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Winners and Losers of EU Integration in Central and Eastern Europe:
The Case of the Baltic States

Economic part


Ramunas Vilpisauskas
Guoda Steponaviciene[1]
Vilnius, October 1999

	Introduction
	Institutionalization of relations between the Baltic States and the EU
	Identifying winners and losers in selected areas
	Free movement of goods
	Free movement of labor
	Free movement of services
	Free movement of capital
	Common agricultural policy
	Economic and monetary union
	Conclusions
	(Annex 1.) Table 1. The main bilateral economic agreements between the Baltic States and the European Union
	(Annex 1.) Table 2. Instruments of Baltic States’ integration into the European Union
	(Annex 2.) Table 1. Gross domestic product by economic activity in 1998, %
	(Annex 2.) Table 2. Employed persons by economic activity, 1998, May, %
	(Annex 2.) Table 3. Selected macroeconomic indicators, 1998
	(Annex 2.) Table 4. Export structure by trade partners in 1998, %
	(Annex 2.) Table 5. Import structure by trade partners in 1998, %
	(Annex 2.) Figure 1. GDP Growth, %
	(Annex 2.) Figure 2. Inflation (December - December), %
	(Annex 3.) Table I. Losers and winners (Sphere: I. Free movement of goods)
	(Annex 3.) Table II. Losers and winners (Sphere: II. Free movement of labour)
	(Annex 3.) Table III. Losers and winners (Sphere: III. Free movement of services)
	(Annex 3.) Table IV. Losers and winners (Sphere: IV. Free movement of capital)
	(Annex 3.) Table V. Losers and winners (Sphere V.: Common Agricultural Policy)
	(Annex 3.) Table VI. Losers and winners (Sphere VI. Economic and monetary union)
	(Annex 3.) General Table. Losers and winners in the selected areas

