German Unification and the International Economy (Centre for International Studies)

German unification and the international economy

Now that the initial euphoria surrounding unification has passed, the practical difficulties of this momentous upheaval are becoming increasingly apparent. It is also becoming obvious that the economic impact is going to have very profound implications for the rest of Europe and beyond. In German unification and the international economy a group of eminent economists analyse the major short-and longerterm repercussions of unification in Germany, and the spillover effect on the rest of Europe, North America and the less developed countries (LDCs). Their conclusions are clear: economic developments in Eastern Europe will be arduous and slow. In particular, the capital requirements in Eastern Europe will have consequences for the rest of the world, and critically for those less able to stand the new competition—the LDCs. The authors also argue that world interest rates will continue to rise, trade patterns will change and the demand for capital will intensify. The book is divided into three parts. In the first part, six renowned German economists analyse the macroeconomic, trade impacts and potential of Eastern Europe. Part II traces the implications for North America and the LDCs, using the LINK model to forecast spillover effects on world interest rates, capital flows and trade. Mexico and the LDCs are examined separately as it is not just macroeconomic aggregates which are vital for their survival and growth. In the final part of the volume the authors focus on the alarming rise of nationalism in Europe and argue that a rearrangement of the agenda is both desirable and necessary. Bernhard Heitger is Senior Economist at the Kiel Institute of World Economics. He has extensive research experience in international trade. Leonard Waverman is Professor of Economics and Director for International Studies at the University of Toronto. He has specialized in industrial organization and trade.

Centre for International Studies University of Toronto The Centre of International Studies (CIS) is based at the University of Toronto and was established in 1976 as a non-partisan, interdisciplinary research centre, focusing on the political, legal and economic relationships between sovereign states. The CIS serves as a link between academics, governments and global corporations who are interacting in an increasingly interdependent and competitive world. The formal mission of the CIS is to: – analyse the major underlying forces shaping the international economy, i.e. trends in trade, investment and technology flows, the transformation of the centrally planned economies, and the globalization of corporate strategies; – explore the linkages between these trends and government policies in an international policy framework; – explore the policy options necessary to extend and strengthen transparent, predictable multilateral rules to create a level playing field for the private sector, an essential condition for sustained growth. The CIS works towards achieving its mandate by organizing research, conferences, seminars and workshops that focus on the issues of a globalizing world.

German unification and the international economy Edited by

Bernhard Heitger and Leonard Waverman Centre for International Studies University of Toronto

London and New York

First published 1993 by Routledge 11 New Fetter Lane, London EC4P 4EE This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 © 1993 Bernhard Heitger and Leonard Waverman All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage and retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN 0-203-98262-2 Master e-book ISBN

ISBN 0-415-08216-1 (Print Edition) Library of Congress Cataloging-in-Publication Data German unification and the international economy/edited by Bernhard Heitger and Leonard Waverman. p. cm. Includes bibliographical references and index. ISBN 0-415-08216-1 (Print Edition) 1. Economic forecasting—Germany. 2. Germany—Economic conditions—1990- 3. Economic forecasting—Europe, Eastern. 4. Economic forecasting—North America. 5. Economic forecasting — Developing countries. 6. Germany—History—Unification, 1990– Economic aspects. I. Heitger, Bernhard. II. Waverman, Leonard. HC286.8.G47 1993 337.43–dc20 92–18169 CIP

Contents

List of figures and tables Preface

vi viii

Part I Developments in Eastern Europe 1

The economics of German unification Heidemarie C.Sherman

2

2

Recent developments of world savings and investment Dieter Duwendag

10

3

Causes and consequences of the expected shift in the savings-investment balance in Europe: the case of German unification Karlhans Sauernheimer

18

4

Comparative economic growth: East and West Bernhard Heitger

35

5

Structural change in Eastern Europe Roland Döhrn and Ullrich Heilemann

45

6

Eastern Europe and the EC—trade relations and trade policy with regard to industrial products Dieter Schumacher and Uta Möbius

60

Part II Spillovers 7

Global investment and saving flows: some macroeconomic scenarios Peter Pauly

95

8

Implications of changes in global investment flows for the less developed countries (LDCs) Albert Berry

106

9

Macroeconomic outlook for Mexico and economic policy Rogelio Ramirez de la O

114

Part III Central issues 10

Prospects for the Uruguay Round Frank D.Weiss

123

11

The nationstate—much ado about (almost) nothing? Guy Kirsch

129

12

Beyond the Uruguay Round means beyond the border Sylvia Ostry

138

Index

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Figures and tables

FIGURES USA, Japan, OECD total: gross national savings (Sg) and investment (Ig); per cent of GNP 11 EC: gross national savings (Sg) and investment (Ig) (per cent of GDP) 13 Eastern Europe and the USSR: gross national savings (Sg) and investment (Ig), current account balance (CAB) 13 Eastern Europe and Poland: gross national savings (Sg) and investment (Ig), current account balance (CAB) 13 Eastern Europe and Hungary: gross national savings (Sg) and investment (Ig), current account balance (CAB) 13 Eastern Europe and Romania: gross national savings (Sg) and investment (Ig), current account balance (CAB) 13 Eastern Europe and the CSFR: gross national savings (Sg) and investment (Ig), current account balance (CAB) 13 Developing countries: gross national savings (Sg) and investment (Ig); per cent 13 Industrial countries: gross national savings, gross domestic investment and current account balance, 1965–87 (per 19 cent of GNP) 3.2 Selected major industrial countries: gross savings rates by sector, 1965–87 (per cent of GNP) 19 3.3 Industrial countries: gross national savings, 1980–7 (average in per cent) 19 3.4 Selected major industrial countries: gross national savings, domestic investment and current account balance, 1965– 19 87 (per cent of GNP) 3.5 Selected major industrial countries: national, private and general government gross savings rates, 1965–87 (per cent 19 of GNP) 3.6 Selected industrial countries and the EC: gross national savings, domestic investment and current account balance, 19 1965–89 (per cent of GNP) 3.7 Illustration of short-run effects and the adjustment process 30 3.8 Long-term interest rates in the USA and Germany, 1986–90 30 3.9 Nominal external value of the Deutschmark, 1986–90 30 4.1 Technological gaps and per capita growth in OECD countries 41 4.2 Technological gaps and per capita growth in centrally planned economies 41 5.A1 Stability of parameters of sectoral growth functions 50 5.1 GNP per capita and manufacturing 53 5.2 Root mean square errors of sectoral growth functions 55 5.3 Sectoral structures of selected countries 55 7.1a Quantity and price effects of international financial transfers 97 7.1b Regional saving-investment imbalances and the world real interest rate 97 7.2 Global effects of CPE transfers, 1991–5 100 7.3 GNP effects of CPE transfers, 1991–5 100 7.4 Trade effects of CPE transfers, 1991–5 100 7.5 Global effects of LDC transfers, 1991–5 101 7.6 GNP effects of LDC transfers, 1991–5 101 7.7 Trade effects of LDC transfers, 1991–5 101 10.1 Benefits and costs of negotiations 124 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 3.1

CHART 5.1

The newly liberalizing countries

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TABLES 3.1 Real gross investment in Europe, the United States and Japan, 1961–90 24 3.2 Current account balances in Europe, the United States and Japan, 1960–90 25 3.3 Simulation results of German unification, 1990–9 32 4.1 Per capita growth in Western market and centrally planned economies, 1950–88 35 4.2 Technological gaps in Western market and centrally planned economies, 1950–80 38 4.3 Shares of investment in Western market and centrally planned economies, 1950–88 39 4.4 Determinants of growth in Western market and centrally planned economies, 1950–88–regression results 39 5.1 Economic and demographic patterns of NLCs, 1986 47 5.2 Economic and demographic patterns of twenty-eight countries, 1986 49 5.3 Regression results of sectoral growth functions, 1978–86 51 5.A1 Regressions of sectoral growth functions, 1978–86 54 5.4 Growth elasticity of manufacturing in selected regions, 1970–86 54 5.5 Economic structure of the NLCs, 1986 55 5.6 Estimated sectoral structure of the NLCs, 1986 57 6.1 Exports of industrial products from the EC to Eastern Europe, North America and to developing countries by groups 60 of products and by EC countries, 1989 6.2 Imports of industrial products from the EC to Eastern Europe, North America and to developing countries by groups 61 of products and by EC countries, 1989 6.3 Commodity and country component of the share of EC countries on the export and import markets in Eastern 63 Europe, 1980–5 6.4 Skill intensity of exports over that of imports for EC trade by groups of countries, 1985 65 6.5 Imports from Eastern Europe, developing countries and North America affected by general non-tariff trade barriers of 67 the EC and individual EC countries, 1987 6.6 Imports from Eastern Europe, developing countries and North America affected by special non-tariff trade barriers 68 of the EC and individual EC countries, 1987 6.7 The fifty most important industrial products imported by the EC from East European countries, 1989 69 6.8 Average import market shares in the EC of the main export products from Eastern Europe by import barriers, 1989 80 6.9 Initiated anti-dumping investigations in the EC by regions, 1980–8 80 6.10 Utilization of selected EC countries’ special import quotas by selected East European countries, 1988 81 6.11 Initiated anti-dumping and anti-subsidy investigations of the EC against East European countries, 1985–8 84 6.12 Rank of exporting countries according to the similarity of their sales pattern with those of East European countries in 85 the EC, 1985–7—index values 6.13 The 100 most important industrial products imported by the EC from East European countries and their main 87 competitors, 1989 8.1 Growth rates and levels of selected economic variables in less developed countries, by regional and other groupings 107 8.2 Selected features of the external financing of Latin America during the 1980s 109 8.3 International factors in the growth deceleration of Africa and Latin America in the 1980s 110 9.1 Foreign trade and economic growth in Mexico, 1982–9 115 9.2 Fiscal adjustment and inflation in Mexico, 1982–9 116 9.3 Scenario of moderate growth in Mexico, 1990–4 119 10.1 Uruguay Round issues and participants 126

Preface

The great euphoria with which the promise of German unification had initially been met was soon replaced by more sober assessments of the economic effects on East and West Germany, and on the international economy. This volume deals primarily with the major short-term and longer-term economic effects of German unification on Germany and their spillovers to North America and less developed countries (LDCs). These spillovers stem from the increased investment demands as well as from the impacts that the German mark has on world interest rates. While much of this volume analyses the economic effects of German unification and the potential for economic development of Eastern Europe, these developments have clear impacts on the rest of the world. These impacts are due to the major changes involved. These developments in Eastern Europe are not ‘at the margin’ but involve wholesale drastic change. Thus, world savings, investment, trade and GNP are impacted. It is also these effects which are traced in this volume. There are three parts to this book. Part I consists of six papers by renowned German economists aimed at analysing the macro-economic and trade impacts and the potential of Eastern Europe, especially the old East Germany. The papers suggest that development will be difficult and that political objectives (DM1 for M1) have had crucial economic consequences. These developments are used in the second part of the book to trace out the implications for North America and the LDCs. The LINK model1 is used to forecast spillover effects to world interest rates, capital flows and trade. Impacts on Mexico and the LDCs are separately examined since it is not just macroeconomic aggregates which are crucial to their survival and growth. The third part of the volume looks at two other important issues —the rise of nationalism in Europe and the need to move new issues on the agenda: issues such as the harmonization of R&D policy across the triad blocks. The message of the volume is clear—economic developments in Eastern Europe will take time, and will be arduous. The capital requirements in Eastern Europe will have consequences for the rest of the world, crucially for those less able to stand the new competition—the LDCs. World interest rates will rise, trade patterns will change and demand for capital will intensify. I. DEVELOPMENTS IN EASTERN EUROPE In the first chapter in this volume, Heidemarie Sherman of the IFO Institute in Munich provides a wonderfully interesting review and a fairly detailed summary of the economic and political factors that influenced the eventual German unification. This chapter is essentially the introduction to the volume. She examines the effects of the particular conversion rates chosen for the DM and mark and analyses the consequences for monetary policy and inflation which were believed by many observers to be destabilizing. Fear of excessive money creation and accelerating inflation initially led to steeply rising bond rates. Potential temporary disruptions were not believed to call into question the Bundesbank’s monetary policy concept and practice. Therefore the rate of inflation was not expected to rise very much. We in the world feel the ramifications of these policies seen today in December 1991 as German interest rates rise and those in the USA fall. Dr Sherman concludes with several key and insightful observations. Some US$50 billion annually is the absorptive capacity of the former East Germany. As a result, she (and all other authors in this volume) see higher interest rates but also greater investment. The author forecasts that the EMS partner countries would be hurt by German monetary policy, but that other countries with flexible exchange rate policy could have a higher growth. Dr Sherman suggests that these impacts explain the push for a European central bank ‘which would replace (conservative) Germany monetary leadership in the EMS’. The chapter by Dieter Duwendag provides a very useful global review of the factors determining capital flows. Duwendag examines longer-term trends and the consequences of German unification against the backdrop of world savings and investment stocks and flows. We are reminded that during the last two decades saving and investment rates in all important sectors of the world economy have declined markedly. From the 1970s to the 1980s this process was associated with the emergence, the widening and the persistence of large saving/investment gaps in specific country areas, a phenomenon fostered by financial deregulation and

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increasingly integrated world capital markets. Duwendag argues that as a consequence, international competition for capital increased considerably and was clearly reflected in a sharp rise of real interest rates during the last two decades. There are in addition two other important calls on world savings: the need for funds to finance reconstruction in Eastern Europe and the former Soviet Union, and the continuing requirement for capital to finance development in the Third World. It is increasingly clear that the funds absorbed in the Eastern European and former Soviet economies might well be at the expense of the other ‘traditional’ developing countries. Duwendag’s overall assessment leads him to the conclusion that increasing global investment will continue to put pressure on capital markets in the coming years. In order to avoid higher interest rates and to match increasing investment demands, global savings will need to rise, the latter especially being brought about through a reduction in public sector dissaving. Karlhans Sauernheimer discusses the ‘causes and consequences of the expected shift in the savings-investment balance in Europe, especially in Germany’. The macroeconomic effects of German unification and their spillovers to other countries are distinguished for the EC countries on the one hand and USA/Canada/Japan on the other (since the European Monetary System links the European countries in an exchange rate union to Germany, whereas floating exchange rates characterize Germany’s monetary relations to other countries). These institutional facts are captured in a three-country model, with two countries forming a monetary union and floating jointly vis-à-vis the third country. Sauernheimer’s analysis predicts an increase in world interest rates and ‘a real appreciation of the union’s currency. Economic fears outside Germany seem to be not totally unfounded.’ However, he has ‘good news’ as well—the increase in interest rates is temporary. But temporary in the Sauernheimer model appears to be until the labour force in eastern and western Germany have the same capital equipment. Sauernheimer’s chapter also analyses the impact on the medium-term German growth potential (up from 2.75 per cent to about 4 per cent) and examines the fiscal costs of unification (supplemental budgets, German Unity Fund) and the optimum way of financing them. Bernhard Heitger (‘Comparative economic growth: East and West’) provides another wide-ranging critical review by comparing the growth patterns in the East and the West since 1945. He suggests that world economic development after the Second World War was dominated by an international ‘convergence club’—with the United States as the technological leader. International technology transfer and international trade led to an immense exchange of technological know-how. From this exchange, ‘backward’ economies with favourable institutional frameworks—such as Japan and West Germany—gained the most. In the 1950s the East European bloc countries were able to catch up slightly with the West through the production of standardized mass products propelling economic growth. Heitger argues, however, that in the decades beginning in the 1960s the centrally planned economies were more and more unable to cope with the increasing complexity of modern industrial structures. This finally led to the relative stagnation in economic development in the 1980s to a level of relative per capita income equal to that which the Western economies on average had already reached at the beginning of the 1950s. Heitger sees some optimism in this technological imbalance. Because of the relative economic ‘backwardness’ of the East, there is also a big chance: after having changed their economic system, the East European countries and the former USSR could increase economic growth, and by applying state-of-the-art Western technologies, they would even be able to make relatively large leaps in their economic development. He argues that this process would not even require oversized investments efforts (a view not shared by Duwendag). Above all, Heitger argues, it is necessary to adopt the mechanisms of a market economy; thus, investment this time will also be efficient, i.e. will promote economic growth. The chapter on ‘Structural change in Eastern Europe’ by Roland D−hrn and Ullrich Heilemann examines what the economic structure of the Central and East European countries may look like after their transition to free-market economies. To ‘predict’ what could happen in these countries the Chenery hypothesis is tested with data from the late 1970s to the mid-1980s for twenty-eight countries (later condensed to three regional groups). The Chenery hypothesis links sectoral growth to per capita income, value added per capita and a nation’s size. Examining the growth of twenty-eight economies could then assist in forecasting the economic development of Eastern Europe. However, while the empirical results suggest a comparatively high intertemporal stability of reactions and explanatory power, this does not hold for the differences among regions. The results do not distinguish between sectoral patterns for high-and low-income regions, and thus several patterns emerge. For example, an ‘Asian’ and a ‘Mediterranean’ type of development pattern can both be seen in the past data. Using this model to predict the future sectoral structure of Eastern Europe, therefore, requires the selection of some kind of ‘masterplan’ from past developments. The chapter concentrates on only two: the overall ‘middle-income country-type’ and the special ‘Mediterranean country-type’. Assuming a doubling of real per capita income within ten years, a common feature from all the empirical results is that all these East European countries will experience marked extensions of their service sectors. No such universal prediction holds for the manufacturing sector; the results vary depending upon the past group used as the model. The explanatory power of the hypothesis is not so overwhelming that the sectoral structures are completely determined; the path of structural change is a rather broad one with a number of options and alternatives. Finally there are many limitations to the Chenery hypothesis. There are many key elements not represented in the model, the behaviour of consumers, government, macroeconomic or monetary policy, trade policy of these countries and how other countries react to them.

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Dieter Schumacher and Uta M−bius (‘Eastern Europe and the EC—trade relations and trade policy with regard to industrial products’) provide a crucial empirical basis for analysing the impacts of the most recent developments in Eastern Europe on the international trade relations of the EC. The analysis starts by describing the structure and elaborating on the main characteristics of trade between the EC and the East European countries. They then give an overview of the EC’s trade policy with respect to imports from Eastern Europe compared to those from developing countries and North America. Market shares of the relevant countries are analysed at a more disaggregated level and the supply patterns of competing countries are compared in order to assess the effects of a liberalization of imports from Eastern Europe. Trade barriers are examined in detail. The result of this very insightful analysis may be summarized as follows. In terms of its structural characteristics (commodity patterns, factor content) the EC’s trade with Eastern Europe ranges between her trade with developing countries on the one hand and her trade with Western industrialized countries on the other. Up to now, the importance of the East European countries as suppliers of industrial products on the EC market is minor due to their inability to supply adequate products; existing quantitative restrictions are not real barriers. Therefore, the authors argue that if quantitative restrictions are lifted for the other countries as they were lifted for Poland and Hungary in 1990—no profound upsurge in supplies from Eastern Europe is to be feared. If tariffs are reduced further no great competitive advantages for the East European countries can be expected. All in all, the developing countries and North America do not have to expect trade diversion effects on a large scale because of the changes in the EC’s trade policy vis-à-vis Eastern Europe. The trade creation effects will be much more important. II. SPILLOVERS The chapters in Part I of the book convince us that the transformation of the East European economies will require enormous capital and time. Thus in an interdependent world economy, all other returns and areas are impacted. In this section of the volume, an attempt is made to spell out these impacts. Peter Pauly (with the Wharton LINK model) examines the impacts of various scenarios for East European developments on world interest rates, GNP, inflation and trade. The LINK models involve some seventy-nine countries ‘linking’ macro-models. Thus the induced effects of changes in one economy on others can be measured. Pauly begins with a theoretical analysis of the internationally transmitted impacts of a demand shock and transfer into one region. An upward push on interest rates is clear; the size depending on the interest elasticity of saving and investment and on ‘behavioural reactions in the private and public sectors’. Pauly then moves on to an examination of the potential capital needs in Eastern Europe and translates these into incremental investments. These incremental investment demands are then added to the base case—the world economy in 1991–6. The transfers amount to US$100 billion over five years (‘almost the Marshall Plan at today’s prices’). Pauly shows that there is an impact on the world economy-something in the order of a little less than a half-point rise in world interest rates with resulting negative effects on North America which requires offsetting trade creation to maintain GNP. The stimulus to the recipient countries is about a 3 per cent increase in GNP after five years. These small impacts and Dr Sherman’s earlier analysis of an annual absorptive capacity of US$50 billion for East Germany alone suggests far larger transfers than Pauly’s US$100 billion five-year estimate and larger shocks on the world. Pauly then examines an equivalent transfer, but this time to the LDCs as part of a North-South transfer. Here the stimulus to world trade is only three-quarters the size of the stimulus from a transfer to the CMEA countries because of different propensities to import. However, a CMEA transfer mainly benefits Europe, a North-South transfer mainly benefits North America. The macroeconomic spillovers from German unification are important. Albert Berry (‘Implications of changes in global investment flows for the LDCs’) argues that the impacts of substantial capital inflows into Eastern Europe on the LDCs cannot be considered simply by measuring the impact that this increased capital demand might have on world interest rates. Berry provides a cogent analysis of the difficulties faced by the LDCs in the 1970–90 period and argues forcefully that these difficulties were due to a capital withdrawal not a ‘pure’ interest-rate effect. This analysis buttresses the one made for Mexico by de la O; Berry analyses the mechanisms whereby, in his opinion, this capital withdrawal led to the growth slowdown. While other analysts single out the demise of LDC exports as the source of the macroeconomic failure, Berry argues that the fall-off of LDC exports can only explain some 50 per cent of the GDP slowdown in these low-income countries. The fall-off in imports which Berry classifies as ‘essentially capital goods’ explains the other half of the slowdown. The reduction in imports of capital goods is tied to the sharp fall in capital investment and this fall is clearly long-term growth-reducing. Therefore, while an increase in interest rates will hurt LDCs, any further reduction in net imports of capital goods which are in effect financed abroad will be more important. The LDCs, unlike the East Asian tigers, have growth paths which are dependent on market access and capital flows form the developed world. A capital flow net of US$20 billion to US$40 billion per year to Eastern Europe would then decrease growth and GNP in LDCs. Important spillovers exist from developments in Eastern Europe for the LDCs.

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Rogelio Ramirez de la O provides a synthesis of recent Mexican developments and an analysis of the state of the Mexican economy. The chapter underlines Berry’s concerns as to capital availability and stresses the concerns of Mexico. The clear constraint is capital availability. The debt repayment requirements, potential exports and capital inflows all show that the latter, given the other two, places an upper limit on Mexican growth. It is the need to attract foreign capital which partially explains the Mexican government’s decision to liberalize trade and now to negotiate free trade in North America. Thus developments in Eastern Europe have important spillovers to Mexico—first, a rise in world interest rates is painful since the outflow needed to make payments on the external debt is already high. Second, Mexico is a direct competitor for foreign investment and for investment in some of the same industries as Eastern Europe. De la O argues that the opening of Eastern Europe has accelerated Mexican liberalization and focused attention on the North American market. III. CENTRAL ISSUES To this point, the volume has concentrated on macroeconomic effects and microeconomic restructuring. But there are other developments, perhaps more important than economic impacts. In Part III, three such areas are addressed. Frank Weiss examines the Uruguay GATT Round, Guy Kirsch examines the rise of nationalism and Sylvia Ostry examines ‘Beyond the border’, the need to address domestic policy issues (such as innovation policy and competition policy) on an international level. Frank Weiss’s chapter, first written in August 1990, was entitled ‘Prospects for the Uruguay Round’; this same title was kept in the January 1992 version! Weiss suggests that the current GATT round will be successful even with an enormously widened agenda over previous rounds. In fact, Weiss attributes success to the widened agenda, pointing out that concessions in one area can be balanced by gains in others. Thus, adding agriculture, textiles and clothing, intellectual property, traderelated investment measures and trade in services ‘makes active participation by new groups at all thinkable’. Another new feature of the current GATT round is a newly protectionist USA. Even this ‘feature’ can be seen as breeding success as it raises the costs of failure. The USA is also utilizing foreign policy in order to lead to ‘success’, suggests Weiss, by involving German trade concessions for US support for reunification. This is especially true for the sector where fighting is most visible —agriculture. Agriculture and textiles are the last two trade able goods sectors where substantial trade barriers exist and are crucial elements to the round. Weiss does not view the protracted round as a failure, since so much is on the table. Guy Kirsch (‘The nationstate—much ado about (almost) nothing?’) addresses the rise of nationalism. Kirsch observes that while the nationstate is a young and relatively rare phenomenon it is far from certain that it will be a long-lived and general one. On the contrary: he sees a possible, even a probable, withering away of the nationstate. A nation is defined as consisting of any group of people who share the feeling that they belong together, without knowing, without even asking, why. A state is defined as an organizational device for making collective decisions, these decisions being legitimately binding and compulsory for all the members of that organization, and the organization being legitimated and able to enforce these decisions. Kirsch argues that if a nationstate is to exist, the prerequisite for the existence of the state and the prerequisite for the existence of the nation must be given: the nationstate, as it has developed in the nineteenth century, is the result of circumstances allowing groups of people, who felt that they belonged together, to make collective decisions without overly frustrating individual interests, and allowing groups of people to make collective decisions without straining the citizens’ loyalty to the nation. In other words, in the nineteenth century Europe’s situation was characterized by circumstances that allowed national groups to form successful states, and/or that allowed states to weld their populations into nations: the rise of the nationstates. Kirsch’s hypothesis is plausible that, at least in Europe, the nation and the state are about to divorce. The European nationstates lose at least part of their political competence as states to the supranational collectivity of the European Community, and they lose at least part of their emotional cohesiveness as nations to the infrastate regions. The nationstates’ competence evaporates upwards, the nationstates’ emotional cohesion is drained off. Consequently, Kirsch argues that the supranational collectivity is in need of an emotional coherence and the infrastate collectivities are in quest of political goals and formal institutions. He sees the nationstates becoming less and less nations and less and less states; and the European Community as being too strong a suprastate and too weak a supranation. Therefore, Kirsch views the different regions as too weak to be infrastates, and as infranations they are over developed. The end product of this analysis is that we are in a disequilibrium process (as Canadians are all too well aware of). Sylvia Ostry, former Canadian Ambassador to GATT, examines the central issues which are creating disputes between North America, the EC and Japan. She contends that these disputes are beyond the ‘narrow’ trade issues which take up GATT agendas, even the fuller Uruguay Round agenda. At the heart of present discussions of Semiconductor Agreements, Sematech versus Race, Airbus versus Boeing are a set of domestic policies which have not been traditionally discussed or harmonized. These policies are R&D and innovation policy at heart and include aspects of competition policy, corporate governance

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(vertical integration between financial intermediaries and the industrial sector) and vertical integration (the Keiretsu-type form of organization versus US-style competition). Dr Ostry argues forcefully for a forum which will allow these issues to be discussed and, hopefully, harmonized. Bernhard Heitger (Kiel) Leonard Waverman (Toronto) NOTE 1 Project LINK connects macroeconomic models for seventy-nine countries and is centred at the Wharton School.

Part I Developments in Eastern Europe

1 The economics of German unification Heidemarie C.Sherman ifo Institute for Economic Research, Munich

EAST GERMANY'S PEACEFUL REVOLUTION The 1989 social and economic upheavals in Eastern Europe, spelling the capitulation of the totalitarian socialist regimes, have entered our consciousness as truly historical events. The Gorbachev era or perestroika facilitated the people’s revolution against the grave economic and social failures of these regimes. Faster than anybody dared to hope, there is now a chance for democratic market-based lifestyles in the countries of Eastern Europe. East Germany, i.e. the German Democratic Republic (GDR), was one of the last countries to free itself from the Communist yoke, and may be the first country to enjoy the fruits of freedom in the form of a higher standard of living, because its newly gained freedoms include the freedom of choosing unification with West Germany, the Federal Republic of Germany (FRG). The end of Communist rule in East Germany was near when Hungary opened its border with Austria in September 1989, permitting a flood of East German refugees to escape repression for a free life in the West. Thousands of other East Germans vacationing in Eastern Europe joined the flow. The mass defection was the largest since the Communist regime put up the Berlin wall twenty-eight years earlier. On 2 October, 15,000 people took to the streets of Leipzig following the traditional Monday services in the Nicolai church. There were 50,000 on 9 October marching peacefully through the centre of town, expecting the worst; but instead the omnipresent security forces suddenly disappeared. This was the first victory. On 16 October 150,000 people marched, and on 23 October there were 200,000, one day after the demise of state and party chief Honecker. It was at these Monday marches that the people first demanded free elections and unification with West Germany. But while thousands joined the peaceful demonstrations in all major cities, thousands left the country. To stem the exodus, which was paralysing many firms, hospitals and schools, the East German government, on 9 November, opened the Berlin wall. Since then the East-West border, which had divided Germany for forty-five years, has been dismantled. But the exodus continued: 200,000 people left within the next three months. During the entire year, 344,000 East Germans emigrated to the West, badly taxing the capacity of West German resettlement camps, employment offices and housing stock. This prompted Chancellor Kohl, on 7 February 1990, to propose the formation of a currency union between West and East Germany. THE EAST GERMAN ECONOMY East Germany, with a population of 16.4 million people at the end of 1989, occupied an area of 108 square kilometres. It was thus much smaller than West Germany: its territory corresponded to 44 per cent, its population to 28 per cent of that of West Germany. Despite the many problems caused by central planning and its forced specialization within Comecon, East Germany had achieved a remarkable standard of living, especially when compared to the other Eastern-bloc countries. It ranked about seventeenth in the world in terms of per capita income, comparable to Portugal. When compared to West Germany, however, the standard of living in East Germany was and is drastically lower. Although East German labour has an above-average level of education and qualification, its productivity was only about 40 per cent of that of West Germany because of an obsolete capital stock and an inadequate infrastructure. Economic structure At the end of the 1980s East Germany’s economic structure resembled that of West Germany twenty years ago. Almost half of the labour force was employed in the mining, energy, manufacturing and construction sectors, 11 per cent still worked in agriculture. On the other hand, the service industries were relatively underrepresented, especially with respect to modern services.

ECONOMICS OF GERMAN UNIFICATION

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The structure of the industrial sector was very similar to that of West Germany. It was dominated by mechanical engineering, chemicals, electrical engineering, precision tools and optics (Gerstenberger and Kischel 1989). One of the largest and also most competitive industries in East Germany was mechanical engineering; most of its output was exported to the Soviet Union, but it also traded with the West. Of great importance was the chemical industry which achieved inglorious fame by what it did to the environment. This is even more true of the energy sector with its lignite-based power plants. The relatively large weight of nondurable consumer goods and food in the GDR reflects past efforts at achieving self-sufficiency. In East Germany, the various manufacturing and processing stages were integrated in large industrial combines. Robotron (computers, office equipment) was on of the largest with 69,000 employees. East Germany lacked the small- and mediumsized firms which are the mainstay of West German industry. Not surprisingly, 70 per cent of East German trade was with the other Comecon countries, with the Soviet Union accounting for 37.5 per cent of total East German trade. Among the GDR’s Western trading partners, West Germany was by far the most important with a share of almost 15 per cent. ECONOMIC REFORM PLANS FOR EAST GERMANY There is agreement today that in view of the obvious inefficiency of the socialist economic system only a radical change to a market-based economic system can solve the existing problems. But the key question of whether such a system transformation ought to occur via a ‘big bang’ or by a gradual, step-by-step process of adjustment has not been resolved. In the case of the GDR, the approach was dictated by the force of events. The first step toward economic integration with West Germany was taken when East Germany opened its border on 9 November 1989. It thereby created an all-German labour market, even though mobility has been primarily one-way, from East to West, induced by the large differences in wage levels and living standards. East German reform plans It was the very pressure exerted by the wave of migration—85,000 people left for West Germany during the first six weeks of 1990 alone—which even turned members of the former Communist party into promoters of the social market economy, although their intent would have been to establish a market-based economy in a specific socialist variant. Under the provisional government of Prime Minister Hans Modrow, East German reform plans ranged from the gradual abolition of central planning by the end of 1992 and the start at that time of ‘a socially and ecologically oriented market economy in a state-regulated environment’ all the way to ‘the immediate adoption of the social market economy’ with all the necessary legal norms now existing in West Germany. The early speeches of East German politicians and economists revealed how difficult it was for them to think in market terms. While realizing that the highly bureaucratic centralized planning mechanism had been responsible for the overall inefficiency and the huge productivity differential vis-à-vis West Germany, they were very cautious in their approach to a market-based system. This was most obvious in their position vis-à-vis private property. The then Economics Minister Christa Luft’s joint-venture legislation reflected the same cautiousness: whereas joint ventures were viewed as a major way of attracting the essential foreign capital, foreigners were prohibited from acquiring majority holdings. Even after loud protests by Western firms and trade associations, the law was modified only to permit certain exceptions. The view that there was a ‘third way’ between capitalism and socialism was initially also accepted by some economists in the GDR. According to this view, by combining market and plan all the advantages of a market-based system could be retained, especially the highly efficient, demand-oriented, innovative production system, while at the same time macrodistribution planning would prevent disturbances of macroeconomic equilibria, the creation of large excess capacities, mass unemployment, potential environmental damage. Opinions and language changed drastically, however, after the East German elections of 18 March 1989, which resulted in a large majority for the centre-right parties and for unification with West Germany and its strong currency. West German concepts for economic reform in East Germany Between November 1989 and February 1990, West German economists devised and discussed a number of plans for the transition from a planned economy to a market-based economy. The exchange rate between the Deutschmark and the GDRmark played a pivotal role in these plans. Most plans shared a basic prescription: only after East Germany had reformed its economic system, eliminated most of the previous distortions, restructured its economy on the basis of market-determined costs and prices, and raised productivity and competitiveness, could a proper exchange rate be fixed or— ‘crowning’ the process— could a currency union with West Germany be established.

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One of the first public statements by professional economists, prompted by the opening of the border, was the set of recommendations presented by the Economic Advisory Panel to the Federal Economics Ministry (Die Zeit 1989) of early December 1989. They stressed that the massive emigration which might threaten the very survival of East Germany could only be stemmed by a rapid improvement of the entire environment in the GDR and that this could only be achieved by a thorough reform of the economic system and the introduction of democracy. In textbook fashion the advisers set forth and discussed the fundamental conditions for changing the East German economic system into a market economy. The Advisory Panel recognized the importance of the exchange rate between the GDR-mark and the Deutschmark as a link between two areas of vastly different levels of productivity. ‘Careful steps towards a market exchange rate of the GDR-mark’ were considered necessary. The advisers condoned some quantitative exchange controls at the beginning, but expressed preference for exchange rate adjustment in the case of persistent disequilibrium in the foreign-exchange market. They warned against Bundesbank support of an arbitrarily chosen exchange rate for the GDR-mark because of the risk entailed for the stability of the Deutschmark. In order to attract a large flow of private capital from abroad which was considered essential for rebuilding the GDR economy, the advisers not only stressed the rapid move to a market-based economic system, but the eventual adoption of the Deutschmark as an all-German currency. They even went a step further by proposing that the best chances for successful integration of the GDR and for raising its standard of living was to tackle the immense task ‘under a common German roof’. On 20 January 1990, the Council of Economic Advisers published a special report on ‘Supporting economic reform in the GDR: prerequisites and potential’ (SVR 1990), charting in detail the reform course to be taken by East Germany. The Council recommended a fixed exchange rate of the GDR-mark against the Deutschmark rather than a flexible exchange rate. The latter was thought to be subject to large fluctuations during the period when the price system was still being reformed. Exchange rate fluctuations, however, would seriously impair the transformation of international prices into domestic relative prices. In contrast, an exchange rate fixed against the Deutschmark would allow the transformation of world market prices into domestic prices and could serve as a guideline for changes in domestic prices and wages. It would also provide the necessary orientation for the control of the money supply in a way which would guarantee price stability. Alternative exchange-rate solutions The above-mentioned reports testify to the fact that there was general agreement among the economic profession on the need for and the conditions of establishing a market-based economic system in the GDR. Most reform plans shared a basic prescription: first the GDR would have to transform its economic system, eliminate most of the existing distortions, restructure its economy on the basis of market-determined costs and prices, and raise productivity and competitiveness. Only then could the proper exchange rate between the GDR-mark and the Deutschmark be determined and fixed or —‘crowning’ the process—could a currency union with West Germany be established. But what to do in the near future? With an open border and the new right to travel abroad, East Germans were eager to acquire Deutschmarks. The travel fund, which replaced the ‘welcome money’ of DM100 per head paid out in West Germany to visiting East Germans, did not go far in meeting expenses abroad. A grey foreign-exchange market developed on which the GDR-mark continuously depreciated. At a rate of DM1 for M20, East Germans got very little for their day’s labour. At the same time their desire to participate in the high West German standard of living increased. Thus more and more people moved to West Germany and many at least got temporary jobs there. In view of the quick devaluation of the GDR-mark, the idea of introducing a flexible exchange rate was soon discarded. But introducing a fixed rate would also lead to a host of problems, starting with the choice of the ‘proper’ exchange rate: a rate which was high enough to benefit the consumers and thus relieve the pressure of migration would be unsustainable because of the big discrepancy in productivity and the still highly distorted relative prices. Further, if the exchange rate were irrevocably fixed, it could no longer serve as an adjustment mechanism. Rather, the adjustment burden of the integration process would have to be borne by the prices of goods and factors of production. If, for political or social reasons, reductions in wages and prices were not accepted, the country would become internationally uncompetitive. The result would be high unemployment and the need for larger transfer payments from West to East Germany to relieve social hardships and stem a renewed flood of migration. This was basically the position of the Bundesbank which argued vehemently against a fixed exchange rate between the GDR-mark and the Deutschmark, the near-term introduction of the Deutschmark as a common currency or even the official use of the Deutschmark in the GDR as a second currency. CHANCELLOR KOHL'S PROPOSAL OF A MONETARY UNION WITH EAST GERMANY All proposals for a slower pace of integration, the retention of the exchange rate as an instrument of adjustment, and the adoption of a common currency only after the GDR had achieved a thorough reform of its price and wage systems, a certain

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amount of restructuring, and an increase in its level of productivity were reasonable from an economic point of view. But they ignored the tide of emigration which could only be stemmed by a faster move toward economic and political unification. Mass demonstrations in East Germany for unification and for the immediate introduction of the Deutschmark as a symbol of economic freedom and prosperity, the rapid deterioration of economic conditions in East Germany, the imminent collapse of economic order, and the continuing massive exodus of people forced the Federal Government’s hand. On 7 February 1990, following a visit to Moscow at which he had obtained Gorbachev’s tacit approval of unification, West Germany’s Chancellor Kohl—in a surprise move— offered East Germany immediate negotiations regarding a monetary union conditional upon simultaneous economic reforms (Presseund Informationsamt der Bundesregierung 1990a, 1990b). The financial markets greeted the announcement with a sharp drop in the prices of German bonds, reflecting fear of an impending surge in inflation as well as the general increase in the demand for capital. The bond rate rose by a full percentage point. In the following weeks, many academic economists voiced their reservations against a swift formation of monetary union with East Germany. An immediate negative response came from the Council of Economic Advisers. Instead of a monetary union, the Council again advocated a stepwise approach to the convertibility of the GDR-mark (FAZ 1990). Other academic economists also warned of the high risk associated with this economic experiment (Hoffmann 1990). And most of the banking community responded with great scepticism (Handelsblatt 1990). But politics had surpassed economics, the die had been cast in favour of a monetary union. The campaign preceding the parliamentary elections in East Germany provided a platform for the West German political leaders to expound on the virtues of a social market economy and the advantages of an economic and monetary union. Chancellor Kohl, in particular, emphasized that East Germans would not lose purchasing power or welfare by accepting the monetary union. The East German elections of 18 March were in fact won by the ruling coalition in West Germany, because East Germany voted for economic and monetary union, for rapid unification with rich West Germany, and for the parties closest to the West German CDU which held the purse strings. The socialists and the (former) communists were voted down and even the small reform groups which had precipitated the revolution received only a few votes. It was the Deutschmark that the East Germans wanted and, if possible, at a very favourable rate. Now that East Germany had a legitimate, democratically elected government with Lothar de Maizi×re as the new prime minister, intra-German cooperation entered a new phase. The German Unity Commission went to work to prepare all aspects of the economic, monetary and social union. THE STATE TREATY On 18 May 1990, the governments of the Federal Republic and of the GDR signed the state treaty establishing an economic, monetary and social union to become effective on 1 July 1990. In six chapters and thirty-eight articles, the document which included a joint protocol on guidelines as well as nine appendices containing detailed legal procedures, spelled out the specifics of how the economic unification process was to be accomplished (Presse-und Information-samt der Bundesregierung 1990c). The State Treaty, which prepared the way for economic unification, was ratified by both East and West Germany on 22 June 1990. It has since been followed by the Unity Treaty, a document of almost 1,000 pages preparing for political unification, which was ratified by the parliaments of West and East Germany on 21 September 1990. The Unity Treaty not only filled gaps in the economic area which were left by the State Treaty and provided a large number of transitional regulations: it also spelled out the political, legal and administrative conditions under which the two nations were willing to merge. The GDR decided to become part of the Federal Republic of Germany under Article 23 of the West German Basic Law on 3 October 1990, the day of German unification. The first all-German elections were held on 2 December 1990. ECONOMIC EFFECTS OF GERMAN UNIFICATION The great euphoria with which the promise of German unification was initially met has since been replaced by more sober assessments of the economic effects on East Germany, on West Germany, and on the international community. While great hopes accompanied the rapid progress toward political unification and optimism pre-vailed about the longer-term benefits of economic unification, the transition demanded drastic adjustments in East Germany and a huge financial commitment by West Germany. The economic, monetary and social union between East and West Germany started, as planned, on 1 July 1990—with the actual conversion of the unloved GDR-marks into the desirable Deutsch-marks as the most visible sign of a new era beginning in East Germany.

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Effects on the conversion rates chosen In view of the dearth of data on the real and monetary state of the GDR economy, a multitude of official exchange rates and a greatly fluctuating free market for the GDR-mark, it was difficult to determine the ‘correct’ conversion rate between the GDRmark and the Deutschmark. The choice required a balancing act between important economic, social and political criteria. Equal consideration had to be given to keeping the inflationary risk to a minimum, to safeguard the competitiveness of GDR firms, to limit the budgetary costs, and to facilitate the social acceptance by the population in the GDR and the Federal Republic. To do justice to these—in part conflicting—goals, a differentiation between the flow and the stock variables was necessary. Regarding the stock variables, i.e. the assets and liabilities of the banking and financial system of the GDR, the conversion method chosen had to take account of the effect on the disposable financial assets of the savers as well as on the value of the firms’ debts to the banks. A general conversion rate of 1:1 would have implied a massive increase in the savers’ purchasing power leading perhaps to an inflationary consumption binge. For the firms and other debtors it would have meant a debtburdened start into the market economy. The conversion rate which was finally chosen constituted a compromise which generally converted all stock variables at a rate of M2 for DM1 with the exception of an age-graduated volume of private savings which, for social reasons, was converted at the rate of 1:1. The average conversion rate thus amounted to about 1.8:1. This was a rather generous rate compared to the other exchange rates previously applied by the GDR against the Deutschmark. For example, in trade with the Federal Republic the general rate of exchange had been M4.40 for DM1; since 1 January 1990 the official exchange rate for private citizens had been 3:1, since May 2:1. And —as we saw—the grey market rate had fallen as low as 20:1. At the conversion rate chosen for private savings, the introduction of the Deutschmark in East Germany resulted in a DM160 billion (13 per cent) jump in the level of the money stock M3. Following the expected shift of some of the additional money supply into less liquid assets, the total money stock M3 in the monetary union might have been 10 per cent higher than its former level in the Federal Republic. Since this corresponded roughly to the potential GNP added by the East German economy, it did not pose a threat to price stability. Regarding the flow variables (wage and salary payments, social security payments, etc.), the conversion rate was to provide only a reasonable initial base for nominal incomes in East Germany. The primary concern was the establishment of an appropriate relationship between DM-wages and GDR productivity which would not jeopardize the firms’ competitiveness right from the start. Since labour productivity in the GDR was estimated at 40 per cent of the West German level and the differential in average gross wages roughly corresponded to that ratio (although the wage comparison necessarily suffered from the different price and tax systems), the conversion rate of DM1 for M1 chosen by the government was not out of line. When the conversion rate for wages was negotiated, both governments had agreed that the expected rise in the East German price level and the increase in taxes and social security contributions (in accordance with the West German system) should not be offset by general wage increases. Wage agreements failed to reflect these considerations; wages were raised by 17 to 25 per cent before monetary union and by 25 to 50 per cent in the first bargaining round following 1 July. The high wage increases in advance of realized productivity gains, which frequently more than offset the cost savings accruing to the firms from the new tax and social security systems, must necessarily damage the competitive position of East German firms and aggravate the problem of unemployment which is unavoidable in the transition phase. Within two months of monetary unification (registered) unemployment in East Germany had risen from 80,000 to more than 360,000 for an unemployment rate of 4 per cent. In addition, 1.4 million people were registered as short-time workers. Unemployment was expected to peak at 1.5 million people in 1991 or at more than 15 per cent of the labour force. The argument of the trade unions that higher wages were justified by the expected increase in the East German consumer price index proved to be invalid. In fact, the first price index published for East Germany in July showed a general decline in the cost of living compared to the average of the previous year. Effect on private investment in East Germany The State Treaty, the Unity Treaty, the law on firms’ initial DM balance sheets, the new investment law which guaranteed the priority of employment-creating investment over old ownership claims, and the new ruling which transfers liability for old ownership claims to the government (i.e. the Trust Agency) have greatly simplified the difficult problem of property ownership as well as the issue of GDR firms’ existing debts. As a result of these recent legal decisions, major barriers to Western private investment in East Germany have largely been eliminated. The pessimism regarding the volume of private investment flowing into East Germany might not have been justified. In addition, information on Western involvement in East Germany was not systematically available, with the exception of the East German joint-venture statistic, but must be gleaned from newspaper reports, bank documentation or personal interviews. By the end of June, cooperations between West German and East German firms totalled between 2,500 and 3,000. Permits for

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large projects numbered ninety-two. Of the total number only 400 have been joint ventures with former state-owned companies, the rest have been newly founded small firms in the trades or other services. The capital of the joint-venture firms amounted to a total of DM1 billion, of which 55 per cent belonged to foreign owners. Most of the joint-venture applications have been in industry. Major locations have been the manufacturing centres of Berlin, Magdeburg, Dresden, Leipzig and Chemnitz. The construction sector including all upstream branches was subject to great interest with intensive competition for existing East German companies. While foreign investors, especially from Western Europe, were also getting increasingly involved in East Germany, the bulk of private investment was originating in West Germany. Besides some well-publicized large transactions in the hotel, airline, energy, banking and insurance sectors, there have been a good number of investment projects in the food and beverage industry. Much greater than in the non-durable consumer goods sector is West German involvement in the motor vehicles industry and especially in the non-electrical machinery sector. GDR firms in the latter sector have had close trade relationships with Eastern Europe, especially the USSR. Because of its specialization, this sector further offers a pool of highly qualified labour. Private investment in East Germany is the key to the revival of its economy. The sooner and the more new jobs are created in the new German states, the shorter and the lower will be total unemployment and the faster will the restructuring be completed. It is important, therefore, that the wage level not be raised too fast to West German standards, but remain related to the level of productivity. Relatively low labour costs are not the prime motive of West German investment in the Eastern states, however. A recent survey (Brander 1990) showed that lower labour costs rank approximately equal with capacity limits at home, favourable financing conditions and the availability of skilled labour. The major investment motive mentioned was the proximity to the Eastern German market, followed by East Germany as a bridgehead for business in Eastern Europe. The fiscal cost of unification The process of transforming and rebuilding East Germany requires sizeable transfers during the difficult phase of transition and a huge volume of future public and private investment. Figures for the total investment necessary to bring East Germany up to the West German standard of living range from DM650 billion to DM1000 billion and more. Whatever the true cost of reconstruction, it will necessarily be distributed over many years because real transfers take time and because East Germany’s absorptive capacity is limited. Based on West Germany’s average ratio of gross fixed investment to GNP of 23 per cent in the 1950s and 26 per cent in the 1960s, annual gross investment of around DM70 billion may be a reasonable figure for East Germany’s annual absorptive capacity for investment. Whereas most of the infrastructure investment will have to be provided by the public authorities, an increasing share of investment in East Germany will be private. More immediate is the concern of providing public transfers to East Germany to bridge the gap between output and consumption there. Additional financing needs of East Germany and with them the claims on the West German budget did rise from week to week. Unpredictable are the full expenditures for unemployment compensation, health insurance benefits and pensions in East Germany, where revenue shortfalls have been generated by higher than expected unemployment, by lower than expected contributions and by the inexperience of the firms and institutions regarding the collection and transfer of the contributions. In addition, the Trust Agency’s demand for funds has grown because privatizations have been delayed by organizational and legal problems and because the liquidity needs of the East German companies ‘owned’ by the Trust Agency have been substantial during the first weeks following economic unification. Furthermore, although actual outlays have been relatively small to date, the total volume of subsidies to be paid under investment promotion programmes cannot be foreseen. In addition, on 16 May 1990, two days before the State Treaty was signed, the West German federal and state governments agreed to set up the ‘German Unity Fund’ whose major purpose was to help finance the deficits in the East German budget during the coming four-and-a-half years. The establishment of the German Unity Fund with a volume of DM115 billion, of which DM95 billion had to be raised by borrowing and the remaining DM20 billion had to be generated by savings elsewhere in the budget, raising the borrowing requirement of the Federal Republic by DM20 billion in 1990 and DM31 billion in 1991.1 Added to this must be the borrowing authorization for the GDR government of DM10 billion in 1990 and DM15 billion in 1991.2 Including the three supplementary budgets for 1990, totalling DM38 billion, the net government borrowing requirement had been more than DM100 billion in 1990. The fiscal costs were estimated to rise to as much as DM150 billion in 1991. They included claims related to GDR trade agreements with former Comecon partners, claims arising from the cancellation of GDR company debt, as well as payments to the Soviet Union under the recently concluded agreement (DM13 billion over four years). In 1989, the West German government budget (national income accounts definition, including the social security surplus) showed a small surplus. In 1990 and 1991, the unified German public sector was estimated to run deficits which—including the German Unity Fund—amount to 3 to 4 per cent of GNP. Although this still compared favourably with public deficits in other European countries, it was a level which put undue strain on the capital markets and placed a severe burden on monetary policy efforts to contain inflation.

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International repercussions Most of the forecasts for West Germany3 predict a continuation of relatively high economic growth at tolerable rates of inflation. Growth is based on ‘normal’ domestic demand, supplemented by the additional demand generated by increasing integration of the two German states. The high German government deficit must be financed out of the financial surplus of the private domestic sector plus a drawdown of the balance-of-payments surplus. Tight monetary policy and expansionary fiscal policy correspond to the adjustment process of the Mundell/Fleming model: the German policy mix is expected to result in higher interest rates, capital imports and an appreciation of the Deutschmark. Capital imports will limit the rise in interest rates, the appreciation has the effect of lowering relative import prices which not only help to reduce the current account surplus but also defuse the risk of inflation. This scenario is believed to be too optimistic by some observers. In their view, the very expansionary fiscal policy entails great risks. They point to the fact that German capacity utilization is very high, that recent wage agreements have been higher than before and, together with declining productivity gains, are leading to substantial increases in unit labour costs. Faced with strong demand, producers will find it easier to pass on their higher costs. In a tight West German labour market wage demands may—after years of declining wage shares—react more promptly to the higher rate of inflation. With price stability gone and a high budget deficit, the exchange rate could depreciate, and capital imports could decline as foreign investors move their assets elsewhere. In order to defend the exchange rate, monetary policy will have to rely on high interest rates, domestic demand growth would slow down and so would GNP growth. Slow German growth, higher prices and interest rates would then have negative effects on other countries. The evidence to date supports the optimistic view. Although the huge inflow of long-term capital witnessed in the fourth quarter of 1989, in the euphoric phase, was reversed in the first quarter of 1990 as foreign as well as domestic investors preferred foreign assets, total net capital exports are clearly declining. The current account surplus is declining as well. In the second quarter of 1990, the surplus was lower by roughly a third compared to a year earlier and also (seasonally adjusted) compared to the preceding quarter. Net exports in real terms fell even more than the nominal trade balance because of declining import prices. The utilization of the current account surplus for the real adjustment in line with the process of unification has definitely started and may be expected to continue. The effective exchange rate of the Deutschmark has been rising, the largest appreciation occurring against the US dollar, the Canadian dollar and even the Japanese yen. Within the EMS, however, the German currency has rather tended toward weakness. This is the more surprising as price performance has consistently been better in Germany than in the other EMS countries. Increasing capital inflows in the form of direct investment are likely following political unification and adoption of West German law and administrative rules. Of the 12,000 nationalized firms in the GDR, 80 per cent had applied for reprivatization, 1,100 had been returned to their previous owners by the end of August 1990. There had been 136,000 business applications, and more than 100,000 small firms had been founded. After its recent reorganization, the Trust Agency is expected to make greater progress in its privatization efforts. Of the 8,000 state-owned companies under its roof, 7,000 have been formally transformed into joint stock companies, but only a few have been privatized to date. The process of German unification initially involves a large flow of transfers to soften the impact of ‘creative destruction’ on the population and to provide bridge financing for those firms which— after reorientation—may stay in business. These transfers will be followed by a huge investment programme, public and private, for the restructuring and rebuilding of the East German economic base. As mentioned above, there are great risks attached to this process. The adjustment may be relatively smooth generating high growth with little inflation; or adjustment may be bumpy with more inflation, higher unemployment and many economic setbacks. But in the longer run the outcome should be a modernized East German economy, adding to rather than detracting from the German growth potential. Whatever happens will happen in the centre of Europe, in a country with a very open economy which is closely integrated into the European Community, the world economy and international financial markets. By their very nature, the financial markets were the first to react to the events of autumn 1989. German bond rates rose by 2 percentage points between October 1989 and March 1990. The effect of a rise in German interest rates has a tendency to counteract the increase in German aggregate demand induced by unification. Likewise, the net effect on the international economy will also depend on the size of the demand boost, given the rise in interest rates. But the effect on the other countries will vary according to whether their exchange rate is fixed or flexible with respect to the Deutschmark. Theoretically, within the European Monetary System, the increase in German interest rates should be matched to keep exchange rates constant. In other countries, the reaction is likely to be much weaker. As a consequence there will be an appreciation of the EMS currencies against the dollar and the yen. Whereas the rate of inflation will slow in the EMS countries, it will accelerate in the others. But the higher interest rates and the higher exchange rates will tend to depress

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economic activity in the EMS countries. As the result of the interest rate increase alone, the expansion of world trade is expected to slow down. If the primary boost to German GNP of the unification-related growth in aggregate demand is now included in the analysis, the negative interest rate effect is shown to be more than offset by the positive income effect. The volume of world trade expands. For Germany the effect on GNP is, of course, the largest. Again the Deutschmark and with it the other EMS currencies appreciate. The decline in German net exports is reflected in an improvement of the current accounts of all its trading partners. The German demand stimulus may not be strong enough, however, to offset for the other EMS partners the negative impact of currency appreciation vis-à-vis the rest of the world. For them the net effect may well be deflationary. The United States and Japan, via the depreciation of their currencies, should enjoy a boost to their economies, but may also have to accept an increase in their price levels. Germany is also confronted with an acceleration of its rate of inflation. The failure of the EMS exchange rates to respond to the demand shock from Germany implies an output loss for Germany’s partner countries and inflation for Germany. This analysis has several implications: – Given the rise in German interest rates, the greater the German unification-related demand boost, the higher will be the positive net effects on the international economy, but it will be accompanied by a higher level of prices and interest rates. – Countries whose exchange rate is flexible with respect to the Deutschmark enjoy a greater improvement in their balances of payments and higher GNP growth than the countries whose exchange rates are tied to the Deutschmark. – Within the EMS the conflicts are obvious: (1) Germany will try to keep inflation to a minimum by pursuing a conservative monetary policy. This will keep interest rates high, depressing the partner countries’ economies. They would be better off if Germany inflated more. A higher level of German prices would improve their trade accounts with Germany, offsetting some of the losses vis-à-vis the depreciating non-EMS countries. (2) Whereas Germany will try to finance its unificationrelated budget deficit primarily via borrowing in the financial markets and a reduced capital outflow, its EMS partners would prefer a German policy mix which puts more emphasis on tax increases than on deficit financing of the costs of unification, thereby taking pressure off interest rates. NOTES 1 The federal subsidy to the Fund of DM2 billion in 1990 and DM4 billion in 1991 was deducted from the total of DM22 billion in 1990 and DM35 billion in 1991 because it is already contained in the federal budget. 2 The GDR Trust Agency’s borrowing which was authorized at DM7 billion in 1990 and DM10 billion in 1991, while adding to the total demand for credit, should not be counted as government borrowing as the funds are directly transferred to business. 3 See, for example, ifo digest (1990).

REFERENCES Brander, S. (1990) ‘Die DDR als Investitionsstandort aus der Sicht westdeutscher Unternehmer’, ifo Schnelldienst 26/27. Die Zeit (1989) ‘Challenges facing economic policy of the Federal Republic in its relationship with the GDR’, 1 December. FAZ (Frankfurter Allgemeine Zeitung) (1990) ‘Bedenken der Sachverstàn-digen gegen Wàhrungsunion’, 10 February. Gerstenberger, W. and Kischel, W. (1989) ‘Deutsch-deutsche Industries-truktur im Vergleich’, ifo Schnelldienst 34. Handelsblatt (1990) ‘Schnelle Verwirklichung der Wàhrungsunion kann Strukturprobleme der DDR nicht l−sen’, 8 February. Hoffmann, L. (1990) ‘Wider die −konomische Vernunft’, Frankfurter Allgemeine Zeitung, 10 February. ifo digest (1990) ‘Economic prospects 1990/1991: boom in the Federal Republic, disruption in the GDR’, No. 3. Presse-und Informationsamt der Bundesregierung (1990a) Bulletin, No. 11, 6 February. — (1990b) Bulletin, No. 12, 8 February. — (1990c) Bulletin, No. 63, 18 May. SVR (Sachverstàndigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung) (1990) ‘Zur Unterstétzung der Wirtschaftsreform in der DDR: Voraussetzungen und M−glichkeiten’, Sondergutachten, 20 Jan-uary.

2 Recent developments of world savings and investment Dieter Duwendag* Hochschule fér Verwaltungswissenschaften, Speyer

This chapter draws a broad picture of most recent developments of world savings and investment. In comparing these trends with past developments some background information can be provided for an assessment of the future direction of international capital markets and interest rates. To this end an attempt is made to identify the sources of major changes in savings and investment trends in important subgroups of the world economy: the OECD and the East European countries, both subdivided in further groups, and the less developed countries (LDCs). An extensive graphic representation may help facilitate the overview. Beforehand a short note on the database: for most IMF member countries savings and investment ratios could be easily calculated from International Financial Statistics (IMF 1990a). Because data on savings are normally not reported in these statistics, savings rates (S) were derived as a residual from the (ex-post) identity of investment (I) and the current account balance (CAB) [S=I CAB]. It should be noted that this procedure might suffer from the large statistical discrepancy in the world current account balance. Major data problems, however, arose with respect to the East European and Soviet economies, where the validity of official statistics is notoriously poor, particularly in so far as most recent trends and up-to-date prospects are generally concerned. In these cases it was necessary to collect data from various sources—both from official statistics and private projections—and to put the pieces together, in order to get some fairly reliable information. The paper starts by giving a brief overview of long-term developments of world savings and investment, it then proceeds with a more detailed review of recent trends in important subgroups of the world economy, and it ends with a summary and outlook. LONG-TERM OVERALL DEVELOPMENTS In the last two decades savings and investment behaviour in the two most important groups of the world economy (OECD, LDCs) has undergone major changes. Their common feature was a pronounced fall in both the average (gross) savings and (gross) investment ratios from the 1970s to the 1980s. For the OECD area as a whole, savings and investment rates fell by 2.5 and 2.0 per cent, respectively. Since both rates started from almost the same base level, a savings gap occurred (Figure 2.1). A similar picture holds for the LDCs as a whole, where average savings and investment rates declined by 4.5 (S) and 4.0 (I) per cent, thus leading to a widening of the savings gap (Figure 2.8). For the third subgroup, Eastern Europe and the USSR, the corresponding average data for the 1970s and the 1980s proved to be highly unreliable and hence were omitted here. As a result, in the course of the last two decades international competition for capital has considerably increased in the industrial (OECD) and the Third World IMF member countries, which represent a share of approximately 90 per cent of world savings and investment (the OECD alone comprises more than 75 per cent). The emergence and respective widening of the savings gaps in these two country groups—going hand in hand with growing current account deficits—is clearly reflected in a sharp rise of real rates of interest throughout the period considered. Taking for instance long-term US Treasury bonds as an indicator, their average (ex-post) real rates of interest have risen from –0.4 per cent in the 1970s to 6.3 per cent in the 1980s. In this context, long-term developments of savings and investment behaviour do not appear to have confirmed a phenomenon which became known as the Feldstein-Horioka ‘puzzle’ (1980). In their study, the authors found a strong correlation between national savings and investment rates for the years 1960 to 1974: a ‘puzzling’ result in so far as in a world of international capital mobility, national savings and investment need not be related anyhow. Actually, the evidence from the 1980s points to this direction (Figures 2.1, 2.2, 2.8): the emergence, the widening and the persistence of savings-investment gaps (and of external imbalances) were associated with and permitted by increasingly integrated world capital markets in the 1980s (liberalization, financial innovations). Recent research on this issue by Feldstein and Bacchetta (1989), Artis and Bayoumi (1990), and Dean et al. (1990) seems to confirm these results. Dean et al. (1990:18) showed that for twenty-three OECD countries the coefficients in the savings-investment regressions are drifting down from close to 1.0 in the 1960s and early 1970s to only 0.58 for the period 1983–7.

WORLD SAVINGS AND INVESTMENT

11

Figure 2.1 USA, Japan, OECD total: gross national savings (Sg) and investment (Ig); per cent of GNP.(a) Sources: Dean et al. (1990); IMF (1990a, c); Commission of the EC (1989, 1990a). Notes: (a) 1971–80 and 1981–8: averages. (b) Data for 1991 are partly author’s estimates, based on IMF (1990a) projections. (c) 1990–1 data are own estimates based on IMF (1990c) projections of changes in real gross fixed investment relative to real GNP.

