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A changing world trade market structure and its influence on Eastern Europe.

The post-world War II policy of the United States was designed to achieve a political and military weakening of the Soviet Union and its allies as the U.S. assumed the global leadership role. That set of policies achieved the intended result. Now what? Western aid to Eastern European countries and the republics to help rebuild their economies will likely be limited. Assess to Western markets may also not be as open to exports from these struggling economies. The reason? The catalyst for global development during the 1990s is trade blocs. They are significantly altering the market structure.

Rather than trade blocs, the drivers of global development during the past 45 years were U.S. military and economic policies designed to contain communism. American wealth was shared, through policy, with major areas in the free world to politically and militarily weaken the Soviet Union and its allies such as those in Eastern Europe. Soviet expansion efforts after WW II in areas such as Bulgaria, East Germany, Poland and Romania caused Congress and the American public to perceive the Soviets as a major threat. Those threats triggered the positioning of military and economic policies to confront the Soviets.

The U.S. chose a well-defined path toward world leadership after WW II in response to the perceived Soviet threat. Some contend that the U.S. started moving toward involvement in world affairs from isolation in the mid- 1930s.[1] America was in a unique position to take a world leadership role to contain the Soviets after WW II. The U.S. was the dominant economy in the world in terms of industrial strength and technology.

Three Steps

The first step in Soviet containment was development of the $12 billion Marshall Plan which helped create stronger Western European economies - the premise being that people living in growing economies would resist communism much more readily than those in stagnating economies. The Marshall Plan was effective in helping reconstruct Europe. A combination of factors such as application of newer technologies, movement toward more open trade, and U.S. aid resulted in a Western European recovery, led by the West German economy.

The second step in Soviet containment was U.S. policy leadership in the Post-WW II period through monetary arrangements and tariff reduction. In July 1944, 44 countries met in Bretton Woods, New Hampshire, to outline the type of international monetary system that would be needed when peace returned. The International Monetary Fund and World Bank were created at the conference with the objective of helping facilitate full employment and economic growth.

In 1945, Congress gave the Administration authority to reduce U.S. tariffs up to 50 percent of rates in existence at the beginning of that year.[2] Successive American administrations implemented the objective of the gradual reduction of U.S. import barriers - the most important part of American foreign economic policy.[3] Providing foreign countries access to U.S. goods and services helped market economies promote their economic development and dependence on the U.S. economy.

Provision of a military umbrella to U.S. allies was the third step in Soviet containment. Defense spending falls into the classification of a public good. A public good is a good that, when consumed by any one person or group, can still be consumed by others. Countries aligned with the U.S., such as those in Europe, could therefore spend less of their economic output on defense as long as U.S. defense expenditures remained relatively high.

Countries that undertook policies to achieve high levels of investment and orient their economies to exports found a ready American market. This resulted in the development of very strong market economies and the defeat of the Soviet Union and its allies.

During the 1990s, market economies are merging into trade blocs. Trade blocs, in conjunction with other secular changes, are acting to displace the U.S. as a global economic leader. Approximately 50 percent of world economic activity takes place in trade blocs.

Trade Bloc Measurement

Trade blocs are alliances of governments or countries explicitly colluding to set policy. Part of that policy is elimination of internal barriers. Tearing down barriers is expected to stimulate additional trade among member countries that does not displace third-country imports.[4]

Industrial organization concepts can be used to measure governments increase in market power or concentration due to the development of trade blocs. in particular, they can be used to measure the structure aspect of the structure-conduct-performance framework. In one sense, it may be overly simplistic to apply industrial organization concepts to global trade because of the multidimensional aspect of trade. In another sense, it is not, because this article deals with governments, not firms. Governments create the trade environment. Industrial organization theory utilized in this article is not new, and neither are the world trade concepts. Their combination, however, is an addition.

Market structure such as number and size distribution of firms determines conduct. In turn, conduct determines performance. This framework implies causality, and empirical studies assume this causality. The number and size distribution of firms in an industry are generally used to obtain a measure of market power or concentration. Concentration, although often used to characterize competitiveness, is a fundamental characteristic of structure and not competitiveness. One measure of concentration is the Herfindahl-Hirschman Index (HHI).

