INTERNATIONALIZATION OF PRODUCTION: OPTIONS AND RESPONSES. EVIDENCE FROM GERMAN ENTERPRISES IN HUNGARY

AICGS/DaimlerChrysler Working Paper Series

A Publication of the
American Institute for Contemporary German Studies
The Johns Hopkins University




AICGS/DaimlerChrysler Working Paper Series
INTERNATIONALIZATION OF PRODUCTION:
OPTIONS AND RESPONSES.
EVIDENCE FROM GERMAN ENTERPRISES
IN HUNGARY
Michael Fichter






DaimlerChrysler-Fonds im Stifterverband
für die Deutsche Wissenschaft
Research Fellowship Program
2003


Dr. Fichter is a lecturer and researcher at the Institute of Political Science, Freie
Universität Berlin. In addition, he holds the position of executive director of the
Institute’s Center for Labor Studies.

Dr. Fichter can be reached at: mfichter@zedat.fu-berlin.de.

AICGS would like to thank the DaimlerChrysler-Fonds im Stifterverband für die
Deutsche Wissenschaft for funding this AICGS publication as part of DaimlerChrysler
Fellowship Program.

© 2003 by the American Institute for Contemporary German Studies

The views expressed in this publication are those of the author alone. They do not necessarily
reflect views of the American Institute for Contemporary German Studies.

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ABSTRACT

The purpose of this paper is to discuss one of the policy choices being pursued by German
enterprises, choices that affect both the current developments in the German economy as well
as the future structure of the European economy in general. Using empirical data gathered at
some twenty German enterprises that have invested in production facilities in Hungary over
the past decade, the paper will evaluate the impact of this strategy on work organization and
labor relations in the Hungarian subsidiaries and highlight possible ramifications for the
remaining or former German production sites.
The research for this paper analyzed a variety of manufacturing sectors to determine
which elements of the German model of production and labor relations have been selected for
transfer to Hungary, why this particular selection was made, and whether there are clear
indications that certain German foreign direct investments are initiated as either a high-road
(high wage, high skill, high technology) or as a low-road strategy (attraction of the low level
of regulation and low costs).
After a brief look at the German Production Model, the paper reviews the development of
German foreign direct investments (FDI) as they relate to central and eastern Europe and in
particular to Hungary. From there, the paper goes on to illuminate the process of production
relocation at the companies in the sample, i.e. just what has been relocated, how this transfer
is managed, and to what extent it represents a developmental process over time. After this, the
focus will turn to the repercussions of the internationalization of production on the enterprises
in general and at their sites in Germany in particular. By way of conclusion, the paper will
present some arguments tying the micro-level focus to the broader issue of the European
Social Model.

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INTERNATIONALIZATION OF PRODUCTION: OPTIONS AND RESPONSES.
EVIDENCE FROM GERMAN ENTERPRISES IN HUNGARY1


INTRODUCTION ........................................................................................................................ 1
THE GERMAN PRODUCTION MODEL.................................................................................. 3
NEW CHALLENGES SINCE 1989/90 ........................................................................................ 4
INTERNATIONALIZING PRODUCTION AS A STRATEGY FOR REGAINING
COMPETITIVENESS.................................................................................................................. 5
CEE: WHAT IT HAS TO OFFER FOREIGN INVESTORS .................................................... 6
THE CASE OF HUNGARY ............................................................................................................. 7
Hungary’s advantages .............................................................................................................. 7
Hungary’s drawbacks ............................................................................................................... 8
GERMAN ENTERPRISES IN HUNGARY: A REVIEW OF CASE STUDIES ....................... 8
THE INVESTMENT PROCESS ........................................................................................................ 9
EXERCISING CONTROL OVER THE TRANSFER AND THE SUBSIDIARY .......................................... 10
PRODUCTION RELOCATION: ELEMENTS, PROCESSES AND MODELS............................................ 11
PROTECTING THE INVESTMENT. INCREMENTAL DEVELOPMENT ................................................. 14
TRANSFER AND RELOCATION: A BRIEF SUMMARY ................................................................... 16
REVERSE DIFFUSION IN GERMANY .................................................................................. 16
THE EUROPEAN SOCIAL MODEL: QUO VADIS? ............................................................. 18
REFERENCES ........................................................................................................................... 20




