Student Publications
El-Jaouni Marianna
Title: International Business Economics Central and Eastern
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INTRODUCTION
The changes that have taken place in
Central and Eastern Europe since the
fall of the
Berlin Wall in 1989 have tremendous
significance for all the peoples of
Europe, both in
the East and the West. They are also
vitally significant for the process
of integration
centered on the European Union and
for the strategies and prospects of
Western
European businesses.
Central and Eastern Europe is not a
homogeneous area. The countries of
the region differ
widely with regard to income levels,
industrial structures and economic
policies, as well
as embodying broader political,
social and cultural differences. At
the risk of
oversimplifying, three main groups
of countries can be distinguished.
Firstly, there are
the Central European countries which
have relatively high income levels,
a strong
orientation towards economic
integration with the West and fairly
stable political
systems. These countries include the
so-called Vise grad Four
(named after an
agreement signed in the Hungarian
city of Visegrad in February 1991)
of Poland,
Hungary, the Czech Republic and
Slovakia, as well as the former
Yugoslav republic of
Slovenia, and possibly Croatia. The
Baltic states of Lithuania, Estonia
and Latvia are also
often lowering included in this
group. Secondly, there is the there
rest of Eastern Europe,
typified by lower income levels, a
more volatile political environment
and a more
protracted and difficult transition
process towards a market economy.
Relevant countries
here are Bulgaria, Romania and
Albania, as well as the remaining
Yugoslav republics,
notably Serbia. Thirdly, there are
the European parts of the old USSR;
most importantly
Russia, but also the Ukraine,
Belarus and Moldavia. In this
assignment I will concentrate
my discussions on the first group,
and in particular on the Vise grad
countries, since these
have the closest links with the
European Union and are almost
certain to be the first
Central and Eastern European
countries to join the EU.
Trade in Central and Eastern
Europe
Under Communist rule the Central and
Eastern European countries showed
two main
characteristics with regard to trade
and foreign relations. Levels of
trade were low, and
were very much centered on the
Eastern European region, with little
integration into the
world economy.
The intensity of a countrys trade
with another country is defined as
the share of the
countrys total trade with the other
country divided by the share of the
second country in
world trade. If the trade intensity
ratio is greater than unity it means
that the trade of the
two countries is more centered on
each other than we would expect
given the pattern of
world trade. If it less than unity
the reverse is the case .intensity
ration are taken to be
better indicators of trade patterns
than simple trade shares because
they are not affected
by factors like size of country and
income. For example, we expect trade
within North
America and in Africa to be
relatively low compared with Western
Europe because in the
first case there are only two large
countries, and in Africa the
countries are poor and
cannot afford large import bills.
The intra-regional trade intensity
for Eastern Europe in the late 1970s
was considerably
higher than anywhere else in the
world, while the intensity of
Eastern European trade
with the rest of the world was lower
than elsewhere. At the same time,
trade in Eastern
Europe was relatively limited in
total size. In 1990s, Eastern Europe
had only a 5 per cent
share of world trade, as compared
with 46 per cent for Western Europe,
16 per cent for
North America and 21 per cent for
Asia.
The reasons for this pattern have
been extensively analyzed. It has
been argued that
centrally planned economies
(Lavigne 1991). Trade is seen in
such systems primarily as
a way of overcoming difficulties in
achieving nationally determined
plans: plans are not
drawn up with international
considerations in mind. In addition,
the Eastern European
countries were limited in their
trade by the fact that much of what
they produced was not
competitive in Western markets.
During the late 1970s and the 1980s,
Hungary and
Poland, in particular, faced debt
.political problems also played a
role in limiting trade,
especially the Comecom restrictions
on export of military or
technologically sensitive
materials to the East (Govan
1990).
Despite the fact that trade within
Central and Eastern Europe was very
much centered on
trade within the region, no
successful multilateral trading
framework was developed prior
to 1989 between these countries .
The Eastern European trading
organization, the Council
of Mutual Economic Assistance,
remained essentially a framework for
bilateral trading
relationships between its members.
Of these relationships the most
important were those
between the individual Central and
Eastern European countries and the
USSR. These
took various forms, but generally
involved the supply of manufactured
products to the
Soviet Union in return for fuel and
raw materials; with Soviet oil
exports to the CEECs in
particular being fairly heavily
subsidized.