RECENT TRENDS IN SPECIFIC AREAS OECD, United States, Japan Starting from a post-war low in 1986, savings and investment rates for the OECD area as a whole have picked up quite strongly in most recent years. According to IMF (1990c) projections, both rates are likely to approach their higher average levels of the 1970s in 1991, associated with a doubling of the savings gap (0.6 per cent) compared with 1989 (Figure 2.1). As a consequence, the role of the OECD as a net demander of world savings has considerably increased in the last two years. At the OECD level, changes in specific countries are bundled up and reflected in relatively small net effects. Looking at national levels, savings and investment rates and trends have differed substantially across OECD countries with the United States, Japan and the European Community (EC) being the three main economies. For the United States and Japan, for example, opposite trends as well as considerably differing rates can be observed (Figure 2.1). Although savings and investment rates in the United States are traditionally and, compared with world standards, relatively low, the corresponding Japanese rates were approximately twice as high as the US rates in the last three years. As concerns the trends from 1986 to 1991, US savings rates have moved slightly upwards and investment rates slightly downwards, whereas in Japan savings rates have increased by 3.3 per cent and investment rates by 6.0 per cent. Since the early 1980s, when the United States became a net demander and Japan a net supplier of savings for the rest of the world, these positions have not changed fundamentally. However, compared with 1986, the United States is projected to narrow its savings

12

DEVELOPMENTS IN EASTERN EUROPE

gap by 50 per cent and Japan its investment gap by even more than 60 per cent in 1991. Taking into account that both economies have almost the same proportion of world savings and investment, the net effect of both (opposite) trends is likely to result in a tightening of financial constraints on capital markets and thus in an upward pressure on interest rates. European Community, West and united Germany The twelve EC countries are discriminated between those with a savings gap and those with an investment gap since 1986 (Figure 2.2). Each group comprises six countries with almost exactly the same weight (in GDP purchasing power standards) so that quantitative changes in savings and investment trends in both groups are directly comparable. For the first group with I<S, that is where national savings have been inadequate to finance investment, the savings gap has rapidly mounted up to 2.5 per cent in only three years and is projected to maintain that level until 1991. For the second EC country group with S
WORLD SAVINGS AND INVESTMENT

13

Figure 2.2 EC: gross national savings (Sg) and investment (Ig) (per cent of GDP).(a) (1) Six EC countries(b) with Ig > Sg in recent years(c) (2) Six EC countries(d) with Sg > Ig in recent years(c) (3) West Germany and united Germany(e, f) Sources: Dean et al. (1990); Commission of the EC (1989, 1990a, b); Deutsche Bundesbank (1990); DIW (1991). Notes: (a) 1971–80 and 1981–8: averages. (b) Denmark, Greece, Spain, Italy, Portugal, UK. (c) GDP–weighted averages (EC purchasing power standards); own calculations. (d) Belgium, Luxemburg, West Germany (1990–1: united Germany), France, Ireland, Netherlands. (e) Straight lines refer to West Germany, dotted lines to united Germany (1990–1; estimates by DIW). (f) CAB =current account balance (per cent of GDP).

these projections again are generally based on the assumption of broadly unchanged policies. This means that only such amounts of foreign capital inflows have been taken into account that the developing countries might realistically attract. SUMMARY AND OUTLOOK During the last two decades savings and investment rates in all important groups of the world economy declined markedly. From the 1970s to the 1980s this process was associated with the emergence, the widening and the persistence of large savings-investment gaps in specific country areas, a phenomenon fostered by financial deregulation and increasingly integrated world capital markets. Consequently, international competition for capital increased considerably and was clearly reflected in a sharp rise of real interest rates during the last two decades. As concerns the period from the mid-1980s onwards and most recent trends, savings and investment rates in the OECD area as a whole have picked up quite strongly and on balance led to a doubling of its savings gap. In contrast, savings and investment rates in the developing countries have remained around their depressed average levels realized in the 1980s. As a

14

DEVELOPMENTS IN EASTERN EUROPE

Figure 2.3 Eastern Europe and the USSR: gross national savings (Sg) and investment (Ig), current account balance (CAB). Sources: IIF (1990); Handelsblatt (1990a, 1991). Notes: (a) Straight lines refer to IFF data, dotted lines to ‘External trade bank of the USSR’ data (1987–9) and to IMF CAB projection for 1990–1 reported in Handelsblatt. (b) Sn, In: net savings, net investment (‘accumulation’), both in per cent of NMP. (c) Straight line: according to IIF ‘net exports plus losses’ in per cent of NMP; dotted line: CAB in per cent of GNP (1990 n.a.)

Figure 2.4 Eastern Europe and Poland: gross national savings (Sg) and investment (Ig), current account balance (CAB). Sources: IMF (1990a); World Bank (1990); ABECOR (1990a). Notes: (a) In per cent GDP. 1983–8: IMF (1990a) data; 1989–90: World Bank (1990) projections (‘improved case’ assumed). (b) Transactions in all currencies.

result, the role of the OECD as a net demander of world savings has substantially increased. Among the many factors contributing to this increase the most important are the European Community’s swing from a net supplier to a net demander position of world savings on the one hand and strong investment in Japan on the other. The driving forces behind the stimulation of investment Western Europe can be seen in the run-up to the 1992 EC single market and in the effects of economic unification in Germany. Within the OECD area, the United States is, despite the ongoing ‘twin deficits’, projected to narrow its savings gap and Japan to narrow its investment gap until 1991. Taken separately, these trends will have opposite effects on capital markets. However, with Japan’s substantial drop in the outflow of savings to the rest of the world outweighing the narrowing of the savings gap in the United States, the net effect of both trends is likely to be a tightening of capital markets conditions. There are two other important calls on world savings: the need for funds to finance reconstruction in Eastern Europe and the Soviet Union and the continuing requirement for capital to finance development in the Third World. Most recent

WORLD SAVINGS AND INVESTMENT

15

Figure 2.5 Eastern Europe and Hungary: gross national savings (Sg) and investment (Ig), current account balance (CAB). Sources: IMF (1990a); National Bank of Hungary (1990); ABECOR (1990b). Notes: (a) In per cent of GDP. (b) Transactions in all currencies, except for 1990 (in convertible currencies); 1990 CAB projected by ABECOR (1990b) and National Bank of Hungary.

Figure 2.6 Eastern Europe and Romania: gross national savings (Sg) and investment (Ig), current account balance (CAB). Sources: IMF (1990a); ABECOR (1988). Notes: (a) In per cent of GNP. Sg and Ig data for 1987 not reported by the IMF (omitted). (b) Transactions in all currencies. CAB in per cent of GNP. Data for 1988–90 are estimates by ABECOR.

projections point to the fact that the East European and Soviet economies are on the march into aggravating current account deficits and thus into huge savings gaps. The funds absorbed in this area might well be at the expense of the developing countries. Summing up, an overall assessment leads to the conclusion that increasing global investment will continue to put pressure on capital markets in the coming years. In order to avoid higher interest rates and to match increasing investment demands, global savings will need to rise, the latter especially being brought about through a reduction in public sector dissaving. NOTE * I am grateful to Karola Pfeiffer and Thomas Gàckle for helpful assistance in plotting the charts.

16

DEVELOPMENTS IN EASTERN EUROPE

Figure 2.7 Eastern Europe and the CSFR: gross national savings (Sg) and investment (Ig), current account balance (CAB). Sources: Heitger (1990); Prust et al. (1990); BIS (1990); ABECOR (1990c); Handelsblatt (1990c). Notes: (a) In per cent of NMP. (b) In (‘accumulation’): net fixed investment plus change in stocks and unfinished construction. Sn calculated as residual. (c) 1983–9: transactions in all currencies (J. Prust et al. and BIS data). 1990–1: transactions in convertible currencies (ABECOR 1990c) and Handelsblatt (1990c estimates).

Figure 2.8 Developing countries: gross national savings (Sg) and investment (Ig); per cent.(b,c,d) Sources: Aghevli et al. (1990); IMF (1990c). Notes: (a) IMF definition. (b) In per cent of national income (1976–88) and GDP (1989–91), respectively. (c) 1991 data are own estimates based on IMF (1990c) projections of changes in real GDP and the current account deficit. (d) 1976–81 and 1982–8: average.

REFERENCES ABECOR (Association of European Banks) (1988) Romania Country Report, September. — (1990a) Hungary Country Report, 23 April. — (1990b) Poland Country Report, 20 June. — (1990c) CSFR Country Report, 9 July. Aghevli, B.B. et al. (1990) ‘The role of national saving in the world economy, recent trends and prospects’, Occasional Paper 67, Washington, DC: International Monetary Fund. Artis, M. and Bayoumi, T. (1990) ‘Saving, investment, financial integration, and the balance of payments’, Staff Studies, International Monetary Fund, Washington, DC. BIS (Bank for International Settlements) (1990) 60th Annual Report, Basle: BIS. Commission of the EC (ed.) (1989) ‘Statistical annex’, European Economy 42:243. — (1990a) ‘Statistical annex’, European Economy 46:217–92. — (1990b) ‘Supplements’, European Economy 6:1. Dean, A. et al. (1990) ‘Saving trends and behaviour in OECD countries’, OECD Economic Studies 14:7–58. Deutsche Bundesbank (1990) Monthly Reports. DIW (Deutsches Institut fér Wirtschaftsforschung) (1991) ‘Grundlinien der Wirtschaftsentwicklung 1991’, Wochenbericht 1–3. Feldstein, M. and Horioka, C. (1980) ‘Domestic saving and international capital flows’, Economic Journal 90:314–29.

WORLD SAVINGS AND INVESTMENT

17

— and Bacchetta, P. (1989) ‘National saving and international investment’, NBER Working Papers 3164. Handelsblatt (1990a) ‘External trade bank of the USSR, underwriting prospectus’, 31 July. — (1990b) ‘National Bank of Hungary, underwriting prospectus’, 23 October, Washington, DC. — (1990c) ‘Report’, 31 December. — (1991) ‘Report’, 25/26 January. Heitger, B. (1990) ‘Wirtschaftliches Wachstum in Ost und West im internationalen Vergleich seit 1950’, Die Weltwirtschaft 1:173–92. IIF (Institute of International Finance) (1990) ‘USSR country report’, 11 May. IMF (International Monetary Fund) (1990a) International Financial Statistics, Washington, DC: Publication Services International Monetary Fund. — (1990b) World Economic Outlook, Washington, DC, May. — (1990c) World Economic Outlook, Washington, DC, October. Prust, J. et al. (1990) ‘The Czech and Slovak Federal Republic: an economy in transition’, Occasional Paper 72, Washington, DC: International Monetary Fund. World Bank (1990) Poland: Economic Management for a New Era, Washington, DC: World Bank.

3 Causes and consequences of the expected shift in the savings± investment balance in Europe: the case of German unification Karlhans Sauernheimer University of Munich

INTRODUCTION This chapter discusses the causes and consequences of the expected shift in the savings-investment balance in Europe, especially in Germany. We are mainly interested in the macroeconomic effects of the German unification and their spillovers to other countries. The study is structured as follows: The first section briefly reviews the world savings and investment trends of the recent past. The second section considers the most important aspects of a savings gap in Europe, which could occur in the near future. The third section analyses the effects of a regional savings gap on the rest of the world. At first we will look back at the traditional two-country macro-model à la Mundell (1968). Then we proceed to the three-country models, which enable us to study the interactions between a twocountry exchange-rate union and a third country. Finally we develop a simple exchange-rate union model, stressing supplyside interactions between the countries. With the help of this model it should be possible to derive some international transmission effects of the expected rise in investment in the united Germany, which is an EMS member country. The fourth section gives an account of some empirical work on the worldwide effects of German unification. The last section concludes the chapter with an outlook. SAVINGS AND INVESTMENT IN THE RECENT PAST: SOME FACTS The national savings rate of the industrialized countries, measured as a percentage of GNP has declined from 24 per cent to 20 per cent between 1965 and 1987 (Figure 3.1).1 During this time-span the industrial countries suffered from two oil-price shocks, which triggered a decline in the savings rate from 26 per cent in 1973 to 19 per cent in 1983. A breakdown of the national savings rate into sectoral rates shows that more than two-thirds of the savings loss between 1973 and 1983 can be traced to the government’s savings rate. The private sector’s savings rate, aggregated over households and enterprises, proved to be remarkably stable (Figure 3.2). Figure 3.3 shows the noticeable international differences in the savings rates. Between 1980 and 1987 the savings rate was high in Japan (31 per cent), on the average in Germany (22 per cent), Canada (21 per cent) and France (20 per cent), low in the UK (18 per cent) and in the USA (17 per cent). The decline in the savings rate in the industrial countries as a group (Figure 3.1) can also be observed in each of the G-5 countries and in Canada (Figure 3.4), most clearly in the case of France. If we add the national investment rates to the picture and compare them with the national savings rates, we arrive at the national current accounts. For the industrial countries as a group, Figure 3.1 exhibits two interesting facts: saving and investment rates move largely parallel over the cycle; the structural surplus up to 1973 changed into a structural deficit after 1979. Figure 3.4 reveals that within the group there are large differences amongst individual countries. After 1982 the USA experienced rising current account deficits, whereas on the other hand Germany and Japan were showing rising surpluses. In the USA what came to pass was rising investment rates combined with declining savings rates, whereas the opposite occurred in Japan. In Germany the rising savings rate eventually brought about the improvement in the current account. A breakdown of the national savings rate into private respective public savings for individual countries is shown in Figure 3.5. More recent data on savings and investment for the USA, Japan, Germany and the EC, including the years 1988 and 1989 can be found in Figure 3.6. Apparently in the last two years the savings rate increased in all three countries, strongly in Germany and Japan, weakly in the USA. The investment rate increased tremendously in Japan, less in Germany, but in the USA it fell. Consequently, the current account imbalances were reduced in the USA and Japan.

DEVELOPMENTS IN EASTERN EUROPE

19

Figure 3.1 Industrial countries: gross national savings, gross domestic investment and current account balance, 1965–87 (per cent of GNP). Source: Aghlevi et al. (1990); IMF (1990).

Figure 3.2 Selected major industrial countries: gross savings rates by sector, 1965–87 (per cent of GNP). Source: Aghlevi et al. (1990); IMF (1990).

SAVINGS AND INVESTMENT IN EUROPE: EXPECTED FUTURE DEVELOPMENTS The future development of the global savings-investment balance will probably be strongly influenced by the development in Europe. There are three reasons for this. The German unification The first free elections in East Germany since the Second World War took place on 18 March 1990 and brought an overwhelming victory for the democratic parties. They built a coalition government, which decided to unite East Germany to West Germany. Based on this decision, the two governments signed a treaty (Staats-vertrag), establishing a monetary, economic and social union. It came into existence on 1 July. The political unification was realized on 3 October. Election day on 2 December, when one central parliament for the whole country was chosen, ended this unification process.

20

SAVINGS-INVESTMENT BALANCE IN EUROPE

Figure 3.3 Industrial countries: gross national savings, 1980–7 (average in per cent). Source: Aghlevi et al. (1990); IMF (1990).

With the accession of the GDR to the FRG, East Germany became a part of the West German economic system. In order to close the large economic gap between the two regions it became necessary to induce a flow of private and public investments into Eastern Germany so as to modernize and raise the capital stock there and a flow of governmental transfers in order to ease the adjustments to a market economy and to have the adjustments socially acceptable. The strongly needed public investments to build a new infrastructure and the equally needed transfer payments will not be able to be paid for only by the current tax revenues. The treaty of 1 July allowed the government to establish a DM115 billion ‘Fonds German unification’, financed partly by spending cuts (DM20 billion), partly by additional public debt (DM95 billion). Spending and financing should be spread over four years. By now it is clear that the volume was far too low, roughly less than half of what is needed in fact. Estimates assumed that public deficits will now rise temporarily from 2 per cent to 5 per cent of GNP, or, in absolute terms from DM40 billion to DM100 billion.2 Evidently a gap did arise between investments and savings in the private as well as in the public sectors of the German economy. Eastern Europe The transition to a market economy system in Eastern European countries and in the Soviet Union will strengthen investment demand there too. Deregulation and privatization will create economic incentives and activities. However, the lack of savings in these countries will require them for a long time to come to import capital. The Western nations can hardly avoid to meet these demands for capital, otherwise the transition to market economy and democracy in Eastern Europe would probably be somewhat hampered.3 Completion of the EC internal market by 1992 The Single European Act 1987 provides the completion of the internal market in the EC countries by 1992. The stronger integration will intensify competition. EC firms will have to invest and to innovate in order to be able to survive in more open markets. A portion of this investment push has already taken place.4 (See Tables 3.1 and 3.2) Further investments will follow. Until the returns from these investments allow for additional savings, the financial needs will be a burden for the international capital markets.

DEVELOPMENTS IN EASTERN EUROPE

21

Figure 3.4 Selected major industrial countries: gross national savings, domestic investment and current account balance, 1965–87 (per cent of GNP). Source: Aghlevi et al. (1990); IMF (1990).

22

SAVINGS-INVESTMENT BALANCE IN EUROPE

Figure 3.5 Selected major industrial countries: national, private and general government gross savings rates, 1965–87 (per cent of GNP). Source: Aghlevi et al. (1990); IMF (1990).

Summary Due to the above-mentioned reasons there will probably be a gap between investments and savings in Europe at the beginning of the 1990s. But because the gap follows mainly from higher investment spending, less from higher consumption, problems for the world economy should only arise in the short run, not in the long run. In the long run, the investments raise productivity, income and savings. In the short run, however, there will be an excess demand in the international capital markets, driving up interest rates internationally. There is not much hope for a compensation of European excess demand for capital in other parts of the world. US savings suffered from recession and military expenditures rose because of the Gulf crisis. In the LDCs the demand for capital will remain high. Now, if the additional European investment demand is not compensated for in other parts of the world, what will be the consequences?

DEVELOPMENTS IN EASTERN EUROPE

23

Figure 3.6 Selected industrial countries and the EC: gross national savings, domestic investment and current account balance, 1965–89 (per cent of GNP). Source: Kommission der EG (1989).

INVESTMENT SHIFTS AND INTERNATIONAL INTERDEPENDENCE: THEORY The traditional two-country model The basic approach in discussing the global consequences of a regional investment shift is still Mundell’s (1968) two-country model. Mussa (1979) summed up the development of the model in the 1970s. More modern variants can be found in Frenkel and Razin (1987) as well as Genberg and Swoboda (1989). Mundell Mundell studied two Keynesian fixed-price economies whose production levels are governed solely by demand. The level of demand depends on income and the interest rate, its structure on relative prices, i.e. the exchange rate. The money supply is exogenously determined for the world economy under fixed exchange rates, for each country separately under flexible

24

SAVINGS-INVESTMENT BALANCE IN EUROPE

exchange rates. Money demand depends in Keynesian tradition on income and the interest rate. There prevails perfect international capital mobility and the actual exchange rate is expected to persist. Under these conditions a rise in investment demand at home leads to an increase in the world interest rate and to an income expansion in the domestic economy. With flexible exchange rates income also expands abroad, the direction of the exchange rate change being unclear. With fixed rates on the other hand, the income change abroad remains unclear. The foreign income rises (falls), if the domestic income expansion raises imports by more (less) than the higher interest rate lowers expenditure abroad. In relatively open economies, i.e. economies with a large propensity to import, we should expect positive transmissions of the business cycle, independent of the exchange-rate system. In the case of flexible exchange rates this result follows directly from the money market equilibrium conditions: income and interest rate (with fixed rates: interest rate and income-induced money demand) always move in the same direction, if the disturbances originate in the goods markets. With national interest rates tied together through international capital mobility, incomes must move in the same direction. Mussa If one takes into consideration—contrary to Mundell—the effects of exchange-rate changes on wages and prices, we reach different conclusions concerning the transmission of business cycles. Devaluations no longer appear in the light of their demand expansion, but in the shadow of their cost and price effects. When with rising investments at home the domestic currency appreciates, the foreign country’s import prices and its absorption price index rise. If this Table 3.1 Real gross investment in Europe, the United States and Japan, 1961–90 (per cent change) B

DK

D

GR

E

F

IRL

I

L

NL

P

UK

EUR 12

USA

JA

1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1961–70 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1971–80

12.4 5.9 0.1 14.7 4.1 6.8 2.9 1.3 5.3 8.4 5.8 1.9 3.4 7.0 6.9 1.9 4.0 0.0 2.8 2.7 4.6 2.2

13.9 6.7 2.4 23.5 4.7 4.3 5.4 1.9 11.8 2.2 7.0 1.9 9.3 3.5 8.9 12.4 17.1 2.4 1.1 0.4 12.6 0.8

6.7 4.0 1.4 11.4 4.7 1.2 6.9 3.6 9.8 9.4 4.4 6.1 2.7 0.3 9.6 5.3 3.6 3.6 4.7 7.2 2.8 1.4

8.1 8.4 5.5 20.7 12.8 3.2 1.6 21.4 18.6 1.4 9.3 14.0 15.4 7.7 25.6 0.2 6.8 7.8 6.0 8.8 6.5 2.8

17.9 11.4 11.4 15.0 16.6 12.7 6.0 9.4 9.8 3.0 11.2 3.0 14.2 13.0 6.2 4.5 0.8 0.9 2.7 4.4 0.7 1.6

10.9 8.5 8.8 10.5 7.0 7.3 6.0 5.5 9.2 4.6 7.8 7.3 6.0 8.5 1.3 6.4 3.3 1.8 2.1 3.1 2.6 2.5

15.9 14.8 12.0 11.6 10.0 3.0 6.5 13.1 18.3 0.3 9.8 8.8 7.4 16.2 11.6 2.6 13.6 4.1 18.9 13.6 4.7 5.9

11.6 9.8 8.1 5.8 8.4 4.3 11.7 10.8 7.8 3.0 5.1 3.2 0.9 7.7 3.3 12.7 2.3 0.4 0.1 5.8 9.4 1.1

9.0 7.8 14.2 22.1 13.9 5.1 7.9 4.2 10.5 10.2 3.7 10.8 6.9 12.3 6.1 6.9 3.8 1.1 1.3 4.1 11.8 2.7

6.0 3.4 1.1 19.2 5.3 8.0 8.5 11.2 2.2 7.5 6.7 1.5 2.3 4.2 4.0 4.4 2.2 9.7 2.5 1.7 0.9 0.2

6.7 1.7 15.3 4.0 10.3 17.9 5.2 9.3 8.1 11.4 6.9 10.2 14.0 10.3 6.1 10.6 1.3 11.5 7.1 2.2 8.6 4.1

9.8 0.7 1.4 16.6 5.2 2.6 8.7 6.3 0.6 2.5 5.2 1.8 0.2 6.5 2.4 2.0 1.7 1.8 3.0 2.8 5.4 0.4

9.9 6.0 4.9 8.8 3.4 4.8 4.3 6.6 6.8 5.0 6.0 2.6 3.8 6.1 1.9 6.4 2.5 0.7 2.2 3.3 2.0 1.4

1.4 6.7 7.3 6.6 9.3 4.0 1.0 6.4 1.8 3.7 3.8 5.8 8.7 6.2 6.0 10.7 6.9 11.4 9.5 2.4 6.8 2.5

23.4 14.1 11.9 15.7 4.6 14.0 18.1 20.5 18.9 16.9 15.7 4.5 10.0 12.6 9.5 1.2 2.7 4.0 8.5 5.3 0.0 3.5

1981 1982 1983 1984 1985 1986 1987 1988

16.4 1.7 4.2 2.1 1.0 3.7 7.6 12.9

2.3 5.7 0.1 5.3 2.5 1.4 5.2 4.9

6.7 .4 11.6 0.4 3.3 15.8 5.3 4.5

0.1 8.7 8.8 15.9 6.9 0.9 3.1 5.4

3.1 0.8 0.3 4.9 5.8 6.0 10.3 13.6

19.2 7.1 1.9 12.9 11.8 17.3 9.0 6.5

4.8 5.3 3.2 0.8 0.1 3.3 1.8 5.9

7.5 1.9 1.3 5.7 5.2 5.7 3.2 9.0

3.3 0.5 2.5 5.8 4.1 10.0 14.6 14.0

1.9 1.4 3.6 2.6 2.8 2.9 3.7 7.3

9.5 3.4 9.3 2.0 6.6 0.3 0.0 1.7

10.4 4.1 2.1 5.4 6.8 8.2 1.6 9.7

5.7 3.4 7.6 17.2 3.4 9.5 19.5 15.8

9.6 5.4 5.0 8.6 3.8 0.9 5.5 13.1

4.8 2.0 0.1 1.5 2.5 3.4 4.8 8.3

DEVELOPMENTS IN EASTERN EUROPE

1989 12.3 0.0 7.7 1990 5.8 2.2 5.1 1981–90 2.0 1.3 1.7 Source: Kommission der EG (1989).

6.6 6.4 0.0

13.9 9.9 5.3

5.6 5.5 1.8

8.6 10.0 0.3

5.2 4.0 2.0

4.3 4.0 0.9

6.7 1.4 2.6

11.6 10.0 4.2

4.6 1.7 3.8

6.9 4.9 2.5

2.2 3.6 3.6

25

9.8 5.4 5.9

Table 3.2 Current account balances in Europe, the United States and Japan, 1960–90 (per cent of GDP) 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1961–70 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1971–80

B

B/L

DK

D

GR

E

F

IRL

I

L

NL

P

UK

EUR 12 USA

JA

0.1 0.1 0.6 0.5 0.2 0.6 0.3 0.8 0.9 1.2 2.8 0.6 2.1 3.6 2.0 0.4 0.1 0.3 1.1 1.3 2.9 4.3 0.1

0.7 0.2 0.6 0.5 0.1 0.6 0.2 1.1 1.2 1.7 3.3 0.8 2.3 3.9 2.6 1.5 0.5 1.1 0.3 0.5 2.0 3.4 0.5

1.1 1.7 3.2 0.1 2.2 1.8 1.9 2.4 1.7 2.8 3.9 2.1 2.4 0.4 1.7 3.1 1.5 4.9 4.0 2.7 4.7 3.7 2.9

1.7 1.1 0.2 0.4 0.3 1.2 0.3 2.2 2.3 1.4 0.6 0.7 0.4 0.4 1.3 3.1 1.2 1.1 0.9 1.4 0.8 1.7 0.7

2.9 2.2 1.6 2.2 4.3 5.8 2.0 2.2 3.6 4.0 3.1 3.1 1.5 1.2 3.8 2.8 3.7 1.9 1.9 1.3 1.9 0.5 1.9

3.8 1.9 0.1 1.5 0.1 2.1 2.1 1.5 0.8 1.1 0.2 0.7 2.2 1.5 0.8 3.5 2.9 3.9 1.7 1.0 0.5 2.4 0.8

1.5 1.1 1.0 0.3 0.3 0.8 0.1 0.0 0.5 1.1 0.8 0.2 0.9 1.0 0.6 1.3 0.8 0.9 0.1 1.4 0.9 0.6 0.3

0.1 0.2 1.8 2.8 3.5 4.4 1.6 1.4 1.3 4.8 4.0 2.3 3.8 2.2 3.5 9.9 1.5 5.3 5.4 6.8 13.4 11.8 6.3

0.8 1.2 0.6 1.4 1.1 3.6 3.2 2.2 3.3 2.7 1.2 1.8 1.8 1.6 1.7 4.6 0.2 1.5 1.2 2.4 1.7 2.2 0.2

12.5 6.5 0.6 0.2 0.1 0.7 1.7 7.4 9.7 14.0 15.1 5.6 6.3 10.2 16.2 26.2 16.7 21.3 21.3 19.3 21.5 18.9 17.8

3.0 1.4 1.0 0.7 1.1 0.1 1.0 0.3 0.3 0.3 1.4 0.0 0.3 2.8 3.8 3.1 2.5 2.9 0.8 0.9 1.2 1.5 1.2

4.0 10.0 3.4 3.3 0.0 0.4 0.8 3.7 1.5 3.6 1.9 0.6 2.5 5.5 3.0 6.2 5.5 8.0 9.4 5.7 1.7 6.0 3.2

1.0 0.0 0.4 0.3 1.3 0.4 0.1 0.9 0.8 0.6 1.3 0.1 1.8 0.1 2.0 4.5 2.0 1.7 0.1 0.4 0.1 1.6 0.6

0.8 0.7 0.3 0.1 0.3 0.1 0.4 0.6 0.8 0.6 0.7 0.4 1.0 1.0 0.2 1.0 0.0 0.6 0.0 0.9 0.1 1.2 0.0

0.5 1.6 0.1 1.0 0.5 1.1 1.3 0.0 0.8 1.3 1.0 0.2 2.5 2.2 0.0 1.0 0.1 0.7 1.5 1.7 0.9 1.0 0.6

1981 3.8 2.8 3.0 0.7 1982 3.6 2.1 4.2 0.5 1983 0.6 1.0 2.6 0.7 1984 0.4 1.2 3.3 1.3 1985 0.5 2.3 4.6 2.6 1986 2.0 3.6 5.2 4.4 1987 1.2 2.6 3.0 3.9 1988 1.0 1.7 1.8 4.1 1989 0.8 1.4 2.0 5.3 1990 0.8 1.4 1.1 5.8 1981–90 0.2 1.0 3.1 2.8 Source: Kommission der EG (1989).

0.7 4.4 5.0 4.0 8.2 5.2 2.5 1.5 3.4 3.5 3.8

2.7 2.5 1.5 1.4 1.6 1.7 0.1 1.1 2.9 4.0 1.0

0.8 2.1 0.8 0.0 0.1 0.5 0.4 0.4 0.5 0.5 0.5

14.7 10.6 6.9 5.8 4.0 2.9 1.4 2.0 2.0 1.8 3.8

2.2 1.6 0.3 0.7 0.9 0.5 0.1 0.6 1.3 1.4 0.8

21.4 34.7 39.6 39.2 43.8 39.4 33.0 16.4 14.9 14.5 29.7

2.2 3.2 3.1 4.2 4.1 2.8 1.6 2.4 2.1 2.1 2.8

12.2 13.5 8.3 3.4 0.4 3.9 1.8 1.4 2.8 3.4 3.9

2.6 1.5 0.9 0.2 0.7 0.9 1.6 3.2 4.1 3.3 0.8

0.6 0.8 0.7 0.8 1.2 0.9 0.5 0.4 0.2 0.2 0.4 0.6 0.0 0.3 0.7 0.5 1.4 0.5 0.4 0.5 0.1 0.4 0.2 0.7 0.7 0.1 0.3 0.8 1.4 0.8 0.3 0.1 0.3 0.3

0.3 0.0 1.0 2.4 2.9 3.4 3.6 2.4 1.9 1.8 1.9

0.5 0.7 1.8 2.8 3.7 4.3 3.7 2.8 2.3 2.4 2.5

price increase lowers the real money supply by more than the higher interest rate lowers money demand, income contractions result in the foreign country. The international transmission of business cycles becomes negative. A negative transmission will also arise, if initially real-wage unemployment exists, not as in Mundell’s case, Keynesian unemployment. When again with rising investment at home the domestic currency appreciates, workers abroad will try to raise their nominal wages in order to compensate for the rising import prices. The foreign cost and price level will rise and production and employment will fall. The deterioration of the terms of trade works no longer by their demand effects as an expansionary programme, but by their cost effects as a contractionary force.

26

SAVINGS-INVESTMENT BALANCE IN EUROPE

Frenkel and Razin Frenkel and Razin extended Mundell’s model to include the stock adjustment processes originating from budget and current account deficits/surpluses. They are able to distinguish between short-run and long-run effects of changes in the aggregate demand. With the help of their model they study the short-run and long-run effects of fiscal policy actions on economic variables at home and abroad. They, too, find out the strategic importance of the money market conditions for the international transmission of income changes: the fiscal stimulus will change, depending on the kind of financing, taxes or bonds, and by that disposable income or wealth. Both arguments enter the money demand and thereby influence the exchange rate and the structure of world demand. The short-run effects of debt-financed fiscal policy are similar to the effects of an investment shift in the Mundell model. Taxfinanced fiscal policy works differently: as it keeps interest rates constant, international income transmissions are excluded. In the long run, however, transmission effects may exist in this case too. Genberg and Swoboda Genberg and Swoboda discussed the implications of global shifts in level and structure of world demand. They extended their analysis to the case of full employment, too. Here an investment boom at home raises, as under unemployment, world interest rates, but enforces, not only allows, a real appreciation of the domestic currency. The rise of interest rates is needed to cut back the exogen-ously raised world demand to the fixed supply. The real depreciation of the foreign currency is needed to shift world demand towards foreign production in order to compensate for the loss in demand from higher interest rates. Different to Mundell’s conclusion, the investing country’s currency will definitely appreciate, at least in those cases, where the investment shift favours the domestic export good. Conclusions We conclude that a rising investment-savings relation in one country will raise the world interest rate in the case of fully integrated international capital markets, and in general appreciate the currency of that country. If production and employment are determined primarily by demand-side restrictions, the international transmission of business cycles will be mostly positive. If, however, supply-side restrictions dominate production and employment decisions, the international transmission of the business cycle could be negative or not exist at all. Are the above-mentioned models helpful to answer the question of the effects, arising from the expected investment boom following German unification? One could answer in the affirmative but point to two shortcomings: firstly, the models restrict the international interactions to only two countries, which are linked together by either fixed or flexible exchange rates. Disturbances in a country like Germany, which is a member of an exchange-rate union, but is a floater vis-à-vis the USA and Japan, cannot be studied sufficiently in that context. Clearly, a three-country model is needed, with two countries forming an exchange-rate union, and a third country floating against the former two. Second, the models study demand-side disturbances in Keynesian spirit. Investments are, if they are considered at all, lumped together with consumption in an absorption function, capturing only their demand-side effect. For the expected development in Germany and Eastern Europe their capacity and supply-side effect is probably much more important. Consequently the traditional two-country demand-side models have to be modified appropriately. Exchange-rate union models Work in the theory of exchange-rate unions has been done by Allen and Kenen (1980), Levin (1983), Sauernheimer (1984), Marston (1984), Moutos and Scarth (1988), and others. In the simplest version (Levin), two small countries fix their bilateral exchange rate and float jointly against a large third country. The third country fixes the world interest rate. Each country is specialized in the production of its export good whose price is fixed in national currency. The model produces the interesting result that, if an investment boom occurs in one of the union countries, the income in the other union country is necessarily depressed. The reason is that the temporary increase in the union’s interest rate attracts foreign capital, thereby appreciating the union’s currency (currencies). The resulting loss of export markets in the third country more than compensates for the gain of export markets in the expanding partner country. Because the money supply is fixed for the union as a whole and the interest-sensitive part of the money demand is also fixed given world interest rates, the income-dependent parts of the money demand have to move in opposite directions in the union’s member countries. It is also possible to introduce into these exchange-rate union models the effects of exchange-rate changes on the real money supply, the real money demand and the supply of goods. The results change accordingly. But the possibility remains

DEVELOPMENTS IN EASTERN EUROPE

27

that a member country of an exchange-rate union may be hurt by a rising economic activity in the partner country via the common exchange rate. AN EXCHANGE-RATE UNION MODEL WITH SUPPLY-SIDE EFFECTS The framework In the following we develop a model which tries to capture the demand-side as well as the supply-side effects of an investment boom happening in a member country of an exchange-rate union. The model allows us to analyse some of the important effects of the German unification on the EC partners and third countries. Unlike the models describing the US fiscal policy in the 1980s with their emphasis on the stock adjustment processes via the budget and the current account (Frenkel and Razin 1987; Branson and Buiter 1983), we want to highlight the adjustment process of the capital stock by net investments. The changing capital stock allows for flexibility of production despite a constant labour force, thereby introducing supply-side effects. Unlike the above-mentioned exchange-rate union models with two small countries in a large world economy, we will study three large countries, each of them able to influence the world interest rate by its own actions. This allows us to consider the fact that the EC countries, as well as third countries, are affected by the German unification, not only via exchange-rate changes, but also by movements in the world interest rate. The assumptions We study three countries which produce two goods with the help of two factors of production, capital and labour, both being internationally immobile and fully employed. Countries 1 and 2 form a currency union (exchange rate union) and float their currency (currencies) vis-à-vis the third country. They are specialized in the production of good 1, whereas the third country is specialized in the production of good 2. The consumers in all three countries demand both goods as imperfect substitutes. The supply of goods depends, given the labour supply, on the capital stock. The level of demand for goods depends on income and the interest rate; the structure of demand is governed by the real exchange rate. The money supply for the currency union as a whole is exogenously determined, its distribution depends on the member countries’ money demand. The money of the union (third country) is only held by agents of the union (third country). Besides the non-tradable ‘money’, people hold ‘shares’, an internationally tradable title on the capital stock. These shares can be traded freely and therefore give, with static expectations, the same interest rate everywhere. As a parameter change we consider an addition to the labour force in one of the member countries of the union. Consequently the marginal product of capital rises there. The resulting wedge to the world interest rate induces an investment process, which affects via supply-side and demand-side channels the partner country and the third country. In the short-run goods and money markets clear, given the capital stocks. The existing net investments move the national capital stocks towards their long-run equilibrium values. The equations Equations (1) to (7) describe the model: (1) (2) (3) (4) (5) (6) (7) Equations (1) and (2) give the equilibrium conditions in the goods markets. Si, Ii, Ki (i=1, 2, 3) symbolize saving, investment and the capital stock in the respective countries. X is the export surplus of the union, e its real exchange rate and r the world interest rate (real return on equity). Variables without index relate to the union, the interest rate to the whole world. Saving depends on the interest rate, investment on Tobin’s q (1969), the relationship between the marginal product of capital and the real return on equity. As the marginal product of capital itself is a function of the capital stock, the investment functions may be written as in equations (1) and (2) and ‘a’, symbolizing a shift parameter.

28

SAVINGS-INVESTMENT BALANCE IN EUROPE

The export surplus rises with a rising real exchange rate. The ‘+’ and ‘–’ over the arguments give the sign of the partial derivatives of the function. Si, Ii and X are in real terms, i.e. they are measured in units of the good produced in the union, being zero at the initial stationary equilibrium. Prices and the exchange rates are initially normalized at unity. Equations (3) and (4) characterize money market equilibrium in the union and the third country. M and M3 are the nominal money supplies, exogenously determined under flexible exchange rates, L and L3 the real money-demand functions. Goods prices p and p3 as well as the nominal exchange rate E are flexible and linked to the real exchange rate by definition: e=Ep3/p. The real exchange rate, i.e. the third country’s terms of trade, will be determined in the real sector (1), (2), the prices of goods and the nominal exchange rate in the monetary sector (3), (4). Equations (5) to (7) incorporate the dynamics of the model: as long as the actual capital stocks Ki have not yet reached the level of the desired capital stocks *Ki, net investments will be realized in order to close the gap according to the speed of adjustment parameter bi. In the long-run equilibrium these stock adjustment processes will have come to an end. Parameter change: a rising labour supply The only parameter change we want to discuss is an addition to the labour force in country 1, giving rise to an increase in the marginal product of capital in that country. With this parameter change, we try to capture approximately the inclusion of the factors of production in the former GDR (much labour, little capital) into the production function of the FRG, which is now representative for united Germany. Figuratively speaking, the production function shifts upwards in the output-capital diagram. Which consequences should we expect in the country itself, its partner country in the union, and in the third country? We will differentiate between short-run and long-run effects. In the short run, markets clear, given the stocks. Investments, motivated to adjust the actual capital stock to its desired long-run level, come in only with their demand effect. In the long run, stocks move to their long-run equilibrium position. Now the capacity effects of the investments come into force. Short-run solutions In the short run K1, K2 and K3 are given. With the help of (1) and (2), the real part of the model, we can derive the effects of rising investments on interest rates and exchange rates after differentiation with respect to a. Adding (1) and (2) yields the interest rate change: (8) The rise of investment in country 1, produces an excess demand for goods in the world. A rising interest rate is needed to cut back world demand to the unchanged level of world supply. The exchange-rate effect follows from (8) and (2): (9) After the investment shift and the interest rate reaction we have excess demand for the union’s good, excess supply for the third country’s good. The exchange rate falls in order to shift world demand away from the union towards the third country. The change of the nominal variables p, p3 and E follows from (3), (4) and (8): (10) Prices rise in the union as well as in country 3, the nominal exchange rate remains undetermined. We conclude that the investment expansion in the union leads to higher world interest rates and a real appreciation of the union’s currency. Applied to the German unification it means rising interest rates and rising prices for the world economy. Germany’s EC partners share with Germany the real appreciation of their currencies. Economic fears outside Germany seem to be not totally unfounded.5 Long-run solutions The long-run results for the real sector follow from the flow equilibrium conditions (1), (2) and the stock equilibrium conditions Ki= 0 (5) to (7). Eliminating the current account and the exchange rate by adding (1) and (2) and taking into account that net investments have to be zero in equilibrium, equations (11) to (14) are sufficient to determine the endogenous variables r, K1, K2, K3: (11)

DEVELOPMENTS IN EASTERN EUROPE

29

(12) (13) (14) The results are: (15) (16) With the help of (3) and (e) we get for the nominal variables: (17) Apparently there are no long-run spillovers from the German unification to other countries in this model. Germany simply raises its investment rate until the labour force in East Germany has the same capital equipment as the labour force in the West. Capital intensity, per capita income and real wages are, in the united Germany, finally the same as in the former FRG. Problems for other countries will arise in this model only in the short run. The temporary increase in interest rates will slow down their investment dynamics. In the traditional Keynesian macro-models with price- and/or wage rigidities this slow down of investment demand translates into production and employment problems. These problems are not present here. Instead, we emphasize the weakening of supply conditions. Temporarily capital stocks and production fall. If employment should stay constant, real wages must fall. If real wages are rigid, employment will fall, not due to a lack in demand but due to capital shortage.6 The short-run effects and the adjustment process are illustrated in Figure 3.7. Extensions First, the model neglects income as an argument in the savings function, the money demand function and in net exports. The correct way to model savings in this world of a stationary economy would be to view them as a temporary stock adjustment phenomenon of wealth. If desired wealth depends on income and interest rates, we will have zero savings in the new long-run equilibrium although income has risen. However, the long-run interest rate effect remains ambiguous in this case, depending on the desired structure of wealth. If we had assumed the money demand to depend on income, it would have been appropriate to make the money supply to depend on the production potential of the economy. Because the latter has risen with the capital stock, our results would not change in the case of a unity income elasticity of money demand. With respect to net exports, income effects become important. Rising income follows from rising export production in this supply-side model with specialized production. As consumption is diversified, a rising income leads to a real depreciation in the long run. Second, the paper models on the one hand an exchange-rate union but, on the other hand, keeps the differences between the member countries of that union at a minimum: they produce the same good, they use the same money and the equities they hold bear no country-specific risks. Consequently there are neither price nor interest rate differentials between the member countries. The actual EMS differs significantly from that world. Third, the model assumes static expectations and is therefore unable to explain the reactions of market prices on expected, not yet realized events. For example, long-term interest rates have risen in Germany from January to March 1990 by more than one percentage point without any acceleration of investment demand in East Germany until now (Figure 3.8). Forwardlooking agents have anticipated the future interest rate rise pushing up the actual rate by reducing the net supply of funds at low present rates. Considering the large jump in interest rates at the beginning of the year, it seems possible that there will be no further interest rate rise when the investments are realized; there may perhaps even be falling rates. However, actual information on growing budget deficits considerably exceeding the projected values, contrasts sharply with the hope for lower interest rates. Since October 1989 the interest rate gap vis-à-vis USA closed and—not surprisingly—the Deutschmark appreciated against the US dollar, but not against other EMS currencies (Figure 3.9). Fourth, the model eliminates some possible positive transmission effects, arriving therefore at perhaps too sceptical results. So in reality the German demand expansion will benefit its trade partners, if they are suffering under Keynesian unemployment. Germany’s higher import demand will induce under those conditions an export multiplier process or even an export-led growth process abroad. On the supply side its European partners may benefit from the improved terms of trade which directly raise real income and indirectly offer the opportunity for lower producers’ real wages at unchanged workers’ real wages.

30

SAVINGS-INVESTMENT BALANCE IN EUROPE

Figure 3.7 Illustration of short-run effects and the adjustment process.

GERMAN UNIFICATION AND INTERNATIONAL INTERDEPENDENCE: EMPIRICAL RESULTS Alexander and Gagnon Alexander and Gagnon (1990) discuss the effects of German unification using a simulation of the MX3 model of the Federal Reserve Board. They build four regions—Germany, USA, Japan, rest of the world (ROW)—and study the effects for the next ten years. The parameter change is the addition of the GDR’s factor supplies to the factor supplies of the FRG. As the capital intensity is higher in FRG than it was in GDR, capital productivity rises in Germany. The desired capital stock rises and induces an investment process in order to adjust the actual capital stock. Table 3.3, which is borrowed from Alexander and Gagnon (1990), summarizes the results. The simulations show for Germany in the next three (ten) years an increase in GNP by 2.1 per cent (5.5 per cent), investments by US$88 (US$125) billion, long-term interest rate by 0.6 per cent (0.2 per cent), inflation rate by 0.3 per cent (0.1 per cent) and nominal $/DM exchange rate by 7.2 per cent (2.6 per cent). The current-account surplus will diminish by US$15 (US$29) billion. After three (ten) years GDR will have closed the gap in per capita income vis-à-vis FRG by 32 per cent (86 per cent). Third countries are hardly affected by the German unification process, first because a large share of the additional investments in Germany are financed by additional savings in Germany, second because the remaining financial requirements

DEVELOPMENTS IN EASTERN EUROPE

31

Figure 3.8 Long-term interest rates in the USA and Germany, 1986–90. Source: Deutsche Bundesbank (1990).

Figure 3.9 Nominal external value of the Deutschmark, 1986–90. Source: Deutsche Bundesbank (1990).

are small on a world scale. Long-term interest rates therefore stay virtually constant outside of Germany. In the USA, as well as in the ROW, real GDP declines slightly by 0.1 per cent to 0.2 per cent, attended by a structural change in demand from consumption and investment towards net exports. OECD A country report on Germany (OECD 1990) pointed out the economic potential of German unification but also called attention to the obstacles on the way towards a quick success. Even if productivity in the East grows by 8.5 per cent more than in the West, it will take fifteen years to close the productivity gap (OECD 1990:54). The capital stock has to grow in that case by 10.5 per cent per annum in the East. Surely, some factors hint at a large productivity growth potential as there are now overstaffed jobs, bad motivation through poor income perspectives, interruptions in the production process through bad organization and finally quality insufficiencies through sellers’ markets. On the other side, the absorption capacity to efficiently use the capital inflows is restricted by shortages in qualified labour (at least in the short run) and by insufficient infrastructure like transportation and communication. Turning to the international dimension of the unification process, the report stresses the chances to reduce the macroeconomic imbalances in the world. As demand will expand faster than production in Germany, the German export surplus will diminish. Real appreciations of the Deutschmark will support that process. However, these projections also show that the changes in the external balance will remain very modest (OECD 1990:86).

32

SAVINGS-INVESTMENT BALANCE IN EUROPE

Summarizing, the report saw almost no negative effects of unification, especially because the German capital market is large, government budgets have been consolidated, money supply is under control and the upward pressure on the Deutschmark avoids excessive utilization of domestic capacity. Table 3.3 Simulation results of German unification, 1990–9(a)

Germany Real GDP (%) Fixed Inv. (% of GDP) Priv. Cons. (% of GDP) Gov’t Exp. (% of GDP) Real Net Exp. (% of GDP) Infl. Rate (PGNP) ( ) S.t. Int. Rate ( ) L.t. Int. Rate ( ) Nom. Exch. Rate (% $/DM) Current Bal. (US$.B) ( ) Fixed Inv. (US$.B) ( ) Cap.-Lab. Ratio (E/W) United States Real GDP (%) Fixed Inv. (% of GDP) Priv. Cons. (% of GDP) Infl. Rate (PGNP) ( ) S.t. Int. Rat ( ) L.t. Int. Rate ( ) Real Net Exp. (% of GDP) Current Bal. (US$.B) ( ) Japan Real GDP (%) Fixed Inv. (% of GDP) Priv. Cons. (% of GDP)

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

0.7 1.0 0.2 1.6 1.3 0.3 0.3 0.6 7.8 5.8 42.0 0.4

1.4 2.3 0.0 1.6 2.0 0.2 0.6 0.6 7.5 8.8 69.2 0.5

2.1 3.1 0.1 1.6 2.3 0.1 0.7 0.6 7.2 14.9 88.6 0.6

2.8 3.5 0.4 1.6 2.3 0.0 0.8 0.5 6.6 19.5 102.4 0.7

3.3 3.7 0.6 1.6 2.3 0.0 0.8 0.5 5.9 23.1 111.7 0.7

3.8 3.8 0.9 1.7 2.1 0.0 0.7 0.4 5.2 25.8 117.7 0.8

4.3 3.7 1.2 1.7 1.9 0.1 0.7 0.3 4.5 27.6 121.4 0.8

4.8 3.6 1.4 1.7 1.6 0.1 0.6 0.3 3.8 28.6 123.7 0.8

5.1 3.5 1.7 1.7 1.4 0.1 0.5 0.2 3.2 29.0 125.0 0.9

5.5 3.3 1.9 1.7 1.1 0.1 0.4 0.2 2.6 28.9 125.9 0.9

0.2 0.0 0.1 0.1 0.1 0.0 0.3 7.7

0.1 0.1 0.2 0.0 0.1 0.0 0.4 13.6

0.0 0.2 0.2 0.0 0.1 0.0 0.4 14.6

0.1 0.2 0.2 0.0 0.1 0.0 0.3 14.7

0.1 0.2 0.2 0.0 0.0 0.0 0.3 14.2

0.1 0.2 0.2 0.0 0.0 0.0 0.2 13.2

0.2 0.1 0.2 0.0 0.0 0.0 0.2 12.0

0.2 0.1 0.2 0.0 0.0 0.0 0.1 10.6

0.2 0.1 0.2 0.0 0.0 0.0 0.1 9.2

0.2 0.1 0.2 0.0 0.0 0.0 0.0 7.8

0.0 0.0 0.0

0.1 0.1 0.1

0.1 0.2 0.1

0.1 0.2 0.1

0.0 0.2 0.1

0.0 0.1 0.1

0.0 0.1 0.1

0.0 0.1 0.0

0.0 0.0 0.0

0.0 0.0 0.0

Infl. Rate (PGNP) ( ) 0.0 0.0 0.0 S.t. Int. Rate ( ) 0.0 0.0 0.1 L.t. Int. Rate ( ) 0.0 0.0 0.0 Nom. Exch. Rate (% $/Yen) 0.5 0.8 1.1 Real Net Exp. (% of GDP) 0.1 0.2 0.2 Current Bal. (US$.B) ( ) 2.0 2.4 3.1 Rest of the World Real GDP (%) 0.1 0.1 0.1 Fixed Inv. (% of GDP) 0.1 0.1 0.2 Priv. Cons. (% of GDP) 0.2 0.3 0.4 Infl. Rate (PGNP) ( ) 0.0 0.0 0.0 S.t. Int. Rate ( ) 0.0 0.0 0.0 L.t. Int. Rate ( ) 0.0 0.0 0.0 Nom. Exch. Rate (% S/Row) 1.1 1.0 0.8 Real Net Exp. (% of GDP) 0.1 0.4 0.5 Current Bal. (US$.B) ( ) 11.4 2.3 3.3 Source: Alexander and Gagnon (1990). Notes: (a) Per cent (%) and absolute ( ) deviations from baseline.

0.0 0.1 0.0 1.4 0.3 3.7

0.0 0.1 0.0 1.6 0.2 4.2

0.0 0.1 0.0 1.6 0.2 4.3

0.0 0.1 0.0 1.6 0.2 3.8

0.0 0.0 0.0 1.6 0.1 2.6

0.0 0.0 0.0 1.5 0.0 0.7

0.0 0.0 0.0 1.5 0.0 1.8

0.1 0.3 0.4 0.0 0.0 0.0 0.6 0.6 8.6

0.0 0.3 0.4 0.0 0.0 0.0 0.5 0.7 13.2

0.0 0.3 0.4 0.0 0.0 0.0 0.4 0.7 16.9

0.0 0.2 0.4 0.0 0.0 0.0 0.4 0.6 19.4

0.0 0.2 0.3 0.0 0.0 0.0 0.4 0.5 20.6

0.1 0.2 0.3 0.0 0.0 0.0 0.4 0.4 20.5

0.1 0.1 0.3 0.0 0.0 0.0 0.5 0.3 19.2

DEVELOPMENTS IN EASTERN EUROPE

33

OUTLOOK Our model, as well as the econometric work cited, suggests that the effects of German unification on the world economy will be modest. This view, however, needs some qualification. First, our macroeconomic models neglect the allocation and efficiency gains of the transition from a centrally planned economy to a market economy. Income growth results not only, perhaps even not mainly, from capital accumulation, but also from the incentives provided by a market economy with an efficient money. Obstacles to the free flow of goods and factors will be removed. The international division of labour improves, thereby generating global welfare gains.7 Second, already now the Erhard-type social market economy has a high reputation in Eastern Europe. Its reputation will grow faster, when East Europeans see how fast and successful a centrally planned economy like the GDR can be transformed into a market economy a la FRG. The political will to deregulate and to integrate the East European economies into the world markets will be strengthened. The high absorption capacity of the large German market and the still larger EC market, both lying ‘ante portas’, should be helpful to promote exports. Third, the greater weight of Germany in Europe will induce the other EC members to accelerate the economic unification process in Europe. It is their only possibility to get some control over the EC’s largest economy. Summing up, it may be said that the economic, political and institutional effects of German unification may change the course of events in all Europe, East and West, substantially. NOTES 1 Figures 3.1 to 3.5 are borrowed from Aghevli et al. (1990). Other actual interpretations of the savings-investment balance are given by Danker and Hopper (1990) as well as by the Kommission der EG (1989). 2 See, e.g., Tietmeyer (1990). 3 For an evaluation of the economic reforms in Eastern Europe see BIZ (1990:49–64) and IMF (1990). The special case of Poland is discussed by Lipton and Sachs (1990). Howell (1990) makes a strong case for financial support by Western Countries. 4 On average, real fixed investments in the EC have risen by nearly 7 per cent per annum between 1987 and 1989. As far back as 1962 no other three-year period had investments which grew faster (Table 3.1). At the same time the EC’s current account surplus has fallen from 1.4 per cent (1986) to 0.1 per cent (1989) of GDP, i.e. roughly by US$50 billion (Table 3.2). Direct investments into EC countries have also risen considerably in the last few years. BIZ (1990:91) reports an increase from US$17 billion (1986) to US$34 billion (1987), US$47 billion (1988) and US$63 billion (1989). 5 Besides crowding out effects via the interest rate and the exchange rate some countries fear the more direct substitution effects between GDR investments and investments elsewhere. 6 Because we have here a one-sector model, the supply-side problems refer to the level, not to the structure, of production. Structural elements exist only on the demand-side, where we differentiate between domestic (=exportable) and import goods. If we would admit domestic import goods production, the production structure would be governed by the terms of trade, which improve in our case. So the additional problem of intersectoral resource shifts could be addressed. Alternatively one could use a structure with tradables and non-tradables to discuss the problem of intersectoral resource shifts. 7 A similar positive evaluation is given in IMF (1990:74–5).

REFERENCES Aghevli, B.B. et al. (1990) ‘The role of national saving in the world economy, recent trends and prospects’, IMF Occasional Paper 67. Alexander, L.S. and Gagnon, J.E. (1990) ‘The global economic implications of German unification’, International Finance Discussion Papers 379, Washington, DC. Allen, P.R. and Kenen, P. (1980) Asset Markets, Exchange Rates and Economic Integration, Cambridge: Cambridge University Press. BIZ (Bank fér Internationalen Zahlungsausgleich) (1990) 60. Jahresbericht. Branson W.H. and Buiter, W.H. (1983) ‘Monetary and fiscal policy with flexible exchange rates’, in Bhandari, J.S. and Putnam, B.H. (eds) Economic Interdependence and Flexible Exchange Rates, Cambridge, MA: MIT Press. Danker, D. and Hooper, P. (1990) ‘International financial markets and the US external imbalance’, International Finance Discussion Papers 372, Washington, DC. Frenkel, J.A. and Razin, A. (1987) ‘The Mundell-Fleming model a quarter century later: a unified exposition’, IMF Staff Papers 34. Genberg, H. and Swoboda, A.K. (1989) ‘Policy and current account determination under flexible exchange rates’, IMF Staff Papers 36. Howell, D. (1990) ‘Deadly blows for Eastern Europe’, The Wall Street Journal Europe, 14 August. IMF (International Monetary Fund) (1990) World Economic Outlook, May. Kommission der EG (1989) ‘Ersparnis, Investition und Internationale Fin-anzmàrkte: Ein berblick’, i n Europäische Wirtschaft 42. Levin, J.H. (1983) ‘A model of stabilization policy in a jointly floating currency area’, in Bhandari, J.S. (ed.), Exchange Rate Management under Uncertainty, Cambridge, MA: MIT Press.

34

SAVINGS-INVESTMENT BALANCE IN EUROPE

Lipton, D. and Sachs, J. (1990) ‘Creating a market economy in Eastern Europe: the case of Poland’, Brookings Papers on Economic Activity 1. Marston, R.C. (1984) ‘Exchange rate unions as an alternative to flexible rates: the effects of real and monetary disturbances’, in Bilson, F.O. and Marston, R.C. (eds), Exchange Rate Theory and Practice, Chicago: University of Chicago Press. Moutos, T. and Scarth, W. (1988) ‘Stabilization policy within a currency area’, Scottish Journal of Political Economy 35:387–97. Mundell, R.A. (1968) International Economics, New York: Macmillan. Mussa, M. (1979) ‘Macroeconomic interdependence and the exchange rate regime’, in Dornbusch, R. and Frenkel, J.A. (eds), International Economic Policy: Theory and Evidence, Baltimore: Johns Hopkins University Press. OECD (1990) Wirtschaftsberichte, Deutschland, Paris. Sauernheimer, K. (1984) ‘“Fiscal Policy” in einer Wechselkursunion’, Fin-anzarchiv 42:143–57. Tietmeyer, H. (1990) The economic integration of Germany, problems and prospects’, statement at the International Banking Seminar, Group of Thirty, Washington, DC. Tobin, J. (1969) ‘A general equilibrium approach to monetary theory’, Journal of Money, Credit and Banking 1:15–29.

4 Comparative economic growth: East and West Bernhard Heitger Kiel Institute of World Economics, Kiel

In recent years, some of the centrally planned economies have tried to promote economic development by reforms. These efforts first of all aimed at increasing the efficiency of the central planning system and/or allowing market forces in only a few segments of the economy. The end of the 1980s brought a radical change: not only have the former GDR and other small East European countries turned to the market economy; the Soviet Union too is preparing for a systematic change. In this chapter, economic development in East and West after the Second World War will be analysed and system-specific causes of the recent growth slowdown in centrally planned economies will be discussed and empirically tested. In addition, the potential for economic growth in Eastern Europe in the case of changing the economic system will be projected. ECONOMIC GROWTH SINCE 1950 To compare economic growth between Western industrial countries and centrally planned economies, there are some problems. While for market economies data can be taken from internationally comparable national accounts, data from official statistics of the Eastern countries differ from international standards for two reasons especially:1 data on the contributions to gross domestic product are not based on calculations at factor costs as is usual internationally. Instead, they are calculated at ‘realized prices’, i.e. are distorted, especially by taxes and subsidies. In addition, in official statistics only data on net material products are given, i.e. ‘non-productive’ or ‘non-material’ services are practically neglected. To make these data internationally comparable, considerable recalculations, revaluations and often new estimates are necessary. Such recalculations of the national accounts for the centrally planned economies have been done for years, e.g. by the Joint Economic Committee of the US Congress and by the Central Intelligence Agency. In addition, another data set from the United Nations International Comparison Project may be used, which is based on detailed direct international price and quantity comparisons, and contains data on GDP as well as on purchasing power parities for 130 countries (including the centrally planned economies).2 The data used in this chapter mainly come from these sources. Calculations of per capita income growth rates—based on these statistical sources—show that economic development in the course of time slowed down in both economic systems (Table 4.1). In 1950–88 the average increase of GDP in Western economies halved. In the East, the average growth rate even declined to a quarter of Table 4.1 Per capita growth(a) in Western market and centrally planned economies, 1950–88 (per cent) Country

1950–9

1960–9

1970–9

1980–8

3.3 48.2 6.8 3.7 5.3 7.1 2.2 1.4

4.1 41.6 3.6 4.7 4.5 9.4 2.4 2.5

2.9 34.8 2.8 3.2 3.6 4.0 2.4 1.9

1.6 39.8 2.0 1.1 1.6 3.4 2.4 2.2

4.6 33.1 6.0 3.8 7.2

3.7 25.6 5.2 2.4 3.2

2.7 29.9 2.3 2.0 3.1

1.1 63.1 1.2 1.2 1.9

economies(b)

Western market Mean Coefficient of variation Former FRG France Italy Japan United Kingdom United States Centrally planned economies(c) Mean Coefficient of variation Bulgaria CSFR Former GDR

36

DEVELOPMENTS IN EASTERN EUROPE

Country

1950–9

1960–9

1970–9

Hungary 3.8 3.1 2.3 Poland 2.7 3.2 2.6 Romania 4.8 4.2 4.4 USSR 4.2 4.2 2.3 Total sample Mean 3.6 4.0 2.8 Coefficient of variation 45.7 39.0 33.4 Sources: CIA (1989); IMF (1990); PlanEcon (1989); Summers and Heston (1988); own calculations and estimates. Notes: (a) Average annual per capita growth rate (b) OECD countries (c) CMEA countries.

