Trade Performance Depends on Bold Reform

by Bartlomiej Kaminski, Zhen Kun Wang, and L. Alan Winters

Despite a common legacy of central planning, transition economies have differed widely in their foreign trade performances. With the dissolution of the communist trading system (CMEA) and the demise of the Soviet Union, intraregional trade declined dramatically. Attempts to reorient trade relations have succeeded in varying degree. The countries that have advanced the most in their economic transition_stabilizing their economies, liberalizing prices, redirecting foreign trade, and liberalizing exchange rate regimes_have been the ones that have had the greatest success in improving their export performance, and in reorienting their foreign trade in line with comparative advantages.

Ranking Trade Performers

This conclusion is drawn from an export performance index, based on 1989-93 data in twenty-one transition countries: Bulgaria, the Czech Republic, Hungary, Poland, Romania, and Slovakia, and the fifteen states of the FSU. The index consists of four indicators:

• Change in total exports.
• Change in the share of CMEA (for the Central and East European countries) or intrastate trade (for the countries of the former Soviet Union) in total exports.
• Increase in manufactured exports to OECD countries.
• Ratio of OECD-oriented manufactured exports to GDP.

The indicators reflect different dimensions of performance and, when combined, offers a relevant picture of export reorientation. Countries are ranked according to the four criteria (see table). "Good" export performers, among them Poland, Hungary, the Czech Republic, and the Baltic countries, recorded a substantial reorientation on their trade (the share of CMEA or interstate exports in total trade fell by an average of more than one third) and, measured against GDP, produced a significantly large share (on average, around 14 percent) of OECD-oriented manufactured exports. Early predictions that primary commodities or simple manufactured goods would be the only source of export expansion for transition economies, even for the good export performers, proved only partly true: labor-intensive manufactures, especially footwear and clothing, accounted for the bulk of export growth, although capital-intensive manufactures also figured in the increase.

In several countries of the former Soviet Union, foreign trade regimes retained major traits of earlier central planning, including the application of either direct export controls (as well as foreign exchange surrender requirements), or indirect export taxes. Import regimes appeared to be liberalized, but in many cases administrative controls and foreign exchange allocation hampered imports and helped shield domestic producers from international competition. These implicitly protective policies worked against timely restructuring and adjustment, lessened exports earnings, encouraged capital flight, and fostered corruption and rent-seeking.

The countries that applied market-based foreign trade regimes have also liberalized domestic prices. Those that failed to move in this direction usually retained control over an important array of prices. Such administrative controls kept domestic prices of tradable goods below world market prices, thus creating a strong incentive to divert the goods from domestic to international markets. This then legitimized export controls over these goods and impeded genuine trade liberalization.

Market-based foreign trade regimes and credible stabilization policies usually also work in tandem. Persistent expectations of macroeconomic disequilibria

can discredit a domestic currency and encourage hoarding of hard currency. Both macroeconomic disequilibria and export restraints tend to further depreciate an already undervalued domestic currency, and thus to further reduce opportunities to import high quality inputs and consumer goods from abroad. They deplete international reserves and make current account convertibility a remote possibility.

Doubts and Assurances

Critics who have questioned that progress in transition would improve foreign trade performance have usually advanced the following arguments:

1. Inherited dependence on interrepublic or CMEA trade would preclude domestic producers from expanding exports. But: Inherited levels of trade distortions have not had a decisive impact on countries' ability to reorient their trade. Estonia and Latvia, for example, have made great strides in reorienting their trade despite their exceptionally high level of integration into the Soviet economy.

2. Opening up the economy would destroy domestic production. But: Competition from imports has not devastated the economies of good export performers. In the early stages of stabilization programs, the pressure of competition was weakened by undervalued domestic currencies and in the later stages, fears that rapid real appreciation would curtail export growth and boost imports to unsustainable levels, therefore undercutting import-competing industries, did not materialize. Nor did export growth nor domestic industrial output suffer unduly. The availability of imports stimulated efficiency and helped sustain export expansion.

3. The improved foreign trade performance of Central and East European countries was only the result of preferential market access. But: Market access was improved for all such countries, so the removal of discriminatory measures in OECD markets cannot explain the varying pace of the trade reorientation. Slow and vacillating reformers were incapable of using this advantage.

4. Liberalizing international trade should be preceded by privatization and domestic liberalization. But: If budget constraints for state-owned enterprises are significantly hardened, then in the short run at least privatization is not necessary for strong export performance. In the long run, however, privatization, liberalization, and realistic exchange rates are crucial to assure an efficient response to improved market signals.

Conclusions

To sum up, those countries that liberalized prices quickly, cut subsidies, and dismantled state trading systems, and then stayed on their reform course, generally became good export performers. Liberal import regimes often disguise extensive export controls designed to keep subsidized products at home, while artificially undervalued domestic currencies effectively insulate domestic producers and consumers from international markets. It is extremely important to open up the economy to international market forces during the initial stages of transition. But it is also true that trade reforms also important for exporting success, but they are largely ineffective without macroeconomic stabilization, price liberalization, proper exchange rates, and wide-ranging enterprise reform, but to do effectively requires action on a broad front.

L. Alan Winters is Division Chief of the International Trade Division at the World Bank.

Bartlomiej Kaminski is Professor at the University of Maryland.

Zhen Kun Wang is a consultant of the WDR Division at the World Bank.

The article is a summary of the authors' forthcoming paper, "Foreign Trade in the Transition: The International Environment and Domestic Policy," to be published by the World Bank.