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CEEC Prospects for Convergence: A Theoretical and Historical Overview
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David L. Ellison *
**[The following is a shortened, revised and updated version of a partial chapter of my Ph.D. dissertation at the University of California, Los Angeles (UCLA). Numerous individuals have commented on and contributed to this paper in various ways. In particular, I am grateful to Lars-Erik Cederman, Andrea …ltetŲ, Chris Erickson, Preston Keat, Ed Leamer, Mohan Penubarti, Ron Rogowski, and Michael Wallerstein. I would also like to thank participants at three previous conferencesóthe "First International Graduate Student Retreat for Comparative Research", the 95 th Annual Meeting of the American Political Science Association in Atlanta, Georgia, Sept. 2-5, 1999, and the conference for which this version of the paper was preparedófor their helpful comments. Finally, I am eternally grateful for the opportunity to explore the archives of the Institute for World Economics of the Hungarian Academy of Sciences (Budapest, Hungary) and for the opportunity to use their Eurostat Comext trade database. Special thanks goes to Binyam Tadesse for timely data assistance.]
Seen with Western eyes, linking the economies of Central and Eastern Europe (CEECs) [I use the term CEECís here to refer to the 10 Central and East European countries that have formally applied and are being considered for membership in the European Union. They are the three Baltic states (Latvia, Lithuania and Estonia), the four Visegrad states (Poland, the Czech and Slovak Republics, and Hungary), the two Balkan states (Bulgaria and Romania), and one of the former Yugoslav states (Slovenia).] to those of the European Union (EU) is generally considered the principal means of securing the future growth prospects and political stability of the former Soviet Bloc countries. The European Unions own strategy of integrating the CEEC economies into the Western sphere gave rise to the Europe Agreements and to a gradual process of accession which may lead to eventual membership. While the Europe Agreements included a political component, the principal tool of economic renewal was the trade liberalization protocols they contained and CEEC fulfillment of the broader objectives of market reform required for EU membership and laid out in a later White Paper from the European Commission. [See the European Commissionís White Paper on the "Preparation of the Associated Countries of Central and Eastern Europe for Integration in the Internal Market of the European Union" (European Commission, 1995).]
For the countries of Central and Eastern Europe, membership in the European Union has likewise been seen as the key to political and economic stability, and ultimately prosperity. The Return to Europe is expected to bring rewards surpassing the costs of EU accession and, in its pursuit, the governments of Central and Eastern Europe have adopted market reforms and EU regulations with a passion. The Czech Republic, Estonia, Hungary, Poland and Slovenia made December 2002 or January 2003 their target date for EU membership.
[The EU limited the first round contenders to a subset of five countries (plus Cyprus). The countries that began official membership negotiations in March 1998 were the Czech Republic, Estonia, Hungary, Poland and Slovenia. As a result of the December 1999 Helsinki summit, the remaining CEECís (Bulgaria, Latvia, Lithuania, Romania and Slovakia) and Malta, were invited to join EU membership negotiations as of Feb. 14-15, 2000. Negotiations began March 28 th , 2000. More recently, it was agreed at the Gothenburg Summit that some CEECís could potentially become EU members as early as January 2004. Although, from the EU side, 2004 is mentioned as the first possible membership date for individual applicants, some European officials have suggested the likelihood of later dates.]
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from EU political and market linkages is less obvious and a matter of some debate. Although there is a broad consensus that closer economic ties with the EU represents the most promising alternative for future CEEC prospects, it is surprising, given the relatively lackluster performance of European integration in promoting economic growth and reducing unemployment, that this alternative is not greeted with more skepticism.
The literature addressing the consequences of greater economic openness, trade liberalization, increased economic integration and closer association with more advanced regions largely supports conventional assumptions about the positive benefits that countries should expect. Based primarily on the Heckscher-Ohlin (HO) model of international trade, predictions about these benefits are of two kinds. First, that economic integration improves economic competitiveness, promotes economic growth, reduces prices and increases aggregate welfare. Second, that integration promotes convergence in the costs of the factors of production (labor, capital and land), and ultimately in the standard-of-living. Both for the less and the more advanced economies, the benefits of economic integration are thought to be greater than the losses. With economic integration, economies should grow more rapidly, there should be an overall increase in the standard-of-living and less-skilled labor in the less-advanced countries should benefit from rising wages. EU membership is seen as the logical conclusion of the process of economic integration. As such, if trade liberalization implies a greater capacity for economic competitiveness and growth, then EU membership should generate the greatest possible return on the political decision to integrate.
Despite such rosy predictions, the likelihood that all countriesand in particular less-advanced countrieswill benefit equally from economic integration with more advanced regions remains open to debate.
Firstly, given conventional assumptions about economic growth, many less-developed countries have failed to grow as quickly as one might expect. Secondly, wealth tends to remain concentrated in relatively fixed areas of the world. Thirdly, little wage convergence has been noted across the many regions of the world and wage differentials persist even within areas that have achieved a relatively high degree of economic integration. Finally, even the determinants of economic growth are hotly debated. Endogenous growth theory has given rise to concerns that increasing returns arising from the agglomeration of capital may have potentially negative conesquences for less advanced countries seeking integration either in the international marketplace or regional associations. This and recent findings from Rodriguez and Rodrik (1999) and Slaughter (1998, 1997) suggesting that trade liberalization itself may have little to do with the phenomenon of convergence and may even promote economic divergence, provide bellwether caveats to predictions about the welfare-producing effects of trade liberalization in neoclassical models.
This paper seeks to analyze the relationship between economic integration, EU membership and CEEC economic competitiveness. Based on the previous experience of EU Member Statesin particular the less advanced "cohesion" countries; Greece, Ireland, Portugal and Spainthis paper sets out to question some of the more traditional assumptions of the literature on trade liberalization and economic integration. This account finds that convergence among current Member States of the EU has been greater for the less-advanced countries while they were still outside the EU. Based on
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this finding, it is reasonable to question whether the best strategy for the countries of Central and Eastern Europe is necessarily immediate economic integration with and membership in the European Union.
