Crunch Time On The Continent

To compete with Eastern Europe and China, reform is essential

The economic walls that Old Europe has spent the last half-century building around itself are finally starting to crumble. But American interlopers and burgeoning Chinese competitors aren't leading this assault against high wages and short workweeks. No, change is being forced by the rapid growth of Europe's formerly communist cousins to the East -- the very nations Europe wooed into its economic union. Ironically, that integration has set in motion a cycle of events that now threatens to jar the very nature of work, life, and investment across the Continent.

Nowhere is that more apparent than in the automobile industry, Europe's premier manufacturing sector. Major carmakers, such as PSA Peugeot Citroën, General Motors' (GM ) Adam Opel unit, and Japan's Toyota Motor (TM ) have been eagerly building plants in Eastern European locales such as Slovakia, the Czech Republic, even Romania -- the farther east the better. The reasons are simple: Labor costs at a Volkswagen plant in Germany are close to $50 an hour for a 28-hour workweek, while equally skilled counterparts at VW's new plant in Bratislava, Slovakia, cost the company only $6 an hour and work a 40-hour week. You do the math. Moreover, work-rule changes can be implemented literally overnight at the Slovakian plant, compared with the months it takes VW managers to maneuver the sclerotic negotiating process back home.

If projections that, eventually, up to 60% of the Continent's total automobile assembly and parts production could shift east are even halfway realistic, there are big changes ahead. First, the social compact that has allowed workers in countries such as Germany and France to earn some of the highest wages -- and suffer some of the highest unemployment rates -- in the West probably won't be sustainable. To compete with lower-cost EU competitors, European economies must be remade more in the mold of Britain and Ireland -- flexible systems with fewer worker protections. Next, the cozy political relationships between management and labor in countries such as Germany are likely to unravel as their economic interests diverge. There are already signs that this political roiling has begun: Recent German ruling party losses in regional elections were due in part to fears that nations in the East threaten the established European order.

To be sure, traditional Europe will not be the only place that changes. Eastern nations such as Poland, Hungary, and the Czech Republic, flush with new jobs and investment by their Continental brethren, could also start to see their domestic costs rise. That means the stark advantages they enjoy today could be temporary -- especially if Old Europe moves quickly to reduce worker protections or lower taxes. But the East's abundance of cheap land, an eager and educated workforce, and modern car plants mean it should retain a huge advantage for at least a decade.

Europeans have another incentive to get serious about lowering their carmaking costs: China. The Asian giant has become the latest magnet for global auto makers. And several, including Honda Motor Co. (HMC ), have big plans to build on the mainland for export to Europe. The first of these China-built models hit the Continent this year, with large numbers arriving later in the decade. That doesn't give European manufacturers, unions, or governments much time to prepare for competition from the world's premier low-cost manufacturing locale. That's why their ability to quickly adjust to the Eastern threat is so critical. This is only the beginning.

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