Cover Image
close this bookA New Europe in the Changing Global System (UNU, 1997, 253 pages)
close this folder8: The European Communities and Eastern and Central Europe
View the document(introduction...)
View the document1. Reintegration into the World Economy
View the document2. Helping the Reforms
View the document3. Road to Association
View the document4. Costs and Benefits of EC Association
View the document5. EC Interests in Association with the East
View the document6. Benefits for the West
View the document7. Western Assistance and the Developing Countries
View the documentREFERENCES


Tibor Palánkai *

* Dr. Tibor Palánkai is Professor and Head of the Department of World Economy at the Budapest University of Economics.

1. Reintegration into the World Economy

During the past few decades a new world economic system based on interdependence and integration has emerged. The process of internationalization and the growth of intensive economic cooperation contributed greatly to the increase of efficiency and welfare in the participating countries. The present high level of economic development in the industrial countries is, without exception, based on intensive international economic cooperation, enabling complex exploitation of the advantages of the international division of labor. High levels of development are inseparable from full and organic integration into the world economy. This thesis is mostly true, despite the fact that in the present world economy the interdependence is highly asymmetric, with substantial negative processes that work mainly to the detriment of the developing countries. Some regions and countries are at the losing end of the international division of labor and are pushed more and more into a peripheral position. The autarkic experiments in the past decades, however, have all failed, and the only developing countries that have been able to catch up are those that entered into intensive international cooperation and are more or less successfully integrated in the global economy.

As a consequence of maintaining closed systems of bureaucratic planning and management, Central and Eastern European countries mostly deprived themselves of such opportunities. The present state of Eastern European economies, their lower efficiency and level of development, therefore, can basically be attributed to the lack of or improper integration into the world economy. In other words, the world economic isolation of the former CMEA countries is one of the basic reasons for their relative backwardness.

According to World Bank estimates, "over the last four decades, had the East European countries pursued economic policies similar to those of Western countries, their per-capita income would be one-third higher." (The New York Times, January 2, 1990) Therefore, world economic integration is of utmost importance for these countries, a goal which should be emphasized no less than domestic issues. Integration is not merely an option for Central and Eastern Europe (ideas about a "Third Road") but an absolute necessity.

Transformation strategies concentrating on marketization, privatization and democratization have to be implemented in the circumstances of serious economic crisis in Eastern and Central Europe. Most of the countries are heavily indebted and debt-servicing is possible only at the expense of decreasing investments and living standards for many years. These countries have mostly missed the technological revolution since the 1970s and their overall technological structure has become more and more outdated. The infrastructure and the service sectors have traditionally been neglected by the "planned" development policies, and the environment has been polluted beyond tolerable levels. Owing to several special factors (the collapse of CMEA trade, the effects of the Gulf War, internal political and ethnic instabilities, etc.) these countries are in deep recession. In addition, they have to cope now with a drop in production, rapidly growing unemployment, high inflation, and budgetary and external deficits.

Therefore, the Central and Eastern European countries now face the broad and complex tasks of transforming, consolidating and modernizing their economies and societies, undertakings which have to be dealt with simultaneously in an unprecedentedly short time. Any success is basically dependent on domestic economic and political reforms, but externally it will depend on whether it will be possible to integrate these countries rapidly into the world economy.

Close cooperation with highly developed regions is of special importance. Experience over the past few decades has more or less proved that less developed countries can achieve satisfactory development only if cooperating and interacting with more developed regions and partners. The policies of delinking have produced limited and highly questionable results, and the regional integration efforts of some less developed countries so far have not disproved the above assertions. Of course, there are no mechanisms which guarantee that integration with the developed countries brings about only benefits and that catching-up is automatically ensured. On the contrary, the global market mechanisms basically tend to increase gaps between more and less developed countries, and some vulnerable societies suffer great losses owing to world market developments. On the other hand, it is recognized that modern technologies, management and marketing techniques, capital resources and gains from intra-company cooperation can be obtained only in cooperation with developed regions.

Through regional integration the EC countries have established themselves as focal points in the world economy with high levels of development. The implementation of the single market program is likely to further increase the attractiveness of the region. The EC integration has widely exploited the advantages offered by close economic relations, particularly the "static" comparative advantages (cost differences) in the framework of a common market. Since the 1970s, however, the emphasis has shifted to dynamic comparative advantages (innovation and increasing efficiency), and, as a result of the technological revolution, the structural advantages (product innovation, technological sophistication) have gained in importance. Creating a single market is a complex response to that challenge: the EC can provide a model for eliminating or reducing "structural protectionism" (such as specific standards, technical or environmental prescriptions, etc.) that could be applied on a wider basis in world trade.

For the Central and Eastern European countries the development of close and complex relations with the EC is of strategic importance. The EC not only is the most attractive partner geographically, culturally and economically, but also serves as the gateway to the world economy. It is not by chance, therefore, that the Eastern and Central European countries are seeking association with the EC and most of them declared that they hope to be accepted in due course as full members of the Community. "The vacuum left by the collapse of the Soviet empire has had to be filled; and the EC alone can fill it." (Financial Times, December 2, 1991)

2. Helping the Reforms

Owing to emerging political changes, particularly in Hungary and Poland, the OECD countries (Group of 24) have committed themselves to facilitate the processes of transformation. At their meeting in July 1989 the leaders of the Group of Seven asked and authorized the Commission of the EC to coordinate a specific support program for Hungary and Poland.

