Regional integration and the Baltics : which way?

Some propose that the Baltics seek deeper trade integration with the East to maintain existing trade flows and because the Baltics have had little market access to the West. The author argues against such integration, proposing instead that the Baltics improve trade relations with the West, where market access is likely to be less and less of a problem. After assessing factor endowments, and using a gravity model, the author predicts that more than 90 percent of Baltic trade will be with non-former Soviet Union countries. Initial exports are likely to be labor- and resource-intensive goods, because it is easier to adjust to Western standards with those goods. But in the long run, the Baltics will have a comparative advantage in skill-intensive manufactures, as their years of schooling are among the highest in the developing world. (Exports of labor- and resource-intensive products, especially from Estonia, have already increased. Estonia is the most advanced of the Baltics in its transition to a market economy.) The author predicts the Baltics will eventually trade mostly with Europe. She says the Baltics are unlikely to benefit from deeper trade integration with the East for the following reasons. The lower adjustment costs and the benefits of maintaining viable industries resulting from sustained trade flows with the East are likely to be outweighed by the cost of lost opportunities in the West. Temporary preferential arrangements entail high administrative costs and arerarely temporary. Preferential trade could mean slower adjustment and powerful lobbies against change. Numerous nontariff barriers with the East, slow and unreliable payments, unstable currencies, and barter arrangements increase transaction costs and impede the creation of more trade. Preferential trading with Russia or the Ukraine entails the risk of increasing external protection for the more liberal Baltics. This risk is magnified by the relatively slow adjustment of Russia and other former Soviet Union republics and the faster reform in the Baltics. The recent free trade agreement among the Baltics allows countries to maintain independent external trade policies, without creating the many administrative problems of a union. Free trade agreements will not only improve market access but may help lock in reforms at home, which may help attract foreign investment. With liberalized trade, competition from liberal Estonia may help reduce protection levels in Latvia and Lithuania. After initial adjustment, trade with the West will promote faster, more sustainable growth. Allocation of resources based on world prices, and transfer of technology, will increse productivity growth. Trade with the West will probably also lower environmental costs. OECD protectionism is unlikely to become an insurmountable obstacle to more Baltic exports to the West. Recent statements about Europe turning its back on the reforming East seem exaggerated, at least for the Baltics. Their position as the former Soviet Union member most discriminated against by Europe is changing, as they rapidly climb the various pyramids of access to European trade.