FROM DISINTEGRATION TO REINTEGRATION EASTERN EUROPE AND THE FORMER SOVIET UNION IN INTERNATIONAL TRADE

1. FROM DISINTEGRATION TO REINTEGRATIONEASTERN EUROPE AND THE FORMER SOVIET UNION IN INTERNATIONAL TRADE Harry G. Broadman Economic Advisor The World Bank Washington, DC hbroadman@worldbank.org February 2006

2. Coming ‘Full Circle’? For many centuries, the Eurasian continent participated in—indeed at the center of—international commerce Events of 1917 (and those decades thereafter) an ‘interruption’ in the long history of Eurasian international integration • Eastern Europe and the Former Soviet Union an isolated trade bloc The Region’s isolation from the world marketplace ended with: • Fall of the Berlin Wall • Dissolution of the Soviet Union • Demise of CMEA • Breakup of Yugoslavia Today, many of the Region’s countries have ‘reintegrated’ internationally and actively trade with the rest of the world

3. Main Questions I. Why—and how—have some countries in the Region internationally integrated more—and in different ways—than others, and what do the current trends portend for the medium term future? What are the implications for the Region’s competitiveness and prospects for growth?

4. Main Questions (cont’d) II. How does trade performance in today’s Region compare with that of others of the world? What factors are most important in conditioning the relationship between greater trade, geography, policy reforms, and development?

5. Main Questions (cont’d) III. Going forward, which policy reforms are likely to be most effective in using trade as a lever to enhance growth in the Region? What are the priority policy issues that all stakeholders—policy-makers in the countries, developed countries and the international community—should focus on?

6. Summary of Main Messages • Without international trade, there would not have been a transition: open trade an engine for growth in the Region • Two ‘new’–yet uneven–trade blocs emerging: a rich ‘Euro-centric’ and a poor ‘Russia-centric’, latter risks being frozen out of the modern ‘international division of labor’; the blocs’ boundaries are soft • A way out? Yes: behind-the-border reforms critical for trade to leverage and enhance development; trade policy is necessary, but not sufficient • Some countries need basic trade reforms; most need BTB reforms • Who needs to do what? Bulk of needed reforms in the Region’s countries’ hands; actions also needed by developed countries and the international community (donors and IFIs)

7. Contours of the Region’s Reintegration In the last ten years: • Exports tripled • Imports increased two and a half times • Since 1995, the Region’s trade has grown at a faster pace than any other in the world Today: • Trade comprises two-thirds of the Region’s output • Open trade now an important characteristic of many of the Region’s economies; sharp contrast to post-1917 period

8. Contours of the Region’s Reintegration (cont’d)

9. Two Emerging Trade Blocs Direction of Global Trade Flows • While EU8 and SEE global exports to EU15 increased, CIS global exports to EU15 changed little • EU8 and SEE global exports to the Region decreased; but CIS global exports to the Region increased Direction of Intra-Regional Trade Flows • CIS intra-Regional trade flows are more (sub-) regionalized and concentrated: most (not all) CIS countries trade more with themselves • EU8 and SEE intra-Regional trade flows more diffused; still, most EU8 and SEE countries trade more with EU8 & SEE and less with CIS

10. Two Emerging Trade Blocs(based on intra-Regional trade flows)

11. Two Emerging Trade Blocs (cont’d) Not only do the two blocs coalesce around differences in: • direction of trade flows… …but also in terms of differences in: • commodity composition of trade: diversified manufacturing vs continued concentration in natural resources and agriculture • factor Intensity: capital/skilled labor intensive vs unskilled labor intensive • domestic inter-enterprise competition; sound governance • trade in services: e.g,.,banking; telecoms; business services • transport & trade facilitation infrastructure & institutions: customs modernization & reform; IT utilization; port development

12. Two Emerging Trade Blocs (cont’d)

13. Two Emerging Trade Blocs(cont’d) Qualifiers to this stark 2-bloc dichotomy: • A sizeable difference in scale between the two blocs: EU8 and SEE trade flows are twice the size of CIS trade flows • Significant intra-bloc heterogeneity: Some CIS countries (e.g., Ukraine) are increasing non-CIS trade; some SEE countries (e.g., SaM) share features of CIS trade; and some EU8 countries’ exports are unskilled-labor-intensive

14. Two Emerging Trade Blocs(cont’d) Qualifiers to this stark 2-bloc dichotomy:

15. How Open Are the Region’s Economies Compared to Others in the World? • Actual openness ‘95-‘03 greatly increased for EU8 and SEE but declined for CIS… • … but compared to projected openness, CIS not “under-trading”; while SEE is.

