17 modernization strategies adopted by the present government.'9 If foreign direct investment originates predominantly in Western Europe -- and in particular in Germany -- there is reason to believe that machinery will also originate<sup>from</sup> there.

A. First challenge: The progressive integration of Spain<sup>and ?ortugal into the</sup> European system of division of labor According to Hungarian sources, there is ample evidence to<sup>show that, as</sup> a result of the enlargement of the EC to include Greece,<sup>Spain and Portugal,</sup> trade diversion took place aga4nst Hungary in favor of<sup>EC producers of meat,</sup> electrical and textile products in those three markets. However<sup>this will be</sup> minimal compared to the expected full impact of the southern<sup>enlargement of the</sup> EC which has not yet affected agricultural exports from<sup>Spain. In fact Spain</sup> (and Portugal) will obtain free access to the EC for their<sup>agricultural products</sup> only by 1996. Bcth countries will improve substantially on their previous, preferred Mediterranean status, which entailed very<sup>few tariff reductions.</sup> Moreover, the new members will benefit progressively<sup>from all the advantages of</sup> the CAP (e.g., they will obtain export refunds, receive<sup>guaranteed prices, and</sup> so on) which will not take effect until January 1, 1996.

Moreover, the EC has added new protocols to the agreements concluded<sup>with</sup> Mediterranean nonmembers in the mid-1970s. These new protocols provide<sup>for the</sup> progressive elimination of customs duties on traditional<sup>quantities of fruits and</sup> vegetables exported to the EC by these third Mediterranean<sup>countries. As a quid</sup> pro quo, the Canary Islands and Ceuta and Melilla will<sup>be accorded the same</sup> treatment received by other Mediterranean countries<sup>under these new additional</sup> protocols. These, therefore, must be seen as part of "Operation<sup>Enlargement."</sup> Spanish and Portuguese manufactured exports were given duty-free<sup>access in</sup> the EC and in EFTA on July 1, 1989 in advance of what had been<sup>scheduled in the</sup> respective Treaties of Accession to the EC. There are, however,<sup>some exceptions</sup> for sensitive products (which Hungary exports to the EC as<sup>well) for which free</sup> market access will be given much later to Spain and<sup>Portugal.</sup> Even for nonsensitive manufactured products the full impact on Hungary<sup>is going to be felt</sup> in the coming months if not years.2' 19 It is difficult to predict how imports of machinery from the<sup>ex-GDR will</sup> evolve once this territory will be incorporated in the<sup>EC-12. Some lower quality,</sup> lower technology imports may be replaced by Western European<sup>equipment. On the</sup> other hand, the need for spare part. will tend to maintain<sup>such flow at least in</sup> the short run. Moreover the GDR will be a partner to tne<sup>Hungary-EC agreement and</sup> benefit as a GATT member from all the liberalization measures adopted by Hungary.

N The weight of the FRG is not reflected in Hungarian import statistics, because much of the machinery is imported through Austria or produced<sup>in Austria</sup> by German multinationals. More than 75% of FDI in Hungary<sup>originates in Austria,</sup> West Germany and Switzerland.

' Duty-free access into Spanish and Portuguese industrial<sup>markets by EC and</sup> EFTA countries will take place by January 1, 1993. The two acceding<sup>countries are</sup> approximating their customs duties progressively to the level<sup>of the EC's Common</sup> Customs Tariff (CCT), and will adopt it completely by January 1,<sup>1993 as well</sup> (with the exception of some products for which the deadline<sup>is advanced by</sup> several years). This step invariably implies a reduction<sup>in tariff protection</sup> levels on non-EC countries' industrial exports. However<sup>given Hungary's trade</sup> patterns, these two future changes will be of minor significance for<sup>it.</sup>