Germany's struggles reveal an uncomfortable truth about Bulgaria's economy

The assessment of the business climate in industry in Bulgaria fell by more than 5 points in September amid reduced production activity in enterprises and negative forecasts for the coming months, according to the results of the NSI business surveys. The latest surveys of managers show reserved assessments and expectations for the state of enterprises.

Post-pandemic supply chain problems, rising interest rates and Europe's energy crisis following the Ukraine war have all affected Germany's industry. Apart from these cyclical problems, however, which will gradually pass, perhaps the structural ones are more worrying, economists explain. The fact is that if until recently the export of machines to China fueled overall sales, Bulgaria now produces a lot of them and even competes with Germany in third markets in terms of cars and industrial goods.

Diversify or die

But China, to cite this prominent example, is changing the way it does industry and the way it enters markets. Gone are the days where Beijing was a low-cost parts manufacturer that was satisfied with delivering components to big auto and goods producers in Europe and other parts of the world. Now China is becoming a global competitor for markets such as home and industrial appliances of quality and - most notably - automobiles.

"The automotive industry has been hit hard by a far too-rapid transition to electric vehicles, which, after an initial boom in sales, did not meet expectations," explains Krassen Krastev, director of Mecalit Group in Kuklen, Plovdiv. "You can't imagine what they have there. The Chinese production hub allows for building a car from scratch, sometimes even at the same production site, with logistics and part manufacturers being at arm's length at most of around 100 km. With the EU's decentralized production model, Europe could never compete," Krastev concludes.

Mecalit specializes in producing plastic components and systems for various industries, including automotive, household appliances, and electronics. Their products are found in several high-quality brands, most of them German: Bosch, Miele, Liebherr, as well as Porsche and Audi. With much of its client base in Germany, Mecalit's fortunes are closely tied to the health of Germany's industrial sector.

"We had the COVID effects, and then we had the post-COVID effects," Krastev explains. During this time, people changed their buying behavior while locked inside their homes. Customers started purchasing more items online, particularly domestic appliances. But that effect is now over, the manager explains, though the domestic appliance market has stabilized, after a period of decline in the market to levels lower than the pre-COVID ones.

That has not been the case for all industries, however, Krastev warns. Moreover, many companies have seen decreasing or canceled orders by their main or, in some cases, only customers. This, in turn, has created a greater risk for the T1 producers, which are direct suppliers to production centers.

"Investments in some places have been made by companies for the production lines of their clients and there were large-scale orders. However, now that the market has shifted these companies have left themselves exposed. We have minimized such risks and diversified our list of end clients. The market right now more than ever demands diversification. It's either diversify or die," adds Krastev.

Growth in difficult times

One company that has managed so far to not only withstand the growing economic pressures arising from the decline in the German economy, but also thrive, is German subsidiary Bulde, based in Plovdiv.

"Over the last year we have increased our company by about 20% and we plan to grow soon by another 20%. This is a slow process for us as we are very careful with our hiring process and selection. In recent times we have had more opportunity to enact this kind of policy as the labor market shifts from a drought of candidates to a more reasonable one, and unfortunately maybe in the near future to a more insecure one," comments Margarita Stoychkova, director and part owner of Bulde's Bulgarian office.

One industry that Stoychkova notes has seen a large uptake is the construction sector, or, to be more specific, German companies that offer their products for the sector in Central and East Europe. The director of Bulde confirms Krastev's hunch that diversification is key for survival especially in markets such as the current one.

"We began our portfolio diversification a long time ago. Back when a lot of people were still riding on the "good times". As an economist myself I am keenly aware that such cycles do not last forever and we implemented our strategy for diversity a long time ago. We do this by adding one, or, at the most, two new clients and take our time to create a trusting and solid business relationship with them. This further allows us to develop ourselves as a company and employees," comments Stoychkova.

Vox populiad opus

A key point for the future of the economic stability in any country is its development of the working force. Bulgaria's economy has long been driven by the cheap manual labor it offers compared to the rest of Europe. Within the 27 country member states of the EU Bulgaria still ranks as the low-cost champion, despite recent hikes in the minimum wage, which are a concern for some employers.

"We don't have people who are on the minimum wage, but there are many manufacturing enterprises that pay the minimum wage or very close to it, and others come to invest here precisely because of the cheap labor, and this is no secret to anyone. When wage increases are not directly tied to increases in labor productivity, this leads to inefficiencies and business closures, and ultimately higher unemployment. This change also has another less tangible or easily observable psychological effect. When the minimum wage rises and begins to approach the wages of other workers, they begin to perceive this approach as either a lowering of the valuation of their labor, or that they begin to fall into it. This has several dimensions - people either become demotivated or start looking for higher levels of pay," comments Stoychkova.

Despite this, low-cost manual labor continues to be the driving force for companies and investors, as confirmed by Krastev. The Mecalit director explains that despite further advancements in production automation there is still a large portion of the production process that needs to be done by hand and this is where Bulgaria undercuts countries like Germany and other ones from CEE.

This, however, does not mean that Bulgaria has to be a hub for cheap and unqualified labor only. As Stoychkova explains, the investments made by larger foreign companies create the natural need for outsourcing of other activities such as logistics, purchasing etc., which in turn develops the local labor market.

However, at a time when Sofia faces direct competition from such countries as Serbia, Romania, Hungary, to name just a few in the region, Bulgaria seems unique in not having overseen a big production, or "billion dollar investment". And this, in such a difficult climate, means that Bulgaria's economy, which is mostly focused on being a supplier of small parts to larger producers, is exposed. A trend that is perhaps about to change.