1 This paper presents preliminary results of a research project based at the Free University of Berlin and entitled
“Exogenous Influences in Path Dependent Transformation Processes. The Effects of German Foreign Direct
Investments on Work Organization and Labor Relations in Hungary.” My cooperation partners are Christoph
Dörrenbächer (Wissenschaftszentrum Berlin – Science Center Berlin), Laszlo Neumann (National Labor Office,
Budapest) and András Tóth (Academy of Sciences, Budapest). Funding for the project fieldwork has been provided by
the VolkswagenStiftung. I am indebted to the DaimlerChrysler-Fonds im Stifterverband für die Deutsche Wissenschaft
for providing me with a three month fellowship at the American Institute for Contemporary German Studies (AICGS),
Washington D.C. to facilitate the completion of the project. During my stay at the AICGS I was grateful for the
competent support of the staff and the professional critique of other visiting scholars. I am nevertheless solely
responsible for the results.

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INTRODUCTION

The globalization of production and markets along with the political enlargement process of the
EU is reshaping the contours of Europe. Far-reaching changes in technology and information
communication have been further catalyzed by the end of the Cold War and the ensuing process of
transformation in Central and Eastern Europe, buttressed by market liberalization, financial
unification and supranational cooperation within the European Union.
In the course of these developments, Germany, in particular with regard to its renowned export
economy, has undergone profound and fundamental changes. The most prominent of these of
course has been unification, re-establishing a full-fledged German state in the middle of Europe
after almost forty-five years of separation and division along the fault line of the Cold War.
Following that historic moment in November 1989 when the Berlin Wall ceased to exist, the
institutional structures of the West German political system were extended to the new states of what
had been the German Democratic Republic. In contrast to this generally successful transformation
in the political sphere, the task of building a flourishing market economy—the “blühende
Landschaften” envisioned by former Chancellor Helmut Kohl—has been both much more difficult
and decidedly less successful. Indeed, unemployment is still exceedingly high (and would be higher
save the fact that there is a continuous stream of young people from East to West) and there is a
high level of dependency upon continuing and massive public subsidies for the unemployed and for
infrastructural measures, without which the economy in the East would suffer a serious blow.
One indication of the problems faced in eastern Germany is the fact that production firms in
western Germany have not been keen on investing there. Either they are servicing the domestic
market in eastern Germany from their existing locations or they have decided to expand by focusing
new investments outside of Germany altogether. This points not only to the development of a new
competitive arena in Central and Eastern Europe, offering a wider range of opportunities and
conditions for investments from which to choose, but also to the more general impact of the flash-
like exposure of the German economy to the forces of globalization and technological change. Of
course, as one of the leading exporting countries in the world, West Germany was not insulated
from the international economy prior to 1989. But in the Europe of the “mid-century social
compromise” (Crouch 1999: 34), West Germany had developed a protective regulatory shield
designed to ensure prosperity to a maximum number of citizens (at least as defined by their
economic status) in a society of institutionalized negotiated interest representation. The end of the
bloc confrontation was not solely responsible for the changes, but it was an important catalyst
which both hastened and accelerated the weakening of the consensual regulatory regime, known in
its economic context as the German Production Model.
The purpose of this paper is to discuss one of the policy choices being pursued by German
enterprises that is affecting both the current developments in the German economy as well as the
future structure of the European economy in general. Using Hungary as an example, the paper will
analyze the process of foreign direct investment and production relocation as pursued by German
manufacturers in Central and Eastern Europe (CEE), evaluating its impact on work organization and
labor relations in their Hungarian subsidiaries.
Foreign investments are profoundly shaping the course of the Hungarian economy. Besides such
large investors as Audi (4,000 employees) or Siemens (3,200 employees) there are many small and
medium sized German companies with investments in Hungary. Enterprises from Germany are key
actors in the Hungarian economy not only because they account for about one-half of all foreign
direct investments, but also by virtue of their home country production model with a high wage-
high skill profile and their commitment to consensual forms of conflict resolution. Thus, looking at
German enterprises and the transfer of the German production model to Hungary seems to be an
interesting case for explaining changes emanating from a particular home country model. With the
focus on German enterprises we seek to explain far-reaching developments at the micro-level
(enterprise) that are having a considerable impact on the development of work organization and
labor relations. We regard this level as being crucial to economic restructuring throughout central

