6 Trends and patterns in offshoring in the European automotive industry

Peter Warda

 

Abstract

What are the positions and trends of the EU member states in the global integration of production? The patterns of shift in production are analyzed by means of an in-depth study of the European automotive industry. The focus is on outsourcing strategies performed as offshoring in production of physical goods. The outline of the European automotive industry considers indicators such as production and employment data, industry dynamics through Foreign Direct Investment (FDI) and two-way trade. An interesting result is that Western European multinationals are frequently offshoring production stages to new markets in Central and East Europe.¹

Introduction

The current era of globalization began sometime in the mid-1970s and is based on rapid expansions in infrastructure, e.g. through road networks, air connections, human capital formation, investments in R&D, and information processing (Karlsson et al., 2010). According to Dicken (2003), a major force behind this development is the multinational enterprise. During this era it has become more common to offshore labor-intensive elements of production to other countries. McCann (2008) finds that more than 70,000 multinational enterprises, with more than ten times as many foreign affiliates, have been involved in some form of relocation. In addition, Obstfeld and Taylor (2004) suggest that the number of firms taking part in the global economic integration is increasing at a rapid pace and so is also the importance of the global movement of capital in world markets.

This development affects certain industries rather differently as comparative advantages can, and do, change over time (Blinder, 2006). For example, Edebalk and Wadensjö (1993) draw parallels to Swedish textile manufacturing where Sweden had a strong comparative advantage during the first half of the twentieth century. After this period, the Swedish textile industry was characterized by a major structural change and the Swedish comparative advantage and jobs shifted to Southern Europe to countries such as Portugal and Spain. Nowadays, the comparative advantage in textile manufacturing has shifted to low-cost countries in Asia.

What has been the effect of such change in terms of jobs and production in the European Union (EU)? Is the EU gaining or losing because of offshoring trends? The purpose of this chapter is to analyze the position and trends of EU member states in the global integration of production by means of an in-depth study of the European automotive industry. The study will focus on outsourcing activities performed as offshoring in production of physical goods. Factors of interest are related to production and employment data, industry dynamics through FDI, and two-way trade. Furthermore, it will contribute to an increased knowledge of what offshoring is and how it has impacted the EU member states.

The chapter is organized as follows: The next section discusses drivers of globalization in context of infrastructure, trade barriers, and trading blocs. The following section outlines various production options for the firm and different forms of outsourcing. Then some theoretical perspectives behind outsourcing and offshoring strategies are presented. The case study of the European automotive industry is then covered. The final section concludes this chapter.

Drivers of globalization

From an economic point of view, Bhagwati (2004: 3) defines globalization as “the integration of national economies in international trade, technology flows, FDI and international mobility of labor and capital flows.” To be able to understand how globalized economies develop, one must ask what the fundamental conditions are that drive economic globalization in different regions. This section presents some important conditions represented as infrastructure, trade barriers and trading blocs.

Infrastructure

Infrastructure can be explained in terms of tangible and intangible factors that are durable and difficult to change. Factors like these create a collective importance for the economy as whole. Karlsson et al. (2010) exemplify infrastructure as rules for setting up business, transportation networks of goods, transportation of energy, information, and people, well-established ownership rights, basic values and attitudes to development, knowledge base and technological know-how in the economy, social protection systems and well-functioning national institutions.

According to Braudel (1994), Europe has been experiencing a slow but stable change in infrastructure over the last millennium. However, when slow dynamics in infrastructure are combined with fast economic processes it causes some form of tension between the two. For example, Solé and Losilla (2010) suggest that if there is an opportunity to profit from better infrastructure in terms of access to production technology and attractive factor conditions in one region, then a relocation of production to that specific region would not be impossible for a firm.

Trade barriers

The implementation of more lenient policies to promote free trade is explained in Bhagwati (2001) as a driver of rapid changing patterns in world trade. An example of such a policy is the General Agreement on Tariffs and Trade (GATT), which is based on supporting and encouraging its member countries to negotiate for a reduced amount of trade quotas and tariffs.

In the mid-1990s, a new regulatory framework was setup to expand the GATT to include more flexibility in trade related to services and new regulations for preserving intellectual property rights, copyrights, and brands. A result of this expansion was the establishment of the World Trade Organization (WTO) (Kleen et al., 2006).

The creation of the GATT and WTO has induced a drastic reduction in trade quotas and tariffs. According to WTO (2010) there has been an exponential increase in world merchandize trade since the creation of the GATT in the late 1940s. In addition, WTO members account for approximately 97 percent of all world trade taking place today.

Trading blocs

Another important role for development of globalized economies is played by regional trading blocs (cf. Wang, 2010). For instance, data in WTO (2010) shows that the majority of world merchandize trade is carried out in the form of trade within and between trading blocs. Moreover, van Winden et al. (2011) suggest that the EU enlargement has contributed substantially to re-shaping Europe. For example, expanding the EU to include members in Central and Eastern Europe (CEE) has resulted in an increased movement of multinational enterprises (MNEs) and for industrial development to take off in CEE. In addition, OECD (2010) finds that the EU expansion has contributed to a rapid increase in intra-regional trade between Western Europe and CEE.

What is also evident from empirical studies such as Blecker and Esquivel (2010), Camroux (2010), and Cîmpeanu and Pîrju (2010) is that trading blocs of today have high incentives to be involved in both extra-regional (e.g. between EU and ASEAN) and intra-regional trade.