Various attempts to deepen the
Comecon machinery to encourage
economic integration
did not succeed .the level of
political involvement in the
planning process made such
integration made such integration an
intensely political matter, subject
to fierce
agreements. This was made worse by
the requirement that Comecon
decision-making be
unanimous. In addition, Comecon
members had markedly divergent
interests along tow
main lines of division. One division
was between those countries
implementing economic
reform, particular Hungary, which
saw integration as involving a
greater use of market
mechanisms in foreign trade,
especially in the area of currency
convertibility, and those
countries such as the USSR, which
saw integration being based on
extending the
planning mechanism across national
frontiers. a second division was
between countries
whose trade was primarily orientated
towards Eastern Europe and those
with wider
international links, which where
more skeptical of integration. For
example, in 1980 the
share of trade with socialist
countries in total trade was 74.8
per cent for Bulgaria, 69.9
per cent for Czechoslovakia, 53.1
per cent for Hungary, 55.7 per cent
for Poland and 41.2
per cent for Romania (Wallace and
Clarke 1986). Comecon did not
appear
institutionally strong enough to
handle these differences and was
finally dissolved in June
1991.
Foreign investment in Central and
Eastern Europe before 1989
Not only trade but also foreign
investment was rather limited in the
CEEs(Central and
Eastern Europen Countries) before
1989. As can be seen, despite
increasingly favorable
conditions for joint ventures from
1971 onwards, the sums invested were
relatively small.
Lavigne (1991) quotes the
soviet author Rodina as finding for
the period 1972-87 that for
Eastern Europe (excluding the USSR)
FDI amounted to only $0.5 billion,
i.e. 0.2-0.2 per
cent of total capital invested in
those countries. For the USSR the
sums were large with
approximately $5oo million being
invested in 1987-88. in the first
seven months of 1989,
immediately before the collapse of
the communist regimes, more Western
money was
invested, but this money still
amounted to only 22.3 per cent of
the investments in
question ( Lavigne 1991). In
Poland, 500 investment
authorizations were granted in the
first nine months of 1989, compared
with 52 in the previous two and a
half years, but the
total FDI inflow was only $110
million (Kilmister 1990).
Problems involved with setting up
joint ventures included the
complexity of legislation,
an insecure environment ( shortages
of materials due to planning
problems and labor
unrest in the Polish case),
relatively high taxes, the
requirement to pay wages t more than
local levels, confusing accounting
systems, and poor communications and
infrastructure.
Against this the CEECs offered both
a large market and a highly trained
workforce.
Trade relations between East and
West after 1989
The magnitude of change required by
the transition to a market economy
involved major
disruption of trading relationship
for the CEECs after 1989. this was
accentuated by two
further developments. Firstly, in
their eagerness to underline the
depth of the changes
taking place, the new Central and
Eastern European governments
dismantled the old
trading arrangements in the region,
such as the Comcon structures, with
considerable
speed. Secondly, the economic crisis
in the USSR from 1990 onwards and
the break-up
of the Soviet Union into its
constituent republics after August
1001 had a dramatic impact
on the CEECs. The effect of all
these factors was to orientate
Central and Eastern
European trade decisively towards
Western Europe. This both opened up
important
opportunities for western European
producers, as a result of the new
markets, and posed
major challenges stemming from the
possibility of a new source of cheap
imports
competing with EU countries.
It can be seen that Central and
Eastern European exports tended to
be concentrated in a
number of areas where western
European producers were facing quite
sever difficulties in
the 1980s, notably agriculture,
steel, chemicals, textiles and
clothing. Indeed most
observers agreed that Eastern
European trade would have been even
more centered on
those areas had there not been
protectionist barriers, notably in
textiles. At the same time,
Central and Eastern Europe offered
new markets for a number of
industries where market
growth was relatively low in the
west and where consumer demand was
previously pent-
up in the East, e.g. motor vehicles
and food, drink and tobacco.
The potential extent of trade
between East and West
There have been a number of attempts
to estimate the likely potential
growth of trade
between Eastern and Western Europe.
