After the pandemic revealed the vulnerability of international supply chains, companies in Europe are rethinking their strategies to look at manufacturing destinations closer to home. This is where the Western Balkans comes in: the six EU aspiring states are geographically and culturally close to the Central and West European countries but with considerably lower costs. However, as two recent studies point out, to attract potentially billions of euros in foreign direct investment (FDI), they need to make reforms.
Globalisation had been accelerating from the mid-20th century into the opening decade of the 21st, enabled by developments such as better communications, containerisation and China’s entry to the World Trade Organisation (WTO) in 2001, offering low labour costs, high production capacities and a massive consumer base. The shift of production from developed countries to low-cost overseas destinations was seized upon by the electronics and garment manufacturing sectors in particular, where in recent years vast and complex supply chains have straddled the globe.
But when the pandemic struck, some links in these supply chains were abruptly severed, starting with the closure of factories in Wuhan, known as “Motor City” because of its role in supplying major automakers such as General Motors, Honda Motor, Renault and Toyota, through the spring 2020 lockdowns in Europe and elsewhere. Both automakers and electronics felt further supply-side disruptions in 2021 due to shortages of semiconductor chips, leading to factory closures, including in emerging Europe. Even before that, the growing trade tensions between the US and China had led to speculation about a shift away from globalisation.
"In view of protectionist tendencies in global trade, a shift of production from Asia back to the vicinity of the old industrialised countries already began during the past decade. This phenomenon, known as 'nearshoring', is set to increase significantly in Europe after the experience of the pandemic,” said Branimir Jovanovic, co-author of a report from the Vienna Institute for International Economic Studies (wiiw), "Getting stronger after COVID-19: Nearshoring potential in the Western Balkans”.
It notes that the pandemic “threw global supply chains into disarray, decimating foreign direct investment and generating uncertainty unlike anything since World War II. It is unclear what global production, trade and investment will look like after the pandemic, but it is almost certain that they will look differently [from how they were] in the pre-pandemic world … The disruptions brought by the [coronavirus] COVID-19 pandemic have made companies think about increasing the resilience of their production through supply diversification, shorter supply chains, geographically closer locations, more production at home and increased inventories.”
There are other factors too, as pointed out in a separate study, "Time to move to the Western Balkans: How diversification of global supply chains can benefit EU resilience” published by the Center for International Private Enterprise (CIPE) and the Institute for Democracy “Societas Civilis” – Skopje.
The European Union’s dependence on China for components and finished products renders the bloc vulnerable both politically and economically. “The economic interruptions caused by the COVID-19 crisis have exposed many vulnerabilities of the European supply chain design and raised doubts about current risk practices from a predominantly strategic perspective. Globalised supply chains, single-sourcing strategies, and dependence on sourcing from specific, remote geographical regions such as China have made it difficult for European companies, and consequently governments, to respond to a market disruption with the magnitude of this pandemic,” says the report.
“The pandemic has proved our over-reliance on China for almost everything from face masks to car parts,” said Zoran Nechev, co-author of the report, during an online conference on June 3.
Marie Jelenka Kirchner, the other author of the report, highlighted the EU’s market dependence on China, which is now “increasingly viewed as more of a competitor or a rival than a partner”.
Aside from the practical considerations there is also a values disconnect. The report points out that while in the 1990s and 2000s there was optimism that economic growth would lead to democratisation in China along the lines of other Asian countries, this did not happen. The plight of the Uighur minority in Xinjiang has made this impossible to ignore. On top of this, the report lists the “known lack of labour protection and union organisation and widespread disregard for environmental and product standards”. “How can the EU demand an economy that works for people but not extend that demand for workers’ protections to the European supply chains outside the EU?” queried Kirchner.
Then there is the environmental cost of shipping products around the world and flying executives and compliance officers to faraway manufacturing plants. This will only grow in importance in the coming decades. “The carbon footprint of globalised supply chains is immense and the trade practices of European economies are at odds with EU’s ambitious climate plans,” says the report.