Defining outsourcing and offshoring

Hatzichronoglou (2005: 6) describes outsourcing as a process in where a firm carries on one or more production activities on its own account outside the firm. Outsourcing can occur within the country where the firm is located (domestic outsourcing) or abroad (offshore outsourcing).

Table 6.1 presents the production options for a firm based on two location categories: within the country or abroad. The first production option takes place within the country where the firm is established, either via domestic in-house production, through an affiliated firm, or by contracting a domestic non-affiliated firm, i.e. domestic outsourcing (Hatzichronoglou, 2005). Turok (1993) suggests a number of reasons for the choice of domestic production. These are, for example, historical ties to domestic networks, efficiency in production, economies of scale, quality,

Table 6.1 Production options for a firm

Location	Internal production (in-house)	External production (outsourcing)
Within the country (domestic)	Production within the group to which the firm belongs, but within the country by affiliate (domestic in-house)	Production outside the firm but within the country by non-affiliate (domestic outsourcing)
Abroad (offshoring)	Production within the group to which the firm belongs, but abroad by foreign affiliate (offshoring in-house)	Production outside the firm but abroad by foreign non-affiliate (offshore outsourcing)

Source: Adapted from Hatzichronoglou (2005).

responsiveness, logistics, proximity to markets, accessibility to technology, and human capital in production.

The second production option takes place when a firm is offshoring, which basically means that the firm allocates the production abroad. In this category, production can be sourced to a foreign affiliate within the group to which the firm belongs (i.e. offshoring in-house) or the firm can establish a source to a foreign non-affiliated firm via offshore outsourcing (Hatzichronoglou, 2005). According to Henderson et al. (2002) and Eriksson et al. (2008), the most common reasons for offshoring production are to minimize production costs (e.g. in terms of land, wages, and taxes), to access more lenient laws and regulations, to gain proximity to global markets, to follow lead partner, economies of scale, and resources in production (e.g. raw material).

In the remainder of this chapter the use of “offshoring” will be generic for “off-shoring in-house” and “offshore outsourcing” when addressing firms that move production abroad.

Theoretical frameworks

It is difficult to apply a specific theory that explains the motives for outsourcing and offshoring strategies, yet what we want is to understand the most important factors associated with production fragmentation in this form. The difficulty arises because of the many dimensions the reasons for outsourcing and offshoring can take on when such a decision is made by the firm. Empirical studies within the topic focus on one or a couple of aspects when building a theory to illustrate the resulting implications. This section outlines various frameworks that can help explain some of the important factors behind outsourcing and offshoring strategies.

Theory of the firm

There are two important questions that need to be raised for a continued discussion on outsourcing and offshoring:

(1) Why do firms exist?

(2) What contributes to decisions of where to produce and by whom?

The first question can be traced back to Coase (1937) who suggested that firms exist in order to reduce transaction costs that arise when economic agents trade in markets. Hence, when production stages are vertically integrating, the main purpose of the firm is to minimize the arising transaction costs.² The initiative to either expand or reduce firm production is directly related to forecasting the market price of its inputs. A way for the firm to track changes in transaction costs is for it to establish contracts that include detailed outlines on how to govern property rights that are established. Williamson (1979) expanded the transaction cost framework with ideas incorporating economic theory to explain various behaviors in the market. Transaction cost economics is grounded in the fact that organizational rationality is bounded to some limit, which, in turn, resides in that all complex contracts are incomplete and indeed rooted in agency theory.

The second question implicitly addresses how outsourcing and offshoring decisions can expose firms to problems related to agency theory (cf. e.g. Sloof and van Praag, 2008). The principal—agent relationship is commonly adapted to explain problems arising because of individual self-interest. People have to make decisions on a daily basis with an ambition to reach optimal results. What tends to deter such outcomes is the absence of full knowledge about options that need to be made to reach such efficient states. Hence, a problem arises in matching the interests in mind of both the principal and the agent (Jensen and Meckling, 1976). A metaphoric example of this problem is provided in Reeves et al. (2010). Suppose that the principal firm is a manufacturer located in country A. Its management has decided to offshore some production stages to an agent located in country B. There are two major problems arising in this situation. The first problem arises on account of the possible difference in goals of the principal and agent. A typical case is when the principal finds it too difficult or costly to monitor the work of the agent in terms of production output or labor working hours. The second problem relates to the possible disparity in risk preferences of the principal and agent. Such disparities can negatively affect the principal firm's decision making and might result in the firm remaining as an in-house producer.

Theories of industrial organization

A way for firms to avoid being outcompeted and remain in the market is to generate ongoing economic processes. Harvey (1982) refers to economic processes through capital circulation, building on Marx (1967). The purpose of the capital circulation model is to have the end time capital greater than the starting point capital, and the value of goods produced greater than the value of inputs used in production. The economic resources created through profits can then be re-invested in new production and the process can start all over again.

Palloix (1977) expands the capital circulation model to three different, although connected, systems for capital in terms of trade, investment, and production. The trade capital was first to be globalized as it grew with the expansion of international trade. The investment capital was the second system to be internationalized with the increase in FDI. Finally, the increasing number of MNEs made the production capital global as their industries were being spread worldwide.

The theory behind the circulation of capital works is a good interpretation for internationalization of economic activities as it connects financial actions to production and commerce. However, according to Eriksson et al. (2008) the theory does not answer to specific issues relating to geography, organization, sector aspects of MNEs, and to internationalization in general.

