and regional economy

- development of dual economy and branch plant syndrome

- increased opportunities for local companies to supply foreign-owned companies

- instability of Western investment


FDI Trends in Central and Eastern Europe
As we shall see in the transformation of CEE economies from command to market with the influx of FDI, the picture did not turn out to be as rosy as initially portrayed.
Nauro Campos and Fabrizio Coricelli argue that “there is enough evidence to argue that, in this first ten years, output fell, labour moved, the stock of physical capital shrank, there was a rapid and in- tense reorientation of international trade to- wards the West, the structure of the economy changed, there was rapid collapse of institutional structures followed by a vacuum in many countries, and the transition involved large social costs principally in terms of worsening income inequality, mortality, and poverty rates.”9
FDI inflow did result in speedy and deep-seated restructuring of foreign invested enterprises, which included organizational restructuring, technology transfer, worker training, the transfer of Western management structures and practices, and new production strategies and organization.10 It also increased quality and competitiveness of produced goods, resulted in productivity gains and expanded production and sales, both domestically and abroad.11
However, although FDI played an increasingly important role in the CEE, its effects across the region have so far been very uneven both sectorally and geographically.12
Petr Pavlinek points out the following interesting statistics about FDI in the region.13
1. Even though there was a dramatic increase in annual FDI inflows to CEE in the 1990s, they remained low in the global context, when compared to its 5.4 percent share of the world’s population.
2. While CEE attracted $166.5B between 1990 and 2001 or 2.7 percent of the total, industrialized countries received a total of $4,404B (71.4 percent) while less developed countries received $1,598B (25.9 percent) in investments.
3. Furthermore, FDI inflows to CEE were low in the European context. Although CEE accounts for 46 percent of Europe’s population, it received only 5.7 percent of total FDI inflows to Europe between 1990 and 2001. In this period, Spain alone, with a population of only 41 million, attracted FDI amounting to $169.5B, higher than the cumulative FDI inflow received by the entire CEE with its population of 334 million.
4. Within CEE, FDI inflows were very uneven. Central Europe accounted for 64.3 percent of all FDI inflows between 1990 and 2001, with the Czech Republic, Hungary, Poland and Slovakia getting almost two-thirds of total FDI inflows to CEE.
Nauro Campos and Fabrizio Coricelli actually claim that capital accumulation slowed down significantly during the transition period.14 And thus we see that while FDI played an important role in transition economies, particularly as an agent of new technology, this role has been concentrated in only a few countries, and this has not been enough to reverse the general downward trend of aggregate investment in the region.15
Transformation of the CEE Car Industry
Peter Dicken claims that automobiles have attracted much more attention in the world than almost any other industry, and that since the 20th century, it has in fact been the key manufacturing industry.16 This is because of its size, linkages with many other industries, and overall effect on economic development.17
We learn from Petr Pavlinek that at the end of the state socialist period, car manufacturing in CEE accounted for merely six percent of the world production in 1989.18 By then, the industry was unproductive and obsolete by Western standards as it had been unable to keep up with the changes that swept through the automobile industry in the West from the 1970s to the 1980s.19
Recognizing the importance of the car industry to the whole national economy, most CEE governments actively sought the promotion of FDI as the primary tool for the industry’s transformation.20
Governments of the CEE countries only needed to establish appropriate institutional and policy frameworks to position themselves within flows of global capital.21
By 1996, foreign-owned enterprises and joint ventures accounted for 85% of the production of the motor industry in Hungary, 82% in Poland, and 67% in Czech Republic, posting the highest degree of FDI penetration within their manufacturing sectors.22
Different automobiles opted for different kinds of investments in different CEE countries.
Brownfield investments were made by Fiat in Poland (FSM), VW Group in then Czechoslovakian (Škoda), Daewoo in Romania (Automobile Craiova), Ukraine (Avtozaz) and Poland (FSO), and Renault in Romania (Dacia); while greenfield investments were made by Suzuki, Audi and GM Opel in Hungary, BMW, Porsche, GM Opel and VW in East Germany, GM Opel in Poland, Peugeot-Citroen in Slovakia, and Peugeot, Toyota and Hyundai in the Czech Republic.23
These foreign investors have been drawn to the region because of two major factors: first and foremost, the possibilities for low-cost production that would increase their competitiveness in lucrative Western European markets, and second, by the sheer market potential of the region itself. Also, investment incentives and the avoidance of trade barriers by producing cars locally also added to the attractiveness of the countries, particularly in the cases of Czech Republic and Poland.24
