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NEW EU MEMBERS OF CENTRAL AND EASTERN EUROPE
Opening of Economies Tibor Palánkai Emeritus
Professor Corvinus University of
Budapest Master Course 2014
Prof. Palánkai Tibor
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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.

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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.

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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.

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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.

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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.

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Trade Liberalisation

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

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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.

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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.).

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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.

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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.

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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.

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  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.
  

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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.

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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

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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).

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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.  
•  

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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.

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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.

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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.

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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).

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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.

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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.

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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.

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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.

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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.

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END

• Thank you

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Prof. Palánkai Tibor