During the late 1970s and early 1980s, Dunning (1979, 1980) made an attempt to analyze firms' incentives to global integration by mixing theories of business administration, trade, and location together. The empirical evidence in Dunning (1979) finds that a firm will establish international production if the following three requirements hold: 1) the firm possesses owner specific advantages that foreign competitors do not, 2) such advantages must be exploited by the firm itself and not be sold or leased to other actors, thus implying that the firm internalizes its owner specific rights, and 3) there must exist specific localization factors making it more profitable to exploit the benefits in a foreign country rather than to setup production at a domestic location.

Dunning's (1979, 1980) theory has been widely criticized because it mainly consists of a set of factors and less of a theoretical base to use when analyzing firms' incentives to globally integrate production (Itaki, 1991). However, the theory is useful for analyzing specific cases of international production.

Theory of the global value chain

The theory developed by Dunning (1979, 1980) only partially explains the reasons underlying international production through FDI. Another theoretical framework that can be adapted to better understand the dynamics of international trade, multiproducts, and industrial organization is the theory of the global value chain. According to Kogut (1985: 15), a value chain refers to,

a process by which technology is combined with material and labor inputs, and then processed inputs are assembled, marketed, and distributed. A single firm may consist of only one link in this process, or it may be extensively vertically integrated.

What is highly significant in this context is the kind of activities and technologies the vertically integrating firm decides to keep in-house and what activities it decides to outsource, and where to, which relates back to Coase (1937).

Arndt (1998) suggests that the value chain creates a somewhat fragmented production, since it allows the firm to relocate production stages across national borders. In addition, value chains also induce global production networks to be formed. Another description of the value chain, in Feenstra (1998), refers to a case where its specific design motivates vertical disintegration through outsourcing of non-core activities.

Vertical disintegrating firms often place new requirements on the value chain, e.g. through increased product differentiation or improved efficiency in just-in-time flows. Baldwin and Clark (2000) find that processes like these increase the complexity of transaction costs in the value chain. However, Sturgeon (2002) suggests that there are various strategies to help reduce the complexity of transactions. One example is to codify technical standards and information processes within the value chain.

In line with Sturgeon (2002), Gereffi et al. (2005) propose a theory that helps explain the dynamics of industrial organization by considering underlying factors such as transaction costs and global value chains. The framework is based on three key elements that are allowed to take on only two values, “high” or “low”:

(1) Complexity of information and knowledge transfers.

(2) The extent of efficient codifications in information and knowledge transfers.

(3) Capabilities of actual and potential suppliers.

Table 6.2 presents five different analytical cases in where the governance of the global value chain is depicted.

If the product specification is easy to follow (as in case of markets), the ability to codify transaction costs is a simple task to proceed with. A result of this is that producers are less dependent on buyers when a product is developed. Since buyers respond to market prices that are set by sellers, there is a low degree of explicit coordination and complexity.

Modular value chains are created when transaction costs are increasingly complex, yet the ability to codify transactions still remains high. This is often

the result if the product design is modular, thus requiring high input amounts of technical competence in production. In this case, the lead firm will act to unify most processes in production under one module. If the supplier is able to produce the complete package under this module, it will tend to reduce the buyer's costs in terms of surveillance and control. The high abilities in codification imply that complex information can be transferred with little distinct coordination (the cost of changing supplier is still kept low, as in the case with markets).

Relational value chains are created when products cannot be codified and transaction costs are too complex to organize. Networks like these require high capabilities from their potential suppliers. The knowledge in production is often incomplete, which allows the lead firm to outsource steps of production in order to gain access to an increased knowledge base. Relational value chains are often characterized by a high explicit coordination via regular face-to-face interactions between actors. Thus, finding new partners may induce a high cost for both the lead firm and the supplier.

Captive value chains are formed when the supplier capability is low and the product specification is complex. The ability to codify detailed instructions and information is high. The lead firm needs to put a lot of effort into monitoring the supplier in the production process. As investment costs increase, the lead firm will seek to lock-in the supplier to avoid its investments going to waste. The supplier faces a high switching cost as it is caught in the lead firm's web. However, the lead firm provides the supplier with enough resources in order to make a potential exit by the supplier unattractive. Captive suppliers are often compelled to a few simple tasks, such as assembly, and are much dependent on the lead firm to be contracted for new tasks.

A hierarchical value chain induces in-house production. This is generally a result of a situation in where products are complex to produce and highly difficult to codify because of a lack of skills to manufacture the product. A hierarchical value chain has a high degree of explicit coordination. Hence, the lead firm organizes its own production flows and attempts to centralize the control over the firm's resources.

Offshoring in the European automotive industry

In this section the patterns of shift in production are analyzed by means of an in-depth study of the European automotive industry. The focus is on outsourcing activities performed as offshoring in production of physical goods. The approach displays trends in production of motor vehicles in the EU and a number of reference countries and to contrast such trends to dynamics in employment in motor vehicles production. An analysis is also made on typical offshoring indicators such as FDI, turnover shares in foreign affiliates, intra-industry trade, and export specialization. The research questions address what has been the effect of such change in terms of jobs and production? Is the EU gaining or losing on account of offshoring trends? Moreover, the analysis is contrasted against drivers of globalization and theoretical frameworks presented earlier in this discussion.

Production dynamics in the European automotive industry

The automotive industry in Europe is seen as “the driving sector” of production in the region. In 2009 approximately one fourth of the total 61 million passenger cars produced globally were assembled within the EU, thus making it the world's largest vehicle producer (OICA, 2011). The European automotive sector supports over two million Europeans with jobs and an additional ten million individuals are employed in related industries (ACEA, 2010). In addition, the European automotive industry is highly heterogeneous with a wide range of differentiated goods being produced and later exported, either as final or intermediate goods, from affiliates and non-affiliates within the various production networks in the region (van Winden et al., 2011). The industry exports in this sector are valued around ∈70 billion annually, making it a highly important industry for Europe (ACEA, 2010).

