After a decade of restructuring, most transition economies have yet to reach the GDP they had before the collapse of communism and conquered inflation only during the past few years. By 1998, the PPP GDP/capita was only 51.0 percent of the EU15 for Central European TE, 32.6 percent for the Baltic States and 22.1 for the South-Eastern European TE. Although the overstressing of industry that had characterized the communist period had declined significantly by 1998,
it was still excessive in most TE. Gross domestic investment as a percentage of GDP was similar to other developing countries with similar level of per capita incomes, government deficits and the external debt seems sustainable, but current account deficits seem excessive, except for the Czech Republic and Slovenia, in view of the limited inflow of foreign capital (especially FDI) into these economies.
A model of economic restructuring shows how the inflow of FDI shifts E’s factor-ratio curves upward while lowering the rate of return on capital and increasing wages. From 55 percent to 80 percent of the economy of TE has now been privatized. Small firms and foreign trade and exchange systems have achieved the standards of performance of advanced industrial nations in TE, but large-scale privatization, price liberalization, competition policy, banking and interest liberalization, and securities markets and non-bank financial institutions are only between 50% and 75% of the level in the advanced industrial nations (closer to 75% in Central Europe and the Baltic States and closer to the 50% mark in the TE of South-Eastern Europe). Thus, TE still have a great deal of restructuring to undertake before they are ready for admission into the EU.
The most advanced Central European TE (the Czech Republic, Hungary and Poland) have average per capita incomes about 42 percent lower than for the three least advanced EU members Greece, Portugal and Spain). As a percentage of GDP, their gross domestic investment is higher, but so are their government deficit and current account deficit (which, however, remain entirely sustainable). Their international competitiveness is between 20 and 30 percent lower than that of the least advanced EU members. With a much lower per capita incomes and competitiveness, TE would contribute much less than they would benefit from EU resources, especially EU regional funds, and this is one serious obstacle to the early admission of even the most advanced TE of Central Europe into the EU.
The hotly debated question that took place after the fall of the Berlin wall as to how much TE should trade among themselves or with Western Europe was a false choice. Trade theory clearly shows that TE should trade as much as market principles allow – without concern of whether this is intra-TE or TE-Western European trade. Although precise data are not available, it seems that the share of TE trade with the West increased from about 10-15 percent a decade a decade ago to between 55 percent to 85
percent today. TE now engage in international trade as much or more than other market economies of similar size and level of economic development. Most TE have a comparative advantage in labor-intensive commodities, especially clothing, except for the Czech Republic (where the principal export is vehicles), Hungary (electrical products), the Slovak Republic (iron and steel) and Estonia and Latvia (oil).
TE have many different exchange arrangements, ranging from currency boards to independent floating, and different monetary policy frameworks, from IMF-supported programs to inflation targeting. TE, however, face the dilemma of targeting the exchange-rate or inflation and may not be able to achieve both as required for participating in the euro. A pragmatic solution would be to have a crawling peg and inflation targeting in the range of 3-5 percent. This means that TE may qualify for admission into the EU before being able to join the euro.
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