Expanding Through the Service Sector: How Spain and Others Can Remain Competitive
Both Europe and the United States are suffering as major multinationals relocate their production facilities to Eastern Europe and Asia, where costs are much lower. The countries most affected by this trend view it as a menace. One such example is Spain, which now faces the challenge of redesigning its business structure in order to retain its competitiveness. Spain and other countries, however, should look to the service revolution, along with increased specialization in higher value-added products, to revitalize their economies.
Already, the European Union (EU) has recognized that when giant multinationals escape to Eastern Europe and Asia, it’s a one-way trip. That will be especially true after May 1 when the 15 current members of the EU take in 10 new members. The new member-states will add about 20% to the EU, both in terms of size and population, but they will add only 6% to the EU’s total economic output. Nevertheless, the governments of the new member-states have already started up campaigns to attract production plants by providing tax benefits and incentives for investments that create new jobs.
According to Jaume Valls, professor of management and product design at the Universityof Gerona, “every country in Europe is going to be affected by this trend. Its proponents justify this approach,” he adds, “by the lower costs that are associated with relocation and production strategies that have a global dimension.”
Spain: Two Faces of the Same Coin
Spain is one of those countries suffering the most from corporate relocation. In recent years, there has been no let up in the steady flow of multinationals that have decided to relocate production plants from Spain. A recent case is Samsung, the Korean multinational, which announced that it is packing its bags, and relocating to Slovakia and China. Samsung’s goals are the same as those expressed earlier by Philips and Bayer – lower costs and concentration of production in fewer plants. According to a study by Mercer Management Consulting, relocating production into developing countries allows manufacturers to cut their labor costs by 10%.
Ironically, these are the same advantages Spain enjoyed more than a decade ago when it went about attracting investments that managed to boost the country’s economy. But, as Benito Arruñada, business professor at PompeuFabraUniversity notes, investing has changed. Nowadays, the most developed countries must redesign their own structure if they are to compete in new markets. It’s the only way they can avoid getting bogged down by making products that use cheap labor but are not highly specialized.
“Current conditions associated with expansion of the European Union affect, above all, those countries that have costs similar to Spain’s. Those other European countries that have even higher costs (than Spain) already suffered through a similar process in their day. That process benefited Spain after it joined the European Union,” explains Arruñada. For example, Germany and France learned how to build an economic future that is based on intellectual capital and services, and allows low-cost manufacturers to leave, if they wish. Moreover, the most important companies in those countries – such as automakers Volkswagen (Germany) and Renault (France) – maintain their corporate headquarters within their native country, even though they have relocated part of their production in other countries.
For Arruñada, it is a mistake to think multinationals are doing nothing but moving to lower-cost countries. “They are getting out of some business activities and into others. The very same industrial multinationals are expanding their design centers in Spain, and the largest global consulting firms have set up important international service centers here. The inward and outward flows are two sides of the same coin; the process must be viewed in its entirety. The reason why capital flows are both coming and going is Spain’s success. Spain has become one of the richest and most productive countries in the world. This success means that our comparative advantage no longer lies in traditional manufacturing. Our advantage is now in designing, financing, selling, insuring, managing, educating, and realizing many other activites that require more advanced training, and pay much better rewards.”
According to Mauro Guillén, a management professor at Wharton, “many industrialized countries are moving away from manufacturing. Globalization, the rapid rise of the Asian economies, and now Eastern Europe’s entry into the EU, are accelerating the relocation process in many industrial sectors. It is the law of the marketplace, up to a certain point. Beyond low labor costs, the cost of outsourcing some expenses (such as environmental protection and worker safety) is very low; artificially low in some countries. As a result, countries that are threatened have two options. They can – and must – combine both. First, they must invest in human capital, and in infrastructure that makes their country more attractive for manufacturing goods that have higher value-added. In other words, they have to make more expensive things, and let other people make the junk. Second, they have to facilitate their transition into services. For example, instead of making video recorders, they have to create the laboratories that design them, or manage how they are marketed.”
The auto industry and electronics will be most affected by this change in direction. According to Guillén, this also includes a wide range of “assembly industries, such as auto parts, electronics, machinery, furniture, and toys. However, I don’t think that firms engaged in continuous processing will be affected – such as petroleum, chemicals, metals, cement or glass.”
Valls would like to see Spain shielded from multinational flight “with industrial activities and industrial plants that have greater value added, and technology based on R&D. Companies such as HP in Sant Cugat (near Barcelona, Spain), which has more than 100 engineers, will not leave [Spain] so easily.” Nevertheless, Valls doubts that Spain, where R&D levels amount to a scant 1% of the Gross Domestic Product, “can count on matching the efforts of other European countries when it comes to industrial policies and programs that help competitiveness and innovation.”