This was an extremely important development in terms of political prestige and recognition of the special role the EC plays in the reconstruction of the Central and Eastern European economies.

The special action plan of the EC (PHARE - Poland and Hungary: Assisting Restructuring Economies) to help the two countries was launched in September of 1989. PHARE envisioned financial support to these two countries in various forms, such as food aid (to Poland only), join investments, and assistance in the fields of environmental protection and management training. The European Investment Bank has offered an ECU 1 billion credit which is guaranteed by the EC budget as well. Contingent upon IMF approval of an economic policy package, Hungary will receive a $1 billion bridging loan from the EC to deal with its structural balance of payment problems for five years. In fact, in order to ensure broad coordination of policy by the Group of 24 members, the conditions for financial support are that the Eastern and Central European countries must come to terms with and meet the requirements of both the IMF and the World Bank.

The assistance of individual countries of the Group of 24 is variable (the main contributors are Germany, Japan, the USA, Finland), and it includes financing certain projects, support for foreign investments, export credit guarantees, education and training, investment in protecting the environment and in the energy sector, and other matters as well.

The PHARE program offered several trade policy concessions to the two countries. On January 1, 1990, the EC eliminated all special quantitative restrictions, five years earlier than it had been designated by the Hungarian-EC trade and cooperation agreement signed in 1988. The quantitative restrictions remained in force only in the fields of voluntary export restraint (steel, textiles, mutton, etc.), but the quotas were also increased (by 13% and 23% for Hungary and Poland, respectively, for textiles in 1990). These measures affected 1,700 products, amounting to about 4 percent of Hungarian exports to the EC.

In addition, the Generalized System of Preferences (GSP) status was extended to these countries, and for a broad range of products they now enjoy free access or preferential treatment. The 1988 agreement, which applied the principle of MFN treatment by mutual consent, put Hungary on an equal basis with developed market economies such as the USA or Japan. Now this status has changed, and Hungary and Poland are categorized as developing countries. The tariffs on some Hungarian agricultural products (goose liver, onions, cherries, etc.) were also reduced.

In June 1991, the European Bank for Reconstruction and Development (EBRD), an organization designed to expedite the transformation and economic consolidation of Central and Eastern Europe, was established. Its initial capital is about ECU 10 billion, and the EBRD began its loan operations in 1991. The Bank's financial supporters originally included the Group of 24, six Central and Eastern European countries, the Soviet Union and some other countries (altogether 42 countries, including some developing countries). Later, the number of participating countries increased to 55. The primary objectives of the EBRD are financial revitalization and expansion of the private sector in these countries, support for the creation of joint ventures with the participation of Western capital, and contributions to infrastructural development.

3. Road to Association

The idea of connecting the Central and Eastern European countries more closely to the previously established European organizations (particularly the EC, but also EFTA) was already raised in the second half of the 1980s. As a way of "returning to Europe," the possibility of full membership in the EC had been broadly discussed in some intellectual and political circles in most of the Eastern and Central European countries already in 1989. On the EC side, the idea of association was raised by several leading EC politicians (Helmut Kohl, Jacques Delors, Hans-Dietrich Genscher) in the autumn of 1989; and the most specific proposal was offered by the former British Prime Minister Margaret Thatcher, who in a statement in the House of Commons on November 14, 1989 proposed a "Turkish type" of association for interested Central and Eastern European countries.

Officially, the idea of offering association to these countries was raised in early 1990, but it was stressed that the implementation of the more pressing EC integration plans (the "deepening" processes, such as the establishment of a single market, monetary union and political integration) should receive absolute priority.

The official decision on the issue that opened the way for concrete and practical preparation was made at the Dublin summit meeting of EC leaders on April 29, 1990: "Discussions will start forthwith in the [EC] Council, on the basis of the [EC] Commission's communication, on Association Agreements with each of these countries of Central and Eastern Europe which include an institutional framework for political dialogue." (Financial Times, April 30, 1990)

In general, it was agreed that trade liberalization should be the centerpiece of any association of Central and Eastern Europe with the EC. The Community offered "European agreements" to these countries which recognized the differences in levels of development and the specific problems of the region. The association agreements with Czecho-Slovakia, Hungary and Poland that were signed on December 16, 1991 are based on asymmetric trade liberalization measures, and have to be progressively implemented during a transition period that lasts until the year 2000. The agreements establish a full free trade area between the affected regions, which is essential for the Central and Eastern European economies in order to exploit all of the market benefits and impulses for the reconstruction and modernization of their economies. The three countries also negotiated free trade agreements with EFTA countries and among themselves (CEFTA). (In January 1993 CSFR was divided into two countries.)

Originally the association was offered by the EC to all of the former socialist countries of the region. Meantime, in some countries serious social and economic conflicts emerged and the dual goals of transition - a market economy and real democracy - proved to be incompatible (Romania and Bulgaria). In Yugoslavia a bloody civil war broke out and the future of the country became uncertain for a long time. In light of these developments, the association offer to these countries was postponed. Romania and Bulgaria concluded similar, but somewhat more limited association agreements about a year later than the Three. Meantime, the waiting list for association has broadened, and the Baltic states appear to have good chances for early association. In view of the break-up of Yugoslavia, an association may be offered to some of the republics later, provided an acceptable peace is created.

Politically, Hungary has made it clear several times that the country strives for full EC membership, and this aspiration is broadly supported by all the major political parties. The new, democratically elected government stated on May 22, 1990 that Hungary "is committed to the idea of European integration" and it aims at gaining "membership in the European communities" in the next decade.