Introduction

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Economic integration, i.e. merging of economies by way of eliminating barriers to free movement of goods, services, capital and labor, conduct of common policies, and pooling of decision-making authority, 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 redraws the boundaries between the state and the market in general and produces 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 proceeding in parallel with implementation of the rules and institutions of market economy and democratic governance has a significant impact on the political economy of these three countries. Several factors contribute to the degree and distribution of benefits and costs in the Baltic States resulting from integration into the EU.
(1) Since the beginning of reforms each Baltic country has been conducting economic policies the character of which has been influenced by the ideological orientation of the government, domestic interest groups, external actors, etc. Although the goals of reforms have been the same, concrete economic policy decisions differed in each state. Thus, in some cases distribution of winners and losers might be different in each country depending on general economic policies pursued since the beginning of the decade (for example, adoption of the EU external trade policy means increasing trade barriers for Estonia while decreasing or not altering significantly in the other two countries).
(2) In some cases economic policies were in line with integration policies (for example, liberalization of trade), while in other cases accession into the EU involves changes in economic regimes (for example, regulation of the agricultural sector or regional policies). This implies that in some cases effects of transition to market economy and integration into the EU on distribution of winners and losers are difficult to distinguish. In more general terms this is an issue of to what extent meeting EU membership criteria is consistent with the objectives of transition and policies conducted in the candidate countries [2]. The general requirement of having a functioning market economy is what the Baltic States are aiming at irrespective of integration into the EU.
However, assuming the obligations of membership involves adoption of the Union’s acquis. This involves investments, which can be divided into two categories. First, the setting up of institutional structure, administrative institutions to oversee and monitor the implementation of acquis requires budgetary spending. These costs, the bulk of which is likely to be covered by tax payers, will be short-term, while likely benefits will appear in the long-term.
Second, adoption of EU regulations has a direct impact on the activities of economic actors. Enterprises will face compliance costs, part of which are likely to be shifted on to consumers. Here, the difficulty of identifying winners and losers lies in the choice of the basis for comparison. Does the anti-mode, or non-integration scenario, need to be considered? Are the current policies a proper starting point for comparative analysis? In the latter case, the difficulty of analytical distinction between transition and integration remains. The ideal of market economy characterized by liberalized prices and trade, competition and private property could serve as a point of reference. On the one hand, this, for example, would imply that abolishing state aid is a matter of implementing market economy, and enterprises that lose their rents are not losers resulting from the process of integration itself. On the other hand, however, if these countries were not aiming at EU membership, some reforms, such as trade liberalization or restructuring of the agriculture, might have been postponed or even reversed [3]. Of major importance is how the policy-makers present their choices to the public, and if the EU is not presented as a scapegoat for unpopular decisions.
(3) Integration is a long-term 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 started with the liberalisation of trade and removal of other barriers to economic exchange and proceeds with the adoption of acquis. Importantly, the timing of effects of integration-related measures might result in concentration of costs in time and area. As some analysts have maintained, “the costs of converging to the EU are not evenly spread across the societies in transition countries and emerge at various stages of accession process” [4].
The analysis of actual and potential economic/fiscal/regulatory impact of integration on acceding countries, their economy and interest groups has important political 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 aimed at reducing the number and extent of losers and creating conditions for increasing the scope of winners. Moreover, understanding likely effects of integration measures on national economies and their sectors is necessary for membership negotiations and rational policy-making.
This study aims at addressing general issues of the political economy of the Baltic States’ integration into the EU. It addresses the following issues: (1) identification of the economic groups that might benefit and the ones that might lose from integration of the Baltic States into the EU; (2) presenting the dynamics of gains and losses in time; (3) addressing possible political consequences of the economic effects of integration, and political measures that could be taken in order to reduce negative impact of integration on economic groups.
The study does not attempt to estimate quantitatively the economic effects of integration on the Baltic economies and concrete economic groups or to provide a balance of macroeconomic costs and benefits of EU membership. Rather, it provides a structured qualitative analysis of integration effects and resulting emergence of the groups of winners and losers in the three countries. It focuses on the effects of removal of barriers to economic exchange between the EU and the Baltic States and implementation of common EU policies and regulatory environment in the Baltic countries.
The main dimensions of analysis are (1) the measures of economic integration in selected areas and (2) the time dimension which distinguishes between the time frame of the effects of these measures on economic groups in the Baltic States (short-term and long-term) and the timing of implementation (stages of integration). Both dimensions are detailed below.
The areas discussed include removal of barriers to trade in goods and services, removal of barriers to circulation of capital, removal of barriers to movement of labor, regulatory measures in line with EU acquis in the area of internal market, common rules in selected sectors such as agriculture, economic and monetary union (EMU), and external trade policy. 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 depth of their integration inside the EU (EMU, for example). The choice of analyzing the effects of “four freedoms” is based on the assumption that they form the basis of the EU. The selection of certain areas and sectors limits the extent of the analysis. This is inevitable for such a type of study, although other, more general aspects of political economy of integration are touched upon in the text.
The study provides the assessment of the likely effects of the above mentioned measures based on theories of economic integration, international economic relations and insights from studies of regulation. As it 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 independent of 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 study assumes that other factors – EU policies, WTO policies, etc. – are constant. This implies that EU policies are implemented in their present form, although in some cases such as CAP it is not likely. Another important assumption concerns the transposition and enforcement of integration-related measures. The complexity of EU acquis as well as the limited administrative capacities of the applicant countries provide opportunities for misinterpretations of the acquis and creating winners and losers that would not have emerged otherwise. While analysis of such cases when “transmission noises” distort the original message might be interesting and illustrative of decision-making in the Baltic States, it is assumed here that principles of the acquis are introduced properly.
The temporal dimension of positive and negative effects of integration is important for several reasons.
First, estimating likely temporal patterns of costs and benefits to the economic groups in these countries has implications for the economic policies in these countries. While most costs are likely to be short-term, benefits might occur only in the long-term and vice versa.
Second, the integration measures are distributed in time – some, for example, liberalization of trade, have been implemented since the bilateral free trade agreements between the Baltic States and the EU were signed, some have been implemented since the entry into force of the Association agreement, others have been introduced on the basis of the White Book, still others will be introduced before the membership, and some might result in transition periods after the accession. This has political implications in terms of the impact of the membership itself and in influencing the distribution of benefits and costs in time. Therefore, in this respect, the implementation of integration measures will be discussed along several temporal stages – (1) the start of economic relations with the EU and signing of the first economic agreements, (2) pre-accession measures, (3) membership itself and likely transition periods.
The comparative analysis is presented in tables where integration measures in selected areas are presented, their effects on the main groups in short and long-term are evaluated (see Annex 3). The groups identified differ depending on the integration measure and include consumers, exporters, importers, local manufacturers, farmers, financial institutions, etc. For the sake of simplification, the effects are evaluated as positive, negative, neutral or controversial.
The paper first presents a brief description of dynamics of economic relations between the EU and the Baltic States since the beginning of this decade. Afterwards, possible emergence of winners and losers in selected areas as a result of integration policies is discussed. These analytical findings are also supported by results of opinion polls conducted in the Baltic States, business attitudes and economic statistics. The identification of likely impact of integration on economic groups in the Baltic States and their likely reactions towards actual or anticipated integration effects will provide the basis for suggesting policy recommendations. The paper concludes with general remarks, policy recommendations and presentation of directions for further research. The main text is supplemented by annexes presenting with overview of bilateral agreements between the EU and the Baltic States, trade and FDI data, GDP structure of the three countries, and tables with evaluation of political economy of integration effects in selected areas.

