The growing importance of CEEC’s intra-regional trade

The study foresees a tripling of trade between Central and Eastern European countries over the next ten years, similar to the evolution of trade between Spain and Portugal after they joined the European Economic Community.

The disintegration of the COMECON bloc resulted in a sudden fall in intra-CEEC trade. But whereas studies often place the emphasis on the redirection of commercial flows towards the European Union, stimulated by direct investment (FDI) from the EU15, intra-regional flows appear even more dynamic since 1994. How could they continue to evolve over the next ten years?

To take bilateral trade, the dynamism between CEEC varies from one pair of countries to another. It is possible to distinguish three sub-regions or basins, in which trade flows are particularly intensive: the Baltic States (Estonia, Latvia, Lithuania), the countries of Eastern Europe (Romania and Bulgaria) and those of Central Europe (Poland, Czech Republic, Slovakia and Hungary). Trade within these basins accounts for three quarters of the total intra-CEEC trade. For companies, the importance of the proximity factor and the even greater importance of the basin effect, probably constitute the key to a successful strategic approach to the increasingly integrated region that will be the enlarged European Union.

The model used in our forecast took into account these sub-regional basin effects. It foresaw a tripling of trade between CEEC’s over the next ten years. This evolution recalls that of the trade between Spain and Portugal on their entry into the European economic area. For the future enlarged Europe, the trade potentials calculated in this survey go in the direction of a continent which is less concentrated than it is at present and also more polymorphic in terms of the geographical distribution of wealth.

1 – Intra-CEEC trade has been particularly dynamic since 1994

As a direct consequence of the collapse of Comecon, from 1989 onwards, there was a massive shift of CEEC exports towards the OECD countries. Intra-CEEC exports suffered most from this change since they were divided by three over two years, declining from 16% to less than 8% of the total exports between 1989 and 1991, while the EU share leapt from 40% to 60%. However, since 1992 and especially since the recovery of 1994, exports between the CEEC have been steadily increasing in volume (see the CEECa curve on the graph opposite).

But taking into consideration the exports of all the candidate countries to each other distorts the results because of the trade between the Czech Republic and Slovakia. Their trade lost much of its weight following the “velvet divorce” between these two countries in 1992, but still accounts for a third of the total intra-regional trade flows. In order to eliminate this distortion, we defined a CEECb area which excluded this bilateral trade. It then appears that intra-CEEC exports have increased more quickly than those towards the EU: +215% against +171% between 1993 and 2000, illustrating a region which has become increasingly open since 1994.

Indeed, in terms of value, the regional market still remains small compared to the EU15. On average, the region’s countries exported nearly 7 times more to the EU in 2000 than to the other CEEC. However, in relation to the respective economic sizes of the two areas, the ratio being 1 to 11 in PPP, their commercial integration is already a reality and justifies an understanding of its stimuli, the better to understand its future.

2 – Three subregions are emerging and structuring the area

The effects of proximity, including history, are one of the driving forces of this intra-regional trade dynamism.

From an economic point of view, there are two arguments in favour of the positive impact of proximity in its broad sense:

Firstly, on the supply side, there is the essential phenomenon of potential economies of scale: the splitting up of production processes is very sensitive to proximity, in particular because of logistic costs. According to our survey of in ternational hauliers, the cost of transport between a town in the EU and the CEEC is about 0.12 €/ton/km compared with an average of 0.3 € between towns in the CEEC. Although exporting to Hungary is more economical from Slovakia, for example, in terms of cost it is less rational to export the same product to Estonia from Slovakia than from Sweden.

Next, in terms of demand, two countries which are close to each other theoretically have more similar spending habits than two countries which are far apart. These consumer preferences, minutely observed by mass retailers, support cross-border trade in a wider range of products.

Synthetically, these effects are measured by the calculation of the relative intensities of trade, comparing the flows between two countries with their respective share of world trade. Thus, if higher than 1, this means preferential trade relations between two countries. Using this indicator, three basins stand out sharply as being closely involved with different EU countries:

a Scandinavian sub-region around the Baltic Sea, dating back to the old Hanseatic League, integrating the Baltic States and the north of Poland with Scandinavian economies such as Finland, Sweden or Denmark.

a Central European basin around Germany and Austria, and, on the CEEC side, the south of Poland, the Czech Republic, Slovakia, Hungary and part of Slovenia.

an Eastern European zone with Italy as its centre, which goes from Slovenia to Greece, including Romania and Bulgaria, but also the Western Balkans which are not taken into account in our statistics, and Turkey.

