Trade Flows among CEEC and EU Countries: what future perspectives? Universidade de Évora, Departamento de Economia PORTUGAL - PDF

Trade Flows among CEEC and EU Countries: what future perspectives? José Caetano * and Aurora Galego Universidade de Évora, Departamento de Economia PORTUGAL Draft Please do not quote

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Trade Flows among CEEC and EU Countries: what future perspectives? José Caetano * and Aurora Galego Universidade de Évora, Departamento de Economia PORTUGAL Draft Please do not quote The Eastern enlargement represents an opportunity for trade expansion for all the countries involved. In fact, trade between the EU and the Central Eastern European Countries (CEEC) has grown considerably in the nineties, coinciding with the transition period and the preparation of the CEEC to full-membership. In this paper we analyse the characteristics and evolution of the EU-CEEC trade in the last decade and study the potential bilateral trade flows between the EU and the CEEC. In particular, besides analysing trade relations between CEEC and the EU, we will study trade developments among the CEEC. Moreover, we will take into consideration the sectoral dimension in the analysis. The analysis is based on the gravity model approach using panel data from 1993 to It is possible to conclude that there is still scope for further expansion of the trade flows between some CEEC and some of the EU countries. Furthermore, there is scope for growth on trade flows among the CEEC, due to the fact that EU membership will promote complete trade liberalisation among these countries. Corresponding author: University of Évora, Departamento de Economia, Largo dos Colegiais 2, Évora, Portugal. Tel , Fax , address: 1 1. Introduction The process of enlargement has originated a vast literature trying to quantify its effects, particularly upon trade relations. Many analyses report changes in terms of volume, composition and nature of trade between EU countries and the CEEC during the process of transition. The enlargement to the East represents an opportunity for trade expansion for both the EU and the CEEC, and in effect trade relations between the EU and the CEEC grew considerably during the last decade. In what concerns the impacts on trade, one key aspect is whether the trade potential between the EU and the CEEC has already been exhausted. Studies on the effects of enlargement on trade have presented contradictory results about the overall trade effects of gradual integration of CEEC into international markets. However, recently most papers conclude that actual EU-CEEC trade is either close to potential level or above potential. Other authors have concentrated on the determinants of trade relations and on the evolution of specialization patterns. In this paper, we analyse the characteristics of trends on the EU-CEEC trade relations during the transition period. In addition, we investigate the determinants of bilateral trade flows and compute the potential trade between the EU countries and the CEEC 1, giving particular attention to the relations among the CEEC. The evolution of intra-ceec trade relations has not been receiving enough attention in the literature. The strong dynamics of intra-ceec trade is not only a result of geographic proximity, but mostly a consequence of industrial location strategies from western companies, which led to the development of cross flows within sectors between countries of the same sub-region. On the one hand, multinationals try to take full advantage of geographic and economic proximity and establish strategic positions in these emergent markets. On the other hand, they intend to collect the benefits of economies of scale and technology spillover effects by structuring more competitive clusters which cross the CEEC national borders. In the context of enlargement, one might expect the CEEC to keep up the EU tendency for increasing intra-regional flows and intra-ceec trade to grow faster than EU-CEEC trade. 1 We consider in the analysis the following Eastern countries: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia that joined recently the EU and Bulgaria and Romania which are expected to join the EU in some years to come. 2 One other feature that has not been receiving enough attention in the literature is the sectoral dimension of trade relations. In this paper, an attempt is done to ascertain industry differences, based on the intensity of production factors, in the evolution of trade. In fact, usually the studies consider homogeneity of goods produced using the same proportions of factors. However, lately it has been recognised that the heterogeneity of factor and technological contents draws from different determinants. Therefore, we adopt a classification of industries by the factors considered decisive for the competitiveness of each sector 2, trying to identify the factors explaining the different intensities on trade flows. The paper is organised as follows. Section 2 reports the global and sectoral trends of trade relations between CEEC and EU, giving particular attention to the relations among the CEEC. Section 3, examines the model specification and the results for both total bilateral trade and the industry differences on the EU and CEEC trade relations. Section 4, gives a brief overview of earlier empirical studies on potential trade and investigates the potential trade flows among these countries. Section 5 concludes. 