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and eastern Europe. Moreover, in the Hungarian context of a weak state regulatory framework and a
fragmented labor movement (Neumann 2000, 2002), the scope of structuring capacity at the
enterprise level is especially noticeable. Nevertheless, processes at the micro-level have been
largely ignored in the research on transformation and EU enlargement.
In its research design, our project looks at a variety of manufacturing sectors to determine which
elements of the German model of production and labor relations have been selected for transfer to
Hungary, why this particular selection was made, and whether there are clear indications that
certain German foreign direct investments are initiated as either a high-road (high wage, high skill,
high technology) or as a low-road strategy (attraction of the low level of regulation and low costs).
In general, research on developments in central and eastern Europe has not adequately dealt
with the phenomenon of exogenous influences on the transformation process. Although we do not
subscribe to transformation theories that support a “capitalism by design,” we also question the
validity of ascribing all political, economic and social developments to path dependency. Rather, we
postulate—and are endeavoring to empirically define and verify—a process of hybridization as the
exogenous influence of foreign investment interacts with host country transformation processes. By
this we mean that both the host country environment with its path dependent influence and a set of
powerful impulses from external sources outside of Hungary are pushing the country towards a
European style environment which admittedly, as yet, can only be rudimentarily defined.
A key determinant of how that environment may be evolving is the relationship between foreign
investment and the host country context. In the Hungarian case, our hypothesis is that foreign
investors are moving into what we call a permissive institutional environment. By this we mean that
the institutional setting is generally weak, that it is lacking in sufficient capacity for conflict
resolution and that it is far from being consolidated. Trade unions, for example, are rather
powerless, fueling their propensity to accept whatever cooperative arrangements management
offers. In this position they have yet to find a new role commensurate with their independent status
as representatives of workers’ interests. The decentralized nature of industrial relations
arrangements, we believe, facilitates the introduction of production regimes specifically tailored to
management’s goals and practices.
Whether the primary direction is generally tending toward higher standards or whether it signals
a low road production model similar to a Central American style maquiladora economy is still an
open issue. There are cases in which the German investor is clearly striving to rapidly upgrade
standards in line with production techniques and employee relations policies at other sites within the
enterprise. Such a strategy certainly reflects the characteristics generally associated with the
German model of production and labor relations. At the same time, other German investors are
taking a different approach. What kind of production regime develops after an initial investment is
dependent on a variety of factors, not the least of which is the dimension of market success.
Maintaining or expanding the initial investment over time could induce changes in production
organization or product lines based on positive learning experiences and the overall increase of
know-how and qualifications among employees. In following such an upgrading path, the investor
would be departing from the initial “low road” strategy and perceivably have a radiating influence
extending beyond the immediate workplace environment to the local political and economic
community. Such a development must be reinforced by measures emanating from the host
environment and by the creation of a constructively regulative and participatory social framework.
The outcome of the exogenous-endogenous interaction at the micro-level will be vastly different in
a permissive institutional environment than in a local environment marked by social regulation and
thriving trade unions, anchored in a stable and strong institutional framework. Successful
production models contribute to increasing productivity and in turn to rising income and wealth.
Economic prosperity, it may be argued, helps build public support for the newly democratized
political and economic system.
This paper uses Hungary as a model of these developments to find answers to a variety of
questions: How have German companies reacted to the impact of the demise of the Soviet bloc and
the restructuring of the political, economic, and social framework of Europe since 1990? What has

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drawn German investments to Hungary? What has constituted a successful investment policy and
how have the more successful investment strategies differed from the less successful ones? What
repercussions do production relocation and enterprise restructuring resulting from investments in
Hungary have on such firm-specific issues as product development and research, employment
policies, work organization, labor relations or internal enterprise communication and cooperation?
After a brief look at the German Production Model, I will review the development of German
foreign direct investments (FDI) as they relate to CEE and Hungary. From there, the paper will go
on to illuminate the process of production relocation at the companies of our case studies2, i.e. just
what is relocated, how it is managed, and to what extent it represents a developmental process.
After this, the focus will turn to the repercussions of the internationalization of production on the
enterprises in general and at their sites in Germany in particular. By way of conclusion, the paper
will present some arguments tying the micro-level focus to the broader issue of the European Social
Model.
THE GERMAN PRODUCTION MODEL