1980–8 1.1 0.2 0.8 2.0 1.5 45.3

its former value. In both systems there is a convergence in per capita growth rates, at least until the beginning of the 1980s in the case of Western market economies and until the beginning of the 1970s in the case of the centrally planned economies. Given the cross-country decline in economic expansion, economic growth in the former rapidly growing countries did adjust to the general (lower) trend in economic growth. But in the 1970s and 1980s, differences in economic growth increased, especially in the centrally planned economies. For example, the Soviet Union could realize an above-average growth rate, while for Poland the opposite was true. The real extent of the growth slowdown in centrally planned economies becomes obvious, if one takes into account the results of previous international studies on economic growth. From these, it follows that countries with a relatively low level of economic development after the Second World War showed the highest growth rates. Considering the low level of development in the East European countries, not only in the 1950s but also in all other decades, they should have grown much faster than the market economies. For example, for the 1980s one would have expected economic growth to be even higher than that of the Western industrial countries in the 1950s. CAUSES OF THE GROWTH SLOWDOWN IN THE EAST In the following, some system-specific causes of the growth slowdown in the East will be briefly discussed. The emphasis is laid on those obstacles to economic growth whose significance has increased in the 1970s and 1980s.3 The most important system-specific features in this respect are distorted prices and incentives, inflexibility of the hierarchy to cope with problems of structural change in the course of economic development, distinct lack of international and national specialization in the division of labour as well as system-specific slowness to innovate. Analysts of centrally planned economies have long emphasized distorted incentives to be a main weakness of the Eastern economic system. Incentives at the enterprise level have always been positively related with the volume of output, but not negatively with the costs of material inputs and other factors of production. Thus, enterprises have always been encouraged to expand production at any cost, to increase their demands for material input, to expand their inventories as well as to disregard material-saving innovations. Since a ‘soft budget constraint’ (Kornai 1980) always allowed socialist enterprises a nearly unconstrained access to financial funds, the distorted incentives resulted in a persistent excess demand for almost everything. Distorted incentives did have a strong impact on the resource intensity of the centrally planned economies. Input-output comparisons show that centrally planned economies on average had a much higher resource intensity than Western market economies (Rostowski 1988). For example, energy intensity in 1965 in the West was 0.52, the value for Eastern economies was 0.73.4 This gap widened still further in the course of the two oil shocks: energy intensity in the West until 1985 did fall to 0.38, while the East then showed a value of 0.78—more than twice the Western value. The significance of distorted incentives as a system-specific growth-retarding factor seems to have risen, since—given the high resource and energy intensity—all centrally planned economies, with the exception of the Soviet Union, by the end of the 1960s had become net importers of energy at rising energy prices at the same time. Another growth-retarding feature in centrally planned economies whose significance has also increased continuously was the inflexibility of the hierarchy to manage problems of structural change in the course of economic growth. The institutional structure in Eastern economies, where enterprise initiatives had been replaced by commands and where an inordinate amount of (often distorted) information did block vertical command and control channels, made central planning a more and more unsuitable instrument to run an economy as development progressed. Comparative input-output analyses again show that the complexity of inter-industry linkages steadily increase with the level of development. Industries in which vertical relationships were predominant (such as in, for example, steel and bulk chemicals) are being replaced as an engine of growth by industries in which enterprises are typically linked horizontally, i.e. act as both suppliers of inputs and as purchasers of outputs from each other at the same time. When the centrally planned economies tried to expand these new industries, the

COMPARATIVE ECONOMIC GROWTH

37

sharply increased demand for qualified management became too great a burden for the inflexible hierarchy. Thus the intended shift away from industries based on economies of scale towards those based on innovation and flexibility was not successful and also technology imports, supposed to circumvent the anti-innovative bias of central planning, did not help much. Lack of specialization was another growth-retarding factor in centrally planned economies. This lack was two-fold. On the one hand, due to a distinct import-substitution bias in centrally planned economies, these countries could not benefit much from the international division of labour. Instead, too large an assortment of products in too small production runs with outdated technologies and too many material-intensive inputs led to too costly products. These in addition have mostly been technologically obsolete, of low quality and largely uncompetitive on world markets as well. The other lack of specialization was the result of other wellknown system-specific insufficiencies. Because of the chronic shortage of raw materials, socialist enterprises showed an extreme do-it-yourself bias. To reduce uncertainty, enterprises tried to produce as much as possible within their own organizations; they tried to do all phases of processing as well as to make all parts and components for the equipment to be installed. As a consequence, labour was spread over too many activities and the costs of intermediate products had been much higher than they would have been in specialized enterprises. Finally, slowness to innovate was an important obstacle to economic growth in centrally planned economies. Beside the aforementioned lack of incentives for material-saving innovations, there was a system-specific fundamental resistance against any innovation. Since every innovation had to be incorporated into existing production facilities, and since the personnel running these facilities were above all interested in plan fulfilment, there was a strong resistance against any change. Even if an innovation might have led to higher production, the risk of delay until the new technology was managed successfully and the risk of other possible disturbances to production schedules led to a strong bias against any change. Since there was no threat of competition as well as of financial failure, innovations have been the exception rather than the rule. Taken together, changes in economic and technological trends in the world economy since the early 1970s, as well as policy decisions in the centrally planned economies, have increased the negative effects from existing structural inefficiencies in the East. Moreover, psychological and moral factors finally did precipitate the economic decline in the centrally planned economies. Stagnation or even declining standards of living since the end of the 1970s must have convinced nearly everybody that even moderate increases in standards of living were unattainable under the then prevailing economic conditions. Thus, in the end a corresponding attitude to life and decreasing incentives to work intensified the negative effects on economic development. ECONOMIC GROWTH UNDER TWO SYSTEMS: AN EMPIRICAL TEST To test whether the observed slowdown in economic growth was caused by shortcomings of the economic system or was a phenomenon common to all countries, it is first necessary to assess the impact of other widely believed sources of economic growth. In a second step, it is then possible to test empirically whether and how much economic growth was different due to the economic system. With respect to the other sources of growth, one may refer to international empirical comparisons of economic growth which have been performed for Western market economies. From these international comparisons one may conclude that technological progress is one of the main sources of economic growth. Identifying its contribution with total factor productivity (‘Abramovitz’s residual’), it has been calculated that technological progress accounted for more than 40 per cent of economic growth in OECD countries after the Second World War (Choi 1983:68). In addition, these international comparisons reveal that the contribution of technological progress varied with per capita income: while the contribution in the United States (and Canada) was smallest, countries with relatively low per capita incomes (such as West Germany, Italy and Japan after the war) could make much better use of this source of growth (see, e.g., Heitger 1985). At first sight this result seems to be somewhat surprising since the United States is widely believed to be the leader in most technological fields. Thus, one would have expected growth in the United States to be determined much more by technological progress than in any other country. The explanation of this putative contradiction seems to have been international technology transfers from the technological leader—the United States—and favourable ‘social capabilities’ (Abramovitz 1986), i.e. the ability to permit successful exploitation of best-practised technologies in the recipient countries. As a result the follower countries have been in a relatively favourable situation. Although payments for patents and licences had to be made, the mere imitation and application of technologies have been cheaper than the initial invention and innovation in the technologically leading country. The reason is that search costs as well as costs of first application could have been avoided. Thus, by replacing superannuated techniques with best-practised technologies it was possible to make larger leaps in economic progress. Last, but not least, technology imports seem to have been a function of technological gaps, i.e. countries which initially were technologically quite similar to the technological leader—had a per capita income close to that of the United States— could profitably import only small fractions of new technologies.5 Countries, however, with a relatively low per capita income

38

DEVELOPMENTS IN EASTERN EUROPE

and a correspondingly high technological gap could get the highest benefits and therefore perform the largest surges in economic growth. But as the technological gaps narrowed, the potential for catching up also declined. To compare economic growth in East and West one may thus refer to those previous approaches to economic growth, where special emphasis is laid on technological adaptation.6 According to these, one may design and test a model of economic development in which besides technological adaptation possibilities (approximated by relative levels of development with respect to the technological leader—the United States), the ratio of investment in GDP and the growth rate of the labour force determine the per capita growth rate.7 With an accordingly specified regression equation, which in the case of Western economies (DCs and LDCs) has led to a relatively high coefficient of determination, the relationships within Eastern countries can also be tested. The reason is that the same determinants—technological adaptation possibilities, investment, labour force—had an influence on the rate of growth in Eastern countries too. Whether economic growth between East and West in addition was different due to the economic system can be tested empirically with the help of binary (‘dummy’) or system variables. The data on the supposed determinants of economic growth show that technological adaptation possibilities after the Second World War have been very different (Table 4.2). Among Western market economies they have been highest in Japan, Italy and the Federal Republic of Germany, while the technological gap in the United Kingdom was relatively low. Since the 1950s technological adaptation possibilities have almost halved. At the same time, the coefficient of variation of this determinant in Western economies was getting significantly smaller, i.e. technological adaptation possibilities in the West have narrowed. The centrally planned economies in all decades show a much lower level of relative development and large technological gaps respectively. At the beginning of the 1980s average per capita Table 4.2 Technological gaps(a) inWestern market and centrally planned economies, 1950–80 (per cent) Country

1950

1960

1970

1980

economies(b)

Western market Mean 52.2 60.4 68.0 Coefficient of variation 44.4 36.0 28.0 Former FRG 42.4 70.7 78.7 France 48.8 60.6 74.8 Italy 30.1 43.8 53.2 Japan 17.6 30.6 58.1 United Kingdom 62.4 67.3 66.8 United States 100.0 100.0 100.0 Centrally planned economies(c) Mean 31.2 42.2 46.7 Coefficient of variation 33.6 32.0 25.8 Bulgaria 20.4 31.7 41.2 CSFR 48.8 61.2 60.6 Former GDR 33.1 57.7 61.7 Hungary 34.5 43.6 46.3 Poland 33.9 38.3 41.1 Romania 16.7 23.1 27.1 USSR 30.7 40.0 47.3 Total sample Mean 47.3 56.2 63.0 Coefficient of variation 47.9 38.1 31.4 Sources: See Table 4.1; own calculations. Notes: (a) Relative per capita income; United States=100 (b) OECD countries (c) CMEA countries.

74.1 24.7 85.9 85.0 62.8 71.2 69.9 100.0 50.0 23.5 43.0 61.4 69.2 48.3 43.9 34.6 49.3 68.4 28.8

income was still lower than it was in the market economies at the beginning of the 1950s. Within the centrally planned economies the former GDR could increase its level of development the most, while Romania is still the country with the lowest per capita income. Investment was also quite different between the two groups of countries (Table 4.3). In the centrally planned economies the share of investment in GDP in all decades was about 7 per cent higher than in the market economies. In the course of time,

COMPARATIVE ECONOMIC GROWTH

39

large variations in the share of investment can be observed: while the share of investment until the 1970s in both groups of countries was steadily increasing, it was falling during the 1980s. The above hypothesis, that economic growth in East and West was determined by technological adaptation possibilities, investment efforts and system-specific factors can be tested empirically with the help of regression analysis. Three equations have been estimated Table 4.3 Shares of investment (a) in Western market and centrally planned economies, 1950–88 (per cent) Country

1950–9

1960–9

1970–9

1980–8

economies(b)

Western market Mean 22.6 26.8 27.2 Coefficient of variation 25.5 18.7 18.8 Former FRG 28.9 31.4 27.9 France 20.2 26.0 27.6 Italy 23.5 27.3 24.5 Japan 20.0 32.4 39.2 United Kingdom 14.5 19.7 19.1 United States 20.8 21.0 21.4 Centrally planned economies(c) Mean 27.6 32.9 34.3 Coefficient of variation 21.9 23.7 12.5 (d) (e) Bulgaria – 35.4 34.3(f) (h) (k) CSFR 31.9 41.3 33.5(f) (j) (i) Former GDR 24.6 21.0 29.6(f) Hungary 34.2(h) 36.4(k) 34.8(f) (h) (k) Poland 28.3 37.7 34.8(f) (d) (d) Romania – – 42.8(f) USSR 19.0 25.8 30.5 Total sample Mean 23.5 28.1 28.8 Coefficient of variation 25.6 21.7 20.0 Sources: See Table 4.1; Alton (1970, 1982, 1988); Stolper (1960); own calculations and estimates. Notes: (a) Average share of gross domestic investment in gross domestic product (b) OECD countries (c) CMEA countries (d) Not available (e) 1968 (f) 1975–9 (g) 1980–7 (h) 1950–8 (i) 1967 (j) 1950–8 (k) 1960, 1965, 1967 (l) 1980–5.

23.9 21.3 24.5 24.3 21.3 36.8 16.0 21.9 29.9 17.4 25.5(g) 30.3(g) 23.3(g) 31.1(g) 29.4(g) 39.8(g) 29.8(l) 25.3 22.3

(see Table 4.4). From these equations, in which technological adaptation possibilities (relative per capita income), investment and three system variables served as exogenous variables, the following conclusions can be drawn:8 – The technological gap of an economy and the corresponding technological potential in both systems had an important impact on the achievable growth rate: the lower the level of development in relation to the technological leader (the United States) the higher was the per capita growth rate. – Besides technological adaptation possibilities, capital accumulation was an important determinant of per capita growth. The higher the average share of investment, the higher was the per capita growth rate. Table 4.4 Determinants of growth in Western market and centrally planned economies, 1950–88—regression results(a) Regression equations (1) gGDP=

4.889 0.047 RGDP+0.044 * * (7.84 ) (8.03 ) (2.10*) (2) gGDP= 4.854 0.045 RGDP+0.039 (7.76*) (7.87 *) (1.90*) (3) gGDP= 4.618 0.049 RGDP+0.059 * * (7.45 ) (8.35 ) (2.70*) Sources: See Tables 4.1, 4.2, and 4.3; own calculations.

F INVSH 1.344 (3.97 *) INVSH 0.027 (3.91 † ) INVSH 0.049 (4.46 *)

SD

0.35

22.1*

SD*RGDP

0.35

21.8*

SD*INVSH

0.39

24.0*

40

DEVELOPMENTS IN EASTERN EUROPE

Regression equations

F

Notes: (a) Combined international cross-section analysis, 1950s, 1960s, 1970s, 1980s (N=117). t-values in parentheses; *significant at 5 per cent; † at 10 per cent. gGDP =Average annual per capita growth rate of gross domestic product in international prices of 1980. RGDP =Relative per capital gross domestic product in international prices of 1980 (United States, 1950, 1960, 1970, 1980 = 100). INVSH =Average share of gross domestic investment in gross domestic product in international prices of 1980. SD =Binary (‘Dummy’) variable; Western market economies=0; centrally planned economies=1. * SD RGDP =SDRGDP. SD*INVSH =SDINVSH.

– Between East and West, there was an important difference with respect to potential economic growth. In the centrally planned economies, per capita growth on average was 1.34 per cent lower than in market economies due to the economic system (Table 4.4, equation 1). – Given the same level of catching-up potential, the impact of this determinant on economic growth in centrally planned economies was only about one half of that in the Western economies, i.e. with growing levels of development centrally planned economies have fallen more and more behind (Table 4.4, equation 2). – The impact of capital accumulation on economic growth in Eastern economies was of minor importance. It was only a fraction of the value observed for Western economies (Table 4.4, equation 3). All coefficients of the regression equations show the expected signs and are statistically significant. The coefficients of determination are in the range from 35 to 39 per cent.9 To illustrate the underlying catching-up process, relative per capita incomes at the beginning of each of the four decades and per capita growth rates of some selected Western economies as well as of all centrally planned economies are shown in Figures 4.1 and 4.2. The estimated regression equations are also given.10 In the case of Western market economies it can be seen that Japan and the Federal Republic of Germany in the 1950s and 1960s could achieve much higher growth rates than those one would have expected, according to their relative level of development. But this fact seems to have been due to an above-average level of investment as well as to favourable macroeconomic policies and/or particularly favourable ‘social capabilities’ for technological adaptation.11 Japan could benefit from a below-average tax burden; West Germany could gain from a relatively high price stability.12 In the 1970s and 1980s Japan and West Germany switched to the general growth path. The United States, because of their high level of development in all decades, could only realize a relatively low growth rate of per capita GDP. Economic growth in the United Kingdom was also low. But this was obviously also due to a below-average level of investment. In the case of the centrally planned economies (Figure 4.2), it can be seen from the path of the regression equation (Table 4.4, equation 2), that with rising levels of development the gap between East and West continuously widened, i.e. the East was falling more and more behind. Moreover, from the graphs for single Eastern countries, it can be seen that at least since the 1970s the estimated regression equation for the East seems to reveal an even too optimistic picture of the general growth trend: in nearly all Eastern countries the actual growth trend after 1970 was directed to relative stagnation. Put differently, despite the observed large investment efforts, especially in the 1970s, the formerly observed catching-up process had nearly come to a standstill in the 1970s and 1980s. GROWTH PERSPECTIVES IN THE CASE OF SYSTEMATIC CHANGE Given these poor trends in economic growth in the centrally planned economies, it is of special interest to consider growth perspectives, say for a decade after a complete systematic change. To estimate this potential for growth, the estimated regression equation again may be used (Table 4.4, equation 2). Since all centrally planned economies in the 1980s had a rate of economic growth much the same as or below that of the United States and thus a level of relative per capita income as in 1980, the expected rates of growth can be taken directly from Figure 4.2: given the respective relative level of development, the corresponding rate of growth is given by the ordinate value of the regression equation (disregarding the system variable). The following rates of growth per year for the decade after a complete systematic change can be read: per cent Bulgaria Czechoslovakia Former GDR

3.8 3.0 2.6

COMPARATIVE ECONOMIC GROWTH

41

Figure 4.1 Technological gaps and per capita growth in OECD countries. per cent Hungary Poland Romania Soviet Union

3.6 3.8 4.3 3.5

Under the assumption that there will be ‘social capabilities’ at least as favourable as in Western market economies, the estimated trends in economic growth point to a relatively high growth potential. The projection in the case of the former GDR seems to be somewhat problematic. This is mainly true because of the underlying per capita income of the former GDR. Until now it has been assumed that the former GDR had reached a level of relative economic development of nearly 70 per cent, a level comparable to that of the United Kingdom. This seems to be too unrealistic because, as could be seen after the fall of the Berlin wall, economic problems in the former GDR seem to have been much worse and the level of development much lower than one could assume from former Western recalculations and revaluations of East German official statistics. For doing a well-founded projection it thus seems more plausible to assume a level of relative development that is about 25 per cent lower.13 The level of relative per capita income —relative to the United States—would then be in the range of about 50 per cent, a level that is little above that of West Germany at the beginning of the 1950s. If this value is put into the underlying regression equation, the yearly average growth rate in the former GDR in the 1990s would be about 3.5 per cent. This value seems to be the lower limit of the future growth potential. Since the former GDR has joined the Federal Republic one can assume a particularly favourable ‘social capability’, i.e. assume a high social consent of political interest groups (high level of corporatism), a high level of price stability and favourable conditions for investments. Thus it seems more plausible to expect for the former GDR a growth rate much the same as the one of West Germany having a relative per capita income of 50 per cent. The corresponding growth rate, which can be read from Figure 4.1, is about 6 per cent per year. This seems to be the upper limit of the average long-run per capita growth rate in the 1990s. There is also an interest to project the relative level of development of the former GDR with respect to the Federal Republic in the year 2000, i.e. to get an impression of the speed of the expected catching-up process. From Figure 4.1 it can be seen

42

DEVELOPMENTS IN EASTERN EUROPE

Figure 4.2 Technological gaps and per capita growth in centrally planned economies.

that the expected average West German growth rate is nearly 2 per cent. If one assumes that this rate can be maintained until the year 2000 —and if one expects a rate of growth of 6 per cent in the case of the former GDR—the relative level of per capita income in the former GDR in relation to the former Federal Republic will be 85 per cent. Supposing that former West Germany can gain from unification and growth on average to be 2.5 per cent, the relative level of development in the former GDR will be 81 per cent. Despite these favourable longer-run growth prospects it is obvious that in the short run there will be serious structural adjustment problems. Especially because of the shown resource intensity—and especially of the high energy intensity—the former GDR in many industries will not be competitive in world markets. Nevertheless, in the longer run the picture seems to be relatively favourable because the former GDR can—in contrast to the industrial countries in the course of the two oil-price shocks in the 1970s—make use of already developed energy-saving technologies and rapidly catch up. CONCLUSIONS World economic development after the Second World War was dominated by an international ‘convergence club’—with the United States as the technological leader. International technology transfers and international trade have led to an enormous exchange of technological know-how. From this exchange ‘backward’ economies with favourable economic and institutional frameworks—such as Japan and West Germany—could gain the most. With regard to economic development in the East, it could be seen that these countries in the 1950s—when the production of standardized mass products propelled economic growth —were able to slightly catch up with the West. In the following decades the centrally planned economies were more and more unable to cope with the increasing complexity of their industrial structures. This finally led to relative stagnation in economic development and only to an average level of relative per capita income equal to that already achieved by Western economies at the beginning of the 1950s. But because of this economic ‘backwardness’, there is also a big chance: by changing the economic system the East European countries and the USSR have the potential to increase economic growth by applying the newest Western technologies and are thus possibly able to make relatively large leaps in their economic development. But this potential to catch up requires levels of ‘social capability’, at least as favourable as in the West after the war, and thus also strongly depends on the respective socioeconomic conditions after the systematic change.

COMPARATIVE ECONOMIC GROWTH

43

NOTES 1 For a discussion of the shortcomings of Eastern national accounts as well as necessary recalculations and revaluations see e.g. Alton (1988). 2 See Kravis et al. (1975) and the following international price and quantity comparisons. 3 The arguments in this section follow Winiecki (1987:16–24). 4 Heitger (1990: Table 3). 5 An empirical test of the relationship between payments for technology imports from the United States (relative to revenues) for eight industrial countries and respective per capita incomes revealed a highly significant, negative relationship between both variables (Heitger 1985: Table 3). 6 See the contributions of Gomulka (1971), Parvin (1975), Cornwall (1977), Heitger (1985), Kormendi and Meguire (1985), Abramovitz (1986) and Baumol (1986). 7 This approach has been developed by Parvin (1975) and has also been applied in Heitger (1985) to explain economic growth in DCs and LDCs since the early 1950s. 8 The exogenous variable growth rate of population (population as a proxy for labour force) proved to be insignificant and has therefore been dropped. The binary system variables SD, SD*RGDP and SD*INVSH are highly correlated with each other. The inclusion of all three variables in one regression equation leads to distorted estimates. To deal with this problem of multicollinearity, three separate equations have been estimated, each containing only one of the system variables. 9 These results are supported by additional estimates in which the growth rate of labour productivity served as the endogenous variable. The estimates led to similar results as in Table 4.4; the coefficients of determination are somewhat higher (about 50 per cent). Thus, the estimates are in support of the results of Bergson (1987). They are in contradiction to the empirical findings of Burkett and Skegro (1989) as well as of Pryor (1985) who, on the basis of insignificant results, argue that there are no system-specific differences in economic development between East and West. 10 The graphs of the regression equations shown in Figures 4.1 and 4.2 are based on equation 2 in Table 4.4. In the underlying calculations an average share of investment in GDP of 26.5 per cent (average share for all countries in all periods of investigation) has been assumed. 11 See e.g. Heitger (1987). 12 Heitger (1989). 13 PlanEcon (1989: Nos. 42–3), for example, makes a downward adjustment of CIA GDP estimates by 25 to 37 per cent to reflect: (i) lack of availability of many goods and services at officially reported prices, (ii) differences in quality between East and West, and (iii) differences in use value of durable products due to lack of spare parts and difficulty in securing repair services.

REFERENCES Abramovitz, M. (1986) ‘Catching up, forging ahead, and falling behind’, Journal of Economic History 46:386–406. Alton, T.P. (1970) ‘Economic structure and growth in Eastern Europe’, in Joint Economic Committee, Congress of the United States (ed.), Economic Developments in Countries of Eastern Europe, Washington, DC: Joint Committee Print. — (1982) ‘Estimates of East European countries’ GNP structure and growth at factor cost’, paper given at the Workshop on CPE National Income Statistics at the World Bank, Washington, DC. — (1988) ‘Comparison of overall economic performance in the East Euro-pean countries’, in Weichardt, R. (ed.), The Economies of Eastern Europe under Gorbachev’s Influence, Bruxelles: Novosti Press Agency. Baumol, W.J. (1986) ‘Productivity growth, convergence and welfare: what the long-run data show’, American Economic Review 76: 1072–85. Bergson, A. (1987) ‘Comparative productivity: the USSR, Eastern Europe, and the West’, American Economic Review 77:342–57. Burkett, J.B. and Skegro, B. (1989) ‘Capitalism, socialism, and productivity: an econometric analysis of CES and Translog functions’, European Economic Review 33:1115–33. Choi, K. (1983) Theories of Comparative Economic Growth, Ames: Iowa State University Press. CIA (1989) Handbook of Economic Statistics, Washington, DC: Library of Congress. Cornwall, J. (1977) Modern Capitalism, London: Martin Robertson. Gomulka, S. (1971) Inventive Activity, Diffusion, and the States of Economic Growth, Aarhus: Skrifter fra Aarhus Universitets Okonomiske Institut. Heitger, B. (1985) ‘Bestimmungsfaktoren internationaler Wachstumsdifferenzen’, Die Weltwirtschaft 1:49–69. — (1987) ‘Corporatism, technological gaps and growth in OECD countries’, Weltwirtschaftliches Archiv 123:463–73. — (1989) ‘Wachstumswirkungen von Steuern und Staatsausgaben’, Kiel Discussion Papers 148. — (1990) ‘Wirtschaftliches Wachstum in Ost und West im internationalen Vergleich seit 1950’, Die Weltwirtschaft 1:173–92. IMF (1990) International Financial Statistics, Washington, DC: Publication Services International Monetary Fund. Kormendi, R.C. and Meguire, P.C. (1985) ‘Macroeconomic determinants of growth—cross-country evidence’, Journal of Monetary Economics 16: 141–63. Kornai, J. (1980) The Economics of Shortage, Amsterdam: North-Holland.

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Kravis, I.B., Kennessy, Z., Heston, A. and Summers, R. (1975) A System of International Comparisons of Gross Product and Purchasing Power. United Nations International Comparison Project: Phase One, Baltimore: Johns Hopkins University Press. Parvin, M. (1975) ‘Technological adaptation, optimum level of economic backwardness and the rate of per capita income growth: an econometric approach’, The American Economist 19:23–31. PlanEcon (1989) PlanEcon Report, Washington, DC: PlanEcon Inc. Pryor, F.L. (1985) ‘Growth and fluctuations of production in OECD and East European countries’, World Politics 37:204–37. Rostowski, J. (1988) ‘Economic structure and material and energy intensity in Eastern Europe’, in Weichardt, R. (ed.), The Economics of Eastern Europe under Gorbachev’s Influence, Bruxelles: Novosti Press Agency. Stolper, W.F. (1960) The Structure of the East German Economy, Cambridge, MA: Harvard University Press. Summers, R. and Heston, A. (1988) ‘A new set of international comparisons of real product and prices for 130 countries 1950–1985’, Review of Income and Wealth 34:1–25. Winiecki, J. (1987) Economic Prospects—East and West. A View from the East, Enfield: Pika Print Limited.

5 Structural change in Eastern Europe Roland Döhrn and Ullrich Heilemann RWI, Economic Research Institute, Essen

Natura non facit saltum, but economies do—at least sometimes. One of these cases is the current transition of central and East European countries from command-type economies to free market economies. The intention of Bulgaria, Czechoslovakia, East Germany, Hungary, Poland, Romania and the USSR (henceforth newly liberalizing countries: NLCs)1 to improve among other things their living conditions by liberalizing their economies, is in many ways associated with structural changes in their economies. This will be a natural consequence of the replacement of the state by private enterprises in many parts of the economy. At first, this seems to be only a change of ownership with no consequences per se for the structure and the efficiency of the economy. But fundamental changes can be expected as a consequence of the comprehensive replacement of central planning by free markets. Among others, this implies an abandoning of the autocentrated and autarkist development strategies and the implementation of policies directed towards an integration of the economies into the international division of labour. A different source of structural change will be the expected productivity and income growth of the NLCs. Even though there is still much debate about channels, extent and details of the proper relationship between structural change and rising income, numerous studies of the hypotheses of Fisher (1939), Fourasti (1949), Clark (1957), Chenery (1960) and others do not leave much reason to generally doubt these links. Since the question of structural change is basically one of the medium and long run, especially with respect to Eastern Europe, demographic and territorial factors must be seen as additional determinants of such changes. It is obvious that there is a manifold interest in the direction, scope and velocity of structural change as well as in sectoral and regional concentration. Unfortunately, the difficulties to answer these questions in theoretically and empirically convincing ways are equally obvious. Policy options are numerous and there is little historic experience which could serve as a guide to the future. This holds with respect to supply-and-demand conditions on factor and goods markets inside as well as outside these countries. In the age of large multi-country and/or multi-sector models such analytical difficulties are rather uncommon.2 But if one looks back some thirty or forty years, there was a similar situation when many students of international growth were confronted with problems not too different from those the analyses of NLCs pose today. One of the hypotheses born then and widely used since then is the socalled Chenery hypothesis. In short, the hypothesis links sectoral growth and thereby also sectoral structural change to the per capita level of production and income respectively. While—as all Stufen-theorien (stage theories)—being very much of a descriptive nature, it can also be used as a pattern book for detecting the current stage and the range of future developments. Of course, the theoretical and empirical simplicity of the reduced form model is a rather rigid reduction of the number of explaining variables, a limitation which for various reasons cannot be overcome completely. However, given the lack of convincing alternatives, low costs and the success of this approach in the past, it seems worthwhile to take it as a base for studying future structural changes in Eastern Europe. The plan of the chapter is as follows. The first section gives a short description of the current economic state of the seven East European countries under study. The second section is devoted to presentation, criticism and some extensions of the Chenery hypothesis. The third section discusses the results of its econometric examination, especially with respect to previous findings. Based on these results, section four tries to mark the dimension of structural change to be expected in Eastern Europe. The chapter ends with a summary and conclusions. THE STARTING SITUATION To get an impression of the situation to be analysed and to help evaluate the results of our rather formal analysis, we start with a short look at the past and present of East European economies. Without question, for most NLCs (Chart 5.1) not only their recent but also their past histories present in many ways a rather heavy burden.3 For centuries, large parts of central and Eastern Europe4 suffered under—often changing—foreign rule, which for some countries ended only with the First World War. Even during the last seventy years, most of these countries underwent at least four fundamental changes (in some cases it would be more appropriate to speak of shocks) in their political and economic systems. A first one took place after the First World War, when some of these countries gained independence (Czechoslovakia, Hungary, Poland) or experienced a

46

DEVELOPMENTS IN EASTERN EUROPE

Chart 5.1 The newly liberalizing countries.

fundamental change of their political system (USSR). Preparations for the Second World War, the war economy itself, and various occupations of their territory marked a second considerable change. The emerging post-war economies, their integration into Comecon presented a third such change, though some of the countries tried to link up to their pre-Second World World War history. The fourth fundamental change, characterized by a shift from the centrally planned economy type to a liberal, market-oriented type, has been under way since the mid-1980s. Economic development in Eastern Europe was not only halted or disturbed by these changes, sometimes it was even misdirected in one way or another. For many years, most parts of these countries were treated as a kind of hinterland by the dominant power (Russia and Habsburg Austria). They were assigned to primary production, excluded from early industrialization and played only a peripheral role in the national and international integration and division of labour.5 Causes and consequences of these developments alike has been a rather late (and slow) start of, or spurt to, industrialization in Eastern Europe. All of these countries or regions, including the leading powers of the area, were follower countries where this process started on a grand scale in the third or fourth quarter of the nineteenth century. In addition, the first few industrial plants in general were rather unevenly scattered over the region. This was, at first, to some degree the consequence of a general lack of sizeable natural resources like coal or iron ore in these countries. At a later stage, however, the little dissemination of industry also reflected the lack of the indispensable infrastructure. Road construction, as well as much of the production of industrial output in these countries (textiles, iron), was largely determined by military or court needs. At the end of the nineteenth century, economic policy in these countries was not only still very much paternalistic, but also very mercantilistic, inward-looking and autarkically-minded. Market forces were rarely allowed to play their full part because of, for example, cartels and customs. This constellation has created traditions still influential in the NLCs today: on the one hand, there was a dominating influence of the state on the investment process, later on complemented or substituted by universal banks of the German type; on the other hand, there was a wide and sadly felt lack of a non-civil service middle class and of entrepreneurship. For too many years economic initiative and investment were either a matter of the state or of foreign investors, of religious minorities, and of the lowest parts of the social stratum. Of course, all these obstacles did not prevent these countries from realizing substantial improvements in their economic conditions, though often they were not large enough to stop emigration to Western Europe or America. In the middle of the 1980s, Eastern Europe presented itself mainly as a middle income region. It is by no means as homogeneous as such a label might suggest (Table 5.1). If we look at population and population density, the USSR has to be separated from the rest of Eastern Europe. With regard to per capita income,6 the divide lies somewhere between Romania, Bulgaria and the

STRUCTURAL CHANGE IN EASTERN EUROPE

47

Table 5.1 Economic and demographic patterns of NLCs, 1986 Country

GDP per capita (a)

Industry (b)

Exports (c)

Agricultural exports (d)

Population (e)

Population density (f)

Romania 1250 – – – 22.9 96 Bulgaria 1650 62 – – 9.0 81 USSR 1800 44 – – 283.0 13 Hungary 2020 38 40 23 10.6 114 Poland 2030 47 40 12 37.5 120 CSFR 2550 61 – – 16.0 125 GDR 3750 66 30 7 16.6 154 Sources: World Bank (1990); United Nations (1989); authors’ estimations. Notes: (a) US$ (b) Share in NMP in per cent (c) Share in GDP in per cent (d) Share in total exports in per cent (e) Million (f) Inhabitants per square km.

USSR on one side, and the rest on the other, with the (former) GDR being a case of its own. As to industrialization the homogeneity of Eastern Europe seems to be somewhat greater, reflecting primarily common policy preferences and the peculiarities of the central planning system. HYPOTHESES, METHODS AND DATA The analysis of structural change has a long tradition, although there is not very much agreement either on variables causing and reflecting it nor on their interaction of the process itself.7 This paper is not the place to discuss the various ways nor the numerous explanations of structural change during the last 100 years. We have to constrain ourselves to the notion that there are theories viewing the process as exogenously or endogenously determined and start either at the supply side or at the demand side. Another distinction can be made between voluntaristic approaches on the one hand and historicistic approaches on the other. The following analysis of development patterns—as first suggested by Chenery (1960)—is based on the hypothesis that structural change is the result of interaction between two groups of factors. The first group consists of so-called special factors of a country, representing its peculiarities such as relative prices and exchange rates. The second group comprises so-called universal factors. They may be a consequence of technical universalities as represented by common production functions, of demand or preference universalities as described for example in Engel’s law, or they may be the consequences of similarities in the way countries are integrated into the world economy (Chenery and Taylor 1968). The relative importance of the two groups of factors depends to a large degree on the level of aggregation. Due to lack of appropriate data for NLCs and many other countries in our reference group, the present study will be restricted to a relatively high level of aggregation. It will concentrate on universal factors, although when interpreting the results, the special factors will not be completely ignored. A widely used approach to detect such universal factors, the direction, and the magnitude of their influence is the estimation of so-called sector growth functions as proposed by Chenery. In distinction to the usual and/or neoclassical view of the growth process, this framework emphasizes the demand side of growth.8 The underlying functions used may be interpreted as reduced forms of a rather simple model of an economy in which a sector’s domestic production is determined by domestic final demand, intermediate demand and exports. With regard to the components of domestic demand, it is hypothesized that they depend on per capita income (indicating the level or stage of economic development), on the size of the economy (because of possible economies of scale), and on sector-specific natural resources. Chenery in his first estimations treated the last factor in a more qualitative manner. This led to the explanation of sector i’ s per capita value added in a country j with the help of a per capita income and a population variable, the latter being a proxy for the size of the economy. As to the influence of the two variables, Chenery expected them to differ with the sector under investigation. Since he assumed constant elasticities with respect to ‘growth’ (i.e. per capita value added) and ‘size’ (i.e. population), the equations were expressed in log form: (1) with Vij=value added per capita in sector i and country j; Yj=income per capita of country j; Nj=population of country j. The parameter i1 is expected to be positive; a value greater than 1 indicates increasing importance with rising income. Parameter i2 may be either positive or negative. A positive sign indicates that some production will take place when the

48

DEVELOPMENTS IN EASTERN EUROPE

economy is reaching a ‘minimal optimal’ size, a negative sign is expected when some basic production is required (e.g. food production). As a correlate, Chenery’s model contains an import function of the same type: (2) with Mij=imports per capita in sector i and country j. Later applications of this approach concentrated on sectoral growth functions, while import functions had been neglected. This will also be the case in the following analysis. Chenery’s model had a strong impact on discussions about development policies, especially in the 1960s. The relations between economic structure and per capita income investigated in international comparisons were often interpreted as ‘normal patterns’ and, for example, served as a yardstick to state a country’s over industrialization (cf., e.g., Fels, Schatz and Wolter 1971; Fels and Schmidt 1981). This interpretation has been criticized for various reasons. One reason was the fact that such ‘normal patterns’ can be estimated only for closed economies. Another criticism referred to the question of causality. While in Chenery’s framework growth is a result of structural change, structural change may also be seen as a function of growth.9 Such problems, as well as later advance of disaggregated econometric models, reduced the attraction of the Chenery hypothesis, or, at least, the way in which it had been expressed. With respect to our objective this approach nevertheless seems to be promising. The present situation in analysing NLCs has much in common with the one in the 1950s: a detailed database (in the broadest sense) is missing and a comparison with other economies is needed to get some general idea about NLCs’ future economic structure and the required changes. To apply the sectoral growth functions approach today, it seems necessary not just to re-estimate these functions but also to examine their stability. This will be done in two ways: first, in a rather general way by comparing the new estimates with those detected for the 1950s and 1960s and, second, by a more systematic stability analysis using the recent database. The latter seems necessary if our results are used as a starting point for estimates of future developments. First of all, for more accurate information about sectoral behaviour, it seems appropriate not to explain the absolute volume of a sector’s value added but its share, a procedure which is, however, identical with that of equation l.10 Second, equation 1 is extended to test for the influence of an economy’s endowment with natural resources. The influence is operationalized with per capita net exports of primary goods (EP). The variable is employed in linear form because it may have negative values (net imports).11 GDP shares of gross capital formation (IQ) are introduced to test for the influence of capital formation. A third modification concerns the functional form. In the 1950s, when Chenery began his analysis, the constant elasticity approach described structural developments sufficiently well. But with increasing per capita incomes in industrialized countries, the contribution of manufacturing to economic growth (after having reached a maxium) did decline—as foreseen for example by Clark and Fourasti. Therefore, it turned out to be more appropriate to use functional forms with flexible elasticities. Chenery and Taylor (1968) used a log-quadratic form, Fels et al. (1971) employed a combination of a logarithmic and a linear approach.12 In our tests, the latter procedure also proved the most successful. We estimated the sectoral growth function as follows: (3) The parameters of equation 3 can be estimated from cross-section data, from time-series data or—as is frequently done—from a pool of cross-section and time-series data. As Balestra and Nerlove (1966) and Hsiao (1986) have shown, however, the error term of estimations based on pooled data does not have OLS-properties.13 We therefore based our estimations mainly on cross-section data. For some countries, time-series as well as pooled data estimates are presented for comparison. The use of uniform functions, as represented by equation 1 for all sectors, would guarantee that OLS-estimates satisfy the addingup criterion, i.e. the (estimated) sum of sectoral value added would equal total income (Prais and Houthakker 1971). The technique employed here, i.e. estimating equations with a different set of variables for each sector, would require some rule of correction when distributing the (positive or negative) differences amongst the various sectors (Heilemann 1978). As the number of sectors analysed is small and the estimated equations for the most part proved to satisfy the adding-up condition, we dropped a correction rule.14 The primary purpose of the present study is to project NLCs’ future sectoral structure. This will be done by estimating ‘normal patterns’ of sectoral structural change for Western market economies. To omit any bias, it seems to be necessary to choose a sample of countries not spoiled too much by the influence of special factors, and of income levels relevant for NLCs at least in the near future. According to World Bank classifications, East European economies may be regarded as middleincome economies. We therefore dropped all low-income countries from our sample. Furthermore we excluded economies of small size (in area or population), such as Hong Kong, Singapore or Luxemburg, as well as countries highly dependent on exports of minerals or fuels such as OPEC members. Finally, some countries had to be excluded due to their atypical

STRUCTURAL CHANGE IN EASTERN EUROPE

49

economic situation (e.g. the high-inflation Latin American countries), or merely because of lack of appropriate data (e.g. Switzerland). Thus our reference group consists of twenty-eight economies (Table 5.2). They may be divided into three subgroups: – East and South-east Asian developed and developing countries; Table 5.2 Economic and demographic patterns of twenty-eight countries, 1986 Country

GDP per capita (a)

Philippines Thailand Malaysia Rep. of Korea Taiwan Japan

560 800 1,850 2,370 4,100 12,840

Morocco Egypt Turkey Tunisia Portugal Yugoslavia Greece Spain Italy

590 760 1,110 1,140 2,250 2,300 3,680 4,860 8,550

Ireland United Kingdom Belgium Austria Netherlands France

5,070 8,870 9,230 9,990 10,020 10,720

Industry (b) Exports (c) Agricultural exports (d) East and South-east Asia 29 25 26 25 28 54 31 57 38 35 41 6 44 49 6 33 12 1 Mediterranean Basin 25 24 27 29 29 14 33 22 33 24 33 13 32 39 16 37 16 12 20 22 35 30 20 19 29 20 8 Middle and northern Europe, North America 28 57 28 28 26 9 26 69 12 31 37 8 28 54 25 25 21 19

Population (e)

Population density (f)

57.3 52.6 16.1 41.5 19.7 121.5

191 102 9 423 547 327

22.5 49.7 51.5 7.3 10.2 23.3 10.0 38.7 57.2

50 50 66 44 111 91 76 77 190

3.6 56.7 9.9 7.6 14.6 55.4

51 231 319 90 356 101

Fed. Rep./ 12,080 33 30 6 60.9 245 Germany Finland 12,160 24 27 14 4.9 15 Denmark 12,600 19 32 36 5.1 119 Sweden 13,160 25 33 10 8.4 19 Canada 14,160 26 27 18 25.0 3 Norway 15,400 29 38 10 4.2 13 United States 17,480 25 7 17 241.6 26 Sources: See Table 5.1; World Bank and United Nations; Executive Yuan of the Republic of China (various issues). Notes: (a) US$ (b) Share in GDP in per cent (c) Share in total exports in per cent (d) Million (e) Inhabitants per square km. Some data refer to other years than specified.

– Southern European or North African countries around the Mediterranean basin; – Middle and north European and North American developed market economies. All data were taken from UN and World Bank sources, supplemented by data from EC and national statistics. If not stated otherwise, data refer to 1978–86. Five sectors are analysed: agriculture, mining and energy, manufacturing, construction, and services. Data on three subgroups of the service sector are also available. Additional estimates for these groups did not lead to satisfactory results and are not presented here.

50

DEVELOPMENTS IN EASTERN EUROPE

Figure 5.A1 Stability of parameters of sectoral growth functions. Note: (a) Per capita, scale factor 103. Source: Authors’ computations.

EMPIRICAL RESULTS The regression estimates of the sectoral growth functions are quite satisfying and significant at least at a 95 per cent significance level (Table 5.3). The coefficients (elasticities) in general meet the theoretical expectations and are in accord with previous experience: growth elasticity in the agricultural sector is less than 1; in manufacturing, the value of the coefficient is greater than 1 at low-income levels and decreases with rising income (the maximum share of manufacturing in GDP is reached at a per capita income of US$5,400). The size-elasticity is significant in the agricultural and in the service sectors. Capital formation has an impact on the share of the construction sector, but not on the share of other sectors, which might be due to the static nature of the underlying approach. The natural resource variable has a positive influence on the share of mining and energy, and a negative influence on the share of the manufacturing sector. Despite macroeconomic imbalances during the late 1970s and in the 1980s, the estimated coefficients as well as the goodness of fit seem to be rather stable (Table 5.3, Figure 5.A1). The results are also interesting from a more economic perspective: the constant term is a distinctive factor in agriculture, mining and energy, and services, indicating that some part of the service sector may be regarded as a sort of ‘primary’ production. With respect to manufacturing, we can only explain a smaller part of international and inter-temporal differences in the sectors’ growth as, for example, Fels et al. (1971). While Fels et al. in a pooled time-series cross-section analysis for 1950–67 estimated a coefficient of determination of 0.84, a similar empirical test based on pooled data for twenty-eight countries in 1978–86, reveals a

STRUCTURAL CHANGE IN EASTERN EUROPE

Table 5.3 Regression results of sectoral growth functions, 1978–86 Year 0

(const.)

1978 1982 1986

1978 1982 1986

1978

Coefficients(a) 1−1

(log income)

2

(income/ 1000)

8.991 (10.2) 9.435 (10.4) 9.465 (14.5)

0.674 (10.6) 0.693 (10.7) 0.716 (12.0)

1.639 (2.1) 2.325 (3.3) 3.730 (3.2)

0.027 (0.3) 0.073 (0.9) 0.259 (1.9)

0.224

0.352

3

(log population)

Agriculture –

4

(primary exports)

5

(investment ratio)

F

0.127 (2.0) 0.168 (2.6) 0.156 (2.2)

–

–

0.804

57

–

–

0.806

57

–

–

0.844

74

Mining and energy –

–

–

0.098

2

–

–

–

0.407

10

–

–

0.00075 (2.0) 0.00068 (4.3) 0.00079 (2.7)

–

0.245

5

Manufacturing 0.072

0.082

0.00044

–

0.514

8

– –

51

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DEVELOPMENTS IN EASTERN EUROPE

Stability of parameters of sectoral growth functions. Note: (a) Scale factor 10 4; t (b) per capita, scale factor 103 . Source: Authors’ computations. Year 0

(const.)

1982 1986 1978

1982 1986

Coefficients(a) 1−1

(log income)

(0.2) 0.164 (1.1) 0.684 (0.6) 0.982 (1.3)

1.189 (1.3) 1.348

2

(income/ 1000)

(3.1) 0.307 (2.4) 0.277 (2.1) 0.296 (2.5)

0.261 (2.0) 0.244

3

(log population)

(2.8) 0.062 (2.2) 0.051 (1.9) 0.062 (3.0)

0.054 (1.9) 0.045

4

(primary exports)

(2.1) 0.070 (1.7) 0.043 (0.9) –

– –

0.00026 (3.4) 0.00025

5

(investment ratio)

(2.8) 0.00022 (2.8) 0.00022 (2.2) 0.00056 (4.0)

F –

0.412

6

–

0.326

4

–

0.446

8

–

0.368

6

–

0.329

5

STRUCTURAL CHANGE IN EASTERN EUROPE

53

Figure 5.1 GNP per capita and manufacturing. Note: (a) 1980 prices and exchange rates. Source: United Nations (1989); World Bank (1990).

1978 1982 1986

(1.5)

(2.0)

0.907 (1.2) 1.063 (1.4) 0.173 (0.2)

0.074 (2.5) 0.088 (2.3) 0.076 (2.1)

(1.7) Construction –

(2.8) –

–

–

–

–

–

Services 2.828 0.099 – 0.023 – (13.4) (6.4) (1.5) 1982 2.850 0.090 – 0.032 – (11.0) (4.8) (1.8) 1986 2.711 0.098 – 0.041 – (10.8) (5.5) (2.3) Source: Authors’ computations. Note: (a) Coefficients according to equation (3) (see text); T-values in parentheses.

1978

0.701 (3.6) 0.697 (3.8) 0.402 (2.1)

0.311

7

0.326

8

0.170

4

–

0.599

21

–

0.455

12

–

0.529

16

respective coefficient of 0.46 (Table 5.A1). A comparison of year-by-year regressions shows that the influence of the variable reflecting size declined. After 1981, the respective elasticity is not significant—not even at a significance level of 90 per cent. However, this seems to be plausible, since the abolition of trade barriers in various GATT rounds as well as increased international trade might have reduced the influence of the economies of scale. Thus in the following calculations the size variable will be dropped. Nevertheless, a look at the share of manufacturing in GDP in the course of time and among countries reveals a still strong relationship between per capita income and manufacturing growth (Figure 5.1). This impression is further confirmed by regression estimates from time-series data for selected countries and groups (Table 5.4). The underlying regression function includes a constant term and the logarithm of per capita income as explanatory variables.15 The slope coefficients are significant at the 95 per cent significance level in twenty-two out of twenty-eight cases. The estimates of growth elasticity from cross-section data lie within the range of estimates from time-series analysis.

54

DEVELOPMENTS IN EASTERN EUROPE

Table 5.A1 Regressions of sectoral growth functions, 1978–86(a) Sector 0

(const.)

Agriculture Mining and energy Manufacturing

Construction Services

Coefficients(b) 01–1 (log income)

2 (income/ 1000)

9.476 (33.6) 2.069

0.705 (35.0) 0.062

(2.6) 0.261 (0.8) 1.202 (4.4) 0.877 (1.2) 2.769 (33.8)

(0.6) 0.308 (7.9) 0.263 (6.7) 0.072 (2.5) 0.095 (16.2)

3 (log population)

4 (primary exports)

5 (investment ratio)

–

0.161 (8.0) –

–

–

0.831

616

0.000774

–

0.098

67

–

0.463

55

–

0.415

60

–

0.605 (7.2) 0.528 (6.1) – –

0.063 (4.8) – – 0.035 (6.0)

(3.1) 0.00022 (8.1) 0.00026 (9.9) – –

F

0.677 0.329 62 (3.6) – 0.522 136

Source: Authors’ computations. Notes: (a) Pooled time series cross-section analysis (b) Coefficients according to equation (3) See text; T-values in parentheses. Table 5.4 Growth elasticity of manufacturing in selected regions, 1970–86 Income group (US$ per capita)(a)

Region Asian countries Mediterranean Basin Middle and northern Europe, North America Total

below 1500

1500–3000

3000–6000

above 6000

No. Range Mean No. Range Mean No. Range Mean No. Range Mean Mean

3 1.08–1.68 1.40 4 0.31–1.69 1.18 – – – 7 0.31–1.69 1.27 1.2

1 1.32 1.32 2 0.84–1.30 1.07 – – – 3 0.84–1.32 1.16 1.14

1 0.98 0.98 2 0.02–0.91 0.45 1 1.61 1.61 4 0.02–1.61 0.87 1.04

1 0.55 0.55 1 0.19 0.19 12 0.74–0.83 0.11 14 0.74–0.83 0.15 0.77

Memo item: cross-section elasticity 1986 Source: Authors’ computations. Note: (a) No.: number of observations in subgroup; Range: minimum and maximum elasticity in subgroup; Mean: average of elasticities in subgroup.

Table 5.4 also shows growth elasticities of the manufacturing sector for subgroups of countries. The results suggest that the elasticities in Asia are somewhat higher than in the Mediterranean region. Though this result must be judged with some care because it is based on a very limited number of observations, it might be of special relevance for the NLCs: the regional setting of the East European countries seems to have more in common with the Mediterranean than with the Asian countries in our sample. The latter are situated in a less developed surrounding with only one highly industrialized economy (Japan) as a centre and with trade relations being strongly oriented across the Pacific Basin. The Mediterranean countries and the East European ones, are located at the rim of a large and ‘old’ industrialized centre (with which they used to have traditionally strong trade relations). Furthermore, climatic conditions and the importance of tourism in the southern NLCs speak in favour of the ‘Mediterranean model’. To examine the feasibility of our approach for forecasting sectoral growth of countries outside the sample, we first made an ex-post forecast based on parameter estimates from our cross-section analysis for 1978 (Figure 5.2). Though usual error measures (e.g., the root mean square error, RMSE) indicate that the goodness of fit is somewhat worsening when we leave

STRUCTURAL CHANGE IN EASTERN EUROPE

55

Figure 5.2 Root mean square errors of sectoral growth functions. Source: Authors’ computations.

Figure 5.3 Sectoral structures of selected countries.

our sample, the distortion is not systematic. As expected, the manufacturing sector shows the greatest error variance, mainly because it had to bear most of the consequences of the slump of the early 1980s. We also applied our estimates to the sectoral structure of four economies which were not part of our database. As Figure 5.3 shows, the observed structure is met fairly well. STRUCTURAL CHANGE IN EASTERN EUROPE Moving to the main topic of our analysis, it is worthwhile to start with some stocktaking about the economic structure of the NLCs. As stated above, East European economies are highly industrialized. Their large industrial sectors are complemented by equally large agricultural and construction sectors whilst the service sectors are small (Table 5.5). This result is to a large extent due to statistical peculiarities, or to be more specific: to the net material product Table 5.5 Economic structure of the NLCs, 1986 (per cent) Sector

Agriculture

Total

Industry mining and energy Sectoral share in net material product

Manufacturing

Construction

Services

56

DEVELOPMENTS IN EASTERN EUROPE

Sector

Agriculture

Total

Romania Bulgaria USSR Hungary Poland CSFR GDR

– 15 21 13 15 8 13

– 62 44 38 47 61 66

Industry mining and energy

Manufacturing

– – – – – – – – – – – – – – Sectoral share in employment Romania 29 37 – – Bulgaria 21 34 – – USSR 19 29 – – Hungary 22 31 – – Poland 29 29 4 24 CSFR 14 37 3 34 GDR 11 41 – – Hypothetical share in GDP(a) Romania 19 27 7 20 Bulgaria 17 29 4 25 USSR 10 28 7 21 Hungary 13 29 5 23 Poland 11 29 5 24 CSFR 10 30 4 26 GDR 8 31 3 27 Sources: United Nations (1989); International Labour Office (1989); authors’ computations. Note: (a) Calculated according to regression results for 1986 presented in Table 5.3.

Construction

Services

– 10 12 11 12 11 8

– 14 23 23 22 20 18

7 9 9 7 8 8 7

27 35 43 40 31 41 41

5 5 5 5 5 5 5

45 45 52 46 49 49 50

(NMP) system employed in national accounts in the NLCs. According to NMP, most services are regarded as being not productive and not contributing to national value added. This leads to an underestimation of the service sector, compared to the system of national accounts (SNA) (United Nations 1971). To get a more comparable picture of the extent of the service sector in NLCs, one may have a look at employment. But even then, and after dismissing statistical distortions, the service sector in these countries is still relatively small, reflecting their (past) political preferences. In order to get a first impression of structural change in Eastern Europe, we refer to our previous empirical results and develop some kind of hypothetical sector structure for the NLCs. Although there are a lot of problems in getting appropriate estimates of the data of the exogenous variables, we refrain from discussing them here.16 Bearing these problems in mind, our estimates may help to suggest to what extent sectoral structure has been distorted by the central planning system. Compared with developed and developing market economies, the shares of the industrial as well as of the construction sectors in the NLCs are almost twice as high, whilst in the service sector is usually relatively small (Table 5.5). The share of the agricultural sector (share in NMP) lies in the range observed in Western economies, with the USSR as an important exception. Comparing shares in NMP and in employment it can be seen that productivity in agriculture must be low in most East European countries. Differences in income levels indicate that the hypothetical structure also differs among the NLCs, but these variations are significantly smaller than the ones now observed. Before considering future sectoral structures in NLCs, the composition of the service sector may be looked at in more detail. Although differences within this sector have thus far been neglected, the composition of the service sector in the East European economies, which differs widely from those in Western countries, points to serious adjustment problems. In Western industrialized economies, about 40 per cent of the employees in the service sector are concentrated in activities like trade, financing and business services. In Asian countries, employment in the service sector is even dominated by these services. In Eastern Europe, only about 20 to 25 per cent of the employees in the service sector are working in such businessrelated activities; instead, public or governmental services are dominant. Since some important activities such as public relations and consulting are completely missing, the establish-ment of an enterprise-oriented service sector is one of the greatest challenges in sectoral restructuring in Eastern Europe. Thus the necessity for structural change in NLCs is twofold. First, there is the problem of correcting the existing structures, distorted by system-specific factors. Second, structures will have to change according to the expected changes in income and

STRUCTURAL CHANGE IN EASTERN EUROPE

57

other universal factors. Of course, though analytically both influences can be distinguished, in reality they will become mixed up. To get a picture of future structural change in NLCs a projection may be helpful. Our findings confirm a strong impact of per capita income on future sectoral structures. We assume that NLCs will be able to double per capita income within the next ten years—i.e. will realize an annual growth rate of about 7 per cent—and thus will reduce their economic backlog to Western European economies substantially. Further assumptions are: population in the NLCs will grow according to past trends, investment will increase to renew capital stocks, and net exports of primary goods will remain roughly the same as observed in the recent past. The coefficients used were those from the equation for 1986 for the whole sample. According to this—quite optimistic—scenario of growth, the sectoral structure according to our cross-section analysis will develop as follows: Compared to the hypothetical values in 1986 the importance of manufacturing and services will increase, while the importance of the agricultural sector will decrease (Table 5.6). The expansion of manufacturing will be strongest in lower-income economies like Romania and Bulgaria. In economies with relatively high incomes (Czechoslovakia and the GDR), the (relative) increase of the manufacturing sector will be smaller and growth of the service sector will be more marked. Compared with existing structures, it can be stated that structural change due to rising income will be significantly smaller than the need of restructuring due to abolishing the command-type economy. With respect to manufacturing this means that re-industrialization in a period of rising income will be significantly smaller than the decline of the existing industries. The projections presented hitherto are based on the experience of quite a large sample of countries, representing different strategies of industrialization and different conditions for taking part in international trade. For the reasons stated above, the economies of the Mediterranean area may be a more relevant example for NLCs’ future development than, for example, the Asian countries. To make clear the importance of strategies of industrialization as well as of special locational factors, it is helpful to make an additional Table 5.6 Estimated sectoral structure of the NLCs, 1986 (per cent)(a) Sector

Agriculture Total Industry mining and energy Manufacturing Construction Services Memo item: manufacturing based on Mediterranean countries

Romania 12 28 6 Bulgaria 10 30 4 USSR 6 29 6 Hungary 8 30 4 Poland 7 30 4 CSFR 6 31 3 GDR 5 31 2 Source: Authors’ computations. Note: (a) See text for details of the projections.

22 27 23 25 26 29 29

5 6 6 6 6 6 6

48 48 55 49 52 52 54

19 22 19 20 20 22 20

projection based on growth elasticities as they are typical for Mediterranean countries and to concentrate on the manufacturing sector. The results demonstrate that in this case, economic structures in the NLCs will have to be very different from those presented above: there will be almost no increase in manufacturing, although per capita income doubles. Though this scenario is probably not a very realistic one for all NLCs (the USSR in particular will be a special case), it is evident that the future sectoral structure of East European economies will not necessarily be one of the industrial type. In any case the results illustrate that there is a wide range for structural change. SUMMARY AND CONCLUSIONS The need for sectoral change in Eastern Europe is manifold. The question is, how much Eastern Europe will have to undergo these changes. Any answer is burdened with many uncertainties and risks, even for economies with widely known and generally accepted patterns of reactions. For NLCs, for which any such knowledge is, of course, missing, the task is particularly difficult. One promising approach is offered by the Chenery hypothesis. In the light of today’s large disaggregated econometric models the reduced-form approach of Chenery is, of course, a rather simple one. In the present situation the model nevertheless seems to be worthwhile. Indeed, when tested with data of twenty-eight countries from the late 1970s to the mid-1980s, the hypothesis did surprisingly well since our results suggest a comparatively high intertemporal stability and a high explanatory power. Within our estimates we not only can distinguish between sectoral patterns of high-and low-income regions, we can also discriminate between an Asian and a Mediterranean type of adjustment pattern. For various reasons we concentrated on only two ‘master patterns’: the overall middle-income country-type and the special Mediterranean countrytype.

58

DEVELOPMENTS IN EASTERN EUROPE

Assuming a doubling of NLCs’ real per capita income within ten years, a common feature of the general and the special pattern of structural change is that all these countries will experience a marked extension of their service sector. With regard to manufacturing, the results vary with the pattern employed. Following the middle-income country sample, Eastern Europe would (after a period of restructuring)—surprisingly—still have to expand their industrial sectors. Following the Mediterranean pattern, however, no such extensions are required. Although the present approach in line with the analysis suggested by Chenery proved quite helpful, some limitations of the hypothesis and of its informational content may be recalled. First, our findings suggest that even for countries of a certain income group, the path of structural change is a rather broad one with a number of options and alternatives. Second, the explanatory power of the hypotheses is not as overwhelming as to regard future sectoral structures as completely determined. This especially holds true if one remembers that the underlying model is some kind of an equilibrium model and says, for example, nothing about the time-span in which equilibrium is reached. In addition, the results say nothing about intra-sectoral changes, the necessary behaviour of consumers and governments, as well as required macroeconomic and monetary policies, trade policies, etc. Although the share of NLCs in world production and world trade will not be great in the near future, there is some evidence that structural change in Eastern Europe will not leave the structure, especially of Western Europe, untouched. NOTES 1 The expression is borrowed from Fieleke (1990). Fieleke also includes Yugoslavia in this list, but in our eyes it should be treated as a special case. On the other hand, the former GDR is here still regarded as an economy of its own, whose need for structural change has even increased because of the German unification. 2 This is not to say that there is a lack of such models for Eastern Europe (cf., for example, Uebe et al. 1989). Despite the usual difficulties of these models, in a situation like now the prognostic content of their hypothesis is approaching zero. The same holds, of course, for any other type of empirical model. 3 For the following in general cf., for example, Macartney (1968), Maddi-son (1969), Gross (1978), Grossman (1978) and Zauberman (1978). As to migration, cf. Armengaud (1978) and Macura (1978). 4 The former GDR is a special case which has been excluded from the following discussion. 5 An interesting discussion of these problems is in Heller (1933). Though the article is written very much under the impression of Hungary’s problems during the depression, Heller points to a number of factors still relevant for most NLCs. 6 The discussion of the quality of the statistical material has to be postponed until the second section. But there seems to be not much evidence that the within-group relationship is disturbed. 7 Cf., for example, the references in the various reports on structural change of the five West German Economic Research Institutes, commissioned by the Federal Ministry of Economic Affairs. 8 For a comparison of neoclassical and demand-side growth patterns see Chenery (1986). 9 For the interrelations of growth and structural change in the consumer demand in the FRG, cf. D−hrn (1985), for example. 10 The parameters of regressions based on shares (V/Y)—including the standard error of the coefficients—are identical to those of (1). As the variance of V/Y is smaller than the variance of V, the coefficient of determination of a thus modified equation is always smaller than of (1). 11 Other operationalizations of the natural resources variable and of additional universal factors, e.g. the degree of industrialization, can be found in Chenery and Taylor (1968) and in Fels et al. (1971). 12 In a log-linear approach log y= 1* log x+ 2* x the elasticity of y with respect to x is: ey/x= 1+ 2*x 13 In the estimates of Chenery (1960), Chenery and Taylor (1968) and Fels et al. (1971) no error-term corrections had been made. 14 Thus in the following calculations the variable reflecting economic size was dropped. 15 The regression function is: log (Vi/Y)= 0+( 1–1) * log Y 16 To illustrate these difficulties it should be mentioned that estimates of per capita income, a central figure of our calculations, lie within a wide range, e.g. estimates for Poland’s (1989 GNP per capita cover a spectrum between US$977 and US$7,270. Cf. Schweizer Réckversicherung (1990:23)).