The HHI attempts to capture the number and size distribution of firms in one measure and is defined as the sum of the squared market shares of each firm in the market.

Two dimensions of market definition involve the grouping of geographic areas and products. This article focuses on countries and trade, not firms and sales, so market dimensions are altered. Governments (countries) seem to be the relevant geographic area for the one dimension. Previous use of aggregates in international trade suggests that it is reasonable to utilize aggregate merchandise export and import groupings as the product dimension of market definition.

Thus, the HHI is applied to aggregate imports and exports of all countries that comprise the global economy. Use of the HHI implies that each country represents a firm, and each country's share of total world merchandise exports and imports is its market share of world trade. A merger within the context of this paper is simply governments or countries explicitly combining to set policy. In part, that policy is free trade within the union. The point is that the merged governments have the economic power to jointly influence their terms of trade.

On an apriori basis, one would expect the Europe 1992 integration of 12 countries to result in a major increase in concentration. The HHI is a method of measuring that increase.

Pre-economic Integration Results

Data are available on merchandise imports and exports for 158 countries from the International Monetary Fund. The largest share of world exports held by any country in 1988 is 12 percent, but the top 12 countries control slightly more than 70 percent of world trade and the top four have approximately 40 percent of the total. World trade tends to be characterized by a number of sizable competitors and numerous, almost atomistic, players.

The HHI is calculated for 1960 and 1988 on exports and imports to test a hypothesis of no increasing market power over time (Figure One). Market power can lead to the possibility of strategic trade policy in regard to both imports and exports.[5]

HHI values, when related to country movement, suggest that the world trade market is relatively unconcentrated. An unconcentrated world trade market implies there may be considerable movement in market position. Figure Two lists countries exhibiting such movement when using share of world exports as an indicator. Another way of obtaining an interpretation of these aggregate Herfindahl indices is to refer to justice Department guidelines.[6] U.S. industries that have a HFH value lower than 1,000 are classified as being unconcentrated, because implicit coordination among players is likely to be difficult.

Economic Integration Results

US-Canada and Europe 1992 are two cases of economic integration. A popular argument for economic integration is that it will lead to rationalization, lower fixed costs, and increasing returns. To measure the effect of economic integration on concentration, trade data from 1988 for the 12 European countries are aggregated to calculate a postintegration HHI. As expected, there is a significant increase in concentration from integration [Figure Three).

The Europe 1992 integration suggests that the world trade industry is altered from unconcentrated to highly concentrated. An increase of approximately 1300 points on the import and export side suggests a major change in structure of world trade. The US-Canada integration, in comparison, raises the HHI only by about 100 points. The addition of Mexico to the North American bloc has a very small influence on the HHI.

Justice Department guidelines for U.S. industries imply a highly concentrated market when the HHI is greater than 1800. If this change in the HHI, because of the European integration, had occurred in the domestic market, it would reflect movement from unconcentrated to highly concentrated.

Pretrade Bloc Era

Market share behavior and HHI levels suggested a relatively fluid relationship in trade during this time period, which would be expected in an unconcentrated industry. This fluid relationship was promoted by the U.S through tariff reduction as access to U.S. markets helped other market economies grow. A combination of access to U.S. markets, economic aid, and military umbrella resulted in strong market economies in Europe and the Far East.

Countries such as West Germany and Japan started the postwar period by importing more than they exported. But as they built their economies, it was inevitable that their exports should grow more than their imports because now they could supply from their own resources goods previously purchased from other countries. A sizable portion of those exports came to the U.S. as a result of U.S. policy.

