Economics of the Northern Dimension

Economics of the Northern Dimension ETLA, The Research Institute of the Finnish Economy The Institute was founded in 1946 to conduct research in the fields of economics, business and social policy designed to serve financial and economic policy decision making in the organisations sponsoring the Institute, Finnish companies and the entire economy. At present the members of the association sponsoring ETLA are the Confedera- tion of Finnish Industry and Employers, the Central Association of Insurance Companies, the Employers’ Confederation of Service In- dustries in Finland, Leonia Bank plc, Merita Bank plc, OKOBANK Group, Finnvera Corporation, Kesko Corporation and SOK Corpo- ration. ETLA conducts economic forecasting and analysis of economic policies in the international and Finnish economy, both on an aggre- gate and sectoral level, in the short and medium run. The other main activity is research in six programmes: Industrial Economics and In- ternational Business; Technology, Competence and Competitiveness; European Integration; Labour Economics; Finance and Macroeco- nomics; and Environmental Economics. ETLA also conducts special studies financed from sources outside the association. ETLA pub- lishes monographs, reviews and forecasts in several different series. The Institute has two subsidiaries, Etlatieto Ltd., which is ETLA’s project research and information services unit, and Taloustieto Ltd., a publishing company. ETLA, The Research Institute of the Finnish Economy Krister Ahlström, President of the Council of Supervisors Jussi Mustonen, Chairman of the Board of Management Pentti Vartia, Managing Director of the Institute Address: Lönnrotinkatu 4 B, 00120 Helsinki, Finland Tel: + 358-9-609900 Fax: + 358-9-601753 Internet: www.etla.fi E-mail: [email protected] ELINKEINOELÄMÄN TUTKIMUSLAITOS The Research Institute of the Finnish Economy ETLA LönnrotinkatuELINKEINOELÄMÄN 4 B 00120 HelsinkiTUTKIMUSLAITOS Finland Sarja B 166 Series ________________________________________________________________ Kari E.O. Alho (Ed.) ECONOMICS OF THE NORTHERN DIMENSION ETLA, The Research Institute of the Finnish Economy Publisher: Taloustieto Oy Helsinki 2000 Cover: Mainos MayDay, Vantaa 2000 ISBN 951-628-319-5 ISSN 0356-7443 Printed in: Yliopistopaino, Helsinki Preface In 1995 Finland joined, together with Sweden and Austria, the Euro- pean Union. The integration strategy of Finland is to be an active part- ner in shaping Union policies. In concrete terms, this has meant that Finland was among the countries to join EMU in its conception in 1999. Another example of this has been the Finnish initiative of the Northern Dimension in 1997, which has been adopted by the European Council on the agenda of the Union. As such, it covers Union policies and bilateral links in the northern part of Europe with the aim to in- crease stability, both political and economic, and prosperity through increased co-operation in the Region. ETLA, The Research Institute of the Finnish Economy, has carried out intensive research throughout the entire 1990s on economic transition in the nearby countries and regions of Finland, especially in the Baltic countries and Russia. Therefore, in order to celebrate the first Finnish Presidency of the Union in the second half of 1999, we con- sidered it to be a proper venture to organise a conference on the economics of the Northern Dimension. This is the collected volume of the papers and comments presented in the conference. The financial contributions to this project by the Finnish Ministry of Trade and Industry and the Ministry for Foreign Affairs are gratefully acknowledged. I thank Dr. Kari E.O. Alho, Research Director at ETLA, for bearing the major responsibility of organising the conference and being the editor of this volume. Many thanks also to Ms. Arja Räihä for acting as the conference and editorial secretary and Ms. Tuula Ratapalo for typing the volume. Dr. Anthony de Carvalho has assisted in lan- guage checking. The volume is based on the contributions by the vari- ous speakers and commentators, and I warmly thank them all, as well as the active audience and the chairmen of the conference. Helsinki, May 2000 Pentti Vartia Managing Director, ETLA List of Conference Speakers Alec Aalto, State Secretary for EU Affairs, Prime Minister´s Office, Finland Kari E.O. Alho, Research Director, The Research Institute of the Finnish Economy (ETLA) Hannu Arkonsuo, Managing Director, Arewcon-development, Finland Richard E. Baldwin, Professor, Graduate Institute of International Studies, Geneva and CEPR Erik Berglöf, Professor, Stockholm School of Economics and CEPR Grigori Dudarev, General Director, Solid Invest Group, St. Petersburg Gunnar Eliasson, Professor, Royal Institute of Technology, Stockholm Erik