One very influential approach has
been to use what
is known as the 'gravity model' to
estimate the expected growth of
trade flows. This
model stems originally from work
done by Linnemann (1966); the
application of it to
Eastern Europe is due to a number of
writers, such as Hamilton and
Winters (1992),
Baldwin (1994 ) and
Winters and Wang (1994). The
account is based on Hamilton
and Winters (1992),
which has been widely adopted as a
benchmark study in this area.
Hamilton and Winters used a version
of the gravity model which
stipulated that for any
two countries the level of trade
between the two countries would
depend positively on the
level of GNP of each country, the
existence of a common border between
the countries
and the existence of trade
preferences between the two
countries; and negatively on the
population of each country and the
distance between the two countries.
Using data for 76
market economies accounting for
about 80 per cent of total world
trade average over
1984 to 1986, they estimated
coefficients for this model. They
then applied the estimated
model to data for the USSR and the
CEECs for 1985 to derive estimates
for potential
trade with other regions of the
world, which they then compared with
the actual situation
obtaining in 1985.
It can be seen that, according to
this approach, the potential growth
in trade is very
significant. The largest absolute
predicted growth is between Germany
and the CEECs;
however, in proportional terms this
is not so large because of the
existing high level of
trade between Germany and the East.
When the Soviet Union is added to
the picture the
results are even more striking.
Hamilton and Winters found that
in 1985 for the Soviet
Union and Eastern Europe taken
together, actual exports to the
European Union were
$27.2 billion and imports from the
EU were $22.2 billion; while the
gravity model
predicted that exports could have
reached a potential level of $14.7
billion. Other
estimates using the gravity model
have been similar in magnitude.
The gravity model has been
criticized for lacking an explicit
theoretical underpinning. An
alternative approach is that
followed by Collins and Rodrik
(1991), who estimated
aggregate equations for exports and
imports based on levels of GNP and
population and
then applied these to the CEECs to
obtain an overall estimate of
trading potential. They
then estimated the breakdown of this
overall potential between particular
countries by
updating a trade matrix for 1928.
They did this by looking at a sample
of six countries
(Austria, Finland, Germany, Italy,
Portugal, and Spain) and by using
their experience to
estimate a relationship between the
trade flows recorded in 1928 and
1989 trade flows.
They than applied these estimates to
the CEECs and to the USSR.
The result arrived by Collins and
Rodrik are fairly similar to
those based on the gravity
model. In the medium term, exports
from the Czech and Slovak Republics
to the 12 EU
member states were predicted to rise
from $3.8 billion in 1988 to 12.6
billion. For
Hungary the predicted rise was from
$2.4 billion to $5.9 billion and for
Poland from $4.3
billion to $20.1 billion (Baldwin
1994). However, the study has
been criticized for
assuming that one can predict on the
basis of the changes that have been
taken place
elsewhere in 1928 trading patterns.
Hamilton and Winters argue
that the countries used
as a reference group by Collins
and Rodrik have all been
strongly affected by the
process of Western European
integration. Using their experience
as a benchmark leads to
an exaggeration of the extent to
which Eastern European trade will
centre on Western
Europe.
Trade within Eastern Europe
after 1989
The initial effect of the collapse
of communism led Eastern European
countries to trade
much less amongst them and more with
the West in general and the EU in
particular.
However, in recent years there has
been a modest revival in trade
within Central and
Eastern Europe. One factor that has
encouraged this has been the
formation of the Central
European Free Trade Agreement
(CEFTA). CEFTA (Central European
Free Trade Area)
was founded by Czechoslovakia,
Hungary and Poland in 1992. Slovenia
joined at the end
of 1995. Romania and Bulgaria have
been negotiating membership. The
Ukraine, Croatia
and the Baltic states have also
expressed interest in joining CEFTA.
The aim of CEFTA was to abolish all
mutual tariffs by 1 January 2001.
However, it
consists of a group of bilateral
trade agreements, reviewed twice a
year. Most industrial
goods and about half of farm
products are free of tariffs, but
there is no CEFTA
bureaucracy and no proposals to
harmonize product standards or
liberalize capital flows
(Lyons 1997). Including
Romania, CEFTA represents a market
of 89 million people with
a combined GDP of just $280 billion.
However, if all prospective members
do actually
join, the market could increase to
160 million people.
Intra-regional trade is rising.