REFERENCES Armengaud, A. (1978) ‘Population in Europe 1700–1914’, in Cipolla, C.M. (ed.), The Fontana Economic History, vol. 3, The Industrial Revolution, Glasgow. Balestra, P. and Nerlove, M. (1966) ‘Pooling cross-section and time series data in the estimation of a dynamic model: the demand for natural gas’, Econometrica 34:585–612. Chenery, H.B. (1960) ‘Patterns of industrial growth’, American Economic Review 50:624–54. — (1986) ‘Growth and transformation’, in Chenery, H., Robinson, S. and Syrquin, M. (eds), Industrialization and Growth, New York: Oxford University Press.

STRUCTURAL CHANGE IN EASTERN EUROPE

59

—and Taylor, L. (1968) ‘Development patterns: among countries and over time’, Review of Economics and Statistics 50:391–416. Clark, C. (1957) The Conditions of Economic Progress, 3rd edn, London: Macmillan. D−hrn, R. (1985) ‘Sàttigungsgrenzen beim Privaten Verbrauch?—Versuche einer empirischen Bestimmung’, RWI-Mitteilungen 36:125–45. Executive Yuan of the Republic of China (ed.), National Conditions of the Republic of China, Taipei, various issues. Fels, G., Schatz, K.W. and Wolter, F. (1971) ‘Der Zusammenhang zwis chen Produktionsstruktur und Entwicklungsniveau’, Weltwirtschaftliches Archiv 106:240–78. —and Schmidt, K.D. (1981) Die deutsche Wirtschaft im Strukturwandel, Tébingen: Mohr. Fieleke, N.S. (1990) ‘Commence with the newly liberalizing countries: promised land, quicksand, or what?’, New England Economic Review May/June 1990:19–33. Fisher, A. (1939) ‘Production primary, secondary, and tertiary’, Economic Record 15:24–38. Fourasti, J. (1949) Le grand espoir du XXe siècle, Paris: Gallimard. Gershuny, J. (1978) After Industrial Society? The Emerging Self-service Economy London: Macmillan. Gross, N.T. (1978) ‘The industrial revolution in the Habsburg monarchy, 1750–1914’, in Cipolla, C.M. (ed.), The Fontana Economic History, vol. 4(1), The Emergence of Industrial Societies—1, Glasgow. Grossman, G. (1978) ‘The industrialisation of Russia and the Soviet Union’, in Cipolla, C.M. (ed.). The Fontana Economic History, vol. 4 (2), The Emergence of Industrial Societies—2, Glasgow. Heilemann, U. (1978) ‘Die sektorale Produktionsentwicklung 1961 bis 1985’, RWI-Mitteitungen 29:32–52. Heller, W. (1933) ‘Die Zukunft der Eingliederung Ungarns in die Weltwirtschaft’,Weltwirtschaftliches Archiv 3:79–112. Hsiao, C. (1986) Analysis of Panel Data, Cambridge: Cambridge University Press. International Labour Office (1989) Statistical Yearbook, Geneva. Macartney, C.A. (1968) The Habsburg Empire, 1790–1918, London: Heinemann. Macura, M. (1978) ‘Population in Europe 1920–1970’, in Cipolla, C.M. (ed.), The Fontana Economic History, vol. 5(1), The Twentieth Century –1, Glasgow. Maddison, A. (1969) Economic Growth in Japan and Russia, London: Allen & Unwin. Prais, S.J. and Houthakker, H.S. (1971) The Analysis of Family Budgets, 2nd edn. Cambridge: Cambridge University Press. Schweizer Réckversicherung (ed.) (1990) ‘Osteuropa: Schwieriger Weg vom Versicherungsmonopol zum Markt’, Sigma 5. Statistical Office of the European Community (ed.) (1990) National Accounts ESA. Detailed Tables by Branch 1989, Luxemburg. Uebe, G., Huber, G. and Fischer, G. (1989) Macro-econometric Models —An International Bibliography, Aldershot: Gower Press. United Nations (ed.) (1971) Basic Principles of the System of Balances of the National Economy, New York. — (1989) National Accounts Statistics: Analysis of Main Aggregates 1986, New York. World Bank (ed.) (1990) World Tables 1989–90 Edition, Baltimore and London. Zauberman, A. (1978) ‘Russia and Eastern Europe 1920–1970’, in Cipolla, C.M. (ed.), The Fontana Economic History, vol. 6(2), Contemporary Economies—2, Glasgow.

6 Eastern Europe and the ECÐtrade relations and trade policy with regard to industrial products Dieter Schumacher and Uta Möbius* German Institute for Economic Research (DIW), Berlin

INTRODUCTION The transition of the East European countries from centrally planned economies to market economies is met by a more open trade policy of the EC vis-à-vis these countries. Trade between Western and Eastern Europe can be expected to intensify significantly; this raises the question of the effects on third countries’ positions on the EC market. The aim of this chapter is to provide an empirical basis for discussing the impact of the most recent developments in Eastern Europe on international trade relations of the EC. The analysis starts with a description of the structure and the main characteristics of trade between the EC and Eastern Europe. We then give an overview of the EC’s trade policy with respect to imports from Eastern Europe and a comparison with trade policies against developing countries and North America. Moreover, trade barriers to East European countries as well as market shares are analysed at a more disaggregated level. Finally, supply patterns are compared with those of competing countries in order to assess the effects of a liberalization of imports from Eastern Europe. CHARACTERISTICS OF TRADE BETWEEN THE EC AND EASTERN EUROPE Tables 6.1 and 6.2 give an overview of the volume and structure of EC trade with the East European countries,1 as compared to trade with the United States, Canada and the developing countries, by broad groups of industrial products2 and by single EC countries in 1989. In total, EC exports of industrial goods to Eastern Europe amounted to US$22.7 billion and the imports to US$25.2 billion. This was equivalent to some 6 per cent of total EC trade in Table 6.1 Exports of industrial products from the EC to Eastern Europe, North America and to developing countries by groups of products and by EC countries, 1989 (per cent) Products countries

(CN)/EC

East European countries

Soviet Union

Poland

Romania CSFR Hungary Bulgaria Total USA Canada Developing countries

All non-EC countries

25–27

Mineral products Chemical products Plastics, rubber Hides, travelling goods Wood, cork, articles thereof Paper, paperboard Textiles Footwear, headgear, etc.

0.9

1.1

7.5

1.1

0.6

1.1

1.1

4.8

11.0

2.0

3.1

12.8

14.8

15.8

15.6

14.4

13.4

13.7

9.2

8.1

11.7

10.6

6.8

6.7

4.9

7.1

5.7

6.4

6.6

2.9

3.5

4.0

4.4

0.7

0.9

4.0

2.9

3.2

1.1

1.4

1.2

1.8

1.3

1.3

0.1

0.1

1.0

0.5

0.4

0.4

0.2

0.3

0.3

0.3

0.6

1.9

1.7

1.6

1.4

2.5

3.2

2.0

1.8

3.2

2.0

2.4

3.4 2.6

12.3 0.8

33.7 1.0

5.9 0.6

12.1 0.9

6.0 0.8

7.2 1.8

4.5 1.8

6.2 1.9

5.7 0.6

6.4 1.2

28–38 39–40 41–43

44–46

47–49 50–63 64–67

TRADE RELATIONS AND TRADE POLICY

Products countries

(CN)/EC

East European countries

Soviet Union

Poland

Romania CSFR Hungary Bulgaria Total USA Canada Developing countries

All non-EC countries

68–70

Stone, ceramic products, glass Pearls, precious metals Base metals, articles thereof Machinery, electrical equipment Vehicles/ transport equipment

0.8

1.7

4.2

1.7

2.0

2.3

1.4

2.6

3.4

2.0

2.2

0.1

0.2

1.7

0.6

0.5

0.4

0.3

4.8

1.4

5.7

4.0

19.3

9.2

7.6

5.5

7.9

10.5

14.0

7.3

8.9

10.4

9.5

35.4

34.5

9.8

42.9

31.8

37.2

34.9

28.8

26.0

31.1

28.8

2.3

6.9

1.0

2.5

9.6

4.2

4.0

17.2

14.2

13.2

13.6

71

72–83

84–85

86–89

90–92 93 94–96 97–99 25–99

Optical/ measuring instruments Arms, ammunition Furniture, toys, etc. Works of art, etc. All industrial products US$ billion Germany, Fed. Rep. Italy United Kingdom France Spain Netherlands Portugal Belgium/Luxemburg Greece Denmark Ireland Source: Eurostat (1989).

4.1 0.0 0.7 8.2 100.0 11.9 46.9 20.9 7.6 10.9 3.1 3.8 0.7 3.7 1.0 1.3 0.1

4.8 0.0 1.0 3.2 100.0 3.3 53.9 12.7 8.6 8.5 1.2 6.3 0.1 4.4 0.5 3.4 0.5

1.7 0.0 2.0 2.6 100.0 0.6 41.2 13.6 8.0 17.3 0.9 8.4 0.5 3.6 6.0 0.5 0.0

7.0 0.0 0.8 3.9 100.0 2.3 57.3 10.5 8.9 9.5 1.6 6.2 0.1 3.1 0.8 1.6 0.3

4.2 0.0 1.1 3.4 100.0 3.0 59.9 11.9 5.8 8.2 0.9 5.8 0.2 5.0 0.4 1.5 0.4

4.2 0.0 0.7 8.2 100.0 1.5 49.6 17.8 8.4 9.1 1.9 4.6 0.4 3.5 3.5 1.2 0.2

4.4 0.0 0.8 6.2 100.0 22.7 50.7 17.0 7.7 10.1 2.2 4.8 0.4 3.9 1.1 1.6 0.2

5.8 0.2 2.5 4.3 100.0 77.3 30.5 14.7 22.2 13.8 3.6 5.1 0.9 5.5 0.4 1.3 1.9

4.3 0.1 2.9 2.9 100.0 10.0 25.7 14.4 27.8 15.6 3.1 5.8 1.0 3.8 0.3 1.4 1.1

3.7 0.1 1.9 4.3 100.0 141.2 27.4 15.9 15.3 21.2 6.2 4.4 0.5 6.6 0.7 1.3 0.4

61

4.2 0.1 2.5 5.1 100.0 400.9 35.7 14.2 15.4 15.6 3.7 4.8 0.8 6.1 0.5 2.4 0.9

Table 6.2 Imports of industrial products from the EC to Eastern Europe, North America and to developing countries by groups of products and by EC countries, 1989 (per cent) East European countries Products countries

(CN)/EC

Soviet Union

Poland Romania CSFR Hungary Bulgaria Total USA Canada Developing All non-EC countries countries

25–27

Mineral products Chemical products Plastics, rubber Hides, travelling goods

58.6

19.9

35.4

10.7

5.1

11.2

41.4

5.5

16.8

33.9

18.4

4.9

6.6

4.1

8.9

10.4

14.7

6.0

10.0

4.4

3.7

6.6

0.4

2.7

1.4

5.8

6.2

4.7

1.9

3.9

1.0

2.6

3.0

1.1

1.3

0.5

1.2

2.8

1.3

1.2

0.5

0.8

3.2

1.6

28–38 39–40 41–43

62

DEVELOPMENTS IN EASTERN EUROPE

East European countries Products countries

(CN)/EC

Soviet Union

Poland Romania CSFR Hungary Bulgaria Total USA Canada Developing All non-EC countries countries

44–16

Wood, cork, articles thereof Paper, paperboard Textiles Footwear, headgear, etc. Stone, ceramic products, glass Pearls, precious metals Base metals, articles thereof Machinery, electrical equipment Vehicles/ transport equipment

6.2

5.2

3.1

7.6

3.9

2.3

5.6

1.4

9.2

2.9

2.8

1.6

1.3

1.0

6.2

1.4

4.1

2.0

3.7

23.9

0.9

5.2

2.6 0.0

13.5 2.0

18.2 1.5

11.0 1.8

21.0 4.2

15.3 1.0

8.1 1.0

2.1 0.1

1.0 0.0

16.5 2.3

8.2 0.9

0.1

1.7

2.1

6.5

2.4

1.6

1.3

0.7

0.4

0.6

0.8

5.0

1.2

0.0

0.6

0.4

0.6

3.1

1.8

5.9

4.0

3.6

13.0

22.0

13.0

17.0

16.5

18.9

14.9

3.8

14.1

7.3

8.3

1.2

9.4

4.2

8.9

16.6

15.9

4.8

39.8

15.5

13.4

24.0

2.6

6.2

1.8

6.9

1.6

1.0

3.3

13.0

2.8

2.9

7.9

47–49 50–63 64–67

68–70

71

72–83

84–85

86–89

90–92 93 94–96 97–99 25–99

Optical/ measuring instruments Arms, ammunition Furniture, toys, etc. Works of art, etc. All industrial products US$ billion Germany, Fed. Rep. Italy United Kingdom France Spain Netherlands Portugal Belgium/Luxemburg Greece Denmark Ireland Source: Eurostat (1989).

0.3 0.0 0.2 2.2 100.0 14.4 21.9 19.6 8.9 17.5 8.3 11.7 0.4 8.2 1.7 1.5 0.4

0.6 0.0 4.7 1.4 100.0 3.2 45.6 9.4 14.1 8.8 2.0 6.8 0.3 3.3 2.0 5.4 2.3

0.2 0.0 13.2 0.1 100.0 2.7 27.9 32.8 6.9 16.1 3.8 6.8 0.2 2.2 2.8 0.4 0.2

1.2 0.3 3.6 1.8 100.0 2.5 46.2 12.7 10.6 9.7 2.8 6.5 0.5 3.5 3.9 3.0 0.7

0.8 0.1 3.8 2.7 100.0 2.0 54.6 14.4 7.8 9.7 1.8 4.5 0.2 3.1 2.2 1.4 0.2

0.9 0.1 3.0 3.7 100.0 0.4 28.7 19.3 9.3 11.2 5.6 7.5 0.7 3.8 13.0 0.6 0.1

0.4 0.1 2.8 1.9 100.0 25.2 30.7 18.6 9.4 14.7 5.9 9.4 0.3 6.0 2.3 2.0 0.7

8.5 0.1 1.0 4.1 100.0 80.6 20.5 9.5 23.7 16.9 6.4 10.0 0.6 7.0 0.6 1.9 3.0

2.0 0.0 0.5 1.6 100.0 9.6 19.9 10.5 35.7 12.8 3.2 8.3 0.8 6.3 0.6 0.9 1.1

1.8 0.0 2.8 1.2 100.0 143.2 22.7 17.0 14.4 16.2 7.2 10.4 1.6 7.0 1.5 1.5 0.4

4.4 0.0 2.0 2.3 100.0 429.8 25.9 13.4 18.5 14.8 5.8 8.8 1.1 6.7 1.3 2.6 1.1

industrial products with third countries and more than twice the trade volume of the EC with Canada. The Soviet Union accounted for more than half of the EC trade with East European countries, Poland coming second. The third place was taken by Hungary on the export side and by Romania on the import side. The next important trading partner was Czechoslovakia. West Germany, Italy and Greece—all close to Eastern Europe —are engaged above average in East-West trade as compared to their share in trade with all non-EC countries. This is particularly true for West Germany whose share amounted

TRADE RELATIONS AND TRADE POLICY

63

to half of EC exports and to some 30 per cent of EC imports in trade with Eastern Europe. In contrast, the United Kingdom’s trade relations are much stronger vis-à-vis the United States and Canada. As far as the commodity structure of industrial exports is concerned, EC countries supply Eastern Europe with particularly large quantities of machinery, iron and steel, chemicals, textiles, plastic and rubber products as well as footwear. Above average amounts of machinery are exported to Czechoslovakia. Metals are the most important item in exports to the Soviet Union, while Romania and Czechoslovakia buy relatively large shares of chemicals. Romania, Poland and Hungary import high shares of textiles from the EC; as to footwear this is true for the Soviet Union, with leather products for Hungary and Romania. Regarding the commodity structure of industrial goods’ imports from Eastern Europe, the EC countries buy mainly mineral products which make up more than 40 per cent of total imports. Moreover, above average quantities of metals, wood products, furniture, ceramic and glass products are imported from East European countries. Petroleum products are the main item of EC imports from the Soviet Union, Romania and Bulgaria. Bulgaria additionally supplies relatively large amounts of iron and steel as well as clothing; for Czechoslovakia this is true for industrial chemicals, iron and steel. Besides petroleum products, the Soviet Union supplies mainly industrial chemicals and wood; for Romania the next most important products are clothing and furniture. The supplies from Hungary and Czechoslovakia show the highest shares for general machinery, electrical machinery and precision engineering products. Comparing the commodity patterns of exports and imports one may say that EC’s trade with East European countries is mainly an exchange of investment goods and chemicals for production and consumer goods. In this respect it is similar to the division of labour between the Western industrialized and developing countries. From this structural point of view, trade with Hungary and Czechoslovakia is most advanced. The strength of the individual EC countries on export and import markets in Eastern Europe varies according to commodity group and country. In order to analyse the overall market position of the EC countries as compared to that of other Western industrialized countries it is useful to identify a ‘commodity impact’ and a ‘country impact’.3 Regarding exports these computations are based on shares of the respective EC country in exports of all Western industrialized countries to the East European countries and to the world as a whole. The commodity component increases the more the import demand of a particular country is based on the types of goods in which the EC country in question has a particularly high market share in all countries combined. The country component comprises all other determinants except the commodity structure (distance, historical relations, etc.). Its value increases the more the market shares of each commodity in the individual country and destination exceed those in all countries combined. Both the commodity and country components can be positive or negative. Applying this decomposition approach to exports of EC countries in 1980–5, leads to the coefficients compiled in the upper part of Table 6.3. They show that for all EC countries, with the exception of the United Kingdom, the commodity component is positive (2 percentage points for the nine countries combined), i.e. the East European countries’ demand is particularly high for goods in which EC firms tend to have high world-market shares. There is little East European demand, only for British products with high world-market shares. As far as the country component is concerned, the EC as a whole has a negative coefficient for Eastern Europe indicating that European exports are slightly more directed towards other regions. This also holds for most individual EC countries. Only West Germany, Italy and France have a positive country component. Analogously to the decomposition of export market shares, the share of the EC countries in imports of all Western industrialized countries from Eastern Europe can be decomposed as well. Here, a positive commodity component indicates that the export structure of the supplier country matches very well with import focal points of the respective EC country, the country component again covering all other characteristics of the supplier country. Applying the procedure to imports of all products, again based on data for 1980–5, gives a positive commodity component for imports from Eastern Table 6.3 Commodity and country component of the share of EC countries on the export and import markets in Eastern Europe, 1980–5(a) Share in trade of Western industrialized countries with

Germany, Fed. Rep. Italy United Kingdom France Netherlands Belgium/Luxemburg

East European countries

All countries

22.1 7.4 5.0 9.7 3.2 3.0

15.5 6.5 8.5 8.5 5.8 4.7

Difference

Exports (all goods) 6.6 0.9 3.5 1.2 2.6 1.7

Of which: Commodity component

Country component

0.7 0.2 1.5 1.1 0.5 0.3

5.9 0.7 2.0 0.1 3.1 2.0

64

DEVELOPMENTS IN EASTERN EUROPE

Share in trade of Western industrialized countries with East European countries

All countries

Denmark Ireland EC (9)

0.8 0.2 51.3

1.4 0.8 51.6

Germany, Fed. Rep. Italy United Kingdom France Netherlands Belgium/Luxemburg

22.1 10.0 6.7 10.0 10.2 5.6

12.9 6.4 9.1 9.1 5.3 5.1

Difference

0.6 0.6 0.3 Imports (manufactured goods) 9.2 3.6 2.4 0.9 4.9 0.5

Of which: Commodity component

Country component

0.5 0.1 2.0

1.1 0.7 2.3

0.7 0.3 1.4 0.3 0.5 0.0

8.5 3.3 1.0 1.2 4.4 0.5

Denmark 2.1 1.6 0.5 0.3 0.2 Ireland 0.4 1.0 0.6 0.1 0.7 EC (9) 67.2 50.5 16.7 0.2 16.5 Source: Schumacher (1989:5 and 7). Note: (a) The decomposition of the share of an EC country in the exports to Eastern Europe is given by the formula with mk share in exports of all Western industrialized countries to Eastern Europe, in per cent; m share in exports of all Western industrialized countries to all countries (world export market share), in per cent; mi share in exports of commodity i from all Western industrialized countries to all countries (i=1, . . ., n), in per cent; mik share in exports of commodity i from all Western industrialized countries to Eastern Europe (i=1, . . ., n), in per cent; Xik exports of commodity i from all Western industrialized countries to Eastern Europe (i=1, . . ., n); Xk exports of all Western industrialized countries to Eastern Europe. The first summation term on the right-hand side gives the commodity component of the export market share, the second summation term represents the country component. The formula is analogously applied to imports, m representing the share in imports and X being the import values.

Europe for West Germany, Italy, the Netherlands and Denmark and a negative one for the United Kingdom and Belgium. These results are mainly determined by raw materials, in particular mineral oil. Excluding primary commodities and restricting the analysis to manufactured goods results in a lower commodity component for imports of the four large EC countries and a higher one for the smaller countries. In the EC as a whole it is 0.8 per cent including the 0.2 per cent excluding primary goods. The complete picture for imports of manufactures is present in the lower part of Table 6.3. The commodity component for manufactured imports from Eastern Europe is positive in the EC as a whole. It is negative only for the United Kingdom and France. Hence, there tends to be above average import demand in the EC for those goods for which East European countries are very competitive. This is true, however, more for primary goods than for manufactures. The country component of the East European countries is strongly positive in the EC except for the United Kingdom and Ireland. The negative country components of the United Kingdom and Ireland show that—after taking into account the commodity structures of supply and demand—their imports originate less often from Eastern Europe but rather from other countries than imports of the continental EC member states. The export and import market shares of an EC country in the various partner countries or country groups describe the regional direction of its trade compared with that of all Western industrialized countries. Summarizing one may say that the EC countries in general import disproportionately much from Eastern Europe, due to geographical proximity and historical relations. On the other side, West Germany, France and Italy also export above average to that region. The decomposition of exports and imports shows that trade relations between the EC and Eastern Europe are partly due to the commodity structures of demand and supply which match rather well and hence have a positive impact, in particular on EC exports. The negative country impact on EC exports may be due to a political bias of the East European countries’ import policy at the disadvantage of the EC and at the advantage of other OECD countries , for example EFTA countries. The figures also show the extremely strong position of West German firms on East European markets in terms of both suppliers and buyers. Comparing the commodity patterns of exports and imports, the degree of similarity can be seen from an index giving—at the level of the disaggregation chosen—the share of trade, in per cent, which is ‘overlapped’.4 It also indicates the degree of

TRADE RELATIONS AND TRADE POLICY

65

intra-industry exchange. The figures show that the greatest similarity of export and import patterns can be found in EC trade with Western industrialized countries where intra-industry trade predominates (for 1985 patterns of trade in manufactures the index value is 92). The patterns of trade with East European countries are least similar (39). This is mainly due to the extremely high share of mineral oil products in imports from these countries. The exchange of manufactures excluding raw material intensive goods5 shows more similar patterns for exports and imports for the trade with Eastern Europe (61) than for the trade with the developing countries (52). The difference, however, between Eastern Europe and the developing countries is smaller than the difference between Eastern Europe and the Western industrialized countries. Among the East European countries, the trade with Hungary shows the highest similarity between export and import patterns (68). The difference in the commodity patterns of exports and imports are also reflected in the factor content of the trade flows. It differs the more the commodity structures of exports and imports differ from each other and the more the sectoral production functions diverge. In trade with Eastern Europe exports of the EC consist of significantly less raw material intensive products than imports. Moreover, trade is characterized by a high share of skill-intensive goods in EC exports and a lower share in imports from Eastern Europe. This can be demonstrated by calculating the skill content of exports and imports applying sectoral production functions of the EC countries. We have calculated the skill content by using the share of skilled persons, i.e. the total number of employees minus unskilled and semi-skilled workers, in the total number of employees which are directly required to produce the bundle of export goods and the bundle of import substitutes respectively.6 The ratios of the skill intensity of exports over that of imports referring to patterns of trade between the EC countries and Eastern Europe as well as other groups of countries are given in Table 6.4. In trade with Eastern Europe export goods of the EC show an appreciably higher proportion of skilled labour than import goods, i.e. they are more human-capital intensive. This is true for nearly all EC countries considered in the analysis. The differences are greatest for Denmark and West Germany, they are smallest for Ireland. The skill content of exports and imports in trade with developing countries differs in the same direction as in trade with Table 6.4 Skill intensity of exports over that of imports for EC trade by groups of countries, 1985 Trade in manufactures with EC country

East European countries

Western industrialized countries

Germany, Fed. Rep. 1.18 1.04 Italy 1.06 0.91 United Kingdom 1.09 1.03 France 1.14 1.00 Netherlands 1.06 1.02 Belgium/Luxemburg 0.84 0.97 Denmark 1.19 0.95 Ireland 1.02 0.98 EC (9)(a) 1.12 1.00 Source: Own calculations based on data from OECD and Eurostat, see text for methodology. Note: (a) Applying sectoral production functions of West Germany.

Developing countries 1.34 1.09 1.20 1.20 1.22 1.15 1.53 0.97 1.26

Eastern Europe, however to a greater extent. In trade with Western industrialized countries the skill content of exports and imports shows in general the smallest divergence. These findings are in line with the factor endowment to be supposed for the various groups of countries. Summarizing, one may say that in terms of its structural characteristics EC’s trade with Eastern Europe ranges between its trade with developing countries on the one hand and its trade with Western industrialized countries on the other. REMOVING THE DISCRIMINATORY TREATMENT OF IMPORTS FROM EASTERN EUROPE As a whole, the EC’s concept of external relations is characterized by a fine-meshed net of trade policy measures. At the top of the preference hierarchy the EFTA countries are established. Customs duties and quantitative restrictions on industrial goods were almost totally removed on both sides by the Free Trade Agreement concluded in 1972. The countries in Africa, the Caribbean and in the Pacific (ACP countries) also have comparably free access to the EC market for their industrial products by the Lom Conventions - in which this ruling is not reciprocal, i.e. ACP countries are allowed to protect their markets against EC products. Next in line are the Mediterranean countries for whom the EC also guarantees free market access for industrial products in bilateral treaties -however, with a simultaneous limitation on certain textile imports and reciprocal concessions by the more advanced countries amongst them (Israel, Malta, Turkey, Cyprus). The EC’s generalized system of

66

DEVELOPMENTS IN EASTERN EUROPE

preferences (GSP) is applied to all other developing countries and offers (unilaterally and autonomously) freedom from customs duties but with limitations for sensitive products from particularly competitive supplier countries. Simultaneously, quantitative limitations on imports exist for many of these developing countries agreed upon bilaterally within the framework of the multi-fibre arrangement (MFA) and other arrangements restricting exports. By means of these exemptions from duties the developing countries are given a customs tariff preference principally over other Western industrialized countries (United States, Canada, Japan, Australia, New Zealand and South Africa), which still have to pay the most-favoured-nation duties agreed in GATT. These countries however —with the exception of Japan—are not subject to any quantitative restrictions in the industrial sector. The East European countries of the Council for Mutual Economic Assistance (CMEA) ranked at the bottom of the hierarchy scale of the EC’s market-opening policy.7 In fact, the EC has long since granted them most-favoured-nation duties as well, but many of their industrial products were subject to quantitative import limitations in individual EC countries—quite apart from the common treaties limiting deliveries of textiles and steel.8 On the one hand, the incompatibilities between the economic systems hindered trade liberalization. Some of the CMEA countries are members of GATT (Poland, Romania, Czechoslovakia and Hungary; the Soviet Union has had observer status since May 1990), but their centrally controlled foreign trade regime with state licensing of imports impeded liberalization according to GATT rules on the basis of reciprocity. The criteria for liberalization, based on the instruments of market economies—such as customs duties, non-discriminatory treatment of all trade partners, market prices and freely convertible currencies —were not applicable to them. On the other hand, there was also a great political restraint of the CMEA towards the EC and vice versa. However, in the middle of the 1980s a number of factors led to new contacts between the CMEA and the EC: the decline in trade and the deteriorated terms of trade for the CMEA, in which the depressed oil price played a significant part; the change in the Soviet leadership; the constantly increasing need for Western tech nology and last but not least the fear of further isolation after 1992. In June 1988,9 the ‘joint declaration’ was signed by both sides. Thus the basis for bilateral agreements between the EC and the individual countries of Eastern Europe was created. Originally the rapprochement was planned in small steps, but was accelerated by the rapid reforms in Eastern Europe. Even though agreements on trade and on commercial and economic cooperation had been signed with Hungary and Poland to gradually reduce and lift quantitative restrictions for industrial products (with the exception of textiles and ECSC products), they were reduced or lifted all at once effective on 1 January 1990. Furthermore, both countries were integrated into the GSP because of their economic situation which is rather similar to that of some developing countries. They now have a status equal to the more advanced developing countries. This means duty-free exports of industrial products (excluding ECSC products) to the EC with the usual quantitative restrictions on ‘sensitive’ products. Until the middle of 1990, the EC has signed similar agreements with Czechoslovakia, the Soviet Union and Bulgaria. For these countries the reduction of quantitative restrictions will take place gradually till 1995. The signing of such an agreement with Romania has been postponed again because of the violent conflicts in Romania in June 1990. Romania is the only European CMEA country which has been integrated into the GSP from the very beginning, but still with many restrictions. With the exception of Poland, Hungary and Romania, the East European countries are still subject to most-favoured-nation duties which have now been fixed contractually in agreements on trade and cooperation. Real improvements of a changed EC’s trade policy towards Eastern Europe may be expected primarily from the reduction of non-tariff trade barriers (NTBs). Here, quantitative restrictions are of special importance. In order to give an overview of the extent of non-tariff trade barriers in the EC, data from the UNCTAD databank on nontariff measures of Western industrialized countries has been analysed. The analysis refers to the situation in 1987 and to data on individual EC countries (with the exception of Spain and Portugal) as well as on the EC as a whole. The data comprise not only quantitative restraints and import prohibitions but also ‘voluntary’ export restraints, minimum price rules, surveillance of imports as well as special financial and administrative barriers. A supplier country is affected first by measures which refer to all non-EC countries (gen-eral NTBs) and second by measures which are selectively directed against individual countries (special NTBs). To describe the relevance of NTBs for a country the share of imports affected by these NTBs in all imports from that country has been calculated (import coverage ratio). These ratios have been calculated for the East European countries as well as for the eighteen most important suppliers of industrial products among the developing countries and for the United States and Canada for comparison. Selected results are listed in Table 6.5 for general NTBs and Table 6.6 for special NTBs. General NTBs on EC level were concentrated on the agricultural sector, footwear and headgear, etc., as well as on metals. In total some 5 per cent of all imports from third countries were affected by NTBs. Because of the goods structure, i.e. the large weight of highly protected sectors in their supplies, imports from most East European countries as well as those from a large number of the selected developing countries were affected more strongly than average by general NTBs. Protection against the United States and Canada was about average. Additionally, individual EC countries imposed general NTBs against all non-EC countries. In nearly all cases, agricultural products and foodstuffs are affected. Outside the agricultural sector such measures are spread over a broader range of products in Greece and also in France and Italy. They are

TRADE RELATIONS AND TRADE POLICY

67

concentrated on precious stones in the Netherlands and Belgium, on textiles, shoes and headgear in Ireland and on textiles in the United Kingdom. According to their structure of supply countries are more or less affected than average (see Table 6.5 for details). In Greece and France most countries of our analysis are faced with specifically high import restrictions. In Italy and Ireland this applies primarily to developing countries. On EC level special NTBs which were in operation against individual CMEA countries were more important or as important as general NTBs (see Table 6.6).10 Correspondingly, this also applied to developing countries. Only Soviet exports were hardly affected by such specific measures (0.6 per cent). For other CMEA countries the proportion of imports subject to special NTBs at EC level was quite considerable—between 12 (Poland, Czechoslovakia) and 17 per cent (Hungary)—but by far lower than in most of the selected developing countries. Here Thailand (50 per cent), Hong Kong (38 per cent), Pakistan (37 per cent) and India (33 per cent) ranked at the top. In contrast, imports from Mexico (2 per cent) and Brazil (5 per cent) were affected only to a small extent. Those from the Mediterranean countries such as Israel and Turkey were (almost) Table 6.5 Imports from Eastern Europe, developing countries and North America affected by general(a) non-tariff trade barriers of the EC and individual EC countries, 1987 (in per cent of all imports from the respective country) Countries Eastern Europe Soviet Union Poland Romania Czechoslovakia Hungary Bulgaria Selected developing countries(b) Mediterranean countries Turkey Yugoslavia Morocco Tunisia Israel Latin America Brazil Mexico Asia China India Indonesia Pakistan Philippines

FRG

I

UK

F

NL

B/L

GR

DK

IR

EC

0 – – – – 0

0 1 7 6 5 5

– 3 13 4 10 2

77 24 52 12 34 48

63 – 42 2 0 41

62 0 7 1 1 –

3 37 18 35 29 25

– – – – – 2

– 2 3 29 2 6

1 12 6 6 19 13

1 0 0 – 1

27 7 7 10 4

20 8 4 13 13

34 19 58 55 22

2 0 34 2 2

11 – 2 11 69

41 41 20 2 53

0 – 2 – 0

18 11 6 2 38

4 8 13 8 11

7 9

17 13

1 1

7 82

1 1

1 1

26 57

42 11

16 –

9 3

0 5 11 – 0

18 35 30 20 29

10 23 8 24 9

25 32 11 28 28

– 3 – 0 –

0 73 – – 1

66 73 18 98 51

1 2 14 – 1

37 22 14 21 40

6 7 10 7 3

Thailand 1 29 9 26 – 14 45 South Korea – 25 8 21 – 0 90 Taiwan 0 19 2 9 – – 57 Malaysia – 8 3 13 – 20 14 Hong Kong – 19 29 34 0 36 73 Singapore – 41 3 12 0 8 38 North America USA – 8 0 7 1 5 23 Canada – 2 0 9 0 19 12 For comparison: Third countries total 2 8 3 32 6 15 30 Sources: UNCTAD (1987); Eurostat (1987); calculations of the DIW. Notes: (a) Measures against all third countries (b) The most important suppliers of industrial products to the EC.

– – 0 0 – 1

25 29 5 10 20 3

42 6 8 1 1 1

– – 1

1 1 3

4 5 5

68

DEVELOPMENTS IN EASTERN EUROPE

Table 6.6 Imports from Eastern Europe, developing countries and North America affected by special (a) non-tariff trade barriers of the EC and individual EC countries, 1987 (in per cent of all imports from the respective country) Countries Eastern Europe Soviet Union Poland Romania Czechoslovakia Hungary Bulgaria Selected developing countries(b) Mediterranean countries Turkey Yugoslavia Morocco Tunisia Israel Latin America Brazil Mexico Asia China India Indonesia Pakistan Philippines

FRG

I

UK

F

NL

B/L

GR

DK

IR

EC

1 0 1 1 1 2

2 20 2 8 3 3

0 0 0 1 5 0

76 1 35 1 2 36

– 4 2 5 7 1

0 3 6 4 3 –

0 4 1 2 2 4

3 1 3 1 1 –

– – 8 8 – –

1 12 16 12 17 14

– – – – –

– – – – –

– – – – –

– – – – –

– – – – –

– – – – –

– – – – –

– – – – –

– – – – –

0 21 15 20 –

– –

0 –

– –

0 0

– –

– –

– –

– –

– –

5 2

0 – – – –

2 – – – –

1 – – – –

5 0 0 0 0

3 – – – –

1 – – – –

2 – – – –

2 – – – –

1 – – – –

21 33 18 37 18

Thailand – – – 0 – – – – – 50 South Korea – 13 – 5 – – – – – 19 Taiwan – 7 – 3 – – – 1 0 10 Malaysia – – – – – – – 0 – 6 Hong Kong – – – 11 – – – – – 38 Singapore – – – – – – – – – 6 North America USA – – – – – – – – – 1 Canada – – – – – – – – – 1 Sources: UNCTAD (1987); Eurostat (1987); calculations of the DIW. Notes: (a) Measures against the respective country and some other countries (b) The most important suppliers of industrial products to the EC.

completely unimpeded by such non-tariff barriers. The same is true with respect to supplies from the United States and Canada (1 per cent). The sectors protected most strongly by special NTBs at the EC level were textiles and—as with general NTBs—agriculture. The share of these two sectors in the exports of the individual countries to the EC is for the most part a decisive factor in the total extent of non-tariff barrier coverage. Within agriculture, the most specifically protected product group against CMEA countries was animals and animal products; Bulgaria (37 per cent) and Hungary (16 per cent) were particularly affected. Other product groups with import coverage rates of more than 10 per cent were precision and optical instruments and apparatus (Poland 12 per cent, Czechoslovakia 22 per cent), chemicals (Romania 12 per cent) as well as paper and paperboard (Soviet Union 16 per cent). In relation to developing countries it was rather the imports of vegetable products which were protected in agriculture (Thailand 91 per cent, Indonesia 27 per cent) as well as foodstuffs, beverages and tobacco from China (13 per cent). Within industrial products the focal points of NTBs are, next to textiles, centred on chemical products (Malaysia 20 per cent), paper and paperboard (Brazil 22 per cent) as well as iron and steel (Turkey 16 per cent).

TRADE RELATIONS AND TRADE POLICY

69

Special non-tariff barriers to trade did not only exist at the EC level but also in individual EC countries. Here, the different treatment of the country groups under study becomes very apparent. All EC countries used special NTBs against almost all individual CMEA countries. However, the extent of the deliveries affected varied considerably. France was the most protectionist EC country (in particular against the Soviet Union, Romania and Bulgaria, primarily against their deliveries of oil and oil products). In addition, Italy put extensive restrictions into practice against Poland (arms/ammunition, vehicles, plastics, stone/ceramics/glass, machinery/electrical equipment). In all other cases NTBs of individual EC countries affected less than 10 per cent of all imports of the relevant product group from each individual CMEA country. Among the developing countries only China, likewise a statetrading country, was a target of special NTBs by all member countries—again most marked in France. Only South Korea with shoes in Italy and with machinery/electrical equipment as well as chemicals in France, and Hong Kong with machinery/electrical equipment in France, are to be registered as further notable cases. The extent of non-tariff measures imposed by individual EC countries against developing countries was therefore small. The more fundamental restrictions were imposed by the EC. Trade policy against the centrally planned economies so far has not been unified to the same degree. Single member countries thus had more room for individual manoeuvre, which they used selectively.11 The removal of NTBs against Eastern Europe, granted in the agreements on trade and cooperation, will not be any substantial preferential treatment compared to North America and the main suppliers among developing countries. It will rather be a reduction of the existing discrimination, because primarily only special NTBs of the EC countries will be lifted. In order to assess the practical relevance of the most recent trade agreements, in the following section an analysis is presented at the level of more narrowly defined product groups. The import market position of the East European countries in the EC is considered against the background of the trade barriers which have existed so far. The main emphasis is on quantitative restrictions. Tariffs and anti-dumping measures are taken into account as well. THE IMPACT OF TRADE BARRIERS ON EAST EUROPEAN SUPPLIES Generally remarkable is the relatively great share of raw materials and semi-finished goods in the total exports of the East European countries (see Table 6.7).12 This applies especially to the Soviet Union whose exports of oil and gas accumulate to more than 50 per cent of its total exports to the EC. Additional export products are nickel, copper, diamonds, gold, iron and steel, wood, cotton and chemical products. According to the relatively small share of finished export products a considerably large number of Soviet products exported to the EC are subject to no duties at all or to only very low ones.13 An outstanding exception with a tariff of 10 per cent is the only finished product among the ten most important export products, namely motor cars. With 2.4 per cent the weighted average tariff for the fifty most important Soviet export products to the EC, which form more than 90 per cent of all Soviet industrial exports to the EC, is remarkably low. Among the fifty most important products only imports of fifteen single products are quantitatively restricted in at least one EC country.14 Italy, especially restricts imports of chemical products from the Soviet Union. As far as the Federal Republic of Germany is concerned it has to be taken into account that the FRG has offered to make import allowances Table 6.7 The fifty most important industrial products(1) imported by the EC from East European countries, 1989 CN

Good/short text

Soviet Union 2710 Petroleum oils other than crude 2709 Petroleum oils; crude 4407 Wood sawn lengthwise; thickness exceeding 6 mm 2711 Petroleum gases and other gaseous hydrocarbons 7502 Unwrought nickel 7102 Diamonds; not mounted or set 8703 Motor cars etc. for the transport of persons 7403 Refined copper and copper alloys; unwrought 5201 Cotton; not carded or combed 7108 Gold (unwrought/semi-manufactured/ powder form) 4703 Chemical wood pulp; soda; non-dissolving

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5) 3788.5 3537.1 759.5

26.37 24.62 5.29

26.37 50.99 56.28

30.58 7.95 10.76

5.4 0.0 0.0

729.5

5.08

61.36

17.21

1.5

726.6 404.5 320.7 304.2

5.06 2.82 2.23 2.12

66.42 69.24 71.47 73.59

44.53 7.71 2.91 7.12

0.0 0.0 1.0 0.0

244.6 234.6

1.70 1.63

75.29 76.92

14.95 4.24

0.0 0.0

184.0

1.28

78.20

3.16

0.0

IP

70

DEVELOPMENTS IN EASTERN EUROPE

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

2844

170.4

1.19

80.59

13.89

4.9(u)

I

161.1 155.3

1.12 1.08

81.71 82.79

23.16 2.99

0.0 0.0(s)

F

7601

Radioactive chemical elements and isotopes Ferrous waste and scrap Coal; briquettes and solid fuels made from coal Unwrought aluminium

142.1

0.99

83.78

3.73

0.6

FRG

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

2707

127.2

0.89

84.67

28.11

0.0

126.9 91.2 87.1 86.7 85.4

0.88 0.63 0.61 0.60 0.59

85.55 86.86 87.47 88.07 88.66

16.33 4.42 28.43 34.36 18.42

0.2 0.7 0.0 3.2 0.0

77.2

0.54

89.20

14.75

3.2

71.9 70.1

0.50 0.49

89.70 90.19

42.17 5.49

1.1 1.0(k)

67.7

0.47

90.66

8.31

0.0

58.0 41.7 40.4 37.3 33.3

0.40 0.29 0.28 0.26 0.23

91.06 91.35 91.63 91.89 92.12

8.90 5.86 1.90 9.05 4.04

0.0 1.2 0.0 0.0 3.8

32.5

0.23

92.35

6.73

0.0

8108

Oils; other products of high temperature coal tar Cyclic hydrocarbons Ferro-alloys Mineral or chemical fertilizers; potassic Pig-iron, spiegeleisen Raw hides and skins of bovine/equine animals Semi-finished products of iron/non-alloy steel Ammonia Plywood, veneered panels and similar wood Platinum (unwrought/semi-manufactured/ powder form) Intermediate products of nickel metallurgy Acyclic alcohols and certain derivatives Paintings, drawings etc. Raw furskins other than 4101–4103 Refrigerators, freezers, certain heat pumps etc. Synthetic rubber and factice derived from oils Titanium, articles thereof, waste and scrap

30.8

0.21

92.56

9.80

0.5

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

7208 7203

Flat-rolled products of iron; hot-rolled Ferrous products from direct reduction of iron one Wood in the rough Amine-function compounds Aluminium waste and scrap Other fertilizers Wool; not carded or combed Chromium ores and concentrates Certain woven fabrics of cotton Carpets; knotted, whether or not made up Nitrile-function compounds Copper waste and scrap Iron and non-alloy steel (not 7203) Other furniture, parts thereof

30.5 28.4

0.21 0.20

92.77 92.97

2.38 61.40

4.5 0.0

28.3 23.5 23.0 21.9 21.0 20.0 19.8 18.6 17.9 17.5 17.1 15.5

0.20 0.16 0.16 0.15 0.15 0.14 0.14 0.13 0.12 0.12 0.12 0.11

93.17 93.33 93.49 93.64 93.79 93.93 94.07 94.20 94.32 94.44 94.56 94.67

2.32 6.10 6.21 2.98 0.92 16.65 1.69 1.73 7.74 3.57 54.07 0.94

0.0 1.2 2.2 6.6 0.0 0.0 1.0 9.6(m) 1.3 0.0 2.5 5.6

7204 2701

2902 7202 3104 7201 4101 7207 2814 4412 7110 7501 2905 9701 4301 8418 4002

4403 2921 7602 3105 5101 2610 5208 5701 2926 7404 7206 9403

I FRG SP

FRG

I P

SP

P(*)

I I(*)

DK

TRADE RELATIONS AND TRADE POLICY

71

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

4704

Chemical wood pulp; sulphite; nondissolving Phenols; phenol-alcohols Casein, its derivatives; casein glues Peat

14.6

0.10

94.77

2.86

0.0

14.0 13.6 13.5

0.10 0.09 0.09

94.87 94.96 95.05

6.15 9.79 48.15

7.4 9.3 0.0

I

386.7

12.02

12.02

7.44

0.0(s)

F

2907 3501 2703 Poland 2701 Coal; briquettes and solid fuels made from coal CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

7403

266.1

8.27

20.29

6.23

0.0

122.2

3.80

24.09

1.11

1.0

P

96.8

3.01

27.10

1.37

0.0

I

86.6 85.9 82.1

2.69 2.67 2.55

29.79 32.46 35.01

5.21 52.17 3.12

5.6 0.0 1.4

DK SP SP

78.0 65.4

2.42 2.03

37.43 39.46

0.63 2.46

5.3 1.4

61.5 58.0 54.5 53.3 52.3

1.91 1.80 1.69 1.66 1.63

41.37 43.17 44.86 46.52 48.15

44.33 8.34 4.15 3.11 12.78

8.2 0.0 6.5 0.8 4.4

46.5

1.45

49.60

3.63

4.9

42.0 40.9

1.31 1.27

50.91 52.18

4.00 3.66

1.4 1.4

37.6 37.5

1.17 1.16

54.61 55.77

4.00 8.69

5.6 4.1

6205

Refined copper and copper alloys; unwrought Motor cars etc. for the transport of persons Wood sawn lengthwise; thickness exceeding 6 mm Other furniture, parts thereof Sulphur Women’s/girls’ suits, breeches, shorts etc. Petroleum oils other than crude Men’s/boys’ suits, breeches, shorts etc. Casein, its derivatives; casein glues Ferrous waste and scrap Insulated wire/cable etc. Footwear with uppers of leather Angles, shapes etc. of iron/nonalloy steel Flat-rolled products of iron; hotrolled Women’s/girls’ blouses and shirts Men’s/boys’ overcoats, windjackets etc. Certain seats Structures (e.g. bridges, doors) of iron or steel Men’s/boys’ shirts

35.3

1.10

56.87

2.39

1.3

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

6202

Women’s/girls’ overcoats, windjackets etc. Silver (unwrought/semimanufactured/ powder form) Cement and cement clinkers Coke and semi-coke of coal; retort carbon Certain vessels (for persons and goods) Bars and rods; hot-rolled

34.3

1.07

57.94

3.47

1.4

30.3

0.94

58.88

5.86

0.0

26.1 23.0

0.81 0.71

59.69 60.40

14.65 15.63

3.2 0.0(s)

BNL F

22.2

0.69

61.09

1.71

0.2

FRG SP

20.8

0.65

61.74

5.77

4.9

8703 4407 9403 2503 6204 2710 6203 3501 7204 8544 6403 7216 7208 6206 6201 9401 7308

7106 2523 2704 8901 7213

GR SP BNL DK FRG

DK

72

CN

DEVELOPMENTS IN EASTERN EUROPE

Good/short text

8482 Ball or roller bearings 7326 Other not yet classified articles of iron or steel 3102 Mineral or chemical fertilizers; nitrogenous 8408 Diesel engines 4011 New pneumatic tyres; of rubber 7408 Copper wire 4411 Fibreboard of wood or other ligneous materials 4805 Other uncoated paper and paperboard 4202 Suit-cases and all sorts of containers of leather 7211 Certain smaller flat-rolled products of iron 3904 Polymers of chloride; in primary forms

CN 4002

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5) 20.5 20.1

0.64 0.62

62.38 63.00

2.08 3.48

0.9 5.3

SP I GR

19.1

0.59

63.59

4.57

8.6

BNL FRG GR I

18.2 16.3 15.9 15.2

0.56 0.51 0.49 0.47

64.15 64.66 65.15 65.62

1.65 1.33 10.78 6.70

5.3(u) 5.8 0.6 1.0

GR I GR SP FRG

14.7

0.46

66.08

1.95

0.9

GR I

14.7

0.46

66.54

0.97

5.1

SP

14.6

0.45

66.99

6.30

4.4

14.5

0.45

67.44

2.81

12.5

Good/short text

Synthetic rubber and factice derived from oils 7307 Tube or pipe fittings of iron or steel 2707 Oils; other products of high temperature coal tar 7013 Glassware for household, office, etc., use 8509 Certain electro-mechanical domestic appliances 4421 Other articles of wood 4804 Uncoated kraft paper and paperboard 6302 Bed/table/toilet/kitchen linen 7317 Nails, tacks etc. of iron or steel 7004 Drawn and blown glass 8409 Parts suitable for engines (8407, 8408) 7318 Screws, bolts etc. of iron or steel 4412 Plywood, veneered panels and similar wood Romania 2710 Petroleum oils other than crude 9403 Other furniture, parts thereof 7601 Unwrought aluminium 9401 Certain seats 6203 Men’s/boys’ suits, breeches, shorts etc. 6204 Women’s/girls’ suits, breeches, shorts etc.

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5) 13.5

0.42

67.86

2.79

0.0

13.3 12.9

0.41 0.40

68.27 68.67

3.63 2.86

6.2 0.0

FRG

12.6

0.39

69.06

4.05

1.2

BNL FRG

11.8

0.37

69.43

3.91

4.4

11.6 11.6 11.5 11.4 11.3 10.8 10.5 10.5

0.36 0.36 0.36 0.35 0.35 0.34 0.33 0.33

69.79 70.15 70.51 70.86 71.21 71.55 71.88 72.21

5.51 0.50 1.55 12.55 16.16 0.99 1.25 0.82

4.9 0.6 1.3 4.6 0.6(m) 4.9 6.5 1.0(k)

929.6 242.6 152.1 99.3 96.9

34.75 9.07 5.69 3.71 3.62

34.75 43.82 49.51 53.22 56.84

7.50 14.60 3.99 10.56 3.64

5.4 5.6 6 5.6 14

86.3

3.23

60.07

3.28

14

GR I

BNL I DK FRG SP FRG

F DK S FRG DK

TRADE RELATIONS AND TRADE POLICY

73

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

7208 6201 6202

62.6 51.9 46.7

2.34 1.94 1.75

62.41 64.35 66.10

4.89 4.64 4.73

4.9 14 14

36.8 36.0 33.6 31.2 28.5

1.37 1.35 1.26 1.17 1.06

67.47 68.82 70.08 71.25 72.31

8.98 2.10 6.77 3.17 6.83

4.4 8 13 9 9

24.8

0.93

73.24

0.35

0

23.2 22.3 22.0 20.5 19.9 18.5 16.2

0.87 0.83 0.82 0.76 0.74 0.69 0.60

74.11 74.94 75.76 76.52 77.26 77.95 78.55

1.27 2.02 7.04 0.19 1.35 10.41 1.96

14 5 12 10 13 3.2 3.8

6206 4602 5504

Flat-rolled products of iron; hot-rolled Men’s/boys’ overcoats, wind-jackets etc. Women’s/girls’ overcoats, wind-jackets etc. Angles, shapes etc. of iron/non-alloy steel Footwear with uppers of leather Stockings; knitted/crocheted Ball or roller bearings Mineral or chemical fertilizers; nitrogenous Wood sawn lengthwise; thickness exceeding 6 mm Jerseys, cardigans etc.; knitted/crocheted Electric motors and generators Glassware for household, office etc. use Motor cars etc. for the transport of persons Men’s/boys’ shirts Cement and cement clinkers Refrigerators, freezers, certain heat pumps etc. Women’s/girls’ blouses and shirts Basketwork Artificial staple fibres; not processed

16.1 13.5 12.9

0.60 0.50 0.48

79.15 79.65 80.13

1.53 6.60 3.98

14 6.2 8

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

7214 6108 7326

Other bars and rods; not hot-rolled Women’s/girls’ panties, nightdresses etc. Other not yet classified articles of iron or steel New pneumatic tyres; of rubber Other articles of wood Uncoated kraft paper and paperboard Plywood, veneered panels and similar wood Carpets; knotted, whether or not made up Nitrile-function compounds Drawn and blown glass Parts of motor vehicles 8701–8705 Other fertilizers Non-electrical stoves/cookers etc. of iron/ steel Cyclic hydrocarbons Uncoated paper for writing, printing etc. Men’s/boys’ underpants, nightshirts etc. Polymers of chloride; in primary forms Bed/table/toilet/kitchen linen Tube or pipe fittings of iron or steel Women’s/girls’ outer clothing; knitted/ crocheted

11.3 11.2 10.8

0.42 0.42 0.41

80.55 80.97 81.38

3.02 2.14 1.88

4.4 13 5.3

FRG

10.3 10.3 9.9 9.2

0.39 0.38 0.37 0.34

81.77 82.15 82.52 82.86

0.85 4.87 0.43 0.72

5.8 4.9 6.3 10

GR I

8.7 8.7 8.5 8.2 8.2 7.3

0.32 0.32 0.32 0.31 0.31 0.27

83.18 83.50 83.82 84.13 84.44 84.71

0.81 3.74 12.08 0.19 1.11 5.65

9.6(m) 13 6(m) 6.9 6.6 4.9

7.3 7.2 7.2 6.8 6.7 6.5 6.5

0.27 0.27 0.27 0.26 0.25 0.24 0.24

84.98 85.25 85.52 85.78 86.03 86.27 86.51

0.94 0.31 3.17 1.33 0.90 1.79 1.12

1.1 9 13 12.5 13 6.2 14

7216 6403 6115 8482 3102 4407 6110 8501 7013 8703 6205 2523 8418

4011 4421 4804 4412 5701 2926 7004 8708 3105 7321 2902 4802 6107 3904 6302 7307 6104

BNL SP I BNL I

BNL BNL GR I I

I FRG

BNL I GR I

I I

I

74

DEVELOPMENTS IN EASTERN EUROPE

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

2917

Polycarboxylic acids/their derivatives Woven fabrics of artificial staple fibres Corsetry etc. Synthetic staple fibres; not processed Particle and similar board of wood

6.4

0.24

86.75

3.18

10

6.3

0.24

86.99

1.78

11

6.3 6.2

0.23 0.23

87.22 87.45

1.88 2.06

6.5 7.5

6.1

0.23

87.68

1.62

10

FRG

131.2

5.18

5.18

1.86

0.0

SP I

118.5 103.8

4.67 4.09

9.85 13.94

0.96 8.11

5.5 4.7

88.7

3.50

17.44

0.81

1.0

46.3 44.4

1.83 1.75

19.27 21.02

61.94 1.67

0.0(s) 1.4

43.4

1.71

22.73

13.92

1.2

BNL FRG SP

41.3 40.7 39.5

1.63 1.61 1.56

24.36 25.97 27.53

5.32 5.26 7.72

3.4(u) 9.2 0.0

I SP

38.4

1.52

29.05

0.66

0.0

34.2 31.6 29.4

1.35 1.25 1.16

31.83 33.08 34.24

2.06 1.85 7.83

5.6 0.8 4.4

29.0

1.14

35.38

2.48

1.0

5516 6212 5503 4410

CSFR 4407 Wood sawn lengthwise; thickness exceeding 6 mm 2710 Petroleum oils other than crude 7208 Flat-rolled products of iron; hot-rolled 8703 Motor cars etc. for the transport of persons 2702 Lignite, excluding jet 6203 Men’s/boys’ suits, breeches, shorts etc. 7013 Glassware for household, office etc. use 2902 Cyclic hydrocarbons 8701 Certain tractors 4704 Chemical wood pulp; sulphite; nondissolving 4703 Chemical wood pulp; soda; non-dissolving 9403 Other furniture, parts thereof 6403 Footwear with uppers of leather 7214 Other bars and rods; not hotrolled 5208 Certain woven fabrics of cotton

SP I

IP

DK SP BNL DK FRG IR I FRG

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

3904

Polymers of chloride; in primary forms Bars and rods; hot-rolled Wire of iron/non-alloy steel Glass fibres and articles thereof Flat-rolled products of iron; coldrolled Electric motors and generators Certain seats Amine-function compounds Polymers of ethylene; in primary forms

28.6

1.13

36.51

5.56

12.5

27.6 27.0 26.5 26.5

1.09 1.06 1.05 1.04

37.60 38.66 39.71 40.75

7.67 16.92 6.94 6.34

4.9 5.3 9.5 4.6

25.0 24.1 24.0 23.3

0.98 0.95 0.95 0.92

41.73 42.68 43.63 44.55

2.26 2.56 6.23 1.96

0.5 5.6 1.2 12.5

7213 7217 7019 7209 8501 9401 2921 3901

FRG SP

BNL GR SP DK

TRADE RELATIONS AND TRADE POLICY

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

8459

23.0

0.91

45.46

6.64

4.6

22.7

0.90

46.36

9.81

0.5

22.4 21.8 21.6 19.4

0.88 0.86 0.85 0.76

47.24 48.10 48.95 49.71

15.07 1.78 3.11 4.84

0.0 5.8 0.0 0.6

19.0 18.7 18.3

0.75 0.74 0.72

50.46 51.20 51.92

2.18 3.23 4.46

0.0 1.0 4.4

BNL I(*)

17.7

0.70

52.62

1.17

5.1

FRG SP

17.1

0.68

53.30

11.88

3.8

16.2

0.64

53.94

6.76

9.5

5402

Machines for drilling etc. other than 8458 Certain smaller flat-rolled products of iron Quartz except natural sands; quartzite New pneumatic tyres; of rubber Ferrous waste and scrap Bars, rods, wires etc. of certain alloy steel Printed books, leaflets etc. Tubes, wires etc. of iron and steel Angles, shapes etc. of iron/non-alloy steel Suit-cases and all sorts of containers of leather Float glass; surface ground/polished glass Unsaturated monocarboxylic acids/ their derivatives Synthetic filament yarn

15.3

0.60

54.54

1.89

0.9

CN

Good/short text

7211 2507 4011 7204 7228 4901 7304 7216 4202 7005 2916

4002

Synthetic rubber and factice derived from oils 8443 Printing machinery 4403 Wood in the rough 2704 Coke and semi-coke of coal; retort carbon 3204 Synthetic anorganic colouring matter 4415 Wooden packing cases, boxes etc.; pallets 6302 Bed/table/toilet/kitchen linen 7202 Ferro-alloys 6204 Women’s/girls’ suits, breeches, shorts etc. 3920 Plates and similar forms of plastic 4804 Uncoated kraft paper and paperboard 5515 Certain woven fabrics of synthetic staple fibres 4805 Other uncoated paper and paperboard Hungary 6204 Women’s/girls’ suits, breeches, shorts etc. 6203 Men’s/boys’ suits, breeches, shorts etc. 2902 Cyclic hydrocarbons 7208 Flat-rolled products of iron; hotrolled 6403 Footwear with uppers of leather

GR SP I

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5) 15.2

0.60

55.14

3.15

0.0

14.9 14.5 14.4

0.59 0.57 0.57

55.73 56.30 56.87

1.33 1.19 9.80

0.3 0.0 0.0(s)

I

14.3

0.56

57.43

1.53

1.0

FI

14.3

0.56

57.99

19.41

4.9

SP

14.0 13.0 12.9

0.55 0.51 0.51

58.54 59.05 59.56

1.88 0.63 0.49

1.3 5.5(k) 1.4

I

12.6 12.3

0.50 0.49

60.06 60.55

1.12 0.54

12.5 6.8

12.3

0.49

61.04

8.10

1.1

12.2

0.48

61.52

1.62

0.9

96.7

4.84

4.84

3.68

1.4

69.3

3.47

8.31

2.60

1.4

56.7 53.1

2.84 2.66

11.15 13.81

7.30 4.15

0.0 4.7

I

50.0

2.50

16.31

2.92

0.8

BNL FRG I(*)

GR I

GR I

75

76

CN

DEVELOPMENTS IN EASTERN EUROPE

Good/short text

2710 Petroleum oils other than crude 8539 Electrical filament/discharge/arclamps

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5) 49.2 40.3

2.46 2.01

18.77 23.03

0.40 9.38

5.6 5.9

SP

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

8418

Refrigerators, freezers, certain heat pumps etc. Parts of footwear Polymers of ethylene; in primary forms Women’s/girls’ blouses and shirts Angles, shapes etc. of iron/non-alloy steel Other furniture, parts thereof Certain seats Polymers of chloride; in primary forms New pneumatic tyres; of rubber Harvesting machinery Parts suitable for machinery (8425–8430) Corsetry etc. Heterocyclic compounds with nitrogen only Mineral or chemical fertilizers; nitrogenous Aluminium plates; thinner than 0.2 mm Unwrought aluminium Women’s/girls’ overcoats, wind-jackets etc. Ferrous waste and scrap Women’s/girls’ outer clothing; knitted/ crocheted

34.6

1.73

24.76

4.20

3.8

33.2 31.5 30.0 28.4 27.6 27.1 23.9 23.6 23.0 22.1 21.8 21.1

1.66 1.58 1.50 1.42 1.38 1.36 1.19 1.18 1.15 1.11 1.09 1.05

26.42 28.00 29.50 30.92 32.30 33.66 34.85 36.03 37.18 38.29 39.38 40.43

7.32 2.65 2.86 6.93 1.66 2.88 4.64 1.93 3.66 1.99 6.55 1.87

4.6 12.5 1.4 4.5 5.6 5.6 12.5 5.8 3.5 5.2 6.5 7.9

DK SP DK SP GR

19.4

0.97

41.40

4.65

0.8

FRG I

18.4 18.4 17.7

0.92 0.92 0.89

42.32 43.24 44.13

2.45 0.48 1.80

1.0 0.6 1.4

FRG

16.9 16.8

0.85 0.84

44.98 45.82

2.43 2.90

0.0 1.4

6406 3901 6206 7216 9403 9401 3904 4011 8433 8431 6212 2933 3102 7606 7601 6202 7204 6104

I

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

4407

Wood sawn lengthwise; thickness exceeding 6 mm Parts suitable for machines 8501, 8502 Other not yet classified articles of iron or steel Suit-cases and all sorts of containers of leather Television receivers Aluminium waste and scrap Semi-finished products of iron/nonalloy steel Fuel wood, sawdust, wood waste Articles of apparel and accessories of leather Petroleum jelly; certain waxes Ball or roller bearings Wood in the rough Insulated wire/cable etc.

