The Effectiveness of Preferential Trade Liberalization in Central and Eastern Europe

Abstract

After the collapse of communism in Central and Eastern Europe (CEE), many countries in the region radically liberalized their foreign trade regimes in the 1990s. In particular, preferential trade liberalization in the CEE countries has been promoted by the European Union in the form of the association agreements that involved “vertical” trade liberalization between the EU and countries in Central and Eastern Europe. In addition to this, the CEE countries liberalized trade “horizontally” among themselves in the form of sub-regional and bilateral free trade agreements. In this article, we use the generalized gravity equation, estimated on bilateral trade data for ten CEE countries during the period of 1993–2004, to evaluate the effectiveness of preferential trade liberalization in Central and Eastern Europe. We find that all forms of preferential trade liberalization positively contributed to the expansion of trade of the CEE countries, but their impact was country-specific.

Keywords:

• bilateral trade
• gravity equation
• preferential trade liberalization

Notes

¹In a free trade area, all members eliminate barriers to trade in goods among themselves, but each member retains the right to maintain different barriers on non-members, while a customs union goes beyond a FTA by establishing a common external tariff on all trade between members and non-members.

²These studies find that initially that the high unexploited trading potential of Central and Eastern Europe quickly eroded as a result of adjustment in trade flows that took place in the early 1990s. See Brenton and Manzocchi (2002) for the review of this literature.

³Unilateral trade liberalization with the CEE countries was initiated by the EU immediately after the fall of communism in Central and Eastern Europe. In 1990 the EU granted the Generalized System of Preference (GSP) status to Hungary and Poland, in 1991, to Bulgaria and former Czechoslovakia, and, in 1992, to three former Soviet republics: Estonia, Latvia, and Lithuania. Slovenia retained the preferential status for its exports into the EU under the so-called autonomous trade preferences granted to former Yugoslavia in the 1980 Cooperation Agreement. The GSP status significantly improved access of exporters from the CEE countries to the EU markets, especially for industrial products. GSP preferential rate embraced 63% of all CN tariff lines in EU imports with most of them subject to zero rates. However, at about the same time a list of “sensitive” products was created. In fact these products were produced by industries in which the comparative advantage of the CEE countries was the strongest.

⁴In 1992 most EFTA countries signed an agreement with the EU establishing the European Economic Area (EEA) that entered into force in 1994. This agreement created a free trade area covering trade in industrial goods and most services as well as liberalized the movement of labour and capital between EFTA and the EU. Through the EEA agreement, the EFTA countries can participate in the EU Single Market. The exception was Switzerland which concluded a separate bilateral agreement with the EU. In 1995 three EFTA countries: Austria, Finland, and Sweden, which jointly accounted for more than 50% of EFTA's output, joined the EU. However, this EU enlargement did not change much the trade relations between the old and the new EU member states, except for trade in agricultural products, because trade in industrial products was liberalized earlier.

⁵These agreements covered mainly trade in industrial products as well as some marine and processed agricultural products. Similar to the EU Association Agreements, the EFTA agreements implied asymmetric trade liberalization. These agreements opened the EFTA markets to imports from the CEE countries faster than the CEE markets to EFTA products.

⁶In contrast to the CEFTA, the BAFTA did not increase its membership but the coverage of the agreement was increased over time at a faster pace than in the CEFTA member states. In particular, by January 1, 1997, the BAFTA included not only industrial but also agricultural and fish products. In this way, the BAFTA became the first free trade area in the region that provided for completely liberalized trade in these economically sensitive areas. Significant differences in the pace and the coverage of trade liberalization between the BAFTA and the CEFTA member states did not allow creating a single free trade area that would embrace all the CEE countries before their accession to the EU.

⁷The new EU association agreement with Turkey established a customs union with the EU that entered into force in 1996.

⁸The sample choice was determined by data availability. The sample is limited downwards because of the political changes in Central and Eastern Europe related to the collapse of the Soviet Union, the break-up of Yugoslavia in 1992, and the “velvet” divorce between the Czech and Slovak Republics that earlier constituted the Czech and Slovak Federal Republic. This yields a total of over 11,000 observations in the case of exports and almost 10,000 in the case of imports for the whole sample. The sample was limited to countries with a population over 200,000 inhabitants.

⁹In our context, a colonial relationship applies to the former parts of the Austro-Hungarian Empire or the Soviet Union.

¹⁰The F-tests for time specific effects confirm the appropriateness of including time dummies for particular years of our sample in all estimated regressions for the whole CEE sample.

¹¹The median dummy for the common colonizer variable is 2.878, which would indicate a roughly 17-fold increase in trade due to effects due to colonial links. We have to keep in mind that many countries in our sample constituted the Soviet Union before 1991 and the trade linkages between them still remain strong (in particular, this applies to the case of Estonia, Latvia, and Lithuania).