As the economies of Eastern Europe emerge from 40 years of inward-looking and managed trade, the West faces increased opportunities for trade and pressures for adjustment. In Discussion Paper No. 610, Programme Director L Alan Winters and Zhen Kun Wang investigate these issues with a `gravity' model, which accounts for bilateral trade flows as functions of importers' demand, exporters' supply and factors specific to the various flows. Estimating their model on averaged data for 1984-6 for 76 market economies, they find that GNP has a strong positive effect on trade, while population and distance have negative effects. They apply their estimated coefficients to 1985 data on Eastern Europe, and they find that reported intra-CMEA trade substantially exceeded its potential (predicted) level for Bulgaria, Czechoslovakia, East Germany and the Soviet Union. The reported data probably exaggerate these countries' trade severely, however; the actual and predicted trade for Hungary, Poland and Romania (which meet IMF data standards) are roughly equal. Eastern Europe's actual trade with the market economies is just one-quarter of its potential on average, and there are again differences between countries; while its trade with developing countries broadly matches its potential.

Winters and Wang find that the ratios of West German actual to potential exports to all the East European economies are higher than those of other Western economies, so liberalization brings Germany proportionately smaller benefits, although as a large economy close to Eastern Europe, Germany gains the most in absolute terms; the US is also a major beneficiary. Eastern Europe and the Soviet Union account for 18% of potential world merchandise trade, even at current income levels (in contrast to the actual 7%); every 1% rise in East European GNP further boosts imports by 1% and exports by 1.2%.

Winters and Wang conclude that trade liberalization in Eastern Europe offers opportunities for Western producers to expand sales and for Eastern consumers to expand their purchases. These cannot be decoupled: to benefit from the East's liberalization or allow it to develop new market institutions and increase its income, the West must offer decent market access. This requires freeing markets now even for sensitive sectors such as agriculture and steel and accepting large future volumes of imports that cannot be envisaged today. Excluding East European imports to protect uncompetitive Western producers of simple goods can only prevent producers of more sophisticated goods from gaining the market shares they deserve in the East.

The Trading Potential of Eastern Europe
Zhen Kun Wang and L Alan Winters

Discussion Paper No. 610, November 1991 (IT)