NATO Economic Colloquium 1997

Current Status of East-West Trade within International Trade Ferry de Kerckhove Director General, Planning Secretariat, DFAIT, Ottawa (The views expressed below are those of the author and should not be construed as representing the official view of the Government of Canada). As a former member of NATOs Economics Committee in the early eighties, it is a pleasure for me to return to the fold. The title of this panel is wide ranging, so this paper will focus more on linkages than on the statistical dimension of the current state of East-West trade within the international trading World. The first key question to address is what are the broad structures of international trade within which East-West trade occurs. In that respect, Economies in Transition (ETs) are clearly facing a rough ride. They are coming of age precisely at a time when economic capacity and knowledge are the defining elements of international standing. Trade continues to be the engine of global economic growth and competitiveness is the ultimate law for making it or not. Furthermore, the multilateral system as seen from the perspective of ETs is somewhat in a state of flux. In certain parts of the World there is a surfeit of institutions; in others there is a dearth. It so happens that ETs belong mostly to an area where the nexus of institutions is the most complex of all regions and where economic and security variables are deeply intertwined. Furthermore, new players with new weights are emerging and the key for ETs is to determine which model to follow and which group to belong to. Geography doesn't necessarily tell the tale. Whether ETs like it or not, East-West economic relations, including reform efforts, take place within the broad international context of globalisation, the G word, and that World is also a multi-power centered one, marked by an information revolution. This is a lot to adjust to for ETs which are indeed facing, as we are, the emergence of worldwide markets for technology, investment, production, distribution and consumption, including global capital markets and the growing power of multinational enterprises and non-governmental organisations (remember that Greenpeace's budget is twice that of UNEP). ETs are not ready for it and the question is: can they catch up? On the more intangible side, ETs are slowly moving away from the remnants of an imposed ideology only to face an emerging global information infrastructure and, relatedly, the global spread of a value system which takes little account of local differences, past histories, and national pride. "McWorld" is neither a fad nor a fiction but stark reality. For those new economies emerging from the economic dark ages of "Communist" Central and Eastern Europe, aspiring to both "renewal" and respect for their cultural traditions, it leaves a lot to be desired. To reap the benefits of globalisation - for not trying to do so for autarchic/ideological reasons, as perhaps in Russia, is not an option unless ETs wish to be left out of the process of economic transformation - ETs need to open up to the World which leaves them extremely vulnerable to pressures from the outside. A variable, often forgotten, is the human dimension. Citizen insecurity in ETs is one of the most pervasive results of the Brave New World they have entered. We have seen the dangers and risks of this process of cultural transition: ethnic and cultural nationalism, feelings of marginalisation, and a fertile ground for ethnic conflict and even persecution of minorities. The events in the former Yugoslavia have also much to do with the results of the economic and societal transformations affecting Central and Eastern Europe. The profound upheaval in these societies is also cause for the growing and devastating potential for crime, drugs and related ills which know no frontier but seem to prefer certain borders over others. How much "wild capitalism" is too much? I must quote here - he will forgive me for my skepticism - the reassuring comment made to me one day by Alexander Maximovitch Yakovlev, a well known lawyer and one time go-between President Yetsin and the Russian Duma on legislative matters: "wild capitalism is a necessary evil in a transitory stage until such time as Russians discover that ownership requires law and order to defend property". There has been more wildness than true capitalism for quite a long while. And in the meantime, import substitution, capital export, or more precisely capital flight, transfer pricing and unbridled selling of natural resources seem to be the bedrock of Russia's trade surpluses while former Comecon countries are slowly moving from semi-manufactured to unsophisticated manufacturing. How competitive will they be over the long run in what markets remains to be seen. So where are we today or how did we get here? For Central and Eastern European economies the answer is most likely slower than expected and worse than could be imagined. My three years in Moscow have probably given me a Russian bias, both favourable and also probably more critical. The following analysis will therefore reflect more my perception of how things went in Russia than elsewhere although we all know how it started. The theory had it that shock therapy would stop hyper-inflation, cure budget deficits and initiate the start of structural reform. The result of the process would be first an induced recession which would eventually bottom out and lead to real transformation. Five elements were involved in the key decision tree of the neophyte economists of ETs: price liberalisation; balanced budgets; tight monetary policy; tight wage policy; foreign trade liberalisation. The latter called for the ending of export and import licences, the freeing of enterprises who would then be allowed to engage in foreign trade, tariffs cuts or reductions to expose domestic production to competition abroad, limited convertibility to ease up foreign trade operations, and although this may sound a bit brutal, pegging the currency to black market rates, something which was much more effective as an instrument in Russia than the horse-riding militia trying to pick-up money changers on the streets. There was to be of course a strong correlation between price liberalisation and meeting the challenge of competition abroad. Domestic monopolies were no longer to be protected. World prices would be assumed to be able to correct the deficiencies of the previous import price structure and the new shape of exchange rates would deter imports. At least that was the theory. Fundamentally at issue in Russia, during my time there, was the political credibility of shock therapy. Close seconds were the management of the correlation between privatisation and price