In recent years the automotive industry in Western Europe has experienced a substantial decline, causing a drastic slowdown in production of automobiles in Western Europe. According to ACEA (2010) and Sturgeon and van Biesebroeck (2010) this decline was caused by the global financial crisis, as well as from increasing competition from global car manufacturers. However, another implication found in Jürgens and Krzywdzinski (2009) is that automotive plants in Western Europe are commonly being moved across borders or overseas, to locate in low-cost countries in Central and Eastern Europe (CEE). An example is that German automotive firms are found to be more productive as they benefit from low-cost imports from their foreign affiliates in CEE. In addition, the overall effect on growth and employment in Western European automotive firms has been positive. The results from Jürgens and Krzywdzinski (2009) can be supported by various drivers of globalization. For example, imports that originate from CEE mostly come from new EU member countries (e.g. Poland, Czech Republic, and Slovak Republic) where trade barriers are low and markets are close. A benefit of being a member of the EU would simplify trade and in this way prosper growth. Moreover, Western European firms that locate in CEE bring valuable information in the form of production knowledge, which improves the industrial knowledge base in CEE.

OECD (2010) finds that the global automotive industry is characterized by a large presence of foreign affiliates and that these foreign affiliates are organized by a small group of MNEs. A majority of these MNEs are from Western Europe and they hold a dominant position in the world production of automotive and related goods. For example, Germany, which from its historical background is known as one of the most industrialized countries in the world, is the host nation for several MNEs in Europe, followed by France, Italy, and the United Kingdom (Domański and Lung, 2009). MNEs from these countries are often involved in multi-production processes ranging from assembly of passenger cars, trucks, buses, trailers, and engines, to development of electronic software and various security equipment adapted in the motor vehicles, thus making the industry highly heterogeneous (van Winden et al., 2011).

According to van Winden et al. (2011), MNEs in Western Europe (especially German, French, and Dutch) have actively been involved in stepwise re-organization of the firm structure. The outcome of such governance has produced two main patterns of change:

(1) The focus on core competencies, such as corporate management, R&D, marketing, and product design, has increased. Operations like these are commonly kept in the country where the parent firm was first established.

(2) It has become more common to offshore production processes to countries with more attractive factor conditions.³

OECD (2010) suggests that the main implications of 1 and 2 have resulted in access to new and growing markets for motor vehicles, as well as increased benefits from sourcing low priced foreign production factors. The European automotive industry tends to be highly dynamic and countries with leading manufacturers such as Germany, France, Italy, and the United Kingdom have different anatomies in terms of specialization in production.

Table 6.3 shows the production of motor vehicles within the automotive industry in the EU and a group of reference countries for the years 2005–09.

Total production of motor vehicles in EU15 decreased by more than four million units over the five-year period. In the same period, new EU countries located in CEE increased their vehicle production by approximately one million units. Almost all EU countries show falling trends in production of motor vehicles in 2007–09. However, the countries going against this trend (i.e. showing an increased production in 2007–09) are Czech Republic, Romania, and Slovenia.

France has lost most in terms of units manufactured in the EU. The total French production of motor vehicles has dropped by approximately 1.5 million units. Moreover, the United Kingdom has suffered from a drop of over 700,000 units. Germany and Spain also present high values of decreased production. About half a million fewer motor vehicles were produced in these two countries, respectively. Negative trends over time are also experienced by Austria, the Netherlands, and Sweden. An interesting point is that there has been a negative change in total vehicle production in all EU countries located in Western Europe (with Finland as an exception), while all new EU countries in CEE have experienced positive changes.

The average change in the Korean motor vehicle production has been positive, although at an almost constant rate, whereas the production of motor vehicles has fallen in both the USA and Japan. The American automotive production has decreased by more than half its amount over the period 2005–09. On the other hand, the Chinese automotive production has experienced a remarkable growth and the number of units produced in China has more than doubled over the five-year period. Brazil, Russia, India, and China (BRIC) shows a steady increase in units of motor vehicles produced over time, whereas the North American Free Trade Agreement (NAFTA) experiences a huge decline.

The world production of motor vehicles was increasing steadily until 2007. According to ACEA (2010) the drastic fall in world production of motor vehicles

in 2007–09 was mainly on account of the impact of the global financial crisis. Thus, causing the world production of motor vehicles to fall by one percent over the period analyzed.

What is of main importance is that there is an ongoing structural change taking place in the world automotive industry. The decreasing production output of motor vehicles in Western Europe, the USA, and Japan is not only because of the global financial crisis. It is also because of the fact that the assembly lines of motor vehicles are constantly being relocated to more competitive regions located in CEE, China, and Latin America. From a European perspective, it is highly apparent that the producing countries in Western Europe are giving way to more competitive and cost efficient countries in the eastern regions of the EU. This pattern is highly evident when analyzing the average change in production over the five-year period.

The structural change taking place in the world automotive industry can be supported by the theories of Harvey (1982) and Palloix (1977), where global capital investments in the automotive industry are plain. In addition, parallels can also be drawn to Dunning's (1979) specific localization factors (e.g. new markets in close proximity and more attractive factor conditions) when locating production in low-cost countries. In the case of automotive production in Western Europe, low trade barriers and beneficial trade agreements with countries in the EU and with other trading blocs (e.g. MERCOSUR (the common market of southern Europe) and ASEAN (Association of Southeast Asian Nations)) could have acted as an additional motivator to shift the producing pattern in the industry.