Institutionalization of relations between the Baltic States and the EU

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Economic relations between the Baltic States and the EU began developing at the start of the decade. Soon after the recognition of the three countries by the EU in September 1991, the bilateral Trade and Cooperation agreements were signed. They came into force in 1993 providing for the Most Favorite Nation status and non-discrimination in trade relations. The EU has extended its Generalized System of Preferences to the Baltic States (see Annex 1). Economically more significant have been the Agreements on Trade and Trade Related Matters which Baltic States signed with the EU in July 1994, and which are in force since January 1995. They provided for the establishment of a free trade area between the parties. Certain products including agricultural goods, fisheries and textiles were excluded from the general provisions. The EU has committed itself to free trade in industrial products from the entry of the agreements. Estonia declined to apply any transition period while Latvia and Lithuania received four and six year transitional periods respectively during which they agreed to gradually liberalize trade with the EU.
The next stage in the integration process of the three followed after signing of the Association (Europe) Agreements in June 1995. These agreements upgraded the status of the Baltic States to the one of the other Central and Eastern European candidate countries by explicitly acknowledging their wish to become EU members, although they came into force only in February 1998. The Baltic States joined the implementation of the pre-accession strategy, consisting of the Association Agreements, the White Book on preparing the CEECs to join the internal market and the Phare program. In the second half of 1995 the three states officially applied for the EU membership. In 1997, after the Commission announced its Opinions on individual candidates, the European Council decided to invite Estonia to start accession negotiations while Latvia and Lithuania were relegated to the group of “pre-ins”. Their status did not change in 1998, although the EU reinforced its measures aimed at helping the candidate countries to prepare for the membership and assume its obligations.
In October 1999, the newly formed Commission invited Latvia and Lithuania together with remaining “pre-ins” to start accession negotiations and join the first group of the countries. The Commission maintained, however, that these negotiations should follow a “differentiated” approach taking full account of each candidate’s progress in meeting membership criteria. Assuming that the EU will undertake reforms necessary for the enlargement by 2002, it will be up to each candidate country to decide on the speed of integration.
Currently, the Baltic States participate in a number of bilateral and unilateral arrangements facilitating their integration into the EU including the implementation of Association Agreements, the White book provisions, Accession partnerships, National programs of acquis approximation, Screening, Twinning, etc. These arrangements impact significantly on national economic policy-making and institutional structures of the three countries. At the same time, economic relations between the Baltic States and the EU have developed relatively fast. The EU has become the most significant trading partner of the three and the main source of Foreign Direct Investment (FDI) in the Baltics (see Annex 2).

Free movement of goods

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The liberalization of trade has so far been the most advanced area of integration between the EU and the Baltic States. Except for trade in “sensitive” products, free trade has been the main principle and objective of economic relations between the EU and the three countries since 1995. Free movement of goods implies a number of measures in respect of mutual trade – the abolishion of quantitative and qualitative import and export restrictions, applying the same regime to domestic goods as well as imported from other parts of the free trade area (principle of non-discrimination).
Dismantling barriers to trade reduces distortions of competition and protection of domestic producers. The main losers are domestic producers competing with imported products, while the main winners are consumers, exporters and producers using imported goods as intermediary products in their production processes and participating in the intra-industry trade with EU. As some researchers maintain, the share of the latter is rapidly increasing in the Baltic States [5]. Estonia has the largest share of intra-industry trade with the EU, which in 1996 was estimated to equal around 35 percent of trade with the EU. The shares of Latvia and Lithuania were accordingly 19 percent and 17 percent [6]. If this tendency continues, the scope of winners among producers will be the largest in Estonia. The scope of winners will also depend on the intensity of overall informal integration. The EU has been the main trading partner of the Baltic States for several years (see Annex 2). Economic crisis in Russia has resulted in further increases of EU share in the Baltic exports. Estonia is leading with exports to the EU and imports from it accounting respectively for 70 percent and 74.3 percent of its foreign trade at the end of June 1999 [7].
If concrete groups of products are analyzed, in the case of Estonia most of intra-industry trade is conducted in such goods as electronics, footwear, wood, clothing, and parts of machinery for lifting. In the case of Latvia, most of intra-industry trade with the EU is taking place in such products as electric transformers, inductors, leather, clothing and accessories. Most of intra-industry trade between Lithuania and the EU is conducted in footwear, woven cotton fabrics and some fishery products [8]. Producers of these goods are likely to benefit from further integration. The selection of concrete product groups should be treated with caution, however, as markets structures are rapidly changing, in particular in transition economies.
The size of the Baltic economies, the share of foreign trade in their GDP and the importance of outward processing taking place in these countries provide ground to believe that the scope of winners is relatively large in all three countries. However, due to the collective action problem such groups as consumers have less impact on policy-making while domestic producers are better organized and in case of Latvia and Lithuania proved to be able to ensure the introduction of trade barriers to trade with third countries. This has been the case with agricultural producers in these two countries who exert considerable pressure on the governments, in particular after the economic crisis in Russia. Latvian and Lithuanian farmers have been the largest lobby groups, which managed to receive import protection even when it contradicted international obligations of the country [9]. Membership in the EU will provide such domestic producers with new targets for lobbying for common external protection, although the results of the lobbying on the EU level are likely to be more modest.
The impact of integration on domestic producers is likely to differ depending on the destination of their production. Those exporting to the EU are likely to benefit from free movement of goods, especially after the EU faces out anti-dumping and other protection instruments it is able to currently threaten Baltic producers.
In 1998, the main products exported by Estonian producers to the EU include machinery, mechanical appliances and electric equipment, wood and articles of wood, textiles, and base metals and articles of base. The main Latvian exports to the EU included similar products – wood and articles of wood, textiles, mineral products, base metals and machinery and mechanical equipment. The main Lithuanian exports to the EU included textiles, products of the chemical and related industries, machinery and mechanical equipment, wood and articles of wood, and base metals [10]. Re-exports from Russia constitute a large share of the exports indicated above.
The other aspect of free movement of goods is harmonization of basic standards and mutual recognition. The adoption of the acquis in this field is taking place as a part of pre-accession measures on the basis of the White paper and is prioritized according to the individual needs of each candidate. The adoption of these principles is likely to involve large short-term costs related with upgrading the product and process standards (“EU conformity costs”). Although it is likely to be beneficial in the long-term, the costs of regulatory load might prove to be long-term.
Free movement of goods is one element of the Single market. The other one is the common external tariff, which is applied uniformly and forms part of the EU external trade policy. The common external tariff will most probably be adopted only after the formal accession of a candidate country into the EU. The balance between the winners and losers in this respect depends on whether an applicant state has been applying more or less liberal trade regime before acceding into the EU. Estonia, which has been applying a zero tariff foreign trade regime, will have to raise external protection implying benefits for domestic producers but costs for consumers and importers from the third countries. The changes in its external trade regime are likely to be introduced in 2000. The likely impact of common external tariff on Lithuanian and Latvian economies is less clear and will probably depend on concrete product groups as the average customs tariffs in these countries are somewhat close to the EU average or lower. In 1999, the average customs tariff reported by Lithuania was 2.5 percent, the average customs tariff for non-agricultural goods applied by Latvia was 3.71 percent [11]. Producers of some goods such as agricultural products were protected by higher import duties.
Adoption of autonomous and conventional measures that make part of EU external trade policy is likely to have divergent effects on producers and consumers in the Baltic States. It is likely that the level of protection might increase if regulatory barriers applied in high-standard EU countries are extended [12]. The EU has been characterized by the WTO as “one of the most frequent users of anti-dumping procedures” [13]. Domestic producers in the Baltic States might benefit from relevant protective measures applied at the EU level at the expense of consumers. As some have noted, it was “a safe bet that without Community, the United Kingdom and Germany would not have footwear protection today, that UK agricultural protection would be lower, that Denmark would not have am arrangement on Japanese cars, etc.” [14]
On the other hand, more complicated procedures of initiating protection at the EU level as well as control of state subsidies and other forms of aid for local producers by the Commission might reduce the power of domestic producer lobbies in Latvia and Lithuania. As some observers have suggested, EU membership entails a major shift in the balance of power between national lobbies strengthening the power of such groups as consumers and exporters whose interests are often neglected in political decisions on trade policy [15].