16.5

0.83

46.65

0.23

0.0

I

15.1

0.76

47.41

5.22

4.4

GR

14.9

0.75

48.16

2.58

5.3

GR

14.5

0.73

48.89

0.96

5.1

FRG

14.5 13.9 13.0

0.72 0.69 0.65

49.61 50.30 50.95

0.55 3.75 2.49

1.4 0.2 3.2

GR SP F

13.0 12.8

0.65 0.64

51.60 52.24

32.72 0.93

0.0 8.5

12.4 12.3 12.3 11.9

0.62 0.62 0.61 0.59

52.86 53.48 54.09 54.68

18.59 1.25 1.00 0.91

4.4 0.9 0.0 6.5

8503 7326 4202 8528 7602 7207 4401 4203 2712 8482 4403 8544

FRG SP UK

SP GR SP

TRADE RELATIONS AND TRADE POLICY

CN

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

Good/short text

8708 4415

Parts of motor vehicles 8701–8705 Wooden packing cases, boxes etc.; pallets 7304 Tubes, wires etc. of iron and steel 6108 Women’s/girls’ panties, nightdresses etc. 3105 Other fertilizers 8481 Taps etc. for pipes, boiler shells etc.

CN

Good/short text

8516

Electric-thermic appliances for domestic purposes 2707 Oils; other products of high temperature coal tar 8536 Apparatus for switching electrical circuits 6201 Men’s/boys’ overcoats, windjackets etc. 4107 Leather of other animals Bulgaria 7208 Flat-rolled products of iron; hotrolled 2710 Petroleum oils other than crude 8427 Fork-lift trucks etc. with lifting equipment 3102 Mineral or chemical fertilizers; nitrogenous 4703 Chemical wood pulp; soda; nondissolving 6206 Women’s/girls’ blouses and shirts 6204 Women’s/girls’ suits, breeches, shorts etc. 4002 Synthetic rubber and factice derived from oils 6302 Bed/table/toilet/kitchen linen 2926 Nitrile-function compounds 2941 Antibiotics 6205 Men’s/boys’ shirts 9403 Other furniture, parts thereof 8458 Lathes for removing metal

11.8 11.7

0.59 0.58

55.27 55.85

0.27 15.89

6.9 4.9

I

11.5 11.4

0.58 0.57

56.43 57.00

1.98 2.17

1.0 13.5

BNL I(*)

11.4 10.1

0.57 0.51

57.57 58.08

1.55 0.86

6.6 4.6

I

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5) 10.0

0.50

58.58

0.72

5.2

9.8

0.49

59.07

2.17

1.1

9.1

0.46

59.63

0.46

4.6

9.0

0.45

59.98

0.81

1.4

8.8

0.44

60.42

4.52

3.5

47.2

11.00

11.00

3.69

4.6

37.2 16.7

8.65 3.88

19.65 23.53

0.30 3.11

6.2 4.9

SP

16.0

3.71

27.24

3.82

8.6

BNL FRG GR F

8.4

1.96

32.57

0.14

0.0

7.8 7.6

1.82 1.78

34.39 36.17

0.75 0.29

1.4 1.4

7.0

1.63

37.80

1.45

0.0

6.8 6.5 6.2 6.1 5.8 5.3

1.59 1.51 1.44 1.43 1.34 1.24

39.39 40.90 42.34 43.77 45.11 46.35

0.92 2.81 0.78 0.42 0.35 0.88

1.3 1.3 5.3 1.3 5.6 4.9

SP(*) P

F

SP F DK

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

3301 8501 8425 6403 7202 2716

Essential oils Electric motors and generators Fully tackle, winches, jacks etc. Footwear with uppers of leather Ferro-alloys Electrical energy

5.1 5.0 5.0 4.2 3.9 3.6

1.18 1.17 1.16 0.99 0.91 0.85

47.53 48.70 49.86 50.85 51.76 52.61

1.97 0.45 2.65 0.25 0.19 0.53

0.0 0.5 4.1 0.8 6.8 0.0

BNL GR BNL DK FRG FRG

77

78

DEVELOPMENTS IN EASTERN EUROPE

CN

Good/short text

Value US$ million Good(2) Cumulative share in % Country(3) Duty(4) % Quota(5)

6112

Tracksuits, swimwear; knitted/ crocheted Men’s/boys’ suits, breeches, shorts etc. Amine-function compounds Pulps of other fibrous cellulosic material Casein, its derivatives; casein glues Suit-cases and all sorts of containers of leather Ash and residues containing metal Electric accumulators Unrecorded media for sound recording Ferrous waste and scrap Certain seats Polymers of propylene; in primary forms Wood sawn lengthwise; thickness exceeding 6 mm Tubes, wires etc. of iron and steel Certain electro-mechanical tools Cyclic hydrocarbons Wood in the rough

3.5

0.82

53.43

0.83

1.4

3.4

0.80

54.23

0.13

1.4

3.2 3.2

0.76 0.75

54.99 55.74

0.84 5.88

1.2 0.0

3.1 3.1

0.73 0.72

56.47 57.19

2.26 0.20

1.0 5.1

2.9 2.9 2.9

0.68 0.68 0.67

57.87 58.55 59.22

0.37 0.65 0.18

0.0 5.8 4.9

2.8 2.8 2.8

0.65 0.65 0.65

59.87 60.52 61.17

0.40 0.30 0.75

0.0 5.6 12.5

DK

2.6

0.61

61.78

0.04

0.1

F

2.6 2.6 2.6 2.6

0.61 0.61 0.61 0.60

62.39 63.00 63.61 64.21

0.45 0.42 0.34 0.21

1.0 4.5 0.0 0.0

F

6203 2921 4706 3501 4202 2620 8507 8523 7204 9401 3902 4407 7304 8508 2902 4403

F

FRG

F

CN

Good/short text

Value US$ million

Good(2)

Cumulative share in %

Country(3)

Duty(4) %

6104

Women’s/girls’ outer clothing; knitted/ crocheted Men’s/boys’ overcoats, wind-jackets etc. Parts suitable for machines 8501, 8502 Jerseys, cardigans etc.; knitted/ crocheted Certain woven fabrics of cotton Fibreboard of wood or other ligneous materials Typewriters and wordprocessing machines Aluminium waste and scrap

2.5

0.59

64.80

0.44

1.4

2.5

0.58

65.38

0.22

1.4

2.5

0.57

65.95

0.85

4.4

2.4

0.55

66.50

0.13

1.4

2.3

0.54

67.04

0.20

1.0

2.3

0.53

67.57

1.01

1.0

FRG

2.3

0.53

68.10

1.06

4.6

SP

2.1

0.49

68.59

0.57

0.7

6201

8503

6110

5208 4411

8469

7602

Quota(5)

GR

TRADE RELATIONS AND TRADE POLICY

CN

Good/short text

Value US$ million

Good(2)

Cumulative share in %

Country(3)

Duty(4) %

79

Quota(5)

7010

Bottles, flasks, 2.1 0.48 69.07 1.83 0.9 BNL GR jars; stoppers, lids; of glass 7801 Unwrought 2.1 0.48 69.55 0.71 3.5 lead 8459 Machines for 1.9 0.45 70.00 0.56 5.2 drilling etc. other than 8458 4702 Chemical wood 1.9 0.45 70.45 0.87 0.0 pulp; dissolving 2933 Heterocyclic 1.9 0.43 70.88 0.17 6.7 SP I compounds with nitrogen only Sources: Eurostat, External Trade of the EC (Combined Nomenclature), magnetic tape. OJ of the EC L282/89 and L354/89. Notes: (1) Four-digit positions of the goods classification of the ‘Combined nomenclature’ (CN) (2) Share in total supplies of industrial goods by the respective country (3) Share in imports of the respective good from non-EC countries (4) Weighted average based on duties for the eight-digit tariff lines in 1989 and on import values in 1988 (5) Special quotas according to EC regulation no. 3420/1983. In most cases only some sub-positions of the product groups are subject to quotas. Special quotas for textiles are not marked here, but in most cases textile imports are restricted by either member state or common quota. (*) Quota refers to all tariff-lines of this four-digit position, (u) No duty on certain eight-digit positions which are not listed separately in EC trade statistics, (s) Deviant rates of duty in some EC countries only, (k) Exemption from the payment of duty within the limits of annual tariff quota for certain tariff lines within this group, (m) With maximal or minimal rate of duty per import unit.

exceeding the guaranteed quota ‘for trial and on a temporary basis’.15 In the case of Romania, oil is important too. But among the most important products there are more finished goods— especially furniture and clothing—with remarkably high tariffs on clothing.16 The average tariff of 7.2 per cent for Romania’s exports to the EC is by far higher than the rate for Soviet exports. Almost half of Romania’s fifty most important export products are affected by quantitative restrictions, some even in more than one single EC country.17 Most important for Poland are coal, copper, wood and, with cars, clothing and furniture and even some finished goods. Poland’s exports are rather diversified. The fifty most important products make up to only 70 per cent of all exports of industrial products to the EC. The average tariff of 4.7 per cent is well between that of Romania and the Soviet Union. Half of the fifty products are subject to quotas in at least one single EC country; footwear, nitrogenous fertilizers, screws and bolts of iron or steel and some others even in several single EC countries, most often in Spain, Italy and Greece. The range of products from Czechoslovakia is even broader than that of Poland. Wood, oil, iron and steel, half-finished products and lignite are the main products but are of less importance for the export as a whole than in Poland. The fifty most important Czechoslovakian export products add up to only 60 per cent of all Czechoslovakian exports to the EC. Czechoslovakia exports many finished goods, but fewer clothing than Romania and therefore faces an average tariff of only 5. 7 per cent, which is rather in the middle of all East European countries. Of the fifty most important export products the import of twenty-two is restricted in at least one EC country, most often in Italy. The import of glassware, footwear, certain parts of machines and tyres is restricted in three EC countries. Hungary’s range of export goods is as diversified as that of Czechoslovakia. Raw materials play an even less important role. On the top of Hungary’s export list are clothing, hydrocarbons, flat-rolled products of iron, footwear, electrical parts and appliances. With 7.3 per cent Hungary has the highest average tariff among all East European countries. Many products are subject to quantitative restrictions, most often in Italy and Spain. Bulgaria’s main export products to the EC are iron and steel, oil and machines as well as clothing. The average tariff for the fifty most important products is, with 6.4 per cent, only little lower than those of Romania and Hungary, the two countries with the highest rates. Altogether, the Bulgarian exports to the EC are of small quantity. Therefore the number of quantitative restrictions is small, too; restrictions are most often found in France. Regarding the market position in the EC, the six East European countries’ total share in imports from all non-EC countries is rather small (some 6 per cent). The more the product groups are subdivided the more their competitive strength becomes obvious, especially with those countries whose exports are relatively concentrated on few products only. In this respect the strength of the Soviet Union is in certain ferrous products (61 per cent), iron and non-alloy steel (54 per cent), peat (48 per cent), unwrought nickel (45 per cent), ammonia (42 per cent), pig-iron (34 per cent) and petroleum oils other than crude (31 per cent). Romania holds a market share of 10 to 15 per cent for only a few products (certain furniture, drawn and blown

80

DEVELOPMENTS IN EASTERN EUROPE

glass, certain seats and cement). Poland holds a particularly great share of certain sulphur (52 per cent) and casein (44 per cent). With a number of other products it still holds 10 to 16 per cent of the whole market for these products (drawn and blown glass; coke; cement; angles, shapes etc. of iron or nonalloy steel; nails, tacks etc. of iron or steel; copper wire). Czechoslovakia is the EC’s most important supplier of lignite (62 per cent). With wooden packing cases it still holds a share of nearly 20 per cent and shares of 12 to 17 per cent, with wire of iron or non-alloy steel, quartz, glassware and float glass. Hungary’s strength is fuel wood (33 per cent). Petroleum jelly (19 per cent) and wooden packing cases (16 per cent) are important, too. Only supplies from Bulgaria are insignificant for all fifty most important products. Their market shares never exceed 6 per cent of all imports of a certain product from non-EC countries. The main difference between EC trade policy towards Eastern Europe and towards other third countries was the implementation of quantitative restrictions (QR). Based on the data in Table 6.7, we calculated the weighted average of the market share of the East European countries for three groups of products separately, namely those free of such restraints, products subject to QR in one EC country and those subject to QR in two or more EC countries. The results are given in Table 6.8 indicating that the market share tends to decrease the more QR exist, except for Romania and Bulgaria (QRs on petroleum products). This could indicate that the restrictions had a negative effect on the supply of East European countries. In fact, the establishment of quantitative restrictions by itself is already an obvious trade barrier. But they limit supplies Table 6.8 Average import market shares in the EC of the main export products from Eastern Europe by import barriers, 1989 (per cent) No QR Soviet Union 19.1 Poland 7.5 Romania 4.0 CSFR 8.0 Hungary 4.3 Bulgaria 1.5 Source: Own calculations.

QR in one EC country

QR in two or more EC countries

9.1 10.0 6.9 7.4 4.1 1.4

2.9 3.8 7.0 2.8 2.2 2.1

effectively only if quotas are completely exhausted and no additional allowances are made. This is hardly true here.18 Table 6.10 shows that in many cases the Soviet Union, Romania, Czechoslovakia and Bulgaria only utilized their quotas to a very small extent. In many cases products subject to QRs were not important from the respective country at all. In cases, where restrictions refer to sub-positions of product groups, which cannot be identified statistically (so-called exposition), a more than 100 per cent utilization is irrelevant (e.g. in Benelux in the case of the CSFR with ceramics and glassware). Germany, however, for most products has relaxed the restrictions and allowed the quotas to be exceeded from the outset. The CSFR and Romania especially have taken the chance and proved their competitive capacity in some product groups (Romania with glassware, toys made of wood, and ceramic flags and tiles and Czechoslovakia with imitation jewellery, some iron and steel products, and travelling utensils). In other cases, where quotas are exceeded significantly—for example in Italy by Czechoslovakia with motor vehicles for the transport of goods—the fixing of quotas or the surveillance of the imports does not seem to be very strict. Assuming that Hungary and Poland, too, utilized their quotas only partly19 it was not difficult for the EC Commission to lift them totally (with the exception of quotas for textiles and ECSC products). As to the EC’s anti-dumping policy against Eastern Europe, the Anti-dumping and Anti-subsidy Regulation applies basically to all non-EC countries. But during the 1980s these measures in particular were frequently used against imports from state trading countries (see Table 6.9). With respect to the relatively small share of these countries in total supplies this is even more surprising. But one has to bear in mind, too, that export prices in these countries, where Table 6.9 Initiated anti-dumping investigations in the EC by regions, 1980–8 Western Europe Eastern Europe(a) North America Central and South America Africa Middle East Far East

Number

Percentage

69 119 33 29 8 4 86

19.8 34.1 9.5 8.3 2.3 1.1 24.6

TRADE RELATIONS AND TRADE POLICY

Number

81

Percentage

Australia/Oceani a/Oceani a 1 0.3 Total 349 100.0 Source: Commission of the European Communities: Seventh Annual Report on Community Anti-dumping and Anti-subsidy Actions, COM (90)229 final, annex P. Note: (a) Including the GDR.

prices were fixed by governments and where currencies were not freely convertible, did not reflect costs of production but rather often the need for hard currencies as we know by now from the former GDR.20 In most cases investigations21 ended with price arrangements; in 1988, however exclusively with the fixing of definitive anti-dumping duties on imports. The number of investigations which were stopped without imposing any sanctions, i.e. those investigations which did not show cases of dumping, objectionable subsidies or harmful effects to the EC, differed considerably each year. In 1986, 75 per cent of all investigations ended without sanctions. This has been the absolute maximum so far, but it has to be considered that only very few investigations were opened that year in the first place. It can probably be taken for granted that such investigations have deterrent effects and will therefore, in advance, lead to more discipline in price-fixing. Accordingly, the number of anti-dumping investigations against East European countries has decreased during the second half of the 1980s as compared to the first half (see Table 6.11). Nevertheless, their share in the number of all opened investigations increased again in 1988. The European Commission assumes, too, that alongside reforms in Eastern Europe anti-dumping investigations against these countries, which are always initiated by affected branches of industries, will lessen further. Summarizing one may say that the EC trade policy had only a negligible effect on the market position of East European countries, Table 6.10 Utilization of selected EC countries’ special import quotas by selected East European countries, 1988 (per cent) Importing country

CN code(a)

USSR

Romania

CSFR

Bulgaria

Federal Republic of Germany 1 Sulphates of aluminium 2 Urea 3 Calcium, ammonium, potassium, nitrate 4 Travelling utensils 5 Gloves of leather or of composition leather 6 Particle and similar board of wood 7 Fibreboard of wood/ligneous materials 8 Plywood 9 Footwear 10 Setts, curbstones, flagstones 11 Articles of stone and refractory bricks 12 Ceramic flags and tiles 13 Household articles of porcelain or china 14 Glassware for household use 15 Imitation jewellery with metal and glass 16 Ferro-silicon 17 Ferro-chromium 18 Ferro-vanadium 19 Forged bars/rods of iron or non-alloy steel 20 Wire of iron or non-alloy steel 21 Tube/pipe fittings of cast iron 22 Tanks of iron or steel (20 1) 23 Wood screws of iron or steel 24 Hexagon bolts with heads of steel 25 Nuts of iron or steel

2833 3102(b) 3102(b,c) 4202(b) 4203 4410(b) 4411(b) 4412(b) 6403(b) 6801 6815/6902(b) 6908 6911/6912 7013 7117(b,c) 7202 7202 7202(b) 7214(b) 7217(c) 7307(b) 7310(c) 7318(b) 7318(b) 7318(b)

0 9.5 0 0.1 0 0.3 26.7 126.4 36.0 0 0 0 63.9(b) 90.8 27.0 0 112.7(b) 0 0 142.4 0 0 0 0 0

– 0 135.6 – 0 0 32.5 14.3 41.3 85.8 0 211.6(b) 65.3 726.2(b) – 0 0 0 0 0 – 0 0 0 135.4

0 96.9 0 196.7 41.5 123.7 28.1 147.9 9.8 138.2 2.1 92.8(b) 74.9 102.3 328.4 0 0(b) 0 0 259.9 0 0 0 198.0 289.7

0 48.6 0 12.8 0 0 0 0 0.4 0 – 56.8(b) 0 17.2 – – – – – 11.1 0 – 0 0 0

82

DEVELOPMENTS IN EASTERN EUROPE

Importing country

CN code(a)

USSR

Romania

CSFR

Bulgaria

26 27 28 29 30 31 32 33 34 35 Italy 1 2 3 4 5 6 7 8 9 10 11 12

Unwrought aluminium Zinc plates, sheets, strip and foil Spades and shovels Ships and boats Clinical or veterinary thermometers Brass wind-instruments Toys made of wood Toys made of textile materials Articles for Christmas, of glass Vacuum flasks and vacuum vessels

7601(b) 7905 8201 8901/8902(b) 9025 9205 9503(b,c) 9503(b,c) 9505 9617(b)

49.8 0 0 0 0(b) 18.7 0.6 7.3 0 0

79.7 0 0 0 0(b) – 316.7 8.3 80.9 –

0 0 0 0 0 57.5 89.1 36.4 126.3 16.2

0 – 0 – – – 112.5 18.7 77.4 –

Hydraulic cements Certain chemical products Urea Pastes for electrodes Refractory cements Synthetic rubber Pneumatic tyres and tubes of rubber Parquet of wood for flooring Particle board of wood/ligneous materials Fibreboard of wood/ligneous materials Newsprint Kraft paper and paperboard

2523 28–38(c) 2834/3102 3801 3816 4002/4005 4011–4013 4407–4409 4410 4411 4801 4804 etc.

– 5.9 0 – – – – – – 29.4 – 37.8

0 34.0 64.4 – – 0 56.9 0 – – 0 0

– 54.9 51.8 0 0 – 0 0 4.2 – 0 5.2

– 21.0 17.9 – – 4.3 0 0 – – – –

Importing country

CN code(a)

13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

6401–6405 6401–6405 6907/6908 6910 6911 6912 7003–7016 7202 7303/7307 7304/7306 7304/7306 7312 7323 etc. 8407/8409(c) 8443 8452 8482 8702/8703 8704 8705 8708 8714 8711 8712

Footwear with uppers of rubber Footwear with uppers of leather Ceramic flags, paving, tiles Ceramic sanitary articles Household articles of porcelain or china Other ceramic household articles Glass: cast, rolled, drawn, blown, multiple-vailed etc. Ferro-manganese Tubes of cast iron and accessories Tubes of iron or steel Tubes for drilling Stranded wire, ropes, cables Steel balls for mills Internal combustion piston engines, parts thereof Printing machinery, parts thereof Sewing machines, parts thereof Ball or roller bearings Motor vehicles for the transport of persons Motor vehicles for the transport of goods Motor vehicles for special purpose Parts and accessories of motor vehicles CN 8701–05 Parts and accessories of motor vehicles CN 8711–13 Motor-cycles with an auxiliary motor Bicycles and other cycles, not motorized

USSR

– – 0 0 31.9 – – 129.2 – – 0 – 27.1 – 65.7 63.7 0 – 26.6 0 –

Romania

CSFR

Bulgaria

35.2

3.3 9.4 110.8 – 86.8 – 27.7 0 – 91.9 – – – 1.1 123.8 27.9 – 141.4 854.4 0 50.8 112.2 2.4 0

– – 0 0 0 0 0 – – 0 – – – – – – – – – – – – – –

0 – 40.8 – – 0(c) 159.7 0 0 – 0 – 0 104.6 19.3 0 – 46.2 – – –

TRADE RELATIONS AND TRADE POLICY

Importing country United Kingdom 1 Matches 2 Gloves of leather or of composition leather 3 Footwear 4 Hats and headgear 5 Household articles of porcelain, china, pottery etc. 6 Ornamental ceramic articles 7 Ceramic imitation jewellery, ceramic articles of furniture 8 Television receivers France 1 Toluole, Xylole 2 Petroleum oils, crude 3 Motor spirit 4 Gas oils 5 Fuel oils 6 Lubricating oils, other oils 7 Paraffin wax 8 Colouring matter 9 Newsprint 10 Ceramic flags and tiles 11 Household articles of porcelain or china 12 Radio receivers

CN code(a)

USSR

Romania

CSFR

Bulgaria

3605 4203 6401(c) 6501/6503–6506 6911/6912 6913 7117(c)/9405(c) 8528

0 – 0 –

– 0 – 0(c) 60.9 – – 27.7(c)

0 16.9 58.2 56.5(c)

0 – 17.6 –

85.7

0

0

0(c)

2707 2709 2710 2710 2710 2710 2712 3203(c)/3204 4801 6908(c) 6911/6912 8527

– 0 31.6 9.6 278.3 – 0 0 0 – 160.5

– – 10.2 92.9 0 0 – 0 0 0 204.5 0

0 – – – – – – 0 0 92.2 131.5

– – – – – – – 0 – 18.0 11.1

Importing country

CN code(a)

13 Tuners 14 Radio receivers for cars 15 Television receivers, monochrome 16 Television receivers, colour 17 Parts suitable for 8525–28 18 Semiconductor devices 19 Electrical insulators 20 Gliding boats 21 Optical microscopes 22 Instruments for measuring 23 Wrist-watches etc., watch movements 24 Clocks with watch movements 25 Other clock or watch parts 26 Toys Benelux 1 Urea 2 Prepared explosives 3 Matches 4 Footwear with uppers of rubber 5 Footwear with uppers of leather 6 Slippers and other indoor footwear 7 Footwear with uppers of textile materials 8 Ceramic flags, paving, tiles

8527 8527 8528 8258 8529 8541/8542 8546 8901 9011 9014–9032(c) 9101/9102/9108 9103 9114 9503(c) 2834/3102 3602 3605 6401/6402 6403(c) 6403(c) 6404/6405(c) 6907/6908(c)

128.0 4.7(c)

USSR 12.1 99.6

13.7 – 0 57.8 236.4 20.8 – 11.7 13.4 – – 0 – – – – –

Romania

CSFR

Bulgaria

0 0

15.5

44.6

0 0 0(c) – – – 0 – – – 0

0 89.2 – 0 8.9 – 33.8 – 82.8

1.9 – – – 55.1 – – – 17.7

– 0 0 0 0 0 0

– 0 0 0 8.5 0 0 1433.4

82.6 – – 0 0 0 – 0

83

84

DEVELOPMENTS IN EASTERN EUROPE

Importing country

CN code(a)

USSR

Romania

CSFR

Bulgaria

9

6911/6912(c)

–

0

0

0

Household articles of porcelain, china, pottery etc. CN code(a)

Importing country

USSR

Romania

CSFR

Bulgaria

Drawn or blown 7004(c) – 0 0 0 glass, in sheets 11 Bottles, flasks 7010/7013(c) 35.4 6.7 1852.7 0 etc. and glassware used for table 12 Laboratory, 7017(c) – 0 1239.7 0 hygienic or pharmaceutical glassware 13 Tubes and pipes, 7304 – 0 17.5 – seamless, of iron or steel 14 Other tubes and 7305/7306(c) – 0 0 – pipes, of iron or steel 15 Unwrought zinc 7901 0 0 – 0 16 Electrical motors 8501(c) – 5.7 52.1 40.5 for use in civil aircraft 17 Electrical motors 8501(c) 0 34.2 1598.8 40.9 not for use in civil aircraft 18 Bicycles and 8712/8714(c) – 0 4.6 0 other cycles, parts and accessories 19 Shotgun 9306(c) 134.1 – 12.8 – cartridges 20 Tooth/shaving/ 9603 – 0 920.1 – hair/artists’ brushes Sources: OJ of the EC L 82/1989; EC Commission; Eurostat, External Trade, Analytical tables 1988, Theme 6, Series C. Notes: (a) First four digits of the ‘Combined nomenclature’ of the EC’s foreign trade (b) Temporarily and on a trial basis allowed to be exceeded (c) Quota only regarding to part of an eight-digit goods position (ex-position). (–) No special quota exists.

10

Table 6.11 Initiated anti-dumping and anti-subsidy investigations of the EC against East European countries, 1985–8 Country

1985

1986

1987

1988

Good 1988

Soviet Union Poland Romania

1 1 2

1 – 1

2 – 2

1 1 2

Metallic calcium Methenamine Tubes of steel, methenamine Methenamine Methenamine Methenamine

Czechoslovakia 1 2 – 1 Hungary 1 – 1 1 Bulgaria 1 – – 1 Eastern Europe 7 4 5 7 All countries 36 24 39 40 Share of Eastern 19 17 12 18 Europe (per cent) Source: Commission of the European Communities: Sixth and Seventh Annual Report on Community Anti-dumping and Anti-subsidy Actions, COM (89)106 final and COM (90)229 final, annex F each.

TRADE RELATIONS AND TRADE POLICY

85

if at all. The lacking ability to supply products was a more important factor. Therefore, removal of trade barriers alone will not result in an immediate increase of imports from Eastern Europe. The already signed or initiated agreements on trade and cooperation form a basis, however, for discussing closer economic relations between the EC and Eastern Europe. With the planned ‘European agreements’ the EC offers the East European countries an association which is the closest form of economic and institutional cooperation below membership status. Independent of the development of any institutional cooperation between the EC and Eastern Europe it can be expected that the division of labour will intensify between these two regions. Whether sales potentials in the EC for other countries will increase or will be reduced also depends on the degree of competition between imports from Eastern Europe and supplies from other countries. COMPETITION FROM EAST EUROPEAN COUNTRIES Conclusions on the degree of competition can be drawn by comparing the supply patterns of various countries on the EC market. Differential treatment of third countries in terms of trade policy matters the more the regional and commodity patterns of their supplies are similar. In order to measure the similarity of the supply structures of the East European countries to those of other countries a simple indicator is used. It shows how strongly the exports of individual East European countries overlap with those of other supplier countries in the EC in terms of product groups and import-ing countries.22 The index can take on values between 0 (completely different structures) and 100 (identical structures).23 For each East European country Table 6.12 gives the twenty most similar countries out of some 130 supplier countries. According to these calculations the supply structures of the small East European countries are most similar to each other. Some 40–50 per cent of their supplies to the EC consisted of goods in the same product groups sold to the same countries. The Soviet Union is a special case. Its sales of industrial products in the EC showed the closest similarity to those of Canada (38 per cent). Among the East European countries only Czechoslovakia and Poland rank highly, their exports each correspond by around a third to those of the Soviet Union. Beside industrialized countries, a few developing countries also follow with similar index values: Brazil, Chile, Ghana, Ivory Coast and Israel. This reflects the high intensity of natural resources in Soviet supplies. Among the developing countries only Yugoslavia is a major competitor for the other East European countries with similarity values of nearly 50 per cent. This is particularly true in its relationship with Hungary, but also with Poland and Romania. Besides, the East European countries in particular compete with a number of other countries in Europe. There is only a minor overlap of their supplies with those from the bulk of overseas developing countries. More significant similarities are only with some more advanced developing countries (e.g. Brazil, South Korea, Turkey) and with China. For the Soviet Union, Romania and Bulgaria there is the largest number of developing countries among the most similar supplier countries; for Czechoslovakia it is the smallest number. In the context of this conference it is interesting to note the position of the United States and Canada in terms of similarity of supply patterns with Eastern Europe. Their index values are as follows:

Soviet Union Poland Romania Czechoslovakia Hungary Bulgaria

United States

Canada

23 26 18 30 26 20

38 28 18 29 20 17

Table 6.12 Rank of exporting countries according to the similarity of their sales pattern with those of East European countries in the EC, 1985–7—index values Soviet Union

Poland

Romania

Rank

Country

Index

Country

Index

Country

Index

1 2 3 4 5 6 7

Canada Czechoslovakia Sweden Brazil South Africa Finland Chile

38 37 36 35 34 32 32

Hungary Czechoslovakia Romania Yugoslavia Austria Italy Bulgaria

55 54 51 50 44 43 42

Hungary Poland Yugoslavia Italy Czechoslovakia Bulgaria Portugal

52 51 49 43 41 40 38

86

DEVELOPMENTS IN EASTERN EUROPE

Soviet Union

Poland

Romania

Rank

Country

Index

Country

Index

Country

Index

8 9 10 11 12 13 14 15 16 17 18 19 20

Ghana Poland Ivory Coast France Israel United Kingdom Belgium/Lux. Norway Spain Netherlands Mexico Australia Venezuela

32 31 31 31 31 30 30 29 28 28 28 27 27

Brazil Belgium/Lux. Portugal Spain France Sweden South Korea Denmark Norway China Netherlands Finland Taiwan

42 40 40 39 39 38 37 37 36 36 35 33 33

Austria China Thailand Greece Turkey South Korea Belgium/Lux. Tunisia Spain Taiwan Denmark Brazil France

35 35 34 34 34 33 33 32 31 29 29 29 28

CSFR Rank

Country

Hungary Index

Country

Bulgaria Index

1 Poland 54 Yugoslavia 57 2 Hungary 52 Poland 55 3 Austria 51 Romania 52 4 Italy 46 Czechoslovakia 52 5 Belgium/Lux. 45 Austria 47 6 Bulgaria 44 Bulgaria 47 7 Yugoslavia 44 Italy 44 8 Brazil 44 Denmark 39 9 Sweden 42 Switzerland 39 10 France 42 Netherlands 37 11 Netherlands 41 Belgium/Lux. 37 12 Romania 41 Turkey 36 13 Switzerland 39 China 36 14 Norway 39 Greece 36 15 Spain 39 France 36 16 Denmark 38 Portugal 35 17 United Kingdom 37 South Korea 34 18 Soviet Union 37 United Kingdom 33 19 Finland 36 Israel 33 20 GDR 35 Spain 32 Source: Calculations of the DIW based on OECD foreign trade data, see text for methodology.

Country

Index

Hungary Czechoslovakia Yugoslavia Poland Romania Venezuela South Africa Austria Italy Belgium/Lux. Greece Brazil Other Europe Colombia China Switzerland France Turkey Algeria Denmark

47 44 42 42 40 37 35 35 33 32 32 32 32 31 30 30 30 29 29 28

The figures are rather small except for the case of Canada in relation to the Soviet Union already mentioned above. All in all, the similarity analysis shows that preferential treatment in terms of trade policy in favour of individual countries in Eastern Europe has a strong negative effect on the other East European countries. The great majority of developing countries and North America are only slightly affected by increased trade between the EC and Eastern Europe according to the given structures. It might play a more significant role for some advanced developing countries and for Canada in relation to the Soviet Union. These countries, however, are very competitive and should not be very much afraid of additional competition from Eastern Europe. A comparison of competitive relations between East European countries as a group and the developing countries as well as the United States and Canada on the level of the 100 most important product groups supplied by Eastern Europe clearly shows that the East European countries hold strong competitive positions only if product groups are being subdivided to a high degree (see Table 6.13).24 For most product groups the main competitor—most often the United States, for raw materials

TRADE RELATIONS AND TRADE POLICY

87

and semi-finished goods quite often Canada—has a share in the EC market which is greater than the share of all six East European countries together. This is even more remarkable considering the geographic closeness of Eastern Europe to the EC. Main competitors among developing countries vary to a great extent depending on the kind of product in question: Kuwait, Libya and Algeria for oil; Yugoslavia, Taiwan, Brazil, China, South Korea, Israel and Turkey for finished goods; even some smaller developing countries for certain raw materials, e.g. Liberia for diamonds, Niger for radioactive chemical elements and isotopes, or Cameroon for rough-hewn timber. It will not be easy for the East European countries to gain a larger share in the EC market even if they become more integrated into international trade in the future. It will be especially difficult to gain a competitive position in comparison to those developing countries which are already well established on the EC market and which hold a strong position there. Harder competition is rather to be expected for those developing countries with small shares in the EC market at present. CONCLUSIONS Up to now, the position of the East European countries as suppliers of industrial products to the EC market is of minor importance. It cannot be concluded that this is mainly due to existing quantitative restrictions, which were in operation on EC or country level and which applied to a very large number of products of the Eastern countries. Above all, it was the inability of the former CMEA countries to supply adequate products, since a large number of quotas for the East European countries under consideration was not or was only partially used. The breakdown of the CMEA and the transition of the East European countries requires their integration into the international division of labour. In Europe, this can only be achieved if the EC removes trade barriers, especially quantitative restrictions which still exist at EC level (national quotas being removed in the meantime). If such a policy is implemented, competitive advantages of East European countries especially in labour-intensive production can be expected. In addition, it can be assumed that the ‘old’ industrialized countries—Hungary, Czechoslovakia and Poland— in the longer run will also turn to still-intensive goods industries like mechanical and electrical engineering. A liberal trade policy of the EC will thus further economic development in Eastern Europe and help to reduce migration flows. Although developing countries will have to expect trade diversion effects, trade creation effects will also be important. If the gap in prosperity between East and West can be reduced considerably and if economic growth can be triggered off this will be an advantage for third countries, too. Open, market-oriented structures in Eastern Europe will improve sales potentials considerably. The more increased economic growth leads to mass spending power in the East European countries, the more developing countries will benefit. Furthermore, sales potentials in Western Europe will increase because of the expected additional economic growth. First analyses25 showed that, for example, the economic and monetary union between West and East Germany can be estimated to increase value added by a good 1 per cent in West Germany and by 0.5 per cent in the other European Community countries. Table 6.13 The 100 most important industrial products (a) imported by the EC from East European countries and their main competitors,(b) 1989 CN

Product/short text

Value $US million

Product(c)

Cumulative share in %

Country(d)

2710 2709 4407 2711 7502 7403 2701 8703 9403 7102 7208 7601 6204 6203 7204 5201 2902

Petroleum oils other than crude Petroleum oils; crude Wood sawn lengthwise; thickness exceeding 6 mm Petroleum gases and other gaseous hydrocarbons Unwrought nickel Refined copper and copper alloys; unwrought Coal; briquettes and solid fuels made from coal Motor cars etc. for the transport of persons Other furniture, parts thereof Diamonds; not mounted or set Flat-rolled products of iron; hot-rolled Unwrought aluminium Women’s/girls’ suits, breeches, shorts etc. Men’s/boys’ suits, breeches, shorts etc. Ferrous waste and scrap Cotton; not carded or combed Cyclic hydrocarbons

5000.9 3537.1 1031.5 749.3 730.9 581.1 553.4 553.2 412.4 404.8 343.7 315.1 285.8 280.2 260.5 245.5 239.8

19.83 14.02 4.09 2.97 2.90 2.30 2.19 2.19 1.64 1.60 1.36 1.25 1.13 1.11 1.03 0.97 0.95

19.83 33.85 37.94 40.91 43.81 46.11 48.30 50.49 52.13 53.73 55.09 56.34 57.47 58.58 59.61 60.58 61.53

40.37 7.95 14.61 17.68 44.79 13.61 10.64 5.02 24.81 7.72 26.85 8.26 10.87 10.53 37.45 15.00 30.87

88

DEVELOPMENTS IN EASTERN EUROPE

CN

Product/short text

Value $US million

Product(c)

Cumulative share in %

Country(d)

7108 4703 9401 6403 2844 2707 7216 7202 6202 6201 3102

Gold (unwrought/semimanufactured/powder form) Chemical wood pulp; soda; non-dissolving Certain seats Footwear with uppers of leather Radioactive chemical elements and isotopes Oils; other products of high-temperature coal tar Angles, shapes etc. of iron/ non-alloy steel Ferro-alloys Women’s/girls’ overcoats, wind-jackets etc. Men’s/boys’ overcoats, windjackets etc. Mineral or chemical fertilizers; nitrogenous

236.4 236.2 203.0 180.0 171.1 158.6 137.1 112.8 112.7 109.2 100.4

0.94 0.94 0.80 0.71 0.68 0.63 0.54 0.45 0.45 0.43 0.40

62.47 63.41 64.21 64.92 65.60 66.23 66.77 67.22 67.67 68.10 68.50

4.27 4.05 21.58 10.51 13.95 35.04 33.49 5.47 11.42 9.68 24.08

Main competitors Country

Share(d) %

Country

Share(d) %

Country

Share(d) %

Kuwait Libya Canada Algeria Canada Chile USA USA Yugoslavia India USA Ghana Hong Kong Hong Kong USA USA USA Canada Canada Yugoslavia South Korea USA USA Yugoslavia New Caledonia a.dep. Yugoslavia Hong Kong USA

9.35 12.35 10.52 36.85 11.96 32.29 43.78 6.61 6.90 12.91 8.49 8.25 13.45 13.98 32.85 17.91 24.01 7.49 25.69 12.24 17.07 32.30 24.17 9.61 12.55 14.16 16.52 15.56

Libya Saudi Arabia USA Saudi Arabia Zimbabwe Zambia Colombia Brazil Taiwan Liberia Brazil Yugoslavia Yugoslavia Yugoslavia Yugoslavia Pakistan Canada USA USA USA Brazil Niger Libya Turkey Dominican Republic South Korea South Korea Nigeria

7.62 11.98 8.75 3.36 5.48 10.16 7.17 2.33 6.86 11.27 4.43 6.98 12.11 12.87 3.82 7.17 10.72 7.41 21.49 7.14 13.95 19.28 13.63 4.39 5.84 13.82 16.17 7.99

Algeria Iran Malaysia Libya USA Zaire Canada Yugoslavia USA Israel Turkey Brazil Turkey Tunisia Canada Turkey Brazil Zimbabwe Brazil Taiwan Taiwan Canada Yugoslavia Egypt Yugoslavia China China Yugoslavia

7.60 11.44 7.50 3.34 1.35 8.92 2.90 2.30 4.48 8.12 3.79 6.91 9.94 10.40 2.88 6.51 5.69 1.85 3.33 3.91 13.88 6.92 4.49 2.57 5.21 12.05 10.47 5.76

CN

Product/short text

Value $US million

Product(c) Cumulative share in %

Country(d)

7207 4412 8418 6206 7201

Semi-finished products of iron/non-alloy steel Plywood, veneered panels and similar wood Refrigerators, freezers, certain heat pumps etc. Women’s/girls’ blouses and shirts Pig-iron, spiegeleisen

98.9 97.8 97.2 96.4 90.0

0.39 0.39 0.39 0.38 0.36

18.90 7.66 11.81 9.18 35.66

68.89 69.28 69.67 70.05 70.41

TRADE RELATIONS AND TRADE POLICY

CN

Product/short text

Value $US million

Product(c) Cumulative share in %

Country(d)

8482 4101 2503 3104 3501 7013 3904 2814 8544 4011 4002 8501 3901 5208 7110 6205 2921 4403 7214 8539 8701 7213 2905 7501

Ball or roller bearings Raw hides and skins of bovine/equine animals Sulphur Mineral or chemical fertilizers; potassic Casein, its derivatives; casein glues Glassware for household, office etc. use Polymers of chloride; in primary forms Ammonia Insulated wire/cable etc. New pneumatic tyres; of rubber Synthetic rubber and factice derived from oils Electric motors and generators Polymers of ethylene; in primary forms Certain woven fabrics of cotton Platinum (unwrought/semimanufactured/powder form) Men’s/boys’ shirts Amine-function compounds Wood in the rough Other bars and rods; not hot-rolled Electrical filament/discharge/ arc-lamps Certain tractors Bars and rods; hot-rolled Acyclic alcohols and certain derivatives Intermediate products of nickel metallurgy

89.4 89.3 88.6 87.6 87.1 86.3 80.5 79.0 75.2 74.8 72.3 71.8 71.7 69.7 69.3 66.2 65.9 63.9 63.5 63.1 62.8 61.8 58.8 58.0

0.35 0.35 0.35 0.35 0.35 0.34 0.32 0.31 0.30 0.30 0.29 0.28 0.28 0.28 0.27 0.26 0.26 0.25 0.25 0.25 0.25 0.25 0.23 0.23

9.08 19.27 53.84 28.58 62.77 27.67 15.67 46.28 5.74 6.12 14.98 6.50 6.02 5.96 8.50 4.48 17.07 5.23 16.90 14.69 8.11 17.15 8.27 8.90

70.76 71.11 71.46 71.81 72.16 72.50 72.82 73.13 73.43 73.73 74.02 74.30 74.58 74.86 75.13 75.39 75.65 75.90 76.15 76.40 76.65 76.90 77.13 77.36

Main competitors Country

Share(d) %

Country

Share(d) %

Country

Share(d) %

Brazil Indonesia USA Hong Kong Canada USA USA USA Israel USA Turkey USA Trinidad & Tobago USA USA USA USA Saudi Arabia India USA Hong Kong USA

42.70 20.32 34.45 27.49 20.07 19.04 11.53 17.07 29.53 0.91 12.51 15.24 22.92 24.39 9.78 58.27 24.84 19.44 10.18 9.83 20.80 37.31

Mexico USA Yugoslavia India Brazil Brazil Canada Canada Canada Uruguay Taiwan Yugoslavia Bahrain Yugoslavia South Korea Taiwan Yugoslavia USA China Canada India China

4.81 16.51 7.95 13.98 19.08 1.97 3.94 12.54 18.05 0.37 6.91 11.83 4.43 7.58 8.25 2.07 4.07 11.64 8.55 1.75 12.04 1.61

South Korea Brazil Singapore China Algeria Thailand Uruguay Saudi Arabia Jordan Argentina USA Mexico Algeria Taiwan Yugoslavia Canada China Yugoslavia Pakistan Brazil South Korea India

3.01 6.07 0.60 7.63 8.24 1.93 1.91 8.73 4.86 0.27 3.88 5.94 3.60 5.41 6.97 1.11 3.59 4.82 8.03 0.38 8.98 1.59

89

90

DEVELOPMENTS IN EASTERN EUROPE

Main competitors Country

Share(d) %

Country

Share(d) %

Country

Share(d) %

Cameroon Turkey USA USA Turkey USA Canada

11.70 8.69 23.29 18.63 14.81 22.30 51.24

Liberia Yugoslavia Taiwan Venezuela Egypt Saudi Arabia New Caledonia a.dep.

11.19 2.83 6.63 1.62 8.90 19.09 14.83

Gabon Canada China Yugoslavia Argentina Libya Cuba

10.96 1.43 3.27 1.01 6.89 8.08 1.97

CN

Product/short text

Value $US million

Product(c)

Cumulative share in %

Country(d)

4704 4202 2523 8708 7326 7308 4804 3105 9701 6302 4301 2702 6110 6115 7602 2933 6406 8459 8431 2704 7217 7211 4411 7304 2926 6108 7404 7004 6104 4415 8458

Chemical wood pulp; sulphite; non-dissolving Suit-cases and all sorts of containers of leather Cement and cement clinkers Parts of motor vehicles 8701–8705 Other not yet classified articles of iron or steel Structures (e.g. bridges, doors) of iron or steel Uncoated kraft paper and paperboard Other fertilizers Paintings, drawings etc. Bed/table/toilet/kitchen linen Raw furskins other than 4101–4103 Lignite, excluding jet Jerseys, cardigans etc.; knitted/crocheted Stockings; knitted/crocheted Aluminium waste and scrap Heterocyclic compounds with nitrogen only Parts of footwear Machines for drilling etc. other than 8458 Parts suitable for machinery (8425–8430) Coke and semi-coke of coal; retort carbon Wire of iron/non-alloy steel Certain smaller flat-rolled products of iron Fibreboard of wood or other ligneous materials Tubes, wires etc. of iron and steel Nitrile-function compounds Women’s/girls’ panties, nightdresses etc. Copper waste and scrap Drawn and blown glass Women’s/girls’ outer clothing; knitted/crocheted Wooden packing cases, boxes etc.; pallets Lathes for removing metal

57.6 54.8 54.5 52.9 52.0 50.6 50.4 49.8 49.2 48.2 47.6 46.3 45.8 45.4 44.6 44.6 44.4 44.2 42.1 42.0 41.9 40.8 40.7 40.1 39.3 38.8 38.5 37.9 37.2 36.6 34.1

0.23 0.22 0.22 0.21 0.21 0.20 0.20 0.20 0.20 0.19 0.19 0.18 0.18 0.18 0.18 0.18 0.18 0.18 0.17 0.17 0.17 0.16 0.16 0.16 0.16 0.15 0.15 0.15 0.15 0.15 0.14

77.59 77.81 78.03 78.24 78.45 78.65 78.85 79.05 79.25 79.44 79.63 79.81 79.99 80.17 80.35 80.53 80.71 80.89 81.06 81.23 81.40 81.56 81.72 81.88 82.04 82.19 82.34 82.49 82.64 82.79 82.93

11.27 3.62 30.61 1.20 9.01 11.74 2.19 6.79 2.32 6.51 11.54 61.95 2.50 9.14 12.04 3.95 9.77 12.77 3.80 28.52 26.26 17.59 17.89 6.91 17.01 7.39 7.87 54.07 6.41 49.93 5.67

Main competitors Country

Share(d) %

Country

Share(d) %

Country

Share(d) %

Canada China Yugoslavia USA USA

14.35 32.37 20.07 13.24 22.84

USA Taiwan Tunisia Yugoslavia Taiwan

12.49 20.22 13.02 3.46 7.23

Brazil South Korea Turkey Brazil China

5.62 16.86 8.53 1.85 1.82

TRADE RELATIONS AND TRADE POLICY

Main competitors Country

Share(d) %

Country

Share(d) %

Country

Share(d) %

Yugoslavia USA Morocco USA China USA USA Hong Kong Yugoslavia USA USA Yugoslavia Taiwan USA China Yugoslavia Yugoslavia Brazil USA USA Turkey USA Turkey Turkey Yugoslavia Taiwan

5.54 11.58 20.53 38.34 18.77 10.32 14.58 20.69 16.26 25.09 34.18 22.01 13.91 25.04 21.60 9.98 2.80 12.97 8.36 28.18 16.56 31.63 14.35 19.22 1.99 7.75

USA Brazil USA Canada Pakistan Canada Yugoslavia Turkey South Korea Saudi Arabia China India USA Yugoslavia USA Turkey USA USA Yugoslavia Brazil Hong Kong Canada Yugoslavia Morocco USA USA

4.62 4.34 16.20 1.02 15.19 7.43 0.47 13.15 13.38 6.14 2.54 20.08 6.70 2.22 15.59 5.21 0.70 10.45 3.86 4.80 13.81 4.31 11.89 9.88 1.95 3.65

Canada Canada Tunisia Hong Kong Turkey China Saudi Arabia South Korea Turkey Canada Israel Brazil China South Korea Yugoslavia USA Cyprus Yugoslavia Brazil Turkey China Saudi Arabia USA Hong Kong Singapore South Korea

1.11 3.73 11.40 0.80 12.99 1.57 0.06 9.88 11.91 3.69 1.61 7.88 2.71 1.87 7.41 2.34 0.28 7.57 1.20 1.56 9.75 3.06 3.66 9.63 1.23 2.13

Product(c)

Cumulative share in %

Country(d)

83.06

8.15

83.19

10.76

83.32

4.43

83.45

6.25

83.58

2.73

83.71 83.83

1.21 10.79

83.95

3.59

84.07

2.40

84.19 84.31 84.43

13.45 9.06 14.31

CN 7209

Product/short text

Value $US million

Flat-rolled products of 34.0 0.13 iron; cold-rolled 8108 Titanium, articles 33.9 0.13 thereof, waste and scrap 4805 Other uncoated paper and 33.4 0.13 paperboard 7106 Silver (unwrought/ 32.3 0.13 semimanufactured/ powder form) 8481 Taps etc. for pipes, boiler 31.9 0.13 shells etc. 8528 Television receivers 31.8 0.13 8503 Parts suitable for 31.3 0.12 machines 8501, 8502 4901 Printed books, leaflets 31.2 0.12 etc. 8901 Certain vessels (for 31.1 0.12 persons and goods) 2907 Phenols; phenol-alcohols 30.5 0.12 6212 Corsetry etc. 30.2 0.12 4421 Other articles of wood 30.1 0.12 Source: Eurostat, External Trade of the EC (Combined Nomenclature), magnetic tape.

91

92

DEVELOPMENTS IN EASTERN EUROPE

CN Product/short text Value $US million Product(c) Cumulative share in % Country(d) Notes: (a) Four-digit positions of the goods classification of the ‘Combined nomenclature’ industrial goods by the respective country (d) Share in imports of the respective good from

NOTES * We are grateful to Birgit Wezel for valuable research assistance and to Detlef Filip for organizing and carefully carrying out the computations. 1 Soviet Union, Poland, Romania, Czechoslovakia, Hungary and Bulgaria. 2 Chapters 25–99 of the ‘Combined nomenclature’ (Eurostat 1989), i.e. all goods excluding agricultural products and foodstuffs. 3 The following analysis in this section draws on Schumacher (1989). It covers all goods, i.e. industrial products as well as agricultural products and foodstuffs, broken down into some forty-five groups. Due to data availability the computations are restricted to the nine ‘old’ EC member countries; they include trade with East Germany; excluding, however, trade between West and East Germany. 4 The index is calculated as

with xik and yik, representing the share (in per cent) of product group i in total exports and imports, respectively, in trade with country group k. The values of the index may range from 0 to 100. The formula corresponds to the well-known Grubel-Lloyd measure of intra-industry trade applied to trade patterns instead of actual trade flows. The compu Main competitors Country

Share(d) %

Country

Share(d) %

Country

Yugoslavia 3.13 Brazil 1.40 South Korea USA 46.85 China 1.14 Canada USA 7.08 Yugoslavia 4.05 Brazil USA 19.70 Mexico 10.30 Chile USA 40.13 Canada 2.00 Yugoslavia Singapore 10.74 South Korea 7.01 Taiwan Yugoslavia 14.84 USA 12.43 Singapore USA 45.12 Hong Kong 9.54 Singapore South Korea 11.22 Liberia 9.62 Bahamas USA 34.33 China 2.78 Brazil Yugoslavia 11.68 Hong Kong 11.26 China China 13.20 USA 10.59 Taiwan (CN) (b) Only developing countries, United States and Canada (c) Share in total supplies of non-EC countries.

Share(d) % 0.54 0.54 0.62 5.91 1.79 5.36 2.75 3.27 5.20 0.93 10.03 9.23

tations were based on trade figures broken down into some thirty groups of manufactured goods defined in line with the International Standard Industrial Classification (ISIC). 5 Food, beverages and tobacco, mineral oil products, iron and steel as well as non-ferrous metals. 6 For methodology and data see Schumacher (1989:10–17). 7 Here and in the following, the analysis refers to Bulgaria, Czechoslovakia, Hungary, Poland, Romania and the Soviet Union. Other CMEA members were Albania (whose membership was suspended), Cuba, the German Democratic Republic, Mongolia and Vietnam. At the time of writing, the CMEA is in the process of dissolution. 8 The EC has bilateral agreements on textiles with Bulgaria, Poland, Romania, Czechoslovakia and Hungary in accordance with the MFA and for steel in the framework of the European Coal and Steel Community (ECSC). 9 See Official Journal of the EC, L 157/88. 10 Special EC non-tariff measures which had only been taken against one individual country hardly played a role for the countries under consideration. The exceptions are Czechoslovakia with plastics and chemicals amongst the countries of Eastern Europe and amongst the developing countries Tunisia (textiles), Brazil (iron and steel, chemicals), China (chemicals), South Korea (iron and steel) as well as Thailand (vegetable products, here tapioca). Only for Thailand—because of the great significance of tapioca exports (which were subject to a voluntary export-restraint agreement)—this affected almost one-third of the country’s total exports to the EC; for all other countries mentioned such NTBs affected less than 1 per cent of all exports. 11 In the regulation of the EC no. 3420/1983 (OJ of the EC, L 346/83) the EC countries were further permitted the continuation of special quantitative import restrictions against the state trading countries. The goods lists in the annexes have since been repeatedly updated and the restrictions against Poland and Hungary lifted on 1 January 1990.

TRADE RELATIONS AND TRADE POLICY

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12 Four-digit positions of the ‘Combined Nomenclature’. Here, only the fifty most important products per country are taken into account. 13 For respective four-digit groups of products of the ‘Combined Nomenclature’ (Eurostat 1989), weighted average tariffs were calculated based on the rates for eight-digit tariff lines and their import values in 1988. 14 In most cases quantitative restrictions apply to some tariff lines within a group of products only. 15 This applies to all East European countries. See Official Journal of the EC, L 354/89. 16 Some being lifted in the framework of the GSP. 17 Special quotas of single EC countries for textiles are neither listed for these countries nor included in any tables. Nevertheless it can be taken for granted that in those groups of products which are mentioned, at least some products are subject to quotas on EC or country level. 18 Here, referring to the special quantitative restrictions of the individual EC countries only, textiles and ECSC products are excluded. The information is basically drawn from special data of the European Commission, referring only to the seven EC countries and the four East European countries listed in Table 6.5. 19 An evaluation for the GDR showed, too, that in 1987 in each of the four most important countries (Benelux, France, United Kingdom and Italy) more than half of the goods for which quotas existed were not supplied by the GDR at all. Only in very few cases were quotas exhausted. See M−bius (1990a: 9) or Schumacher and M−bius (1990:151–3 and 160–1). 20 During the last few years an average of 3.80 marks was needed to gain 1 Deutschmark, the official exchange rate being 1:1. 21 This refers to all investigations, not only to those of the East European countries. 22 The index is calculated following Finger and Kreinin (1979) who compared the commodity structures of supplies from various sources in given countries. Our analysis includes the regional sales pattern within the EC. Formally the procedure is the same as described in note 5 above, i.e. comparing two percentage structures and then adding up the smaller figures of all the pairs of values. 23 The level also depends on the depth of the product classification; it turns out to be lower the greater the subdivision within the classification. Import data of EC countries for 135 product groups of the manufacturing industry according to the International Standard Industrial Classification (ISIC) were used. The analysis is concentrated on industrial products in a narrow sense, i.e. excluding mineral fuels and non-ferrous metals. 24 In an analysis of two-digit positions it could be shown that for most of the twenty-seven most important export products of East European countries one developing country alone—only developing countries were included in this analysis—exported more to the EC than all six East European countries together. See M−bius (1990b). 25 See Pohl, Vesper and Zwiener (1990), and Franzmeyer and Schumacher (1991).

REFERENCES Eurostat (1987) Import (GZT 6), magnetic tape, Brussels. —(1989) External Trade of the EC (Combined Nomenclature), magnetic tape, Brussels. Finger, J.M. and Kreinin , M.E. (1979) ‘A measure of “export similarity” and its possible uses’, Economic Journal 89:905–12. Franzmeyer, F. and Schumacher, D. (1991) ‘EG-Aspekte der deutschen Einheit’, in Weidenfeld, W., et al. (eds), Die doppelte Integration: Europa und das grö ere Deutschland, Gétersloh: Verlag Bertelsmann Stiftung. M−bius, U. (1990a) ‘EC trade policy towards the GDR’, DIW Economic Bulletin, 27, 3:5–10. — (1990b) The imports of industrial products—little competition between developing countries and central and Eastern Europe on the EC market’, study prepared on the occasion of the 28th Import Fair Berlin, Partner for Progress 1990. Pohl, R., Vesper, D. and Zwiener, R. (1990) ‘Gesamtwirtschaftliche Auswirkungen der deutschen Wàhrungs-, Wirtschafts- und Sozialunion auf die Bundesrepublik Deutschland—Ergebnisse einer −konometrischen Simulationsanalyse’, Wochenbericht des DIW 20/90:269–77. Schumacher, D. (1989) ‘Employment impact in the European Economic Community (EC) countries of East-West trade flows’, International Employment Policies Working Paper No. 24, International Labour Office, Geneva. — and M−bius, U. (1990) ‘Zugang der DDR zum Gemeinsamen Markt’, in Fragen zur Reform der DDR-Wirtschaft, Beihefte der Konjunkturpoli-tik 37:125–61. UNCTAD (1987) Data Base on Trade Measures, Geneva.