Structural changes that take place in the European automotive production are directly related to shifts in employment in the region. For example, van Winden et al. (2011) find that assembling operations in automotive production in Western Europe are gradually shifting to low-cost countries, although with some notable exceptions. A similar shift is also confirmed in Hudson (2002).

Figure 6.1 depicts the employment in production of motor vehicles within the EU for the period 2001–07.⁸ Total employment in EU27 follows a relatively constant trend throughout the time span. The pattern of change in the labor stock is seen by comparing EU15 to EU12.⁹ The employment in EU15 has fallen over time. Countries that suffer a decrease in this sector are Belgium, France, Spain, and the United Kingdom. Austria, Germany, Italy, and Sweden have experienced an increase in the number of people employed in later years. The employment in EU12 has increased during the whole period. Most countries in this group show increases in employment over time. The exceptions are Bulgaria and Romania, where increases have occurred in recent years. Moreover, Poland, Czech Republic, Hungary, and Slovak Republic are experiencing large employment increases over time.

Employment is increasing in production of motor vehicles in Austria, Italy, Germany, and Sweden; this is in spite of a downturn in motor vehicle production in recent years. One factor that might cause such a relationship could be that vehicle producers in these countries focus more on core competencies such as design and R&D. For example, Austria (in Styria and the upper Austrian region), Italy (mainly the Turin area), Germany (Ingolstadt, Munich, Stuttgart, and Wolfsburg), and Sweden (Gothenburg and the Stockholm area) have a broad range of centers that focus on R&D in motor vehicles and automotive related products (cf. Calabrese, 2009; Jenkins and Tallman, 2010; van Winden et al., 2010; Pernstål, 2008). In addition, van Winden et al. (2011) suggest that more focus in core competencies absorbs the jobs lost due to relocation of assembling processes; however,

such activities require a more knowledge-intensive labor supply. Another possible explanation to why these four countries differ could be because the referred countries have a broad knowledge base in automotive production, combined with a domestic automotive industry that is dominated by MNEs characterized by modular value chains (cf. e.g. Gereffi et al., 2005).

FDI in the European automotive industry

Over the last 20 years, Western European automotive firms have experienced many changes in ownership. The majority of these changes have involved huge investments made by leading Western European and American automotive firms. In recent years the interest has also grown to include Asian producers.

A key aspect behind these dynamics is that Western European firms are highly attractive in terms of their technological know-how. A typical example is Sweden, where automotive production has been far ahead in developing safety technology for domestic motor vehicles brands Volvo and Saab. Another case refers to leading British (e.g. Aston Martin and Jaguar) and Italian (e.g. Ferrari and Lamborghini) competence in motor vehicles design. According to Hudson (2002), specific knowledge endowments in core competencies are of great importance to be competitive in the world automotive industry.

Another key aspect behind this ongoing trend involves firms' cost optimization. Increasing wages and rental costs in Western Europe¹⁰ have induced firms to relocate some production processes in order to attain production functions with low costs. In doing so, the first stage that often becomes relocated is the assembling process (Dicken, 2003; Rugraff, 2010; Pavlínek and Ženka, 2011). However, production relocation is associated with large investments in new facilities through FDI, as well as high search costs in terms of finding competent suppliers (e.g. captive value chains) that are able to produce components of interest at a relatively low-cost (Gereffi et al., 2005).

The pattern of ownership change was first depicted in the late 1980s when American motor vehicle producers started to invest in Western Europe. To mention a few examples, GM acquired the Swedish car producer Saab Automobiles in 1989.¹¹ In addition, GM held more than one fifth of the total shares in the Fiat Group during the period 2000–05 (GM, 2011a; 2011b). In 1996, the Dutch heavy truck producer, DAF, was purchased by American truck manufacturer PACCAR (van den Berg et al., 1997). Moreover, in 1999 Ford acquired Volvo Cars, and a year later also the former British luxury car brands, Aston Martin, Jaguar, and Land Rover, from the German automobile producer, BMW. With the financial crisis in 2008, Ford sold the luxury car brands to the Indian vehicle producer, Tata Motors, while Volvo Cars was sold to the Chinese holding firm, Geely (Tata Motors, 2008; SvD, 2011).

Despite these huge investments made by American and Asian firms, the main contributing source of FDI in the European automotive industry comes from a small group of automotive MNEs with Western European origin (Lung, 2003). For example, OECD (2010) finds that foreign affiliates in automotive production are widespread across Europe. Figure 6.2 presents the turnover share of foreign affiliates in the motor vehicle production in Europe for 2007, or latest available year.

The countries located in CEE (e.g. Slovak Republic, Hungary, Czech Republic, and Poland) are experiencing extremely high turnover shares of foreign affiliates, while countries located in Western Europe (e.g. Germany, Italy, and France) display lower shares. Several studies, such as Rugraff (2010), Becker (2006) and van Winden et al. (2011), confirm this pattern. They find that foreign firms in CEE, to a certain extent, originate from Germany, France, and Italy. In addition, some motivators for FDI being directed to CEE are found in the region's attractive factor conditions. For example, the labor force occupies high capabilities that can be acquired at a lower unit labor cost compared to home production. Moreover, the proximity between Western Europe and CEE, and a bilateral EU membership, proves to be highly important for FDI from Western Europe to be directed to CEE.