Development of the Czech Car Industry
“The Czech Republic has a long history as a country of choice when it comes to manufacturing anything on wheels.”25
Even before World War I, the car industry was already existent in then Czechoslovakia, with the Škoda factory producing cars as early as 1905.
“The German occupation in 1939 to 1945 caused a considerable disruption in the history of the company, which was integrated into the industrial structure of the German Empire. The civilian production programme was immediately limited and production was turned to its needs.”26
After World War II, production continued under state socialism. However, such production was concentrated on small, inexpensive, low-quality models, and further development was constrained by the centrally planned economy and its socialist policies.27
The collapse of state socialism led to the de-industrialization of traditional industrial regions in the Czech Republic (northern Moravia, northern and central Bohemia), laying the groundwork for the influx of foreign investment.28
Today, the automotive sector accounts for 20% of manufacturing output and 25% of Czech export. According to Czech Invest, it employs over 130,000 employees and accounts for half of the world’s top 50 component manufacturers. An increasingly powerful engine of the Czech economy, it is set to accelerate further as Skoda, combined with Toyota / PSA and now also Hyundai, will be producing more than one million cars annually.29
The three main players
1. Škoda Auto
In 1991, the Volkswagen Group made a successful bid for Škoda Auto, beating out Renault.
It acquired 30 percent of the company and full management control. VW introduced new management practices, work organization, and quality control, and imposed basic cost-cutting measures to increase labor productivity by minimizing waste and improving the utilization of the working day by employees.30 Using this simple strategy, VW substantially increased the quality of Škoda’s Favorit model without any investment during the two years after takeover.31
Soon after, “despite criticism at the time that it did not know what it was buying, VW bought a chunk more in 1995 to increase its shareholding to 70 percent, and in 2000, purchased the last remaining stock held by the Czech government.”32
Today, Škoda is the biggest Czech exporter, just as it is one of the biggest employers, with approximately 26,000 professionals in the company. In 2006 Škoda Auto produced and delivered a total of 556,433 cars, reaching a growth of 12.5%.33
Before the launch of TPCA, Škoda was responsible for 8 percent of the exports from the Czech Republic.34 Its biggest markets are in Germany, followed by the Czech Republic, Slovakia, Great Britain, Italy and Poland.
Its main facility in Mladá Boleslav is supplemented by factories in Vrchlabí and Kvasiny in eastern Bohemia. In addition to these three plants in the Czech Republic, Škoda is expanding production in India, Ukraine, Bosnia and Herzegovina, and China.
2. Toyota Peugeot Citroën Automotive
Toyota and PSA Peugeot-Citroën launched commercial production at their joint venture plant named TPCA (Toyota Peugeot Citroën Automotive) in the Czech Republic early in 2005.
A typical example of a factory built on the "green field", at around EUR 1.3 billion, this state-of-the-art plant is one of the biggest foreign investments in Central Europe to date.35
This factory said to be the most modern and efficient Toyota plant in the world. With about 3,000 employees in total, it produces 300,000 cars a year – 200,000 for the Peugeot and Citroën brands and 100,000 for Toyota.36
TPCA is the first Toyota plant not to rely on supplies from Japan. Eighty percent of all parts are sourced in the Czech Republic.37 More than 100 supplying firms (about 60 of them Japanese and a similar number of them from Western Europe) followed TPCA to the Czech Republic although they have the intention to work not only for TPCA, but also for Škoda and some other car factories that are about to begin production in Slovakia.38
But one thing to note is that TPCA was granted generous incentives from both the state and the town of Kolín, with the town agreeing to pay for the complete development of the industrial zone, plus the costs of traffic route extensions, sound barriers, new housing units and other adequate infrastructure. As a result of all of this Kolín incurred debts of hundreds of millions of crowns that it will not pay back till 2019.39
3. Hyundai
Hyundai started production in Nošovice in the Czech Republic in November 2008.
At EUR 1 billion, the Hyundai deal is one of the biggest foreign direct investments in the Czech Republic's history and economists say it could boost economic growth by up to 1.3% a year once it reaches full production capacity. To achieve this deal, the Czech government has given about EUR 200 million in tax breaks and other investment incentives to draw Hyundai to the high unemployment region.40
The Nošovice plant now has 1,800 employees but the number should grow to 2,200 by the end of the year and to 3,400 in 2011.41 The government hopes it will create an additional 9,000 jobs indirectly.42
It plans to supply the European market with at least 18,000 Hyundai i30 passenger cars, including 500 destined for the Czech Republic. The company will ship 14,000 of its i30 superminis in November and December and another 185,000 cars next year. The plant should reach its full capacity in 2011, when it will make 300,000 cars per year, or 5 percent of the brand's worldwide output.43
