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International perspective: the world economy and the changes in Eastern Europe.

Recent developments in Central and Eastern Europe will have a significant impact on world economic and political relationships. The basic elements of the new world order include the following: growth of regional groupings centered around the U. S., Europe and japan; an increase in the growth rate of European economies and a flow of capital to Eastern Europe; and a reduction and reallocation of defense expenditures. The world will be fundamentally different, posing a challenge to which both the East and the West must respond.

THE WORLD SCENE continues to be dominated by developments in Central and Eastern Europe. Following the basic breakthrough in East-West relations last Autumn and the hectic pace of change since, the elements of the new order now emerging involve the reintegration of the countries east of the former Iron Curtain. The process of reintegration, however, is likely to extend over a long period. It will affect the pace of advance and the character of previously Communist and partly Communist economies. It also will affect the various countries and country groupings in the West.

This development will affect various countries and groupings differently, depending on the interaction of political, economic, military and social developments. While the interaction of developments, the timing of this process and its consequences for the world economy are uncertain, the issues to be resolved are now becoming clearer.


The most significant consequence as far as the world economy is concerned is the additional and powerful momentum it is imparting to the trend toward regionalism. While such a tendency has been at work for the past fifteen years or so, it was weak and hesitant. However, the forces now at work will give it powerful reinforcement. The emergence of the European Community (EC) and the rapid growth of japan have had in them the seed of the new order. Now, the reintegration of the Central and Eastern European countries into the world economy marks the end of the bipolar, politico-ideological, military and economic system based on the super powers. This system will be replaced formally by a tripolar system with three regional groupings centered in the U. S., Europe and japan.

The strengthening of the trend toward regionalism is likely to work in several ways:

1. Improving the absolute and relative position of Europe, especially the EC, by increasing its potential rate of growth, by expanding its external trade and its share in world trade, and by raising its position as a net provider of capital to the rest of the world as well as an exporter of capital and an importer of capital from other regional groupings in gross terms;

2. Causing the other two regional groupings to extend, expand and cement the links with other members of the same grouping;

3 . Redistributing the burden of financing defense among the regional groupings in a different way than at present, with important consequences on the mix and direction of fiscal and monetary policies.

It must be stressed here that the increase in the relative importance of the European groupings due to the reintegration of Eastern Europe will, initially at least, be rather modest. The absolute size of the economies east of the Iron Curtain is relatively small, their trade flows with the West and developing countries relatively modest, and the size of capital flows also very limited and involving almost entirely the import of capital. According to information recently produced by the OECD, the gross real product (GRP) of the three main components of Communist grouping in Europe, viz., East Germany, other Eastern European countries and the Soviet Union, in 1988 amounted to some 1 1/4 percent, 4 1/2 percent and 13 percent, respectively, of the GRP of all twenty-nine OECD countries of $ 12. 1 trillion. The value of their total external trade (exports only) including intratrade amounted to less than 8 percent of total world trade; more than half represented intrabloc trade and the remaining 4 percent exports to industrial and developing countries. Finally, Eastern European countries have been relatively large borrowers of capital in the 1970s and early 1980s. Now the size of their external debt, whether measured by the net debt export ratio (at 211 percent for six Eastern European countries and 113 percent for the Soviet Union) or debt service ratio (46 percent for six Eastern European countries and 35 percent for the Soviet Union), can no longer be increased except to service existing obligations.

In contrast, the EC accounts at present for 34 1/2 percent of OECD's total output and other European countries (i.e., members of EFTA) for about 5/2 percent - a total of nearly 40 percent. European external trade represents some 47 percent of world trade, of which two-thirds is intratrade. Europe is the largest gross provider and receiver of capital flows.

Although the relative size of Eastern Europe's output, trade and capital flows is relatively small, future development should be more rapid and approach that of other groupings. It will absorb the energies of business and policymakers in the West and bear directly on the developments of economic relationships among the countries in the Western groupings.


Such guestimates as can be made, which are inevitably hazardous, suggest that, as a result of rapid increases in the economic (and other links) between Western and Eastern European countries, the potential and actual rate of growth of European economies is likely to surpass that of the U.S. The rate of growth of external trade of European countries is going to accelerate, raising its share in world trade, and capital inflows into and outflows from Europe will increase very significantly, raising its importance as a financial center.