“Most likely, the most affected sector will be manufacturers that make intensive use of relatively few qualified workers, such as agricultural products where we don’t have any important natural advantages,” adds Arruñada. “In the short term, the impact will be seen in those areas where there is a lower level of fixed investment. Longer term, the impact will also be felt in sectors such as automobiles, where it takes a longer time to recover the cost of investment. In many sectors, there may still be some margin for flexibility. If companies take advantage of it, they can delay the process, at least in some types of manufacturing. However, achieving that goal requires greater flexibility and more willingness to retrain workers than companies have shown until now. In this respect, the (Spanish) government has a responsibility to send a clear signal to executives and workers. No one should expect subsidies and tariffs that conceal a lack of competitiveness. Recent vacillations in European economic policy have squandered a good opportunity in that regard.
“Government doesn’t know where [Spain’s] comparative advantages are. As a result, it cannot guide these processes,” Arruñada adds. “Moreover, government often becomes a captive of private interests, as well as the latest craze. It gets excited about prestigious activities, like some research projects that don’t deserve attention, no matter how prestigious they look. For all that, government and its gurus would never have devoted any attention to the most ordinary activities that have now become our great industrial success stories. Not only civil engineering, infrastructure management, and textile design – in which we are now world leaders – but also other high-growth sectors that are more fragmented. These areas include the glazed tile industry in Spain’s eastern provinces, agriculture in Almería and the cluster of service firms in Madrid.”
Another possible improvement, Arruñada says, would be “to eliminate remaining barriers to importing products from Asia. That way, manufacturing those products can take place in Asia. As a result, we could buy those products at global prices that are much lower than what we pay now, and what we’ll continue to pay if these products are still made in Europe. All you have to do is compare European prices and American prices (even before the rise of the euro) to see that European producers enjoy a high degree of protection. This protection is even greater in agriculture, where it impedes development of the poorest countries.”
The United States is hardly immune to this problem. Alarms bells rang recently when Levi Strauss, the multinational apparel maker, decided to close its American production centers for sewing and finishing jeans. The company has admitted that it will subcontract that production to Chinese, Indian and Mexican companies in order to cut costs. IBM, the computer giant, has already announced plans to move 3,000 white-collar jobs offshore. In the United States, a programmer costs twice as much as his equivalent in China who has the same training and productivity.
To avoid suffering a massive exodus of manufacturing, the wealthiest countries must also try to exploit ties that derive from geography and training. According to an article published by Expansión, the leading Spanish business newspaper, Ireland and Mexico provide two examples of how countries can use that approach to boost their economies. In the case of Mexico, the government is well aware that industrial growth in that country is closely tied to American industrial expansion, so the Mexican government promoted the arrival of American and European factories in the state of Nuevo León, along the border with Texas. From there, companies made the leap into the United States. To add value to that approach, authorities in Monterrey, capital of Nuevo León, took advantage of the links between businesses in the two countries to strengthen, as well, ties between universities on both sides of the border. Their base of operations was the prestigious Universityof Monterrey.
The foundations of Ireland’s success were laid at the end of the last decade by using a policy of fiscal incentives that made it more attractive for manufacturers to set up factories there. To avoid losing its competitiveness, Ireland’s government has been focusing lately on raising the country’s standards of professional training. It has also devoted more of its investment resources to R & D, and moved deeper into new information technologies. Ireland’s goal is to continue to be an attractive country for large multinationals.
In pursuing this approach, Ireland is trying to gain ground on Eastern European countries that base their appeal on lower labor costs and fiscal incentives. While Italy, Spain and Germany impose a corporate income tax of above 30%, the tax in Hungary is a mere 16%. In Poland, the tax is an attractive 22%, according to Expansión. Beyond that, the upstart competitors continue to dream up new ways to win over the multinationals. Take, for example, Seat, an automaker belonging to the Volkswagen group. Seat’s arrival in Slovakia will be totally tax-free until 2008.
To head off similar relocations, some companies are asking their employees to take a more flexible approach. If workers agree, the companies will back down on their relocation strategy. One such case is Nissan, the Japanese automaker. To remain competitive, Nissan wants to cut 600 jobs, or 23% of its labor force in Catalonia (Spain). It also wants to freeze salaries and increase work hours. Moreover, Nissan, which has announced that it will close its Madrid facilities in 2006, has already issued this warning: If it isn’t productive enough to turn out 150,000 vehicles in Spain in 2007 (compared with 70,000 in 2002), the job cuts could affect as many as 900 workers.