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 are rarely 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.