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Eastern Europe may be a victim of its own successWILLIAM J. KOLE Associated Press Writer

A man walks in front of the Microsoft Support Center in Bucharest, Romania. Romania’s IT sector grew by 35 percent in 2006 to over 1.2 billion euro (U.S. $1.6 billion). In February, Microsoft chairman Bill Gates visited Romania to inaugurate a technical support center that’s expected to employ up to 600 specialists.
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.
Experts say the shift is subtle — in some places barely perceptible — but 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.
Barnhart thinks there could be a noticeable “sustained softening” of foreign outsourcing to the East in as early 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 which 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, is giving that country the slip. Last year, it 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.
Smaller mid-size cities are worth exploring because they’re cheaper than capitals, yet often have large universities that produce a steady flow of skilled graduates, McKinsey says.
An example is the northwestern Romanian city of Cluj, where Nokia announced last week it plans to open a cell phone plant and tech center. Nokia will invest $80 million in the project, which the government says eventually will create 15,000 jobs.
Romania’s IT sector grew by 35 percent in 2006 to more than $1.6 billion. Valerica Dragomir, executive director of the Association of Software and Information Services Industries, a trade group, says the opportunities are luring back bright young specialists who left “because they didn’t see a horizon for developing their careers and didn’t see a better life here.”
Yet experts say a shift is inevitable.
In Poland, wages for the first time are expected to grow faster than productivity this year, said Magdalena Iga of Warsaw’s Center for Social and Economic Research. That’s significant because high productivity has been credited for maintaining Poland as a good deal for foreign investors.
As countries develop, salaries, taxes and other social costs go up. Technology Forecasters’ Barnhart says a location starts losing its allure as an outsourcing venue when wages rise to within 70-75 percent of U.S. salaries, and when local raw materials are no longer at least 8-10 percent cheaper than in a fully developed country.
That gives an edge to countries such as India and China, which have kept compensation down to 3 percent of the U.S. level. By contrast, wages in some sectors in Romania already are 50 percent of U.S. levels and rising by 20 percent a year.
Czechs are the top wage-earners in Central Europe. Last year, their average monthly salary rose by 6.5 percent to the equivalent of $963, the government’s statistics office said.
Although Czechs won’t earn as much as Germans until 2037 at the earliest, their prosperity “is catching up with that of an average Western European citizen,” analyst Marketa Sichtarova concedes.
Yet high wages won’t stop South Korean carmaker Hyundai from breaking ground in May on a new $1.3 billion assembly plant in the eastern Czech city of Nosovice. Or Samsung Electronics from moving ahead in talks with officials in neighboring Slovakia on plans to build a new factory to make flat-screen TVs.
Likewise, companies such as Microsoft, which has operated in Eastern Europe since 1992 and now employs more than 1,000 people in 19 subsidiaries, are in no hurry to walk away from that kind of investment.
Underscoring his commitment to Romania, Microsoft chairman Bill Gates visited Bucharest in February to inaugurate a technical support center that will employ up to 600 software specialists.
“The snowball of outsourcing is big,” said Cosmin Mares, spokesman for Romanian software company Softwin. “And it cannot be instantaneously stopped.”
AP correspondents Gary Peach in Latvia, Pablo Gorondi in Hungary, Alexandru Alexe in Romania and Vanessa Gera in Poland contributed to this report.

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