Dieter Haap makes no bones about why W.E.T. Auto Systems, a German car parts maker, mothballed its Hungarian factory and moved production of car seats to a new plant in western Ukraine. “Hungary became too expensive,” says Mr Haap, the company’s chief financial officer. “The Hungarian production costs were seven times higher than Ukraine. We have very labour-intensive production, and as auto suppliers we are under very severe cost pressures.”

That is the logic driving many companies to locate in western Ukraine, where the border to the European Union is close and the labour costs are a fraction of those even in new EU member states such as Poland and Slovakia, which until recently had been seen as the cheap labour reservoir for the rest of the union. But with salaries increasing at double-digit rates in central Europe, and local currencies gaining strength against the euro, investors are looking even further east to save money.

“We get a lot of companies that are being squeezed by labour costs,” says Andriy Beyzyk, head of Western Ukraine Management Consulting, which helps foreign investors in the region. “The main interest is from companies looking for cheap labour.”

Ukraine is becoming increasingly interesting for foreign investors, pulling in $7.9bn in foreign direct investment (FDI) last year.

Leoni, one of the world’s largest makers of car wiring harnesses, the complex tangle of wires and cables needed to make a modern car function, set up one of its biggest factories in Striy, a city south of Lvov, where the mostly female workers tape and splice wires that will eventually make their way into General Motors cars.

The factory makes sense because of a procedure called tolling, under which raw materials are brought in from the EU, reworked within a time limit of 120 days, and then re-exported back to the EU without paying customs duties. “We have 22 employees working on customs issues alone,” says Werner Geillinger, the manager.

The factory, opened in 2003, found a way around Ukraine’s ferocious bureaucracy by making direct contact with Leonid Kuchma, the country’s president at the time, who gave it much-needed protection. “I would say, ‘I will call Kiev,’ and then everything would work out,” says Mr Geillinger.

Leoni also had to deal with the country’s decrepit infrastructure. When it opened its doors it found it was unable to attract workers, despite being one of the few sources of employment. It turned out that the local network of buses was unable to get workers to the plant on time – some were sleeping in stations in order to make their shifts. The company ended up building its own system of 29 buses to ferry workers, who now number more than 4,000, to the factory.

Transport troubles also dog a smaller rival, ODW Electrik, which has a wire harness factory in an abandoned Soviet-era sulphur plant. After Poland joined the EU’s passport-free Schengen zone last year, the company ran into enormous troubles on the border because of a work-to-rule campaign by Polish customs officers. “We had to charter an Antonov airliner to fly our cables to Germany because the lines at the border were too long,” says Michael Traud, the factory director.

But those kinds of problems have not stopped companies involved in the more labour-intensive aspects of car production from relocating to Ukraine.

In ODW’s case, its production costs at their Hungarian factory had almost equalled the costs at their German plants. Now the factory in Hungary is almost completely automated and the work that cannot be done by machines is done in Ukraine.

Labour costs are still fairly low, but they are rising steeply.

Mr Geillinger, who suffered a bout of labour unrest this year, pays about €260 ($400) a month including social security taxes. Leoni has increased salaries by 30 per cent. Those kinds of cost increases are already putting the squeeze on some companies such as HRT, a Danish textile company that makes children’s clothing in Lviv.

Nazar Bychyshyn, the factory’s director, walks through a large sewing room where about a third of the machines stand empty. “For the salary a sewer gets, they can find work in a supermarket as a cashier, which is much more pleasant,” he admits.

“One of my aims is to keep workers, and the other is to reduce costs. It’s a tough job.”

In its hunt for lower costs, HRT shifted production from Denmark to Poland and then to Ukraine. “There will come a time when we can’t increase salaries any more and we will have to shut down here,” says Mr Bychyshyn. The same choice faces other manufacturers that have located in Ukraine, although many of them have nowhere else to go – there are no more cheap countries in Europe.