Due to the controversial nature of this discussion, it is important to emphasize both what this paper suggests and what it does not. It does not attempt to suggest that the countries of Central and Eastern Europe should relinquish their demands for inclusion in the European Union, nor that less advanced countries would be better advised to steer clear of economic integration with more advanced regions. It does suggest, however, that economic integration and closer association with more advanced states is not the be all and end all of improved economic performance. It likewise suggests that purely market solutions to the project of promoting greater economic performance via economic integration are not enough. The role of government, economic policy and even the EUs regional development policy may well be important factors in promoting economic growth and convergence across the regions of Europe. In this respect, the tools of convergence should be advanced to center stage in the enlargement debate.
The paper proceeds in two stages. First, it provides an overview of the literature on trade and regional integration and its predictions for convergence. Second, it discusses EU-CEEC trade over the 1988-1996 period and analyzes the historical experience of convergence and economic growth in Western, Central and Eastern Europe. The final section concludes.
Trade Liberalization, Economic Growth and Convergence
The predictions of the standard neoclassical economics literature and the Heckscher-Ohlin (HO) theory of international trade are sanguine about the prospects of economic integrationespecially in the case of less developed countries integrating with more advanced regions. Countries that are abundant in labor should see a rise in labor-intensive forms of production and countries that are abundant in capital should see a rise in capital-intensive forms of production. Thus, the more advanced EU Member States should benefit from trade with the less advanced CEECs via specialization in more capital-intensive forms of production. The CEECs should likewise benefit via CEEC specialization in more labor-intensive forms of production. On the whole, economic integration is expected to increase aggregate welfare. [For a classic exposition of the HO paradigm, see Krugman and Obstfeld (1994).]
The conventional assumptions of the neo-classical HO model of international trade are that the free movement of the basic factors of productioncapital, labor or goodsis the principal engine of convergence between countries. The regional integration literature most relevant to the experience of the CEEC's builds upon this basic model of trade. It addresses two basic points: 1) whether economic integration promotes competitiveness and economic growth, and 2) whether economic integration leads to convergence, either in the relative costs of the factors of production or in the standard of living across countries. This literature promotes the idea that periods of increasing globalization (understood here as the increasing mobility of goods, labor and capital across political boundaries) are associated with more rapid growth and convergence,
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while periods of increasing trade restriction or relative economic isolation are associated with slow growth and economic divergence.
Economic Integration and Growth: the central argument is that trade liberalization promotes economic growth. Newly emerging economies are encouraged to open up to free trade, since this is seen as one of the central means of promoting industrial restructuring, economic competitiveness and rapid economic growth (Sachs and Warner, 1995; Dollar, 1992). There are a number of mechanisms by which trade liberalization is thought to promote economic growth. For one, it should make inputs cheaper. If economies depend on large amounts of foreign inputs, then the reduction or elimination of tariff barriers will make end products more competitive. For another, opening economies to foreign goods increases competition. This forces companies that may otherwise enjoy a monopoly position to improve their overall competitiveness by boosting productivity and forces prices downward. Domestic firms that are already competitive will likewise gain from the increase in the size of the market resulting from trade liberalization. Finally, some authors point to the importance of the process of technological diffusion triggered by foreign investment as a motor of economic growth and convergence.
[See for example Grossman and Helpman (1991), Zysman and Schwartz (1998), Eichengreen and Kohl (1998).]
Economic Integration and Convergence: a considerable number of authors insist that there is a relationship between economic integration and convergence. This literature focuses either on convergence in the standard of living across countries, or more specifically on convergence in wages across countries. Ben-David (1996), for example, notes that convergence in the relative standard of living has occurred across groups of countries with strong trading relations. Convergence fails where countries are not integrated into the same trading networks. As predicted by the Factor Price Equalization theorem (FPE), the wages of low and unskilled workers are expected to increase in the less advanced countries and decline in the more advanced countries. Wages of highly skilled workers are expected to increase in the more advanced countries and decline in the less advanced countries.
Leamer (1996), likewise argues that trade liberalization accounts for a large share of wage convergence across the US and the new emerging economies. These findings are supported by similar findings from Wood (1995, 1994) for trade between the more advanced countries of Western Europe and the Newly Industrialized Countries, and by Ben-David (1993), for trade within Western Europe. The wages of skilled workers are said, once again, to increase in more advanced countries and to decline in less advanced countries. Less skilled workers in the more advanced countries should see deterioration in their wages; while in less-advanced countries, wages should improve.
However, none of these authors are opposed to trade liberalization. All of them support the view that trade has mutually beneficial effects on economic performance. Increased trade is presumed to lead to a more effective allocation of resources between and within countries, and thus is thought to be mutually beneficial to all countries that adopt trade liberalization. This does not mean, however, that there are no adjustment costs to trade liberalization, nor that there are no adverse effects resulting from it. Indeed, the rise in
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the importance of some political coalitions and the fall of others is, not surprisingly, seen as a consequence of trade liberalization.
[Change in trade regimes is now often seen as one of the principal driving forces in the changing powers of political coalitions. In particular, see Rogowski (1989, 1987).]
Yet views on the benefits and disadvantages of trade liberalization remain controversial. Though few authors genuinely challenge the neoclassical view, recent studies by Rodriguez and Rodrik (1999) and Slaughter (1998) have gone a long way toward suggesting that this debate exhibits serious weaknesses. Presumably, there is a reason for the centuries of resistance to free trade. [See for example Douglas Irwinís (1996) account of the historical evolution of the concept of free trade.] While still broadly supportive of the concept that trade liberalization should promote aggregate welfare, Rodriguez and Rodrik attempt to illustrate that the empirical research underlying support for free trade, including that of the major authors cited above, results from errors in statistical measurement. [For an earlier critical view of the empirical research in support of trade liberalization, see Edwards (1993).] Slaughters work goes one step further than this; it provides evidence that some instances of trade liberalization and economic integration have actually led to divergence rather than convergence. Both of these works agree that convergence, to the extent that it has occurred, appears to be the result of ongoing processes that are independent of the phenomenon of economic integration or trade liberalization. In particular, Slaughter (1997) points to the role of change in capital-labor ratios. [In this regard, see also Van Mourik (1987).]