Free movement of labor

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Free movement of labor is likely to become one of the sensitive negotiation issues because of widely spread fears in the EU member states concerning possible effects of migration into the richer EU countries from the poorer candidates. Although the Baltic States have a comparatively small population (around 8 million all together), this general attitude might impact on the terms of their accession as well and could result in transition periods.
The Europe agreements signed between the EU and the Baltic States contain provisions on non-discrimination of legally employed nationals from the other parties to the agreements. However, free access to the labor market in the territory of the Union involves recognition of education degrees and professional qualifications, the right to transfer social security payments and freedom of establishment and service supply. The White book contains provisions on mutual recognition of education diplomas and qualifications in selected fields such as medical treatment or transport. The Baltic States are implementing these provisions during the current stage of integration; they are included into the national acquis approximation programs.
The free movement of labor is beneficial to both employees and employers in the Baltic States. They are likely to benefit from the most measures related with free access to the labor market providing with more choice when looking for a job or an employee. Some measures such as adjustment of training and activity rules for certain professions will require investments and might be costly in the short-term. There is a possibility of brain-drain from the Baltic States, however, its actual negative effects are not likely.
The free movement of labor, and of people in general, is one the most visible result of integration. Visa-free regimes agreed recently by the Baltic States and members of the Schengen zone provides an example of winners encompassing potentially all citizens of the candidate countries.

Free movement of services

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The free movement of services is closely related with the movement of labor. It implies freedom to establish enterprises or subsidiaries in other members of the Union and provide services under the conditions laid down for the nationals of the host state. The treaty of the EU has provisions specifically for transport and financial services. Measures in the field of providing these two kinds of services are also detailed in the White book.
In the area of transport, mutual recognition of qualification certificates is beneficial to both service providers and consumers. More controversial is the adoption of safety and environmental requirements for vehicles and operation as well as adjusting technical requirements, administrative procedures and meeting other requirements for entry into market. These measures require initial investment, and domestic service providers are likely to bear the costs or these might be shifted on to consumers. The likely magnitude of costs can be illustrated by calculations done in Lithuania. The cumulative investments needed to align environmental acquis in the field of air pollution alone will amount to 2,283 million ECU by year 2020. Even when regulation in this field is omitted, the cumulative costs of the approximation of the remaining environmental regulation are estimated to amount to about 15.2 percent of 1996 GDP [16]. The national environmental institutions estimate that for Estonia to reach the compliance by 2010 would cost around 2.21 billion euro. For Latvia, relevant public investments are estimated to reach 1.2 billion euro and the cost for private sector – 305-742 million euro to reach compliance by 2015 [17].
The winners in this area are service exporters that are already operating on the basis of higher standards. The requirement to separate transport infrastructure and operation are likely to be beneficial for consumers as it is expected to introduce more competition and abolish the distortions resulting from state aid provided to this sector.
In the field of transport the establishment of specialized agencies is necessary to oversee the implementation of directives. This type of agencies in this and other fields are likely to be financed from the budget. Although in some cases part of funds might be contributed by the EU, the consumers are likely to finance indirectly the setting up of a regulatory institutional network. Bussines will bear the regulatory costs.
Integration into the EU also requires adopting concrete measures in the field of financial services. The Baltic States have to implement EU norms governing banking, securities and insurance services, aiming at reducing the risks related with providing these services. The supervisory institutions have been created irrespective of integration. Detailed requirements for market entry and operation of financial service providers are set in the EU norms, and require specific measures to be taken in the Baltic States. Meeting such requirements as information disclosure, minimal capital and deposit insurance might involve costs for service providers, although consumers are likely to benefit. However, as it was noted before balance of costs and benefits depends on the interpretation of EU norms in the Baltic States. As the cases of money laundering prevention measures or setting up the norm of payments for mandatory insurance of deposits adopted in Lithuania illustrate, EU norms can be interpreted in a way biased towards more restrictions imposing costs on economic operators.