Without going too deeply into its history (c.f. Lehmbruch 2001), it is important to recognize that
what came to be called the German Production Model in the 1980’s is the result of some thirty years
of political and economic development and struggle, which gave it a distinctive institutional
structure. Soskice (1999) has referred to Germany as being a “coordinated market economy” and
Lehmbruch uses the term “socially embedded capitalism” (2001: 47) to describe the model. For his
part, Wolfgang Streeck has provided us with an extensive analytical description of the "highly
institutionally coordinated, … politically negotiated and typically legally constitutionalized"
German political economy. (Streeck 1997: 36)3 Features of the institutional framework that are
common to all of these characterizations are summed up succinctly by Flecker and Schulten:

Accordingly, the model consists of the following main parts: “social market
economy” (soziale Marktwirtschaft), that is, capitalism tamed by political macro-
regulation and redistribution of income by the state; long-term perspectives and a
preference for productive investment on the part of capital; highly organized
industrial relations combining sectoral multi-employer bargaining and cooperative
labour relations within the enterprise; a vocational training system that combines on-
the-job training with education in vocational schools; and diversified quality
production4 based on highly skilled workforces. (1999:83)

This combination of two subsystems (Wood et. al. 1975: 296f.), represented by the coupling of
a particular high skill-high wage production system with an industrial relations system that
promotes the drive for higher productivity and quality, has been categorized as a high road strategy.
It contrasts diametrically to less institutionalized systems of labor relations and strategies that are

2 Work on the project commenced in June 2000. An initial phase of refining the research design and information
input created a project database of ca. 135 enterprises representing over 50 percent of all employment at German
manufacturing subsidiaries in Hungary in 1998. From this, we produced a general structural profile of German
investments based on a matrix of relevant variables that were used to select enterprises to be approached with a request
for interviews. From the responses to this first wave of inquiries, some twenty enterprises from a number of different
economic sectors were selected for general interviews with top-level management representatives at enterprise locations
in both Germany and Hungary. The intention was to deepen our understanding of the investment in general, of the
production transfer process and development strategy as well as of the role of the Hungarian subsidiary in the overall
business strategy of the company. On the basis of these interviews a further selection process was initiated. Five
enterprises were selected for in-depth case studies. The field work on these has been completed and the final project
report is in the process of being drafted.
3 He goes on to explain the role of “politically instituted and socially regulated” markets, of firms as “social
institutions” in which labor and capital (universal banks) have institutionalized roles, of the “enabling” role of a state
with “vertically and horizontally fragmented sovereignty,” of “publicly enabled associations” and an economic culture
with a preference for quality. (37-40)
4 For more on diversified quality production, see Sorge/Streeck 1988.

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geared solely to price competition (low road strategy). As Kern and Sabel have noted, the high road
is based on “the strategy of a specific German combination of product perfection, flexible process
automatisation, intelligent work organization and consensual regulation.” (quoted in Berndt 2001:
13) Under the high road strategy, the short term cutting of labor costs is both rather difficult and
costly, both as a result of investments in human capital and machinery and of the organizational
status rights of labor (codetermination). (Jackson 2001)
While the model is certainly useful in providing a structuring instrument for general, macro-
level analysis, its validity at the enterprise level has certain limits. For one, the applicability of the
model may vary in detail across the various sectors of the economy, depending on such factors as
the numbers and sizes of enterprises, the extent to which they are export-oriented, and the
organizational density of trade unions and employers’ associations. Secondly, the question has been
raised as to the actual practice of the model beyond the realm of the large stock corporations, for
example, whether all of the elements of the model are “in place” and functioning in small and
medium-sized enterprises (SME), which make up the bulk of the enterprises in Germany. As we
have ascertained in our project, in which our case studies comprise a number of SME’s that are
generally (still) privately owned and operated, there are some important modifications to the model.
SME’s have a more personalized style of human resource management and labor relations and the
works councils usually have a weaker role (see also Wassermann 1992). SME’s also generally
depend heavily on large customers, not only for volume output but as regards their pricing, their
technological standards and their product development as well. This kind of dependency is not
generally recognized as an element of the model, and yet it has a profound impact on the business
strategies of such enterprises.