Over and beyond the concrete economic benefits of an association, EC membership is attractive for several other reasons, too. Hungary has strong traditional cultural relations with France, Italy and Germany. The EC is considered to be a fulfillment of traditional European political and moral values. There are major expectations of economic improvement and of the stabilization of the democratization processes once a country has joined the EC. Despite their difficulties, Greece, Spain and Portugal are considered as examples of success. There is a deep conviction, particularly among Hungarian intellectuals, that the country culturally and historically belongs to Europe, and a stable and prosperous Europe can be achieved only through unification. Similar aspirations for full membership have been spelled out in each of the other Central and Eastern European countries.

4. Costs and Benefits of EC Association

The benefits of association with the EC (which also apply to similar arrangements with EFTA) can be compared to those that have arisen in different forms of market integration (free trade areas, customs unions or common markets). They can be further extended by several additional measures.

As a result of the formerly closed character of the Eastern and Central European economies, both structurally and institutionally, large potential "static" gains (latent comparative advantages) can be anticipated. Although Hungary has so far implemented some one-sided import liberalization measures, the opening will become mutual through free trade association. A free trade association may enable the countries of Eastern and Central Europe to exploit such advantages on a large scale, making it possible for producers and consumers to use the cheapest import sources for both production inputs and final consumption. This could lead to "trade creation" in both directions (replacement of inefficient and expensive domestic production by cheaper imports). These "static" advantages and efficiency gains could be substantial. In the areas where Hungary has a comparative advantage, export possibilities can be opened, and a conscious exploitation of them (by proper marketing strategies, flexible adjustment to market changes) could ensure over time a satisfactory external balance for the country. Parallel free trade arrangements with other partners (the other associating countries, EFTA, and even the USA) would assure that the diversion of trade would be minimal.

By opening the formerly closed domestic markets, their structures can be broken up, and really competitive market conditions can be created. Such a development would be extremely important. Thus far the reforms oriented toward marketization have often failed to produce the anticipated benefits precisely because monopolistic market positions have not been eliminated and so profits have remained a function of market position rather than expressive of increasing efficiency. Market competition could lead to the cutting of monopolistic prices and costs, to eliminating shortages, to improving the quality of goods and increasing efficiency in general.

Market competition and direct company contacts with Western partners would promote technological progress and the transfer of modern technologies as well as structural change. The bureaucratic central planning and the monopolistic position of state-owned enterprises were accompanied by an unreasonably slow rate of technological development, a lack of interest in innovation, and the general structural rigidity of the economy. Revolutions in technology have made drastic cost reductions possible (for example, by computerized systems of organization, new management structures, organization of cooperating partners outside the company). They have also led to a radical transformation of services and infrastructure (new information techniques and communication systems). The Central and Eastern European countries have missed much of this development, and thus the gap between them and the Western countries has increased. The competitiveness of Central and Eastern Europe has further deteriorated, and the region has missed many market opportunities (which have been seized by the NICs, especially in Asia). This was accompanied by serious distortion of their development. These countries had become severely indebted by the 1980s. There is no doubt that renewed emphasis on technology is of utmost importance; technological and structural modernization could help to realize enormous benefits once the market is adjusted.

The so-called dynamic effects of market integration can be exploited through association, too. Large open markets can give scope for utilizing the economies of scale and reducing costs in different fields of production. Technological progress, productive cooperation, and specialization in supplying components and in certain services lead to dynamic comparative advantages. Extensive participation in transnational company relations can increase microeconomic efficiency and ensure better access to global markets. These advantages can be extended by eliminating all the barriers to trade and cooperation (as within the EC owing to the internal market).

The larger markets can attract joint ventures and private capital investments. In the framework of market integration, capital resources can be mobilized and allocated in a more efficient way (particularly in common markets). The trade and the flow of technology, and the related capital movements, are interconnected. With larger markets, national economies are better placed to overcome structural and institutional bottlenecks in capital supplies. In this respect, Hungary's association and participation in the 1992 measures would improve the opportunities and the competitiveness of Hungarian enterprises. "Above all, the combination of market access in the EC, import liberalization and the improved and more predictable legislative framework should further stimulate the inflow of foreign investment, on which the three countries must rely for new technology and management. They hope that the association agreements will enable them to take full advantage of their two main advantages: a cheap and well-educated workforce; and proximity to the heart of an EC market about to become the largest in the world." (Financial Times, December 2, 1991) Companies from EC countries as well as the USA or Japan could take advantage of the skilled labor force and the low wage rates in Central and Eastern Europe to build factories there and ship products to the West.

An association may also improve the macroeconomic performance of the countries concerned in many respects. It is generally assumed that the dynamic effects of market integration increase the growth rates. The process of economic growth can be stabilized beyond the market impulses by proper economic policies, and in some fields by the coordination of policies. The structural change can help the nation better utilize its labor resources (thus reducing unemployment). Monetary cooperation (some sort of connection to the EMU) is, as the experience of some members and outsiders clearly proves, indispensable for stabilizing exchange rates and paving the way for the convertibility of national currency. It is, of course, necessary from the beginning to control tendencies toward accelerating domestic inflation. The association can improve the chances (through trade preferences and other support mechanisms) of avoiding serious external imbalances which would likely result from integration into the world economy.

It must be stressed that the Central and Eastern European countries (including Hungary) are not yet at all prepared for integration into Western Europe. The above advantages, therefore, are highly hypothetical and they may be realized only after a long and conscious preparation that must include tough adjustments. It should be clearly understood, as well, that association also involves several dangers. We need to be fully aware of them. These dangers could generate substantial costs, sometimes arising out of a confusingly close relationship to benefits.