Free movement of capital

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Free movement of capital implies abolishing barriers to payments and investment among the candidate states and the EU. Both business and consumers benefit from these measures. Although some might lose because of competition from foreign investors, domestic business attracting investments will benefit.

Common agricultural policy

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Common agricultural policy (CAP) is one of few policies harmonized at the EC level since the establishment of the organization. Around half of the EU budget is used for CAP purposes and acquis in this field covers about 40 percent of total EU acquis. This area is characterized by a very strong lobby of farmers in some member-states and resistance to reforms despite high costs of the CAP to EU consumers, international disagreements with WTO partners and potential budgetary costs of extending CAP to acceding countries.
Adoption of EU norms regulating the agricultural sector implies both complying with veterinary and other standards related to the free movement of agricultural products inside the Union, and extending support measures to farmers in the Baltic States. The former group alone represents about 1000 measures aimed at ensuring product quality, setting labeling requirements, standards of farming processes including raising of cattle, growing of plants, using fertilizers, delivering products to consumers, etc. About 160 measures have a status of the essential requirements. Necessary for the implementation of these measures is the setting up of administrative infrastructure including veterinary agencies and other institutions of certification and inspection.
Investing into necessary infrastructure and supporting its functioning is financed from the national budgets with some assistance coming from the EU. Implementation of EU standards will increase opportunities to export to the EU, although most exporters are likely to adopt standards before the accession. Currently only some agricultural producers, mostly in Lithuania where twelve establishments are authorised to export milk and diary products and one company is authorised to export processed game meat, have been certified to export to the Union. Growing regulation of agricultural production and trade also provides opportunities for domestic producers to use the product standards, as non-tariff barriers as it was the case in the end of 1998 and 1999 in trade disputes between the Baltic States [18].
There have been some estimates made of the effects of joining the CAP on agriculture. It has been calculated that if Lithuania joined the EU in 1999, its payments to the EU budget (VAT and GDP based) would equal 407 million litas, while receipts from the CAP would reach around 459 million litas, from the Structural funds – 3.8 billion litas, and from the Cohesion funds – 760 million litas [19]. However, the perspective that current rules of CAP will be extended to the new member states is very unlikely.
Projecting the political economy of joining the CAP is based on the assumption that reforms discussed in the Agenda 2000 are implemented. Extending CAP to Baltic States is likely to have significant effects on farmers and consumers, in particular in Latvia and Lithuania where around a fifth of labor force is employed. Farmers in all three states are likely to benefit from CAP measures, which include import duties from third countries, export subsidies, structural funds, price support and direct income payments. Agricultural policy is likely to change most in Estonia, where the first major changes in increasing support for agriculture were undertaken already at the end of 1998.
It is difficult to distinguish concrete groups of agricultural producers that are likely to benefit or to lose. It seems that small farmers will lose from increased pressure of competition, while the large farms might win. According to some estimates, milk and beef producers in Lithuania would win [20]. Balance of trade in agricultural and food in all three countries in trade with the EU is negative, while it is highly positive in trade with the CIS. However, current market distortions in agriculture deprive of a more reliable basis for predictions of concrete agricultural product groups in which the Baltic economies are likely to have comparative advantage. Suppliers of agricultural equipment are likely to benefit.
At the same time, clear losers of implementing CAP measures are consumers. Although the Baltic States are likely to receive more funds than they will contribute to the EU budget, implementation of CAP will redistribute resources from consumers to farmers. Some economic groups are likely to have a mixed record. Food producers using imported products from third countries are likely to lose from most CAP measures and a resulting increase in prices. Food producers will benefit from upgraded quality of agricultural raw products supplied inside the EU. Producers exporters are likely to benefit from export subsidies.

