While the opening of Central and Eastern Europe to international trade is expected to yield large efficiency gains in the long run, these changes will inevitably entail significant short-term adjustment costs. The 1991 demise of the CMEA trading system and the shift to convertible currency settlements and world market prices were expected to lead to a severe contraction of trade within Eastern Europe and large imbalances in its trade with the former Soviet Union. The observed trade collapse was exacerbated by deep domestic recession and political unrest in the region. A Central European Payments Union (CEPU), modelled on the successful (West) European Payments Union (EPU) of 1950-58, was proposed with the aims of alleviating transition costs and preserving Eastern Europe's existing trade patterns.

In Discussion Paper No. 650, Research Affiliate Dariusz K Rosati reviews the historical experience of post-war Western Europe and argues that despite the prima-facie analogies, there are important differences between the conditions faced by the EPU in the 1950s and those in Eastern Europe today, so that a CEPU would be neither economically justified nor politically feasible in the early 1990s. He then uses a simple gravity model to estimate potential trade flows among Central and East European countries following the CMEA's dissolution, applying structural parameters estimated on trade flows among West European countries to determine the `normal' levels of trade flows among the post-CMEA countries. He finds that most bilateral trade flows in the region will decline relative to their 1989-90 levels, with the abolition of the preferential trading system and the sharp decline in GDP levels. Most of this adjustment will take place through the reduction in the region's trade with the former Soviet Union, but there will also be a substantial reorientation of its trade towards the West.

Rosati concludes that if the `normal', sustainable levels of trade among the post-CMEA countries, corresponding to current levels of economic development, are below the actual levels recorded during 1989-90, seeking to preserve existing patterns of trade flows may not be the most appropriate policy. Policy should aim rather to restructure these economies' production and to reorient their trade towards a more balanced market structure based on principles of comparative advantage. A payments union may be of little help in this regard, since it is essentially a short-term, `trade-lubricating' mechanism. The restructuring required can be achieved only over a longer period, within a comprehensive programme of financial assistance supported and coordinated by an international institution devoted to the economic recovery of Central and Eastern Europe.

Problems of Post-CMEA Trade and Payments
Dariusz K Rosati

Discussion Paper No. 650, April 1992 (IT)