(1) Structural changes based on and induced by market integration could lead to uncontrollable and undesirable economic and social consequences and tensions. The rapid elimination of inefficient enterprises and subsequent bankruptcies could result in relatively high unemployment, which could be aggravated by institutional and infrastructural rigidities (such as immobility of labor because of housing shortages, etc.). The process can be moderated by the asymmetric and gradual liberalization measures of association, and also by proper and comprehensive domestic employment and social policies.

(2) Structural changes based on market integration may be subordinated to an undesirable extent to the short-term commercial interests of foreign companies, which may even reproduce the structural distortions on a new scale. The growing foreign company involvement may concentrate simply on the region's cheaper labor, while the high-tech capacities are not introduced. Foreign concerns might mostly invest in fields vulnerable to the business cycle, leaving the country in trouble during a recession. These investments may also be limited only to certain sectors, leading to growing structural dependence of the country on the world markets. Or they could strengthen existing monopolistic structures instead of creating competitive alternative patterns.

Association, therefore, must be accompanied by comprehensive national structural policies based on carefully constructed preferences and incentives that consider the interests of both the foreign companies and the country. Recent experiences prove that these types of structural policies are absolutely necessary in order to strike a balance between host country interests and those of the foreign companies. Structural policies are also needed to avoid regional distortions arising out of market integration.

(3) Servicing the accumulating debt would require a surplus on the balance of trade and payments over a long period of time. Experience over the past few decades suggests, however, that market integration often leads to deterioration of the balance of trade and payments, particularly in the case of a less developed country. In spite of broad liberalization measures since 1988, this danger so far has not been demonstrated to occur in every instance. On the contrary, owing to rapid export expansion, Hungary managed to bring down its debt service ratio (percentage of debt service in export earnings) from 75 to 29 percent between 1986 and 1991. Once association is implemented, however, the balance of payments problems may emerge in the future because of structural weaknesses and inherited rigidities of the economy.

(4) Market integration can also cause deterioration in the macroeconomic performance of the affected country (depending on the economic policy). This particularly refers to the macrobalances, and not only the external balance. The country may suffer serious terms of trade losses through liberalization, and the continuous external imbalances may force a progressive devaluation of the national currency, which could result in uncontrollable inflation. Inflation and unemployment may induce economic policy-makers to set a course that is counterproductive from the point of view of consolidation and structural change.

On the other hand, of course, the country may be compensated for these losses. The need for monetary cooperation beyond simple free trade association must also be stressed in this context. One of the main shortcomings of the association agreements signed with the three Central European countries is that the EC has failed to address their financial difficulties in any respect.

To sum up, the association arrangement is accompanied by dangers and social costs which are neither totally unavoidable nor unmanageable. Some costs must be simply accepted, but they may be counterbalanced by the overall benefits of association. Others (e.g. unemployment) can be treated by appropriate economic policy measures, and the negative consequences can be reduced to a tolerable level. It is, however, very important to stress that an association is not automatically beneficial, and comprehensive integration strategies and measures must be developed both at the EC and domestic policy levels.

5. EC Interests in Association with the East

Western European countries are less enthusiastic about association with Eastern Europe than the other way around. In the short run, Western interests are particularly weak and vague in many fields, and there are spheres where interests conflict.

First of all, the political interests of the EC in accepting the countries of Eastern and Central Europe even as associated countries are fairly contradictory. The reforms and revolutionary changes in Eastern and Central Europe were received enthusiastically by the West at the outset. It was a common hope that the division of the continent by hostility and confrontation could be replaced by cooperation and friendly relations, and that the tremendous costs and burdens of military confrontation could be saved. It was also broadly accepted that the Eastern and Central European countries, by transforming themselves into democratic societies, were entitled to be integrated into the European unification process as full partners.

At the same time it seems that the feeling of urgency about taking these countries into the democratic club of Western countries is not nearly as strong as it was in the case of the accession of Greece, Portugal, and Spain. While under the conditions of bloc confrontation in Europe the fairly balanced economic pros and cons on both sides were unambiguously overridden by political considerations in favor of letting these countries into the EC, the disappearance of the bloc division has seemed to make comparable initiatives concerning Central and Eastern Europe weaker.

The changes in Central and Eastern Europe have also renewed the discussions about the EC's priority of "deepening" or "enlargement." There were anxieties and fears that any form of closer relations (association or membership) with the East might endanger political integration and undermine the progress related to the single market and monetary union. The region is afflicted in this period by serious social, political, national and ethnic conflicts, and the EC is clearly reluctant to undertake any full commitment to the security and stability of these countries. The Maastricht Treaty and subsequent decisions clearly indicate that priority is to be given to early membership of EFTA countries in the EC, while the question of admitting countries from Central and Eastern Europe is being postponed.

However, it must be stressed that the goals of EC deepening and integration with Central and Eastern Europe are not necessarily contradictory and incompatible. Though the countries in the East are definitely behind with respect to marketization and privatization, most of them are roughly at the same level of development as the Mediterranean members. Portuguese and Greek membership has not wrecked the EC; why should it be supposed that, for example, Hungary's admission would do great damage? It must also be emphasized that these countries are no less supportive of European unification than are present EC members and they have no reason to obstruct the integration process.