Polish exports to CEFTA raised from
3.6 per cent of its total
in 1993 to 5.8 per cent in 1996. On
the other hand, trade within CEFTA
is dominated by
trade between the Czech Republic and
Slovakia. In 1994, Czech exports to
Slovakia
totaled $2.4 billion. Each of these
flows was over four times as large
as the next largest
set of trade flows within the CEFTA
region for that year (that between
the Czech
Republic and Poland).
Asea Brown Boveri
Asea brown Boveri (ABB), the
Swiss-Swedish engineering combine,
has been one of the
most active investors in Central and
Eastern Europe since before 1989. By
1996 it had
built a network of 60 companies in
the region, the largest
manufacturing operation of any
Western group.
ABB operations in Eastern
Europe 1996
County number of subsidiaries
number of
employees
Poland 13 7000
Czech 6 7000
Russia 14 3000
Romania 4 2000
Ukraine 5 1500
Hungary 4 600
Slovakia 4 500
Croatia 2 500
Latvia 2 400
ABB began negotiating with the
Polish government about possible
investments in 1988
and completed its first acquisitions
in 1990. these were of Zamech, the
only turbine
maker in Poland, and of Dolmel, the
largest generator manufacturer in
the country. This
was the basis for further expansion
in the region, especially in the
area of power
engineering, particularly the
renewal and replacement of out-dated
power stations. ABB
bought a large power engineering
complex in Brno in the Czech
Republic. Orders in the
region grew from $225 million in
1990 to $1.65 billion in 1994. by
1996 ABB employed
almost 30 000 people in Eastern
Europe, out of a total of 211 000
world-wide.
Eastern Europe is an attractive
location for ABB because of both
cost considerations and
market-related factors. Components
like turbines and switchgear are up
to 40 per cent
cheaper there than from Western
suppliers. Acquisition costs are
kept low|; the company
rarely spends more than $20 million
on a single company and its whole
Eastern network
is estimated to have cost just $300
million. In the first nine months of
1996, ABB
reported a 47 per cent increase in
net profits, to a figure of $651
million.
While cost are important, they are
not the sole reason for ABB
investment in the East.
After all, while revenue per worker
in the companys Czech plants doubled
between 1994
and 1996 it remained four times
lower than the ABB average, as a
result of lower
productivity and lower value-added
production. In some ways more
important than costs
are growing markets as the region
builds some ways more important than
costs are
growing markets as the region builds
up the infrastructure of railways,
airports, factories
and energy supplies.
The group has had some problems; it
lost $1 million when a joint venture
in Russia had
to be abandoned when the partner
company was found to be involved in
criminal
activities. More importantly, the
Eastern European activities have
demanded a large
commitment of management time and
energy. The chief executive of ABB,
Percy
Barnevik, is estimated to spend
about a fifth of his time in the
region and ABB has had to
train thousands of Eastern managers
and technicians. In 1995, for
example, ABB trained
17 000 workers in Poland and the
Czech Republic. It has founded
training centers in both
Brno (Czech Republic) and Warsaw.
The company has committed itself to
a common level of quality in both
Western and
Eastern plants, and to managing its
Eastern factories with managers from
the region.
Eastern European managers were
paired individually with Western
counterparts to learn
management and marketing skills.
This approach has now been developed
so that Polish
and Czech employees of ABB are
training Russians and Ukrainians. In
addition to
management expertise the company has
transferred technology, such as
machine tools,
computer programs, technical
drawings and sales manuals.
There has been some suspicion within
the company about the Eastern
European policy,
focusing on claims about the
,,export of jobs from the west.
Between 1990 and 1994 the
Western European workforce of ABB
decreased from 141 000 to 125 000,
with further
large job losses in North America.
At the same time the Czech and
Polish subsidiaries
gave taken over production work from
factories in Germany and
Switzerland. The ABB
Kraftwerke plant in Mannheim,
Germany orders sat least DM35
million of suppliers from
ABB plants in Poland, while the
company has replaced an
engine-starter production line
in Germany with one in Brno and has
moved the production of air-cooled
generators
from Switzerland to Gdansk (Poland).
ABB management argues that this was
inevitable
anyway and that the Eastern
investment safeguards jobs
through-out the company making
it more competitive. Around half the
components in the Asian power plants
built by ABB
come from Central Europe.