Forsman, Director, Confederation of Finnish Industry and Employers Carl B. Hamilton, Professor, Stockholm School of Economics and CEPR Inkeri Hirvensalo, Director, Institute for Markets in Transition, Helsinki School of Economics Juha Honkatukia, Research Supervisor, The Research Institute of the Finnish Economy (ETLA) Outi Honkatukia, Administrator, OECD Einar Hope, Professor, Norwegian School of Economics and Business Administration, Bergen Jaakko Iloniemi, Managing Director, Centre for Finnish Business and Policy Studies (EVA) Jaak Leimann, Professor, Tallinn Technical University, Former Minister of Economic Affairs, Estonia Kaj-Peter Mattsson, Ministerial Adviser, Finnish Ministry of Transport and Communications Markku Ollikainen, Professor, University of Helsinki Michael Rauscher, Professor, University of Rostock and CEPR Wolfram Schrettl, Director, International Economics, DIW, Berlin Timo Summa, Director, EU Commission Pekka Sutela, Head, Bank of Finland, Institute for Economies in Transition Matti Vuoria, Chairman, Fortum Corporation, Finland Peter Westin, Senior Research Fellow, Russian European Centre for Economic Policy (RECEP), Moscow, and Stockholm School of Eco- nomics Mika Widgrén, Professor, Turku School of Economics, Yrjö Jahnsson Foundation and CEPR Józef Wiejacz, Ambassador of Poland to Finland Valery Yaroshenko, Deputy Trade Representative of Russia, Helsinki Chairmen Urpo Kivikari, Professor, Turku School of Economics Pekka Sutela, Head, Bank of Finland, Institute for Economies in Transition Pentti Vartia, Managing Director, The Research Institute of the Finnish Economy (ETLA) Contents 1 Introduction 1 Kari E.O. Alho Part One Economic and Political Ties within the Northern Dimension 2 Opening presentation 13 Alec Aalto 1 Increasing Prosperity 14 2 Towards Positive Economic Interdependence 15 3 The Northern Dimension; the Politics of it 17 Jaakko Iloniemi 1 Why a Finnish Initiative? 18 2 Russia of the North 18 3 Unlimited Resources 20 4 Russia before Choices 21 5 European Interest 22 Discussion 25 Jaak Leimann 1 Energy 25 2 Transport 26 3 Forestry 26 4 Economic Developments and Interrelationships within the Northern Dimension 27 Kari E.O. Alho 1 Introduction 27 2 Economic Developments within the Northern Dimension 29 3 Economic Linkages within the Region 33 3.1 Trade Potential 35 3.2 Structure of Trade 38 3.3 Trade and Investment Barriers 39 3.4 Trade Policy 39 4 Economic Growth and Integration within the Northern Dimension 41 4.1 International Spillovers in Growth 41 4.2 A Digression into the Theory of Economic Geography 44 4.3 On the Growth Strategy in the Region 46 5 The Macroeconomy in the Northern Dimension 48 6 Conclusions 50 Discussion 55 Inkeri Hirvensalo 5 Comparative Advantage, Intra-Industry Trade and Location in the Northern Dimension 59 Mika Widgrén 1 Introduction 59 2 Revealed Comparative Advantage 63 3 Intra-Industry Trade 68 4 The Northern Dimension and Economic Geography 74 Discussion 79 Richard E. Baldwin 6 The Baltic Economic Potential – Competence Blocs, Firm Strategies and Industrial Policy 83 Gunnar Eliasson 1 The Problem of the Northern Dimension 83 2 Economic Historic Background 88 3 How Does Economic Growth Occur? 94 – The Experimentally Organized Economy (EOE) 4 Competence Bloc Theory Applied 101 5 The Northern Industrial Potential 106 6 Industrial Policy Conclusions 110 Discussion 119 Wolfram Schrettl Part Two Sectoral and Regional Studies 7 Transport and the Northern Dimension 125 Kaj-Peter Mattsson 1 A Key Question 127 2 What Should Now Be Done 128 Annex 130 Discussion 137 Hannu Arkonsuo 1 Background and the Present Situation 137 2 Competitive Situation and Future Development Plans 140 8 The Northern Dimension and the Future of European Energy Markets 143 Matti Vuoria 1 The Development of the Markets 143 2 The Northern Dimension 144 3 Natural Gas 145 4 North Transgas – A Practical Example 147 Discussion 149 Einar Hope 1 The Role of Public Authorities 149 2 The Integration of Regional Energy Markets 150 3 The Integration of Energy Markets 150 – Electricity and Gas 4 North Transgas 151 Discussion 153 Grigori Dudarev 1 Introduction 153 2 Russian Energy Sector 153 3 Prospective Co-operation Areas 156 4 Role of the Northern Dimension 158 9 Cleaning Up the Northern Dimension: Pollution Control in the Baltic Sea 159 Juha Honkatukia, Outi Honkatukia and Markku Ollikainen 1 Introduction 159 2 Theoretical Framework for a Pollution Reduction Agreement 161 2.1 Nitrogen Pollution in the Baltic Sea 161 2.2 Economic Models of Pollution Reduction: Nash Solution and Cooperation by Agreements 164 2.2.1 Non-cooperative Solution 164 2.2.2 Cooperative Solution: An Optimal Agreement 165 3 Emissions and Abatement Costs of Nitrogen 168 3.1 Emissions, Transfer and Concentration of

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