2. The Dynamics of EU-CEEC Trade 2.1. Global trends in the transition period The collapse of centrally planned economic regimes in the CEEC, and the subsequent process of economic liberalisation, brought along important transformations in economic terms and of course in external trade. The European Agreements were an additional determinant for these countries reforms. In consequence, after more than one decade of transition process it is possible to identify some major tendencies in the CEEC-EU trade 3. The CEEC openness to world markets was rapid and generalised, with the degree of openness 4 evolving from 56% in 1993 to around 80% in 2001 in global terms. In some countries like Estonia, Slovakia, Czech Republic and Hungary, the degree of trade openness already exceeded 100%, which clearly underlines the importance of external trade in new EU members. One other issue that is worth mention is the fact that the 2 According to Boillot et. al. methodology, the following groups of industries are used: resource intensive; labour intensive; scale and capital intensive; specialised suppliers; R&D intensive. 3 A detailed analysis on the EU-CEEC trade relations may be seen in Caetano et al. (2004). 4 Defined as the weight of external trade on GDP. 3 CEEC display high and increasing structural trade deficits (around 7,5% of GDP in 2001). In the Baltic countries and in Bulgaria the trade deficit was above 10% of GDP, a result of the deterioration occurred during the last decade. In this period, there was a progressive orientation of the CEEC trade relations to the EU, which coincided with the decline in the relationships with old members of COMECON. In effect, in 2001, the weight of EU in the CEEC total exports was about 66% (in 1993 it was of 54%), which was close from the average of the EU-15 countries. Though, in spite of the intensification of the trade among the old and new members of the EU, the commercial unbalances have subsisted and the trade relationships with EU have been responsible for about 50% of those countries deficit in Yet, EU members contribution for this deficit is not equal for all the countries. In fact, Italy, France and Finland have been responsible for around 74% of EU surplus, whereas Germany, Austria 5, Denmark, Greece and Portugal present a deficit in their trade with the CEEC. In spite of the expansion of the EU-CEEC trade relations, the weight of CEEC in the EU total trade continues to be small in global terms, contributing 5% and 4,3% to the exports and imports, respectively, in 2001 (see Table 1). However, the situation was not similar for distinct countries, with Austria, Greece and Germany displaying the highest values while in the EU peripheral countries, as Portugal and Spain, the weight of CEEC did not exceed 1% of total trade. Trade intensity 6 is quite different across countries as well, being Hungary, the Czech Republic and Poland, amongst the new members, and Germany, Austria and Finland, on the part of the older EU members, those which are clearly more involved in reciprocal trade. The intensity of bilateral trade is also heterogeneous, being the relationships more intense in the following cases: Austria and Germany with Hungary, the Czech Republic, Slovenia and Slovakia; Greece with Bulgaria and Romania; and Finland and Sweden with the Baltic countries. On the contrary, the level of trade is low between the CEEC and the 5 The deficits for Germany and Austria could be considered as surprising. However, this situation is a consequence of the increasing subcontracting activities between firms in these countries and in CEEC, specially under the regime of Outward Processing Trade. 6 The index of the relative intensity of exports has a three-dimensional nature, and therefore takes into account the evolution registered in the exports of the country of origin and the imports in the country of destiny, weighted by the flows of world trade during the period of analysis. 