Economic and monetary union

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In 1999, the third stage of the Economic and monetary union (EMU) began with the participation of eleven member-states. Accession of the new countries raises the question of their membership in the EMU. The EMU criteria are not formally treated as the membership criteria to be accepted into the EU, and it is very likely that candidate countries will join the EMU after a certain transition period, which would allow new members to participate for a defined period of time in the Exchange rate mechanism (ERM2).
The participation of the Baltic States in the EMU will be judged on the basis of the same convergence criteria that current EU members willing to join the EMU had to meet. Meeting convergence criteria will have an impact on the Baltic States economies. The countries will have to maintain low levels of inflation, restrict budget deficit and state borrowing. Currently the Baltic States meet the fiscal criteria. If this situation remains, meeting convergence criteria is not going to involve major policy change in these countries. It will, however, limit the possibilities for borrowing which is high on the agenda in the Baltic States after the period of economic slowdown and budgetary deficits following the economic crisis in Russia. Targeting fiscal criteria might also limit spending on integration related measures and public investments needed to co-finance resources provided by the EU (SAPARD and ISPA programs).
Enterprises doing business in the euro zone are likely to win. The impact of joining the EMU on the Baltic economies will depend on the intensity of trade and capital flows between the latter and the euro zone, and the degree of production factor mobility [21]. While the economic links between the Baltic economies and the euro zone have been expanding rapidly (see Annex 2), labor mobility might remain low, especially if the EU applies transition periods. Another case of divergent forces at work that result in loses of domestic producers might be the regulation of wage setting and participation in the euro zone. The model of wage setting by a trilateral council, which is imported from the EU, might result in a rise of wages exceeding the growth of productivity, thereby damaging the competitiveness of producers. Finally, lower productivity and per capita income in the Baltic States cautions against quick joining of the EMU. Economic operators will benefit from elimination of exchange rate uncertainty and reduction of transaction costs. The benefits will be higher, the more intense is informal economic integration between the Baltic States and the EU.
The participation in the EMU implies loss of national monetary and exchange rate instruments. The governments will lose the autonomy to conduct independent monetary and exchange rate policies. This in all three Baltic States will not, however, involve a major policy change as all apply monetary policies based on fixed exchange rates. Estonia and Lithuania currently have currency board regime in place, which constrains national monetary policy. The change is also limited because currently, i.e. during the preparation for accession, euro plays a major role for the Baltic economies. Estonia’s kroon is directly pegged to euro, the value of the Latvian lats is determined by a basket of currencies with heavy euro weighting foreseen in the next revision in 2000, Bank of Lithuania announced in October 1999 about plans to peg litas to euro in 2001.
The powers to conduct monetary policy will be transferred to the European Central Bank (ECB). The likely effects of its policy on business and consumers will depend on its autonomy, accountability and transparency of the ECB policy. The powers on national banks, especially in Estonia and Lithuania, are likely to increase when they join the ESCB and implement monetary instruments such as repo tenders, purchases and sales of debt instruments, intervening in foreign exchange markets with swaps, lending and deposit facilities for commercial banks [22].
Finally, joining the EMU implies introduction of the new currency euro. The loss of national currencies might cause adaptation problems for consumers. In the short run they include psychological adaptation as well as costs of adjustment which might be shifted on them by banks [23]. However, there will be benefits for those travelling in the Euro zone. Adoption of the common currency might exert a downward pressure on prices of imported goods. In the short-term, the adoption of the new currency and resulting adjustment of payments and the banking system are likely to impose costs on commercial banks but in the long-term they are likely to prove beneficial. The transition might prove to be smoother if subsidiaries of euro zone commercial banks have a significant presence in the Baltic economies.

Conclusions

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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 able to exploit comparative advantages and having established economic links (trade, production chain, investment) with the EU [24]. They will have increased market access as a result of removal of non-tariff barriers, which are distorting trade between the Baltic States and the EU despite the principle of free trade. Farmers, mostly large ones, are another category of winners, which are likely to receive higher levels of support, although at the same time they experience the increase in competition. The enterprises still receiving state support as well as those trading with third countries (Russia, for example) are going to lose. The former will lose economic rents, the latter are likely to have the transaction costs raised.
Compliance with the EU regulatory system involves high costs for the Baltic economies. The costs of compliance or of “attaining EU conformity” include changing economic and legal system, EU norms and standards, institutional structure of regulation and administration overseeing the compliance with regulations governing economic activities [25]. The economic and fiscal impact of investing into this system imposes (at least in the short-term) costs on economic operators and consumers. A need for continuos administrative state institutions fulfilling obligations of EU membership will remain in the long-run, and will have to be financed by tax payers. Introduction of environmental or social regulations will impose costs on economic operations while setting up of institutional structure 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 Baltic economies and national budgets.
Consumers in the Baltic countries are likely to benefit from increase of the competition after joining the Single market, although part of regulatory costs will be shifted on to consumers. Consumers are also likely losers from the introduction of the CAP. Population having links with the EU and frequently commuting to the Union is likely to benefit most.
The above said applies to all three countries. The economic structure of the Baltic States is relatively similar, and the balance of costs and benefits is not likely vary to a high degree. There are some differences grounded in the inherited industrial structure (Ignalina nuclear power plant in Lithuania the closing of which might impose high costs on the economy; bigger share of agriculture in Latvia and Lithuania) or economic policies implemented during transition reforms (more liberal foreign trade policy in Estonia, or more powers to intervene into the monetary affairs by the Central Bank in Latvia). However, the governmental integration strategies are likely to be the most significant factor in determining the balance of costs and benefits and their distribution in time.
Optimal integration strategies require systematic understanding of accession impact on the country’s economy in the context of transition. The analysis of abolishing barriers to economic exchange and regulatory impact of adopting EU norms in separate areas as well as the whole economy is a precondition for sound integration strategy.
First, it will reduce the chances of costly (mis)interpretations. The EU regulation norms are formed for solving particular economic and social problems. Automatic adoption of EU norms in the Baltic States without considering the objectives of regulation and their adequacy for the Baltic economies increases chances of not achieving the objectives and imposing costs on economic operators. Analysis of the regulatory impact is a priority area for further research and has clear implications for improving policy-making in the Baltic States [26].
Second, a well-informed policy-making will reduce the costs of uncertainty for business which arise from this complex and changing regulatory environment.
Third, understanding of accession impact on economies and concrete economic groups allows government to make a better information campaign and to avoid making promises that later would not be fulfilled. The problem of expectations can be minimized if analysis of the impact is undertaken and presented to the public.
Fourth, the integration strategy should aim at maximizing the scope of winners and minimizing losers taking into account possible future scenarios. Returning to the introductory assumptions, the most relevant basis for reference and for policy proposals seems to be the situation of an implemented market economy. The consumers are the policy target group respresenting the interests of the majority. Examples of such strategic policy decisions are the following.
(1) Reducing the economic rents of enterprises before the act of accession. This would create incentives for them to transform, which is necessary sooner or later, and would eliminate the seeming connection between a decrease in state support and the EU membership. In similar vein, the agricultural sectors should be reformed before the accession to provide 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 the accession. (3) The Baltic negotiators should aim at avoiding transition periods for free movement of labor, as this is one the most visible benefit of integration and is crucial to the smooth functioning of the EMU. (4) The economic gains and scope of winners will be larger the higher is the intensity of trade and investment flows between the EU and the Baltic States at the time of enlargement. 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 be larger the closer is the level of productivity and per capita income in the Baltic States to the one in the euro area. The last two points raise 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 the accession and belonging to the second wave candidate countries might result in the integration fatigue and lower attractiveness for investments. The decisions concerning the speed of integration and implementing acquis should be taken after considering both types of arguments.

