LFMI has completed a research project "Winners and Losers of EU Integration in Central and Eastern Europe: The Case of the Baltic State" which was sponsored by the World Bank and the Bertelsmann Foundation. A study prepared as a result of the project addresses general political economy issues arising from the integration of the Baltic States into the EU. The aims were: (1) to identify economic groups that might benefit or t lose from integration of the Baltic States into the EU; (2) to assess the dynamics of gains and losses in time; (3) to evaluate possible political consequences of the economic effects of integration, and to define measures that could reduce the negative impact of integration on economic groups.

Economic integration is the merging of economies by: (i) eliminating barriers to the free movement of goods, services, capital and labor; (ii) the conduct of common policies; and (iii) the pooling of decision-making authorities. All this implies significant changes in the patterns of economic activities in the participating states. Integration changes the political and economic environment in which production and economic exchange take place. It entails redrawing the boundaries between the state and the market. Also, it brings concrete benefits and losses for economic groups in each country. Support for or opposition to further integration depends on expectations of the balance between the benefits and costs that different economic groups are likely to experience.

Integration of the Baltic States into the European Union, in parallel with the implementation of the rules and institutions of a market economy and democratic governance, have a significant impact on the political economy of these three countries. The analysis of the actual and potential economic/fiscal/regulatory impact of integration on acceding countries, their economies and interest groups has important implications for public policy. Although the Baltic States are constrained by the EU norms they are committed to adopt, there is still enough room for policies that can reduce the number of losers and create conditions for increasing the scope of winners. Moreover, understanding the likely effects of integration measures on national economies and their sectors is also necessary for membership negotiations, rational policy-making, and public awareness.

Several factors should be considered in determining the degree and distribution of benefits and costs in the Baltic States resulting from integration into the EU. These are as follows.

1. The distribution of winners and losers resulting from EU integration might be different in each country depending on the general economic policies pursued since the beginning of the decade. Although the goals of reforms have been the same, concrete economic policy decisions have differed in each state. For example, Estonia has been pursuing a much more liberal trade regime than Latvia and Lithuania, which means that the adoption of the EU external trade policy will result in increasing trade barriers for Estonia while decreasing or not changing the trade barriers in the other two countries.

2. Analysis of winners and losers arising from EU integration is complicated by the fact that in some cases economic policies are in line with integration policies, for instance in the case of trade liberalization. In these instances, it would be difficult to distinguish the effects of the transition to a market economy from the effects of integration on the distribution of winners and losers. In cases where accession into the EU involves changes in economic regimes, such as regulation of the agricultural sector or regional policies, the analysis is more straightforward.

3. The timing of the effects of integration-related measures might result in the concentration of costs in time and sector. This is because integration is a lengthy process extending far beyond the formal act of accession, while its impact depends on the issue area and economic group. Integration of the Baltic States into the EU has already started with the liberalisation of trade and removal of other barriers to economic exchange and it will continue with the adoption of acquis.

The study does not attempt to estimate the economic effects of integration on the Baltic economies and economic groups in quantitative terms or to provide a balance of the macroeconomic costs and benefits of EU membership. Rather, it provides a structured qualitative analysis of integration effects and the emergence of the groups of winners and losers in the three countries. It focuses on the effects of the removal of barriers to economic exchange between the EU and the Baltic States and the implementation of common EU policies and the regulatory environment in the Baltic countries.

The measures of economic integration included in the analysis are: the removal of barriers to trade in goods and services; the removal of barriers to the circulation of capital; the removal of barriers to the movement of labor; regulatory measures in line with EU acquis regarding the internal market; common rules in selected sectors, including agriculture; the economic and monetary union (EMU), and external trade policy. The "four freedoms" are analyzed because they form the basis of the EU. The areas and sectors are selected on the basis of their economic and political significance to the Baltic States (agriculture, for example) as well as the depth of their integration inside the EU (EMU, for example). The selection of certain areas and sectors limits the extent of the analysis. This is inevitable for this kind of study, although other, more general aspects of the political economy of integration are touched upon in the text.

The study analyzes the winners and losers for each of the "four freedoms", the CAP and the EMU. The groups identified differ depending on the integration measures and include consumers, exporters, importers, local manufacturers, farmers, financial institutions, and so on. They are selected on the basis of the likely impact of integration - potential costs or benefits for these groups, which include profit losses (for business), higher expenditures (for consumers) or power losses (for state institutions). An assessment of the likely effects of the above mentioned measures is provided based on theories of economic integration, international economic relations and insights from the studies of regulation. As was noted before, integration-related measures need to be analytically differentiated from transition measures or other measures of integration into the world economy that are to be implemented independently from integration into the EU. Therefore, the analysis focuses on integration measures set in the bilateral agreements between the EU and the Baltic States, as well as EU treaties and legal norms, unilateral documents and opinions.