NEW CHALLENGES SINCE 1989/90

The current pressure on the model also provides the backdrop for a further issue relating to its
future. It has always been postulated that the model has a particularly effective regulatory impact on
the system of labor relations and that the system of labor relations is an integral part of the model.
For one, the German brand of bank involvement in corporate governance and the adherence to strict
monetary policies sets definitive limits for collective bargaining. (Vitols 2001) Through the dual
structure of sectoral wage bargaining by employers’ associations and trade unions on the one hand
and legally anchored and independent works councils at the workplace on the other, the system
keeps conflicts over wages more or less out of the bargaining arena of the workplace while at the
same time allowing works councils to exert some influence on employment conditions via
information, consultation, and codetermination rights.
The political, economic and social changes that have been impacting the German economy over
the past decade or more have made inroads on the functionality of these institutional structures.
Whether the system of labor relations has been undergoing a process of “erosion” or whether the
noticeable changes are better understood as a restructuring is a subject of intense academic debate.
In either case, it is generally agreed that there has been accelerated change and that the major actors
–employers’ associations and trade unions—are under growing pressure to find ways to re-establish
the effectiveness of the model. (Dörre 2001; Hassel 1999; Hoffmann/Jacobi/ Weiss 1998;
Kern/Schumann 1998)
Under globalization pressures, enterprises have devised new business strategies of innovation,
product and market diversification, cost reduction and increased productivity using the established
institutional mechanisms. At the same time, globalization has also opened the way for expanding,
transferring, and relocating beyond the home country borders. While Abraham and Konings (1999:
591) concluded from their study that only a small minority of firms (12 percent) opted for
“delocalisation” as “one possible strategic response to increased competition,” the socio-economic
ramifications of such a response extend beyond the immediate operating range of the single
enterprise. In this case, the question is what happens to the institutional embeddedness of
enterprises when they invest in production sites abroad? This is an issue that has been written about

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in connection with investments throughout the EU (Muller-Camen/Tempel 2001; Bélanger 1999) as
well as in regard to German investments in other EU countries (for example, Ferner/Varul 2000),
but there is still little research available in regard to CEE (see Dörr/Kessel 1999; Dörrenbächer
2002; Kluge/Voss 2003; Tóth 1999). As such, it is highly interesting that with the exception of the
one “global player” in our sample, a transfer of the German system of labor relations as an integral
part of the production model has not taken place at our case studies.
The reasons for this are many and varied and will be discussed in full in the course of the paper.
What is important to note at this point, however, is that the internationalization process and the
cross-border transfer of the German production model is not restricted to only the recognizable
multinationals. In today’s world, it encompasses enterprises of all sizes. Among the strategies
pursued to enhance competitiveness, going international with production appears to be widely
regarded as a matter of necessity, a “natural” reaction to factors pushing enterprises to make a
selective departure from the embeddedness of their institutionalized home country environment in
the hopes of staying competitive with lower production costs while maintaining productivity and
quality levels. This is a development which has been enhanced by the opening of CEE to foreign
investments and by the advantages which new technologies offer in managing decentralized
business operations, in communicating, storing and retrieving information, and in transporting
goods across borders and over greater distances. The restructuring and internationalization of
product and supplier markets has opened the way for SME’s as well as MNE’s as foreign investors
to take advantage of the host country opportunities because of their better access to capital or to a
technology unavailable to local firms, but also through the opportunity of a multi-locational
operation or “fragmentation.” (Brown/Deardorff/Stearn 2002: 24f.)