Gravitational models were then used to show the explanatory power of the effects of proximity in general, and especially to test whether dividing the region into basins was not more relevant than using this “common border” variable.

Intuitively, the idea is that exports from country i to country j increasingly depend on the size of the market (and thus on the GDP of j), as well as on the variety of goods country i can produce, also a postive function of the size of its economy, i.e. its GDP. On the other hand, the export rate decreases with the population, as it reduces the need for foreign trade. It also decreases as a result of higher market access costs, in particular transport costs. Here the distance between i and j can be used as a simplified indication. Finally, we add an indicator which measures the adequacy of a country’s export structure with that of the import structure of the trading partner, in order to take into account sectoral effects. Tests are then carried out using two alternatives, one with a dummy “common border” variable, i.e. of a value of 0 or 1 in the event of immediate vicinity ; the other with a “regional basin” variable, also a dummy. Results show that the latter has a better explanatory power than the effect of immediate proximity.

Thus historical and geographical factors facilitate factory specialization with resulting economies of scale. This is all the more important as the CEEC region mainly consists of small national markets. The concentration of same branch industries as well as sectoral transborder specializations should consequently develop in future.

3 – Location of activities, specialization and development of trade

The dynamism and structuring process of intra-CEEC trade owe their origin to FDI from Western Europe. In particular, they lead to the development of cross flows within sectors between countries of the same sub-region.

Historically, two dynamics have become superimposed. At the beginning of the transition period, a traditional vertical inter-branch specialization emerged, based on comparative advantages in labour intensive activities. It remains for this type of product but its importance is waning. The quality of the local production, which is increasing thanks to FDI and imported technologies, has made it possible for these products, initially designed to capture national markets, to meet the emerging demand for diversity in the other applicant countries. For a whole range of consumer goods, but also some intermediate products, demand is thus nowadays satisfied through exports from the CEEC themselves rather than via imports from the EU, as in the automotive or food sectors. And these products are also finding more and more outlets in the EU. This brings about an increasing similarity in the structure of the candidate countries’ exports to the two regions, EU and CEEC. For companies, which thus extend their production range while specializing their factories on a pan-European level, there result economies of scale together with increased output, stimulating trade inside companies and more generally intra-branch trade between the CEEC.

These investments, and consequently the optimization of upstream and downstream logistic restrictions, contribute to the increasing specialization of the complementary transborder basins which have emerged, based on a generally preexistent common industrial know-how (see table below). Inside these sub-regions, a finer division of the productive processes takes place, reinforcing the basins’ integration by stimulating trade within a sector. Two characteristic examples are petroleum products between Baltic states and automotive parts in Central Europe.

These main sub-regional specialization trends have become more prominent since 1993. They should accentuate between the CEEC as they did in the EU15, where industrial concentration operates according to production factor content (capital, labour and technology) and potential economies of scale. A report produced by the CEPII confirms this trend for the CEEC.

It now remains to estimate the potential future development of intra-CEEC trade.

4 – Volumes of intra-regional trade by 2010

Using these structuring factors as a model, our projections establish that by 2010 intra-regional trade could account for around 15% of these countries’ total trade, against 13% currently. This change might appear insignificant if it were not coupled with a three-fold increase in the total trade of the CEEC. A significant reinforcement of the former USSR, to the detriment of the EU15, would also be noticed. The latter’s share would drop to 59%, against 66% in 2000.

Within the region, trade between these three basins should also intensify, rising to 85% of the total trade between the CEEC, against 80% currently. The central basin (Czech Republic, Slovakia, Hungary and part of Poland) should still dominate widely** Slovakia should play a central role thanks to its geographical position and see its exports grow very quickly in the medium-term. The central basin should continue to be focused upon itself in spite of growing Polish exports to the Baltic basin and Hungarian exports to Romania. Conversely, the reinforcement of the other two sub-regions should be less marked, particularly as regards Eastern Europe, as the Central European basin will still constitute an important export market for these countries with a more traditional specialization towards the EU15.

For more analyses of the EU’s enlargement process, see the

enlargement website of DREE.