The broad picture that emerges from the analysis of the political economy of integration can be characterized shortly as gains from increased opportunities versus the costs of compliance. The main winners are likely to be competitive enterprises that are able to exploit comparative advantages and have established economic links (trade, production chain, and investment) with the EU. They will have increased market access as a result of the removal of non-tariff barriers that are distorting trade between the Baltic States and the EU despite the principle of free trade. Competitive farmers, mostly large ones, are another category of winners as they are likely to receive higher levels of support, although they will, at the same time, face increased competition. Enterprises that continue to receive state support are going to lose, although this is more a result of their privileged position, which needs to be abolished irrespective of integration.

Compliance with the EU regulatory system involves high costs for the Baltic economies. The costs of compliance or of "attaining EU conformity" include the costs of changing the economic and legal system, of meeting EU norms and standards, and of setting up the institutional structure of regulation and administration to oversee the compliance with regulations governing economic activities. Investing in compliance with the system imposes (at least in the short-term) increased costs on economic operators and consumers. The need for administrative institutions to continuously fulfill the obligations of EU membership will remain in the long run and will have to be financed by taxpayers. Introduction of environmental or social regulations will impose costs on economic operations, while setting up institutional structures to oversee their implementation will have to be financed from the national budgets. The compliance with EU norms might impose further limits on the already strained national budgets in the Baltics.

Consumers in the Baltic countries are likely to benefit from increased competition after joining the Single market, although part of the regulatory costs will be shifted onto consumers. Consumers are also likely losers from the introduction of the CAP. Those groups in the population who have links with the EU and who frequently commute to the Union are likely to benefit most.

Optimal integration strategies that could aim at reducing the scope of losers and increasing the scope of winners have to be based on extensive analysis of the impact of integration. First, this would reduce the chances of costly (mis)interpretations. EU regulation norms were developed to address particular economic and social problems. Automatic adoption of EU norms in the Baltic States without considering the objectives of the regulations and their adequacy for the Baltic economies increases the chances of not achieving the objectives and imposing costs on economic operators.

Second, well-informed policy-making will reduce the costs of uncertainty for business which arise from this complex and ever-changing regulatory environment.

Third, understanding the accession impact on economies and economic groups allows the government to develop a better information campaign and to avoid making unrealistic promises. The problem of expectations can be minimized if analysis of the impact is undertaken and presented to the public. At the same time, a clear plan of actions to be taken by the government would reduce uncertainty in the markets and allow for longer-term business planning. The below provided examples of the policy measures could serve to optimize the impact of integration into the EU.

1. Reducing the economic rents of enterprises before the act of accession. This would create incentives for them to transform, which is inexorable, and would eliminate the seeming connection between a decrease in state support and the EU membership. In a similar vein, the agricultural sectors should be reformed before accession to provide the right conditions for markets to function. CAP reforms will, in any case, take place and the governments of candidate countries should anticipate the change by creating necessary conditions before accession.

2. The Baltic negotiators should aim at avoiding transition periods for the free movement of labor, as this is one of the most visible benefits of integration and is crucial to the smooth functioning of the EMU. Although the relations of the Baltic States with the EU are characterized by large asymmetries in political power and economic dependency, which implies that the Baltic States have weaker bargaining power, an active and innovative negotiation policy might increase the scope of winners.

3. Priority should be given to adopting EU product standards while process regulations need to be spread over a longer period of time. The former require less investment while their positive economic effect in terms of removing non-tariff barriers to trade is larger.

4. The higher the intensity of trade and investment flows between the EU and the Baltic States at the time of enlargement, the greater the economic gains and the scope of winners will be. Functioning markets and informal integrated economic exchanges create conditions for expanding the scope of winners of EU membership. The benefits of joining the EMU will depend on the comparability of the level of productivity and per capita incomes of the Baltic States and those in the euro area. The last two points raise the politically sensitive issue of the speed of integration. On the one hand, large disparities in the above mentioned characteristics would necessitate longer pre-accession periods. On the other hand, long periods before accession and being grouped with the second wave candidate countries might result in integration fatigue and could be regarded negatively for reasons of political prestige. The decisions concerning the speed of integration and implementing acquis should be taken after considering both types of arguments.