The Europe Agreements
Preserving Free Trade?

Have the Europe Agreements preserved free trade in the East? At a London lunchtime meeting held at the European Bank for Reconstruction and Development on 28 March, André Sapir argued that while trade liberalization in Czechoslovakia, Hungary and Poland has been rapid, there are now doubts about its sustainability. Sapir examined the impact of the EAs on trade policy and trade flows within Eastern Europe, particularly focusing on the Hungarian experience since 1991. He addressed two key issues: were the EAs successful in `hand tying' governments and ensuring they pursued liberal trade policies? And how many hands were successfully tied? Tying only one hand would mean that the EAs simply led CEEC governments to shift protection to their trading partners outside the EU, those not covered by the EA umbrella. Sapir is Professor of Economics at ECARE, Université Libre de Bruxelles and a Research Fellow in CEPR's International Trade programme. His talk was based on research reported in his CEPR Discussion Paper No. 1024, `The Europe Agreements: Implications for Trade Laws and Institutions. Lessons from Hungary', also published as a chapter in Foundations of an Open Economy: Trade Laws and Institutions for Eastern Europe.

Trade liberalization in Czechoslovakia, Hungary and Poland was accomplished in record time. Between 1989–91, these countries completely removed state monopolies in foreign trade, freed over 90% of imports from licenses and quotas, and reduced their average tariff rate to less than 15%. This achievement is remarkable: in developing countries, trade liberalization on this scale has usually taken decades. Yet the experience of developing countries suggests that we should not rejoice too quickly: the main problem with trade liberalization is usually not its initial implementation but its long-term sustainability. This indeed became a major concern in the CEECs, as the `honeymoon' of trade liberalization ended in 1991–2.

Economic transformation requires far-reaching and painful structural change, and this has led, not surprisingly, to increased protectionist pressures in the CEECs. This pressure has arisen from a number of sources. First, not only industrialists, but also some academics have argued that too rapid and too profound a trade liberalization threatens the survival of potentially efficient domestic producers. Second, &nbsprestructuring involved sales of domestic enterprises to powerful foreign investors, who demanded concessions from local governments, such as trade protection. &nbspThird, the collapse of the Council for Mutual Economic Assistance (CMEA) market created additional pressures on those domestic firms already suffering from import liberalization.

Sapir argues that recent research on the political economy of trade policy provides a simple explanation of the growth of protectionist pressure in the CEECs. The research reveals that protectionist pressure is likely to dominate trade opening efforts during the transition from socialism, unless trade policy is credibly nondiscretionary. The research also highlights the important role that institutional arrangements such as the EAs can play during the transition. By limiting the government's discretion in setting trade policy, such institutional arrangements can give credibility to these trade policies and so discourage demands for protection.

Sapir's research focuses on a single country, Hungary, something that he notes has both advantages and disadvantages. A major advantage of selecting Hungary is the 1991 GATT review of its trade policies, which provides an excellent benchmark. The main disadvantage is that Hungary's commitment to liberal trade policies probably places it at the far end of the spectrum in the region. Sapir first examines the process of trade policy formulation in Hungary. He finds that, compared with its multilateral GATT obligations, the EA imposes significant additional constraints on the formulation of Hungary's trade policy, but that these mainly affect its bilateral trade relations with the EU. The extent of the added restraints imposed by the EA differ markedly between industrial and agricultural products.

Sapir also examines the impact of the EA on the trade policies which Hungary adopted after 1991. &nbspDemand for protection rose substantially after 1991, and by 1992 was in full swing. Several factors have fuelled the pressure for protection. The transition process produced the expected falls in output and employment. A second factor was the surge of imports. The final factor was the resurgence of &nbspspecial interest groups, and here there was a clear difference &nbspbetween foreign and domestic firms. The large foreign investors were the first to campaign successfully for protection. For their part, domestic producers lacked the lobbying power that multinationals derived from Hungary's need for money, management and technology. Some of them, however, had substantial political weight, especially the agrarian lobby and large-scale state enterprises.

Did the Europe Agreement tie the government's hands? &nbspSapir finds that, despite strong protectionist pressures, Hungary was able to maintain course and continue with trade liberalization, partly due to the EA. The government's resolve to resist protectionist pressures and sustain import liberalization was strengthened by two complementary decisions. The first was the adoption in March 1991 of the liberal-minded four-year `Programme of Conversion and Development for the Hungarian Economy'. The second decision was the signing in December 1991 of the Europe Agreement. At the same time, Sapir finds little evidence of `protection diversion', though there is a clear exception that proves this general rule. The Europe Agreement imposes little discipline regarding the protection of agricultural products. As a result, much of the recent demand and supply of protection in Hungary have taken place in this area.

Sapir concludes that the EA has indeed helped to tie the hands of the Hungarian government, as well as helping it to implement a rapid liberalization. But will the government slip free of its bonds in the future? Sapir questions whether the EA provides a sufficiently solid environment to enable Hungary to sustain its trade liberalization. There has been a deterioration of the trade balance, and this has produced `liberalization fatigue' in Hungary. In December 1993, the government presented an economic programme aimed at reducing the trade deficit through a combination of export promotion and import curtailing measures. The latter included the reintroduction of licenses and the increase of import duties for certain agricultural products, as well as the freezing at the 1993 level of the 1994 quota for consumer goods. The second development is the May 1994 election, which produced a new majority whose commitment to resisting protectionist demands remains untested.