Suppliers are most important
Supplying firms form the most important part of the Czech car industry, actually employing a greater number of workers. Taken as a whole, this part of the industry achieves higher revenues than the actual car producers and takes a 56 percent share of the sector's production.44
Some of the supplying firms are Czech based. The majority, however, were established through extensions or shifts of production from abroad. These companies manufacture not only for the car factories in the Czech Republic, the main portion of their production is directed to other EU countries.
For example, Ford, which does not have any direct production established in the Czech Republic, uses components delivered by about 30 companies based in the Czech Republic, while in 2004, Volkswagen (not including Škoda Auto) was delivered components worth EUR one billion.45
Among the biggest suppliers is Continental in Otrokovice (Moravia), which employs 4,500 workers and has become the biggest European producer of tires for personal vehicles. Another important supplier is Bosch, which makes components for diesel engines in Jihlava and employs 5,800 people. Most of their customers include all major European car factories as previously mentioned, but they also export to Asian and South American producers.
Conclusion
It is true that FDI affects a host country both favorably and adversely. However, it cannot be said that FDI alone can spur an economy’s growth. The idea that it is actually economic growth that attracts FDI is more believable in my opinion.
In the case of the Czech Republic, we have seen that the role of FDI in the transformation of its car industry has been significant, and it is likely to remain so.
If one were to analyze the Czech car industry alone, it is faring quite well compared to other car industries across the globe. Skoda itself is in a better position than VW in Germany, for example. But it must work to maintain this favorable position by capitalizing on its competitive advantages. While it may no longer be attracting investment on the basis of its previous appeal, i.e., cheap labour, it has developed a highly competitive R&D position globally. This highly significant competitive edge must be maintained and further strengthened.
In the light of today’s global economic crisis, the impact of Hyundai’s entry into the Czech car industry has been quite beneficial for the Czech economy as a whole. The entry of TPCA in 2005 gave a similar boost to the Czech economy.
This, however, paints a risky picture for the Czech Republic in the future. With this increasing dependence on a single industry, a similar crisis in the future would then have a much greater impact on the Czech economy. The Czech Republic must look to transform and develop its other industries as well, with or without the help of FDI.
Bibliography
Automotive Industry in the Czech Republic, Czech Invest, www.czechinvest.org.
Hyundai plant to cushion Czech GDP slowdown, Czech News, 11 November 2008; available from http://aktualne.centrum.cz/czechnews/clanek.phtml?id=621766; Internet; accessed on 19 November 2008.
Hyundai to build Czech car plant, Turkish Weekly, 28 March 2006; available from http://www.turkishweekly.net/news.php?id=28793; Internet; accessed on 28 November 2008.
John Pickles and Adrian Smith, Foreign Direct Investment and Regional Development in East Central Europe and the Former Soviet Union, ed, David Turnock, Aldershot: Ashgate (2005).
Nauro Campos and Fabrizio Coricelli, Growth in Transition: What We Know, What We Don't, and What We Should, Journal of Economic Literature, Vol. 40, No. 3 (Sep., 2002), pp. 793-836.
Nina Bandelj, Embedded Economies: Social Relations as Determinants of Foreign Direct Investment in Central and Eastern Europe, Social Forces, Vol. 81, No. 2 (Dec., 2002), pp. 411-444.
Peter Dicken, Global Shift: Mapping the Changing Contours of the World Economy, 5th edition, London: The Guilford Press (2007).
Petr Pavlinek, A Successful Transformation? Restructuring the Czech Automobile Agency, Springer (2008).
Petr Pavlinek, Foreign Direct Investment and Regional Development in East Central Europe and the Former Soviet Union, ed, David Turnock, Aldershot: Ashgate (2005).
Petr Pavlinek, Regional Development Implications of Foreign Direct Investment in Central Europe, European Urban and Regional Studies, Vol. 11, No. 1, pp. 47-70 (2004).
Škoda: Common History; available from http://new.Škoda-auto.com/com/about/tradition/history/Pages/History.aspx; Internet; accessed on 23 November 2008.
Tomas Johanek, Auto Industry Restarts Engines, Czech Business Weekly, 14 May 2007; available from http://www.cbw.cz/en/auto-industry-restarts-engines/4571.html; Internet; accessed on 5 December 2008.
UNCTAD, according to Balance of Payments Manual: Fifth Edition (BPM5) (Washington, D.C., International Monetary Fund, 1993).
Wild Ride – A Different Perspective on the Czech Car Industry; available from http://libcom.org/library/wild-ride-a-different-perspective-on-the-czech-car-industry; Internet; accessed on 22 November 2008.
William Kimberley, Škoda: An Eastern European Success, June 2001; available from http://findarticles.com/p/articles/mi_m0FWH/is_6_113/ai_76445145; Internet; accessed on 4 December 2008.