It is also the case that ABB plants
in the East have even seen
restructuring and cost-
cutting. At Zamech in Poland the
workforce was cut from 4300 to fewer
than 3200 by
1993 through retirements and the
outsourcing of services such as
cleaning to new private
companies. Production costs fell as
labor; raw materials and factory
space were used
more intensively. In the early years
of the Zamech investment, funds were
concentrated
on computerizing and modernizing
existing equipment. By 1996,
however, total
investment in the subsidiary had
risen to $70 million and the
workforce was rising once
again. Between 1992 and 1996 Zamech
increased its profits from $2000 per
employee to
$16000. Source adapted from
Wagstyl, S. (1996) Woven into the
fabric, Financial Times, 10
January;
Business Central Europe survey on
Foreign investment, April 1996.
Central and Eastern European
external debt
The debt crises have not passed by
the CEECs. Poland was one of the
first countries
which could not meet its debt
obligations (in 1982) and requested
the rescheduling of its
debt. Most of this debt is owed to
western governments with only around
20 per cent
owed to Western banks, mostly
Western European ones.
For the region as a whole the
external debt situation of the CEECs
deteriorated rapidly in
the late 1980s. the total gross debt
of the region reached $ 142 billion
at the beginning of
1991, with the most heavily indebted
countries being the then Soviet
Union, Poland and
Hungary, Bulgaria ran into debt
service ratio of 25 per cent is a
critical figure, the figures
for 1990 for Bulgaria, Poland and
Hungary of 77 per cent, 71 per cent
and 65 per cent,
respectively, show the extent of
these countries difficulties. In
addition, by early 1990 the
Soviet Union began to accumulate
sizeable amounts of external debt.
The strategies used to overcome the
debt problems in the CEECs included
measures by
Western creditors to reduce their
exposure to debt together with
increased direct and
equity investment. For specific
countries the period of the early
1990s saw both Poland
and Bulgaria continuing to seek debt
relief measures, increased borrowing
from
international financial
organizations by Poland, the former
Soviet Union and Bulgaria,
and debt rescheduling by Bulgaria.
Within the CEECs it has been
appreciated that their debt issue
problems cannot be solved
in the short term. The
transformations that have been
taking place with these countries
require greater export growth, and
growth in their economies. At the
same time the
question needs to be raised
concerning the creditworthiness of
these countries.
EU enlargement
Part of the transformantion of the
CEECs has come about through
adopting Western
European practices. However, the
CEECs do not see themselves as
simply following their
larger Western European neighbors
but envisage that they will play a
full part in the
future development of Europe and the
EU. As such, a number of them have
made
applications to join the EU. As a
response to this the European
Commission published
agenda 2000 in July 1997. this dealt
with three main issues:
The future of the Unions main
policies;
The EUs financial perspectives for
the years 2000-2006;
The enlargement of the Union.
As an indicator of the degree of
competitiveness, the EU considered
the degree of trade
integration of the country with the
EU before enlargement, and the
proportion of small
firms. In considering where the
countries are now it is also
important to bear in mind the
position expected of the countries
by the year 2005. in the Commissions
view, Hungary
and Poland come closest to meeting
the two economic criteria taken
together, whilst close
behind come the Czech Republic and
Slovenia. Estonia meets the first
criterion, but has
still got some way to go to meet the
second. Slovakia meets the second
criterion but is not
regarded, at present, as a
functioning market economy. In
addition to these transitional
economies, Malta and Cyprus have
also been included in the first wave
group.
For the successful applicants the
move towards full membership of the
EU is somewhat
different to the accession issues
faced by earlier Western European
economies. They are
poorer, they are in a transitional
phase to a market economy, they face
an EU that is
undergoing change, and they may have
to accept agreements, such as
monetary union,
which are far greater than those
experienced by other applicant
countries before. For
those countries unsuccessful in the
first wave there is a need for the
EU to make sure that
they are not sidelined and that a
major distinction should not be
drawn between those that
are ,,in and those that are ,,out.
Privatization in Central and
Eastern Europe
The growth in FDI into the CEECs can
come through a variety of means: the
establishment of Greenfield sites,
the development of joint ventures
and strategic
alliances between Western companies
and those in the CEECs and through
the process of
privatization.