Annex 1.

Table 1. The main bilateral economic agreements between the Baltic States and the European Union

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Table 2. Instruments of Baltic States’ integration into the European Union

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Annex 2.

Table 1. Gross domestic product by economic activity in 1998, %

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Source: Statistical Office of Estonia, Latvian Statistical Office, Lithuanian Department of Statistics

Table 2. Employed persons by economic activity, 1998, May, %

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1998, 2nd quarter
Source: Source: Statistical Office of Estonia, Latvian Statistical Office, Lithuanian Department of Statistics

Table 3. Selected macroeconomic indicators, 1998

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Source: Statistical Office of Estonia, Latvian Statistical Office, Lithuanian Department of Statistics

Table 4. Export structure by trade partners in 1998, %

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Source: Statistical Office of Estonia, Latvian Statistical Office, Lithuanian Department of Statistics

Table 5. Import structure by trade partners in 1998, %

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Source: Statistical Office of Estonia, Latvian Statistical Office, Lithuanian Department of Statistics

Figure 1. GDP Growth, %

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* - August, 1999

Source: Statistical Office of Estonia, Latvian Statistical Office, Lithuanian Department of Statistics

Figure 2. Inflation (December - December), %

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* - August, 1999

Source: Statistical Office of Estonia, Latvian Statistical Office, Lithuanian Department of Statistics

Annex 3

The following tables present simplified classification of likely winners and losers in selected areas. The estimated impact is based on the principles and EU norms that the Baltic States have to adopt to be accepted into the Union. The documents used include bilateral free trade agreements, association agreements, the White book, the Treaty of the EU and national programs of acquis approximation

Evaluation: "+" - positive, "-"- negative, "0" - neutral, "?" - controversial

S-term: short term (1 to 5 years), L-term: long term

Producers_Ex: producers for which import terms are relatively unimportant, Producers_Im: producers that import capital and intermediary goods important for the production.

Sphere: I. Free movement of goods

Table I. Losers and winners

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Point 3. Positive: possibility of increased safety, negative: possibility of limited choice - existing products that will not meet higher required standards disappear from the market, the consumers with lower demands and low income will be disadvantaged.

Point 7 depends on the present tariff level. In the case of Estonia, it would mean raise of tariff and benefits for producers-exporters and looses for other groups (consumers). In the case of Latvia and Lithuania it would differ depending on concrete product groups.

Sphere: II. Free movement of labour

Table II. Losers and winners

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Point 1. Advantages related with incoming qualified labour force, disadvantages related with probable "brain drain".

Point 6. Advantage - expenditures saved from the budget for customs offices, disadvantage - possible illegal migration.

Sphere: III. Free movement of services

Table III. Losers and winners

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Impact of the Point 1 for service providers will depend on their export level.

Transport

Points 3 and 4 are separated cases of harmonisation of standards and rules (see table I).

Point 5 will entirely depend on the new system, as for the moment there is no system of payments for infrastructure in the Baltic countries.

Points 6 and 7 for service providers. Advantage - for the competitors of the state owned monopoly, disadvantage - for the state owned monopoly.

Points 8 and 10. Expected advantage - increased safety, disadvantage - costs for consumers (raised prices for service or budget spending).

Financial services

Point 12. Expected benefits - increased safety, disadvantage - business limitations to financial institutions and their clients.

Sphere: IV. Free movement of capital

Table IV. Losers and winners

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Sphere V.: Common Agricultural Policy

Table V. Losers and winners

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Point 3 for consumers depend on their type. Those who work in supported area, buy products of supported company or are in other way related with supported entity, benefit. The rest of population lose as their tax money is spent to support particular region.

Sphere VI. Economic and monetary union

Table VI. Losers and winners

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Point 4 for commercial banks. Advantages derive from non-interventionist situation in money market. Disadvantages - loss of last lending source.

Point 5 is evaluated as a positive measure for consumers and business as major share of Baltic countries' foreign trade is with EU countries. In the case of foreign trade structure with predominant part of non-EU partners, the effect of this measure would be negative. For commercial banks the effect could be twofold: positive, as uncertainty with EU currency is eliminated, and negative, as one source of income is closed.

Point 6. Advantages - improved services for clients, disadvantages - increased prices.

Point 8. Impact on commercial banks depends on the actual operation of Central banks.