The work of Rodrik and Slaughter falls into the category of an emerging strain that attempts to emphasize factors related to growth and economic convergence that differ from those predicted by the more conventional HO model of international trade. While trade liberalization theorists and the so-called Washington Consensus emphasize market solutions to the problems of less advanced economies, a growing number of authors point to other growth and convergence promoting factors. Alternatives to the HO style free flow of goods model have emphasized models of endogenous growth and the potential for increasing returns, the free flow of other factors of productionin particular capital or labor, the diffusion of technology and the role of government in promoting economic performance. [In addition to the role of government, endogenous growth models and the potential for increasing returns that are discussed in some detail below, there is a large and growing body of literature on the remaining factors. Slaughter (2000) and Braconier and Ekholm (forthcoming), for example, discuss the free movement of capital. On the free movement of labor, the historical work of Williamson (1997), and OíRourke and Williamson (1995), suggest that wage convergence in the European core is primarily the result of labor migration between these countries over the period 1870-1913. As countries became less open after 1913, and as labor became less mobile, wages also ceased to converge. While in the 20th century labor is thought to be less mobile (Hatton and Williamson, 1997, 1995), trade and capital flows have increased greatly, thus leading to an emphasis in the literature on the growth and convergence promoting effects of trade liberalization and capital mobility. Feenstra (1996) has focused on the role of technological diffusion. Eichengreen and Kohl (1998) likewise place a great deal of emphasis on technological diffusion in promoting CEEC growth and convergence.]
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The existing literature on the growth and convergence prospects for Central and Eastern Europe is largely optimistic about the advantages of economic integration with the EU. Zysman and Schwartz (1998), for example, suggest that the increasing integration of the CEECs into what they call International Production Networks (IPNs) will lead to the diffusion of technology and the development of linkages between Western and Eastern firms that will boost CEEC competitiveness. A significant number of authors implement the measurement of intra-industry trade (IIT) in order to estimate the growth and convergence potential of the CEECs and find that these countries have steadily improved over the period 1989-1996. [Landesmann (1995), Landesmann and Burgstaller (1997), Wolfmayr-Schnitzer (1997).] A few authors have also used either unit value measures or a mix of unit value measures and IIT to test for changes in the quality content of CEEC production. [In particular see Aiginger (1997), Aturupane et al (1997), Eichengreen and Kohl (1998).] One final study measures the distribution of production across economic sectors that exhibit significant linkage effects in the promotion of economic development. This study has likewise turned up favorable predictions for the CEECs. [Guerrieri (1998).]
CEEC experience with economic growth over the 1988-1996 period, however, is patchier than the above literature attests. The CEECs have all experienced significant declines and some rebirth of their economies over the period 1988-1996. Poland was the only country that had managed to regain its 1988 level of economic development by 1996. Not surprisingly, the literature on CEEC growth and convergence prospects is lightly peppered with articles signaling cautionary tales about the structural weaknesses of the Central and East European economies and the potentially negative impact of economic integration with the West.
[A few of these are cited in Ellison (2001: Ch. 3). In addition, a number of authors have pointed to the need for relevant reforms in the CEECís. Potratz and Widmaier (1996) and Widmaier and Potratz (1997) point to the importance of restructuring the research institutes that build the foundation for a knowledge-based economy.]
For the CEEC's and for less developed economies more generally, it is difficult to ignore the potential threat that trade liberalization and economic integration entail. Worries about the consequences of trade liberalization are mirrored, justifiably or otherwise, in concern over rising trade deficits. As the work of Rodriguez and Rodrik (1999) and Slaughter (1998) neatly underlines, not all countries necessarily benefit from trade liberalization or economic integration and some countries may even be placed at a disadvantage. Trade liberalization can have long-lasting effects on the wage and labor market structure of the liberalizing country and these effects can be both positive and
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negative. Some have pointed to the potential for path dependence and the possibility that, as a result of trade liberalization and the possibility for low-wage equilibria, economies may get caught in their developmental paths and fail to converge on more advanced economies. [Rodrik (1996) develops one such path dependent scenario for Eastern Europe. See also Matsuyama (1992, 1991).] Others observe that third world countries do not seem to converge upon first world countries as quickly as one might expect under neoclassical assumptions. [Lucas (1990), Pritchett (1997, 1996).] Wealth is more highly concentrated either in the first world or even in specific regions. These authors suggest that variation in the role of education and national or sectoral skill levels may explain some of this variation, [Barro (1997), Barro and Sala-I-Martin (1995, 1992), Mankiw, Romer and Weil (1992).] while others suggest that increasing returns may explain such dramatic differences across countries. [Increasing returns are generally thought to be the most problematic for economic integration where they are "external" to the firm and arise from geographic or regional concentrations of capital. Krugmanís (1991) model of geographic concentration suggests that some countries could possibly gain from regional integration, while others might lose.]
Although the literature referred to above focuses primarily on the predictions of the HO model of international trade, the Solow (1956) model of economic growth also predicts convergence in factor prices and the standard of living. In this case, convergence occurs not as a result of trade, but rather as a result of diminishing returns to investment in more developed economies and economic sectors and variation in the rate of economic growth across countries. Where the ratio of capital to labor is high, additional capital inputs produce ever-smaller returns on investment. Economies that are less advanced and have lower capital-labor ratios are presumed to have higher rates of return and thus should converge to the income levels and standard of living of more advanced economies. This growth-induced model of economic convergence differs from the trade liberalization model in that trade no longer plays the central role. In this model, depending upon assumptions about the mobility of capital and labor across borders, the convergence mechanism depends either on the movement of labor toward higher wages or the movement of capital toward higher returns on investment.