The developments after the revolutionary changes, in fact, indicate that the Central and Eastern European countries will not hinder the process of European integration. On the contrary, the changes have given new impetus to accelerating the implementation of plans for monetary union and political integration in the EC. Community officials point out that the revolutionary changes in the East have highlighted the need and urgency to continue the process toward a single market, and toward monetary and political union as well. (Business Week, November 13, 1989, p. 43) The EC's role in world affairs has been greatly upgraded by East European events both with respect to the coordination of aid and recently in handling the Yugoslavian crisis. The latter may contribute to the formulation of a security policy and role in the Community, even if the efficiency in settling the conflict has proved to be highly questionable.

In economic terms, Central and Eastern Europe is still a marginal partner for the EC, and this situation will not change overnight. The trade of the former seven European CMEA countries (including the USSR) with the EC was about 3.3 percent of the EC's total trade in 1990, which meant exports of ECU 36.6 billion to the EC and imports of ECU 33 billion from the Community. The foreign trade of the seven countries, with 380 million population, roughly equaled in the same year that of Switzerland (ECU 34.3 billion export) with only a 6.5 million population. The trade with the three associated countries (Czecho-Slovakia, Hungary and Poland) was only ECU 11 billion on both the export and the import side, while all six countries (i.e. the above three plus Bulgaria, Romania, and Yugoslavia) of the region had total exports of ECU 21 billion and total imports of ECU 22 billion with the EC.

The six Central and Eastern European countries have about 130 million people, and their combined trade accounts for only roughly 4 percent of world trade, while the share of the twelve member countries of the EC is more than 33 percent. There are also asymmetries in the trading relations among different member countries. More than two-thirds of Hungary's EC trade takes place with Germany and Italy (52.4 and 17.7 percent of Hungary's EC exports in 1990, respectively). (Foreign Trade, Eurostat, April 1991) Taking into account the heavy indebtedness of these countries, the prospects of rapidly dynamizing this trade are rather bleak, particularly in terms of Western supplies. It must be stressed, however, that in the long run the above disproportions have to be considered potential assets rather than liabilities.

The structural weaknesses of the Central and Eastern European economies create limits and counter-interests in trade and cooperation. Their exports are composed mainly of such materials and goods in which the expansion of trade is limited by static demand, and also by inflexible export capacities. These sectors are particularly vulnerable to cyclical changes.

In the short run, Hungary's export potential is mostly concentrated in such fields as textiles, steel and chemicals, which are considered "sensitive" products, and thus are subject to protection in most countries. This output of "crisis industries" often faces fierce competition both from West European producers and from developing countries.

One of the stress points of any Eastern and Central European future membership is agriculture. Most of the countries of the region have agricultural surpluses (potentially the same could apply to Romania or Bulgaria, which may overcome present shortages in a relatively short time in the future) and many have comparative cost advantages. Therefore Central and Eastern Europe would be a serious threat to the CAP (Common Agricultural Policy) as both a competitor and a candidate for budgetary support.

In the middle of the 1960s, agricultural goods accounted for more than 60 percent of the Hungarian exports to EC countries. This share decreased to 30 percent by 1981, and it was 25.6 percent in 1990. In the middle of the 1970s still more than half of Hungarian agrarian exports consisted of meat and live animals, which share fell to only a little more than 15 percent by 1990. Because of substantial and influential farm interests in many EC countries this situation cannot be significantly altered: the agrarian and "crisis industry" lobbies of the less developed EC members will exert the greatest resistance not merely to a full membership, but even to the association of these countries. This was well demonstrated by the rigidity of France's position toward the three association candidates concerning beef and goose liver exports, which disclosed that the EC is reluctant to give even minor and marginal concessions to these countries in "sensitive" sectors. There are particularly strong sectoral counter-interests (textiles, furniture, glassware) and fears against granting such concessions in the less developed member countries.

Of course, the interests and views of EC countries and peoples are far from being unanimous on these issues. Some are in favor of the overall development of relations, and they see the integration of Central and Eastern European countries as a factor pushing the EC to undertake long overdue reforms and structural changes. "Hungarian agricultural products have to find ways to EC markets," according to Professor Victor Halberstadt of Leiden University, "and the East European developments will force the common market countries to reform their agricultural system more quickly than otherwise." (Vilaggazdasag, February 13, 1990) Despite wide-ranging reforms over the years, these countries were considered as "state-trading" countries until recently, and there are still fears in the West about possible unfair competition and hidden protectionism inherent in their system.

The disappointing experiences of the past with respect to debt, as well as continuing political uncertainty in Central and Eastern Europe, have made many in the West reluctant to give more extensive help. On the other hand, the President of the EC Commission, Jacques Delors, stressed in a television interview as early as October 1989 that the EC felt obliged to help Central and Eastern European countries, and had the resources to do so. "It is in our interest, because if we do not help them, the political reforms in Poland and Hungary can easily fail, they can fall back into the cold night of totalitarianism with all of its consequences, including the danger of a conflict." (Magyar Nemzet, October 24, 1989) In a speech at the economic gathering of the CSCE (Conference on Security and Cooperation in Europe) in Bonn in March 1990, the Italian Minister of Foreign Affairs Gianni de Michelis proposed that the EC allocate $15 billion a year in aid to Central and Eastern Europe, which would mean setting aside 0.25 percent of Western countries GNP for such help. He also argued that "this relationship does not depend simply on generosity and political solidarity, but on our self-interest." (Financial Times, March 24, 1990)

Although aid to Central and Eastern Europe is seen less and less as a simple financial burden or as a politically and economically uncertain venture, the resources needed are substantial and the EC could easily find itself financially committed beyond its current capacities. According to Delors, if the six new democracies of the East get the same help under the same criteria as the EC's own less developed regions, it would require an extra ECU 14 billion a year in new EC resources, plus an additional ECU 5 billion a year from the European Investment Bank. (Financial Times, January 18, 1990) Altogether, that would mean an amount of ECU 100-200 billion for the EC rechanneled to the Central and Eastern European countries over a period of five to ten years. The annual budget of the Community was less than ECU 50 billion in 1991. The costs of German unification were estimated at about DM 140 billion in 1991 and they may have reached another DM 200 billion in 1992, magnitudes of expenditure that have substantially exhausted European capacities to help the other new democracies.