Portugal, United Kingdom, Netherlands, Spain, Austria, and Sweden also depict high turnover shares of foreign affiliates. The high shares of the latter group of countries are mostly on account of the recent changes in ownership of domestic firms (as discussed above). Technological know-how in terms of safety, design, and R&D tends to be a main attractor of FDI to these countries (cf. van Winden et al., 2011). In addition, Becker (2006) finds that Portugal has the lowest wage cost in automotive production (less than a third of the German wage cost) in Western Europe. Moreover, van Winden et al. (2011) suggest that the low

Portuguese wage cost has produced strong FDI streams into the country. The European average, corresponding to approximately 60 percent, shows that the majority of turnover shares are directed to affiliates with foreign origin.

Global value chains in the European automotive industry

Intra-industry trade (IIT) can be classified as two-way trade in the same product group, i.e. as simultaneous exports and imports in the same product group. Andersson and Andersson (2000) suggest that IIT often occurs between rich economies, usually characterized by the same economic structures and close proximities to one another. A typical feature of FDI is that it attracts IIT and so also the possibility for global value chains to be formed. OECD (2010) finds that value chain creation is most likely because of MNEs' high incentive to locate affiliates in foreign markets, thus increasing trade between parent company and its foreign affiliates. Several other studies confirm that value chains exist in the European automotive industry (cf. Lung, 2003; Sako, 2010). For example, Bilbao-Ubillos (2010) finds that there is a great variety of inter-firm relationships that arise because of different relational links between automotive firms on both production and knowledge flows. In addition, he also finds that automotive-producing MNEs in Europe are more likely to offshore production-only plants to low-cost countries.

One way to observe trends in global value chains is to study patterns in two-way trade between countries. Another way is to distinguish patterns in export specialization. Figure 6.3 displays the EU countries' share of total EU exports and imports of road vehicles in 2009.¹²

Germany has the largest export share, that corresponds to more than one third of total EU exports. The importance of Germany in this sector is further strengthened by comparing its share to the combined exports of all EU economies directed to non-EU countries. Moreover, countries such as France, Spain, and Belgium have shares around 10 percent of EU exports. Germany, France, Spain, Belgium, and the United Kingdom have a combined export share of approximately 70 percent of EU exports in road vehicles, making the quintet of countries highly important for exports within this product group. Other countries that show good export shares are Italy, Poland, and Czech Republic.

Germany also dominates the share of EU imports of road vehicles in 2009. It is followed by France, Italy, the United Kingdom, and Belgium. The combined imports of these five countries make up about two thirds of EU imports. EU imports from non-EU economies are about 15 percent, which is less than the German import share corresponding to 19.2 percent. The import share is lower than the export share in all EU countries located in CEE (i.e. Poland, Czech Republic, Slovak Republic, Hungary, and Romania), indicating that these countries were net exporters of road vehicles in 2009. This also applies to Germany and Spain, while France, the United Kingdom, Belgium, Italy, the Netherlands, Austria, Sweden, and Portugal were net importers of road vehicles in 2009.

Figure 6.3 indicates that EU economies are highly involved in simultaneous trade within the same product group. This result strengthens the view of global value chains existing in the European automotive industry. Furthermore,

OECD (2010) finds the world automotive industry to consist of large production networks, where trade usually involves intermediate inputs. In addition, MNEs tend to have four common strategies that motivate global value chains to be formed:

(1) to offshore simple production processes to low-cost countries;

(2) to import back simple production processes in the form of intermediate inputs;

(3) to complete final goods in the domestic market;

(4) to supply the home market with final goods and export remaining surpluses to foreign markets where demand for the good is strong.

Table 6.4 breaks down the EU exports (imports) of road vehicles presented in Figure 6.3 into the top five destinations (origins) for some selected EU countries in 2009.

The German chart shows that the United Kingdom and the USA are the two largest export markets for German road vehicles, followed by France and Italy. German exports within this product group are mostly directed to Europe. In France, approximately one fifth of French exports are directed to Germany. Other important markets for French road vehicles are Spain, Italy, Belgium, and the United Kingdom. The Belgian chart depicts Germany as the most important market. About one fourth of the total exports of road vehicles in Belgium are directed to Germany. The United Kingdom is the second largest market, followed by France and the Netherlands. British exports are mostly intended for the USA, followed by Germany as the second largest export market. Other important destinations for British automotive goods are Belgium, France, and Italy. The Italian chart indicates that the two largest export destinations are Germany and France. Moreover, Spain, the United Kingdom, and Poland tend also to be supplied by Italian producers within this product group. From the perspective of the Czech Republic, the top five destinations all comprise EU member countries (similar to Italy). The most important export markets for the Czech Republic are Germany and France. The country also has strong ties to the Slovak Republic, the United Kingdom, and Poland.

The last two columns in Table 6.4 show the origin of imports of road vehicles for the selected group of EU countries in 2009. The German import shares are highest for France, Spain, and the Czech Republic. In France, approximately half the imports originate from Germany and Spain. Moreover, Belgium has large import shares for Germany, France, and Japan. Nearly one third of the British imports are from Germany. Other main countries that the United Kingdom imports from are Belgium, Spain, and France. The chart for Italy displays an impressive import share from Germany of nearly two fifths. Automotive goods from France, Spain, and Poland are important as well for the Italian market. The Czech Republic's import share of road vehicles from Germany is above 40 percent. The importance of German road vehicles (and related goods) in the Czech industry is highly significant. France, followed by Poland, are the next largest suppliers to the country.