A broad consensus now exists that growth potential of a reunited Germany will be between 4 and 4 1/2 percent a year - a full percentage point higher than before. The growth potential of the other three large Western European countries (France, Germany and the U. K.), now at around 3 percent a year, should increase between 1 and 1 1/2 percentage points, partly because of more rapid expansion of Germany and also because of increased economic links with Central and Eastern Europe. That share of Europe's trade (i.e., EC and EFTA) in the world total can be expected to rise from some 47 percent in 1989 towards 50 percent by the second half of the 1990s. Europe's gross and net capital inflows and outflows probably will grow faster than those within and with other groupings.

This improvement in the potential performance of the European economy, in addition to reflecting further progress toward a single European market and a common currency, can be attributed to:

1. Reunification of the two German states;

2. Rapid growth of trade with the Central and Eastern European countries together with gradually increasing inflow of capital;

3. From about 1992-93, a marked acceleration of the pace of economic growth of these countries, excluding the USSR;

4. A similar but initially a somewhat slower development in the link with and growth of the Soviet Union, although this growth will gain momentum later in the 1990s.

Following the replacement of the Ost Mark by the Deutsche Mark, the recent agreement between Chancellor Kohl and President Gorbachev, and the recent six nation meeting, the formal process of reunification of the two German states will be complete by the end of the present year. At that time, East Germany, as part of Germany, effectively will become a member of the EC, qualifying for all the privileges this carries. Included are unrestricted entry of exports to other EC countries, investment funds from the European Investment Bank, regional support and agricultural subsidies. Unlike other Eastern European countries, East Germany with the DM, with no restrictions on capital movements, and with quite a sizeable market - subject to the resolution of property rights - is likely to become a magnet for West German and other Western enterprises. A widely held view is that, given an educated labor force, East Germany's growth rate, because of improvement in productivity, could approximate that of Germany after the currency reform of 1949, when total output was growing 9 to 10 percent a year and trade expanded at twice that figure.

Of the remaining five Eastern European countries, Czechoslovakia, Hungary and Poland are now in the process of moving rapidly toward a market economy, by privatization, liberalization of trade and deregulation, and also by redirecting their trade from intrabloc trade to partners in the West, partly because of geographical proximity, partly because of the former links with Western Europe and also because the largest share of capital inflow is likely to come from this source. Trade with Europe is already increasing rapidly, helping these countries to move to areas where they have comparative advantage. These countries already have been accorded special treatment by the EC with regard to their exports, including generalized tariff preferences and special quotas to be extended into associate status also offered to the EFTA countries. A similar approach to trade with Eastern European countries has been adopted by the EFTA countries. Although experiencing recession at present, these countries are expected to show a marked and accelerating advance from 1991-92, which could raise their rate of growth from the mid 1990s toward growth rates now experienced by the Western countries, or, in the case of East Germany, above it.

An important problem deserving special attention is the impact on agriculture. At present virtually all Central and Eastern European countries are net importers of grains and other foodstuffs, in spite of their rich natural agricultural resources. If and when their productivity in this sector improves and their position begins to change from net importers to net exporters, the whole structure of the EC agricultural policy and indeed world agricultural arrangements will come under new, additional and powerful pressures. These policies are one of the main areas for negotiations in the Uruguay round of trade negotiations.

Similar factors will be at work in the two remaining countries, Rumania and Bulgaria, as well as the Soviet Union. However, the pace of progress and the impact on the European and world economies are likely to be more modest and delayed. Rumania and Bulgaria are relatively small in size, with a less advanced state of development and a much slower pace of advance towards a market economy. The Soviet Union lags even more and is exposed to special problems associated with its character, including ethnic diversity.


A rise in the importance of Europe in the world economy because of the developments east of the former Iron Curtain can be expected to extend to the financial area also. Here again East Germany is in a category of its own. The updating of its infrastructure and productive and social capital should be to a large extent self-financed. Higher productivity and a faster rate of advance will generate additional savings for necessary investment. The part not self-financed should have no difficulty in attracting savings:

1. From West Germany by way of public investment (i.e., transport, communication, social and similar investments), private investment on the part of German corporations and later portfolio investment;

2. From other industrial countries that will make direct and later portfolio investment in East Germany and also that will increase their investment in West German corporations in order to help them expand their activities in East Germany and other Eastern European countries.

As far as other Eastern European countries are concerned, it is unlikely that in the immediate future they will be recipients of a large volume of private capital. They have a relatively large volume of foreign indebtedness, except for Rumania. This fact is reflected in high net debt/exports ratios; at the end of 1989 this ratio ranged from 169 percent for the Soviet Union, to 263 percent for Bulgaria, 326 percent for Hungary and 532 percent for Poland. High foreign indebtedness raises the question of the extent to which it will be necessary to reduce the burden of foreign debts through special debt relief measures within or without international machinery, including the Brady approach.