Within this growth-induced framework, the concept of conditional convergence [Mankiw, Romer and Weil (1992), Barro and Sala-I-Martin (1992).] represents one attempt to explain the failure of economies to converge. In these models, economies have steady state equilibria that depend on their capital-labor ratios, their level of technological development and their share of human capital. Once economies move to their steady state, the only factor that will produce further convergence is a change in the level of technology or the share of human capital. Though trade openness may produce an initial phase of convergence, once these economies have reached their steady state, no further convergence is to be expected. Additional convergence will be driven by factors endogenous to that economy. Cho and Graham (1996) have noted that less developed economies may even converge to their steady-state equilibrium from above. In isolation, these economies may remain above their competitive market equilibrium. In this case, the move toward greater economic openness will produce divergence rather than convergence.
The divide in the literature between growth-induced and trade-induced convergence suggests that the debate on convergence producing effects is more complex than the
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trade liberalization theorists would have us assume. In fact, it is useful to characterize the convergence debate using the following typology (see Diagram I). Theories about convergence differ both in whether they are growth-induced or trade-induced, as well as in whether they assume constant returns or increasing returns. Each of these theoretical paradigms produces very different predictions based on their initial assumptions.
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Within the endogenous growth framework, economic theories on the potential for increasing returns have uprooted thinking on the potential for convergence. While increasing returns that are internal to the firm should serve to raise the returns from economic integration for all countries concerned due to the growing size of the market, the impact of increasing returns are potentially more hazardous where they are external to the firm. In this latter case, where increasing returns arise from the agglomeration effects of accumulated capital or from geographic concentration effects from the clustering of firms, less developed economies may be at a distinct disadvantage. To the extent that this results in variability in the rate of technological change across regions and countries, the outcome of economic integration may even be negative rather than positive.
In the event of external increasing returns, the pre-existing uneven distribution of capital may pose a dilemma for less advanced economies and in particular for the CEEC's. As these economies liberalize, it is not necessarily true that the free flow of capital, labor and goods will affect them positively. Models of the type that Krugman and others have developed suggest that the opposite is equally likely. Due to geographic concentration, there is every reason for less developed countries or regions to be concerned about the consequences of economic integration. In some cases, these countries might even want to seek compensation for the adjustment costs they have to underwrite and for the potentially more negative costs of the wholesale geographic reorganization of production centers.
While authors typically argue that convergence is the result of either growth- or trade-induced factors, one should not consider these perspectives as mutually exclusive. Both growth- and trade-related factors may have an impact on convergence, and growth- and trade-related effects may even pull in opposite directions. Moreover, additional intervening variables may lead to further complications in these models. The role of capital and labor mobility, technological diffusion and the degree and form of government intervention are all factors that can adversely affect these models. Although the remainder of this section will emphasize the role of government intervention, capital and labor mobility and technological diffusion are likewise capable of having independent effects on the phenomenon of convergence (or divergence).
Debate over the importance of the role of government in promoting economic growth extends well beyond the confines of Central and East European countries. Much of it has focused, as suggested above, on the Asian Tigers. While some authors insist that trade liberalization alone gave the needed boost to the economies of these countries, others argue that they could not have achieved their unusual levels of economic success had it not been for massive governmental efforts at economic restructuring.
[Until the recent collapse of the Asian growth miracle, the growth performance of the advanced industrialized countries was eclipsed for almost two decades by the rapid growth of the "Asian Tigers". These countries have experienced growth rates well above those to which the advanced industrialized countries have grown accustomed over the postwar period. For some, their positive experience has been driven solely by trade liberalization and export-led growth (Dollar, 1992; Sachs and Warner, 1995). However, there is likewise a growing body of literature that emphasizes the role played by governments in engineering this growth performance (Krugman, 1997, 1995, 1994b; Rodrik, 1995; Young, 1995; Wade, 1990; Mardon, 1990; Amsden 1989).]
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politically and institutionally organized means of promoting the economic competitiveness of states, Krugman (1994a, 1987) and others have insisted on the dangers of government involvement in the economy.
As the standard argument runs, in pursuing policies intended to promote competitiveness, governments are more likely to misallocate resources and thereby weaken economic performance.
[Krugman is not opposed to the notion that certain types of protection or subsidization might potentially be helpful, but he is opposed to the idea that governments can reasonably make these decisions. Governments are subject to "capture" from interest groups for a number of reasons. They are placed before mixed incentive structures, both electoral success and the promotion of economic performance. They have high information costs: governments lack expertise, and the experts they hire do not face the same incentive structures that firms do. And finally, some interest groups benefit from organizational advantages: intense interests are more easily collectivized than diffuse interests, enabling some groups to promote particularistic agendas.]
Others are less sanguine about the ability of less developed economies to develop competitive potential via the path of the trade liberalization and non-government intervention. The argument that government intervention may provide not only a sufficient, but perhaps also a necessary counterweight to the role of the market has gained some currency in recent years. And this is all the more true to the extent that trade liberalization and economic integration themselves do not provide the necessary foundations for convergence. Thus, someamong them leading economists and politicians in many of the CEECs [See for example the views of some of the former Ministers of Finance in Poland and Romania, Kolodko (2000), and Daianu (1998).] have gradually increased their criticism of current policies. Others point to the need for more consistent efforts to build skilled labor forces and attempts to promote more technologically advanced or higher value-added production. Edwards (1997, 1993) openly advocates focusing a greater share of governmental effort on a mix of industrial and/or educational policy. Despite the efforts of protagonists of the so-called Washington consensus, openness to trade as the principal or sole engine of growth is, at best, controversial.
The upshot of the counter-arguments against the prevailing ideology of non-intervention is two-fold: First, many of the factors that presumably contribute to the competitiveness of individual countries, such as educational policy and the development of infrastructure, lie directly within the purview of governmental decision-making. The conditional convergence literature highlights the notion that without intervention real convergencein any more than the conditional senseis not likely to occur. Second, the potential imbalance brought about by the concentration of capital and the potential for increasing returns likewise strengthens arguments that favor greater government involvement in the promotion of economic competitiveness. Correcting this initial imbalance between countries and regions may be impossible without state intervention.
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In this context, many recommendations made to the countries of Central and Eastern Europe should be seen as problematic. In order to achieve more rapid accession to the European Union, some proposed that the CEECs forego claims on EU structural and cohesion funds (the body of redistributive policies intended to finance the restructuring of the less developed regions of the EU), in return for greater trade liberalization, presumably in sectors such as agriculture where the only significant barriers remain.