Table 6.4 highlights the importance of Germany in the European automotive industry. Germany is the largest export market for France, Belgium, Italy, and the Czech Republic and the next largest export market for the United Kingdom. In terms of imports, Germany is the largest supplier for all selected EU economies. This result is in line with Wixted (2009), where Germany is described as a one of the largest automotive hubs in the world. Another interesting result is that the selected EU countries trade mostly with other EU countries. This proves the importance of the EU market as well as proximity for trade in the European

Table 6.4 Top five destinations and origins of exports and imports of road vehicles (SITC78) for 2009

	Exports			Imports
	Top 5 destinations	Export share		Top 5 origins	Import share
Germany	United Kingdom	11		France	11
	USA	10		Spain	11
	France	9		Czech Republic	9
	Italy	9		Italy	8
	Spain	6		Belgium	7
France	Germany	20		Germany	31
	Spain	13		Spain	17
	Italy	11		Italy	7
	Belgium	11		Turkey	6
	United Kingdom	8		United Kingdom	5
Belgium	Germany	25		Germany	27
	United Kingdom	17		France	18
	France	11		Japan	13
	Netherlands	11		United Kingdom	7
	Italy	4		Spain	6
United Kingdom	USA	13		Germany	36
	Germany	11		Belgium	13
	Belgium	10		Spain	10
	France	8		France	9
	Italy	7		Japan	5
Italy	Germany	22		Germany	37
	France	15		France	12
	Spain	6		Spain	11
	United Kingdom	6		Poland	10
	Poland	5		Japan	4
Czech Republic	Germany	36		Germany	42
	France	10		France	8
	Slovak Republic	6		Poland	7
	United Kingdom	6		Spain	6
	Poland	5		Italy	5

Source: Comtrade (2011).

automotive industry. Countries such as Germany and Italy importmore from CEE. In this respect, the Czech Republic and Poland are the largest suppliers of road vehicles, which is also comparable to findings made by Hudson (2002), Jürgens and Krzywdzinski (2009), and Pavlínek and Ženka (2011).

Figure 6.4 synthesizes the spatial pattern of offshoring and diffusion by displaying export specialization patterns in the European automotive industry towards semi-peripheral and peripheral spaces in two distinct phases: the first phase shows that there is a diffusion towards Southern Europe, mainly Spain, but also Portugal, while the second phase from the late 1990s and onwards, depicts that offshoring activities are mostly directed to CEE countries, including Turkey.

Where to produce, what to produce, and why to produce at a specific location is a difficult task to give concrete answers to. However, the empirical literature suggests a number of reasons that may be favorable in explaining the trend depicted in Figure 6.4. Dunning (1979) refers to location specific factors which from a theoretical point of view fits well into the trend depicted in the European automotive industry. To see this, over time Spain and Portugal have had relatively low wage costs in automotive production in combination with labor forces that occupy knowledge characteristics of interest (Becker, 2006; van Winden et al., 2011). In this way, automotive producers are attracted to establish production in Spanish and Portuguese markets, given that sunk costs (e.g. writing off fixed assets ahead of time or terminating employment contracts) are outweighed by benefits from producing in low-cost countries. However, as production in Spanish and Portuguese markets increases over time, so will labor demand and relative wages. Some production stages will again diffuse to new low-cost markets (e.g. CEE and Turkey). The shifting trend in Figure 6.4 shows a clear resemblance to the Southeast Asian diffusion explained in Akamatsu (1961).

Offshoring strategies through FDI abroad play an important role in the progress of two-way trade between European economies in the same product group. This is highly evident in the European automotive industry, where most EU countries show clear patterns of involvement in IIT. Moreover, offshoring brings a number of macroeconomic effects to the region being exposed to it in terms of job losses, tax revenue reductions, and, thus, increased societal costs. On the other hand, Andersson and Andersson (2000) suggest that it might also improve the development taking place at the offshore destination. The structural change taking place within the EU is an example of such improvement since the majority of the off shored production stages are still kept within the region, allowing the industrial development to expand to new EU member countries. According to Bhagwati et al. (2004) the lower factor costs, induced through offshoring, increase the firm productivity and so also the value added surplus that can later be re-invested in core competencies of the parent firm (cf. e.g. economic processes in Harvey (1982)). In this way, both the home market and the foreign market can benefit from structural change.

However, production networks in the European automotive industry are heavily dependent on well-established tangible (e.g. roads, airports, harbors, energy, and information technology) and intangible infrastructure (e.g. knowledge and basic

values). They also require advances in technology for capital movements to be fully implemented in international trade and for value chains to be organized well in terms of production and distribution. Moreover, trading blocs are major contributors to the global value chains seen in the world automotive industry today. In the case of EU and European automotive production: proximity matters, trade barriers are few, and transportation costs are kept at a low level. Hence, relocating production from Western to Eastern Europe has its advantages. Firms can, via globalization drivers, find strategic ways to benefit from location specific advantages explained in theory by Dunning (1979), as well as establish the appropriate governance type of the value chain as presented in Gereffi et al. (2005).

Conclusions

This chapter has discussed the ongoing trends in offshoring in the European automotive industry by highlighting the importance of global drivers. It is evident that the up-going trend in offshoring has affected the European countries quite differently. Three aspects are found to be highly interesting in this study: First, the world automotive producing industry is highly exposed to FDI flows, which in turn indicates that international production is apparent in the industry. Second, employment in the automotive industry in most Western European countries is decreasing with a decreased local production. On the other hand, employment in the automotive industry in all CEE countries is increasing with an increased local production. Third, employment in the automotive industry in a few Western European countries is increasing with a decreased local production.