INTERNATIONALIZING PRODUCTION AS A STRATEGY
FOR REGAINING COMPETITIVENESS

The opening of CEE presented enterprises—especially those from the EU—with an enormous
opportunity to strengthen their competitiveness and establish themselves in new markets. As one
observer has summed it up,

… the opening up of CEECs brings together economies characterised by large wage
differentials. This offers EU firms an alternative production base, something which
comes at a particularly appropriate moment during a period of heightened world-
wide competition. From a Western perspective, CEECs’ comparative advantage in
labour-intensive goods is associated with proximity, thus enabling Western firms to
take advantage of lower production costs in their immediate vicinity. (Pellegrin
2001: 5)

The relationship of these various factors to each other will be discussed more fully below in
regard to our case studies. But as a general orientation on this point, suffice it to say that decisions
by enterprises from the EU on new business activities in CEE are affected by both “push” and
“pull” factors. On the “push” side of the equation are the highly developed and, especially in the
case of Germany, highly regulated economies of western Europe which are going through processes
of adjustment (i.e. deregulation, globalization, technological change); on the “pull” side are the
transitional CEE countries which offer certain advantages. Among the most sought-after are new
markets, reduced production (labor) costs, and a lower level of state regulations and taxes.
In the literature on the internationalization of business, attention is focused on trade and FDI as
the primary instruments firms use to extend their business activity to a new region. But in the case
of EU enterprises and the CEE countries in the 1990s, normal trade relations were not necessarily a
viable option. In many sectors, the CEE countries lacked developed markets for industrial products
from the West. Secondly, the “push” problems faced by EU enterprises fostered the need for more

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binding arrangements and involvement in production development, such as contract production,
licensing, joint ventures or ownership.
With its program “outward processing traffic” (OPT), the European Commission found a way to
meet these needs without relinquishing trade as an economic instrument. The OPT regulations
relaxed restrictions (tariffs, quotas) on a variety of goods (especially labor-intensive) produced in
the CEE countries and allowed them to be imported. For such goods to qualify under this program
they had to be manufactured in the CEE region by local producers under contract to enterprises
from EU member countries, which supplied the materials and, in some cases, even the machines
and the transportation. The host firm was responsible only for providing the labor (passive job
processing) and meeting the production date. OPT arrangements enabled EU firms to “re-import”
manufactured articles against which EU restrictions discriminate when their source is a non-OPT
producer in CEE. (Pellegrin 2001: 34)
Hungary provides a good example of the importance of OPT during the first decade of
transformation. In 1993, 20 percent of its exports to the EU resulted from OPT arrangements. As
trade volume with the EU grew by 25 percent between 1993 and 1998, the OPT portion fell to
around 7 percent, a trend which Pellegrin attributes to a statistical effect (34), to increased trade as
EU restrictions are relaxed, and to a transformation of OPT relationships into ones of capital
investment. (Pellegrin 2001: 63f.)
In particular, German enterprises have approached the opening of CEE as a strategic answer to
the growing challenges to the production model, especially since the end of the bloc confrontation
in Europe. Not surprisingly, the statistics show that German enterprises have been far more likely
than their competitors from other EU countries to take advantage of OPT regulations, and that in
Hungary, for example, “the German share in EU OPT is 80 percent, whereas the German share in
FDI ranges between 40 per cent and 45 percent” (Pellegrin 2001: 15), which is still much larger
than the share of any other country.5
Indeed, the statistical record shows a similar dominant position taken by German enterprises
with regard to FDI in all CEE countries. Not only is there a very high level of German FDI in
absolute terms, but compared to the investments of the United States and other EU members, there
is a noticeably disproportionate regional concentration of German foreign investments in CEE.
Estrin, Hughes and Todd (1997: 45ff.) explain this to be primarily a result of geographic proximity,
historical ties, language (German) affinity, and labor cost differentials. Again, Hungary is a good
example of this predominance: In 1998, for example, “40 percent of foreign capital invested in new
foreign undertakings came from Germany, 15 per cent from France …” (Hungarian Ministry of
Economic Affairs 1999)