Relative market share changes, in combination with the HHI, suggest that moderate protectionism on the part of some countries can be successful in raising their national income at the expense of other countries, as long as the other countries do not retaliate. This suggests that moderate unilateral protectionism yielded gains during this period. Prior research indicates that many goods are traded in markets where competition can't be counted on to eliminate high returns.(6]

Trade Bloc Era

Before integration, the top four world competitors had approximately a 40 percent share of world trade exports. After integration, the top four competitors have slightly more than a 70 percent share, and the top three have slightly over a 68 percent share. The top three, of course, are the Europe 12, US-Canada, and Japan. That leaves a 32 percent share for the other 143 countries (a few very large economic units and many small economic units).

Merged governments have enhanced economic power. For instance, EC 1992 is economically much stronger if the respective governments collude then if any individual country government acts on it own. Enhanced internal power of trade blocs helps hold each bloc together. With economic integration, prospects of engaging in beneficial unilateral protection may actually be lessened because of the changing market structure.

Models of industrial organization - oligopoly and oligopsony - appear to fit the large economic units in world trade, according to the HHI results. Oligopoly fits the export portion, and oligopsony describes the import side in which the top three importers account for 66 percent of imports.

Oligopoly and oligopsony descriptive models fit world trade better after integration than before in the sense that mutual interdependence will likely take on a larger role. During preintegration, countries took unilateral protectionism steps that yielded gains because other countries did not retaliate. Unilateral actions suggest the mutual interdependence assumption of an oligopoly was not met in the preintegration period.

Explicit collusion among, for example, EC 1992 members can stifle trade with another trade bloc or individual country.[7] A counter argument is that EC members demonstrated a willingness to sacrifice political sovereignty to obtain economic benefits. Therefore, the same idea may lead to greater trade with other blocks, rather than less. Self-interest of the combined EC countries to intervene in the market mechanism may dominate that idea if EC countries can raise their national income at the expense of another country. Fear of retaliation is the implicit factor that may limit use of enhanced economic power of individual trade blocs.

World-wide benefits of trade blocs can be achieved as long as individual trade blocs do not attempt to favorably influence their terms of trade. Trade blocs may attempt to favorably influence their terms of trade through methods such as political power and nontariff barriers. If so, that could lead to economic warfare among blocs.

The postintegration market structure - oligopolies and oligopsonies - may lead to blocs and members of blocs focusing inward and among themselves, not on smaller economic units. Smaller economic units include countries of Eastern Europe. For instance, Germany may focus on the integration of West and East, and the U.S. may focus on internal problems.

This suggests that Western economic assistance to countries of Eastern Europe and the Commonwealth may be less than adequate. If so, countries in Eastern Europe may continue their economic struggle for many years. The trade bloc market structure also suggests that large blocs may attempt to extract gains from smaller countries. One can argue that countries of Western Europe may reach out to countries of Eastern Europe just like West Germany did in the case of East Germany. If so, implications derived in this article may not hold up.

But West and East Germany are a rather unique case, and one would be hard pressed to apply that situation to other countries in Eastern Europe. The West and East Germany case may, however, be applied to South and North Korea if events in North Korea unfold in a fashion favorable to freedom.

[1] Kindleberger, Charles P. "U.S. Foreign Economic Policy, 1776-1976," Foreign Affairs, 55, January 1977, 395-417. [2] Council of Economic Advisers, "Economic Report of the President," 1989. [3] Viner, Jacob, Economic Foreign Policy on the New Frontier," Foreign Affairs, 39, July 1961, 560-570. [4] Krugman, Paul, "Rethinking International Trade," Business Economics, April 1988, 7-12. [5] Krugman, Paul, and Helpman, Elhanan, Trade Policy and Market Structure, Cambridge, The MIT Press, 1989. [6] U.S. Department of justice, "Merger Guidelines," Federal Register, 49, 1984. [7] Krugman, Paul, "Rethinking International Trade." [8] Cosgrove, Michael H., "Success of Developing Countries' Export Strategies and World Trade Structure," Seoul Journal of Economics, 4, March, 1991, 81-92.

Michael H. Cosgrove, Ph.d., is an assistant professor in the Graduate School of Management at the University of Dallas in Texas.
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Author:Cosgrove, Michael H.
Publication:Business Forum
Date:Jan 1, 1993
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