I Regional and Sub-Regional Integration in Central and Eastern Europe: An Overview Zdenik Drtibek1 I Introduction The political events of 1989 in Central and East European countries (CEECs) brought along a number of important changes in these countries' external economic relations. One of the legacies of communism for these countries was that they had been isolated from world markets and become extremely insular. Trade policies were highly protectionist and autarchic. Inward foreign investments were practically forbidden, and industrial coop­ eration agreements were at best limited to joint ventures with foreigners holding a non-majority interest in the enterprise. Outward foreign invest­ ments were few in number, and again limited only to securing "essential" services or material inputs. It goes without saying that the integration of labour markets was even more restrictive since the communist regime hard­ ly permitted any internal labour mobility let alone foreign migration. The abolition of communism dramatically turned the attitudes in these countries. External economic policies were completely overhauled. Suddenly, the most important challenge was no longer whether these countries should open up to external competition and whether they should seek world markets more actively, but the real question has become how these general goals should be achieved. Theoretically, the countries could pursue two separate routes: they could join the multilateral "club" of coun­ tries through participation in the Bretton Woods system or they could seek strong alliances in the regional context. The third alternative was to pursue 1 The views expressed in this paper are personal and should not necessarily be attributed to the World Trade Organization or its members. The paper has been prepared for the conference on "Regional Economic Integration and Global Economic Cooperation: The Case of Central and Eastern Europe", Prague, 13-14 January 1997. I have benefitted from rich comments of the conference participants, especially Mark Allen, Franz-Lothar Altmann, Stephany Griffith-Jones, Andras Inotai, Ricardo Lago, Friedemann Muller, Joan Pearce, Barbara Stallings, Jan Joost Teunissen, Albrecht Von der Heyden and Per Magnus Wijkman. Statistical assistance of Maika Oshikawa and typing of Lidia Carlos-Silvetti are also most gratefully acknowledged. 11 From: Regionalism and the Global Economy: The Case of Central and Eastern Europe FONDAD, The Hague, 1997, www.fondad.org both options at the same time. As we shall see, most of the countries under consideration indeed pursued both routes. The issue of seeking full participation in the multilateral trading system, on the one hand, or partnership in regional trading and other economic arrangements, on the other, has been studied extensively. The desirability of multilateral versus regional trading arrangements has been recently addressed, for example, in WTO (1995), de Melo and Panagariya (1993) and others. According to some authors, regionalism constitutes a danger for the multilateral system, while others (see, e.g. Mistry, 1996) argue that it helps to strengthen it. Pari passu, this issue obviously looms very heavily over the region of Central and Eastern Europe. The purpose of this paper is, therefore, to review the recent literature which evaluates the new regional arrangements in Central and Eastern Europe and identifies the constraints for further integration of these countries. Evaluating regionalism is neither simple nor straightforward. Regional arrangements arenormally assessed on the basis of the Vinerian "trade diversion" and "trade creation" criterion (see Viner, 1950). More recently, researchers have begun to focus more on the extent to which regionalism affects the country's welfare (e.g. Baldwin et al., 1996). In practice, howev­ er, the evaluations run into many difficulties. For example, there may be conflicting factors which determine the efficiency consequences ofregional integration arrangements (de Melo, Panagariya and Rodrik, 1992). Moreover, empirical studies have been subject to a number of technical and data problems.2 For a brief comment, see, for example, WTO (1994). As a result, many analysts believe that assessments of regional arrange­ ments are basically an empirical problem (Laird, 1995). We shall approach the assessment of the regional initiatives in Central and Eastern Europe from two different perspectives. Ourfirst approach will be to assess the regional agreements as options faced by these countries in the light ofvarious alternatives. Following the general literature on region­ alism (e.g. Bhagwati, 1995), this can be done by ascertaining whether the regional agreements meet any or all of the four following criteria: (i) the extent to which the multilateral and regional agreements are consistent with domestic policy objectives; (ii) whether the regional agreements create incentives to reduce, minimise or eliminate trade diversion; (iii) whether the agreements have been leading to a deeper integration than what could have been achieved through the "multilateral option"; and (iv) whether the agreements have allowed a faster rate of integration with out­ side countries than what would have been possible under the multilateral 2 For a briefcomment, see, for example, WTO (1994). 12 From: Regionalism and the Global Economy: The Case of Central and Eastern Europe FONDAD, The Hague, 1997, www.fondad.org alternatives. In more concrete terms, we will raise questions such as: Do the regional initiatives in CEECsrepresent a protectionist trend or do they support the officially declared objective of liberalisation instead? Have the regional initiatives been concentrated only on trade arrangements or have they also been extended to other areas as well? Do the .initiatives exceed the scope of measures and concessions negotiated in multilateral agree­ ments? Have the measures negotiated in the regional arrangements been actually and fully implemented? If not, why? What is the time schedule for the completion of the negotiated trade measures and how does this com­ pare with the multilateral agreement? Our second approach will be to review the empirical literature which focuses on the quantitative assessment of regionalism in Central and Eastern Europe. The literature can be summarised under two separate headings. One route has been the attempt to estimate the nature and extent of trade diversion/creation. It includes studies based on "gravity models" and other methods to evaluate intra-regional trade, as well as studies which try to measure extra-regional trade effects. Another route has been to evaluate the impact of regional agreements on welfare in the ED and in the CEECs by looking at income, employment and the budget in the ED and income effects in theCEECs. Due to limitations of space and time, we will concentrate on two agree­ ments - the Europe Agreements and the Central and East European Free Trade Agreement (CEFTA). This means that we shall have to disregard a number ofimportant bilateral agreements that have been concluded by the CEECs, such as the customs union between the Czech Republic and Slovakia, and various bilateral investment protection treaties. We shall focus on the "economics" of the regional arrangements although other issues may be equally important. For example, it would be interesting to address the broader question of the importance of global integration for transition of the CEECs but this would go beyond the scope of this study.3 Non-economic factors, which also determine the success ofregional arrangements, will only be touched upon in this paper.4 The .. paper will cover six CEECs - Bulgaria, Czech Republic, Hungary, Poland, Romania and Slovakia. However, due to lack of information, Bulgaria and Romania will receive a relatively less rigorous treatment. Finally, the focus of the paper is trade, even though much more could and should be said about 3 The reader is referred to the World Bank's World Development Report 1996 which addresses this question. 4 However, the reader may wish to consult Eofinger (1995) for more details and for a dis­ cussion of the broader political economy aspects of the ED enlargement. On the "eastern" view, see, for example, Richter (1996). 13 From: Regionalism and the Global Economy: The Case of Central and Eastern Europe FONDAD, The Hague, 1997, www.fondad.org capital markets. This emphasis is arguably the weakest point of the study since the integration of capital markets has been quite successful, as will be shown in the text. But since it was the trade segment of the Europe Agreements and CEFTA that has been most controversial, our choice fell on trade rather than investment. The paper is organised in the following way. Part Two describes the starting economic conditions for the CEECs to get more closely integrated into the world economy. The description is important because it helps us to understand the new opportunities created by the political changes. In addition, the description is necessary in order to evaluate various regional agreements in the rest of paper. Part Three reviews the main features of the Europe Agreements and CEFTA and discusses the main impediments to integration. Part Four reviews the empirical literature which focuses on quantitative assessments ofthese regional initiatives. II The Initial Conditions: the Collapse ofCMEA and the New Opportunities for Integrating the CEECs into the World Economy The Collapse ofCMEA The collapse of communism in Central and Eastern Europe also result­ ed in