CEE: WHAT IT HAS TO OFFER FOREIGN INVESTORS

Such statistics point to the fact that since the end of the Cold War, central and eastern Europe
has been in a particularly strong “pulling” position regarding foreign investments. As reported by
UNCTAD, FDI flows have continuously grown in the region. Between 1993 and 1997, overall FDI
increased by 28.5 percent per year. While the distribution among the countries was quite uneven,
with Poland, Hungary and the Czech Republic accounting for the lion’s share, all of the CEE
countries showed a high level of investment in manufacturing. Of interest as well is the fact that the
EU continues to account for most FDI flows into CEE. (Dörrenbächer et.al. 2000: 437)
Several factors may be highlighted as contributing to the investment drawing power of the CEE
region. One is its geographical proximity to the EU, an advantage valued in particular by small and
medium sized enterprises and by those firms making their first foreign investment (Meyer 1998: 85)
as a means of “testing the waters.” The CEE region has also offered firms low wage levels:

5 Pellegrin’s assumption from the statistical difference between the German shares of OPT and FDI in Hungary that
Germans prefer OPT to FDI is debatable, but the issue will not be pursued here further.

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Wherever the gap in labour costs is particularly wide, as between the industrialised
and the developing countries (“North-South”), but also within the same (large)
country, and increasingly between Eastern and Western Europe, the question arises
how relevant low labour costs are in locational decisions. With capital and
technology increasingly mobile internationally, differences in the cost and the
quality of (immobile productions factors such as) labour can be expected to weigh
heavily in locational decisions, provided labour is used productively and labour costs
make up a significant portion of total cost. Where this is the case, as in clothing or
footwear among others, the attractiveness of low labour cost areas is likely to be
irresistible. Where automation is technically impossible there is a strong financial
incentive for the labour-intensive activity to move to or remain in a low labour cost
area. (van Liemt 1992: 313)

Of additional importance for manufacturing investors is the relatively high skill level and
industrial production experience of the workforces in some of the CEE countries,6 which enables
them to set up subsidiaries to produce for the world market. Winters and Wang (1994) even place
the level of skills and educational achievement above that of Southern Europe. They conclude from
this that the CEECs have the potential to become a producer of sophisticated industrial goods. A
certain (European) cultural affinity seems also to serve as a drawing card. Finally, the CEE
countries have devised a broad range of programs, including investment subsidies and tax breaks, to
bring in investors.

The case of Hungary
Hungary’s advantages
There are a variety of reasons why German enterprises regard Hungary as a preferential host
country for investment. Among its particular “pull” factors, Hastenberg (1999: 64-66) refers to
Hungary’s reputation for having a fairly unorthodox economic policy (“goulash communism”),
which, together with FDI-conducive legislation, was a seedbed for the post-1989 privatization
policy aimed at attracting western capital7. Historical links (German speaking population) and
geographical proximity have also been conducive to German investment. But Hungary was also
preferred because its proximity had an impact on costs, flexibility and delivery time. According to a
summary of the literature presented by Estrin, Hughes and Todd (1997: 13), “factor cost incentives,
and in particular lower labor costs, are found to be more important [than new market entry – MF]
for small firms and firms from neighboring countries such as Germany and Austria. German firms
also appear to use outward processing contracts relatively more frequently, so as to exploit the
differential with domestic costs of production.”
Surveys conducted by the Deutsch-Ungarische Industrie- und Handelskammer among its
membership (see Table 1, p. 10) show new market entry to have been the strongest motive overall
as measured by the number of firms that chose this option. Low labor costs, at least through 1999,
was a further leading motivation. In another study, these two motives were disaggregated along
sectoral lines, showing that cost reduction outweighs market entry as a preference on the part of
manufacturers, while for commercial investors, the preferences are the other way around.
(Hastenberg 1999: 67, 90) In the early years of the transformation process in CEE, investors also
gave high priority to the stable political and economic environment that Hungary represented. More
recently, this has come to be expected and as such, less important for an investment decision.
Further motives reported by the DUIHK surveys were geographical proximity and the presence
of a highly skilled and industrially experienced labor force. (DUIHK 2000: 128) Finally, among
other advantages that investors attributed to Hungary are the favorable tax and investment

6 Not surprisingly, there is a strong correlation between the level of FDI and the skill level of the work force. Those
countries with sizeable amounts of FDI are also those with the most highly skilled workforces.
7 Hungary had accrued a sizeable foreign debt by 1989 and was therefore highly interested in acquiring hard
currency.

7

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