If the EC is committed to helping Central and Eastern Europe then the necessity of financial and budgetary reform can hardly be neglected. The reforms are particularly urgent because under present arrangements there is a constant danger of budgetary overspending owing mainly to common agricultural policies. In fact, the EC faced budgetary constraints already in 1988; these have been eased somewhat because of an increase in agricultural world market prices and the improved export possibilities of those products, which formerly had accumulated in large stocks. This budgetary relief, however, proved to be short-lived and the constraints began reemerging again in 1991 expenditures. The decisions on EMU in Maastricht mean substantial additional budgetary burdens (structural and "cohesion" funds) for the Community and according to "Delors package II." The Eastern and Central European countries can expect to receive only modest financial support in the future.

Helping Central and Eastern Europe on a larger scale might also adversely affect certain regional interests, in connection with the proffer of trade policy concessions. Less developed EC nations such as Spain, Portugal and Greece are concerned that some of the economic aid they had expected to gain from the newly integrated Community may go instead to Central and Eastern Europe. (The Washington Post, February 24, 1990) There are also financial commitments to the less developed countries outside Europe, particularly arising out of the Lomé Conventions. There have been traditionally tough bargaining sessions between the EC and the African, Caribbean, and Pacific (ACP) countries over the volume of aid, but this time Central and Eastern Europe may be blamed for any aid reductions.

There are also still fears about possible misuse and inefficient utilization of the resources transferred to Central and Eastern Europe. A report by the secretariat of the United Nations Economic Commission for Europe concluded that an aid program to the Soviet Union, Central Europe, and the Balkans comparable to the Marshall Plan would cost about $16.7 billion a year over a four-year period. As reported in the Financial Times (April 18, 1990), however, the ECE secretariat doubts the capacity of the Eastern and Central European economies to absorb aid on this scale efficiently. Therefore, the study puts emphasis on technical instead of financial assistance, which would first help to create the necessary legal, financial and institutional frameworks (for example, a Central European Payments Union) to improve the infrastructure, and to develop requisite market skills and conditions.

Despite dramatic political changes and the efforts to enact economically attractive legislation, the countries of Central and Eastern Europe do not yet offer sufficiently encouraging and convincing conditions for investment and business opportunities to most Western companies. There is no need to stress that foreign private investments and joint ventures would be of utmost importance for the technological and structural transformation and modernization of these economies. According to estimates by the Hungarian government, a minimum of $1.5-$2 billion in capital is needed annually to create a viable investment environment, beyond financing the $3-$4 billion debt service obligations in 1990-92. So far, however, somewhat less than $4 billion had been invested cumulatively in Hungary up to the end of 1992. There is a danger that, owing to the Yugoslavian civil war, foreign capital will remain reluctant to invest in the country on a larger scale.

Although the progress of democratization in most of the Central and Eastern European countries has been leading to positive changes in the investment atmosphere, several restrictive legal, institutional and economic policy factors remain with us. The attractiveness of Central and Eastern Europe from an economic viewpoint is still limited because of some persistent difficulties and certain discouraging social and political developments (such as accelerating inflation, balance of payments and budgetary problems, reemerging ethnic and nationalist conflicts). It should be appreciated that, as a function of changes and improvements, investment interest on the part of some foreign companies is growing, but caution still remains. The Yugoslavian civil war and the uncertainties in other countries have definitely had an inhibiting effect on the process.

Conversely, there are some fears and reservations that Central and Eastern Europe might be "too successful" in its adjustment and "too attractive" for foreign capital, particularly in the long run. Some EC industries are afraid that the region may become a cheap supplier of goods and a major competitor in a variety of products (labor-intensive products based on cheap skilled labor, mass consumer durables and other items). In particular the less developed EC countries see a direct threat in the Eastern and Central European countries because the latter may attract large transnationals, thus diverting capital resources away from them.

As has already been mentioned, such fears of the less developed members are not totally unfounded. Spain, for example, has attracted $45 billion in investment since 1986 and now fears that some of the private investment previously directed toward the developing Mediterranean nations might soon be rechanneled to the Central and Eastern European countries, which offer dynamic domestic markets for some products and, through their association, access back to the West European markets.

6. Benefits for the West

It must be stressed, however, that association with Central and Eastern Europe could provide great benefits and extensive market opportunities to EC countries (and, of course, to EFTA too). For example, Central and Eastern Europe can offer broad markets for the West, and the huge West European market could soon be extended to include the "hungry" consumers of Central and Eastern Europe. As Frans Andriessen said, "Eastern Europe, with its 136 million inhabitants with a high level of education and great material needs, will become an important trading partner to our mutual benefits." (The Washington Post, February 24, 1990) It is now widely realized that these potential opportunities are substantial, and that depending on the marketization of the Eastern and Central European economies they can grow considerably.