For the CEECs privatization could be
seen as an important step towards
the creation of a
market economy. It allows state
monopolies to be broken up, creates
a property-owning
middle-class, provides the
motivation for managers, increases
external funding, brings in
new technology and new management
where the company privatized is sold
to Western
businesses, and develops a
share-owning society. The process of
privatization is not
without its difficulties, however.
Firstly, there is a need to consider
how the process of
privatization will take place. It is
possible that free shares can be
distributed to everyone.
Although this returns state assets
to the private sector it does so
without providing the
state with new money. A variation on
this approach is for the free shares
to be in large
investment trusts or funds, which in
turn hold shares in Polish
government. Alternatively,
share could be given or sold to
employees and managers in
organizations, thus providing
an incentive for employees to make
sure that the business operates
effectively. This
approach adopted in Russia. The use
of vouchers is another approach
adopted by the
Czech Republic and Russia. These may
be given to individuals, as was the
case in Russia,
or sold to them as in the Czech
Republic. Foreign investors are also
encouraged to
purchase vouchers. A similar voucher
system has been used in both Poland
and Romania.
The privatization process could also
include the restoration of assets to
previous owner,
and this has been important in East
Germany. Hungary has also ownership.
Finally,
privatization in the CEECs can also
follow the approach adapted by
Western European
governments where shares are sold,
at a fixed price, to both domestic
and foreign
investors. This method was used by
former East Germany and Hungary.
One thing that distinguished the
state sector in the CEECs from that
in the West is the
sheet size of the sector and the
speed with which privatization was
anticipated to take
place . in many Western economies it
took a number of years for
privatizations to take
place and this was with
sophisticated financial and legal
institutions. In the CEECs the
process of privatization has not
been as rapid as expected, and on a
number of occasions,
the privatization process itself has
been halted. The Czech Prime
Minister, Vaclav Klaus,
has explicitly warned against the
"family silver".
In Hungary, opposition to
privatization through foreigners has
been growing. Polish privatization
minister warned against giving
foreigners too much preference in
the privatization process; former
Prime
Minister argued that he had tried
his utmost to prevent foreign
investors taking over Polish
companies.
Polish trade unions accuse foreign
investors of employing ,,salve labor
,, and taking away the ,,family
silver. Russia has restricted the
shares of assets that can be sold to
foreigners and has made little
attempt to
withdraw discriminatory regulations
that exclude foreign investors.
Sinn Weichenrieder 1997, page 182
It can be argued that this is a
rather one-side view of the current
attitude in Eastern
Europe, given the prevalence of
large-scale privatization programs
and the expressed
desire to join the EU. In fact, the
role of state ownership has
diminished somewhat in the
CEECs.
It is important to note that the
process of privatization can be
divided into small scale and
large scale. The privatization of
small-scale enterprises has been
fairly successful,
transferring ownership to the
private sector of small state-owned
enterprises or co-
operatives. It is with large-scale
privatizations that the problems
have occurred. Because
of the lack of financial markets in
their countries, the lack of
resources, and the lack of
management expertise, large-scale
enterprises either have been
difficult to sell or the
government has looked to foreign
capital. As result of these
difficulties, privatization in
the various CEECs has advanced at
different speeds.
CONCLUSION
The past decade has seen a major
changes in the economies of many
CEECs as they have
moved from centrally planned
economies through transitional
phases and on towards the
market-based economies of the West.
This move has been brought about by
the demise of
communism and the realization that
in terms of economic development and
sound
finances the Western European model
for all its deficiencies has much to
offer. Part of
the move towards transition was
prompted by the level of external
debt occurred by some
of the Eastern bloc countries. In
addition to debt issues, the last
decade has seen the
CEECs become more heavily integrated
with the EU, not only through trade
but also
through the role of Western FDI and
the selling-off of state-owned
assets. Many CEECs
now perceive that they would like to
take the next step to greater
integration with the
west by becoming members of the EU.
Integration into the EU is not
without its problems
for both the CEECs and current EU
members. If all proceeds to plan, by
the year 2010
the EU will be seen to cover a
region from the Arctic to the
Mediterranean and from the
Atlantic to the Baltic
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