NEW EU MEMBERS OF CENTRAL AND EASTERN EUROPE Opening of Economies Tibor Palánkai

NEW EU MEMBERS OF CENTRAL AND EASTERN EUROPE Opening of Economies

Tibor PalánkaiEmeritus Professor

Corvinus University of Budapest

Master Course 2014

Prof. Palánkai Tibor

Concept of Opening

Distinction between structural and institutional openness:

Structural openness relates to high share of foreign trade in GDP and role of FDIs (small countries).

Hungary, as a small country, with about 40% of the foreign trade in its GDP, structurally was an open economy (now 70%).

Institutional (policy) closed character meant protectionist and discriminatory trade policy, non-convertibility of national currency, and exclusion of foreign capital.

The main measures of opening, therefore, arose mostly in policy terms.

Impacts of Reforms in Hungary

Only certain and minor modifications of the foreign trade and currency monopoly.

In Hungary, after 1968, the export rights were extended directly to producers, market-conform tariff system was introduced (1973 – GATT membership) and more realistic (unified) exchange rates were applied (1981 IMF and World Bank membership).

The real and radical market opening was implemented only after 1986-89.

In non‑reforming countries this measures only following 1990.

Discriminations

Before, former Soviet block countries. Now terrorist states.

• Centrally Planned Economies – CPEs and State Trading Countries – STCs – protectionists and discriminative. Countermeasures justified.

• Plan target equal with quota.• Artificial prices and exchange rates, subsidies

equal with tariffs.• Special tariffs, quota and dumping measures.

COCOM Coordination Committee for Multilateral Export

Controls. 1949 – Paris (NATO, Australia, Ireland, Japan (some neutral countries Austria included).

• About high-tech products and technologies.• Two lists: (1) prohibited products (mostly military

products) and licensed products.• (2) Strategic products and „dual use” (military

and civil) products and technologies.• Depending on detent or tensions.

Opening as „Negative Integration”

Opening (liberalisation) meant: • Liberalisation of foreign trade,• Re-creation of convertibility of national

currencies,• Elimination of obstacles before foreign direct

investments, liberalisation of capital markets.

Trade Liberalisation

1. The complete elimination of the "monopoly of foreign trade" - the extension of foreign trade rights to all economic agents.

2. In Hungary, in 1988, the 41 large foreign trade state companies controlled 81% of foreign trade, and about 300 other traded abroad.

By 1992, about 15,000 companies conducted foreign trade on permanent basis, and further 50,000 occasionally.

Trade Liberalisation

2. Import liberalised by abolishment of licensing. In Hungary, in 1988, import fully licensed.

By 1993, import licensing fell to 3-4%, to similar level as in industrialised countries (only drugs or weapons etc. under control).

By 1993, 78% of domestic production was exposed to import competition.

Quantitative quotas were eliminated (except for some products - alcohol).

Similar measures in other countries.

Trade Liberalisation

3. Tariff reductions. The average tariff level in Hungary reduced from 32% to 24% after joining GATT in 1973.

By 1991, the Tokyo round, the Hungarian tariff level was cut to 13% (Tokyo Round etc.)

By early 2000s, average Hungarian industrial tariff level was 6,8% (EU average 3,6%), about 85% of the import liberalised due to free trade agreements (EU, EFTA, CEFTA, bilateral treaties etc.).

Trade Liberalisation

4. Drastic reduction of subsidies. Under the planning system, the high subsidies

distorted the profitability and competitiveness of export.

Subsidy cuts created real import competition and helped restructuring of economy.

In Hungary, subsidies were cut from 13% in 1989 to 1% in GDP in 1996.

Similar measures in other countries.

Evaluation of Trade Opening

The trade liberalization by early 1990s, was substantial. In 1988, CEE, including Hungary, was 100% protected. In 1992, the general level of protection no more than 25%.

By around 1992-93 CEE EU candidates converged with OECD averages, and their protection level corresponded to the countries likeArgentina, Turkey, Israel or Chile).

By early 2000s, CEEcs have become open economies.

Criticism of Trade Opening

Sudden and radical elimination of subsidies gave not enough time for adjustment of those producers with viable capacities, but coping with transitory problems.

Some felt, that "big bang" liberalizations were ill‑advised, by unilateral and hurried "over‑liberalization", substantial bargaining were lost in trade negotiations with West. In spite of Western trade concessions, structurally better deals were missed for sensitive products (agriculture).

The possibility of "tariffication" of some of the QRs or administrative licensing was missed.

Issue of non-tariff barriers was neglected. OECD tariffs were only 2,9%, but 57,4% of import from Hungary was covered by non-tariff measures, while CEE markets remained unprotected.

  Criticism of Trade Opening

Historically, trade liberalizations usually implemented under

recovery and favorable world market conditions. In CEE, they were introduced under extreme and extraordinary conditions.

Opening measures were accompanied by deepening recession, cuts in budgetary subsidies, revaluation of currencies in real terms, shortage of export financing by banks, high real interest rates, fall of investments and shrinking domestic and external demand. Result: collapse of whole sectors in undesirable proportions.