In some fields the opportunities for Western firms to sell are immediate because of a large hidden effective demand coupled with acute supply shortages on the one hand, and accumulated inconvertible money incomes on the other. Owing to heavy indebtedness these countries, of course, need and want to export to the Western markets rather than to buy Western products. But the hidden demand has been very rapidly activated, and in broad fields, in fact, the shortages have been effectively eliminated.

For example, owing to liberalization measures on both sides, Hungary's imports from the EC grew by 27 percent in 1989, by 8 percent in 1990 and by a further 30 percent in 1991. Hungarian exports to the EC increased by 20 percent in 1989 and by 16 percent in 1990. The share of the EC in Hungarian imports and exports was about 25 percent in 1989, it jumped to 31-32 percent in 1990, and it was nearly 50 percent in 1991. (Külkereskedelmi Statisztikai Evkönyv, 1990) It may be assumed that the trade liberalization measures of association will further increase this share in the future.

The potential markets are really enormous in the long run. For example, the number of cars per 1,000 people is 145 in Hungary, while in the USA it is 572, in Western Germany 446, and in Japan 235. The ratios for telephones are 134 in Hungary, 650 in the USA, 641 in Western Germany and 535 in Japan; for television sets it is 275 in Hungary, 621 in the USA, 377 in Western Germany and 250 in Japan. (Financial Times, March 6, 1990) The Hungarian level of comparative consumption of durables, as listed above, is a little lower than those in Eastern Germany and the CSFR, and higher than in other Central and Eastern European countries. The consumption of durables in the region, in general, is about one-fourth to one-third of that in the highly industrialized countries, and the housing situation is even worse. According to a report from the Economist Intelligence Unit in London: "Eastern Europe's demand for cars will exceed supply for at least another decade, even if current price restrictions and the general shortage of goods come to an end... Eastern Europe's production capacity could double to 4.8 million cars by 2000," still leaving substantial possibilities for Western sales. (The Economist, December 2, 1989)

The potential demand may grow even more rapidly if the accelerated replacement of many durables owing to poor quality, energy waste and environmental pollution beyond Western standards begins to take place. The aggregate impact could be even greater if the related service sectors and the enormous possibilities in the housing sphere are included.

The advantages of market integration can be utilized by the EC in terms of both "static" and "dynamic" gains, and the region may offer great opportunities for the exploitation of economies of scale. As a cheap supplier, Central and Eastern Europe may be considered a welcome partner as well as an undesired competitor. These countries, as already noted, have comparative advantages, particularly in their skilled and cheap labor force, and they could easily be transformed into high-quality manufacturing zones for Western companies.

The modernization of outdated industrial structures and technological reconstruction offer immense investment and business opportunities. The long-neglected service sector and infrastructure not only are bottlenecks, but they also offer opportunities for investment and business expansion. Western experiences have proved that investments in this sector can bring attractive returns for investors. According to a British team which visited the Soviet Union under the aegis of the government's know-how fund program in September 1991, the need for and the possibilities of help in services and distribution are enormous. They discovered a country that was logistically crippled. The primitive state of transport, storage, and distribution had given rise to wastage of horrific proportions with almost 40 percent of all produce being squandered. There are clearly great possibilities for Western companies to help develop the distribution infrastructure in Eastern Europe. For those with sufficient vision, patience and determination, an enormous and unprecedented business opportunity awaits. (Financial Times, December 4, 1991) Of course, the picture is different in the other countries, but the great opportunities are there with even better prospects for earlier improvement.

It is not too far-fetched to suppose that in Central and Eastern Europe, as a result of structural modernization and market expansion, there are good prospects for rapid economic growth. The closing of the gap in productivity and consumption in various sectors of the economy (motorization, housing, infrastructure, services, environmental protection, etc.) could secure dynamism within the whole economy for many years. An EC Commission report suggests that, if a proposed free market reform package were implemented, then the Central and Eastern European region could move from the present zero or negative growth to an annual rate of development of 5-6 percent after 1992-93. (Financial Times, May 15, 1990) The measures of 1992, if coupled with an association with such a growth region, could mean powerful potential dynamizing effects for West European economies, unparalleled in any other region of the world, except perhaps Southeast and East Asia.

Many experts predict higher growth rates in the 1990s than in the 1980s for EC countries, partly because of an expected rapid expansion of trade with Central and Eastern Europe, and partly because of the positive effects of the single European market. "The goal of Europe 1992 is to promote a renaissance of the Continent crippled by so-called Eurosclerosis that Europe suffered a decade ago," according to a report in US News and World Report, and "the architects of 1992 hope that by dropping barriers that impede the growth of globally comparative industries,... by cooperating on research and development, accelerating the establishment of Pan-European companies and taking other expansionary steps... Europe could catch up with the US and Japan in five to ten years." (US News and World Report, November 27, 1989, p. 43) Some foresee that even Central Europe may become a new subregional growth and economic power center on the European continent. "The analysis of development path of the West European regions may suggest such a conclusion, that the center of gravity of European economic power may shift from the North French-Benelux-West German-British quadrangle - favourably for Hungary - toward East, in the direction of South German, North Italian, Austrian and Swiss provinces." (Horvath, 1991, p. 107)

By 1992 it had become clear that the problems of transformation are more complex and the accompanying crisis is much deeper and longer than expected. Western Europe also went into recession, owing, to a great extent, to the changes in Eastern Europe (German unification) and to high European interest rates. If the strict Maastricht criteria for monetary union are met, then rapid economic growth can hardly be expected in the EC during the 1990s. One should not exclude, however, the possibility that the positive processes may mutually strengthen each other in the two parts of the European continent. If this happens, it may help to overcome the present crises. There are some serious doubts and reservations, but such an optimistic scenario is not totally out of the question, especially in the longer run.