4 Iberian countries and Ireland, in spite of an increase in recent years. So, the intensity of trade is higher for neighbouring countries, which are therefore closer in economic, cultural and historical terms. (see table 2 and 3). Reflecting these asymmetries, new members that share a common border with the former EU members are responsible for 82% of CEEC trade with the EU 7, while the Balkan and Baltic countries present figures of around 10,5% and 7,5%, respectively (Caetano et al., 2004). In what concerns EU member states, trade is also concentrated in frontier countries, with Germany, Austria and Italy being responsible for more than 64% of trade with the CEEC. Portugal, Ireland and Greece, on the other hand, generated only 2,5% of such. As a consequence of the geographical reorientation of the CEEC trade after the collapse of the their economic regimes, the weight of the intra-ceec trade in the total trade of these countries has registered a slight reduction, from 14,7% to 13,8% between 1993 and Nevertheless, in terms of trade dynamics among these countries, there was a sharp decline of 35,8% in the relative intensity of the trade in this period, which was particularly noticeable between 1993 and On the other hand, after 1997 there was a decline in the intensity of trade with the other CEEC in the former-czechoslovakia, Estonia and Hungary (see table 4). It has to be referred also that trade intensity was particularly intense in the several sub-regions (CEEC-5, Baltic and Balkan countries- see table 5), which reinforces the conviction that geographical proximity has been a decisive factor of trade intensity and it will probably continue to be a central aspect after the recent enlargement. 3. Trade Patterns by Factor Production CEEC economic liberalisation changed the relative costs of production factors, causing adjustments in productive structures and trade patterns, reflecting the pattern of comparative advantages in the countries. For along the period of analysis, there were significant adjustments, as in 1993 CEEC had just left centrally planned economic regimes and in 2001 these countries were already integrated into the international markets and they were getting prepared to join the EU. 7 The so-called CEEC5: Hungary, Slovenia, the Czech Republic, Slovakia and Poland. 5 The traditional approach of the comparative advantages pattern, relies in the proposition that goods may be classified according to the factor intensities and proportions employed in production. We can then use this approach to explain the structure of trade among CEEC and EU. We have used in this work a classification of sectors according to the factors that are determinant for the competitiveness of each sector (following Boillot, 2003). We have considered five sectoral groups: Natural Resources, Labour intensive, Scale and Capital intensive, Specialised Suppliers (differentiated goods) and R&D intensive. In 1993, CEEC exports to the EU were fundamentally based on natural resources and labour intensive sectors, reaching about 64% of total exports to the European Union (see Table 6). Profound changes have occurred in the sectoral pattern of comparative advantages in these countries and in 2001 those sectors represented only about 42%. On the other hand, exports of Capital and R&D intensive goods had a significant increase, from 13% to 28% of total exports to EU. The differentiated goods exhibited also a positive evolution. However, there is strong heterogeneity at the country level, with the most significant progress occurring in the CEEC-5, where the weight of scale and capital-intensive industries in total exports was higher then in any other Eastern countries. These countries show a sharp reduction in the labour intensive industries, as well as strong growth in capital-intensive sectors and differentiated goods. On the other hand, the CEEC imports exhibit a similar evolution (Caetano et. al, 2004), suggesting a growing demand for sophisticated goods, from sectors technologically more advanced and that use more qualified labour. Therefore, the pattern of Revealed Comparative advantages 8 of the CEEC-EU trade had undergone significant transformations. Nevertheless, in 2001 the CEEC comparative advantages were still in sectors intensive in natural resources and unskilled labour (see Table 7). In opposition, the comparative advantage of EU countries occurs in sectors intensive in R&D, Capital and Specialised Suppliers. 8 The index used can be seen in appendix. 6 It is also important to refer that along the years there was an increase in the degree of heterogeneity for the several countries and it is possible to identify different tendencies in the specialization pattern. First, those countries with higher level of GDP per capita (CEEC-5) became progressively less dependent on sectors intensive in natural resources and unskilled labour 9. Second, the comparative advantage of the Baltic countries is still based on natural resources, with the industries of wood and its by-products, and oil refinery highly contributing to this situation. These countries major disadvantages are in sectors intensive in Capital, R&D and Specialised Suppliers. Within the Baltic countries, Estonia presents a different evolution since it reveals advantages on differentiated goods 10, built on a few electrical and home-appliances components 11. Finally, the Balkan countries are in an intermediate situation, as advantages are centred on sectors more intensive in labour and natural resources, while comparative disadvantages appeared on industries producing differentiated products or intensive in capital and R&D. There were not significant modifications in the Balkan trade patterns. Meanwhile, there were not many changes in the composition and intensity