General Table. Losers and winners in the selected areas

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Point 1 for consumers, point 4 for service, point 5 for transport companies, point 8 for consumers, importers, producers, farmers and banks depend on the degree of being able to exploit the opportunities of common market.

Point 5 for consumers, importers and producers-importers, point 6 for consumers and farmers depend on the balance of actual costs and benefits of the current situation and change after the implementation of integration measures.

Point 7 for importers, service, banks and transport depend on concrete CAP measures and their implementation.

[1] The authors are grateful to the World Bank, and Helena Tang in particular, as well as the Bertelsmann Foundation for initiating the project and funding it, to Dr. Andras Inotai and the Institute for World Economics for comments and opportunity to discuss research issues in Budapest as well as to LFMI experts who provided helpful comments; to Klaudijus Maniokas, and Ikka Korhonen for comments and suggestions.
[2] One of the examples of raising this issue and attempting to bridge the gap between the accession process and the general transition context is the study of Estonian integration into the EU produced by the World Bank. See The World Bank, Estonia. Implementing the EU accession agenda, Washington, D. C.: The World Bank, 1999.
[3] The alignment of national regulations with EU acquis might also strengthen market reforms. As it was noted about transition countries in general, “harmonization of laws with the EU may be the most efficient way of stopping covert protectionism in the form of technological and procedural prescriptions and other forms of NTB [non-tariff barriers]”. Csaba, L. The Political Economy of Trade Regimes in Central Europe, in Winters, A. (ed.) Foundations of an Open Economy, London: CEPR, 1995, p. 82.
[4] Gacs, J., Wyzan, M. The Time Pattern of Costs and Benefits of EU Accession, Laxenburg: IIASA, Interim Report, IR-99-015/May, 1999, P. ii.
[5] See Kaitila, V., Widgren, M., Revealed Comparative Advantage in Trade between the European Union and the Baltic Countries, Florence: European University Institute, RSC WP, draft, December 22, 1998.
[6] Kaitila, V., Widgren, M., p. 12.
[7] Regular Report from the Commission on Progress towards Accession. October 13, 1999.
[8] Kaitila, V., Widgren, M., p. 13.
[9] See Vilpiđauskas, R. Regional integration in Europe: analyzing intra-Baltic economic cooperation, Florence: EUI, Robert Schuman Centre Working paper, draft, 1999.
[10] Statistical Office of Estonia. Estonia, Latvia, Lithuania. Foreign Trade 1998. Tallinn, 1999, p. 28-30.
[11] Regular Reports from the Commission on Progress towards Accession. October 13, 1999.
[12] See Moravcsik, A. The Choice for Europe. Social Purpose and State Power from Messina to Maastricht, Ithaca, N. Y.: Cornell University Press, 1998, p. 40.
[13] Cited in Pelkmans, J., Carzaniga, A. G. The Trade policy Review of the European Union, The World Economy. Global Trade Policy 1996, Oxford, 1996, P. 89.
[14] Winters, L. A. The European Community: a case of successful integration? In De Melo, J., Panagariya, A. New Dimensions in Regional Integration, London: CEPR, 1994, P. 211.
[15] Bofinger, P. The Political Economy of the Eastern Enlargement of the EU, Discussion paper No. 1234, London: CEPR, 1995, P. 9.
[16] Ministry of Environmental Protection of the Republic of Lithuania. Costs of Approximating Lithuanian Environmental Legislation with the European Union. Final Report. 1998, p. 92.
[17] Regular Reports from the Commission on Progress towards Accession. October 13, 1999.
[18] See Vilpiđauskas, R. Regional integration in Europe: analyzing intra-Baltic economic cooperation, Florence: EUI, Robert Schuman Centre Working paper, draft, 1999.
[19] World Bank, Strategy of Lithuania’s accession into the EU. The Alignment of Lithuanian Agricultural and Trade Policy with the EU Common Agricultural Policy, March 22, 1999, p. 56.
[20] Information provided by the Lithuanian Agricultural Institute.
[21] On Baltic States membership in EMU see Korhonen, I. Some Implications of EU membership on Baltic monetary and exchange rate policies, Florence: EUI, RSC working paper, draft, May 1999.
[22] Korhornen, I.,p. 26.
[23] As it was noted about public attitudes in the EU, “much of the voting publics holds a strong attachment to its national currency for reasons having little to do with economics” (Jones, E. Economic and Monetary Union: Playing with Money, in Moravcsik, A. (ed.) Centralization or Fragmentation. Europe Facing the Challenges of Deepening, Diversity, and Democracy, NY: Council on Foreign Relations, 1999, p. 70). Such sentiments might be even stronger in the Baltic States which relatively recently reestablished their national currencies.
[24] This is also a view shared by business in the Baltic States. In November 1998, the survey of 52 Lithuanian enterprises from the largest 100 revealed that according to business, the main aim of the EU membership is access to its market, the main winners will be exporters and consumers.
[25] For similar argument see Kiss, J. The Political Economy of Hungary’s accession to the European Union, Budapest: Institute for World Economics, WP No. 77, March 1997.
[26] For examples of attempts to introduce the idea regulatory impact analysis see OECD, Assessing the Impacts of Proposed Laws and Regulations, Paris: OECD, Sigma Papers No. 13,1997; also proceedings of Taiex Seminar on Impact Analysis in Hague, 4-6 of June, 1997.