1 UNCTAD, according to Balance of Payments Manual: Fifth Edition (BPM5) (Washington, D.C., International Monetary Fund, 1993).

2 Ibid.

3 Nina Bandelj, Embedded Economies: Social Relations as Determinants of Foreign Direct Investment in Central and Eastern Europe, Social Forces, Vol. 81, No. 2 (Dec., 2002), pp. 411-444.

4 Petr Pavlinek, Regional Development Implications of Foreign Direct Investment in Central Europe, European Urban and Regional Studies, Vol. 11, No. 1, pp. 47-70 (2004).

5 Ibid.

6 John Pickles and Adrian Smith, Foreign Direct Investment and Regional Development in East Central Europe and the Former Soviet Union, ed, David Turnock, Aldershot: Ashgate (2005).

7 Ibid.

8 Petr Pavlinek, Regional Development Implications of Foreign Direct Investment in Central Europe, European Urban and Regional Studies, Vol. 11, No. 1, pp. 47-70 (2004).

9 Nauro Campos and Fabrizio Coricelli, Growth in Transition: What We Know, What We Don't, and What We Should, Journal of Economic Literature, Vol. 40, No. 3 (Sep., 2002), pp. 793-836.

10 Petr Pavlinek, Regional Development Implications of Foreign Direct Investment in Central Europe, European Urban and Regional Studies, Vol. 11, No. 1, pp. 47-70 (2004).

11 Ibid.

12 Ibid.

13 Ibid.

14 Nauro Campos and Fabrizio Coricelli, Growth in Transition: What We Know, What We Don't, and What We Should, Journal of Economic Literature, Vol. 40, No. 3 (Sep., 2002), pp. 793-836.