Part II Spillovers

7 Global investment and saving flows: some marcroeconomic scenarios* Peter Pauly Institute for Policy Analysis, Toronto

INTRODUCTION There appears to be little disagreement among international economists these days that one of the most significant current trends in the world economy is the potential for a dramatic increase in claims on global financial resources; see for example, the discussion in European Economy (1989, 1990). In Europe, the demands are caused by the costs of German unification and, potentially, the financial requirements of economic restructing of Eastern Europe and the Soviet Union. In addition, the developing countries experience an increased need for the resumption of net inflows of financial resources, including those to support the reconstruction efforts in the Middle East. At the same time, large private and public sector deficits in North America persist. The situation can be expected to be aggravated further by a decline in excess resources generated in traditional surplus countries such as Germany and Japan, as a result of medium-term structural adjustments in both countries. All this raises obvious questions as to the capacity of world financial markets to absorb these additional demands for funds. More specifically, the issue is whether the stimulus to world economic activity resulting from transfers into the recipient countries in the East and/or South will be sufficient to facilitate continued growth at stable world real interest rates, or whether important crowding-out effects in the OECD and elsewhere are likely. From a policy perspective, the issue clearly is how to ensure that internal and external adjustments in various regions of the world do not take place in a way that jeopardizes growth objectives. World capital markets are likely to become increasingly competitive. Most of the potential Third-World capital importers, the economies in Eastern Europe and the Soviet Union, and traditional deficit countries in the OECD region will face scarcer capital supplies. How much of an upward pressure on prices and real interest rates is likely to result from this, and what are the likely costs in terms of real economic activity? Three issues are of particular concern to the international economist. First, one would like to be able to identify the relevant transmission channels and estimate the extent of the strain that additional capital needs in certain countries, combined with a redirection of financial resources from industrial countries into the recipient countries in Eastern Europe and the developing world, will place on the world financial system. Without corresponding spending adjustments in the North, interest rates on industrial financial markets might indeed increase by enough to wipe out the potential activity gains that are usually associated with a capital transfer. Second, one needs to identify and estimate the macroeconomic responses to changes in the world real interest rate, i.e. the effects on levels of activity (consumption, investment) and trade flows through exchange rates, price and income effects. Third, there is legitimate concern over the effects on world trade and global economic activity through trade redirection and trade creation as a result of differences in marginal propensities in import between donor countries and recipient countries. In this chapter, we attempt to provide some empirical information pertaining to these issues based on simulation exercises performed with the world econometric model system of Project LINK. In particular, we examine the short- to medium-term effects, over a five-year horizon, of two scenarios involving international financial transfers of different orders of magnitude and with different characteristics. Our prime example is that of international financial transfers into Eastern Europe (including East Germany) and the Soviet Union. These transfers are grants and loans, with about equal shares in the total amounts, and are financed out of public sector programmes and/or international multilateral facilities such as the IMF, the World Bank and the newly established European Bank for Reconstruction and Development. We examine the importance of accommodating monetary policies as well as adjustments in public and private savings behaviour. In order to highlight the critical role of the regional distribution of transfers we compare these results with an alternative scenario based on the assumption of an equivalent transfer to developing countries.1 While motivated primarily by current events, the issues addressed in this chapter are, of course, far from being new. The determinants of real interest rates on a worldwide scale have recently been explored by Barro and Sala-i-Martin (1990), building on earlier work by Blanchard and Summers (1984), among others. There is also a rather extensive literature on fiscal policy effects in open economies, most prominently represented by the work of Fremkel and Razin (1985, 1987). Our

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empirical analysis within the framework of a complete dynamic global econometric model will hopefully provide a better assessment of the general equilibrium effects of such transfers, while at the same time allowing for a rich characterization of short- and medium-term adjustment paths. THE GLOBAL MACROECONOMICS OF FINANCIAL TRANSFERS Our subsequent analysis will focus on an evaluation of the global macroeconomic effects of public bond-financed financial transfers. Most of the discussion will be based on an example dealing with public financial transfers to Eastern Europe and the Soviet Union, yet the approach in general had wide-ranging validity. This is being demonstrated by a parallel examination of the implications of financially equivalent North-South transfer. We also systematically examine the sensitivity of these results with respect to a number of critical a priori assumptions. It is important to emphasize that our analysis is very much macro-economic in nature; the perspective is that of an international economist. In particular, we will have little to say about the specific micro-implications of the adjustment processes in Eastern Europe, apart from pointing out that all results are generated under the implicit assumption of a gradual successful continuation of the process of marketization. We are, of course, quite aware of the substantial uncertainties associated with an assessment of future developments in Eastern Europe and the Soviet Union, and of the effects of such policies on these countries. The speed with which the formation of markets will proceed, or the effects of marketization on economic activities, can hardly be analysed fully within a traditional macroeconometric framework. The subsequent empirical results, therefore, incorporate extraneous adjustments at various levels representing the best assumptions available to this group at the present time. Some basic theory The global macroeconomics of financial transfers can best be illustrated within the context of a simple multi-region AD–AS frame-work.2 For purposes of our analysis, we define three regions: a (current account) surplus region, a deficit region and the recipient region. The latter is to be understood as either being in the (European) East or in the South. For simplicity, we shall assume that all funds are provided by those industrial countries which are in surplus; the deficit region then contains all third countries.3 In Figure 7.1a we analyse regional price and activity reactions. A conditionalized transfer into the recipient region provides a stimulus to demand and, in the medium term, through increases in the capital stock and improvements in total factor productivity, supply-side effects a shift as well. Equilibrium income is raised to Y , and prices adjust to p . At the same time, both the original donor region and third countries benefit from trade creation as a result of improved activity in recipient countries. The demand shock shifts aggregate demand to D , respectively, and will tend to increase prices and real activity. In the donor region (and potentially in all other regions), this outward shift in aggregate demand is counteracted by the crowdingout effect of higher real interest rates (see below). The ultimate effect on inflation and activity remains ambiguous and depends upon the relative size of trade effects vis-à-vis the crowding-out effect of real interest rate changes. In a world of (nearly) integrated capital markets, the real interest rate will adjust so as to equilibrate regional savingsinvestment imbalances on a global scale: the current account constraint determines the interest rate. In Figure 7.1b, saving and investment functions for the three regions are graphed. At the initial interest rate r, the current account surplus in the surplus region just offsets the corresponding deficit elsewhere; the current account in the recipient region is assumed to be in equilibrium initially. The incremental investment projects in the recipient region ceteris paribus generate an excess demand for funds which would raise interest rates to a new level at r , at which rate the ensuing current account deficit in the recipient region is facilitated by an increased surplus (reduced deficit) in both other regions. Obviously, the outcome depends critically on savings and investment behaviour in the original surplus and deficit regions. Any autonomous increase in private or publicsector saving, or reduction in investment, in either of these regions would allow world interest rates to remain at the original level or increase to a level below r . The global real interest rate effects thus depend as much on the interest elasticity of savings and investment as on behavioural reactions in the private and public sectors. The dynamics of transfers to the East It is generally recognized that, above and beyond the fundamental structural changes expected to be implemented in all these countries, for the process of transition to a market-oriented economic organization in these countries to be successful, substantial technical assistance, conceptual advice and financial support from Westerndeveloped market economies will be required. The analogy with the European economic recovery programme, designed just after the Second World War to rebuild the economies of Western Europe, comes to mind immediately. Just as the Marshall Plan provided seed investments during that period, a concerted Western financial aid programme at the present time might be a necessary component of a successful transition strategy. Western assistance programme will, of course, be only one piece in the puzzle. Within the Eastern economies,

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Figure 7.1a Quantity and price effects of international financial transfers.

Figure 7.1b Regional saving-investment imbalances and the world real interest rate.

the institutional, monetary and currency systems have to be adjusted, marketization and privatization efforts continued, and the integration of these countries into the institutions of the Western international economic community have to be intensified. Where will these funds come from? Some corporations will be, and have already been, attracted to the new market potential in Eastern Europe. But these investments will be only modestly helpful, particularly since they can be expected to be moderate in size during the early adjustment period. Political uncertainty during the transition to a decentralized economy will continue to deter large investments. Corporate funds cannot overcome the burden of a weak infrastructure and a decaying industrial plant, and can hardly generate international competitiveness. Questions about ownership rights, the possibilities of profit repatriation, currency convertibility remain, and the scope of barter trade will always be rather limited. Indeed, recent experiences with large international commercial or institutional lending have been quite disappointing; besides, the current high level of global interest rates makes it virtually impossible for the countries in question to gain access to private funds. The only viable alternative, then, is for a consortium of major industrial countries, through institutions such as the European Development Bank, to provide grants, aid and soft loans to the East. This chapter examines the effects of such policies. This focus of our analysis on the role of public monies over the relevant short-run horizon is crucial to an analysis of the process. In the short run, initial investments are likely to be financed by foreign (and international) public monies, while in the medium term the current account deficits will be financed through private net capital inflows as the increased prospects of positive returns attract private capital to exploit profit opportunities. With the exception of the German case, we thus feel compelled to focus specifically on the catalytic nature of initial public flows. Incidentally, these are also the only ones that, at least potentially, carry the conditionalities that may be required to secure additional funds for already heavily indebted countries. How can private sector reactions be expected to unfold over the short to medium term? It is probably easiest to represent expected future private sector behaviour both in the East and the West as responses to an increase in the expected rate of return on capital. The basic notion underlying this argument is that the return on capital has been compressed by an ineffective system of incentives and resource allocation mechanisms. The current economic reforms consist of replacing, at different speeds and with important nuances in the actual implementation, this framework by a more efficient organization. As a result, system productivity is expected to increase, and with it the rate of return on capital. The increase in the expected rate of return on capital raises investment and therefore domestic demand. In the short to medium term, this effect of increased demand dominates the effects of increased supply resulting from productivity gains; consequently, the countries will generate current account deficits and continue to build up net external debt. In the long run, the supply effects are expected to dominate the demand effects. Indeed, it is the defining characteristic of the ‘long-run’ that

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increased productivity generates sufficient supplies to satisfy the demands initialized by higher investments. At this stage, the countries will increase their net exports, begin debt repayments to the West and resume a steady growth path. Incidentally, the transitional problems for the ex-GDR in a unified German economy are no different from the other countries. The major differences are two: the sources of financial transfers into the ex-GDR are almost entirely German funds; in addition, increased demand resulting from Eastern restructuring will, for the most part, be satisfied by German production. Other countries will, for the most part, benefit indirectly. The expected course of events in the West is, to some extent of course, the mirror image of what goes on in the East. The initial seed support for Eastern development will generate an incremental deficit for the public sector, and possibly exert upward pressures on interest rates. In the medium term increased Eastern demands for Western products will, through standard trade multipliers, lead to an increase in net exports. The positive demand stimulus should generate further upward pressures on interest rates, and cause exchange rates to appreciate. The effects on interest rates and exchange rates could, of course, be mitigated by an expansionary monetary policy. Accommodating the increased demand resulting from an increase in net exports would further fuel inflationary tendencies. In addition, on the budget side, the problem is to what degree the increase in net exports will be allowed to crowd out net budgetary expenditures; in that case, the resulting increase in interest rates may crowd out interest-sensitive components of demand. It is assumed subsequently that all additional transfers are indeed entirely bond-financed and no fiscal policy adjustments are made. Finally, a crucial aspect in examining the global effects is their distribution across developed market economies. The increase of demand from the East will probably be distributed unevenly. To a first approximation, the present shares of EastWest trade in total trade of various countries will be indicative of these distributional imbalances. Thus, Europe will be more exposed to a positive demand shock than the US and Japan; Germany, and to a lesser extent Italy and France, will benefit most from this windfall of demand. For industrial countries outside Europe and for developing countries the main concern in the context of these adjustment processes should be related to the nature of the trade effects and the extent to which their national money markets are affected. As for the latter, while a certain part of the adjustment in financial markets will no doubt be contained within Europe, the nature of integration of global capital markets will make interest rate and exchange rate effects elsewhere unavoidable. This will potentially have negative effects on investment behaviour in these countries, and debtor countries may experience slightly higher debt service burdens. On the trade side, the initial stimulus of an increase in world trade will be positive for all regions in the world. However, it is often believed that with an improved level of competitiveness in Eastern Europe at least some amount of trade diversion is likely to occur. This concern is most vocally expressed by the group of developing countries, and by some of the NIEs, and semi-NIEs which will expect to face competition from Eastern Europe on global markets. EMPIRICAL RESULTS In this section, we shall provide some empirical estimates of the orders of magnitude of the short-and medium-term effects on global economic activity, trade flows, prices, exchange rates and interest rates. Our estimates are based on simulation exercises performed with the world econometric model system of Project LINK. The model is particularly well suited for such an exercise, since it represents explicitly all the economies of Eastern Europe and the Soviet Union, as part of a system representing more than 130 countries of the world, represented by seventy-nine econometric models. The international transmission mechanisms are captured by a multi-faceted approach, modelling merchandise and service trade flows, international price linkages, capital flows and exchange rates so as to generate a consistent representation of the global economy. Financial transfers to Eastern Europe and the USSR Explicit assumptions have to be made about the sources of these transfers, which are grants and loans with about equal shares in the total amounts. Some private investment may, in the medium term, be attracted to the new market potentials in Eastern Europe, particularly in the Eastern part of Germany. In the short run, however, it is most likely that substantial official money will be necessary. The current high level of interest rates globally also militates against most of the recipient countries gaining access to private institutional funds, including large international commercial banks. We therefore assume that most of these transfers are financed out of public sector programme and/or international multilateral facilities such as the IMF, the World Bank and the newly established European Bank for Reconstruction and Development (EBRD). Obviously, considerable uncertainty is also attached to any estimate of the size of financial transfers which are likely to be mobilized in international capital markets and through official channels in support of restructuring efforts. In our subsequent

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analysis, we take a rather agnostic stance in this regard, and try to provide a realistic estimate of the amount of funds that are likely to be available under present conditions. In our base case, we examine the international implications of a transfer package totalling about US$100 billion over a period of five years, from 1991 to 1995; for a detailed description of the setup, see Pauly (1990, 1991). It is assumed that the amount is just about evenly spread over the five-year period of the programme. The total package amounts almost to the Marshall Plan at today’s prices. About three-quarters of these transfers are accounted for by intra-German transfers, i.e. the support for the former GDR amounts to about US$75 billion over this period. The remaining US$25 billion are split as follows: Bulgaria US$1 billion, Czechoslovakia US$6 billion, Hungary US$6 billion, Poland US$8 billion, Romania US$1 billion and the Soviet Union US$3 billion. One way to interpret the size of these transfers is to note that the total (outside the former GDR) amounts to about twice the current allocation of the EBRD. On the other hand, the amounts assumed to flow into the Soviet Union are much smaller than those currently discussed. In general, in retrospect it is obvious that current reality has already exceeded the assumptions made in this chapter by a large margin. None the less, the results presented here may be indicative of the implications of the effects of those currently observed, much larger, flows as well. The inflows into the former GDR are assumed to be generated entirely within Germany, in equal parts in the private and public sectors. The monetary policy assumption for our base case is that monetary authorities in the OECD will follow monetary policies aimed at stabilizing the paths of some appropriate monetary aggregates around baseline values. Note that it is assumed that the responses are the result of coordinated policy actions; they do not, however, constitute ‘optimal’ policy responses in terms of a well-defined joint criterion function. In addition, in order to focus on the central issue of this chapter, the following major supplementary assumptions are made: (a) Fiscal policies in all industrial countries remain at baseline settings; particularly, no tax increases are implemented. (b) No allowance is made for a rescheduling of interest or principal payments for Eastern hard-currency debts, or for any form of debt forgiveness. (c) The additional financial resources in Eastern Europe and the Soviet Union are used entirely to facilitate spending on fixed investment. (d) Except for the case of the former GDR, incremental imports are allocated completely to non-CPE exporters according to the pre-shock trade shares. (e) For the former GDR, three-quarters of the incremental imports are allocated to the former FRG; the remainder is allocated according to pre-shock non-FRG shares. (f) No adjustments are being made to third-country exports into recipient countries’ export markets. The results for our base are summarized in Figures 7.2 to 7.4, presented as deviations from the current baseline forecast. The monetary policy assumption underlying this scenario would imply that some of the global demand stimulus of the financial transfer is being accommodated, resulting in a moderate increase in nominal interest rates (G-7 GNP-weighted average) of a little more than 40 basis points. The implied monetary tightening would, for the OECD as a whole, generate virtually no GNP losses. The distribution of the Western activity effects, however, remains uneven. While for the EC the trade effects dominate, in North America the monetary tightening would not be accompanied by sufficiently large trade effects to avoid some GNP losses. For the other areas the slightly higher interest rates would almost exactly offset the positive trade stimulus and keep levels of economic activity just about at baseline levels. Such a scenario would, therefore, trade off desired increases in economic activity in Eastern Europe and the Soviet Union against a trade balance shift in favour of the OECD. In other words, it would involve classical external debt financing of initial development in the region, without noticeable negative effects on activity elsewhere, since the response of real interest rates never exceeds the range of 20–30 basis points. The GNP effects for the recipient countries reach about 3 per cent after five years. This seems small relative to the effects of the Marshall Plan, when proper adjustments for the size of the stimulus are made. However, the economic environment in which the aid can be effective is very different in the present case. The post-war economies had state-of-the-art technologies, convertible currencies, free-enterprise systems in place, and a reservoir of entrepreneuriallyinclined individuals as well as a broad base of well-qualified skilled workers. Many of these components are still not in place in Eastern Europe. Furthermore, a large fraction of the transfer does not immediately lead to domestic production activity, but leaks into imports. While the shock as implemented corresponds to a classic supply-side policy by restricting the use of funds to investive purposes, the capacity effects of such investments are relatively slow to materialize. The trade-balance effects are indicative of this: the recipient countries accumulate an incremental net foreign debt of more than US$90 billion, almost the equivalent of the initial transfer. While some trade balance benefits accrue to developing countries, most of the counterpart to the Eastern deficit appears in the OECD, and most significantly in the EC.

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Figure 7.2 Global effects of CPE transfers, 1991–5. Source: Project LINK.

North-South transfers An issue of particular importance for the global implications of financial transfers is the geographical distribution of recipient countries, given the noticeable differences in trade shares of industrial countries with recipient areas. To illustrate this point, we simulate the effects of financial transfers from developed market economies into LDCs. The order of magnitude of transfers is roughly equivalent to the CMEA transfers considered in the previous section. The allocation of funds is as follows: two-thirds of the funds go to net debtor countries according to their share in total developing countries’ debt; the remaining funds are allocated to low-income developing countries according to GNP shares. It is, furthermore, again assumed that the funds are entirely used for domestic investment purposes, not for debt reductions. The funds are bondfinanced, i.e. monetary aggregates are pegged at baseline values; no accommodating policies are implemented. The results are summarized in Figures 7.5 to 7.7. The stimulus to world trade as a result of this North-South transfer is only about three-quarters the size of the CMEA-induced stimulus, reflecting different marginal propensities to import from the OECD area on the part of the recipient countries. The growth stimulus is of roughly the same order of magnitude, albeit a little smaller than in the previous case. Despite a similar claim on world financial resources, the effect of these transfers on nominal world interest rates are noticeably smaller, amounting to about 30 basis points. The corresponding real interest rate increase is in the range of 10–20 basis points. At the same time, since a substantial part of the transfer is directed toward Latin American countries, North America benefits in a substantial way from trade feedbacks, which appear to be large enough to offset the contractionary impact of real interest rates; there is also a corresponding improvement in the trade balance. The results illustrate that for deficit countries, which are generally thought to be negatively affected by fiscal transfers comparable to those analysed here (Frenkel and Razin 1987), there still exist possibilities to derive net gains from a transfer. These countries would, however, not be indifferent as to the selection of recipient countries. SENSITIVITY ANALYSES Alternative monetary policies In order to evaluate the sensitivity of our results to the nature of accommodating monetary policies, we have performed our transfer scenarios under two alternative assumptions regarding the response of monetary authorities in the West:

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Figure 7.3 GNP effects of CPE transfers, 1991–5. Source: Project LINK.

Figure 7.4 Trade effects of CPE transfers, 1991–5. Source: Project LINK.

– the first set of results is based on the assumption that monetary authorities monetize the ensuing public deficits and stabilize nominal interest rates at baseline levels; – at the opposite end of the spectrum of possible responses, we have implemented a monetary policy aimed at stabilizing inflation, thus allowing for a significant increase in interest rates worldwide, in response to the additional withdrawal of financial resources from Western capital markets.

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Figure 7.5 Global effects of LDC transfers, 1991–5. Source: Project LINK.

The detailed results for these alternatives are reported in Pauly (1990, 1991). In the absence of noticeable interest-rate effects, financial transfers into Eastern Europe and the Soviet Union generate unambiguously favourable effects for all regions in the world, thus simply reflecting the positive transfer. Increased purchasing power in the East leads to an export demand stimulus for developed market economies in the West, reflected in increased world trade and larger GNP effects than in the base case. Unemployment rates are slightly lower, while the inflationary impact is markedly higher than in the base case. The GNP gains are, of course, concentrated in Western Europe, mostly in Germany, but the trade multipliers generate positive spillovers everywhere. The results would, of course, be quite different if one were to experience a sharp rise in world interest rates as a result of activist monetary policies in the face of additional claims on world financial resources. The growth effect in the East would be virtually the same, but the stimulus on Western economic activity would be completely negated. The negative effects of interest-rate increases would dominate, and the OECD economies would experience a net loss in economic activity. Despite the larger trade multiplier, this is the case even for the EC, since for the European region the interest rate effect is at the same time larger than elsewhere. The trade effects are somewhat smaller than in the earlier scenario. Obviously, then, if the risk of imposing additional strains on world financial markets really are deemed non-trivial or a tight policy response is considered likely, a policy of providing substantial financial aid to Eastern Europe may indeed entail the possibility of real losses for the OECD countries. Private and public savings rates A tentative conclusion based on our empirical results is that fears of significant real interest-rate effects, and corresponding negative impulses to real economic activity in donor countries, as a result of incremental claims on public funds over the next few years, may be somewhat exaggerated. For transfers in the order of magnitude of around US$20–30 billion annually, as was assumed here, there exists a wide range of accompanying non-inflationary monetary strategies which limit the real interest-rate effects to a range of 20–30 basis points, with relatively benign effects on industrial countries’ economic activity. In fact, for most countries the gains from the implied trade stimulus dominate unambiguously. In some sense, the results should not be too surprising. After all, total world savings in current US dollars are in the range of about US$4,000 billion (see Masson and Meredith 1990: Table 2). Hence, an incremental programme of the order of magnitude considered here amounts, at best, to an initial excess demand for world savings of about 0.7 per cent. Under worstcase assumptions, involving neither compensating fiscal measures to increase public savings (such as the German tax increase) nor changes in private sector spending behaviour, the issue is whether real interest-rate increases in the range of 20–

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Figure 7.6 GNP effects of LDC transfers, 1991–5. Source: Project LINK.

Figure 7.7 Trade effects of LDC transfers, 1991–5. Source: Project LINK.

30 basis points appear reasonable. Compared with average baseline real rates of around 4 per cent, that represents an increase of around 8 per cent. On a G-7 scale, we thus observe an elasticity of real interest rates with respect to the excess demand for savings on the order of five. On the other hand, the size of the programme simulated here clearly underestimates the need, and probably understates the actual flows over the next few years by as much as US$100 billion, given current claims and recent proposals in particular for the USSR. However, apart from possible adjustments in public savings behaviour in the industrial world, there exists the

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possibility of major increases in public sector savings in the recipient countries, mostly as a result of reductions in military expenditures. Most importantly, however, the results presented here may under-represent the extent of private sector adjustments. The offset in terms of private sector saving in the present set of scenarios is relatively small, amounting to less than 20 per cent of the public sector stimulus. While the empirical evidence on the extent of Ricardian equivalence remains sketchy, the possibility of a more significant adjustment cannot be ignored. In fact, given the magnitudes entertained here, it would only take a small further adjustment in private sector behaviour to virtually eliminate the initial excess demands. For example, preliminary scenario analyses indicate that an increase of private savings rates in Germany of less than 2 per cent, combined with an increase in the US private savings rate of less than 1 per cent would virtually eliminate the strain on monetary sectors. Under such conditions, nominal interest-rate implications of a public transfer would be negligible. The crowding-out present in the base case scenario presented above would disappear and the trade multipliers would be positive for all countries. Further work will be necessary to examine these issues in more detail. SUMMARY Much of the economic debate has recently focused on the perceived threat of a potential international financial crunch caused by increased investment needs in various areas of the world in the face of stagnant or even falling national savings rates. In this chapter, we have attempted to address these issues both theoretically and empirically. Our empirical analysis has focused primarily on the effects of transfers to Eastern Europe and the Soviet Union. We conclude our analysis by observing that, based on this limited set of simulations, it appears that sufficiently conditionalized Western public support in the form of loans, combined with some grants, can play an important role in Eastern restructuring efforts without necessarily straining the Western financial system. Provided the institutional environment in the recipient countries continues to improve as assumed here, Western transfers can jump-start the process of increasing Eastern productivity while at the same time generating sufficient positive feedback effects on global economic activity. We have, however, also identified important sources of regional imbalances in the resultant effects on activity. These point to potential political difficulties in implementing such scenarios. These transfers scenarios were finally contrasted with a set of simulations focusing on transfers into developing countries. As expected, the global implications of a North-South transfer differ quite substantially from those of a West-East transfer, on account of both different absorption characteristics of the recipient areas and differences in the regional distribution of the trade multipliers which determine the allocation of positive feedback effects. Given those differences, it appears to be much more attractive for the present deficit countries to support transfers to the South rather than the East. The analysis can be extended in a number of ways. Many analysts would claim that computations such as those presented here underestimate the positive effects of the initial stimuli by underestimating the efficiency gains through marketization and privatization; moreover, it is argued that those gains might be obtainable without financial transfers altogether. While some allowance to a systematically higher contribution over time of the Solow-residual could be implemented exogenously, the extent of such effects cannot but remain highly speculative. Also, while these channels may indeed turn out in the long run to be more important than the replacement and expansion of the capital stock, they may not be dominated over the short- to medium-term horizon considered here. Finally, the results are, of course, model dependent. They appear, however, to be broadly in line with those obtained in other work (e.g. Alexander and Gagnon 1990; Masson and Meredith 1990). The major conceptual shortcoming of the present framework is the absence of forward-looking elements in the system. That will not however, generally affect the long-run effects, but rather only the timing of the short-run adjustment. In addition, we know that it takes only small changes in parameters to generate sufficiently large increases in private savings in the industrial world which would likely eliminate the problem altogether and even allow for a significant reduction in real interest rates. That is to say, relatively small changes in private and public sector behaviour can alleviate some of the important problems, such as the North American claims on global surpluses. NOTES * Revised version of a paper presented to the Joint Canada-Germany Symposium, Centre for International Studies, University of Toronto, 1–2 November 1990. 1 In the conference version of this chapter we also examined the effects of a temporary increase in crude oil prices to address the related concerns about real financial transfers to OPEC countries as a consequence of the Gulf crisis that was unfolding at the time. Detailed results for that scenario are available from the author upon request. 2 For a more detailed theoretical discussion of these issues in the context of a multi-region intertemporal Ramsey growth model, see Avesani, Gallo and Pauly (1991).

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3 The analysis could easily be extended to allowing for part of the transfers to originate in industrial countries with current account deficits; the present simplification is adopted for purposes of illustration only.

REFERENCES Alexander, L.S. and Gagnon, J.E. (1990) ‘The global economic implications of German Unification’, Board of Governors of the Federal Reserve System, International Finance Discussion Papers No. 379, Washington DC, April. Avesani, R.G., Gallo, G. and Pauly, P. (1991) ‘Regional savinginvestment imbalances and the world real interest rate’, paper presented at the NBER International Seminar on Macroeconomics, Madrid, June. Barro, R.J. and Sala-i-Martin, X. (1990) ‘World real interest rates’, NBER Macroeconomics Annual 15–69. Blanchard, O.J. (1985) ‘Debt, deficits, and finite horizons’, Journal of Political Economy 93, 223–46. — and Summers, L.H. (1984) ‘Perspectives on high world real interest rates’, Brookings Papers on Economic Activity 2, 273–324. European Economy (1989) ‘Savings, investment, and international financial markets: an overview’, No. 42, November, 163–77. — (1990) ‘Saving, investment, and real interest rates’, No. 46, December, 201–16. Frenkel, J.A. and Razin, A. (1985) ‘Fiscal expenditures and international economic interdependence’, in Buiter, W.H. and Marston, R.C. (eds), International Economic Policy Coordination, Cambridge: Cambridge University Press, 37–73. — (1987) Fiscal Policies and the World Economy, Cambridge, MA: MIT Press. Masson, P.R. and Meredith, G. (1990) ‘Domestic and international macroeconomic consequences of German unification’, in Lipschitz, L. and McDonald, D. (eds), German Unification: Economic Issues, IMF Occasional Paper No. 75, Washington DC, December, 93–114. Pauly, P. (1990) ‘Economic restructuring in Eastern Europe and the Soviet Union: implications for the world economy’, in Purvis, D. (ed.), Economic Developments in the Soviet Union and Eastern Europe, Kingston: John Deutsch Institute, 91–103. — (1991) ‘Global economic implications of restructuring in Eastern Europe and the Soviet Union’, in Klein, L.R. and Moriguchi, C. (eds), A Quest for a Stable World Economic System, Norwell: Kluwer Academic Publishers, forthcoming. Sachs, J. (1982) ‘The current account in the macroeconomic adjustment process’, Scandinavian Journal of Economics 84, 147–59. Sinn, H.W. (1991) The macroeconomics of German unification’, NBER Working Paper No. 3401, March.

8 Implications of changes in global investment flows for the less developed countries (LDCs) Albert Berry University of Toronto

INTRODUCTION AND BACKGROUND A reallocation of global capital flows away from the LDCs in the near future would be most inopportune from the point of view of those countries, or more precisely that large subset still struggling with the after-effects of the debt crisis which began in the early 1980s. It has become increasingly obvious over the last few years that in most cases a healthy recovery from that shock will require both more time and a greater inflow (or smaller outflow) of resources than has been available so far. This chapter addresses some implications of the level of resource flow to the LDCs, a flow which should rise given the countries’ urgent need for more resources, but which could fall due to the combination of new competition from the countries of Eastern Europe on the demand side and a decrease in supply of available funds from Japan and Germany. Some feel for the quantitative implications of the level of resource flows is provided; all estimates are approximate, however, since many economic relationships which are relatively stable under conditions of continuous growth can be erratic when a developing economy moves between growth, recession and recovery. The events of the last fifteen years in the LDCs have set the stage for the current scenario. With the oil-price increase of 1973 and the resulting large supply of petro-dollars in the international capital markets, the more advanced and ‘credit-worthy’ of the developing countries were in a position to borrow extensively. Most did so, for a variety of reasons, both good and bad; the sales pitch of the international banks was strong and the real interest rates were still on the low side due to the continuing inflation and relaxed monetary policy in the industrial countries. Even countries which participated in the oil revenue bonanza often borrowed extensively (e.g. Nigeria, Mexico), though their needs were obviously not acute like those of oil importers such as Brazil or the poorer countries. The ease and cheapness of borrowing were too much to resist, and prospects for using such capital to develop the export capacity with which to repay it in the future seemed good. Countries previously dependent on the World Bank and the IMF, perhaps together with some of the bilateral aid agencies, were able to opt for the now readily available commercial bank funding. When the combination of higher real interest rates and the recession in the industrial countries appeared at the beginning of the 1980s, many of the developing countries had built up levels of debt which were difficult or impossible to service at those interest rates and in weak commodity markets. As the potential for crisis became apparent, the private international banks were no longer willing to lend to the LDCs and, instead, desirous of extricating themselves from their exposure as quickly as possible. Though it was of course impossible for them to significantly reduce that exposure through repayment of principal and interest, the net resource flow to the LDCs was quickly and sharply curtailed from an average of US$67.7 billion over 1980–3 to about zero over the rest of the decade. For those most in debt and suffering the sharpest fall in their imports, the result has been a decade either of crisis and/or of slow, fitful growth, in most cases too slow to prevent a fall in per capita GDP and much too slow to prevent a fall in per capita absorption. In many countries the initial crisis pushed per capita incomes and absorption down by 20–35 per cent; wages, at least in the modern sectors of these economies, fell by up to 40 per cent and in a few cases even more. Since the immediate crisis period (usually two or three years during the first half of the decade) there has in most countries been some growth, but at lower rates than before; in most cases per capita incomes are presently no higher than they were in the late 1970s or even the 1960s. The crisis has been and remains most severe in the developing countries of sub-Saharan Africa and Latin America. The former had already suffered a slowing of their growth in the 1970s due to a variety of problems including most prominently the weak performance of agriculture. But few of these countries were viewed by the international banks as attractive clients, so most did not build up the sort of private debt incurred by the countries of Latin America. Latin America did appear creditworthy and was thus able to build up very large debts. South Asia, and especially India, is characterized by a relatively low ratio of international debt to GDP, partly because India is unusually self-sufficient and partly because the whole region grew faster than most others over the last fifteen years or so. The countries of the Middle East either have oil or are substantially affected by its prominent place in the economy of the region, so they too have escaped the brunt of the debt crisis. Finally, the crisis did not impinge long or heavily on the East Asian countries (with the exception of the Philippines)

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because some were not heavily indebted and some, most notably Korea, achieved an export performance (mainly manufacturers) which permitted them to ‘grow out of’ the debt dilemma. In the dramatic slowdown of growth between the pre-crisis period (say the 1970s) and the 1980s, when growth slipped from close to 6 per cent in Latin America to 1.2 per cent and in Africa from 4.3 per cent to under 2 per cent (see Table 8.1), the key direct casual factor was the decline in imports which forced economies to get by on a lower quantity than was by then required to keep them both operating at full capacity and expanding the capital stock at an acceptable rate. For the highly indebted countries as a group, and for the countries of sub-Saharan Africa, the import to GDP ratio fell by about 37 per cent over 1980–6 (World Bank 1987:27) as imports fell by almost that much in absolute terms. For all of the non-oil-developing countries taken together, imports fell by 15 per cent or US$65 billion (current) between their peak in 1981 and the trough in 1983 (IMF 1985:248); by 1985 they had just recovered to about the average of 1980–1. Meanwhile, exports had risen by US $70 billion, cutting the trade deficit from about US$80 billion to just US$4 billion, but interest payments had risen by US$25 billion from the 1980 level and by US$35 billion from the 1979 level. Capital inflows to all developing countries net of principal repayments but gross of interest payments slipped from their peak of US$76 billion in 1981 to about US$25 billion by the middle of the decade (World Bank 1987). The debt to GDP ratio doubled from 20 per cent to over 35 per cent. For the indebted LDCs the current account deficit peaked out at a little over US$100 billion dollars in 1981–2 but was down to under US$40 billion by 1984. Estimated capital flight rose from U$S3.4 billion in 1979 to a peak of about US$25 billion in 1982 and was back down to US$3.7 billion in 1984, (IMF 1985:250). Over 1977–86 it may have been in the order of US$100 billion according to IMF estimates. The less developed countries as a whole grew at 3.1 per cent during the 1980s, compared to 5.5 per cent in the 1970s (Table 8.1). Table 8.1 Growth rates and levels of selected economic variables in less developed countries, by regional and other groupings Region or group

Average 1970–80

Average 1980–3(c)

Gross domestic product, average annual growth rate Less developed countries 5.49 2.03 Africa 4.33 0.96 Western hemisphere 5.73 1.24 (a) (b) Heavy debtors 4.9 1.11 Per capita GDP, average annual growth rate Less developed countries 2.88 0.27 Africa 1.54 1.64 Western hemisphere 3.05 3.37 Heavy debtors(a) 2.2(b) 3.14 Merchandise export volumes, average annual growth rate Less developed countries 3.96 3.84 Africa 2.75 8.60 Western hemisphere 1.91 4.36 Heavy debtors(a) 2.4 2.19 Merchandise import volumes, average annual growth rate Less developed countries 8.22 0.15 Africa 6.18 6.28 Western hemisphere 7.03 13.49 Heavy debtors(a) 7.6 8.78 Merchandise terms of trade, average annual growth rate Less developed countries 5.82 0.44 Africa 3.92 2.82 Western hemisphere 4.12 5.61 (a) Heavy debtors 5.58 4.65 Region or group

Average 1970–80

Average 1980–3(c)

Average 1983–7

Average 1987–90

Average 1980–90(c)

3.97 2.07 3.52 3.12

3.13 2.80 0.56 0.90

3.13 1.95 1.19 0.83

1.72 0.71 1.32 0.92

1.03 0.07 1.40 1.04

0.92 0.76 0.99 0.90

6.22 1.38 3.33 3.90

7.37 1.51 6.36 6.64

3.43 1.68 4.53 4.20

1.03 7.52 3.55 0.27

7.73 1.09 4.35 6.59

2.69 4.23 1.66 1.85

3.93 6.88 3.23 4.69

0.46 2.32 1.91 1.62

1.86 4.32 3.56 3.76

Average 1983–7

Current account balance as a percentage of exports of goods and services Less developed countries(d) 1.1 8.60 3.40

Average 1987–90

Average 1980–90(c)

1.27

4.32

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Region or group

Average 1970–80

Africa 11.27 Western hemisphere 20.42 (a) Heavy debtors 17.10 Current account balance (US$ billion) Less developed countries(d) Africa Western hemisphere Heavy debtors(a) Trade balance (US$ billion) Less developed countries(d) Africa Western hemisphere Heavy debtors(a) Services, net (US$ billion per year) Less developed countries(d) Africa Western hemisphere Heavy debtors(a) Net external borrowing (US$ billion per year) Less developed countries(d) Africa Western hemisphere Heavy debtors(a) Region or group

Average 1970–80

Average 1980–3(c)

Average 1983–7

Average 1987–90

Average 1980–90(c)

23.53 23.97 25.60

8.15 6.58 5.05

7.10 6.67 5.23

12.45 11.82 11.27

60.43 18.77 30.76 38.50

22.18 6.07 7.58 6.75

11.57 9.43 9.93 9.37

30.47 10.89 15.24 17.06

29.5 2.50 10.76 8.87

44.43 8.12 26.88 33.08

47.93 4.07 19.67 32.30

41.00 3.66 19.88 25.58

105.40 21.10 43.06 50.20

89.55 20.95 37.83 44.38

86.30 22.80 41.10 47.77

93.33 21.55 40.38 47.14

98.57 15.90 38.87 43.47

42.62 5.95 9.35 9.05

36.67 10.37 8.56 9.13

57.62 10.26 17.97 19.40

Average 1980–3(c)

Average 1983–7

Average 1987–90

Average 1980–90(c)

Net external borrowing from private creditors, including short-term flows (US$ billion per year)(f) Less developed 53.93 13.80 12.23 25.37 countries(d) Africa 4.23 0.80 2.77 1.78 Western hemisphere 28.93 1.60 4.33 7.90 (a) Heavy debtors 29.83 3.58 0.83 7.27 Net borrowing from commercial banks (US$ billion per year) Less developed 67.70 3.62 2.20 28.19 countries(d) Africa 5.47 0.88 1.10 1.62 Western hemisphere 45.20 0.35 7.63 11.13 Heavy debtors(a) 41.27 1.75 8.37 10.84 Sources: IMF, World Economic Outlook, 1982, October 1988 and October 1990. Notes: (a) A category defined in the IMF’s World Economic Outlook as ‘fifteen heavily indebted countries’. In recent years this group included Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Ivory Coast, Mexico, Morocco, Nigeria, Peru, Philippines, Uruguay, Venezuela and Yugoslavia, (b) The figure refers to the period 1972–81. (c) The 1981 figure used in this calculation is from the October 1988 issue of World Economic Outlook, (d) The figures under the last four columns are the average of the data for each of the years except for the first one, which is excluded. The last column does not include a figure for 1990. (e) Average of 1988 and 1989. (f) Net external borrowing minus that from official creditors and the IMF and liabilities constituting foreign authorities’ reserves. Calculated as a residual and hence also including errors and omissions and the effects of discrepancies in coverage.

The crisis period was 1980–3, when growth was only 2.3 per cent (negative in per capita terms). All regions, and most countries, recovered somewhat over the next few years, and the overall growth rate for 1983–7 was about 4 per cent. By the late 1980s it had slipped back to just over 3 per cent however, a rate sufficient to keep per capita GDP growing at 1 per cent but not per capita absorption, given the sharply negative terms of trade shift (32 per cent over the decade) and the sharp reversal in capital flows. The loss of momentum was particularly serious in Latin America (from 3.5 per cent in the

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mid-1980s to just 0.6 per cent 1987–90), as several countries, most notably Brazil, saw incipient recoveries cut short; this regional category overlaps closely with the set of heavily indebted countries so the same can be said of that grouping. By the end of the 1980s the contrast between the success of the Asian countries and those of the other two regions was stark; per capita output was growing in the former at an annual average of 4.8 per cent while the comparable figures for Africa and Latin America were about 0 per cent and –1.4 per cent respectively. The absorption gap was even wider since terms of trade effects were most negative in the latter two regions, as were the losses from the reversal of capital flows. A possibly ominous feature of the Latin American picture in the late 1980s (again very closely parallel to that of the set of heavily indebted countries) is the combination of a stable balance of payments deficit at US$10–12 billion per year (over 1987–90), far below the level of the late 1970s, coupled with a rapid increase in long-term borrowing from official creditors which has been almost exactly offset by negative borrowing from commercial banks (Table 8.2). Table 8.2 Selected features of the external financing of Latin America(a) during the 1980s (flows in US$ billion) Deficit on goods, services and private transfers Use of reserves Net external borrowing Long-term borrowing from official creditors Borrowing from commercial banks

1982

1983–6

1987–90

1991(b)

41.1 20.0 40.0 6.0 43.2

8.4 1.7 11.4 8.6 5.1

11.7 1.9 9.3 9.5 7.6

13.0 12.1 16.8 20.5 23.1

Source: IMF (1988) 40. Notes: (a) Essentially equivalent to the IMF category ‘western hemisphere developing countries’. (b) Projections, as are the figures for 1990.

Although net external borrowing was predicted by the IMF to be higher in 1990 and 1991 than the low levels of 1985–9 (average US$6.9 billion), the deficit on goods, services and private transfers was not. Increased lending from official creditors was predicted to be just eaten up by repayments to the commercial banks, and it was (perhaps optimistically) hoped that reserves would be built up (in 1991). Required interest payments on the existing debt are of course very large. If one concluded from these countries’ very unsatisfactory growth performances over 1987–90 that the existing net inflow of resources was inadequate, then the prediction of a constant inflow would not be at all reassuring. An aggregate overview of what happened in the 1980s in the Third World leaves a number of ambiguities. It is clear that the worsening of the terms of trade has had an important negative effect in the cases of the three groups singled out here, Latin America, Africa and the heavily indebted group. In each case the accumulated decline was at least 30 per cent; this was almost enough to offset the considerable growth of exports from Latin America during the decade and in the case of Africa, where exports did not grow (in 1990 they were still over 15 per cent below their 1980 level), it was responsible for the tremendous decline in import purchasing power. Had the debt been held constant since the crisis emerged, the amortization and interest payments would have imposed an even heavier burden on the paying countries than their actual repayment performance did. But the major analytical uncertainties at this point involve the mechanisms linking the shortage of imports and the unsettled context to growth performance. IMPACT OF THE CRISIS AND ITS INTERPRETATIONS To predict the results of a future cutback in capital flows to the LDCs it is necessary to understand the mechanisms whereby the capital withdrawal of the early 1980s led to the growth slowdown. The events of the 1980s have left per capita incomes far below what they would have been had the 1965–80 trends continued through the 1980s. For all low-income countries as a group, excluding India and China, the differential by 1989 was 30 per cent, for Latin America it was 42 per cent and for subSaharan Africa about 50 per cent. In the case of Latin America the great bulk of this gap can be attributed directly or indirectly to the withdrawal of the capital flows, whereas in Africa some part was due to other factors. There is no doubt that the shortage of imports slowed capital investment and caused under-utilization of existing capacity when imported inputs became too scarce; it may also have discouraged savings. Whereas gross domestic investment had risen at 8.6 per cent per year in the LDCs over 1965–80 the increase was just 3 per cent per year over 1980–7 (World Bank 1989: 179). In sub-Saharan Africa the drop was dramatic from 9.3 per cent per year to 8.3 per cent and in Latin America only a little less so, from 8.3 per cent to 4.5 per cent. Savings performance looked more satisfactory (gross domestic savings were 13 per cent of GDP in subSaharan Africa and 20 per cent in Latin America as of 1987 (World Bank 1989:181)), but since the relative price of imported machinery had been pushed up by its scarcity, a given amount of savings would not finance as much investment as before. The crisis also encouraged capital flight, caused instability in macroeconomic policy and prices, and became a plague on the newly installed democratic regimes which came into existence with some frequency during this

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period. Finally there was a series of negative second-round effects on output, due to lack of demand for some products, general economic uncertainty, fiscal crises, etc. In varying ways and in varying degrees the countries which are under the debt-gun have grappled with these problems, helped or not depending on one’s point of view by the ministrations of the IMF and the World Bank. How far have they been able to get and what are the implications for them of a possible tightening of the international capital market at this time? If one takes account only of the most direct and obvious effects of changes in the aggregate foreign sector variables between the 1970s and the 1980s, one cannot fully explain the decline in growth rates either in Africa or (especially) in Latin America. In the former case, the growth rate of GDP was 2.4 per cent lower in the 1980s than in the 1970s. Both export quantum and the terms of trade performed less well in the 1980s, with the result that the purchasing power of exports fell by 6. 1 per cent per year, compared with a growth by 6.8 per cent per year in the 1970s (Table 8.3). Between the two decades the trend in import quantum shifted down by a little less (10.4 per cent, or from +6.2 per cent to 4.4 per cent) than did the purchasing power of exports (about 13 per cent), consistent with the fact that the deficit in the current account balance was a little greater in the 1980s. If one assumed that export production had no opportunity cost in terms of reduced output of domestically produced and consumed items, the decline in the Table 8.3 International factors in the growth deceleration of Africa and Latin America in the 1980s

Africa Export quantum growth rate Terms of trade (average annual change) Purchasing power of exports growth rate Import quantum growth rate Current account balance as a percentage of exports of goods and services Latin America Export quantum growth rate Terms of trade (average annual change) Purchasing power of exports growth rate Import quantum growth rate Current account balance as a percentage of exports of goods and services Source: Table 8.1.

1970s

1980s

2.75 3.92 6.80 6.18 11.27

1.88 4.32 6.12 4.23 12.45

1.91 4.12 6.10 7.03 20.42

4.53 3.56 1.68 1.66 11.82

growth rate of export quantum (4.57 per cent) would directly account for an output growth decline of a little over 1 per cent. In fact the production of exports does normally have some opportunity cost in terms of other goods, so only a somewhat less than 1 per cent change in the GDP growth rate can be accounted for in this way. (The negative shift in the movement of the terms of trade would account for a substantially larger decline in national income.) If one thinks of imports as essentially being capital goods, the more than 10 per cent decrease in their rate of increase, given the average import/GDP ratio of about a quarter, would be expected to affect the investment ratio negatively by about 2.55 per cent of GDP, and to slow growth by say 1 per cent per year. The combined negative effect on the GDP growth rate from the slowed growth of export quantum and of import quantum, looked at in these two ways, could approach 2 per cent, i.e. it could explain most of the observed decline in the rate of growth of GDP. In Latin America, the growth rate of GDP was a full 4.5 per cent less in the 1980s than in the 1970s. Although the terms of trade trend moved from quite positive (4.1 per cent per year) to quite negative (3.6 per cent), export quantum rose faster in the 1980s (4.5 per cent to 1.9 per cent), so the purchasing power of exports did continue to rise, at 1.7 per cent versus the 6.2 per cent of the previous decade (Table 8.3). Import quantum growth fell by 8.7 per cent, a decline greater than that of the purchasing power of exports (4.4 per cent). This marked discrepancy is due in part to the sharper reduction of the net resource flow to Latin America than in the case of Africa; allowing for that decline would be equivalent to a reduction of about 0.9 per cent in the growth rate of the purchasing power of exports. The faster growth of export quantum should have had a positive direct effect on the overall growth rate, but not amounting to more than 0.4 per cent even under the most optimistic assumption that the exports are produced at zero opportunity cost to the rest of the economy. The slower growth of imports would cost the economy about 1 per cent of GDP each year in terms of investible funds, and presumably slow growth by not more than 0.5 per cent per year. Given the dramatic growth deceleration by 4.5 per cent it is evident that most of it is not explained directly by these simple mechanisms but by other, usually more complicated, ones. Gross domestic investment fell sharply from around 25 per cent in the 1970s to around 16 per cent in the mid-1980s (Berry 1986: Table 1). At the latter level

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it is unclear whether the capital stock would in fact be rising at all, since estimates of depreciation are always subject to considerable imprecision. In some of the Latin American countries it is also clear that the marginal capital-output ratios became very high. According to one estimate the ratio of gross domestic investment to output growth rose from 4.42 over 1975–80 in the region as a whole to 25.12 over 1980–5 (Berry 1986: Table 2a). For a set of fifteen heavily indebted countries, which overlaps closely with the major Latin debtors, the ratio rose from 4.1 over 1970–80 to 11.3 over 1981–9 (IMF 1988: 40). While these gross investment figures are not good proxies for the conceptually relevant net investment figures,1 it seems quite likely that the ratio of net investment to growth would also have risen significantly during this period. It is reasonable to assume that the uncertainty created by the lack of any plausible international plan to deal with the debt crisis would have impeded healthy growth, even if hyperinflation and other manifestations of social and economic chaos had not come along as well. At the same time it is reasonable to assume that under favourable conditions the majority of the LDCs could move to a more efficient growth path than the excessively import–and capital-intensive ones towards which many had been pushed by the state of the international capital market in the 1970s. To date, however, very few countries have returned to anything like a stable growth path. For most, and for the debt-ridden countries as a group, it remains to be seen how successful the various programmes of structural adjustment have been. In defining the malady which together with the exogenous shocks of the early 1980s plunged so many LDCs into economic crisis, one would include too free access to imports and too little emphasis on the promotion of exports, too loose fiscal and monetary policy and (less systematically) too little domestic savings effort. The sharp decline in the availability of imports has put a premium on their efficient use, and should have discouraged import-wasting projects and industries, but this process probably occurs slowly and with considerable lags in relation to the shocks which push it along, so it is not yet clear how much more import-economizing is the growth of the last few years than that of the 1970s. Export growth has had some success, especially in the countries of East Asia, but its potential for the LDCs as a whole has clearly been and will continue to be hampered by the protectionism of major industrial country markets. Fiscal responsibility has been pushed hard in a number of countries, but whether the composition of expenditure declines has been close to optimal is as yet hard to judge. One of the empirical difficulties in interpreting the degree of sustainability in the modest growth that many countries have been able to achieve in the latter part of the 1980s is the likelihood that some part of it is little more than recovery from the undercapacity operation of the depths of the recessions, and that another part is based on running down/wearing out both private- and public-sector capital (infrastructure in the latter case). Thus in most countries of Latin America such modest growth was often achieved with investment rates which were still very low; only if growth is in fact considerably more efficient than before would it be possible to sustain such growth after under-capacity is ended. The interpretation of the behaviour of national (domestic) savings rates re-emerges as a matter of some importance, and the ‘two-gap’ model made famous in the 1960s by Chenery and Strout (1966) is once again an important concept. That model raises the possibility that savings may adjust downward to the level of investment which can be attained given the available level of imports. It highlights the fact that while in some situations a low savings rate may be the key impediment to faster growth, in others this role is played by the low level of imports and there may then be little if any gain to be had by trying to push the savings rate up. Among the policy prescriptions forming part of the typical IMF package is import liberalization, along of course with export promotion. The logic of the former is that with less intervention/ controls resource allocation will be better. Too few natural experiments have thus far occurred to give this idea much of an empirical test; the great export success stories of East Asia are a counterexample since those countries have traditionally controlled import direction quite tightly, but they were also no doubt more efficient in the allocation of those imports than most other LDCs. In any case if liberalization is to improve the growth process it must overcome at least two hurdles: it will naturally have a negative direct impact on the balance of payments, and it may leave too little discrimination in favour of capital goods and of certain industries to which the infant industry argument for protection does apply. The structural adjustment which has over the last decade become a byword in development policy has in fairness to the proponents of the typical package not had enough time to prove itself out one way or the other; there is as a result much guesswork in trying to judge whether the debt-ridden LDCs as a whole have by now embarked, albeit haltingly, on a growth path which will gradually make them less and less dependent on capital flows and market access in the DCs. (It should not be forgotten that the countries of Eastern Europe constitute an unwelcome competitor for the LDCs in the manufactures exporting business just as they do with respect to capital flows.) During the 1980s, as the powers that be blundered from one inadequate approach to the alleviation of the debt-crisis to another, the major justifiable complaint from the Third World was that the financial flows were niggardly, usually enough to prevent some major conflagration in some key country (like Mexico) but never enough to re-establish a solid growth path. This may prove to have been very costly since there is more than a little evidence to suggest that growth momentum at one point of time greatly facilitates growth in the next period. The recent growth rate of the economy or of incomes frequently appears as a significant independent variable in savings functions; the allocation of public expenditures often appears to be more

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efficient when the total is growing at some minimum rate: in short, fast growth once achieved seems not nearly as hard to sustain as it is to achieve in the first place.2 By extension, there is a possibility that the long duration of the period of stagnation for many LDCs has now left them in a situation where satisfactory growth will be harder and more expensive to re establish than it would have been if firm and effective steps had been taken soon after the crisis hit. By this reckoning the costs of inadequate response are even greater than suggested in some of the earlier discussion of this chapter. THE CHALLENGE There is no doubt that the build-up to the debt crisis, with its easy access to private international finance, saw unhealthy behaviour patterns creep into the economic management of some Third World countries; it is also clear of course that such patterns were fostered by the behaviour of the international banking system at this time. It is useful to distinguish several different elements to the challenge of re-establishing growth, at a time when oil prices are still high and recession still plagues the industrial world, but the easy access to cheap capital which characterized the 1970s, at least for the middle-income countries, will be absent this time around.3 First, they must learn to exploit world market opportunities better, develop comparative advantages in new products, and so on. Second, they must learn to be more economizing in the use of now scarcer capital and imports. Third, since the reallocation of resources entailed in these requirements may, if handled badly (e.g. if pushed too quickly), lead to an unnecessarily high level of underutilization of resources, some attention to under-employment through lack of demand must be given. Fourth, they must develop a level of efficiency in the political and administrative processes which was not present (nor essential to success) before. This involves, among other things, shirking some of the responsibilities which typically get Third World governments in trouble, such as managing too many parastatals. But it also calls for (i) a possibly major reallocation of resources in the economy, something with which few countries have any recent and relevant experience, and (ii) a sensitive demand management policy, another area with no very relevant procedents since these countries have seldom had to worry about under-utilization of resources due to low aggregate or sectoral demand. All of these processes naturally take time. The pressure must be kept on to prevent slacking, but at the same time if too much is demanded of a system the result may simply be chaos and failure. Judging how fast the support from the outside can be removed without serious withdrawal effects is obviously tricky. If one expected the withdrawal of funds which did occur in the 1980s to be efficient in this sense, one would in retrospect have been very wrong. There is evidence of increasing competence in some countries, as a prior generation of managers of the economy is replaced by a group with ideas more consistent with the new reality; but it is also evident in quite a few cases that the ‘new guard’ is (not surprisingly) inexperienced and often naive, suggesting that it would not always be able to handle situations demanding subtle policy mixes. To further complicate the task, many countries are unable to factor into their long-range planning a predictable level of resource support from the international community. Effective recovery of the ailing regions of the Third World requires a significant and flexible (though in some cases not particularly large) capital inflow, good economic policies, and domestic political stability, important for its own sake and as a necessary condition to the maintenance of the first two conditions. A much discussed aspect of the North’s contribution involves the conditions which should be attached to renewed capital flows. The standard IMF-type conditions involve macroeconomic stability (fiscal and balance of payments) without which a good part of the flow could be wasted. Increased export orientation may be wise, as may a better programme of import substitution. Direct foreign investment is widely touted by some as having potential, but this remains a matter of opinion and there is limited empirical support for such a view. A combination of an exchange rate and capital prices which do not induce excessive use of capital and foreign exchange are central. THE EFFECTS OF US$20 BILLION MORE OR LESS While it is not possible to estimate with any precision the capital inflow which would be required to achieve a given growth performance in the lagging regions of the Third World, some reasonable guesses can be made. For purposes of illustration, we here ask what difference the presence or absence of financial transfers to the LDCs on the order of US$20 billion per year over the next few years would make. Most of this flow would go to the middle-income heavily indebted countries, where international debt now amounts on average to about 40 per cent of GDP.4 This flow would be about 4 per cent of 1989 debt for this group, or about 1.0 per cent of that year’s GDP. With a marginal capital/output ratio of 3, if the flow simply added the corresponding amount of resources to investment, it would increase the growth rate of GDP by one-third of a percentage point. But this would no doubt under-estimate the true effect since with both foreign exchange and capital in short supply, the impact would be much greater—possibly much greater, as suggested by the record in Latin America to which we referred above. Restricting one’s attention to the direct impact of capital flows on investment as per the above logic, even in a dramatic case where the capital inflow changed quickly from 3 per cent of GDP to 3 per cent, one would have expected a decline in the growth rate of only 2 per cent; but in fact the declines were much greater. Disorder, the rendering worthless of

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some past investment, the uncertainty effect on investment, the capital flight, and other factors all played their role in creating extremely high marginal capital output ratios (or so it seems) and pushing investment rates down sharply. In a number of developing countries the marginal capital output ratios and the import coefficients observed during the 1970s and on into the early 1980s do not represent a most economical use of those resources, partly because neither input was in short supply in countries with good access to international capital market— roughly the same set of countries as ultimately became very indebted. So it is legitimate to ask how much lower the capital/ output and import/output ratios could be under ‘best practice’. A related question is how quickly any given economy can move towards that best practice, having established an economic structure and a set of behavioural patterns on the basis of lower prices for those now scarcer resources. It is unlikely that the tradition would be very quick—perhaps a decade or more would be a reasonable estimate, though I have seen no analysis on this point. Thus far, however, the unsettled and unpredictable international setting of the heavily indebted countries has permitted only a modest movement toward such better utilization of resources. A few, such as Chile and Costa Rica, do appear to be on sustainable growth path. A few others might be approaching that state, but they account still for an insignificant share of total economic activity in the beleaguered part of the Third World. Though it would be excessively optimistic to expect any imminent improvements to return the growth performance either of Latin America or of the substantially overlapping group of heavy debtors to what it was in the 1970s, a healthy resource inflow which also contributed, as it normally would, to a better growth context in general, could be part of a package which raised growth in those groups of countries from the less than 1 per cent level of the last three years (1987–90) to at least 3 per cent. Failure to provide such a flow would thus have a significant cost in terms of growth. The loss of a couple of percentage points from the growth rate must be seen in the perspective of developing countries, where population growth continues to be rapid, usually in the range of 1.5–2.5 per cent per year for the Latin and heavily indebted countries, but even faster in Africa. An acceleration of GDP growth from say 1 per cent to 3 per cent might not seem so dramatic in its implications until one recalls that, with population growing at say 2.0 per cent, this constitutes the difference between slow growth and slow decline in per capita income. And certainly a 3 per cent rate provides a better base from which to accelerate further to the 5 per cent or so which must be considered the minimum acceptable long-run performance in these low-income countries, which still have so much ground to cover before reaching a comfortable standard of living. NOTES 1 Since depreciation changes less sharply than gross investment, net investment changes more sharply than either in a downturn. 2 Possibly the apparent validity of this proposition is misleading, and all that we see is an autocorrelation among the policy and exogenous factors which affect growth. But until the latter is demonstrated one must take seriously the former possibility. 3 For the poor countries, where agricultural problems loom much larger among the challenges, the case is somewhat different. 4 As of 1989 the debt/export ratio was estimated by the IMF to be just under 3.0 for a group of fifteen heavily indebted countries (IMF 1988: 40). The export/GDP ratio as of the late 1980s for this group was about 0.14.

REFERENCES Berry, Albert (1986) ‘Aspects of savings and investment during the economic crisis in Latin America’, mimeo. Chenery, Hollis, and Strout, Alan (1966) ‘Foreign assistance and economic development’, American Economic Review 56:679–733. IMF (International Monetary Fund) (1982) World Economic Outlook. — (1985) World Economic Outlook. — (1988) World Economic Outlook, October. — (1990) World Economic Outlook, October. World Bank (1987) World Development Report 1987, Oxford: Oxford University Press. — (1989) World Development Report 1989, Oxford: Oxford University Press.

9 Macroeconomic outlook for Mexico and economic policy* Rogelio Ramirez de la O Ecanal, Mexico

INTRODUCTION I discuss in this chapter how the current economic transformation of Mexico has been successful but remains incomplete, with major policy measures pending for the restructuring of Mexican industry and state enterprises, and with an urgent need to reduce inflation and consolidate economic stabilization. With inflation at its present level of 28 per cent and many publicsector prices still under artificial control, the prospects of a rapid reduction in inflation appear relatively slim, as the Mexican government has given every signal that it wants to avoid shocks or dramatic fiscal action. The present economic policy poses a problem for the exchange rate, which has suffered a substantial appreciation in real terms since the anti-inflation programme started at the end of 1987. The relative confidence which financial markets have shown so far in the government’s exchange-rate policy is based on the perception that reducing inflation is still the top policy priority, and that it will be attacked at the root and soon recede. This carries the implicit understanding that the government will not adopt an expansive fiscal policy in the short run and that monetary policy will remain tight. The current-account deficit—which resulted from the exchange-rate appreciation of 1988–9, the mild economic recovery since 1988, and the liberalization of import trade—has now reached 2 per cent to 3 per cent of GDP and should be maintained there during a steady recovery of the economy at moderate growth rates of 3 per cent to 4 per cent annually. A higher rate of growth, however, would provoke higher deficits and could make it difficult to reduce inflation soon enough to avoid an erosion of confidence in the financial markets. This is even more important now in the presence of global capital scarcity, amongst other reasons, because of the opening of Eastern Europe and the continuing problems the United States will face to reduce its current-account deficit. Although Eastern Europe is not generally regarded as competing with Mexico for foreign capital, it is clear that its opening has caused increases in the cost of international financing and also in the opportunity cost of risk capital. The reconstruction of Eastern Europe with resources from Western countries makes it more difficult for Mexico to attract European capital. At the same time, however, it has helped Mexico to refocus its regional priorities and explore ways to increase its economic integration with North America. The signing of a free trade agreement (FTA) with the United States, and later on with Canada, will probably spur capital inflows to Mexico that would otherwise not become available, and permit the increase of the rate of economic growth over the medium term. It must be noted that one problem Mexico will have in attracting large inflows of foreign direct investment is the bad state of its economic infrastructure, which has suffered from reductions in public capital spending during the period of economic adjustment. This will block increases in productivity which would otherwise result from trade liberalization, and it calls for massive fresh resources to be channelled into infrastructure. Therefore, while the government is obliged to maintain a stance of fiscal austerity over the medium term, it must open up investment rules to allow private investment in sectors until now restricted. This and deregulation in many areas of the economy are the most important policies to be implemented in the immediate future. Any failure to implement them will render the stabilization and restructuring of the economy incomplete. DEVELOPMENTS IN MEXICO'S ECONOMIC PROSPECTS During the 1980s the Mexican economy experienced one of the greatest economic crises in modern times, second only to the 1930s depression. The Mexican government responded to this crisis with an orthodox stabilization plan, supported by a threeyear extended credit facility from the IMF starting in 1983. Despite the depth of the intended fiscal adjustment and the dramatic exchange-rate devaluation that accompanied it, the government soon came to realize that the economy could not be put back on the path of sustained growth until profound structural changes were made and the causes of the crisis attacked at their roots. These adjustments were introduced gradually and over a prolonged period, and their effects are generally regarded as positive, putting Mexico on course for a mild recovery.