Radical and rapid opening had high costs, but they could not be entirely saved, they greatly contributed to successful restructuring and improvement competitiveness of these economies.

Convertibility of national currencies

The convertibility - a currency is freely exchangeable for other currencies (till 1970s for gold)

Distinction of convertibility by economic agents involved: domestic ones (companies, institutions, physical persons etc.), and foreigners or external ones.

Transactions: current or capital accounts convertibility. De facto and de jure convertibility are also often

distinguished.

Types of Convertibility

IMF definition - freedom of current account transactions (trade of goods and services, tourism, current transactions, transfer of capital incomes, interests, dividends or profits - for domestic and foreign users as well).

Convertibility criteria extended to capital accounts (OECD), particularly liberalising of direct foreign investments.

EU – internal market – liberalisation of all capital transactions - full convertibility

Convertibility under Central Planning

Central planning in CEE was connected with non-convertibility.

• Exchanges were monopolised by Central Bank. • It was illegal to hold and trade of foreign currencies.• Agents were obliged for compulsory conversion, if they

acquired foreign currency.• Acquisition to foreign currency was strictly controlled and

limited (tourist quota).• Exchange rates were artificially fixed.• Most countries applied multiple or dual exchange rates

(trade and tourist).

Convertibility and the Reforms

In Hungary and Poland, the exchange rate as an „active” economic policy tool after 1973.

It meant, first, anti-inflationary revaluations (following 1973 oil price explosions) and from 1980s, devaluations for import (energy) savings and improving export competitiveness.

The overvalued tourist rates served as a certain taxation of foreign tourists, because of the subsidized food or services, in all countries.

Unified exchange rates were introduced in Hungary, in 1981 and in Poland, in 1982.  

Convertibility as part of transformation

For domestic companies, for import of goods (since 1989) and services (1993) forint became de facto convertible.

Most radical convertibility in Poland related to the shock therapy from January 1 1990, but services were included only after 1994.

The Czech- Slovak krone became convertible for companies in 1991.

Tourist quota increased gradually, and abolished by October 1, 1995, in the Czech Republic, and by January 1 of 1996, in Hungary.

Convertibility as part of transformation

Two-tier banks systems re-established, separation of commercial banks from Central Bank, which should be responsible for monetary policy.

In Poland, commercial banks have been trading foreign currencies since 1989, in Hungary, only after July 1, 1992. In other CEEcs, the intra-bank currency market was introduced mostly after 1991.

Convertibility as part of transformation

Profit repatriation of foreign investments and joint ventures allowed since 1986, in Hungary, and in Poland, in 1991.

The reinvestment of profits of foreign companies were encouraged by tax preferences.

Direct investments abroad were possible for CEE companies only with licence.

Foreign companies were free to invest and withdraw their investments in every country.

The investment guarantees were given in laws and by the Europe Agreements.

Exchange Rate Policies

Diverging exchange rate policies:

Free floating (most countries). Managed floating (H. between 1989-1995). Crawling Peg (P. after 1990, and H. between 1995-

2001). Floating in band (H. since 2001, unilaterally imitating

ERM, since 2008 free floating). After 2004, joining ERM2. (Baltics, Slovenia, Slovakia).

State of Convertibility

By 1995-96, the convertibility of national currencies has been achieved in most of the CEEcs, (West -1958).

For „full” convertibility, by abolishing all limitations on capital, in Hungary and in Czech Republic by 2001.

NMs full convertibility from 2004, as they joined the single market no derogations for capital markets).

Most of them committed for early adhesion to the Euro-zone (from 2007-2014).

SL joined euro-zone in 2007, MT and CY in 2008, SK in 2009, EE in 2011, LV from 2014.

Lack of Capital Markets in CMEA

Under the "socialist system" the international flow of capital was rejected on ideological grounds (considered as ‘exploitation”).

CMEA lacked capital market and had a poor credit system (only trade-related credits). Among other factors, this led to acute shortages of capital.

Opening for FDIs

In 1989, the foreign companies' treatment was put on equal basis with the Hungarian ones ("national treatment"), and their operation was fully liberalised (100% share allowed in joint ventures).

Practically, by early 1990s, full opening for direct capital investments in CEEcs.

Former central planning was abolished, institutional and legal frameworks for FDIs were created.

Full capital market liberalization was implemented by early 2000s, related to EU adhesions.

Attraction of Foreign Capital

Former reform countries in advantage, but great differences among countries:

• Poor infrastructure, particularly in communication and transport, as deterring factors.

• The weakness of internal capital markets, as an obstacle for foreign investments.

• High interest rates (15‑20% higher than in Western Europe) increased the capital costs,financing enterprises from the local capital markets.

Attraction of Foreign Capital

• The legal‑bureaucratic regulations not totally eliminated, the frequent changes in laws.

• Serious problems arose concerning the interpretations of legal regulations.

• In many countries, the social‑political instabilities.

• Associations to EU helped, but not enough.• FDIs strategic role in integration of CEE into the

global world economy.

END

Thank you

Prof. Palánkai Tibor