[Sachs and Warner (1996).]
Ironically, these authors recognize that EU membership involves not only a degree of trade and market liberalization, but also a significant degree of regulation and (re)-regulation. As part of EU membership requirements, the CEECs are expected to adopt the "acquis communautaire", (the existing body of EU legislation and market regulations). These regulations not only serve to increase the costs of economic association,
[Alone the costs of meeting the EUís existing body of environmental regulations are likely to exceed the immediate budgetary capabilities of most of the CEECís. Poland, for example, recently estimated the cost of meeting the EU environmental regulatory requirements contained in the acquis at 35 billion USD ( Financial Times , 11/30/2000). As noted in Ellison (2001: Ch. 3), in Hungary, the costs of compliance with EU environmental regulations have been estimated to be as high as 2.5 trillion HUF. Though there are few accurate estimates of the actual costs of compliance, there have been several attempts. See for example Environment Policy Europe (1997). With regard to adopting EU social policy, Burda (1998) estimates that the rapid adoption of the EU regulatory framework could potentially impede economic transition in the CEECís.]
they also have the potential to reduce economic efficiency.
[Koedjik and Kremers (1996), for example, point to a strong correlation, among EU Member States, between lower levels of regulation and higher rates of economic growth. While market liberalization and flexibility in the labor market may have strengthened the US economy and helped to reduce unemployment, the European economies remain far more regulated and much less successful at reducing unemployment. Recently there has been discussion of the fact that countries such as Estonia, which engaged in a complete and unilateral liberalization of trade with the EU, would actually have to engage in a considerable amount of "de"-liberalization in order to join (see for example Central Europe Review , 1(5), http://www.ce-review.org , 7/26/99).]
But the pursuit of EU membership will result in more than just financial burdens. For one, the Asian Tigers continue to enjoy the capacity to determine their own trade and economic adjustment regimes
[While globalization clearly diminishes the ability of individual countries to control such economic factors as interest and exchange rates, the degree of independence of the NICís is still much greater than that of a country that has joined the Union.]
while the CEECs are progressively losing this advantage as they become more and more firmly anchored in the European marketplace. The terms of the Association Agreements have already greatly limited their room for maneuver on trade management. Integration into the EUs European Monetary Union (EMU) will eliminate the use of exchange rate regimes as an additional balancing mechanism.
[Not surprisingly, the CEECís have vacillated on the issue of membership in EMU.]
Both the terms of the Association Agreements and actual EU membership imply the greatest potential restriction on the use of these tools, involving substantial restrictions on the ability to pursue an independent industrial policy.
[Community initiatives have moved away from the support of state-level industrial policies. These policies are viewed as slowing rather than promoting structural adjustment. In order to favor the workings of the Single Market, the EU has attempted to restrict the use of state aids (Smith, 1998: 59-60). The Commission has authority to rule over state aids, and to restrict state aid that may affect competition between Member States. In addition, Member States are obliged to report all forms of State aid to the Commission (Smith, 1998: 58). The Association Agreements have already begun restricting the use of state aids in the CEECís and the EU has already sanctioned some of the CEECís for misuse of this governmental tool.]
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monetary and fiscal independence to the degree required for EU membership may have serious consequences for the development of less advanced economies. The abandonment of a sovereign trade regime or the inability to pursue an independent industrial policy may likewise impede the ability to shape economic development. [BŠrta and Richter (1996) likewise note that there are potential costs to the loss of a sovereign trade regime. A number of these points are also made in Dauderstšdt (1998).]
For the countries of Central and Eastern Europe, the opportunity for economic renewal afforded by the end of Soviet domination is historic. Most assume those countries that manage to make it into the EU in the first round of membership negotiations are more likely to achieve what countries in the region typically failed to achieve during the previous two centuriesi.e. a general restructuring and strengthening of their economies through a solid anchoring in the Western sphere. [See for example Berend (1997).] To what extent the CEECs can be expected to win or lose from economic integration and EU membership is the subject of the remainder of this paper. The CEECs may well require far more than trade liberalization in order to achieve their goals of economic growth and ultimately convergence to the Western standard of living. In addition to policies that promote industrial and economic competitiveness, greater injections of capital than those afforded by openness to foreign investment may be necessary in order to maintain competitiveness with the Member States of the EU.
What follows, will assess the proposition that convergence will occur under market conditions as a result of trade liberalization and economic integration with the EU. I would like to answer the general question: 1) have other European states become more competitive as a result of increasing economic integration with the EU? The political gamble of economic openness and EU integration anticipates a "yes" answer to this question. Thus the following section attempts to test the proposition that EU membership has promoted convergence among the regions of Europe. This goal is addressed by analyzing the phenomenon of convergence among the member states of Western Europe from 1820 to the present.
Long-Term European Convergence: The Western Link
In order to better understand the consequences of economic integration with the EU, I will consider the long-term experience of convergence in the EU and between the EU and other European states. This section focuses on two measures used to assess their performance. The first is long-term convergence in GDP per capita over the period 1820-1998. The second is average real growth over the period 1960-2000. While CEEC-EU trade has certainly benefited the CEECs, the long-term evidence on convergence is less promising. The so-called cohesion countriesGreece, Ireland, Portugal and Spain [These countries have received the largest share of EU structural and cohesion funds as a result of their lower level of economic development compared to average EU GDP per capita.] converged more rapidly on the European average per capita GDP while out-
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side the EU. Since these countries have become EU members, apart from the exceptional performance of Ireland, their rate of economic growth has either declined to below the EU average or remained only marginally above.
