Industrial specialization patterns in the EU with focus on Central and Eastern Europe

¶ … Industrial Structure and Specialization of the EU:

Central and Eastern Europe

In contrast to the past, today's globalization is distinctive as a micro-phenomenon that enables production integration and networking and, as such, creates deep international integration at firm level. There are high expectations that EU enlargement will lead to deep integration of central and eastern Europe (CEE) into pan-European industrial networks. It is certain that the extent and nature of the linkages that emerge between the east and the west of Europe will strongly shape the competitive dynamics and industrial development not only in CEE, but also in individual sectors in the EU. However, whether east-west industrial networks will act to improve the growth prospects of the enlarged EU or whether they will deepen the differences in levels of development and undermine the prospects for more balanced growth is an open issue. Significant dynamic economic benefits have accrued to both the new and the incumbent Member States, which are associated with reforms and greater specialization across a market of 500 million consumers (Sergi, et al. 2007).

Concepts and research questions

There are several concepts that inform our comparative analysis and which we explain briefly. Each of the concepts raises respective research questions, which we try to answer in subsequent sections of the paper.

First, deep or industrial integration includes production and technology integration. Production integration refers to value chain linkages and can be described through buyer-supplier relationships and involves flows of products, parts and materials. Technological integration is the integration of domestic enterprises into a dynamic learning process with foreign partners whereby they become involved as active contributors and recipients in the production of knowledge for generating technical change (Radosevic 1999a, b). We want to find out whether the surveyed companies have been integrated at the level of technological integration or only at the level of production integration.

Second, any firm has three basic strategic choices for growth: to (a) undertake generic expansion, (b) conduct mergers and acquisitions (M&A) and/or (c) develop inter-organizational relationships, that is, networks (Timmer, et al. 2007). Networks help overcome a firm's problem of having insufficient resources to accommodate growth, while avoiding the substantial bureaucratic costs of internalizing operations (Foster & Stehrer, 2007). In the period of post-socialist transition, deficiencies in resources have pushed firms to pursue a network strategy. This internal pressure driven by resource deficiencies matched a broader change in production systems towards fragmented value chains (Stehrer, 2005). For example, in electronics, domestic firms with developed production capabilities were able to meet the requirements of own equipment manufacture (OEM) and contract manufacturers, which were diversifying supply bases (Timmer, et al. 2007).

Third, from a network perspective the biggest problems for post-socialist firms are system integration at product level and process integration at firm level. Production and continuous improvement require integration of different functions (finance, R&D, engineering, procurement, production, sales) whose integration is essential to innovation dynamics. Hence, system integration at product level or the capability to integrate different functions is essential for firms to cooperate in networks. The more developed a firm's range of business functions the better is its position in global (regional) value chains (Peneder, 2004).

Production and innovation have to be organized across several tiers of suppliers which are all involved to different degrees, not only in production, but also in innovation. Hence, process integration at firm level is essential to participate in global networks. Firms called 'network organizers' are those that are able to organize local supply chains (Stehrer, 2005).

Socialist firms were only production, not business organizations. This explains why post-socialist firms are the weakest in these two types of capabilities, which require strong connection capabilities. Peneder (2007), defines connection capabilities as the skills desirable to broadcast information, skills and knowledge to, and collect them from, module or raw material contractors, subcontractors, advisors, service firms and knowledge institutions. We want to find out if firms have overcome weaknesses in system integration at product level and process integration at firm level and how strong their linkage capabilities are. These capabilities are essential for CEE firms to be active in the process of network alignment, that is, in plugging themselves in at different stages and levels (functions) of value chains (Peneder, 2004).

Fourth, the key driving mechanisms of network alignment are complementarities in strategies between actors. The notion of complementarily rests on the distinction between a mere evolutionary coincidence of several factors, which jointly produce a fortuitous one-off outcome, and situations where complementarities operate in a systemic fashion. In the latter case, doing more of activity A raises the value of increases in activity B, which then, by increasing B. also raises the value of increasing A (Foster & Stehrer, 2007). Firms operate in a context where their growth may be constrained by weak external networks, be they national or local networks, or by weak supporting infrastructures or anti-competitive regulations. On the other hand, organizations in the immediate and indirect environment may be strong and able to support the growth of firms but if their strategies do not match the complementarities are not realized. We want to find out how strong is complementarity-driven network alignment in each of our cases (Peneder, 2005).

First, the strategy and structure of firms determine the scale and scope of network alignment. This is not to deny that other elements of network alignment do not play an important role but very often they can be considered to be secondary. The structure and strategy of MNCs sturdily form the depth and the degree of industrial systems. Soufflet and Soko-ow are oriented towards building their supplier base by offering technical assistance to farmers (Timmer, et al. 2007). This orientation arises naturally from the predominantly market-seeking orientation of their foreign direct investment (FDI). ABB has been very quick and successful in integrating its local subsidiaries into a global company network. Tesco has applied its business processes and practices to its CEE operations. EBS is developing links with local upstream suppliers (Gligorov & Podkaminer, 2007). Elektrim's foreign strategic investors and their controlling interests have strongly shaped company strategy. In all cases where foreign investors are present as full owners or as strategic investors their strategies have been decisive in determining the extent and nature of network alignment and local sourcing that has taken place. When faced with negative externalities in the business environment such as poor supplier networks or weak support from government for agriculture these strategies tend to become more conservative or less ambitious in terms of network building (Stehrer, 2005). Equally, strategy is a self-discovery process and in a few instances investor strategies have been re-shaped by the prospects for growth or by the difficulties, which initially were not foreseen. Examples are R&D and the technology links of ABB with local universities or moves to assist farmers made by food MNCs (Peneder, 2004).

Domestically controlled firms have the strongest need for network-based growth as a way to overcome the resource constraints that they are faced with. Access to technology, to finance and to export markets can be more easily achieved through a network-based strategy than through generic expansion (Peneder, 2005). Videoton and Vistula are good examples of the firms that have advanced in building network relationships and which in relation to domestic firms started to operate as network organizers. Dobrogea and Braiconf are examples of the firms that do not yet operate as network organizers but which have grown largely due to networking or linkage capabilities (Gligorov & Podkaminer, 2007).

Second, for the time being industrial networks in CEE are most often vertical and dyadic and confined to production, that is, involving parent company and local subsidiary (ABB, EBS, Tesco) or local firm and foreign strategic investors (Elektrim, Soko-ow). Domestically controlled firms grew through a combination of generic expansion and networking or reliance on foreign buyers (Braiconf, Vistula, Videoton) or technology suppliers (Dobrogea) or on foreign strategic partners (Elektrim, Soko-ow). Domestically controlled firms with good organizational capabilities in sectors that require local subcontracting and contacts with multiple foreign buyers are the only ones involved in multiple networks (Vistula, Videoton). In this respect, they seem to be the best potential agents of network alignment or growth in these economies. In many CEECs, FDI is very important in terms of sales, employment and even more in terms of profit generation and investment. However, from a long-term and structuralist perspective domestic firms which are capable of becoming network organizers seem to be equally, if not more important for building externalities and synergies (Stehrer, 2005).