liberalisation, inter-enterprise debt, and taxation - or more precisely, the size of the tax base. While it is gratifying to agree with Madame Brard that privatisation is an irreversible process and to note that in Russia it has gone further than in any other economy in transition, the system has not entirely adjusted to the process, if at all. In three years in Moscow from 1992 to 1995, I don't recall having ever seen a major bankruptcy despite the debt overhang affecting so many and despite the shaking down which should have followed privatisation. The results for all ETs, as World Bank statistics show, can be characterized as "the good, the bad and the ugly". My diplomatic status prevents me from drawing a list under each heading. Clearly I would not want to define a new "Nomenklatura". What is interesting is that of all the macroeconomic stabilisation measures taken, external balancing appears to have been the most successful. Indeed, in the beginning, ETs exports to the West increased and a good chunk of exports formerly going to the CMEA region as a share of total exports were being redirected toward the West. Trade balances and current account balances improved. However, since 1993, some opposite trends have appeared quite extensively in ET countries. The reasons are complex. There was excessive devaluation in the beginning and the real value of currencies, even today, is still an issue as long as the rate of depreciation and the changes in the price levels are not stabilised. Furthermore, in Russia there was such a dollarisation of the economy that price levels were profoundly distorted. I recall that, at some stage, it was hard to find roubles in Russia. And the story has it that, at the time, there was some US$20bn in cash in the Russian economy. The other reason for the worsening of trade balances is related to what Marie Lavigne, the well known specialist on Central and Eastern European economies, calls "Distress Exports" which could not be sustainable over the long run. Indeed, the future of the export capacity of ETs is very much in question particularly in sensitive sectors like textiles, agriculture and steel products. Finally, foreign debt constitutes a major overhang which is not helped by the reluctance of ETs to accept sovereign guaranties. It is amazing that some ETs have either not understood or not accepted the consequences of the fact that the most important variable for transition/transformation is investment, both foreign and domestic. Although privatisation is an irreversible process in ETs, it has not led everywhere, particularly in Russia, to the kind of investments expected, whether with or through foreign capital beefing-up existing production units or with foreign investment replacing existing structures. So the issue of ETs being poised to reintegrate or, in the case of Russia, to integrate fully into the World economy is still very much out there. Or put differently. it is still more a theology than a fact despite recent remarkable progress in some countries like Poland. I think some of the ideological underpinnings of the great rush to the West by the ETs need some sober rethinking. There is an assumption out there that joining Western institutions is not only the ultimate panacea but that it is necessarily an accepted holistic proposition. I wish to unscore that preferential security treatment in the post Cold War world does not mean automatic preferential economic treatment. I am aware that it sounds irritating for ETs to be told not to give up former trading linkages among themselves and with Russia entirely. Of course, at present, that trade is collapsing and the Central European reorientation of its trade toward the West appears irreversible. Yet the integration drive is very much a political process and ETs should be alert to the fact that the economic reality check will hit, notably in the sensitive areas I mentioned earlier. During recent trilateral consultations with my counterparts in Poland and Ukraine I underlined the fact that the "merchants of Venice" would be guided by their economic interests which will not necessarily coincide with the political aspirations of countries from Central and Eastern Europe. The question of the relevancy of the CIS also needs to be answered. Trade is growing but the institutionalisation of the CIS seemed to be either faulty or scaring away potential partners. The existence of a rouble zone may not be readily accepted but it is a fact; and maybe it would help if that was appreciated for its economic virtues rather than for political implications drawn of the scarecrow variety. Now, in the West, we too need to get our act together. We are both critical of the CIS when we try to see in it some kind of reconstitution of the USSR as if that were possible, but at the same time we encourage the deepening of intra-CIS and Central and East European trade. It is high time that we recognize that economics are somewhat more relevant today than past anguish on security grounds. Russia's "strategic partnership" with China may have as a political goal "keeping Washington honest", but it is clearly driven much more by the economic imperative. Old bonds die hard. While Russia is more advanced in terms of privatising its former public sector compared to China's huge, bloated, and inefficient public enterprise system, China can help in terms of economic zones and reform. There are also some very useful series of agreements with the European Union, including EU Association Agreements, Partnership Agreements, Trade Agreements and also EFTA Arrangements. There has been some very good relief in terms of quantitative restrictions and tariffs but it remains to be seen when the limit will be reached in the area of sensitive products such as agriculture, textiles, coal and steel products. The European Union is going through a major period of adjustment and implementation of its own remarkable commitments and one should ask honestly whether economics can catch up with politics. EU enlargement is not a panacea, neither is it a done deal and my fear is that while so much effort is focussed by ETs on the enlargement of the EU, there is the train of globalisation out there which may be leaving the station. When and where Central and East European ETs wish to board is to be decided soon. I am aware of, and admire, the commitment of West European leaders to making enlargement happen. I am also profoundly sensitive to the fact that the negotiations will be very long and arduous and that our East and Central European friends should not necessarily be wedded to a timetable because they might be sorely disappointed. They also need to look at the broader world and see if, beyond Europe, there are further synergies that might work.