16. How is this Openness the Result of the Region Liberalizing its Trade Policies? • Much liberalization done unilaterally by the countries themselves through lowering tariffs, among other reforms • Substantial liberalization through global trade agreements: • reorientation of trade to the rest of the world, especially toward the EU, through EU accession and SAAs • increasing participation in the multilateral trading system: 17 out of the 27 countries are WTO members • Regional integration through many RTAs: • CEFTA, BFTA, SEE 29 BTAs, CIS FTA, Eurasia Economic Community, Central Asian Cooperation Organization • manifested in “spaghetti bowls”

17. How Has the Region Been Liberalizing Trade Policies?

18. Current Stance of Formal Trade Policies in the Region: Tariffs Today, the Region’s tariff rates compare favorably with those of LDCs at similar income levels

19. Current Stance of Formal Trade Policies in the Region: Non-Tariff Barriers NTBs still a problem in several countries, especially the CIS

20. How Has Trade Been Propelling Growth in the Region? Early years of transition • Liberal import policies, but weak domestic market institutions and incentives—especially competition and governance—led to ineffective enterprise restructuring • Consequently the increased trade flows had limited adjustment effects on enhancing productivity, growth and reduction of poverty • Indeed, distortions in resource allocation—labor and capital—were created and the higher import levels exacerbated poverty

21. How Has Trade Been Propelling Growth? (cont’d) Later years of transition Countries that: • eliminated disincentives to export • established basic market institutions, and • facilitated restructuring of non-competitive enterprises … benefited from: • increased trade flows • supply response where prices of tradeables rose • business restructuring and creation of new jobs • growth

22. International Integration and Domestic Reform: A “Two-Way Street” Countries that have integrated the most have made more progress implementing market-oriented institutional and domestic policy reforms, and vice versa….. Source: IMF DOT Statistics and EBRD

23. Which Are the Key ‘Behind-the-Border’ Reform Challenges? • Weak competitive domestic business climate and poor governance: high barriers to entry/exit; horizontal & vertical market dominance; state involvement; corruption • Underdeveloped trade and transport facilitation systems and institutions: e.g., discretion in customs; weak regional cooperation • Closed and over-regulated domestic services sectors: especially in “network” sectors, constraining positive externalities • Low levels of FDI participation in high value added global production sharing: EU8 integrated in producer-driven network trade (autos/IT); CIS/SEE—at most—integrated into buyer-driven network trade (clothing, furniture, diamonds) • Rigid factor markets: labor and capital cannot reallocate in response to trade and reduce poverty

24. CIS SEE EU8 Region Domestic 27.1 37.6 30.5 31.3 Foreign 27 .3 48.5 40.0 35.2 Key ‘Behind-the-Border’ Reform Challenges: Weak Competition • Import competition induces efficiency; but less in CIS • Region-wide, foreign firms more sensitive to import competition • Export levels are low where entry barriers are high Importance to Businesses of Competition from Imports Percentage of surveyed firms in 2002 indicating that competition from imports is very or extremely important. Source: BEEPS2

25. CIS SEE EU8 0 5 10 15 20 25 Avrg. subsidies, % of total annual sales Key ‘Behind-the-Border’ Reform Challenges: Weak Competition Evidence from enterprise-level survey Softer budget constraints in CIS; prevents value-subtracting firms from exiting the market and freeing up capital for new investments

26. Key ‘Behind-the-Border’ Reform Challenges: Poor Governance

27. CIS SEE EU8 0 10 20 30 40 avrg. share of sales Key ‘Behind-the-Border’ Reform Challenges: Poor Governance Share of Sales Made on a Pre-Paid Basis Source: BEEPS2 In countries where contract enforcement is weak, firms are adopting risk-averting business practices.