Rethinking supply chains
All this has made rethinking supply chain strategies a pressing need. For EU countries one of the most obvious choices is the six aspiring members of the bloc in the Western Balkans. The wiiw report says: “Near-shoring to countries and regions closer to Western Europe is likely to emerge after the pandemic.” Among the reasons are “not just because of their good geographical locations and competitive wage levels, but also because of ‘soft’ factors such as cultural proximity and the reputation of their workers as skilled and hard-working.”
Between 2010 and 2019 a total of €45bn of FDI entered the six Western Balkans economies, with €23bn going to Serbia. For the region this amounts to 6.1% of GDP, which is higher than the other countries in Central, Eastern and Southeast Europe. This is encouraged by the governments who have set up free economic zones and offered tax holidays and other financial incentives.
The wiiw study cites two surveys of thousands of German companies, showing that many are considering changes to their supply chains or relocation of production. It estimates that even if only a small number follow through with this, billions of dollars in direct investment for the region are possible.
Meanwhile, the CIPE/Societas Civilis report lists further benefits of relocation to the Western Balkans. On a political level, it would create opportunities for the EU to support the Western Balkan countries on their European path, whilst benefitting the EU by reducing its dependence on China. The Western Balkans’ proximity to EU markets makes it easier to carry out inspections to guarantee compliance with European norms and standards, while at the same time cutting the distance for shipments of final products or parts.
“Although localised sourcing might increase manufacturing costs, it offers multiple material benefits in other areas. For example, it reduces the complexity of the supply chains, it minimises lead times, decreases or eliminates tariff costs and reduces the risks for cross-border delays,” adds the report.
When it comes to looking for partners closer to European markets, “The Western Balkans is particularly well positioned to offer nearshoring to most of the investors operating within the EU area that are looking to adopt more balanced distribution and diversification of supply sources and develop means of production closer to consumers,” Tanja Miscevic, deputy secretary general of the Regional Cooperation Council (RCC), told the June 3 conference.
However, this is a region made up of small fragmented markets, and Jovanovic stressed during a webinar to present the wiiw report in May that while economies in the Western Balkans can benefit from nearshoring, they “would have to take the right policy steps in order to benefit fully”.
Noting there had been discussion of nearshoring before the pandemic, Jovanovic said: "Whether this will emerge in the Western Balkans is another question, but generally the Western Balkans is the first choice for West European companies – the region is geographically close, the culture is close and there are relatively low costs compared to other destinations. So the Western Balkans can benefit. Whether they will benefit depends on the availability of skilled labour, governance of institutions and good infrastructure."
He added that governments in the region may have to change their approach to attracting investors: "The Western Balkan economies were trying to attract FDI with a strategy based primarily on low costs, but it turns out that high quality will be more important in the years to come, so they will have to try to change their strategy. If they are to benefit from nearshoring trends in the post pandemic world, they will have to go beyond low wages and low taxes, to address education, infrastructure and governance.”
The issues holding back investment, as identified in the wiiw report, go beyond practical considerations such as the availability of qualified workforce and transport infrastructure, with the study recommending a “fundamental change in the investment environment in addition to addressing long-standing deficits such as poor governance and political instability”. Specifically, Jovanovic said: “Low labour costs and low taxes no longer play the decisive role. Foreign investors need above all a well-qualified workforce and infrastructure.” This implies increased government spending on education, particularly in STEM fields, as well as practical vocational education and training.
Sophia Kluge of the Chamber Partnership Western Balkans told the wiiw webinar that one of the surveys of German companies reveals investors typically do not find the educated workforces they expect. “The quality of education is different from what companies expected, so they have to invest in training and upskilling. The second reason for the lack of available workforce is the brain drain. Companies have no hope this will get better,” she said.
Meanwhile, Tatjana Sterjova Duskovska, secretary general of the WB6 Chamber Investment Forum, outlined the views of investment agencies in the region. They list the geographic location and proximity to the EU, the possibility to obtain free access to some of the key markets, the low level of wages and the political and economic situation in the last 10 to 15 years as the positives from the region. However, she said, the downsides as perceived by the agencies are “first and foremost complex legal and regulatory framework. In addition, there is the need for a digital transformation and work to improve infrastructure, and the chronic problems of corruption and unpredictably.”