of factors in the trade relations among the CEEC (see table 8). While in the CEEC exports to the EU, differentiated goods and Labour intensive products are more important, in the trade intra-ceec products intensive in Capital and Scale and in Natural Resources are of greater magnitude. Though, in the CEEC exports to the EU there was a high dynamics in differentiated goods and in the products intensive in R&D and Capital and Scale, while sectors intensive in Natural Resources and labour lost weight in that structure. Analysing the level of technology employed during the production process allows us also to conclude that there are different tendencies among the countries. In the trade among the CEEC continues to prevail the flows based in low technology (it is about 51% of the total intra-ceec trade whereas it represents only 30% of the CEEC exports 9 In 2001, Hungary had already a clear comparative advantage in R&D and Differenciated goods in the trade relations with the EU countries. 10 This type of products represented about 5% of exports to EU and 31% in to the EU). Trade in products of high technology represents only 16% of the intra- CEEC trade against 31% in the exports to the EU. For this distinct situation it contributed in a decisive way the dynamics in the period , where exports to EU countries of average products and of high technology increased more than 9pp. In short, in the transition period there were several different tendencies in the CEEC trade partners. On the one hand, in the exports to EU there was a rapid growth, in particular in R&D intensive sectors and in differentiated goods. On the other hand, trade relations among CEEC were relatively sluggish, not only in terms of trade intensity but also on the sectoral pattern of trade among these countries. Also, there was an increasing divergence of trade patterns among CEEC which suggests different factor endowments, as well as distinct dynamics of integration into the international process of production. 3. Empirical methodology and results In order to study bilateral trade relations between the EU countries and the CEEC, and to predict the trade adjustments associated with the removal of trade barriers, we estimate a gravity model for the period between 1993 and 2001, considering data not only on EU countries but also on the CEEC. Besides analysing total bilateral exports we also take a sectoral approach. This later aspect is important as the countries and sectors involved in the process of enlargement display different characteristics and therefore they are expected to have different determinants. As a consequence, one of the aims of this paper is to analyse the relative importance of the determinants of trade for several sectors. The sectoral analysis has not been common in the literature. One of the exceptions is Marques and Metcalf (2003), which have concluded that in fact the determinants of trade differ across sectors. Yet, these authors use a different sectoral classification and a different methodology. In this paper we employ a gravity model where, following previous studies (like Egger, 2000 or Fontagné at al, 1999), bilateral trade flows are modelled as a function of the sum of GDP of both countries (GDT), the degree of similarity between the two countries 11 This can be associated with FDI from Finish firms, within the process of production reallocation (Kaitila, 2001). 8 (SIM) and the economic distance between the two countries (ED) 12. We also included the geographic distance between the countries, the existence of a common border and two other dummies: EU (indicating whether both countries belong to the European Union or not) and CEFTA 13 (that equals one if the two trading partners were members of CEFTA). There are several specifications that may be adopted to estimate a gravity model. In this study we try to use appropriated econometric procedures to obtain more accurate results. More specifically a panel data approach is employed in order to take into account unobserved country heterogeneity. We consider a panel data model with both time and individual specific effects. Also we consider a general specification using trading pairspecific or bilateral common effects as it was proposed by Fontagné et al (1999), Egger and Pfaffermayer (2003) and Cheng and Wall (2005), which argued that it is the best specification. Furthermore, it is argued that this general model, considering common bilateral effects, gives better in sample predictions. This type of model assumes that there are systematic differences across pairs of countries captured by country-pair constants. These effects control for all time invariant factors that are specific to each of the trading pairs: Exports ijt = 0 + δ ij + γ t + β1gdtijt + β 2SIM ijt + β3edijt + β5distij + β 6Frontierij + β 7EU ij + β8 α CEFTA + ε ij ijt where δ ij represents the unobservable country pair effect, γ t the unobservable time effect and ε ijt is the remainder stochastic disturbance term. The time dummies were included
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