7. Western Assistance and the Developing Countries

It is beyond the limits of this chapter to analyze all the global economic consequences that might result from the association of the Central and Eastern European countries with the EC. However, the EC's extensive commitments towards developing countries are crucial and thus inevitably need special attention.

There is broad agreement among experts that the consequences of the changes in Central and Eastern Europe for the developing countries will be far-reaching, but in respect of their actual character and direction opinions are deeply divided. There are growing fears among developing countries that, as a result of the suddenly increased interest of the West in Central and Eastern Europe, resources may be diverted, and many worry that the EC governments may eventually rechannel a part of the aid earmarked for developing countries in the South to Central and Eastern Europe. The disappearance of the East-West rivalry, which formerly played an important role in aid determination, now may reduce the motivation and interest in helping the developing countries. The East may be more attractive than the latter for Western private capital because of historical, geographical and emotional ties.

There are mixed feelings about the recent revision of Central and Eastern Europe's status concerning the GSP; many developing countries see this as being directly disadvantageous to their export competitiveness. For many years, the developing countries have resented World Bank loans to Central and Eastern Europe because, on the basis of per capita income calculations, they seemed to them unjustified. Furthermore, the East may now enjoy substantial competitive advantages in free trade agreements, and some of the newly industrialized countries may be particularly affected thereby, despite the official statement, released by the heads of the world's leading industrial countries at their 1990 Houston economic summit of the Group of Seven, that their help for developing nations would not be undermined by support given to reforms in Central and Eastern Europe.

Of course, there are some observers, in both West and East, who feel that, because of inadequate aid distribution to developing countries (only a fraction of all aid reaches those in need), there is no justification for a priority to help the "Third World," particularly if its high social and economic diversity is taken into account. No doubt, some of the newly industrialized economies in the South are even in better shape than the economies of the Central and Eastern European countries because they have large competitive export sectors, established market institutions, developed infrastructures, and socially strong and viable middle classes. At the same time, some of the Central and Eastern European countries, as well as the countries arising from the former Soviet Union (particularly some of its regions), claim, not totally without foundation, to have similar problems to those of the developing countries (such as, among others, hunger, severe poverty and resource underutilization).

It must, however, be strongly stressed that the solution of the problems of poor developing countries is of utmost importance. The priority of their support should be maintained and therefore any cutting of the aid to them must be avoided.

It is very important that both the lenders and the receivers of loans make it clear that reductions in aid will not happen in the future. The Central and Eastern European countries should be supported in their efforts to integrate themselves into the international economy, including, as appropriate, their adhesion to international institutions. This will benefit not only their own people but also the rest of the world. This support must not be allowed to detract from the high priority placed on international development and cooperation with developing countries. The integration of Central and Eastern Europe in the EC will strengthen its role as a dynamic trade partner, as a market outlet, and as a source of technology for developing countries. (General Assembly of the UN, 1990, Para. 35) As Barber Conable, the former president of the World Bank, pointed out: although the World Bank's global mandate "requires us to take an active role in Eastern Europe, our human and financial resources will not be reduced in continuing the fight against poverty wherever it exists." (International Herald Tribune, May 7, 1990)

It has also been pointed out that, although the elimination of East-West confrontation may reduce some forms of aid to developing countries, demilitarization and the reduced importance of ideology, even at times of less aid, may be more beneficial to them. In the long run, the reduction of the East-West military rivalry and arms race should release substantial resources for civilian use, and, though there are difficulties inherent in the conversion process, the potential capacities for helping developing countries could increase. There are indications of growing cooperation between East and West in assistance to developing countries, particularly through international institutions, which could increase both the volume and the efficiency of aid.

Most of these converted resources are aimed at the East, in both their character and structure, and are thus simply not transferable to meet the needs of developing countries, political considerations notwithstanding. This applies particularly to private investment, where direct business calculations and political circumstances generally play decisive roles.

The consolidation of the Central and Eastern European economies and the management of their debt problems actually serve the interests of the developing countries. The default or bankruptcy of any Central or Eastern European country could have broad and undesirable consequences for developing countries. This is true even without mention of the fact that some Central and Eastern European debt had originated in the transfer of resources to developing countries. A consolidated and prosperous Central and Eastern Europe will have more resources and capacities for helping developing countries; the region represents a major, potential addition to the world market, and these countries, if successful, will themselves become sources of capital and technology exports. It is in the overall interest of developing countries that Central and Eastern Europe develops and grows.

Some of the NICs have already recognized the tremendous business potential of the region, and they are ready to take part in the consolidation of the region both as private investors (taking into account the appeal of such access to the broad European markets) and as financial contributors (as participants in the EBRD). Though the worries indicated above should not be ignored, the consequences of changes in Central and Eastern Europe for the developing countries and the world economy, if properly handled, are on balance beneficial for all sectors of the world economy.


General Assembly of the UN (1990), Declaration on International Economic Cooperation, in Particular the Revitalization of Economic Growth and Development of Developing Countries.

Horvath, Gyula (1991), "Az európai régiók gazdasági együttmüködése" (Economic cooperation of European regions). Europa Forum. Budapest, I, No. 1 (August).