The EU represents a significant export market for the countries of Central and Eastern Europe and trade liberalization with the EU has certainly been of great significance for them. Overall, CEEC exports to the Member States of the EU have increased 4.5-fold over the period 1988-1996, to a total of 47.1 billion Euros in 1996 from 10.4 billion Euros in 1988. Yet, as Ellison (2001: Ch. 4) and other authors have illustrated, the degree and nature of trade liberalization adopted by the EU greatly favored the EU while placing the CEECs at a relative disadvantage. CEEC exports to the EU in sectors in which the CEECs had a presumed comparative advantagethe so-called sensitive sectors, coal, steel, textiles and agricultural productswere greatly restricted. While trade in these sectors is now fully liberalized, apart from agriculture, the consequences for the CEECs were quite serious.
The EU, on the other hand, was granted virtually unrestricted access to CEEC markets except in the same sensitive sectors where the need for trade restrictionsbased at least on the logic of comparative advantagewas questionable. Preliminary integration into the European Coal and Steel Community has likewise resulted in a substantial curtailment of Polish steel firm production via mutually agreed production quotas, thereby dampening the potential impact of some of the more competitive Polish steel firms on the EU marketplace and labor structure (Keat, 1999). Political intervention in the sphere of trade relations has tended to favor the more traditionally protected EU sectors at the expense of Central and East European production.
The long-term experience with convergence in the European arena is instructive with regard to the potential for CEEC convergence to the EU standard of living. As noted above, the strong assumption of the trade liberalization literature is that integration in the European core and the reduction of trade barriers should lead to convergence among these countries. For the CEECs, the experience of the cohesion countries compared to the remaining European states provides the most relevant example. Like the CEECs, these countries arrived late to the club of EU member states (Ireland-1973, Greece-1981, Portugal and Spain-1986). In addition, like the CEECs, these countries entered the EU with per capita GDP levels far below those of the existing Member States. Finally, again much like the CEECs, three of these countries emerged from under authoritarian regimes (Spain, Portugal and Greece) and sought EU membership, in part, as a means of consolidating democracy.
Experience with convergence across Europe is quite varied. Some countries have exhibited a remarkable ability to catch up, while others have either failed to do so or have even fallen behind (see Table I). Within the core group of European countries (Germany, France, Italy, Denmark, Belgium, the Netherlands and the UK), there has been substantial convergence over an extended period (1820-1998). While some of this convergence may be the result of economic openness among EU Member States, there was likewise considerable convergence prior to the signing of the Treaty of Rome in March 1957. Moreover, the creation of the customs unionas proscribed by the Treaty of Romedid not immediately lead to full trade liberalization between the original six
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Member States of the European Community until 1967. [Internal tariff reductions between the Member States were introduced only progressively over an extended period of time from 1959 to 1967.] In fact, apart from some economic divergence that was presumably the result of WWII, convergence within the European core was a remarkably steady phenomenon from approximately 1870 to 1989.
The EFTA countries have experienced a considerable degree of convergence with the European core (see Fig. I), as well. On the other hand, convergence between the European core and other regions of Europe has been much less pronounced both for the cohesion countries and for the CEECs. Between 1820 and 1998, variation in the level of economic development and convergence between the CEECs and Western Europe illustrates that the CEECs have lagged considerably behind the current Member States of the EU. This is a long-term trend dating back at least to the 1820s 1820s. Between 1820 and 1992, the CEE economies fell from 69.1% of the Western and Northern average GDP per capita (W+N) to roughly 28.6% of the Western and Northern average. There is almost no upward variation over this entire period, though there have been very minor improvements since 1992.
Figure 1: Convergence in Europe 1820-1998
There are two great periods during which the economies of Southern, Eastern and Western Europe diverge the most: from 1820-1928, and from 1960-1998. Between 1820-1928, per capita GDP in the CEE economies dropped from 69.1% to 48.8% of the Western and Northern average. Between 1928 and 1960, this gap remained relatively stable, fluctuating around 48.8% and 44.6% of the Western and Northern average. From 1960 to 1992, the gap between Western and Central Europe increased even more dramatically with CEEC per capita GDP dropping to 28.6% of the Western and Northern average in 1992. This gap has improved only very slightly to 31.6% of the Western and Northern average as of 1998.
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The two sets of standard deviations presented in Table I measure the relative differences in GDP per capita both within each of the four regions of Europe and across successively larger regions of Europe. These standard deviations are presented here as a share of the average per capita GDP within each respective region and as a share of average per capita GDP across successively larger regions of Europe. These figures tell a somewhat similar story. There has been a considerable amount of convergence both within and across the regions of Europe, but the Central and East European countries generally have not participated in this convergence. They have seen only marginal convergence within the region and have otherwise diverged from the rest of Europe.
While the first and last periods (1820-1928 and 1960-1998) exhibit the strongest divergence between the Central and East European countries and the rest of Europe, the first period covers over 100 years [While there is doubtless more year-to-year variation during this period than this data illustrates, Maddisonís (1995 and 2001) data do not permit greater precision.] whereas the second period covers only twelve. This latter period of divergence is attributable in part to the initial economic decline experienced by the CEECs just prior to the fall of the Soviet Bloc, as well as to the collapse of the former CMEA markets and the ensuing economic restructuring after 1989. But clearly the decline in the gap for the Central and East European countries is part of a longer-term trend that dates much further back in time than 1989.
The figures on convergence presented thus far disguise to some extent the relative improvement in GDP per capita in all of the regions of Europe. Figure II presents a graph of the Average GDP per capita across the regions of Europe. While the EU core countries, the former EFTA countries and even to some extent the cohesion countries have exhibited relatively marked increases in their overall GDP per capita over the 1820-1998 period, the CEECs have participated only marginally in this change since approximately 1945. As of about 1960, the cohesion countries began to leave Central and Eastern Europe behind and follow a trend not unlike that in the EU core and the former EFTA countries.
Figure II: Average GDP Per Capita Across the Regions of Europe
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Over the period 1820-1998, comparison of GDP per capita in the Central and East European economies and the West suggests that some degree of catch-up is possible. Austria and the former Czechoslovakia illustrate this point. In 1950, directly after the Second World War, Austria was relatively close to the per capita GDP of Czechoslovakia (68% and 65% of the EU area average, respectively). More significantly, in 1928, per capita GDP in the cohesion countries of Spain and Ireland was between that of Hungary and Czechoslovakia, with Greece just below that of Hungary. As depicted in Figures II and III, from about 1945-1960, the cohesion countries and the countries of Central and Eastern Europe did not differ greatly from each other in terms of the level of development. On average, no significant gaps separated these two regions. Thus, given appropriate conditions, there is no reason to assume that the CEE economies could not have developed apace with the rest of Western Europe. In particular those CEECs most closely linked to the West (Czechoslovakia, Hungary and Poland) presumably had excellent prospects of approaching the Western average in 1950.