15 Ibid.

16 Peter Dicken, Global Shift: Mapping the Changing Contours of the World Economy, 5th edition, London: The Guilford Press (2007).

17 Petr Pavlinek, Foreign Direct Investment and Regional Development in East Central Europe and the Former Soviet Union, ed, David Turnock, Aldershot: Ashgate (2005).

18 Ibid.

19 Ibid.

20 Ibid.

21 Petr Pavlinek, Regional Development Implications of Foreign Direct Investment in Central Europe, European Urban and Regional Studies, Vol. 11, No. 1, pp. 47-70 (2004).

22 Petr Pavlinek, Foreign Direct Investment and Regional Development in East Central Europe and the Former Soviet Union, ed, David Turnock, Aldershot: Ashgate (2005).

23 Ibid.

24 Ibid.

25 Tomas Johanek, Auto Industry Restarts Engines, Czech Business Weekly, 14 May 2007; available from http://www.cbw.cz/en/auto-industry-restarts-engines/4571.html; Internet; accessed on 5 December 2008.

26 Škoda: Common History; available from http://new.Škoda-auto.com/com/about/tradition/history/Pages/History.aspx; Internet; accessed on 23 November 2008.

27 Petr Pavlinek, A Successful Transformation? Restructuring the Czech Automobile Agency, Springer (2008).

28 Wild Ride – A Different Perspective on the Czech Car Industry; available from http://libcom.org/library/wild-ride-a-different-perspective-on-the-czech-car-industry; Internet; accessed on 22 November 2008.

29 Automotive Industry in the Czech Republic, Czech Invest, www.czechinvest.org.

30 Petr Pavlinek, Foreign Direct Investment and Regional Development in East Central Europe and the Former Soviet Union, ed, David Turnock, Aldershot: Ashgate (2005).

31 Ibid.

32 William Kimberley, Škoda: An Eastern European Success, June 2001; available from http://findarticles.com/p/articles/mi_m0FWH/is_6_113/ai_76445145; Internet; accessed on 4 December 2008.

33 Automotive Industry in the Czech Republic, Czech Invest, www.czechinvest.org.

34 Wild Ride – A Different Perspective on the Czech Car Industry; available from http://libcom.org/library/wild-ride-a-different-perspective-on-the-czech-car-industry; Internet; accessed on 22 November 2008.

35 Wild Ride – A Different Perspective on the Czech Car Industry; available from http://libcom.org/library/wild-ride-a-different-perspective-on-the-czech-car-industry; Internet; accessed on 22 November 2008.

36 Automotive Industry in the Czech Republic, Czech Invest, www.czechinvest.org.

37 Ibid.

38 Wild Ride – A Different Perspective on the Czech Car Industry; available from http://libcom.org/library/wild-ride-a-different-perspective-on-the-czech-car-industry; Internet; accessed on 22 November 2008.

39 Ibid.

40 Hyundai to build Czech car plant, Turkish Weekly, 28 March 2006; available from http://www.turkishweekly.net/news.php?id=28793; Internet; accessed on 28 November 2008.

41 Hyundai plant to cushion Czech GDP slowdown, Czech News, 11 November 2008; available from http://aktualne.centrum.cz/czechnews/clanek.phtml?id=621766; Internet; accessed on 19 November 2008.

42 Hyundai to build Czech car plant, Turkish Weekly, 28 March 2006; available from http://www.turkishweekly.net/news.php?id=28793; Internet; accessed on 28 November 2008.

43 Hyundai plant to cushion Czech GDP slowdown, Czech News, 11 November 2008; available from http://aktualne.centrum.cz/czechnews/clanek.phtml?id=621766; Internet; accessed on 19 November 2008.

44 Wild Ride – A Different Perspective on the Czech Car Industry; available from http://libcom.org/library/wild-ride-a-different-perspective-on-the-czech-car-industry; Internet; accessed on 22 November 2008.

45 Ibid.


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