For this reason, and also because it will be some time before a new legal framework covering property rights emerges, most of the inflow of capital in the next few years will be in the form of public funds covering aid and loans for specific purposes (project finance), including funds to be made available by the newly created European Bank for Reconstruction. Later, private capital flows probably will gather momentum.

The extent to which capital will flow to Eastern European countries, excluding East Germany, is difficult to assess. A number of special packages have been announced for Hungary and Poland and other Eastern European countries amounting to some $13 billion for the next three years but excluding IMF standby credits to these two countries of $700 million. A special government guaranteed credit from Germany to the Soviet Union of DM 3 billion has been extended. The flows so far discussed, almost entirely from public sources, are very small compared with those to developing countries. In 1989, developing countries received $30 billion by way of grants, some $21 billion by way of guaranteed export credit, and direct investment of $16 billion. Likewise, the flows are very small compared with gross outflows of capital from major industrial countries, which last year are estimated at around $1.2 trillion, including $240 million of direct investment, purchases of $250 million of bonds and $140 million of equity, and bank lending of around $500 billion. Given propitious conditions, including the resolution of the foreign debt problem and fundamental reforms either under way or about to be adopted, funds necessary to complement domestic saving for the development of infrastructure, productive investment and social investment should be available from the West without imposing upward pressures on cost of capital in the West, especially from Europe.


The trend toward regionalism, now powerfully reinforced by the developments east of the Iron Curtain, has already led to a response in North America. There the creation of the Free Trade Zone between the U.S. and Canada, appears to be the first step in this direction. It has been followed by the idea of extending it to cover Mexico and then a grand vision recently of a North American and Latin American economic zones.

In the Far East, in addition to ASEAN grouping, an Asian Pacific block now is emerging, including India, Australia, New Zealand, Pakistan and Korea. These nations' exports account for more than 20 percent of world trade. Their economic and other links within the group are increasing by way of rapid intrainvestment, both direct and portfolio and also intratrade.


Closely associated with the strengthening of the trend towards regionalism, developments in Eastern Europe will reduce and reallocate defense expenditures among the major industrial countries. Last year such spending amounted to 5 3/4 percent of GNP in the U.S. (compared with 9 1/2 percent in 1961), 4 percent in the U.K., slightly over 3 percent in France, 2 1/4 percent in West Germany, 1 1/4 percent in Canada, and 1 1/4 percent in japan. Plans to decrease such spending are already being debated in the U. S., U. K. and France, and will be revealed shortly in other countries. Reduction in such spending, yielding a so-called peace dividend, probably will be largest in the U.S., the U.K. and France. in addition to releasing resources for public and private consumption and investment, it will probably diminish the differences in the relative size of such spending in major countries redistributing the responsibilities now carried by them.

A decline in the relative size of military expenditures has important implications on the balance of power, the way responsibility for world security is shared and indirectly on the economic structure and development of the three groupings. Whether or not the new arrangements will lead to the convergence of the relative size of defense spending is too early to say. That such a tendency will be set in motion is, however, reasonably certain. If this view is validated by events, the U.S. in a special sense will be the greatest beneficiary, because its military spending is relatively very high. This process is likely to be very gradual and unlikely to gain powerful momentum until mid 1990s. It has both important cyclical and structural implications.

The emergence of three blocs or regional groupings - with the Soviet Union probably being associated with Europe and China, partly with japan and partly with the U.S. - does not necessarily imply that the world will enter a new era of protectionism. Provided the policies adopted are outward looking, designed to stimulate competition and help growth, the new configuration may in fact be helpful to the resolution of the problems ahead. What the new configuration means is that the responsibility for world trading arrangements, for world monetary arrangements and for peace will be in the hands of a new triumvirate rather than in the hands of a single hegemonial power, as was the case for about 150 years until the 1970s.

The post-Yalta world is going to be fundamentally different from the one we have known for the past 200 years or so. It will pose new and different questions, requiring new thinking by those in the world of political affairs, academia and business. It will call for imagination, flexibility and boldness. This is a new challenge to which both the East and the West must respond.

*T. M. Rybczynski is an economic consultant and visiting professor, City University, London, and formerly Economic Advisor to Lazard Bros. & Co., Ltd.
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Author:Rybczynski, T.M.
Publication:Business Economics
Date:Oct 1, 1990
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