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The most important of these structural changes was the transformation of the old economic policy model that Mexico had maintained during most of the post-war period. This consisted of import substitution and growing state intervention in the economy, with an implicit agreement between the state and business that any policy changes would not go against established interests, and that special areas of economic activity would be reserved for Mexican capital to the exclusion of foreigners. Trade protection ensured economic rents in many sectors of the economy dominated by a small number of producers. The transformation of this growth model did not, of course, occur in a vacuum. The crisis of 1982 and the dramatic economic adjustment which ensued made domestic markets collapse, while real wages fell dramatically and indebtedness rose, putting most producers in a difficult financial position and obliging them to seek markets abroad. This move introduced the first elements of international competition into the dormant and protected industrial sector. Aided by the rapid economic recovery in the United States and its appetite for imports, exports of manufactures started to increase, and for the period 1983–7 were the main engine of growth. The export sector, however, was too small to offset by itself the stagnation of the domestic market. Nevertheless, the rapid growth in the exporting industries unleashed economic and social forces which later on demanded an even more rapid transformation of the economy, particularly the opening of the trade regime and deregulation. Eventually the Mexican government had to liberalize imports in a serious way by becoming a member of GATT. THE NATURE OF THE MACROECONOMIC ADJUSTMENT Mexico’s macroeconomic adjustment commenced in 1983 with a typical three-year IMF programme negotiated at the end of 1982 and backed by extraordinary financing from the US government. The targets of this adjustment were the reduction of the government’s fiscal deficit, which reached 16.9 per cent of GDP in 1982, and of the external deficit, which reached US$12. 5 billion in 1981 and was reduced by means of import controls and the economic contraction in 1982 to US$2.7 billion. This policy was to be accompanied by an exchange-rate devaluation, which took place in various stages during 1982, from a rate of Ps 26 to the US dollar to Ps 148. At the time of this agreement both the Mexican government and the IMF considered that such a programme would suffice to put the economy back on the path of growth, while correcting the internal and external imbalances and reducing inflation from the annual rate of 98.8 per cent recorded at the end of 1982. Table 9.1 shows that most of the foreign trade gains which were expected to stem from the new exchange-rate policy did not materialize during the next three years. From 1983 through 1985 the value of non-oil exports, and in particular of manufactured exports, rose by only US$2.3 billion, despite the fact that GDP suffered from a large fall in 1983 followed by only a moderate recovery in 1984–5. I consider this first stage of Mexico’s macroeconomic programme inefficient, in that the correction of the external imbalance was only temporary and not based on higher levels of productivity and export growth. Furthermore, it failed to reduce inflation permanently: once it had fallen to 59.2 per cent in 1984 it bounced back in 1985 to 63.7 per cent and continued to rise through 1987. The core of macroeconomic policy during this first stage of the stabilization programme (1983–5) was directed at the reduction of the public-sector deficit. Table 9.2 shows that fiscal policy managed to protect public-sector revenues despite the erosion of their real value of inflation. This suggests that the increases of public-sector prices were inflationary per se, since they reflected a higher inflation rate than the one officially ‘expected’. The government was clearly trying to protect the revenues of state organizations and enterprises, which were heavily indebted and were hit even harder by increases in domestic and international interest rates. Since prices were liberalized, increases in key public-sector prices were easily passed on to the general price level by a private sector often enjoying sufficient market power. The only exception to this rule was the wage rate, since the labour market was generally weak throughout this period and firms were trimming themselves down in order to face heavy payments on their debts. Tight political control on the part of the government over the labour unions, and a preceding period of real wage growth, permitted the government to adjust real wages downward without internal political disruption. The contribution of this factor to the final success of stabilization policy—at least to date—has not been sufficiently emphasized in the literature and is a topic worthy of research. Table 9.1 Foreign trade and economic growth in Mexico, 1982–9 (US$ billion and percentage of GDP) Exports Oil Non-oil Manufactures Imports GDP annual growth Exports of manufactures/GDP (%)

1982

1983

1984

1985

1986

1987

21,229.7 16,477.2 4,752.5 3.017.6 14,437.0 0.6 1.76

21,398.8 16,001.8 5,397.1 3,665.5 7,720.5 4.2 3.08

24,196.0 16,601.3 7,594.7 5,594.8 11,254.3 3.6 3.52

21,866.4 14,766.8 7,099.6 5,266.6 13,460.4 2.6 3.45

16,031.0 6,307.2 9,723.8 7,115.7 11,432.4 3.8 5.93

20,656.2 8,629.8 12,026.4 9,907.4 12,222.9 1.7 7.19

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1982

1983

1984

1985

1986

1987

Source: Ecanal © October 1990. Table 9.2 Fiscal adjustment and inflation in Mexico, 1982–9 (% of GDP) Public-sector revenue Oil sector Non-oil’ Taxes Sales of state enterprises Others Public-sector expenditure Current spending Interest on debt Capital expenditure Financial intermediation Financial deficit Consumer inflation (average) Consumer inflation (December) Source: Ecanal © October 1990.

1982

1983

1984

1985

1986

1987

1988

1989

28.9 9.9 19.1 9.9 8.1 1.0 44.5 33.4 8.2 10.2 1.3 16.9 58.9 98.8

32.9 14.2 18.7 10.2 7.4 1.1 41.0 33.0 12.4 7.5 0.5 8.6 101.9 80.8

32.2 13.0 19.1 10.3 8.1 0.8 39.3 32.1 11.9 6.7 1.4 8.5 65.4 59.2

31.2 11.5 19.7 10.2 9.2 0.3 39.2 32.6 11.5 6.1 1.5 9.6 57.7 63.7

30.4 9.0 21.4 11.3 8.9 1.2 44.9 38.1 16.6 6.0 1.1 16.0 86.2 105.7

30.5 9.8 20.7 10.7 9.2 0.8 44.9 39.2 19.7 5.5 1.0 16.0 131.8 159.2

29.9 7.6 22.4 11.9 9.2 1.2 39.1 34.7 16.7 4.4 1.6 12.3 114.2 51.7

30.5 6.9 23.6 12.7 6.6 2.3 36.9 31.7 13.0 3.9 0.6 5.8 20.0 19.7

Fiscal policy did manage to effect a reallocation of public-sector expenditure. During the seven years from 1982 to 1989, the share of public investment expenditure fell by 6.3 per cent of GDP, as is shown in Table 9.2. This was a deliberate attempt to control the overall deficit and, given the political difficulties, to reduce current expenditure. The government seems to have perceived that public servants were already taking the brunt of falling wages so that a further reduction in expenditure, which would have called for massive redundancies, would be difficult to achieve without putting political stability at risk. Hence, current public expenditure as a proportion of GDP actually increased during some years, fell back to precrisis levels in 1988, and experienced a small reduction in 1989. There were several reason for this. The devaluation of the peso and the economic crisis put many public entities in a difficult financial position, so that transfers from the central government had to rise. Most importantly, the cost of interest on the domestic debt rose as interest rates increased, and that on the foreign debt rose with new peso devaluations in 1985. Furthermore, in early 1986, Mexico suffered from a US$7.2 billion fall in oil revenues owing to weak international prices, which precipitated a new exchange-rate devaluation and aggravated the budget position and inflation. To sum up, fiscal policy was aimed at the right target during the first stage of the IMF programme, i.e. the reduction of the publicsector deficit. It was, however, implemented in an inefficient way, since it did not manage to cut into the structure of public-sector expenditure and was too rigid to respond quickly to the fall in oil revenues in 1986. THE SECOND STAGE OF STABILIZATION Stabilization policy entered a second stage, however, when the government began to examine structural problems requiring profound reforms which ultimately led to the overall improvement in the economic climate. This stage began in 1985 with the reduction of import tariffs and the removal of import licences. Such a policy eventually led to the rapid growth of non-oil exports, and particularly those of manufactured goods. The factors responsible for this increase were the liberalization of imports of materials for export industries, the rapid growth in the United States—where imports were booming—and the depressed state of the Mexican domestic markets. Import liberalization did not cause the import explosion and the large trade deficit which many expected, since the domestic market remained weak and the heavy exchange-rate devaluation of 1986 performed the role of a high tariff. Once Mexico joined GATT in 1986, a more rapid liberalization of import trade than had been negotiated became feasible, particularly in 1988, when the government decided to apply a shock anti-inflation plan. Weak domestic markets therefore account for the fact that imports only began to soar in 1988, when the real peso exchange rate began to appreciate, and many industries experienced the removal of import licences and tariff reductions in support of a domestic price-control programme aimed at reducing inflation. Thus, the reason for trade becoming the Mexican government’s most efficient policy during stabilization is that it was adopted under circumstances where it would not cause a rapid deterioration of the external balance.

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By comparison, tighter fiscal policy was more difficult, since it would have caused political problems for the government. The disparity between policies in different areas once economic reform began was important and disturbing, but nevertheless it seems to be the rule rather than the exception. From 1987 the economy was on the path to recovery, and the climate for business was improving as the government continued to liberalize trade. The rub, however, was that inflation, 105.7 per cent in December 1986, was not falling but increasing, in reflection of the monetization of the public-sector deficit. The government at the time sounded convincing in its argument that public finances were healthy, since the budget primary balance (which excluded all interest payments on the public debt) was in a high surplus of over 6 per cent of GDP. So, the argument ran, inflation would eventually fall in response to the government’s strong budgetary position, while the climate for business would improve as further structural changes were signalled consistent with market forces. The experience of late 1987 added a new lesson in stabilization for the Mexican government: no economic programme can succeed in the presence of inflation, and thus no other policy target, including economic growth, can take precedence over that of reducing it. In October 1987 the equity market collapsed following similar falls in world stock markets, provoking a run on the peso, justified by high inflation and the lack of confidence in domestic financial instruments. This, the third failure of President de la Madrid’s economic policy to prevent a run on the peso, was uncomfortably close to the presidential election of 1988. The government therefore had to adopt a radical anti-inflation plan including reductions in nominal expenditure, a fixed exchange rate, and price and wage controls. Fortunately for the government, this programme had the support of business, which saw that the alternative would be a hyperinflation cycle and severe political difficulties. The Pact of Economic Solidarity was introduced as the result of consultations between government, business and labour, and consisted of a series of short-term programmes during which wages and public and private prices would remain fixed, while fiscal and monetary policy would aim to maintain the nominal exchange rate. As inflation receded throughout these stages and the programme gained wider credibility, this pact was successively renewed. The reduction of inflation in a single year, 1988, achieved for the government what many other policies and policy announcements during the previous five years had not: a credible reduction in the public-sector deficit and in inflation and a recovery of the domestic markets. Part of that recovery stemmed from anticipated purchases of consumer durables, as economic agents expected prices to bounce up again as they had done in Brazil and Argentina, where similar programmes had been implemented. Another cause of the recovery was the improvement in the purchasing power of wages, as imported items began to substitute domestic goods, aided by a strong exchange rate and greater consumer confidence. The question of wages deserves a brief mention, since most analysts consider that they have been falling throughout the stabilization period. This is not supported by the evidence: average real wages in manufacturing rose by 8.7 per cent in 1989, when further gains in the control of inflation were secured, after falling only 1.7 per cent in 1988, the first year of the antiinflation plan. These increases are measured in real pesos and therefore they do not incorporate the positive effect on purchasing power of the reduction of import tariffs on consumer goods. It is true that these gains in wages were not the rule for all industries, including the sector of minimum wages which recorded real falls in both years. They reflect, nevertheless, the average in manufacturing, which includes industries previously protected by import licences and high tariffs and now exposed to international competition. It is consistent with theory that the opening of trade forces firms to become more efficient, and this eventually contributes to the increase in real wages. Another effect of the reduction of inflation was the change of sign in the current account on the balance of payments, which had remained in surplus since 1983 (US$5.5 billion) through 1987 (US$4.0 billion) with the exception of 1986. For the fiveyear period the accumulated surplus was US$13.1 billion, but in 1988 it turned into a deficit of US$2.4 billion which rose in 1989 to US$5.4 billion. This represented a change from a surplus of 2.8 per cent of GDP in 1987 to a deficit of 2.7 per cent of GDP in 1989. Such a deficit was viewed largely as a natural result of stabilization, since this improved the prospects for investment and raised average wages. It has not been recognized how much of this change was caused by the strengthening of the real peso exchange rate against the US dollar, although we believe that is part of the explanation. Nevertheless, Mexico, as a developing country, must be a capital importer and that means that the current account must be in deficit within a manageable band. CURRENT ECONOMIC STRATEGY The implications of the change of sign in the current account are important for government policy. First, it was considered impossible to continue progress with stabilization unless the value of the foreign debt was reduced, which was partially achieved with a debt renegotiation under the ‘Brady’ strategy. Second, the Mexican government had to give high priority to the attraction of foreign investment and capital repatriation by Mexicans, which must provide the funds to finance the current deficit. A large part of government policy and actions since 1988 have therefore been directed at attracting foreign capital by eliminating restrictive rules on foreign investment and promoting more government contacts with potential investors.

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Mexico’s economy began to reduce its net financial transfers abroad in 1988, when the fall in inflation increased domestic demand. This, combined with import liberalization and a stronger peso exchange rate, contributed to the reduction of the surplus on the current account of the balance of payments from US$4.0 billion in 1987 to zero during the second quarter of 1988. The current account entered deficit: US$2.4 billion in 1988 and US$5.4 billion in 1989. For 1990 this deficit is expected to reach US$5.0 billion, despit e oil revenues that were US$1.5 billion higher than last year. Thus, the Mexican government recognized the need for foreign capital. The Regulations on Foreign Investment in May 1989, the reprivatization of Telmex and the banks, President Salinas’s extensive contacts with foreign business circles, and the initiative for the discussion and negotiation of a free trade agreement with the United States are largely motivated by the need to consolidate our economic recovery by attracting foreign and Mexican repatriated capital. This strategy has been successful so far, and today capital inflows are enough to finance the current-account deficit. But quite independently of the capacity for attracting foreign capital inflows, the economy must undergo further transformations in order to ensure that a steady economic recovery can be sustained. The current economic strategy is addressing some of the structural changes that are necessary. But progress in some of these areas has been slow, namely in a large part of the public infrastructure, in major enterprises which remain under the administration of the state, and in the agricultural sector, where there are restrictions on the private ownership of land. The government has signalled that it intends to further deregulate the economy and introduce legislation to allow private investment to participate in some public infrastructure, such as road construction. Other areas, however, such as electricity and petroleum, remain restricted. In the agricultural sector, the main problems are the extremely low productivity levels of collective farmers and the lack of incentives for producers, coupled with land-ownership restrictions for private enterprise. Many of these problems prevent the economy from acquiring the efficiency that would be consistent with an open trade and investment regime and, while they remain unsolved, imperil Mexico’s capacity to reap the full benefit of international trade liberalization. Some areas deserve specific mention, although lack of space prevents my entering into details in each case. First is agriculture, where important restrictions remain on land ownership and price controls and subsidies prevent an efficient functioning of the price system, with the result that many producers live in conditions of extreme poverty and must receive credit, fertilizer and water subsidies amongst others from the government or its state enterprises, while Mexico must increase food imports every year. A second case is in the functioning of the state enterprises and their management, where the lack of investment in recent years prevents them from reaching efficient levels of operation, but also massive reorganization is needed in the face of the opening of the economy to greater foreign competition. This situation affects sectors such as petroleum, petrochemicals, electricity, steel, food distri bution, socialized medical services, railways, fisheries, maritime ports, customs (although much has been done in this area), and municipal services (water, tax rates, permits for economic activity). The problem of state enterprise has three elements. One is the redefinition of the scope of the state intervention in the economy, which has been attempted by the government but has not always crystallized in the Constitution; a clearer definition is needed. A second problem is the investment needed to upgrade these entities in order to support higher rates of economic growth for the rest of industry. A third problem is the political implications of the reorganization of large state enterprises, such as for example the redrafting of labour contracts, the management of redundancies and the elimination of subsidies they provide to groups of consumers or producers. Economic legislation represents a third set of issues. The law of 1973 limiting foreign investment, the Banking Law of 1990, and Articles 27 and 28 of the Constitution restrict in different forms and degrees private and foreign investment in certain activities. The labour law imposes severe restrictions and high costs on firms wanting to adjust personnel and excessive regulation on businesses create a complex legal system for economic activity. Foreign capital inflows require that the appropriate business climate be established, and that opportunities be open to foreign capital in deregulated areas within a certain legal framework. Although recent changes in some laws and the issue of new regulations aimed at promoting capital inflows have been well received by the private sector, it is clear that a more significant role of foreign capital in Mexico’s development must be preceded by important institutional and legal changes which create a stable, not restrictive climate. Many of the changes the Mexican government has made are intended to reassure Mexican and foreign investors that structural changes will continue and that the conditions now exist for investing in Mexico. Nevertheless, the current macroeconomic policy must still deliver the long-awaited reduction in inflation. Until inflation is reduced to international levels and policy is oriented to keep it there over the medium term, many of the accomplishments of fiscal and monetary policy in recent years, however important, could be reversed. The risks of inflation soaring to higher levels than the present 28 per cent rate are there, and little more can be done to further improve the economic climate while Mexico suffers from an inflation rate six times higher than that of its main trading partner. To bring down inflation permanently, the Mexican government has used a strong exchange rate supported by monetary policy and agreements with workers and business, which have instilled confidence in the financial markets. Of course, the macroeconomic framework within which a nominal future exchange rate can be maintained is a sound one, and this is the

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principal reason why the market has not questioned such a policy. Nevertheless, for some time since the introduction of the antiinflation programme, the Bank of Mexico has kept interest rates high and has only reduced them in one-off moves, justified by changes in external conditions or in the announced rate of peso depreciation against the US dollar, which the markets interpret as helping to keep inflation down in the future. Expectations have therefore been crucial in determining the success so far of the anti-inflation programme. But, by the same token, they could have the opposite effect if the markets become convinced that present policies are not enough to assure the convergence of our inflation rate with that of our main industrialized trading partners. It seems plausible, however, that the exchange rate will continue to serve as an anchor to the rest of the price system and, with appropriate management, will guide the industrial sector to noninflationary behaviour. For this to be feasible, however, the government must make fiscal policy credible again, which means that fiscal consolidation must be completed and a new budget discipline adopted. Only with a one-digit rate of inflation, and for that matter a low one, will exchange-rate policy succeed at a time of a pickup in domestic demand and massive investment projects. The latter are largely motivated by the need to upgrade the economic infrastructure and allow Mexico’s industrial sector to become competitive at the world level. Otherwise, the real exchange rate will appreciate without justification. At present there are enough indications that the Mexican peso has become overvalued in terms of purchasing power parity, at least against the US dollar, and that such overvaluation is hitting the profitability of export industries while pushing imports up. In the short run, therefore, the main problem of macroeconomic policy is the high rate of inflation and its corresponding effect on the real exchange rate. Even though this is not yet a cause for concern in the financial market, it could well be if there is a rapid deterioration in the current-account balance. FINANCIAL FLOWS AND INTEREST RATES At a time when foreign exchange inflows have become so important for Mexico in view of their potential impact upon expectations and exchange-rate policy, capital repatriation and foreign direct investment (FDI) become the most important financial flows. Both will depend on domestic economic conditions as well as on international financial conditions, and the latter probably explain why investors have not responded to the liberalization of investment policies in Mexico in the way many observers had optimistically expected. To illustrate this point we can look at Table 9.3 where the current deficit is put at between US$5 and US$8 billion during the next five years, compatible with annual GDP growth of 4.0 per cent, probably the maximum rate achievable with price stabilization. Such a moderate rate of economic growth would maintain the current-account deficit at between 2 per cent and 3 per cent of GDP. The deficit could be comfortably financed with a mix of short-term capital inflows and foreign direct investment, the former responding to the differential in interest rates between Mexico and the United States. Table 9.3 Scenario of moderate growth in Mexico, 1990–4 GDP growth Inflation average Inflation December Public-sector deficit (% of GDP) Current account of the balance of payments Capital account Public sector (net) Private sector of which FDI Short-term (US$ billion) Others Change in reserves Oil price (Mexican mix) US economic growth Source: Ecanal © October 1990.

1990

1991

1992

1993

1994

3.0 24.0 29.0 4.0 5.0 1.5 2.0 3.0 3.0 0.5 2.0 18.0 1.4

3.0 24.0 19.0 3.5 7.4 1.5 3.0 4.0 3.5 0.5 1.1 26.0 0.0

4.0 19.0 15.0 4.0 9.0 2.5 2.5 4.0 3.5 0.5 0.0 26.0 0.7

4.5 13.0 8.0 3.0 8.0 2.5 3.5 3.5 3.0 1.0 2.0 26.0 3.0

6.0 8.0 8.0 4.0 9.0 2.5 2.5 3.5 3.0 0.5 0.5 26.0 3.5

The fact that inflation is so high and the government is reluctant to increase interest rates—for fear of the effect on the budget and on expectations—thus makes it tempting to predict further reductions in the daily rate of peso depreciation against the US dollar, which, in the presence of a credible exchange-rate policy, would automatically ensure higher dollar returns on

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peso financial assets. Short-term capital inflows are therefore likely to be maintained. Our macroeconomic scenario of moderate growth in Table 9.3 will therefore necessitate relatively modest amounts of foreign direct investment, i.e., in the range of US$3–4 billion, which is probably realistic enough, given the growing scarcity of risk and financial capital in the world. The amounts of such inflows are indeed modest next to the claims, in part of the international press and in some Mexican circles, of much greater amounts of foreign direct investment. These would appear to be optimistic, for two reasons. One is the opening of Eastern Europe, in particular of Germany and the Soviet Union, combined with the United States’ continuing need to finance its current-account deficit. The second reason is that a rapid fall in inflation in Mexico is not to be expected and, therefore, foreign investors and Mexicans repatriating capital from abroad are expected to behave cautiously. Developments in Eastern Europe have an important implication for Mexico in connection with the capital inflows on which the Mexican government counts to cover the forecast current deficits. The implication is twofold. First, risk capital from Europe will be much harder to attract into Mexico as opportunities for investment are open in the East. While East European countries do not have the market systems nor all the institutions required for a large absorption of foreign capital, on the other hand they are physically closer than Mexico to the sources of West European capital and the cultural differences and working habits are less than those to be encountered in Mexico. Thus one effect of such developments is that direct foreign investment from European sources will be much more difficult than in the past. And the inflows in recent years are far from impressive: US$2 billion annually on average during 1985–90, of which we estimate that European capital represented US$400 million. Foreign direct investment only rose above US$3 billion in 1987, when Mexico allowed large debt-equity swaps representing substantial gains for the investors and de facto a subsidization of the initial cost of investing. The second implication is for the financial markets as European developments produce, amongst other effects, an increase in interest rates. Such an increase would force Mexico to raise domestic interest rates in order to maintain the attractiveness of peso financial assets. Dollar returns of peso assets today (at around 21 per cent annually), compared with US rates of about 7 per cent points to the high premium that is necessary to encourage capital inflows into Mexico. The increase in interest rates abroad thus raises: (1) the cost of Mexico’s interest on its foreign debt and (2) the level of domestic peso rates. With roughly a total foreign debt of US$100 billion (subtracting the 1989 reduction of principal agreed with commercial banks and adding the new debt for the collaterals of new ‘Brady’ bonds as well as new credit received in 1990), a 1 per cent increase in Libor interest rates costs Mexico US$1 billion which is over two-thirds of the savings in interest obtained from the lengthy renegotiation of its foreign debt in 1989. This effect would roughly offset the benefit from an increase of US$2 per barrel in the price of the oil exported by Mexico. The increase in the international cost of capital and in interest rates resulting from the European developments will therefore have unfavourable consequences for Mexico. Mexican total exports of goods and services of about US$40 billion are expected to grow by 15 per cent annually in the short term (i.e. US$6 billion), but each point increase in Libor rates will cancel 17 per cent of this growth. In addition, the current deficit, projected at US$5 to $8 billion over the next few years, could deteriorate with an increase in interest rates, while its financing with foreign direct investment would also be more difficult. MEXICO'S TRADE STRATEGY The opening of Eastern Europe to international trade and investment, and the drive for privatization of state enterprises, is therefore forcing Mexico to accelerate domestic economic reforms. The greater difficulty to attract capital into Mexico, either for the privatization of state entities or for fresh investment projects, is already perceived even if Mexico and Eastern Europe are not regarded as competitors for risk capital, since they belong to quite different regional markets. Thus one indirect consequence which East European developments have on Mexico is the greater awareness it has provoked of the need for the Mexican government to accelerate structural changes, deregulation and especially the refocusing of the Mexican regional interests. This has caused the Mexican government to bring forward its plans to sign a free trade agreement with the United States, and to reprivatize the Mexican commercial banks which had been nationalized in 1982. Moreover, as the informal consultations on the FTA have started, the Mexican government has now realized that eventually Mexico must be a member both of a North American free trade area and of a North American common market, including Canada and the United States. The eventual participation of other Latin American countries in a western hemisphere trade area is now regarded as a plausible project, even though its implementation is still considered to be remote. It is the FTA with the United States and eventually with Canada which may change the basic scenario outlined in Table 9.3, provoking much higher capital inflows than we are now ready to acknowledge as feasible. These inflows would result from a reallocation of resources taking place in North America, following the opening of trade and the elimination of barriers against foreign direct investment in Mexico. The amount of such inflows, although potentially considerable, will nevertheless be limited by the economic slowdown now being experienced in the United States and Canada, with its corresponding effects on business expectations in Mexico.

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Increased trade with the United States would lead eventually to increased foreign direct investment (FDI). Our scenario projects US$3–4 billion of FDI annually, which is considerably more than Mexico has had in recent years (US$2 billion annually as previously mentioned). These inflows have been largely accounted for by large North American, British and German multinationals, which in the 1980s wanted to gain positions in the automobile industry, chemicals, petrochemical and tourism. Japanese investors have stayed away, although some renewed interest is evident. Investment flows in the 1990s will be primarily in those industries regarded as beneficiaries of an FTA with the United States and Canada. Mining, chemicals, steel, glass, cement, automobiles, clothing and footwear are clear targets for FDI. Undoubtedly, these flows will be reflected in greater trade with the US and Canada, and Mexican repatriated capital will figure prominently in some of these industries. The future opening of Mexico’s financial sector, which seems inevitable at this stage, should further renew the interest of foreign investors. Mexico’s recovery is likely to be a modest one in the medium term, given the combined conditions of a limited infrastructure, worldwide capital scarcity and a US recession. It could, nevertheless, be a solid, steady recovery based on a sound macroeconomic policy and continued economic reform and will eventually make the Mexican market attractive for North American and European investors. Over the next few years, however, the pace of change in Eastern Europe will impose an important constraint on Mexico’s potential growth via its effect on the cost of capital. NOTE * Paper presented to the Joint Canada-Germany Symposium, Centre for International Studies, University of Toronto, 2–3 November 1990.

Part III Central issues

10 Prospects for the Uruguay Round Frank D.Weiss* Johns Hopkins University, Bologna

INTRODUCTION Will the Uruguay Round of multilateral trade negotiations (MTNs) be a success? Of course it will. This forecast of success taken by itself is completely uninteresting. For one thing, success may be interpreted to the public, or to oneself, as an agreement on some document. Since what is contained in a document may be positively harmful, this definition of success can hardly be accepted. For another thing, the forecast, if successful, could have been a one-off, lucky shot. The method of arriving at the forecast needs to be understandable and criticizable. In this chapter it will be argued that the Uruguay Round will be successful because: – many issues are to be settled in the Round; – the United States has gained credibility as a protectionist country; – overriding foreign-policy considerations entered the Round at a critical juncture. All of these factors contribute to potential success of the Round. In addition there are a number of more minor contributory factors which will be discussed below where appropriate. What is meant by success? Toward the end of the Tokyo Round negotiations the US was still pressing for movement toward agricultural trade liberalization. The desire for some kind of result was so strong that any kind of result proved acceptable (Winham 1986). This is obviously not what is meant by success. Indeed, one could go so far as to say that even if no written agreement is reached, the Uruguay Round will prove to be successful. This position would go too far in the other direction, making the prediction of success almost completely immune to empirical refutation. Success means that an agreement will be signed which will liberalize world trade further, and that such an agreement is not counteracted by other developments in countries’ international trade policy. COSTS AND BENEFITS OF AGENDA WIDENING The Uruguay Round is characterized by a far broader agenda than heretofore tackled in international trade negotiations. As this became clear early in the Round, dubious voices were heard about the difficulty of negotiating on such a long agenda. Negotiations were seen as becoming so tedious, that they would bog down, and that no agreement could be reached. There is certainly something to this point of view. The longer the agenda, the higher the negotiating costs, or the longer the negotiations take. But the cost side is only half the story; there are also benefits to agenda widening, and when the benefits relative to costs are high, one would expect a deal to be closed. To the benefit side: to the extent that each of two parties have differing intensities of preferences over issues, the benefits of making agreements increase, for each party may give in on those issues where its preferences are weak, and obtain concessions on those issues where its preferences are strong. Real-world governments will have differing intensities of preferences on their positions over various issues. This increases the opportunities to trade as the number of issues rises. Thus, the expected total benefits from coming to an agreement rises as the number of issues rises. Moreover, there are several reasons for believing that total benefits rise more than proportionately as the number of issues rises—at least at first. This seems to follow from progressive removal of restrictions on market trade in goods: if exchange were restricted to a subset of goods, the parties’ desired exchange quantities would be constrained by the requirement that not all goods are exchanged. As this constraint is relaxed, the gains from trade in the tradable subset of goods would appear to increase. Thus, a country would be the more willing to liberalize its protected sectors, the greater the degree of liberalization other countries offer the first country’s export sectors. Such could only occur if the country’s export sectors were on the agenda in the first place. As the constraints imposed on the agenda are relaxed, one would expect total benefits to increase further, but to a lesser degree than

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Figure 10.1 Benefits and costs of negotiations.

initially because the remaining constraints constrain less. If this is true, one could legitimately draw the standard figure for maximizing total costs and benefits due to adding issues to an agenda. Figure 10.1 includes both the cost and benefit considerations. As issues are added to the agenda, total benefits approach the free-trade level. Transactions costs prevent the system from moving to free trade. Innovations in reducing transactions cost would push the system to freer trade. The history of trade negotiations in the multilateral framework is full of such innovations. The most wellknown one is probably the tariff-cutting formula invented during the Tokyo Round. Other arguments drawing on the goods-market analogy of course apply to the total number of participants in negotiations. Increasing the number of participants increases the potential gains from trade, when preferences differ, but of course transactions costs rise throughout, too. (In Figure 10.1, the two curves would shift upward.) Here too, innovations to reduce transactions costs have been discovered. Perhaps the most well known in this case is the exclusively bilateral negotiations between main traders of each good discovered in the Kennedy Round. Probably as important as either of these two considerations is the interaction between issues and participants. If participants have different intensities of preferences over outcomes an increase in the length of the agenda may make it possible for some countries to participate at all in the trade negotiations: countries with only weak preferences on on-agenda items may have strong preferences on off-agenda items and vice versa. Thus, original participants may be able to make additional concessions on new issues, conferring great gains upon newcomers to the negotiations, who would in turn make concessions to the original participants, and so on. These two possibilities are the greater, the greater the number of issues. Thus, in Figure 10.1, the benefits curve moves upward and to the right when the number of participants increases. The transactions costs of course increase at least proportionately with the product of participants and issues. Successful negotiations are predicated, therefore, on innovations in reducing transactions costs. THE URUGUAY ROUND, AGENDA WIDENING AND INCREASE IN PARTICIPATION The major innovation of the Uruguay Round is, of course, agenda widening. Whereas previous MTN Rounds were devoted to tariffs, and the Tokyo Round also included subsidies, the present Round is devoted to (almost) everything. Indeed, as shall be seen, some things not on the agenda are on the agenda. The fifteen negotiating baskets are (The Economist 21 April 1990): 1 Tariffs. An overall cut of one-third is envisaged.

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2 Non-tariff measures. Their reduction and elimination is sought. 3 Natural resource products. This is just a hard-core protection sector. Some liberalization is sought. 4 Textiles and clothing. These sectors were legally taken out of GATT and are to be brought back under normal rules. At present, countries may act unilaterally against imports by right. 5 Agriculture. Like textiles and clothing, these have been taken out of GATT rules by the (in)famous waiver of 1955 (Winham 1986), and are to be brought back in. 6 Tropical products. Another hard-core protection sector, where liberalization efforts are to be made. 7 GATT articles. Exceptions to normal GATT rules, primarily article 19, balance-of-payments reasons for non-tariff barriers, to be scaled down. Graduation. 8 GATT codes—Anti-dumping, inter alia, to be more strict. 9 Safeguards—Reigning-in emergency protection. 10 Subsidies and countervailing duties—like 8. 11 Intellectual property—better definition and enforcement of property rights. 12 Trade-related investment measures (TRIMs)—liberalize foreign direct investment. 13 Dispute settlement. To increase speed. 14 GATT system. Forming a better institution, e.g. through trade policy review mechanism. 15 Trade in services. Define fair-trade rules for services. Liberalize trade in services. At first sight, this looks like a motley assortment of issues. The choice of issues is not at all haphazard, however. Of course, the perennial tariff-cutting process is included on the list. But by common agreement, this is not where significant gains lie. Indeed, tariffs in industrial countries have come down markedly since the Second World War. Other issues, like tropical products and subsidies, have always been discussed somehow. Further issues, like GATT articles, anti-dumping and safeguards have been problem areas in that protective devices, legal or semi-legal under GATT have burgeoned since the Tokyo Round. It is obvious that they should be talked about, but it is not obvious that a substantively liberalizing agreement could be reached on any one of them taken by itself. The truly new issues are agriculture, textiles and clothing, intellectual property, trade-related investment measures (TRIMs) and trade in services. It is inclusion of some of these issues on the agenda that makes active participation by new groups at all thinkable. Specific inclusion of textiles and clothing makes it lucrative for the developing countries to actively participate for their potential gains from liberalization are great. The inclusion of agriculture and minerals trade makes participation to another group of countries attractive—Argentina, Australia and other members of the Cairns group. Almost all the new countries are in some ways highly protectionist, so that they would have much to offer others. And that is the key to the inclusion of some of the new issues. Previously non-participating countries have strong preferences on these issues and weaker preferences on other issues. The successful inclusion of more countries through the inclusion of more issues certainly raises the potential benefits from closing a deal. As it turns out, the cost of finding a deal has probably not risen too dramatically, for groups of countries have similar enough preferences so that they may negotiate together. In the Uruguay Round, the institutional innovation consists of the forming of two coalitions of countries to reduce transactions costs—namely the Cairns group and the developing countries. (The developing countries are resistors on some of the new issues, i.e. have a preference for no liberalization.) There are probably effectively only five participants (the United States, the EC, Japan and the two already mentioned) when it comes to calculating costs, but of course many more when it comes to calculating benefits. The diversity of preferences across these five effective participants can be illustrated in Table 10.1. Participants are categorized as demanders or resistors, resistors have a negative preference for liberalization in each area. Table 10.1 shows that preferences across issues vary from country to country, though it does not show the strength of those preferences. Agenda widening has had the effect of increasing the benefits of trade negotiations and of increasing the number of participants who can benefit. The realization that they would occur may or may not have been a contributory cause for the agenda widening in the first place. What certainly did contribute to agenda widening was that the innovator—the US administration—needed to forge a new free-trade coalition at home, as the old one, which consisted mostly of export-oriented manufacturing industries had been decimated by internal economic structural change. The new free-trade coalition could not simply consist of additional industries, because the rapidly expanding industries, like fast food and other retailing, hardly trade internationally. Issues had to be found which cut across industries. Intellectual property, trade in services, and TRIMs are the cases in point. All three also capture the interest of multinational corporations, who are important traders. So basically, the same considerations which led to agenda widening domestically contribute to increased expected benefits internationally.

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Table 10.1 Uruguay Round issues and participants Issues

US

EC

Japan

Developing countries

Cairns group

Agricultural liberalization Textile liberalization Intellectual property (TRIPS) Investment measures (TRIMS) Service rules and liberalization Non-tariff measures (NTBs) liberalization Tariff liberalization Subsidies/anti-dumping/countervailing rules Tropical products liberalization Natural resources liberalization Safeguards disciplines ‘Graduation and differentiation’ Functioning of GATT systems (FOGS) Dispute settlement Key: D=demander; R=resistor.

D R D D D R

R R D D D R

R

D D R R R D

D

R R D

R R R R D

D R

D D

D

D

D R

D D D

D D D

D

D D

MORE INCENTIVES An important incentive to actually come to agreement emanates from the protectionist strand in US trade policy (see, for example, Siebert and Weiss 1990). There are other costs of not coming to an agreement than the size of expected net benefits as plotted in Figure 10.1. The most important of these is that the world trading system need not merely revert to the status quo ex-ante should no agreement be signed. Rather, trade wars might break out. The US has used its singularly bipolar trade policy-making process strategically in raising the perceived costs of failure. That the US administration, as the promoter of broad interests at home, and as the maker of overall foreign policy, has a stake in free trade is not in doubt. That the US Congress, as the proponent of sectional interests, would prefer restrictive outcomes in world trade is equally not in doubt. It is actually useful that two disparate institutions have a role to play in policy-making in the United States: it enhances the administration’s credibility in saying that coming to no agreement will be followed by a protectionist policy. The administration need not pursue an active protectionist policy—all it would have to do is to let the protectionist forces in Congress gain the upper hand. That is to say, the president need not make the—incredible threat of becoming protectionist. It would not be credible because he represents a large group, which is more free-trade-oriented than a small group. And Congress looks precommitted. The protectionist weapons Congress has endowed the president with, or even (more or less) has ordered him to use—notably section 301 of the Trade Act—are already law. A DIFFICULT ISSUE ON THE AGENDAÐAGRICULTURE; AND AN ISSUE OFF THE AGENDA ÐFOREIGN POLICY While all this may sound very nice, it is possible that there is one issue so contentious, namely agriculture, where the gulf is so wide between key players that no amount of trading on other issues can bring agreement on agriculture itself. It must be recalled that once upon a time agriculture practically was the EC. And it is difficult to negotiate about one issue alone, if that one issue constitutes the body participating in the negotiations. Thus, the EC successfully kept agriculture off the agenda during the Kennedy Round, and successfully got agriculture treated as a separate issue during the Tokyo Round. In other words, no policy trades between agriculture and trade in industrial goods were to be allowed. In the more recent past, the agenda to which the European Community addresses itself has been substantively lengthened, mostly in terms defined by the 1992 programme. This gives economic sectors other than agriculture a much larger stake in the EC than before, and concomitantly gives the EC a larger stake in the economic well-being of other sectors. All this taken together has certainly weakened the position of agriculture. Recently, there has been much confusion in negotiating on agriculture within the European Community. The 30 per cent reduction in subsidies, which was suggested without the initial approval of member countries’ ministers of agriculture, unsurprisingly found no consensus. At the same time, leaders of other broad-based interest groups articulate in public that the Uruguay Round must not fail for the sake of agriculture. It is the first time one has seen such anti-lobby lobbying on a wide scale. The mechanism which has appeased agricultural interest groups in Germany is the promise of income transfers instead

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of price supports. The French support this proposal. A coalition between France and Germany on this issue will be hard to beat, so that an EC proposal will surely be tabled. In technical economic terms, this is a fairly sensible proposal which has been understood for years, but had little chance of being implemented politically. What caused the turnaround in policy? Certainly not insight into the social costs of agricultural protection. The key to the impasse on agriculture is the strength of preferences on the agricultural issue in the EC. At the centre, the EC once was agriculture, as has been mentioned above. In the member countries, farmers’ votes are often crucial elements in a minimum winning coalition ruling the country. If no other issues harbour such strong preferences, no deal will be found. But there is one issue that is likely to be even more important than agriculture. It is never explicitly on any agenda, but is always implicitly on the agenda wherever trade negotiations take place, and that is foreign policy. And so it was for agriculture and the Uruguay Round. The prime mover appears to have been Chancellor Kohl’s promise to President Bush at the Houston summit that Germany would not support any EC Commission proposal that was deemed too restrictive. This was part of the payoff to the United States for supporting German unification, and part of German foreign policy to keep the nuclear umbrella in place. The promise has so far been honoured in the reigning-in of the Minister of Agricultural Affairs by the Chancellor on the form of farm support which may be given. What the exact EC proposal in the Uruguay Round will be is not all that important, because what has been agreed upon is a mechanism acceptable to the United States (in principle) by which domestic farmers can be compensated to any extent required to reach agreement. There is little that can go wrong on the agricultural issue now because the mechanism could apply even if the EC does not get its way on ‘rebalancing’, i.e. on increasing protection for some agricultural products while reducing the average. TWO MORE SECTORS While the US has characterized agriculture as a ‘make or break’ issue, textiles and clothing and services are also issues crucial to the success of the Round. Perhaps somewhat surprisingly, there has not been so much public acrimony about these two issues, at least one of which is still sensitive in terms of employment in industrialized countries. In textiles and clothing only two minor points are at issue: the speed with which the sector is to be brought under GATT rules (Die Welt 15 October 1990), and the technical mechanism of quota allotment across importing countries and goods (The Economist 22 September 1990). Further goodwill toward developing countries was created by President Bush’s veto of restrictive US textile legislation. The success of textile protectionists had been due to their getting themselves off the agenda of international trade liberalization in the first place (Yoffie 1983); once back on the agenda, they had little chance. The US would like the help of the developing countries on agriculture. Therefore it makes sense to tie tropical products liberalization to an agricultural deal, putting further pressure on the EC, and in return, it is nice to the LDCs on textiles and clothing, nicer perhaps than the EC. The results of the services agreement look fairly clear. Essentially ‘national treatment’ will emerge as the consensus. The only open issues are precisely which sectors will fall under national treatment at which time. ‘National treatment’ is in a sense a meagre result. One cause of this meagreness is some late worry on the part of one or two interest groups within the United States (The Economist 22 September 1990). Services do not seem to be as important at the end of the Round as at the beginning. More substantive liberalization could perhaps have been achieved by a ‘code’ approach among, say, OECD countries. But it is not to be sneezed at. The minimal result of national treatment is more likely to bring in the LDCs and anyway it puts services de facto under GATT-like rules. Later they can be liberalized through further negotiations like any other sector. Out of the original fifteen issues only three or four are still open in any sense. These will have to be handled at the highest political levels for deals to be made. But the agenda at the highest level will be short enough, so that the decision-making process does not get swamped. RESULTS? Substantive and enduring results to be expected from the Uruguay Round are the re-integration of agriculture and textiles and clothing, the last two bulwarks of quantitatively high, temporally durable and geographically widespread protection back under the rules which apply to all other traded goods, and at the same time they will be liberalized. While the liberalization is welcome and good, the thrust of this chapter has been to argue that the fact that they are on the agenda at all is perhaps far more important. To the extent that this is true, the inclusion of services indicates that substantive progress can be made in the future, if not now. What looks seriously open is the national prerogatives by which countries selectively and semi-legally discriminate against imports of goods produced by individual firms. This has been the thrust of ‘the new protectionism’ since the first oil crisis in 1973. No doubt the rules will be tightened, but it remains to be seen if an agreement can effectively reignin such behaviour. But if it is true that such protection has low costs because it is cheap to get around, this apparent lack of a substantive result is more than made good by progress in agriculture and textiles.

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BEYOND THE URUGUAY ROUND Problems or issues that remain for the world trading system are probably not too serious. One development that has been severely misunderstood is the sometimes apparent tendency for the multilateral trading system to disintegrate into trading blocs. This could in fact lead to serious welfare losses if GATT did not exist. Trading blocs more likely constitute an unequivocal move to more efficient trade when the starting point of the bloc-building is from low trade barriers in the first place. But this has not been the case—e.g. Spain and Portugal joining the EC, precisely in high protection sectors, particularly agriculture, which the Round is addressing. Thus the formation of trading blocs can be faced with great equanimity on this score. The one new region which over the short or the long haul will join the world trading system is central and Eastern Europe. Were it not for the magnetic attraction of the EC, one could legitimately fear that the small central European countries could turn protectionist. Now, these are small countries, so that if they did, they would harm themselves rather than harm the world trading system. More pressing would appear the problem of integrating the Soviet Union or its republics into the world trading system, not so much because they could hurt the world trading order, but because they would contribute to overall world stability. Surely this problem will be tackled after the Round ends. Here, too, optimism is in order, because the inward lookingness of the small central European economies and the Soviet Union in the inter-war years was certainly a result of macroeconomic and international political conditions, conditions which are radically different today. ADDENDUM (JANUARY 1992) The course of the Uruguay Round negotiations by and large bear out the correctness of the above analysis. Yes, negotiating costs are high—the round has had to be extended. But the perceived benefits are also obviously high—the Round was not broken off. The only remaining negotiating issue is in agriculture—the speed and extent of liberalization. But that agriculture is to be liberalized is not at issue.’ NOTE * The author is grateful to Gernot Klepper for helpful discussions and to Vincent Cable for the table.

REFERENCES Die Welt (15 October 1990) ‘GATT—Gewaltige Hérden auf der Zielger-aden’. Economist, The (21 April 1990). — (22 September 1990) ‘A survey of world trade’. FAZ (Frankfurter Allgemeine Zeitung) (23 October 1990) ‘Die Verhand-lungspunkte der Uruguay-Runde’. Financial Times (21 April 1990) GATT brief—The American connection’. (28 April 1990) GATT brief—‘A better deal for poor countries’. — (5 May 1990) GATT brief—‘Centre stage for services?’. — (13/14 October 1990) ‘Hills warns of trade wars if Uruguay Round not completed’. Siebert, H. and Weiss, F.D. (1990) ‘US trade policy and the global trading system: a view from Europe’, Kiel Working Paper No. 422, May. Winham, G.R. (1986) International Trade and the Tokyo Round Negotiation, Princeton: Princeton University Press. Yoffie, D.B. (1983) Power and Protectionism, New York, Columbia University Press.

11 The nationstateÐmuch ado about (almost) nothing? Guy Kirsch University of Freiburg, Switzerland

INTRODUCTION For two centuries the nationstate has been a most important phenomenon in European history: many a chapter of this history deals with the making of the different nationstates, deals with their confrontations and with their coalitions. Quite recently the social tensions and the political disturbances resulting from the collapse of communist power in middle and Eastern Europe, and the unification of Germany. seem to have enhanced the importance of the nationstate as a form of political organization and as a concept of political analysis. There can be no doubt that the nationstate is still with us; but it is not self-evident that the nationstate, as we have come to know it in the past, has still today and will have tomorrow the importance it used to have in the past. Other forms of political organization seem to be emerging; it is important not to miss what is coming into existence under our very eyes. Overlooking the undeniable fact that the nationstate is a relatively recent innovation, we have been induced to consider the nationstate not as a possibly transitory artifact, but as an enduring natural datum. In this we are definitely wrong. For millenniums mankind has lived and prospered without any nationstate; and, even in the present, the nationstate is the political organization mainly of the industrialized countries of the West; it would be grossly misleading to characterize most African and Asian countries as nationstates. So, the nationstate is a young and a relatively rare phenomenon; it is far from absolutely certain that it will be a long-lived and a general one. On the contrary: the premonitory symptoms of a possible, even of a probable withering away of the nationstate can be made out already in the present, supranationality being the most obvious, though not the only one. Now, it is to be acknowledged that most of us are more or less consciously aware of these developments. But though we feel that there are some changes taking place, we still stick to the idea that the nationstate was, that the nationstate is, and that the nationstate will be the optimal, if not the only form of political organization. The lack of logic seems to be an ever-present symptom of any age of transition. The political rhetoric reflects this ambivalence and these contradictions: Margaret Thatcher’s eager combat with and against the supranational institutions in Brussels and her fight for London’s sovereignty stand in sharp contrast with Helmut Kohl’s prudent talking about how the German ‘Vaterland’—which is not quite the same thing as the German ‘Nationalstaat’— will be European, so as to save Europe the danger of going German. The difference, at least as far as the rhetoric is concerned, could not be greater: Thatcher defends her nationstate against the risks and dangers of a supranational integration: Kohl invokes the European integration as a bulwark against the risks and dangers of a German ‘Vaterland’. It does not come as a surprise that very often the changes which the nationstate has undergone in the recent decades pass unnoticed: those who are directly affected by large-scale developments quite often are least able to witness these very developments, all the more so if these developments are in their beginnings. Stepping back, i.e. creating an analytical distance, is the best way to bring into focus large-scale changes. That is what this chapter is all about; which means that a certain degree of theoretical abstraction is unavoidable. THE NATIONSTATE: A STATE AND A NATION As everybody knows, it takes two to tango. Everybody should know that it takes two to make a nationstate: a nation and a state. Furthermore, everybody knows that you do not tango unless you cling to your partner closely; everybody should know that in order to have a nationstate it is essential to bring the state and the nation into very close contact. This seems to be obvious; it is not. It seems to be no problem; it is. Neither the existence of the nation, nor the existence of the state can be taken for granted. And even if they do exist simul taneously in a given country, their mutual relation may be such as to prevent the creation of what we call a nationstate. Some examples may illustrate this point: when Louis XIV claimed that he was the state—‘l’ta t c’est moi’—he did not identify himself with the nation and he did not consider the state and the nation as identical. He could not, because the ‘nation

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franaise’ did not exist; all there was, was the ‘l’tat’. Only one hundred years later did the Revolution and Napoleon weld the Bretons, the Vendens, the Alsat ians, the Auvergnats, etc. into the ‘nation franaise’ to go al ong with ‘l’tat Fran ais’. Vice versa they say that the Palestinians form a nation, Arafat being one of their leaders; it is evident that for years his efforts have tended to create a state for his nation. Napoleon had at hand a state, and lacked a nation; Arafat claims to have a nation, and is in search of a state. Napoleon’s achievement and Arafat’s dream are identical: the creation of a nationstate. It is obviously a truism to say that in order to have a nationstate you need a nation and a state. If we are to go beyond this truism, it is necessary to clarify the concepts. Let me begin with the concept of the nation. Quite a great number of sophisticated definitions have been brought forward; a very simple one should do for our analysis: a nation consists of any group of people who share the feeling that they belong together, without knowing, without even asking, why. In that a nation is different from a family, a religious denomination, a political party, a labour union. Whereas the members of a nation do not even want to know what is their common denominator, the others know that their relationship is based on a common ancestor, a common belief, a common ideology, common professional interests, etc. This does not mean that in a nation a common ancestry, a common creed, a common history, etc. may not exist. On the contrary, these may have been causal in the genesis of the feeling of togetherness; what is essential is that the individual members of the nation are neither willing nor able to ask whether they belong together. Accordingly, in a nation the feeling of belonging together will not inevitably die, if that cause—a common ideology, a common creed, common interests, etc.— disappears. One may be quite certain that, once you begin to ask explicitly why you belong together in a nation, the nation as a nation is threatened; once you begin to look for the reasons justifying your national feelings, the national cohesion is in danger. When Michel de Montaigne was asked why he and La Botie were friends, he answered: because I am me, and because he is him. Likewise the members of a nation feel united because they are them. This does not necessarily imply hostile feelings towards nonmembers. However, it implies that all non-members are seen as being different. Here again it is essential that the question why they are different is not even asked: if you do not share a common feeling of togetherness with non-members of your nation, it is not because they are catholics or blacks or capitalists, but because they are—well—just what and who they are: them. So, in this definition the concept of the nation is based on an inarticulate, visceral feeling. Which comes to say that it is a nondimensional feeling. Being non-dimensional, this feeling transcends any cleavage that may cut through the group, it tides over any opposition that may divide its members, over any difference in ideology, creed, belief, interest, status, that may exist in the nation. ‘You pray to God, I am an atheist; you are a right-wing conservative, I am a liberal, your ancestry is noble, mine is common—it doesn’t matter; we belong together.’ A nation is based on a sense of mutual loyalty that transcends differences of interests, of opinions, of ideologies, etc. A nation is a group of individuals who do not even ask why they belong together, though they know, even without asking, what may match them against one another. This is an aspect to be remembered; it will be important for our further argument. This feeling may be very strong, it may be rather weak; it may unite a large number or a small number of individuals; it may grow and it may decrease; and: a group may have been held together by identifiable causes, these causes may lose their importance in the opinion of the members, in which case a non-nation group changes into a nation. On the other hand, you may have a situation in which a group of individuals who stood together without asking why, begin to look for reasons why they should belong together and without which they should separate; this is a situation in which a group begins to lose its character as a nation and to change into something different. The nation is fundamentally a dynamic process, it is not a static affair. As will be seen below, this aspect too is of the utmost importance for the understanding of this study’s problem. As to the concept of the state we may limit ourselves to saying: a state is an organizational device for making collective decisions, these decisions being legitimately binding and compulsory for all the members of that organization, and the organization being legitimated and able to enforce these decisions. At least in a liberal-individualistic perspective the ultimate objective and the only justification of the state and of the compulsory power that goes with it resides in its ability to further its citizens’ interests. Which means that, contrary to the concept of the nation, the concept of the state centres not on a nonarticulate, i.e. non-dimensional emotion, but on an articulate, more or less multidimensional calculus: whereas in a nation the members stick by one another without even wanting to know why, the citizens of a state cooperate and submit to the collective decisions because they know why. The foundation of the state is reason; emotion is at the basis of the nation. A further difference between the nation and the state should be mentioned: the size and the structure of a nation depend on the ability and on the willingness of its members to share a feeling of togetherness with a more or less large number of individuals, who may be more or less different from themselves. The size and the structure of a nation depend mainly on psychic factors. The optimal size of a state depends on the social and spatial distribution of the positive and the negative effects entailed by the collective decision-making; which means that a state can be sub- or supra-optimal for economic and technical reasons.

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Summing up: the concept of the nation centres on emotion and empathy; the concept of the state centres on calculus and self-interest; the nation centres on harmony, the state on conflictual cooperation; the members of a nation interact because they also take an interest in one another; the citizens interact because they pursue their own individual interests. IT TAKES TWO TO TANGO These conceptual differences are important; however they should not veil the fact, that in real life the state and the nation may interact, and—if a nationstate is to exist—have to interact. So, the more or less long experience of a fruitful conflictual cooperation in a state may create among its members a sense of belonging together: the state gives birth to a nation; as both—the state and the newborn nation coexist—a nationstate is born. This seems to have happened with the Grand Duchy of Luxemburg, which was created as an independent state, in opposition to what the inhabitants wanted, at the 1839 London Conference by the great European powers; one and a half centuries later the state of Luxemburg has generated a Luxemburg nation, a group of people with a strong feeling of belonging together. On the other hand it is possible—the European history of the nineteenth century gives many examples—that a certain national feeling is pre-existent, and that on the basis of the common feeling of belonging together a state is erected: the nation gives birth to a state. However, too simplistic a view is to be avoided. It is a plausible hypothesis that in most cases the relation between the state and the nation is reciprocal: an increase in the national feeling creates opportunities for a successful state policy; the beneficial results of this policy strengthen the emotional cohesion among the citizens of the state, which in turn…, etc. This seems to have been the experience of most European nationstates up to the Great Depression and the Second World War. On the other hand you may imagine—the European history of the recent past gives examples—that the limited and, at times, dubious success of the old nationstates weakens the national feeling, thus putting in motion a downward circle: the failures of the state weaken the national feeling, which in turn limits the possibilities and the chances of success of state policy, etc. So, a closer analysis of Italy for example would show that the failures of the state involve a perturbation of the national feeling and that the ‘malgoverno’ of the state is at least partly caused by the deficiencies of the national feeling. (There most probably is some kernel of truth in the exaggeration: Italy is a state without a nation and a nation without a state. This may at least partly explain the importance of organizations such as the Mafia, which, being infranational and extrastate organizations, stand in sharp contrast both to the deficient state and to the incoherent nation.) This process seems to be rather probable if the failures of the state do not consist in single dramatic incidents, but if they add up to a long line of trivial shortcomings: a lost war, a foreign invasion may kindle the national sentiment; a failing water supply system most probably will not. If the individual frustrations are caused not by the intracollective decision-making, but by extracollective intervention or aggression, they may not affect the national feeling negatively, but positively. Which explains why many a group has survived as a strong nation as long as external factors prevented it from having its own state; whereas the national feeling may suffer considerably from the failures of an existing state. The Kurds are an example for a nation existing without a corresponding state. All this adds up to the hypothesis that a nation may give birth to a state, and that a state may give birth to a nation; the result of both processes will be the same: a nationstate. Furthermore, the hypothesis is plausible that an intensification (weakening) of the national feeling and an increase (decrease) in the possibilities of the state policy are mutually related: the strengthening and the weakening of a nationstate tend to be self-feeding processes; they tend to feed upon themselves up to that very point where external factors restrain and eventually stop the rise or decline of the nationstate. The hypothesis that a reinforcement of the national feeling strengthens the state and that a successful state policy intensifies the national feeling is plausible: indeed it is very difficult for individual members to remain loyal to a group, if their interests are continually thwarted by the collective decisions of that group; on the other hand—as Albert Hirschman has pointed out— collective decisionmaking cannot do without the loyalty of the group members. The citizens’ individual calculuses must be backed by the loyalty of the members of the nation; and: this loyalty to the nation must be reinforced by the results of the state policy. A state which cannot rely, up to a certain point, on the loyalty, on the national feeling of its members, can hardly survive the individual frustrations that are inevitably connected with collective decision-making; and: if these individual frustrations, i.e. if the violations of individual interests go beyond a certain limit, the loyalty, the national feeling will suffer and, eventually, disappear. The emotional ties in a nation are necessary if the tensions in a state are to be mastered; the tensions in a state must be mastered if the emotional ties in the nation are to survive. All this does not come as a surprise to those who remember that man is moved both by calculus and by sentiment, by reason and by emotion, by self-interest and by moral sentiments. When we are right in saying that the nation stands for the emotional element and the state for the rational factor, when we are also right in stating that the nationals’ emotions and the citizens’ interests are not independent, but mutually interdependent, then we are also right in saying: the nationstate, as it has developed in the nineteenth century, is the result of circumstances allowing groups of people, who felt that they belonged together, to make collective decisions without overly

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frustrating individual interests, and allowing groups of people to make collective decisions without straining the citizens’ loyalty to the nation. In other words: in the nineteenth century, Europe’s situation was characterized by circumstances that allowed national groups to form successful states, and/or that allowed states to weld their populations into nations: the rise of the nationstates. The fact that neither the concept of the nationstate nor the nationstate itself existed before that period suggests that the circumstances making possible the creation of nationstates did not exist before; which gives a certain plausibility to the hypothesis that they will not necessarily exist in the future. History tells us that even in the nineteenth and twentieth centuries the making of the nationstates was, depending on the circumstances prevailing in the various countries, more or less easy and the existence of the nationstates more or less perfect. Some examples may illustrate this point: France and Great Britain have obviously been very successful in combining the nations and the states into nationstates. In both countries the ‘raison d'tat’ and the national feeling often engage in a liaison that is hardly to be understood by foreigners. The history and the geography of both countries may explain France’s and Great Britain’s success in creating nationstates. But though these explanatory elements are numerous and strong, even in these countries the birth of the nationstate was characterized by bloody difficulties; still today Corsica, Alsace, Bretagne, PaysBasque are at least latently unquiet regions in the French republic; Wales and Scotland have never been and are not today easy-going parts of the United Kingdom. The unification and the unity of Germany, the reunification of which recently was on the agenda, have not been so simple and so self-evident as right-wing historiography might like to suggest: Bismarck’s Reich was not the glorious combination of one allpervading national sentiment and a successful state; it was—at least —partly the result of Bismarck’s bribery and brutality, of Prussia’s arrogance violating quite a number of subnational sentiments. However, there is no denying the fact that in the German Reich from 1871 to 1914 the feeling of belonging together increased. But then this development had been greatly promoted by the glittering symptoms of a successful state policy (economic growth, naval policy, colonial expeditions), had been greatly inflamed by the blatant triumphalism of the ‘Kaiser’. The case of Italy has already been mentioned; there can be no doubt that Garibaldi’s and Cavour’s creating the Italian nationstate in the nineteenth century did not only rely on the national sentiment against regional potentates and pontiffs, holders of state sovereignty; it also relied on the growing nationstate’s power against regional sentiments. To this very present the political situation in Italy, the dynamics of its socio-political process, are not to be understood without remembering the specific characteristics of the making of the Italian nationstate. As to Middle and Eastern Europe, the creation of prosperous, even operational nationstates has been less than a success. These states either did not succeed in devising and in implementing the constitutional arrangements that would have permitted two or more nations to live in one state, or the members of many a nation were prevented from being the citizens of one and the same state. The frustrations that are inevitably connected with the political collective decision-making were dramatically enhanced by the heterogeneity of the loyalties to different nations cohabiting in one state, and/or the citizens living in one state were prevented from enduring the frustrations of political decision-making by the fact that they were members of a nation scattered over many states. It does not come as a surprise that the First and Second World Wars originated in ‘Nationalitàtenfragen’, in the deficient adjustment of national sentiments and state jurisdictions. Though the causes of these wars may lie deeper, it is symptomatic that they were triggered off by the imperfections of the different nationstates. One might have got the impression from the lucky years of the Austro-Hungarian Empire that this kind of problem had been solved for good; this impression was wrong: as soon as the loyalty to the Kaiser lost its impact, as soon as the inhabitants of the Austro-Hungarian Empire were no longer united by the sentiment that they belonged to the emperor, the loyalty to the different nations surfaced, the inhabitants of different groups discovered anew that they belonged together without even asking why, particularly without accepting the shared allegiance to a monarch as an answer to this question. It is interesting and alarming to watch in the present how, after the collapse of an authoritarian ideology and of a totalitarian regime, the ‘Nationalitàtenfrage’ reappears in these countries: the Czech and the Slovak begin to wonder why they should belong together, whereas even without asking, these very Czechs know why the Czechs belong together, and these very Slovaks know why the Slovaks belong together. The parallelism is striking: the weakening of the imperial authority at the beginning of the century had in Middle and Eastern Europe the same effect as the dismantlement of the totalitarian regime has at the end of the century: being no longer willing or no longer forced to stick together in a certain mega- or macro-group for a determinate reason, people (re)discover that, they belong together in some other micro–or meso-group, without knowing why, i.e. for some indeterminate reason. Yugoslavia and the Soviet Union are examples illustrating the same phenomenon. Despite these reservations, for about two centuries the nationstates have been dominant collective actors; on the whole the process of nations giving birth to states, and of states giving birth to nations has been extremely successful. However, this is not to say that this success will last forever; it might just be that the factors undermining the foundations of the nationstates are already at work. In the following pages we shall try to analyse some of these factors. They do not all have the same

