Policy-makers seeking to restructure Eastern Europe's industries have to identify which firms should survive and which should not, if the relatively competitive branches are to expand and the less competitive to contract; but concerns about the social and political effects of high unemployment have led them to defer unpleasant decisions through subsidies, credits and tax reliefs. In Discussion Paper 653, Research Fellow Gordon Hughes and Research Affiliate Paul Hare seek to assess the competitiveness of the individual countries' industrial branches. After the initial liberalization, market signals alone may still provide inadequate information about the relative competitiveness of branches or of enterprises within them. Even if such signals are `correct', financial markets may still be too distorted to ensure the flow of funds to the branches or firms with the greatest long-term promise.

Hughes and Hare combine input-output data (for about 100 branches) for Bulgaria, Czechoslovakia, Hungary, Poland and the former Soviet Union with world market prices to calculate the `domestic resource cost' (DRC) the ratio of domestic labour and capital inputs (at domestic prices) to value added (at world market prices) for each branch. They find a wide spread of DRCs in all five countries, but energy-intensive branches and the food sector perform badly everywhere. They show that recent output changes have not improved competitiveness in general. Finally, they assess the likely changes to the volume and composition of trade that would result from improved access to EC markets and examine the prospects for the revival of trade within Eastern Europe.

The composition of exports is weighted towards relatively competitive branches, but exports to the non-EC market economies are the most influenced by such considerations. Restructuring of output, value added and employment in line with DRCs would therefore have major beneficial effects, while the effects of either doubling exports to EC countries without restructuring or of changing the pattern of exports to the Community in accordance with DRCs would be much smaller.

Hughes and Hare conclude by calling for measures to foster intra- regional trade, especially between the former Soviet Union and its former partners, which requires a recovery of domestic demand backed up by access to foreign currency. Also, exports to the Community will account for very small shares of EC industrial markets, even if some East European sectors grow quickly with restructuring. Any resulting additional exports will certainly be offset by additional East European demand for EC goods and services, so the Community's current trade policies towards the East seem unnecessarily cautious.

Industrial Policy and Restructuring in Eastern Europe
Gordon Hughes and Paul Hare

Discussion Paper No. 653, March 1992 (IT/AM)