ungary, reduced to a dependent satellite state within the European communist bloc during the second half of the 20th century, is now showing fellow central European nations how to prosper by manufacturing electronics.

Hungary may be a landlocked country slightly smaller than the state of Indiana, but it is home to about 10.2 million people eager to rebuild an economy that emerged faster than most from a painful transition in the early 1990s.

What's more, it has managed to rebuild while maintaining the political, legal and market stability that allows inward investment and, ultimately, internal entrepreneurship.

In 2000, Hungary's gross domestic product grew 5.2 percent, according to the Hungarian government's Central Statistical Bureau. The value of the Hungarian GDP was 12.9 trillion forints (about $43 billion). In 1999, the economy grew by 4.5 percent. Even though Hungary's economic growth is showing some signs of slowing during 2001, it is still growing at a very healthy clip compared with growth in most Western economies.

With skilled labor costs at one-sixth to one-tenth of what they are in the West, it is clear to see why manufacturing companies would be attracted to Hungary. For a number of reasons, Hungary's electronics industry is being rejuvenated by inward investors, with particular emphasis on systems and contract manufacturing rather than chip manufacturing.

"The early 1990s was the beginning of the transition to a Western economy. Hungary had broken free from the previous Soviet-style controls, and they were ready for a market economy," said Malcom Penn, founder and chief executive of Future Horizons (Sevenoaks, England), a research consultancy with special expertise in European electronics."There had been a Soviet-sponsored electronics industry in Hungary, but it collapsed quickly once the wall came down."

InterMOS had been the Hungarian flagship chip company. A second company, Interbip Microelectronics Co. Ltd., was created to produce bipolar ICs. The main products included switching diodes, power transistors and thin and thick hybrid circuits.

"They were using 1970s technology in the early 1990s. It was unrecoverable," said Penn. It is true that InterMOS quickly stopped wafer processing, developing a business model that had it concentrating on packaging. But the remains of Hungary's chip industry subsequently passed into the hands of Germany's Telefunken Microelectronics GmbH (Temic) and then to Vishay International when Temic was sold by Daimler-Chrysler.

InterMOS' realistic assessment of its competitive position and its readiness to react to market forces is a strong contrast to the Russian chip companies in the 1990s.

"All of the [Hungarian electronics] companies were forced to go bankrupt or to reinvent themselves. Most of them went bankrupt," said Penn. "But the good news is that the restructuring process went very quickly and has produced more stable economic conditions, where the legal infrastructure is credible."

During the transition from 1989 to 1993, Hungary suffered a recession, where-in its GDP dropped 20 percent. By 1994-1995 Hungary's GDP was back to where it had been in the Soviet era, only now it was growing along free-market lines.

"The renovation of the telecom infrastructure and the build-out of mobile networks was one of the drivers," said Penn.

Inward investors through the 1990s included Bosch, Clarion, Electrolux, Ericsson, IBM, Nokia, Philips, Samsung, Siemens, Sony, TDK and contract manufacturers Flextronics International Ltd., Jabil Circuits and SCI.

It is mainly European companies that have chosen to invest in Hungarian factories, usually at a cost of a few million or tens of millions of dollars at a time, rather than the billions needed for wafer fab investments.

As Greg Linden observes in a paper for the Berkeley Roundtable on International Economy (brie.berkeley.edu/~briewww/pubs/wp/wp126.htm), the opening of central Europe to investment offers European firms opportunities to enhance their home-continent manufacturing networks, providing them with a more diverse array of production costs and capabilities. In response, Europe's leading electronics companies-such as Siemens and Philips-have invested early and often in central Europe.

"It started as screwdriver assembly just for reasons of cost," observed Penn, "but the level of education and skills is very high in Hungary, as it is elsewhere in the former Soviet bloc, so assembly of complex boards and surface-mount production is very credible there."

Peter Baumgartner is an executive director of Flextronics' central and eastern European manufacturing team. Although the company's main base of operations is in Singapore, Baumgartner is based in nearby Austria.

"We've been involved for seven or eight years, from right after the change in the political system," said Baumgartner. "Hungary offers a very good skill set.

"There's also a rapidly maturing infrastructure. But most important, we found a government very much in the mood [to] help our enterprise. We now have a couple of operations working in four different plants, employing 10,000 people," said Baumgartner.

Having started in Hungary with simple assembly work, he said, Flextronics is now moving on to offer all types of manufacturing services, including logistics and supply-chain management as well as some product development.

Baumgartner said that Hungary in general-and Flextronics in particular-manufactures most high-volume goods, covering everything from mobile phone handsets to set-top boxes.

"In central and eastern Europe the labor rate can be 10 to 15 percent of [that in] western Europe, but other costs, while less, are more comparable. So building a factory is much the same. Energy costs are less but not a lot less," he said .

Penn echoed the fact that the investment climate is very good, with the Hungarian government offering many incentives to inward investors in terms of tax holidays and economic zones where duties are not applied. "But that's a double-edged sword. What goes in easy can also come out easy," said Penn.

So far the contract manufacturers are benefitting from transitions within many of the systems companies, as some are turning to outsourced manufacturing. For example, Philips-created plants in Hungary have now passed to Flextronics, which supplies equipment back to Philips but can also use the facilities more broadly.

As Western economies have suffered turmoil during the last couple of quarters, the effects in Hungary and other eastern European countries have been mixed.

Even as Ericsson and Nokia, Europe's two global giants of mobile communications, announced some 3,600 job cuts, the news broke just one week before Flextronics was due to take control of Ericsson's worldwide mobile phone handset production and supply-chain management, and shift the bulk of manufacturing to low-cost areas.

Silver lining
Although that may not directly benefit Hungary, it is a noticeable trend that Ericsson is cutting jobs in Sweden and the U.K. while Flextronics, with plants in Hungary, is winning Ericsson's business. Similarly, computer company Compaq abolished 700 jobs in Scotland, while turning to a contract manufacturer in the Czech Republic.

Baumgartner said that Flextronics, which also has plants in southeast Asia, has no particular policy about what types of equipment or levels of equipment get made where. "It's related to our customers' preferences," he said. "Some like us to have manufacturing close to their selling point. So if you have equipment going on sale in Europe, then it makes sense to manufacture it here in Hungary. For North America it would be Mexico, and for southeast Asia it would be China."

However, like investments in wafer fabs, investments in manufacturing plants-while they may generate some employment opportunities-do not create many indigenous companies or an emphasis on more permanent design-oriented jobs.

"The creation of industry parks, with multiple complementary companies on-site, is meant to try and help," said Penn. "There is some design work going on but not much. On the other hand, the global shortage of engineers and the high level of education means it will come. Hungary is ahead, and the Czech Republic is not far behind."

Flextronics' Baumgartner confirmed Penn's observations. "We can offer a small amount of design capacity in Hungary, but design services are conducted from a design center in Austria," he said.

The fact that Hungary is on a fast track to join in expanding the European Union can only help speed Hungary's absorption into the global electronics industry. However, it may take a lot longer than official timetables indicate, said Penn.

"It is meant to happen in 2002, but it's clear that won't happen. Basically Hungary is geared up to pass all the economic tests for entry to the European Union.

"It is the Union itself that is having a crisis of confidence and struggling to overcome internal resistance to enlargement," Penn said. "[You] can't put a timescale on that."