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importance and the same visibility; some are easily seen, others being, as it were, in statu nascendi, are hardly identifiable; so a certain degree of speculation is not to be avoided. SUPRANATIONALITY Let me begin by the transfer of decision-making competences from the nationstates to the supranational collectivity of the European Community. The phenomenon is so well known, so manifest, its dynamics have accelerated to such dramatic a degree, that no further evidence is needed to prove its existence. However, some of its consequences deserve some comments. First it is to be stressed that the transfer of national competences to the supranational level inevitably entails an increase in the decision-making costs and in the expected external costs as registered by the citizens: the greater the number of participants in a decision-making process and the greater the heterogeneity of their interests, preferences, points of views and analytical and procedural ways, the more difficult it becomes for individuals to win respect for their own views, to assert their own preferences in the collective decision-making process. And: with an increasing number of the participants and with increasing differences among their interests and preferences, the risk of decisions that are opposed to an individual’s interests and preferences increases for the individual member of the collectivity. Which means that for the individual citizen the transfer of political competences to the supranational collectivity reduces the chances to decide on a policy a person likes and it increases the risks of policy decisions a person dislikes. Buchanan and Tullock would say that the level of the interdependence costs has shifted upwards; i.e. it is more expensive and risky to decide on the production of collective goods in a large supranational collectivity than in smaller national collectivities. It may be rational—and in the case of the European integration it is—to accept these costs and these risks of collective decision-making: on the lower level of the nationstate the production of these collective goods would have been more expensive, perhaps prohibitively so. But even if the transfer of competences from the nationstates to the European Community is rational under allocational aspects, this transfer inevitably causes a certain amount of frustration among the citizens as far as decision-making is concerned. Now, one might expect that every citizen will compare the allocational advantages that person owes to the European integration with the disadvantages caused by the transfer of collective decisionmaking from the national to the supranational level, and find out that, when all is said and done, that person is better off for being (also) a member of a supranational collectivity. One might expect that the frustration caused by the decision-making process would be overcompensated by the allocational result. Unfortunately reality does not always live up to this expectation: the beneficial results and the welfare increases due to the European integration are quite generally taken for granted to such an extent that they are seldom connected to the European integration; on the contrary, the frustrating experience of having one’s preferences at least partly neglected in the supranational decisions is often felt quite vividly. The rhetoric in favour of the European integration in general should not conceal the hostility in particular to that very integration. Above we have pointed out that the collective decision-making process, that any collective decision-making process, is frustrating and risky for its participants. One might deduce from this that there is nothing specific in the supranational collectivity of the European Community causing a sentiment of frustration among its members. Though the omnipresence of frustration in any collectivity is a fact, there is something specific in the supranational collectivity: first, the frustration tends to be higher than in the nationstate; second, up to this day there exists among the ‘Europeans’ hardly, if ever, the feeling of belonging together. Which comes to say that up to this day, the supranational collectivity of the European Community is mainly what the state is on the national level: an organizational device for making collective decisions, but that it lacks what, on the national level, has been called a national identity. Though it may be somewhat misleading, one is tempted to say: the European Community is about to become a suprastate without evolving into a supranation. At the same time the nationstates are more and more drained of their competences, the national feeling remaining, at least in the beginning, unimpaired; the consequence: the nation and the state no longer perfectly combine into a nationstate; the gap is widening between the feeling to belong together and the possibility to decide one’s own business among nationals. Whereas the nineteenth- and part of the twentieth-century history in Europe has been characterized by a more or less tight correspondence between the nations and the states, the end of our century is characterized, on the supranational level, by the construction of a monumental state structure without the development of a corresponding emotional counterpart, and, on the national level, by the dismantlement of existing state structures without—at first— the national sentiments diminishing correspondingly: an adolescent suprastate, and an embryonic supranation; declining states, and nations still going strong. This development is dangerous. If the thesis we have put forward above, namely that a state without a nation and a nation without a state are inherently unstable situations, is right, then this evolution certainly is dangerous: if on the supranational level the frustrations linked to the political process grow and if, at the same time, the feelings of loyalty necessary to cope with these frustrations are wanting, then one need not be a pessimist to expect decision-making processes and the institutions

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of the supranational collectivities to be overburdened. And, if on the national level the sense of a national identity is stronger than the political possibilities of the state, then, again, you need be no pessimist to foresee some trouble. These dangers have not gone unnoticed; the Europeans have tried to meet them. Indeed, for years efforts have been made to develop a supranational European identity and—at times—to slow down the development of the suprastate structure, so as to avoid too large a gap between the frustrations caused by ‘Brussels’ and the loyalty to ‘Europe’, so as to avoid also too large a gap between the intensity of the national feelings and the shrinking possibilities of the nationstates. At times, one could have the impression that the efforts to develop a supranational European feeling prevailed over the efforts to slow down the European integration process; at times, the opposite impression dominated. Up to now these efforts have been successful in avoiding a dramatic overburdening of the supranational institutions and decision-making processes, though on some occasions the blocking-up has hardly been avoided. Up to now these efforts have also succeeded in avoiding a dramatic overshooting of the various national sentiments into harmful nationalisms. One may hope that in the future it will be possible to maintain an equilibrium between the development of the supranational integration and the corresponding shift of the individual loyalties from the nations to ‘Europe’. Unfortunately this hope may be disappointed. If it is, then we shall witness supranational institutions oscillating between being more or less blocked up, and functioning more or less aloof from the people, their interests, their views, their needs, their opinions. Pompous and, at times, perfectly fruitless sessions of the European Council and the self-centred autocracy of the European bureaucracy are symptoms that both possibilities are much more than mere speculations. Then we shall also witness nationstates oscillating between a flamboyant European rhetoric and a stubborn national egoism. These dangers are real ones: the intracollective conflicts in the European Community have increased, the decision-making process is ever more complicated and its results are ever more subtle and detailed. This is not to say that substantial decisions are no longer made, but that it is ever harder to agree on these decisions. This intensification of the intracollective conflicts in the European Community would be less of a problem, were it not for the ‘Europeans’ ‘deficient loyalty. It is highly symptomatic that at the moment the transfer of political competences from the nationstates to the European Community has led to a corresponding transfer of lobbying activities from the national capitals to Brussels: it would be rather difficult to diagnose a corresponding transfer of the citizens’ loyalty from the nations to ‘Europe’. INFRANATIONALITY There is a rather surprising side effect to this evolution: as the frustrated citizens realize that the nationstates are less and less able to defend their interests in ‘Brussels’, it becomes more and more difficult for these groups to remain loyal to the nationstates. Why and how should those farmers whose interests can no longer be defended effectively in ‘Brussels’ by ‘Bonn’ or ‘Paris’, be loyal to Germany and France? Why and how should farmers who feel that they are no longer defended by their state, abide to the laws of that state; why should they accept the political decisions, if and when loyalty no longer asks them to do so. The loyalty which they refuse the nationstate changes quite often into an aggressiveness which they turn against the supranational collectivity of the EC. The number of extra-legal demonstrations, of manifest violations of national and supranational law, can be read as signals of an already deficient national sentiment and of a yet underdeveloped supranational sentiment; so can be the obvious reluctance, respectively the manifest impotence of the nationstates to take action against these breaches of the law. More often than not the European nationstates have been either unwilling or incapable of preventing the illegal blocking up of highways and bridges by demonstrating truck drivers and farmers. It is no exaggeration to say that, as a consequence of the integration, the European nationstates lose at least part of their political competences as states to the supranational collectivity of the European Community, and that they are also drained of at least part of their emotional cohesiveness as nations. Now it would be unrealistic to assume that people can live without wanting to belong together: loyalty is not only a prerequisite of social cohabitation, it is also a necessity of individual life. So, the question is what becomes of those loyalty sentiments, of those psychic energies that are withdrawn from the nationstates? A closer look at what has been happening in Europe during these last years indicates in what direction an answer to that question can be looked for: the revival of regionalism, the reactivation of time-honoured and long-forgotten linguistic, ethnic, cultural ties, the rediscovery of the common historical destiny of infrastate groups are but some of the symptoms for the individuals’ desperate and pathetic efforts to find a place where they may feel at home, comfortable, cosy and warm. These infrastate collectivities, as they have originated in Europe during the last years, share two interrelated characteristics: first, in general they lack a formal institutional framework; most of them consist in a set of perhaps lively, but very informal relations, and —second—most of them lack definite collective objectives and goals. Their ‘raison d’tre’ is limited to an exchange of emotional signals; there is hardly any collective decision-making going on, but there is a lot of folkloric ritual being enacted in these collectivities. This is the more so, as these regional collectivities very often tran scend the borders of the nationstates, thus forming transnational collectivities: ‘Saar-Lor-Lux’ (comprehending the Saar in Germany, the Lorraine in France and the Grand Duchy of Luxemburg) and the ‘Regio Basiliensis’ (comprehending parts of Baden-Wérttem-berg in

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Germany, parts of Alsace in France and the Canton of Basle in Switzerland) are examples simultaneously illustrating the intensity of sub–and transnational feelings and the difficulties in creating corresponding institutional frameworks. So, there is a double tendency for the nationstate to dissolve: it loses (part of) its political competences to a supranational collectivity, the European Community, and it loses (part of) its emotional cohesion to infranational, regional collectivities. So, the twin development of the supranational integration and of the infranational regionalization leads to a double leak: the nationstate’s competences evaporate upwards, the nationstate’s emotional cohesion is drained off. Consequently, the supranational collectivity is in need of an emotional coherence and the infranational collectivities are in quest of political goals and formal institutions. The members of the European Community should feel who they are, the members of the different regions should know what to do. In so far as the nationstates lose more or less of their political competences and more or less of their emotional appeal, the danger exists that a vacuum opens up in the sociopolitical order of the continent. The nationstates are less and less nations and less and less states and the European Community is too strong a suprastate organization and too weak a supranation. The different regions are too weak to be infrastates and as infranations they are overdeveloped. As we have already pointed out, efforts are made to give the European Community an emotional loyalty basis. Efforts are also made to define concrete and operational goals and to institutionalize formal mechanisms for the infranational collectivities. ‘L’Europe des regions’ is a catch-phrase for these efforts to combine the European integration with a revitalization of Europe’s cultural, linguistic, ethnic, etc., regions. It is a simple fact of logic that the political design of ‘l’Europe des regions’, as opposed to ‘l’Europe des nations’, entails, though without always saying so explicitly, the renouncement of the concept and the reality of the nationstate as an essential—as the essential—politico-institutional form of social cohabitation. However, the efforts tending to replace the nationstates by the creation of a both supranationally and infranationally organized Europe are neither always nor everywhere successful. We have already hinted at the rather limited development of a European loyalty: instead of feeling more ‘European’, many a German feels more Bavarian; instead of growing a loyalty to Europe, many a Frenchman rediscovers that he is a Breton; instead of extending his feelings to belong as far as Athens, many a citizen of the United Kingdom develops an ever-intenser feeling of being a Scot. So not only is the development of a supranational a European sentiment hardly in accordance with the construction of a suprastate edifice, but very often there is also a want of proportion between the flare-up of infranational, regional collective identities and the infranational collective decision-making mechanisms and institutions. Where this disproportion does not exist or is not so very important, the renaissance of infranational sentiments may lead at most to political frictions; in general it does not lead to extra-constitutional and extra-legal troubles. On the contrary, in those countries where strong regional sentiments meet with the absence or the deficiencies of infrastate institutions, unconstitutional, illegal, even downright criminal activities are to be feared; France, Spain, Turkey, Yugoslavia, Czechoslovakia, USSR, Great Britain should know what we are talking about. And even if the disproportion between the infranational sentiment and the infrastate institutions does not open on crime and terrorism, i.e. on sheer destructiveness, it may give rise to organizations which—like the ‘Lega Lombardia’ in Italy—oscillate between ridiculous exaggerations and dangerous simplifications, to groups which are either unwilling or incapable not to be obstructive. It is noteworthy that in general the disproportion between infranational sentiment and the infrastate structure is greatest in those countries, which, by history and tradition, are most centralized, whereas those countries which have a longer experience in decentralization and federalism are less prone to it. Consequently the danger of a strong infranational sentiment mutating into terrorist separatism and criminal activity is greater in countries with a time-honoured centralization than in those with a living practice of decentralization. So, for example there is no separatist movement in the Federal Republic of Germany: with the exception of the Third Reich, Germany has never been a centralized state. On the contrary, France, for all practical purposes, has been a centralized state for most of its history, ever since Saint Louis set up his court in Vincennes; hence it does not come as a surprise that the actual government is somewhat helpless facing, for example, the mounting regionalism and separatism in Corsica. The central government in Paris reacts in a remarkably and symptomatically helpless and contradictory way. On the one hand it tries to grant Corsica a degree of autonomy corresponding to the Corsican feeling of a distinct identity; on the other hand it makes appeals to French and republican feelings, it relies on police repression to crush the manifestations of infranational feelings, as befits the centralized regime of the French Republic ‘une et indivisible’. If ‘Paris’ grants Corsica a notable degree of autonomy, the central nationstate loses part of its competences, being consequently in fact less of a state. If, on the other hand, it does not succeed in rekindling national feelings and if it has to rely on force and repression to ensure the national cohesion and integrity, it is evident that its character as a nation is partly flawed. Either it is less of a state or it is less of a nation than the traditional concept of the nationstate might suggest. The French-Corsican example illustrates most clearly what happens at least latently in many a European country. Of course, not all political competences and not all emotions are withdrawn from the existing nationstates; though the nationstate as a state is challenged by the supranational integration, though as a nation it is challenged by the infranational revival, it is neither totally dismantled as a state, nor entirely dissolved as a nation.

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AND EXTRANATIONALITY However, there is another line of development that threatens the very existence of the nationstate: the rise of collective actors that have no or hardly any national feelings and which are not or only partly subjected to the laws of the nationstates. Up to this point our study has limited its scope to the existence of individual actors, individuals feeling at ease with other individuals in one nation, individuals participating with other individuals in the political decision-making process of the state. This is only one part of the story; the other part deals with collective actors, such as corporations, interest groups, unions, etc. The importance of these had been growing over the last decades and it is not possible to understand the problem of the nationstate without taking into consideration some of the differences separating collective from individual actors. Let me begin by asking a simple question: is it possible for corporate actors to be parts of a nation? The answer is: no. How could a collective actor develop a feeling of togetherness? Being unable to feel anything, a collective actor does not have any sentiments towards anybody. A corporation being essentially a-loyal, it can be neither loyal nor disloyal; being essentially unable to love or to hate, it has neither likes nor dislikes. Above we stated that a nation is constituted by a group of people who feel that they belong together without knowing, without even asking why; we also stated that the nation centres on a nondimensional, inarticulate emotion. Now, all these characteristics do not apply to interest groups, corporations, unions. Corporate actors, unlike individual actors, have mainly, if not exclusively, relations to other actors, that are based on one- or multi-dimensional calculuses; non-dimensional, non-articulate emotions play, if any, but a subordinate role. Even if one would argue that some decades ago, Krupp was a German firm, it would be definitely wrong to say that IBM had any national affiliation. Krupp was owned by the German citizen Alfred Krupp, whereas IBM is—nomen est omen—an international corporation specializing in business machines. This does not mean that the members of these corporate actors have no feelings; on the contrary, they may be tied together by strong emotions, by vivid sentiments of loyalty. But then, this again is a further element debilitating the national cohesion. In so far as IBM for example succeeds in creating a corporate identity, i.e. in giving its employees the feeling to belong together, to be IBM men, prior to being Americans, Canadians or Germans, the attachment to the different nations is weakened. The least one can say is that the attachment to the German, French, etc., nation is competed with by the obligations due to the corporate actor called IBM. Even if the corporate identities of the collective actors are not hostile to the national identities, even if the corporate cultures of corporations, unions, federations, associations are not in opposition to the national cultures—and they are not necessarily so—they are extraneous to them. In itself this would not be so very important, were it not for the fact that the role played by the collective actors in the social and political life of the different countries has notably increased over the last decades. It is the importance of this role which makes the a-sentimental character of the collective actors a point of weakness in the cohesion of the nation. Being apart from the emotional household of the nation, the corporate actors do not contribute to the national cohesion; and if ever the corporate culture and the corporate identity are at variance with the national culture and identity, it is not to be excluded that the former may prevail over the latter. Though this risk is probably greatest with corporate actors operating on an international scale, it is not necessarily nil with collective actors whose activities are limited by the borders of a nationstate. One might object that though collective actors are a-sentimental beings, their policy is decided on by individual actors who are able to feel emotions, to be loyal, to belong to, i.e. to be part of a nation. This is certainly true, but it is not up to being an argument against our thesis of the corporate actors threatening the national cohesion of the nationstate. Even if collective decisions are made by individuals, these individuals’ decisions are also influenced by the collectivity in and for which the decisions are made. One may doubt whether in the corporate actor IBM an individual actor will arrive—and stay at the top— if he feels and acts more like an American, a German, a Frenchman than like an IBM man. Either, when making decisions, he abides to the IBM culture even if it is hostile to some national culture, or he is loyal to his nation; in which case he most probably will lose his decision power and be replaced by a loyal IBM man. But collective actors not only threaten the nationstate by not participating in the emotional exchange of the nation; they also at times threaten the nationstate by arrogating to themselves part of the political competences of the state. Even if, as a matter of form, the corporate power is curbed by state laws, it can no longer be denied that very often these laws are influenced by the corporate power. To obey a law one has made it not equivalent to obeying a law somebody else has made; here lie all the differences between autonomy and heteronomy, between being governed by one’s own or by somebody else’s laws. As a matter of form, the nuclear industry may be subjected to the state decisions concerning the energy policy. However, one may wonder whether the state’s energy policy is not largely influenced by or even dependent on the policy options of the nuclear industry. Karl Marx was definitely wrong when he said that the state would be ever more an ‘Executive committee for the defence of capitalist privileges’; but then one would also be definitely wrong to say that the state has not at least partly been forced into the role of an ‘Executive committee for the defence of corporate actors’. At least part of the power of the state has been seized upon by extra-state collectivities, by collective actors. The extent to which this has happened may vary from country to country. But in so far as this transfer of power from the nationstate to corporate actors has taken place, the nationstate has lost part of its political substance.

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POMP AND CIRCUMSTANCE The declining importance of the nationstate has been partly concealed by the respect that is still reverently paid to its rites and symbols. It is perfectly possible that, despite the actually decreasing importance of the nationstate as a political factor, its pomp and circumstance may be seen for a long time to come. It cannot be excluded that the ceremonial, the ritual forms of the nationstate’s sovereignty will last for many years to come; but these rituals will no longer reflect the real importance of the nationstate; they will veil its absence. The pageant of the British monarchy does not reflect the power of the Queen; the Queen is part of the pageant. Her Royal Majesty is at the service of the pageant, and not vice versa. It is true: the laws have to be signed by the Queen if they are to be valid; but then the Queen must sign the laws if she is to stay. Analogically one may expect that in the future the nationstates will be at the service of the symbols of their sovereignty; the rituals will no longer symbolize the nationstates’ sovereignty. There will even be laws that have to be passed by nationstates if they are to be valid, but then the nationstates will be ever less able not to pass these laws. SUMMARY The nationstate is young and a relatively rare phenomenon; it is far from certain that it will be a long-lived and a general one. On the contrary: the premonitory symptoms of a possible, even a probable, withering away of the nationstate can be made out already in the present. In order to correctly interpret these symptoms it is essential to rely on operational definitions: a nation consists of any group of people who share the feeling that they belong together, without knowing, without even asking, why. A state is an organizational device for making collective decisions, these decisions being legitimately binding and compulsory for all the members of that organization, and the organization being legitimated and able to enforce these decisions. If a nationstate is to exist the prerequisites for the existence of the state and the prerequisites for the existence of the nation must be given: the nationstate, as it has developed in the nineteenth century, is the result of circumstances allowing groups of people, who felt that they belonged together, to make collective decisions without overly frustrating individual interests, and allowing groups of people to make collective decisions without straining the citizens’ loyalty to the nation. In other words: in the nineteenth century, Europe’s situation was characterized by circumstances that allowed national groups to form successful states, and/or that allowed states to weld their populations into nations: the rise of the nationstates. The hypothesis is plausible that, at least in Europe, the nation and the state are about to divorce: the European nationstates lose at least part of their political competences as states to the supranational collectivity of the European Community, and they lose at least part of their emotional cohesiveness as nations to the infrastate regions. The nationstates’ competences evaporate upwards, the nationstates’ emotional cohesion is drained off. Consequently, the supranational collectivity is in need of an emotional coherence and the infrastate collectivities are in quest of political goals and formal institutions. The nationstates are less and less nations and less and less states; the European Community is too strong a suprastate and too weak a supranation; the different regions are too weak to be infrastates, and as infranations they are overdeveloped. It is up to the extra-European countries, such as Canada, to learn their own lessons and to draw their own conclusions from the analysis presented in this chapter.

12 Beyond the Uruguay Round means beyond the border* Sylvia Ostry Centre for International Studies, University of Toronto

INTRODUCTION I shall start with a typical economist’s assumption: let’s assume the Uruguay Round is a great success. What would be an appropriate post-Uruguay international economic policy agenda? The title I have chosen—‘Beyond the Uruguay Round means beyond the border’—suggests that the new arena for international cooperation basically involves domestic policies. The reason for this shift lies in changes in the extent and nature of international linkages among countries which have generated a struggle over competitiveness in leading-edge sectors. This struggle is symptomatic of a more pervasive discord I’ve called system friction. Let me briefly describe these developments as a background to the policy agenda. INTERNATIONAL LINKAGE There have been three phases of growing international linkage among countries since the Second World War. The first was driven by trade, the golden age of the 1950s and 1960s launched by the dismantling of protectionist barriers in successive GATT Rounds. Over the decade of the 1970s, three massive commodity and oil shocks initiated the second phase, which was financial integration, via the recycling of the OPEC surplus. The wave of financial integration accelerated in the 1980s, because of deregulation and privatization and the emergence of the Japanese current-account surplus. We are now at the outset of a third phase called globalization which is characterized by a surge in foreign direct investment (FDI). After the war foreign direct investment was mainly ‘le defi Americain’ in Western Europe. The present upsurge, which began in 1983 and has steadily picked up speed, is very different in both origin and destination. By 1983 the US had become a net recipient of FDI (i.e. large outflows were outweighed by still larger inflows). By 1985 Japan became the largest net direct investor (due to large outflows and negligible inflows) followed by the UK and Germany. The G-5—the US, Japan, Germany, France and the UK—account for over 75 per cent of both outward and inward FDI. If present investment flows are extrapolated, a conservative estimate suggests they will grow at twice the rate of trade flows in the 1990s. The prime agent of this third phase is the multinational enterprise (MNE). MNEs have a variety of objectives and rarely make decisions on the basis of only one consideration. However, one important factor driving globalization today is the increased research and development (R&D) costs required in the race for the technological frontier in leading-edge sectors. This has stimulated not only a wave of international mergers and acquisitions (the major form of FDI) but also spawned an array of new forms of international networking among the MNEs including R&D/technology alliances. This technology networking is even more concentrated than investment: over 90 per cent of the technology agreements are made between companies with their home base in the Triad of the United States, Japan and the European Community. So the third phase of international linkage is centred on capital and technology flows. To a considerable degree, it has tended to exclude the non-OECD countries with the exception of some in the Pacific Rim. Another manifestation of growing international linkage has been the changing nature of trade itself: an increasing proportion of trade among industrialized countries is in technologically sophisticated manufactured products produced by large firms operating in imperfectly competitive markets. And, finally, powerful new players have entered the global arena; most importantly, Japan. Indeed it has been concern over the Japanese growth model and the role played by targeting so-called strategic sectors and technologies which has made competitiveness such a high-profile issue in the Triad. While the debate about Japanese targeting is by no means settled, the most important new development over the 1980s has been the ‘policy spillover’ involving various kinds of support for strategic sectors in the other two regional blocs.1 It is these changes in a transformed and far more interdependent international economy which have spawned the new international friction manifested in the struggle over leading-edge sectors and technologies but reflecting a much more pervasive phenomenon of system friction. For the battle for market share involves not only competition among multinational

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enterprises but rivalry among the different market systems which influence the enterprise’s ability to compete. Let me now describe the notion of system friction and the policy questions it evokes. SYSTEM FRICTION Economists have long ignored cultural, historical or institutional differences as factors of significance in market analysis. While interest in international economics has greatly increased, international forecasting models, for example, are based on the assumption that there is only one market model and thus the different ‘country blocs’ all have identical structural properties. More recently, however, some economists have urged that a better understanding of institutional (including regulatory) differences among countries may be significant, however difficult to incorporate into theoretical or econometric modelling. An important reason for the interest in different system properties was the challenge of Japan. It is clearly beyond the scope or purpose of my presentation to describe in any detail the burgeoning literature on institutional differences within the Triad.2 A highly stylized depiction would distinguish three dominant models: – the US paradigm of a pluralist market economy with its aggressive financial markets is strongly consumer–and short-termoriented. Its strength is dynamism and flexibility. Its dominant ethos is private sector competition and minimal government. But producer interest groups generate an ad hoc, ‘implicit’ industrial policy response. – The Continental European models are variants of the social market economy and involve more extensive government interaction with the ‘social partners’. ‘Social market’ implies a recognition of market imperfections and a governmental responsibility to rectify them as well as provide public goods. An elastic definition of ‘public goods’ may sometimes blur the line between the role of the market and the role of the state. – The Japanese corporatist market economy is unique in its long view; in its producer orientation; its strategic use of cooperation and competition and blending of macro–and micro-policies; in the close and continuing interface of the state with business and in its remarkable capacity to adapt to external shock. For our purposes it is useful to distinguish two aspects of these systems: the cultural and historical roots which influence behaviour, tastes, and also institutions on the one hand, and government policies (which of course are also affected by the cultural legacy) on the other. The reason for this distinction is that the appropriate domain for international policy cooperation is government policy not tastes, preferences of behaviour which should be accepted as ‘given’ although, of course, not immutable. I shall shortly return to this point. As many studies have shown, both the cultural legacy and government policy affect the competitiveness of the firm. Fundamental to competitiveness is innovation: the research, development and adoption of new products and processes. Innovation stems from the interaction between capabilities within the firm and industry and its external environment, an omnibus term which comprises government policy (R&D, education, macro-policy, trade policy, investment policy, competition policy, capital market regulation, etc.) and behavioural phenomena such as the tastes and attitudes of consumers, workers, entrepreneurs, etc. One of the more important insights which is emerging from studies of the innovation process is that some national systems are more consonant (system friendly) with particular technological paradigms than others. The American leadership, from the end of the nineteenth century, in the Fordist paradigm of mass production is one example. Japan is more system friendly to the more flexible manufacturing paradigm of electronics-based technology. But systems can adapt and, indeed, the process of market competition is one major transmission mechanism of adaptation. Moreover, expanded international linkage (especially foreign investment) and the revolution in transport, information and communication technologies also create pressures for adaptation and a momentum to convergence that goes well beyond the organization and behaviour of the firm. There are many who would argue that competition among firms, and a gradual process of system convergence are both necessary and sufficient to sustain the health of the world economy so long as governments refrain from self-defeating protectionist or interventionist policies. But, as I have noted, the competitiveness of the firm depends not only on its own competitive strength but also on the interaction of its capabilities with the capabilities of the external environment in which it operates. Smart firms may have the potential to build superb mousetraps but not to determine the key policy and institutional aspects of their external environments. So competition among firms is also competition among systems and the slow ‘natural’ process of convergence will produce serious discord—system friction—along the way. A globalizing world has a low tolerance for system divergence. Continuing instability and growing pressure for new forms of managed trade are the likely outcomes. But a new approach to mitigating system friction is, in fact, to undertake an international policy process to promote the convergence of those government policies which are most relevant to the process of innovation. Most of these policies are domestic: the new international arena beyond the border.

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It is important to ask if a process of international policy cooperation is undertaken to promote convergence: convergence to what? What is the regulatory model to be promoted? As I have suggested, there is no single paradigm ‘out there’. Of course, the overall objective must be to promote convergence towards policies that are compatible with market-oriented outcomes. But in some policy areas no clear-cut guidelines emerge. In such cases the regulatory standards themselves will be an output of the process of harmonization. It is instructive to note that two processes of convergence are now in fact under way in the international economy. The most advanced—locational competition—is that emerging in Europe, catalysed by Europe 1992. The choice laid out in the 1985 White Paper to base market competition on ‘mutual recognition’ (one country accepts the regulation of the other) and the free flow of mobile factors of production launched a process of locational competition between different regulatory systems. This is a market-like process producing convergence ex-post. But even in the case of European locational competition, there will be the need for the Commission to promote ex-ante convergence in instances of significant differences in key regulatory instruments such as competition policy, capital market regulation, intellectual property, social policy, taxation, etc. The European locational competition process of convergence is attractive but could not be duplicated at a global—or even an OECD—level at the present time not only because the basic conditions of mutual recognition and free factor flow do not exist but also, and more importantly, the divergences in regulation are wider (as between Japan, for example, and the US). The other very different process of policy convergence recently launched is the bilateral US-Japanese ‘structural impediments initiative’ (SII). The SII covers a vast range of subjects—macro-and micro-policies as well as corporate culture and consumer tastes —and is tied to demonstrable results in the bilateral trade balance. It implies a quite impracticable or even unacceptable view of convergence on ‘everything’ (to the American model?). Moreover, another serious danger in the SII is that it is unlikely to produce the desired changes in the bilateral trade balance (which is influenced by many other factors unrelated to the negotiations) and thus risks inflaming congressional animosity. If the European approach is desirable but unattainable and the bilateral approach highly risky and potentially destabilizing, the only feasible alternative for initiating a process of harmonization is to place the issue in a multilateral forum. The only logical forum is the OECD which alone has the secretariat expertise and the mandate to cover the broad range of policies relevant to the exercise.3 PROMOTING CONVERGENCE: AN OECD POST-URUGUAY PROGRAMME The idea behind the promotion of convergence is an extension of the multilateral rules-based system, originally designed for international trade, to include domestic rules which significantly affect enterprise performance (competitiveness) and market access not only for goods and services but also for investment and technology flows. Persistent marked asymmetry of access for investment and technology will generate serious friction because broad overall reciprocity is fundamental to sustaining political support for the multilateral system. There are at least two questions which would have to be confronted if the OECD were to launch this ‘post-Uruguay programme’: (1) What policies? (2) Will convergence lead to overall reciprocity? WHAT POLICIES? The major criterion for policy selection is impact on the innovation process because for advanced countries innovation is the primary determinant of competitiveness at the level of the firm and of rising productivity at the national level. But in the case of some policies of undeniable importance in that context—education and training is the best example—the international friction stems more from access or reciprocity issues rather than divergence per se. In others, for example fiscal policy, while the impact on innovation via savings, investment and the cost of capital is very considerable, there are other fora, specifically the G-7, where a policy coordination process is already under way. Finally, the GATT Uruguay Round agenda includes a number of key items central to the innovation process for example intellectual property; anti-dumping regulations; industrial and agricultural product standards; government procurement —very important in supercomputers—and a successful outcome will lead to the reduction if not elimination of policy divergence. In some areas—intellectual property or standards, for example — OECD countries may want to go beyond the GATT agreement and negotiate more ambitious codes of behaviour in the GATT or the OECD after the conclusion of the Round. Taking all this into account I would propose that an initial list of policies for the OECD to consider should include: competition policy, research and development (R&D) policies, foreign direct investment policy, and financial market regulation as it affects corporate governance. In the case of competition policy several high-profile issues are already on the international agenda and provide a useful starting point. A number of these were prominent in the SII (vertical arrangements in the Japanese keiretsu, different enforcement procedures in the two countries, etc.). The differing treatment of research and production joint arrangements in

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the US as compared with both Japan and the European Community has also generated a lively debate in the US.4 Thus it would be useful to begin with an analysis of differences in both vertical and horizontal arrangements (including enforcement) in the three trading blocs and an assessment of these differences on performance. In merger law, which is of increasing importance because of the large increase in transnational mergers and acquisitions (including newer modes such as joint ventures and strategic alliances) there does not appear to be any difference in substantive law: the language is remarkably similar in most jurisdictions. The divergence— and conflict—arises in application, since the general prohibition against mergers which will (or are likely to) ‘substantially lessen competition’ leaves ample scope for discretion on the part of the authorities. The situation is even more complicated in the US where all fifty states can exercise jurisdiction independently from the Fed eral government. For corporations planning transnational mergers the degree of uncertainty created by differences in enforcement of merger law is a major impediment to rational decision-making. In the R&D area a number of policy issues need probing. One of the most obvious is government subsidies (including sectorallytargeted tax incentives). Another concerns the thorny question of membership in government-sponsored consortia. There has already been a dispute over the membership of foreign subsidiaries in the European consortium called Jessi and the American Sematech. The basic reason for the exclusion rests on the cloudy concept of ‘strategic’ industries or technologies. The question of how to define ‘strategic’ and other questions (e.g. What is a ‘foreign’ firm?) will have to be confronted before disciplines or codes of behaviour on government-sponsored consortia can be agreed. In the foreign direct investment (FDI) policy sphere the present GATT Round will deal with a limited aspect in the TRIMs (trade-related investment measures) negotiations. Within the OECD area the main problem is less likely to be TRIMs than direct and indirect measures to influence the content or ‘quality’ of investment such as local content regulation or rules of origin. But the major source of system friction in the investment area relates to asymmetry of access or overall reciprocity. Indeed the US has announced that it will raise the issue of its ‘investment imbalance’ with Japan in a new round of SII follow-up citing the 1989 figures of US$32.5 billion of Japanese investment in the US versus US$1.64 billion United States investment in Japan. Within the European Community the reciprocity question has surfaced in the differences in ease of takeovers (mergers), the chief mechanism of FDI, among different member countries, especially the UK versus Germany.5 This also relates to our fourth policy: financial market regulation as it affects corporate governance. Obstacles to mergers in both Germany and Japan stem primarily from differences in the composition of corporate ownership and control, especially the much greater importance of banks versus shareholders. This presents not only a structural impediment to foreign investment but also affects the way corporations are managed, i.e. corporate governance, although the popular image of a clear-cut dichotomy between Anglo-Saxon financially-driven short-termism versus JapaneseGerman long-term growth-driven models is too simplistic. Finally, the question of reciprocity also arises in the technology area. RECIPROCITY: TECHNOLOGY The question of reciprocity of access in technology is complex.6 A firm secures the information necessary to solve technological problems from many sources. The relevant ‘knowledge base’ varies according to the particular technology and a distinction can be made between the degree of ‘publicness’ and universality versus ‘tacitness’ and specificity. Scientific inputs are typically public and so is much generic technology, although to access such inputs requires a sophisticated base in R&D. But ‘public’ knowledge is itself complementary to the more specific and ‘tacit’ knowledge generated within the firm. And it is the firm-specific knowledge which results in new products and processes. The crucial point in these distinctions in that with the necessary investment in R&D it is easier to access the public than the tacit part of the knowledge base. If, as in the case of the United States, the knowledge system is characterized by a much heavier weight of university-based research and technology than that of Europe or Japan, that system is structurally more accessible. But there are also avenues of access to tacit, specific knowledge: hiring employees from innovating firms or buying new high technology start-up firms are examples. Again, in systems where employee mobility is greater, small start-up firms more prevalent, and takeovers easier, there will be a greater structural accessibility of the non-public knowledge base. Thus, as in the case of investment, structural characteristics of different systems will generate asymmetry of access to technology. It will be essential to examine these issues in far greater depth and search for policies either to reduce or compensate for differential access. An example of ‘compensation’ is the Japanese-funded Human Frontiers Programme of basic research in the biological sciences. It is likely that more such efforts will be requested.

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CONCLUSIONS In this chapter I have suggested a post-Uruguay policy agenda for the OECD. I must emphasize that I would see the OECD initiative as a complement to the Round’s efforts to strengthen GATT. If those efforts prove successful, and in particular if a World Trade Organization (WTO) is established, it would be important to ensure that strong informational links are forged between the OECD and the enhanced secretariat of the WTO. In the early 1980s much of the analytical work on trade in services, intellectual property, investment and agriculture was carried out at the OECD and proved invaluable in helping launch the GATT Round. Perhaps one objective of this new OECD initiative should be to develop a set of codes for transfer to the WTO for broader application. After all, the basic purpose of OECD policy cooperation is to further global integration by extending and adapting the multilateral rules-based system which has served the world so well. NOTES * Paper presented to the Joint Canada-Germany Symposium, Centre for International Studies, University of Toronto, 1–2 November 1990. 1 For an account of policy developments and of the new international trade theory in this context see Sylvia Ostry, Governments and Corporations in a Shrinking World: Trade and Innovation Policies in the United States, Europe and Japan, Council on Foreign Relations, New York, 1990, Chapter 3. 2 See, for example, Sylvia Ostry and Val Koromzay, ‘The United States and Europe: coping with change’, OECD Observer, May 1982, 9–12 for an early account. 3 Ostry, op. cit., Chapter 3 and Conclusions. 4 See Thomas M.Jorde and David J.Teece, ‘Innovation and cooperation: implications for competition and antitrust’; Joseph F.Brodley, ‘Antitrust law and innovation cooperation’; Carl Shapiro and Robert D.Willig, ‘On the antitrust treatment of production joint ventures’, in The Journal of Economic Perspectives (Volume 4, Number 3, Summer 1990), 75–130. See also Ostry, op. cit., Chapter 3, for discussion of NCRA as a response to the Japanese innovation paradigm. 5 See Booz-Allen Acquisition Services, Studies on Obstacles to Takeover Bids in the European Community, Executive Summary, prepared for the Commission of the European Communities, PGXV-B-2, December 1989. On the Japanese-US comparison see W. Carl Kester, ‘Capital and ownership structure: a comparison of United States and Japanese manufacturing corporations’, Financial Management, Spring 1986, 5–16. For a discussion of the theoretical issues see Oliver E.Williamson, ‘Corporate finance and corporate governance’, Journal of Finance July 1988, 467–91, and Michael C.Jensen and William H.Meckling, ‘Theory of the firm: managerial behaviour, agency costs and ownership structure’, Journal of Financial Economics, March 1976, 305–60. 6 See, for example, Giovanni Dosi, ‘Sources, procedures and microeconomic effects of innovation’, Journal of Economic Literature, September 1988.

Index

Abramovitz, M. 70 absorption 43, 204 acquisitions and mergers 281–2 Africa: debt crisis 204; economic growth 205, 206–8, 211–12; exports 211, 212; imports 211, 212; population growth 219; savings performance 211; see also individual countries aggregate demand and German unification 18 Aghevli, B.B. 29 agricultural sector: Eastern Europe 105, 106, 107, 108; exports 92–3; growth of 94, 98, 101; in Mexico 230; and Uruguay Round at GATT 244–5, 248–50, 251 Alexander, L.S. 58–9, 200 Algeria 164 Allen, P.R. 49 anti-dumping policy, EC 152–3, 160 anti-subsidy regulations, EC 152, 160 appreciation, currency 18, 43, 48, 49 Arafat, Y. 256 Artis, M. 22 Asia: and debt crisis 204–5; demographic patterns 92; and the EC 128–9, 130–1; economic growth 209; exports 92; GDP 92; industry 92; manufacturing sector 102, 103; see also individual countries Austria 92 Austro-Hungarian Empire 262

industry 92; non-tariff trade barriers 127, 128; population 92 Berry, A. 213 Blanchard, O.J. 181 Brander, S. 14 Branson, W.H. 50 Brazil 127, 128, 130, 164 budget deficit(s) 48; in unified Germany 16, 19 budget surpluses 48 Buiter, W.H. 50 Bulgaria: agricultural sector 105, 108; competitive relations 161, 163; construction sector 105, 108; and the EC 114–15, 116–17, 118, 126, 130, 150–1, 154–9; economic growth 66; energy sector 105, 108; exports 87, 116–17, 150–1; GDP 87; and import quotas of EC 154–9; imports from EC 114–15; industrial sector 87, 105, 108; investment 73; manufacturing sector 105, 108; mining sector 105, 108; population 87; service sector 105, 108; technological gaps 72 business cycles, transmission of 43, 48, 49 Cairns group 245, 256 Canada: competitive relations with Eastern Europe 161, 164; and the EC 114–15, 116–17, 129, 131; exports 93, 116–17; and free trade agreement with Mexico 221, 236; GDP 93; imports from EC 114–15; industry 93; population 93; savings 36 capital accumulation and economic growth 73, 75 capital flight in less developed countries 205, 211 capital flows 276 capital imports 16, 17 capital stock and investment 50, 51, 52, 53 capital-output ratios 213, 218

Bacchetta, P. 22 Balestra, P. 91 bank lending to less developed countries 204 Barro, R.J. 181 Bayoumi, T. 22 Belgium: exports 92, 115, 120; GDP 92; imports 117, 120; 143

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centralization and infranational sentiment 269–70 centrally planned economies: economic growth 66, 72–9; economic growth slowdown 67–70; incentives 68–9; institutional structure 68; investment 72, 73; lack of specialization in 68–9; and technological progress 69, 71, 72, 77, 79 chemical industry in East Germany 5 Chenery, H.B. 214 Chenery hypothesis 83, 84, 88–9, 90, 109, 110 China 161, 164; and the EC 128, 130, 132 Choi, K. 70 Clark, C. 83, 90 clothing and textiles sector and Uruguay Round of GATT 244, 250, 251 CMEA (Council for Mutual Economic Assistance) 125–6, 127, 165 competition policy 281 competition/competitiveness 276, 278–9, 280; from Eastern Europe 160–1, 164, 166–72; locational 279 consortia, government-sponsored 282 construction sector: in Eastern Europe 105, 108; growth of 94, 99, 101 consumer price index: East Germany 13 corporate actors and the nationstate 270–3 corporate governance 282 corporatist market economy 277–8 Corsica 270 Council of Economic Advisers (Germany) 7, 10 Council for Mutual Economic Assistance (CMEA) 125–6, 127, 165 CSFR (Czech and Slovak Federative Republic) 27, 30; agricultural sector 105, 108; competitive relations 163; construction sector 105, 108; and the EC 114–15, 116–17, 152, 154–9; economic growth 66; energy sector 105, 108; exports 87, 116–17; GDP 87; and import quotas of EC 152, 154–9; imports from EC 114–15; industrial sector 87, 105, 108; investment 73; manufacturing sector 105, 108; mining sector 105, 108; population 87; service sector 105, 108; technological gaps 72; see also Czechoslovakia currency appreciation 18, 43, 48, 49 currency union see exchange rate union; monetary union current account: Mexico 228–9, 233 current account balances 35, 38, 40, 46, 47; Eastern Europe 27–9, 30;

less developed countries 207 current account deficits 36, 48 current account surpluses 48; and German unification 17 Czech and Slovak Federative Republic see CSFR Czechoslovakia 165; competitive relations 161; and the EC 118, 119, 126, 127, 128, 130, 150, 151; see also CSFR de Maizi×re, L. 10 Dean, A. 22, 24 debt 30, 204–5, 209–10, 235 debt-GDP ratios: less developed countries 204–5 decision-making processes and supranationality 263–4 deficit, current account 48 deficit, budget 16, 48 demand: and income 43; for money 43, 48; see also aggregate demand demand effects of financial transfers 185, 186 demand-side economics 43, 48–9 demographic patterns 86, 87, 92–3, 219 Denmark: exports 93, 115, 120; GDP 93; imports 117, 121; industry 93; non-tariff trade barriers 128; population 93 devaluation, exchange rate 43 developing countries see less developed countries dumping 152–3, 160 Eastern Europe 32, 41–2; agricultural sector 105, 106, 107, 108; competition from 160–1, 164, 166–72; construction sector 105, 108; current account balance 27–9, 30; and the EC 113–72; economic growth slowdown 67–70; energy sector 105, 108; exports 87, 116–17, 118, 119, 120–1, 122–52 passim; financial transfers to 184–93, 197, 199–200; and import quotas of EC 152, 154–9, 165; imports from EC 113–115, 118, 119, 120–1, 122–4; industrial products exports and imports 113–72 passim; industrial sector 105, 106, 108, 109; industrialization in 86, 88; infrastructure 86; investment 25, 27–9, 30, 41; manufacturing sector 105, 107, 108, 109; mining sector 105, 108; and the nationstate 262–3; per capita income 107; savings 25, 27–9, 30, 41; service sector 105, 106–7, 108, 109; structural change in 104–9;

INDEX

trade relations with EC 113–72; see also individual countries economic effects of German unification 11–19 economic growth 65–80, 224; Asia 209; and capital accumulation 73, 75; in centrally planned economies 66, 72–9; demand side of 88–9; Eastern Europe 67–70; Latin America 205, 209, 212–13, 214, 224, 233–4; less developed countries 205–19, 224, 233–4; in market economies 66, 67, 72–5; and technological progress 70–2, 76, 77, 79 economic growth slowdown in Eastern Europe 67–70 economic legislation in Mexico 231 economic reform in East Germany 5–9 economic union: East and West Germany 10 EFTA (European Free Trade Association) 124 Egypt 92 emigration, East-West 4, 8, 9 energy sector 5, 94, 98, 105, 108 European Community (EC) 31; anti-dumping policy 152–3, 160; anti-subsidy regulations 152, 160; and the CMEA 125–6; current account balance 40; and Eastern Europe 113–72; exports to Eastern Europe 113–15, 118, 119, 120–1, 122–4; and GATT 248–9; generalized system of preferences (GSP) 125, 126; import quotas 152, 154–9, 165; imports from Eastern Europe 116–17, 118, 119, 120–1, 122–52 passim; industrial products exports and imports 113–72 passim; internal market 42; investment 25, 26, 40, 62–3n; non-tariff trade barriers (NTBs) 126–33; quantitative restrictions (QR) 151–2, 154–9, 165; savings 25, 26, 40; supranational collectivity of 263, 264–6, 267, 268, 274; trade policy measures 124–33, 150–3, 160, 165; trade relations with Eastern Europe 113–72 European Free Trade Association (EFTA) 124 European Monetary System (EMS) 18, 19 exchange rate union 49–50; with supply-side effects 50–7 exchange rates 17, 18, 19, 43; Deutschmark-GDR mark 6–9, 11–12; devaluations 43; fixed 43; flexible 43; Mexico 220, 223, 232 exports 92–3; Africa 211, 212; Eastern Europe 87, 116–17, 118, 119, 120–1, 122–52 passim; EC to Eastern Europe 113–15, 118, 119, 120–1, 122–4; Latin America 212; less developed countries 205, 206, 211, 212, 214, 235; net 55 extranationality 270–3

Feldstein, M. 22 Feldstein-Horioka puzzle 22 Fels, G. 90, 94 financial integration 275 financial markets: and financial transfers 186; Mexico 234, 236; regulation of 282 financial transfers 180–200; demand effects of 185, 186; and financial markets 186; global effects of 190, 194; GNP effects of 189, 191, 195, 197; and interest rates 180, 182, 184, 189, 193, 197, 198; quantity and price effects of 183; and saving flows 198–9; supply effects of 185; to Eastern Europe and Soviet Union 184–93, 197, 199–200; to less developed countries 193–7, 200; trade effects of 186–7, 189, 192, 193, 195, 196, 197; see also global investment flows; investment Finland 93 fiscal cost of German unification 14–16 fiscal policy: debt-financed 48; Mexico 223, 226; tax-financed 48 Fisher, A. 83 flow variables, East German 12–13 foreign direct investment (FDI) 275–6, 282; in Mexico 229–30, 233, 234, 236 foreign policy and GATT 249 foreign-exchange markets, grey 8, 12 Fourasti, J. 83, 90 France: economic growth 66; exports 92, 115, 120; GDP 92; imports 117, 120; industry 92; investment 73; as nationstate 261; non-tariff trade barriers 127, 128, 132; population 92; technological gaps 72 free trade agreements: EC and Eastern Europe 124; Mexico and North America 221, 235–6 Frenkel, J.A. 43, 48, 50, 181, 197 Gagnon, J.E. 58–9, 200 GATT 125; Uruguay Round 241–52, 281, 283, 284 Genberg, H. 43, 48–9 generalized system of preferences (GSP) 125, 126 German Reich 261 German Unity Commission 10 German Unity Fund 15 Germany (East): agricultural sector 105, 108;

145

146

INDEX

borrowing requirement 15–16; construction sector 105, 108; consumer price index 13; economic growth 66, 78–9; economic reform 5–9; economic structure 4–5; energy sector 105, 108; exports 87; financial transfers to 185–6; flow variables 12–13; GDP 87; industrial sector 4–5, 87, 105, 108; investment in 13–14, 15, 17, 41, 73; joint ventures 6, 14; manufacturing sector 105, 108; mining sector 105, 108; population 87; property ownership 6, 13; service sector 4, 105, 108; stock variables 11–12; technological gaps 72; trading partners 5; unemployment 13; wages 12–13 Germany (united) 58–9; budget deficits 16, 19; current account surplus 58; exchange rate 58; GNP 58; inflation rate 58; interest rates 58; and international interdependence 58–9; investment 25, 26, 58; savings 25, 26 Germany (West): current account 36; economic growth 66, 75; exports 93, 115, 120; GDP 93; import quotas 152; imports 117, 120; industry 93; interest rates 57; investment 25, 26, 37, 73, 276; non-tariff trade barriers 128; population 93; savings 25, 26, 36, 37; technological gaps 72; trade with Eastern Europe 115, 117, 118, 133, 150 Gerstenberger, W. 4–5 global investment flows: to Eastern Europe and Soviet Union 184–93, 197, 199–200; to less developed countries 193–7, 200, 203–19; see also financial transfers globalization 275–6 Greece 92; exports 92, 115; GDP 92; imports 117; industry 92; non-tariff trade barriers 127, 128;

population 92 gross domestic product (GDP) 87, 92–3, 206, 212 gross national product (GNP): and financial transfers 189, 191, 195, 197 Handelsblatt, 10, 27 Heilemann, U. 91 Heitger, B. 70 Hirschman, A. 260 Hoffmann, L. 10 Hong Kong 127, 129, 131, 132 Horioka, C. 22 Houthakker, H.S. 91 Hsiao, C. 91 Human Frontiers Programme 283 Hungary 165; agricultural sector 105, 108; competitive relations 161, 163; construction sector 105, 108; current account balance 28; and the EC 114–15, 116–17, 118, 119, 126, 127, 128, 130, 151; economic growth 66; energy sector 105, 108; exports 87, 116–17, 150, 151; GDP 87; imports from EC 114–15, 118; industrial sector 87, 105, 108; investment 27, 28, 73; manufacturing sector 105, 108; mining sector 105, 108; population 87; savings 27, 28; service sector 105, 108; technological gaps 72; trade with EC 114–15, 116–17, 127, 128, 130, 150, 151 import-GDP ratios 205, 212 import prices 16 import quotas, EC 152, 154–9, 165 imports: Africa 211, 212; capital 16, 17; Eastern Europe from EC 113–15, 118, 119, 120–1, 122–4; EC from Eastern Europe 116–17, 118, 119, 120–1, 122–52 passim; Latin America 212, 213; less developed countries 205, 206, 211, 212, 214, 226–7 incentives in centrally planned economies 67–8 income: and demand 43; see also per capita income India 127, 128, 130; debt-GDP ratios 204–5 Indonesia 128, 130 industrial products, trade in 113–72 industrial sector 4–5, 87, 92–3, 105, 106, 108, 109 industrialization, in Eastern Europe 86, 88 inflation 19; Mexico 223, 225, 227–8, 231–2, 233 infranationality 266–70

INDEX

infrastructure in Eastern Europe 86 innovation 278, 280–1; in centrally planned economies 69 institutional structure in Eastern economies 68 intellectual property 245, 246 interest rates 16, 18, 19, 22; and financial transfers 180, 182, 184, 189, 193, 197, 198; and investment 43, 48–9, 51, 52, 53, 54, 55, 57; Mexico 233–5 internal market 42 international linkage, growth of 275–7 investment 21–32; in centrally planned economies 72, 73; in East Germany 13–14, 15, 17, 41; and interest rates 43, 48–9, 51, 52, 53, 54, 55, 57; in market economies 72, 73; reciprocity 282; see also financial transfers; foreign direct investment; global investment flows; savings-investment balance investment shifts and international interdependence 42–50 Ireland: exports 92, 115, 120; GDP 92; imports 117, 121; industry 92; non-tariff trade barriers 127, 128; population 92 Israel 127, 128, 130, 164 Italy: economic growth 66; exports 92, 115, 120; GDP 92; imports 117, 120; industry 92; investment 73; and the nationstate 259, 261–2; non-tariff trade barriers 127, 128, 132; population 92; technological gaps 72 Japan 31, 276; corporatist market economy 277–8; current account 36, 46, 47; economic growth 66, 75; exports 92; GDP 92; industry 92; investment 23, 24, 32, 36, 37, 44, 45, 73, 276, 282; population 92; savings 23, 24, 36, 37; technological gaps 72 Jessi consortium 282 joint ventures 6, 14 Kenen, P. 49 Kischel, W. 5 Kohl, H. 9, 10, 249, 255 Korea, South 92, 128, 131, 164

Kornai, J. 68 Kuwait 164 Latin America: capital-output ratios 213; debt crisis 204, 209–10; and the EC 128, 130; economic growth 205, 209, 212–13, 214; exports 212–13; imports 212, 213; per capita incomes 210; population growth 219; savings performance 211; see also individual countries law of mergers and acquisitions 281–2 legislation, economic, in Mexico 231 less developed countries (LDCs) 32; absorption 204; borrowing 207–8; capital flight 205, 211; capital-output ratios 218; competitive relations with Eastern Europe 161, 164; current account balance 207; debt crisis 204–5; domestic investment 211; and the EC 114–15, 116–17, 127, 128, 132–3; economic growth 205–19; exports 116–17, 205, 206, 214; and GATT 246; GDP 206, 212; and global investment flows 193–7, 200, 203–19; import-GDP ratios 205; imports 114–15, 205, 206, 214; investment 22, 29–31; per capita incomes 204, 210; population growth 219; savings 22, 29–31, 211, 214; services 207; terms of trade 206, 210; trade balance 207; trade with EC 114–15, 116–17, 127, 132–3; wages 204; see also individual countries Levin, J.H. 49 Libya 164 locational competition 279 Lom Conventions 124 Louix XIV 256 loyalty, national 260, 266–7 Luft, C. 6 Luxemburg 258–9; exports 115, 120; imports 117, 120 Malaysia 92, 129, 131 manufacturing sector: Asia 102, 103; Eastern Europe 105, 107, 108, 109; growth 94, 98–9, 100, 101, 102, 103; Mediterranean countries 102, 103

147

148

INDEX

market economy/economies: corporatist 277–8; economic growth in 66, 67, 72–5; establishment of, in East Germany 5–6, 8; investment 72, 73; pluralist 277; social 5–6, 8, 277; technological gaps in 72 Marshall Plan 184 Marston, R.C. 49 Marx, K. 272 Masson, P.R. 198, 200 mechanical engineering industry in East Germany 5 Mediterranean region: demographic patterns 92; and the EC 127, 128, 130; exports 92; GDP 92; industry 92; manufacturing sector 102, 103; see also individual countries Meredith, G. 198, 200 mergers and acquisitions 281–2 Mexico 127, 128, 130, 220–37; agricultural sector 230; current account 228–9, 233; debt 235; economic growth 224, 233–4; economic legislation 231; exchange rate policy 220, 223, 232; exports 235; financial flows 233–5; financial markets 234, 236; fiscal policy and adjustment 223, 225, 226; foreign investment in 229–30, 233, 234, 236; foreign trade 224, 226–7, 235–7; free trade agreement with North America 221, 235–6; import liberalization 226–7; inflation 223, 225, 227–8, 231–2, 233; interest rates 233–5; Pact of Economic Solidarity 228; state enterprises 230–1; wages 223, 228 Middle East 205; see also individual countries Middle Europe and the nationstate 262–3 mining sector: in Eastern Europe 105, 108; growth of 94, 98, 101 Modrow, H. 6 monetary union 9–10; see also exchange rate union money demand 43, 48 money markets: equilibrium in 43; and financial transfers 186 money supply 43, 48 Morocco 92, 128, 130 most-favoured-nation duties 126 Moutos, T. 49 multi-fibre arrangement (MFA) 125, 173n

multilateral trade negotiations (MTNs) 241–52; see also Uruguay Round of GATT multinational enterprises (MNEs) 276 Mundell, R.A. 42, 43 Mussa, M. 42, 43–4 Napoleon I 256 nation, concept of 256–7, 258 nationstate 254–74 Nerlove, M. 91 net material product (NMP) system 104, 106 Netherlands: exports 92, 115, 120; GDP 92; imports 117, 120; industry 92; non-tariff trade barriers 127, 128; population 92 non-tariff trade barriers (NTBs) 126–33 Norway 93 Organization for Economic Co- operation and Development (OECD) 59; investment 22–4, 31, 32; and polic cooperation and convergence 280–2, 283–4; savings 22–4, 31, 32 Pact of Economic Solidarity (Mexico) 228 Pakistan 127, 128, 130 Palestine 256 Pauly, P. 188, 197 per capita incomes: in Eastern Europe 107; and growth 100; in Latin America 210; in less developed countries 204, 210 Philippines 92, 128, 130 pluralist market economy 277 Poland 165; agricultural sector 105, 108; competitive relations 161, 162; construction sector 105, 108; current account balance 28; and the EC 114–15, 116–17, 118, 126, 127, 128, 130, 150, 151; economic growth 66; energy sector 105, 108; exports 87, 130, 150, 151; GDP 87; imports from EC 114–15, 118; industrial sector 87, 105, 108; investment 27, 28, 73; manufacturing sector 105, 108; mining sector 105, 108; population 87; savings 27, 28; service sector 105, 108; technological gaps 72; trade with EC 114–15, 116–17, 127, 128, 130, 150, 151 policy cooperation and convergence 279–82, 283–4 political union:

INDEX

East and West Germany 11 population and population growth 76, 86, 92–3, 219 Portugal 92; exports 92, 115; GDP 92; imports 117; industry 92; population 92 Prais, S.J. 91 price levels 17, 19 prices, import 16 private investment 185; in East Germany 13–14 private property, ownership of 6, 13 private saving 198–9 privatization 17 property ownership 6, 13 protectionism 248, 251 public saving 198–9 quantitative restrictions (QR) of the EC 151–2, 165; see also import quotas Razin, A. 43, 48, 50, 181, 197 reciprocity: of access to technology 283; investment 282 regionalism 267–70 research and development 276, 282, 283 Robotron 5 Romania: agricultural sector 105, 108; competitive relations 161, 162; construction sector 105, 108; current account balance 29; and the EC 114–15, 116–17, 118, 128, 130, 150, 151, 154–9; economic growth 66; energy sector 105, 108; exports 87, 116–17, 150, 151; GDP 87; and import quotas of EC 152, 154–9; industrial sector 87, 105, 108; investment 27, 29, 73; manufacturing sector 105, 108; mining sector 105, 108; population 87; savings 27, 29; service sector 105, 108; technological gaps 72; trade with EC 114–15, 116–17, 118, 128, 130, 150, 151, 154–9 Rostowski, J. 68 Salai-i-Martin, X. 181 Sauernheimer, K. 49 saving flows and financial transfers 198–9 savings 21–32; less developed countries 22, 29–31, 211, 214; ‘two-gap’ model 214 savings-investment balance 34–62 Scarth, W. 49

149

Schatz, K.W. 90 Schmidt, K.D. 90 sectoral growth functions 88–91, 94–104 Sematech consortium 282 service sector: East Germany 4; Eastern Europe 105, 106–7, 108, 109; growth 94, 99, 101; less developed countries 207; and Uruguay Round of GATT 245, 246, 250–1 Siebert, H. 248 Singapore 129, 131 Single European Act (1987) 42 skill content of exports and imports 123–4 social market economy 5–6, 8, 277 social union: East and West Germany 10 South Korea 92, 128, 131, 132, 164 Soviet Union 32, 263; agricultural sector 105, 108; competitive relations 161, 162, 164; construction sector 105, 108; current account balance 27; and the EC 114–15, 116–17, 118, 126, 128, 130, 133, 151, 154– 9; economic growth 66; energy sector 105, 108; exports 87, 116–17, 133, 151; financial transfers to 187–93, 197, 199–200; GDP 87; and import quotas of EC 154–9; imports from EC 114–15; industrial sector 87, 105, 108; investment 25, 27, 73; manufacturing sector 105, 108; mining sector 105, 108; population 87; savings 25, 27; service sector 105, 108; technological gaps 72; trade with EC 33, 114–15, 116–17, 118, 126, 128, 130, 133, 151, 154–9 Spain 92, 115, 117 specialization and centrally planned economies 68–9 state, concept of 257–8 state enterprises in Mexico 230–1 State Treaty, 1990 (Germany) 10, 11 stock variables, East Germany 11–12 strategic industries 282 Strout, A. 214 structural change, analysis of 88–94 structural impediments initiative (SII) 280, 281 subsidization 152, 160 Summers, L.H. 181 supply, money 43, 48 supply effects of financial transfers 185 supply-side effects of exchange rate union 50–7 supranationality 263–6, 267, 268–9, 274 surplus: budget 48; current account 48

150

INDEX

Sweden 93 Swoboda, A.K. 43, 48–9 system friction 277–80 Taiwan 92, 129, 131, 164 Taylor, L. 88, 90 technological gaps 71–2, 73, 76, 77 technological progress 278; and centrally planned economies 69, 71, 72, 77, 79; and economic growth 70–2, 76, 77, 79 technology, reciprocity of access to 283 technology flows 276 technology networking 276 terms of trade: less developed countries 206, 210 textiles and clothing sector and Uruguay Round of GATT 244, 250, 251 Thailand 92, 127, 129, 131 Thatcher, M. 255 Third World see less developed countries trade 275, 276; East Germany 5; Mexico 224, 226–7, 235–7 trade balance: less developed countries 207 trade effects of financial transfers 186–7, 189, 192, 193, 195, 196, 197 trade negotiations, Uruguay Round of 241–52, 281, 283, 284 trade policy: EC 124–33, 150–3, 160, 165; United States 248 trade relations: Eastern Europe and the European Community 113–72 trade-related investment measures (TRIMs) 245, 246, 282 transnational collectivities 268 travel fund 8 Trust Agency 15, 17 Tunisia 92, 128, 130 Turkey 92, 127, 128, 130, 164 ‘two-gap’ model of savings 214 unemployment: East Germany 13; real-wage 48 United Kingdom 118; economic growth 66, 75; exports 92, 115, 120; GDP 92; imports 117, 120; industry 92; investment 73, 276; and the nationstate 261; non-tariff trade barriers 127, 128; population 92; savings 36; technological gaps 72 United States: competitive relations with Eastern Europe 161, 164; current account balance 46, 47; current account deficit 36;

and the EC 114–15, 116–17, 129, 131; economic growth 66; exports 93, 116–17; and free trade agreement with Mexico 221, 235–6; GDP 59, 93; imports from EC 114–15; industry 93; interest rates 57; investment 23, 24, 36, 37, 44, 45, 73, 276, 282; population 93; savings 23, 24, 32, 36, 37; technological gaps 72; trade with EC 114–15, 116–17, 129, 131; trade policy 248 Unity Treaty (East and West Germany) 10–11 Uruguay Road of GATT 241–52, 281, 283, 284 USSR see Soviet Union wages: conversion rate: East and West Germany 12–13; less developed countries 204; Mexico 223, 228 Weiss, F.D. 248 ‘welcome money’ 8 Winham, G.R. 241 Wolter, F. 90 World Trade Organization (WTO) 283, 284 Yoffie, D.B. 250 Yugoslavia 92, 128, 130, 164, 263