The shift in growth patterns emerging out of the era of Soviet control is dramatic. In 1998, Austrian per capita GDP was 2.2 times the size of the Czech Republics per capita GDP, and almost 3 times the size of Hungarys. Spains and Greeces per capita GDP is approximately 2 times the size of Hungarys and the Czech Republics. Comparison of the Czech Republic and Hungary to Norway and Finland show similar results. While the level of economic development of these northern countries was comparable to that of the Czechoslovakia and Hungary in the 1800s, Norway and Finland have been relatively successful in converging with the core countries of Western Europe. Italys experience has been similar to that of Norway and Finland.
Some authors insist that, with closer integration into the EU, the CEECs should perform very well. On the one hand, historically the CEECs have exhibited per capita incomes that were not far from that of parts of Western Europe and, on the other, smaller states that undertake closer economic integration with larger states are often thought to grow faster. [Sachs and Warner (1996: 1).] Yet, contrary to what these authors claim, the experience of Spain, Portugal and Greece does not confirm this view. Thus far, not all of the cohesion countries have been able to achieve similar growth. Though these countries grew at favorable rates in the latter half of the 1980s, such growth failed to continue on into the early 1990s . On average, growth rates in this region, apart from the stellar example of Ireland, dropped from approximately 4% per year to 1-2% per year (see Figure III, page 40).
At least part of this decline in growth in the early 1990s may have been the result of Germanys attempt to keep inflation down in the wake of German Unification. High German interest rates presumably dampened growth prospects in the cohesion countries. While this has changed more recently as German and now EMU interest rates have come down slightly, growth rates for the cohesion countries have begun to pick up somewhat and have gone above those of the EU. Though it is tempting to view the favorable growth rates of the cohesion countries in the second half of the 1980s and the rising rates of economic growth in the late 1990s as resulting from European integration, it is important to note that the growth rates of this region have exceeded the European average since at least the 1960s. In fact, these countries grew more rapidly compared to the EU during the period 1960-1975 than is currently the case. As noted
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below in Figure III, from 1961 to 1975, the 5-year average annual growth rate of real GDP considerably exceeded the European average during the period from 1981 to 2000.
Figure III: Average Rate of Real Economic Growth (1961-2000)
Only in the 1991-2000 period did the differential begin to increase again in favor of the cohesion countries. However, this figure is primarily the result of Irelands greatly favorable economic performance. Excluding Ireland, the 5-year average annual growth rate for the cohesion countries remains below the European average for the 1991-1995 period and is only marginally above the EU average for the period 1996-2000 (by 0.8%).
[At this rate, it would still take these countries an exceptionally long period of time in order to converge with the EU core. Moreover, the rate of economic growth in Europe has once again begun to decline as a result of a generally recessionary trend.]
Over the 1820-1998 period, the cohesion countries experienced almost no real improvement on their initial position in 1820 when compared to Western Europe. While experiencing significant divergence from the West European level and hitting their low point in approximately 1950, by 1998 the cohesion countries had only succeeded in arriving at a point not too distant from their original position in 1820. More importantly,
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a large share of the improvement experienced by the cohesion countries occurred between 1960 and 1973, when these countries were relatively closed to the outside world.
[However, it should be noted that a portion of this rapid growth in Spain is presumably related to the series of trade and market liberalizations Spain introduced in 1959 and after (see Tsoukalis, 1981: 80-83).]
These findings coincide with a considerable body of literature on convergence in the European arena. Gremmens (1985) found that as the degree of trade integration increased over the period 1959-1979, factor price equalization was less and less capable of explaining wage differences between countries. Van Mourik (1987) found that there was no relationship between the intensity of trade and factor price differentials, despite progress in creating the Common Market. Van Mourik likewise noted that capital-labor ratios were important in the determination of differences in factor prices. More recently, Neven and Gouyette (1995), Fagerberg and Verspagen (1996), Paci (1997), and Quah (1996) have come to similar conclusions. Most of these authors concur that convergence tended to characterize the earlier postwar period, but tended to breakdown in the 1980s. Finally, Paci and Pigliaru (1999) find that convergence is stronger across the regions of the North, while productivity increases in the South do not appear to affect the original gap between North and South.
There has likewise been little wage convergence between the countries of Western Europe. Van Mourik (1994) has completed perhaps the most thorough study of wage convergence in this context. He finds that during the postwar period, unless one controls for purchasing power parities (PPPs), there has been no wage convergence whatsoever among the countries of Western Europe. Once PPPs are controlled for, Van Mourik does find greater evidence for wage convergence. However, the use of PPPs in this context should be carefully considered. PPPs adjust for the effects of exchange rates between countries. Where our analytical criterion is the degree of convergence between countries and the relative cohesion it produces, PPPs risk overstating the amount of
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politically relevant convergence.
[Note that investors are likely to be motivated by wage differences independently of PPPís. Thus wage differences across regions matter in terms of their ability to attract future investment (see for example Erickson and Kuruvilla, 1994). Moreover, workers or consumers likewise presumably care about differences in purchasing power across an integrated Europe, and not just within their country of residence.]
With respect to convergence, the experience of the CEECs is even less favorable than the experience of the cohesion countries. While the CEECs compare favorably to the European average annual rate of growth in real GDP from 1961-1975, their performance begins to decline significantly as of 1975 and is actually negative in several of the years prior to the collapse of the Soviet Bloc (see Figure III above). While their performance goes into a further tailspin from 1991-95, as noted above, this is partly the result of the upheavals that accompanied the collapse of the former Soviet Bloc and the period of economic restructuring that followed. Rates of economic growth in the CEECs have improved relatively dramatically in the 1996-2000 period. On the whole though, the Central and East European countries have diverged strongly from the developmental path of the European core.
