The Free Trade Zone in Southeast Europe: achieving genuine regional economic integration

On 27 June 2001 seven countries in Southeast Europe signed a Memorandum of Understanding on the establishment of a Free Trade Zone in the region by the end of 2002. As at the beginning of 2002, 15 new bilateral free trade agreements (FTAs) are still to be negotiated in order to consider the above process successful. Although the negotiation process is well underway, the public perceptions on the economic implications of the regional trade liberalization processes are still skeptical. A number of questions remain open for discussion among the governments of these countries, the experts and the society. What is the “big picture”? Can we find similar examples in Europe? What are the specific implications for each country? What can be learned from the experience of other countries facing similar developments? How long it will take to catch up with the EU Member States?

The following represents a summary of the most sensitive topics that have to be addressed properly prior to the start of the Free Trade Zone in 2003 in order to achieve genuine regional economic integration that will lead the SEE countries out of the vicious circle. The results of the research performed during the 2001 International Policy Fellowship will serve as a starting point for the continuing of an in-depth comparative research.

1.Avoiding the traps

In this part of the research the practical steps of the negotiation of the remaining FTAs during the year 2002 will be outlined. On the basis of up-to-date information the trade flows between the negotiating countries and the likely implications will be analysed in details. The business community and the society are just beginning to realize the impact of the Free Trade Zone. Undoubtedly, the undergoing process of trade liberalization will lead to the formation of interest groups, which will try to influence the negotiation process in order to preserve some of the existing tariff and non-tariff barriers. The present part of the research will address the following specific problems:

n How should the governments respond to the attacks of the affected parties or industries?

n What kind of arguments shall be brought forward by the governments to persuade changes in the existing public perceptions?

n How a balance between the pressure groups and the long term economic and security interests of the countries in the region can be achieved?

n What are the invisible traps of the final stage of the process and how can they be avoided?

n What kind of support shall the EU and the international financial organizations provide to the governments of these countries?

2.Trade relations of Bulgaria with the SEE countries: a case study

In this part a detailed analysis of the trade between Bulgaria and the other six countries participating in the Free Trade Zone will be analysed in details. The case study will be based on up-to-date trade information referring the following items:

n Current status of trade relations;

n Analysis of bilateral trade flows for the preceding five years (where possible);

n Major commodities traded and share of total import/export;

n Outlining the tendencies in trade flows.

On the basis of this analysis conclusions will be drawn with regard to the specific effects of the Free Trade Zone on the Bulgarian economy.

3.Successes and failures of trade liberalization in CEE: the case of CEFTA

In order to estimate precisely the effects of trade liberalization in Southeast Europe, a comparative survey of another trade block of similar type (CEFTA) shall be analysed as well. The common features of the two groups of countries are numerous as the following three can be considered the major ones: changes in the political and economic structures; regional trade liberalization; and orientation towards integration with the EU.

The research will focus on the economic implications of the liberalization of trade of this group of seven countries: Bulgaria, Czech Republic, Hungary, Slovakia, Slovenia, Poland and Romania. The CEE countries have joined CEFTA with the presumption that regional trade integration will facilitate the process of accession to the EU. On the other hand, some representatives of the political elite within CEFTA countries feared that such regional economic integration would divert the scarce economic resources from the main goal - European Union membership. Such fears can now be observed in Southeast Europe as well. The objectives of the present comparative survey can be summarized in the following way:

n What are the successes achieved during the 10-year history of CEFTA?

n In what areas did the countries fail to achieve mutual understanding?

n What were the reasons for the successes and/or failures?

n What is the level of tax and customs harmonization in these countries with respect to EU requirements?

Based on the above analysis, clear conclusions whether such fears are justified can be drawn with regard to the establishment of the Free Trade Zone in Southeast Europe.

4.Foreign direct investments and tax incentives

The relationship between foreign direct investments (FDI) and tax incentives are subject to a continuing debate. Experts from the World Bank and the IMF support the notion that the tax incentives lead to the erosion of the tax base and create macroeconomic instability, which does not lead to a substantial increase in FDI.

However, even in the European Union a number of tax incentives exist, and the Member States are somewhat reluctant to eliminate the grounds for tax competition among themselves. This fact sharply contradicts the requirements of the EU towards the appropriate tax policies in EU candidate countries. In addition, in five of the seven SEE countries of the Free Trade Zone (excluding Bulgaria and Albania) there exist a number of corporate tax incentives, which have not actually attracted significant FDI inflows by the moment.

Undoubtedly, given the present economic status of the seven SEE countries, only substantial FDI can lead to higher economic growth rates and successful economic reforms. In this part of the research the following issues will be discussed in more details, in order to outline specific conclusions on the relationship between FDI and tax incentives in the region relevant to the prospects of regional trade liberalization:

n Analysis of the main factors influencing FDI in Southeast Europe;

n Timing analysis of the introduction of tax incentives;

n Do the countries of Southeast Europe need tax incentives in order to attract FDI?

n Tax competition versus tax coordination;

n Types of tax incentives, which can be considered applicable for the SEE countries;

n How such tax incentives can be accepted by the international financial organizations?

5.High achievers and slow performers in Southeast Europe

GDP growth rates in the countries of Southeast Europe are rather diversified. For 1999, Albania and Bosnia & Herzegovina show relatively high growth rates at approximately 8%. At the same time Bulgaria, Croatia and Macedonia maintain a modest level of GDP growth, while Romania and FR Yugoslavia are lagging behind. However, high growth does not mean better living standard. If we analyse the GDP/ per capita, we will see that only Croatia maintains a comparatively high level of this ratio – approximately USD 4,500. For most of the other countries, the ratio does not exceed USD 1,500.

If the present levels of the growth rates are preserved, it is not very likely that these countries will soon catch up even with the poorest EU Member States. Recent research findings suggest, that this process of catching up may take up to 30 - 40 years. In addition, the unemployment rates and economic migration are still subject to significant concern.

A web based simulation model will be developed to estimate the years in which each country can achieve a reasonable level of living standards in terms of GDP/per capita. The model will identify three main scenarios for each of the countries in the region: high achievers (GDP growth of 8%), moderate performers (GDP growth of 4%) and slow performers (GDP growth of 2%). The simulation model will consider the long-term economic effects of the establishment of the Free Trade Zone in Southeast Europe as a separate process.

6.Conclusions and outcome

As a result of the analysis in each part of the research clear conclusions will be drawn. Specific recommendations will be presented and made available to the public by way of series of articles in support of the idea for establishment of a common Free Trade Zone in Southeast Europe. The final policy paper will target the seven SEE governments, the Bulgarian Ministry of Economy, the Stability Pact, the EU and the international financial organizations. The results of the research will serve as a valuable resource material for initiating politically oriented discussions in the region for the promotion of further trade liberalization in Southeast Europe.