28. Key ‘Behind-the-Border’ Reform Challenges: Limited Trade Facilitation Capacity/Institutions Simulation results: raising Region’s TTF development to 50% of EU15 level, largest trade gains from improving ports and IT applications

29. Key ‘Behind-the-Border’ Reform Challenges:Closed/Over-Regulated Services Sectors Econometric evidence on the Region’s services sector reform: leveraging the growth effects of increases in investment Note: Coefficients and t-values in brackets, asterisks stand or significance at 10, 5 and 1% level Number of observations: 23 for all equations

30. Key ‘Behind-the-Border’ Reform Challenges: Low Levels of FDI Restrict Opportunities for Trade Trade and FDI flows are complements: in the globalized economy, participation in high value-added network trade is limited if FDI is low Source: Export data based on UN COMTRADE Statistics and IMF DOT Statistics; GDP at market prices (current US$), DDP World Bank; Net FDI Inflow World Bank, World Development Indicators through SIMA and UNCTAD World Investment Reports 1995-2003

31. Key ‘Behind-the-Border’ Reform Challenges: Rigid Factor Markets Can Worsen Poverty • Labor mobility constrained where administrative mechanisms engender wage uniformity, health and pension payroll taxes are high, social safety nets are underdeveloped, or employment protection is excessive. • Consequently, workers will face disincentives from moving out of weakening sectors to growing ones, potentially increasing poverty. • Capital allocation/mobility patterns distorted where creditor rights are weakly enforced or corporate governance incentives are blunted • Undermines investment in higher valued activities and job creation

32. Priority Policy RecommendationsI. Trade Policy Reforms • Reduce and simplify structure of tariff rates; eliminate NTBs • Eliminate bias against exports to promote product diversification • Reform EU CAP and other OECD agriculture protections; revise ‘Non-Market Economy’ anti-dumping designation • Pursue vigorously WTO accession, especially in light of Doha Round • Rationalize and harmonize existing RTAs; make WTO-consistent; and incorporate “new” trade issues, especially services into RTAs

33. Priority Policy RecommendationsII. Behind-the-Border Reforms NB: Detailed policy recommendations are outlined in the study • Encourage inter-enterprise competition • Improve incentives for better governance • Modernize trade facilitation infrastructure and institutions • Liberalize investment in, and regulatory reform of services • Reform FDI policy regime to attract global production sharing participation • Foster flexible factor markets to reduce poverty impacts from changes in prices/output engendered by trade

34. Linkages Between and Sequencing of Reforms • Policy reforms can be mutually supportive and reinforcing: e.g., further tariff reform will enhance import competition, which in turn improves efficiency and increases export penetration • Some actions non-controversial and done in the short- to medium term: e.g., TA for institutional capacity-building • Other reforms face political economy challenges or marshalling resources and done in medium- to long-term: e.g., exposing vested interests to FDI in services sectors; modernizing ports • Sequencing of reforms can be critical: e.g., enhancing labor mobility/strengthening social safety nets prior to liberalizing imports; regulatory reform and strong competition law enforcement prior to liberalization of services

35. Action Plan for Stakeholders:“The Division of Labor” Developed Countries: • Change ‘non-market economy’ designation for AD; OECD reform of agriculture policy; facilitate EU/WTO accession International Community (Donors and IFIs): • TA and institution capacity-building: customs reform; competition policy; governance reform; WTO and EU application process; harmonization of RTAs • Prevent poor CIS countries from “falling through the TA cracks” Region’s Governments Themselves • Rest of policy agenda—largely behind the border reforms—in the Region’s countries’ hands • Trade policy: tariffs; NTBs; anti-export bias; WTO; RTA reform • Implementation of full BTB agenda: competition; governance; services liberalization; TTF; FDI; factor mobility