For individual CEECs (as for the cohesion countries), it is unclear whether there will be any real convergence in GDP per capita as a share of the EU average with economic integration. For the 10 applicant countries of Central and Eastern Europe, any potential convergence is clouded by the fact that the CEECs suffered a serious period of initial economic decline after the opening in 1989. In many cases the extent of economic decline has been greater than that experienced by western countries during the Great Depression and most of these countries still have not regained the level of economic development they enjoyed as of 1989 (see Table I). The Bulgarian and Romanian economies were perhaps the hardest hit by this adjustment process and are still far below their 1989 levels. Only Poland has actually been able to improve upon its 1989 level of economic development.
Based on cursory perusal of the evidence, convergence and divergence are relatively long-term phenomena. Change has not been that great in either direction over relatively long periods of time. Thus, whatever outcome countries might expect from closer integration, progress is typically slow.
The role of EU membership in producing economic growth and convergence should be considered with some degree of caution. Maddison finds that the cohesion countries have gained from their closer association with the European Community, both through trade and capital movements, as well as through European Community transfers and the adoption of economic policies. In his view, this has shown itself most clearly in a rise of productivity levels and an increase in trade (Maddison, 1995: 85). This should be weighed carefully not only against the periods of rapid economic growth that preceded membership, but also against the comparatively poor performance in unemployment rates experienced by these countries in the 1990s. Spain, for example, exhibited regional unemployment rates of over 30%. Moreover, it actually worsened over the
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1985-1995 period, [See for example the cohesion report of the European Commission (1996).] although it has begun to show signs of improvement in the 1995-2000 period.
Attention should also be paid to the experience of the former EFTA countries. These countries have experienced considerable convergence both among themselves and with the EU core over the period 1820-1998. Moreover, they have achieved this without actually being members of the European "club" of six, nine or twelve (see Figure I above). Although some of this convergence may be the result of a similar union of Nordic states that allowed for the free movement of labor as of 1954 and liberalized trade in manufactures in 1967, [The Nordic countries (Denmark, Finland, Norway and Sweden) adopted an agreement on the free movement of labor in 1954 (Pedersen, 1996), and, along with several other non-EU-Member countries (Austria, Switzerland and the UK), signed the EFTA trade liberalization agreement in 1960. Iceland (1970) and Liechtenstein (1991) also joined EFTA. Denmark and the UK left EFTA in the early 1970ís to become member of the EU, and, for the same reasons, Austria, Finland and Sweden left EFTA in 1994. The EFTA countries likewise became members of the European Economic Area (EEA) in 1992. (Mattli, 1999: 5).] most of the convergence in the Nordic region occurs between 1918 and 1944. Moreover, despite increased integration, the period from 1945-1973 is associated with a stagnating period of convergence between the Northern countries and the European core. Just as for the cohesion countries, periods of convergence are not necessarily associated with EU association or membership.
This suggests that it is possible to remain outside the privileged group of EU countries and achieve both high rates of economic growth and a comparable degree of economic convergence. Moreover, it strongly suggests that convergence is less the result of integration and far more the result of other factors thatso farare not well understood. Convergence may ultimately have more to do with world economic growth trends, or with the role of government and economic management. In this sense, some form of "managed" trade regime and renunciation or postponement of EU membership might represent a more viable alternative to EU integration. The example of the Scandinavian countries provides an optimistic alternative to EU membership. In any event, it should remain clear from the data that convergence, to the extent that it occurs, is a long-term process that may have little to do with the fact of EU membership.
Not all the news coming out of Central and Eastern Europe is discouraging. CEEC exports to the EU continue to increase at a significant rate and rates of economic growth have improved dramatically since the initial period of decline. Yet, the evidence presented above provides the foundation for an argument against the view that closer economic association with the EU and actual membership are necessarily associated with the convergence producing effects many claim for them. The path of trade, economic integration with, and membership in the EU does not necessarily represent the panacea for the economies of Central and Eastern Europe that many claim. The convergence promoting effects of trade liberalization and economic integration remain poorly specified and, in many respects, trade liberalization is a relatively blunt instrument. It may produce greater competitiveness in individual firms under one of two
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conditions: firms either eliminate excess labor [NovŠk (1999), for example, finds that most of the productivity improvements associated with the transition in Hungary were the result of shedding labor rather than physical capital improvements. See also Van Ark (1999) for similar conclusions about the broader range of CEECís.] and/or they increase investments in physical capital. But under conditions of capital scarcity, one might expect an excess of the former and only limited use of the latter. The extent of technological change might also be limited under such conditions.
Whether membership in the European Union is the best solution for these economies should be carefully considered. Though the conclusions of this paper are only suggestive, more precise knowledge concerning those factors that predict the potential for convergence and economic growth is needed. Without a better understanding of the factors that explain cases like the Irish success story, it is presumably foolhardy to move forward at full steam. Yet government officials and others in the CEECs frequently point out that they have no choice but to join the European Union in order to become more economically competitive and politically stable. Ironically, this one argument may in fact be one of the strongest points for remaining outside. Many countries have successfully promoted economic growth and convergence while remaining outside the EU. Ultimately, this may constitute a more viable alternative.
To the extent that the CEECs do continue to seek integration into the EU, this process needs to be coupled with mechanisms that support the process of convergence and the creation of cohesion within an enlarged EU. Without this, the project of integration is fraught with risk. The role of promoting convergence and preserving cohesion in the Union has typically fallen to the Unions principal redistributional tool, the Structural and Cohesion funds. Currently, the trend has been to restrict expenditures in preparation for EU enlargement toward Central and Eastern Europe. With insufficient assurances from the EU that the economies of Central and Eastern Europe will receive substantial assistance in the face of competition from the European Union, preservation of sovereignty in decision-making over monetary, fiscal, trade and industrial policy may be preferable. The benefits of trade can be obtained without giving up the tools the CEECs need to pursue what presumably should be their primary goal: economic restructuring and integration into the international marketplace.
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