Economic & Business Focus: A Bigger, Better EU

Ten new member states afford a variety of business opportunities.

The European Union (EU) quietly morphed on May 1 into a 25-nation market for goods and capital. The 10 new members -- the Czech Republic, Hungary, Estonia, Latvia, Lithuania, Poland, the Slovak Republic, Slovenia, Cyprus and Malta -- bring to the European Union 5 million businesses, thriving stock markets, 75 million consumers and GDP growth rates well above those of long-standing EU members (see Forecasts of Real GDP Growth). The new members offer a low-cost, educated workforce; low taxes; and proximity to Western markets. Western European companies have seized the opportunity to invest and source in the new member states, but U.S. firms have lagged behind.

The EU expansion is an evolution, not a revolution, according to Stephen Phillips, partner and head of the European capability sourcing practice for management consultancy Bain & Company Inc. in London. "During the past 10 years of accession negotiations, the endgame has been increasingly clear, causing money to pour into the countries concerned," he says.

The 10 new member states have received more than $120 billion in foreign investment over the past decade. This money has helped establish a manufacturing capacity which is close to that of Western markets, but in a region with one-fifth Western nations' labor costs. It has also helped carve out space for these countries in high-growth-rate industries. Their EU accession will accelerate the flow of capital and goods.

The bad news is that few U.S. companies are poised to benefit from these changes. The notable exceptions are those businesses that had the foresight to move into Central Europe years ago. Cleveland-based manufacturer Parker Hannifin Corp. entered what is now the Czech Republic in 1991. In March of this year, just two months before that nation's EU accession, the company expanded its Chomutov plant, which now employs 1,000 of Parker Hannifin's 46,000 employees worldwide.

"Investing in Eastern Europe is a key strategy for Parker's long-term growth," says Jack Myslenski, executive vice president of sales, marketing and operations support and the lead executive for Parker Hannifin's European initiatives. "To remain competitive in the global market, it is important for Parker to manufacture a portion of high-labor-content products in low-cost countries. In addition, the Czech Republic provides strategic positioning in the heart of Europe so we can remain close to our customers and our existing facilities throughout the EU." The company will open a trading center in the Czech Republic later this year and a new plant there in 2005.

Accession Outcomes

In addition to its operations in the Czech Republic, Parker Hannifin runs facilities in the new EU member states of Poland, Hungary and Slovenia. With the May 1 accession, "we're seeing the benefits of consistent and common trade business practices," Myslenski says. "Opening borders and easing restrictions help us get products to customers more quickly and efficiently. As our customers expand into these markets, it will become easier to supply their needs for motion and control systems and components, regardless of where they were manufactured."

AMI Semiconductor, a developer and manufacturer of integrated mixed-signal and structured digital products based in Pocatello, Idaho, moved into Central Europe eight years ago. Its design center in the Czech Republic is now one of the largest in the region. "We needed to remain competitive with other large chip firms, and the region offered the skilled labor at the best pricing to help the company meet its goal," says David Henry, CFO. Czech universities provide fresh talent for the company and help it recruit. "AMIS was pleased with the decision of the Czech Republic to enter the EU because it will accelerate foreign investment in the country, creating a dynamic employment market," Henry notes.

Yet as investments pour in and labor markets begin to tighten in the new EU states, some of the cost advantages of locating there will be lost. Labor costs are expected to rise 6 percent to 7 percent in the Czech Republic and Hungary this year. "Although we are already seeing signs that salaries are increasing in the region, we anticipate that these increases will align with what we are already seeing in Western Europe in our facilities in Belgium," says Henry. "When costs start to rise, the traditional alternative for the technology sector is India; however, the physical distance, the time difference and cultural gap are much larger barriers for AMIS than those of Eastern Europe. Continuing work in the Czech Republic makes good strategic sense." AMI Semiconductor just opened a new design center in Bulgaria, which is in line for EU accession.

Lower Risks

All of the rules and regulations for doing business in the EU now apply to the new member states. "Prior to accession, there was always the residual fear that a local rule or regulation could be harmful to a company's business," says Brian Hartnett, an antitrust lawyer and managing partner of the Brussels, Belgium, office of law firm Squire, Sanders & Dempsey LLP. "Such a rule or regulation may continue to exist, but to the extent that it is incompatible with the principles of free trade and free movements of goods enshrined in the EU Treaty, the EU Commission has jurisdiction to remove it."

Any product lawfully produced in or imported into the European Union by an EU-based subsidiary of a U.S. business or by an indigenous corporation is classified as an "EU good." It retains that status everywhere in the union, and "any form of discrimination between local and [other] EU goods will not be tolerated," Hartnett notes.

In addition, general counsel of U.S. companies accustomed to working in Western Europe should now feel more confident when addressing legal issues in the new member states. "There will be the possibility of recourse to similar legal processes, and there will be equal guarantees of due process," Hartnett reports. "IP [intellectual property] rights will be afforded identical protection throughout the extended EU. There will, for example, be recognizable remedies against pirating activities."

Still, pitfalls remain. "It would be dangerous to assume that there is a completely level playing field where identical rules and laws prevail throughout the EU," Hartnett says. Whole areas of law have not been harmonized; labor law is a prime example.

Another area of potential danger is government aid. Says AMIS's Henry, "There are opportunities for public funding in Central Europe that are not available in other geographic areas, making it attractive for investment." However, Hartnett warns, "U.S. companies must be wary of governments in the new member states that will offer exceedingly attractive investment incentives as the new member states compete for investment dollars." Government aid -- unless it's expressly approved by the European Commission or falls within specified exemptions -- is illegal. And beneficiaries of illegal aid may be obliged to pay it back. "All of the new member states have negotiated various exemptions from the state aid rules for an interim period, but it is important that such offers of aid are closely checked to ensure compliance with the rules," Hartnett says.

"EU accession did not witness the mass abolition of protectionist regulations, but it represents an important trigger to adjust the economic risk factors embedded in such strategies: currency stability, wage inflation and the ability of these countries to increase productivity to competitive standards," says Phillips.

Change within the new member states is ongoing. They must now work to meet strict requirements for entry into the euro zone. The most optimistic timetable for euro adoption among these countries is 2009. Meanwhile, the three remaining EU applicant nations -- Bulgaria, Romania and Turkey -- will struggle to complete entry into the union. Despite these continuing challenges, the May 1 accession marked an important step along the long path toward a very different Europe, a Europe that offers a multitude of business opportunities for U.S. companies that are aware of the possibilities.