The first aspect raises the question of why the automotive industry is so highly exposed to FDI flows. From the analysis it shows that FDI is directed to both new and experienced markets in automotive production. A conclusion drawn from theoretical insights is that there are two main attractors of FDI in this industry: 1) location specific advantages, and 2) technological know-how. The production pattern in Western Europe has moved further east, to locate in countries in CEE. This shift is clearly depicted in Figure 6.4, along with the high levels of foreign turnover shares and two-way trade in road vehicles in Europe. FDI to CEE is supported by a number of interesting factors for producing firms in Western Europe. Especially so in terms of location specific advantages such as proximity to new markets, no tariffs and quotas in trade with other EU countries in CEE, access to raw material, more lenient tax laws, and low costs of land and labor. It tends to be profitable for firms to offshore certain production stages (such as assembling) to foreign affiliates or foreign non-affiliates by establishing value chains that cherish low costs in combination with high complexity in transactions and ability to codify such transactions. The EU enlargement has increased the possibility for Western European producers to enter new low-cost markets in CEE, thus strengthening their position and productivity in the world automotive industry. However, producers in Western Europe (the USA and Japan as well) are facing higher competition from BRIC countries that are gaining market shares in the world automotive industry. In addition, it is also evident that some BRIC producers (e.g. Geely and Tata Motors) are making huge automotive investments in high cost countries in Western Europe, where industry-specific technological know-how is apparent.

Aspect two raises two questions: Will the costs of the structural change in the European automotive industry outweigh its benefits? What impact will it have on the producing pattern in Western Europe in the future? Establishments of automotive plants through FDI in CEE have increased the demand for local labor in the region simultaneously as automotive plants are being downsized in Western Europe. FDI directed to CEE comes at the expense of declining employment and production rates in Western Europe. In this respect, offshoring through FDI has mainly involved work tasks such as assembling of final goods and intermediate inputs. On the one hand, structural changes like these come at a cost. More unemployed in the automotive industry in Western Europe would induce higher social cost for economies affected in terms of increased welfare programs and reduced tax revenues. On the other hand, there are also positive gains for Europe as a whole, since the boost in FDI to CEE has made industrial development take off in CEE, thus increasing job opportunities for labor in that region. In addition, low factor costs tend to make Western European automotive producers more productive and competitive in the world automotive industry. However, it is rather difficult to draw conclusions on how costs and benefits are associated without conducting more research on structural change in the automotive industry (e.g. through individual country studies). The second question raised in this aspect will be addressed in aspect three below.

Aspect three refers to Western European countries that are impacted differently with structural changes in the European automotive industry, and structural change is not necessarily bad for job creation. Downsized automotive production in Austria, Italy, Germany, and Sweden has increased employment. One conclusion from the analysis above is that research facilities (where focus is on skill-intensive competencies such as R&D, prototype development, design, and safety equipment) in these countries act to absorb the amount of jobs lost on account of offshoring. In addition, empirical studies suggest that job absorption in some markets is supported by firms that re-invest the value added surplus from low-cost country operations into skill-intensive job operations, commonly placed in the home country of the offshoring firm. The current development taking place in the European automotive industry can, with time, cause large-scale changes in the production landscape of the region. A naïve suggestion would be that automotive production in Western Europe replaces blue-collar jobs by white-collar jobs in the long-run, while CEE expands production and employment of blue-collar workers. However, the offshoring trend is still in its early stages. Hence, the automotive production in Europe needs more years of development before any distinct conclusions can be made on how the producing pattern will be impacted. What is important in this study is to shed light on the point that offshoring through FDI is a common strategy among Western European automotive producers. Such strategies have induced global value chains to be formed through increased trade flows between parent firms and their foreign affiliates (non-affiliates). Thus, offshoring strategies tend to play an important role for automotive producers in Western Europe.

Notes

1 Acknowledgement to ESPONWP 2.3.1.

2 Allen (1991) provides two common definitions of transaction costs: first, transaction costs occur only when a market transaction takes place, and, second, transaction costs occur as a property right is established or requires protection.

3 Mainly comprising labor intensive assembling processes.

4 Motor vehicles comprise passenger cars, light commercial vehicles, heavy trucks, and buses.

5 Shows the average change in production of motor vehicles in the period 2005–09. Average changes for “EU15” and “New EU countries” are based on data in the period 2006–09.

6 Czecg Republic, Hungary, Poland, Romania, Slovak Republic, and Slovenia.

7 BRIC comprises Brazil, Russia, India and China. NAFTA includes USA, Canada, and Mexico.

8 Data corresponds to manufacturing of motor vehicles, trailers, and semi-trailers (NACE DM34).

9 Cyprus and Malta are not included in EU12 and Luxembourg is not included in EU15. The employment in these countries is rather small and has no impact on the aggregate total.

10 An example is provided by Becker (2006) who finds that Germany, Belgium, Austria, the Netherlands, and Sweden account for the highest unit labor costs in automotive production in Europe. Moreover, Germany is found to have the highest unit labor cost also when being compared to corresponding costs in the USA and Japan.

11 Saab Automobiles was later (in 2010) sold to the Dutch sports car manufacturer, Spyker.

12 Exports (imports) of road vehicles (SITC78) include motor cars and other motor vehicles, motor vehicles for transporting goods, parts, and accessories of the motor vehicles and motor cycles. Data refers to the share of total exports (imports) of EU in 2009. The countries are sorted based on their export share in 2009.

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