**POI.ucY** RESEARCHI WORKING PArER 1390

# Summary findings

Somc 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.

Sorsa 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, Sorsa 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 resourceintensive goods, because it is easier to adjust to Western standards with those goods. Eut in the long run, the Baltics will have a comnparative advantage in skillintensive 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.) Sorsa predicts the Baltics will eventually trade mosdy with Europe.

She says the Baltics are unlikely to benefit from deeper trade integration with the East because:

- 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.

* Numerous nontariff barriers with the East, slow and unreliablc payments, unstable currencies, and barter arrangements increase transaction costs and impede the creation of more trade.

- Preferential trading with Russia or 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 lome, vhich 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 increase productivity growth. Trade with the West will probably also lower environmental costs.

OECD protectionism is unlikely to become an insunnountable 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.

* Preferential trade could mean slower adjustment and powerful lobbies against change.

- - This paper a product of the International Tradc Division, International Economics Department is part of a larger effort in the department to monitor and advise on the trade policies of transitional economies. Copies of the paper are available free from the World Bank, t81 8 H Street NW, Washington, DC 20433. Please contact Jennifer Ngaine, room _R2-052,_ exrension 37947 (48 pages). December 1994.

**_The Policy Research_** _Working Paper Series_ **_disseninates the_** _findings of_ **_work_** _in progress to encourage_ **_thce_** _exchange of_ **_ideas about_** _development issues An_ **_objective_** _of_ **_the series_** _is to get_ **_rbe fidings out_** _quickly,_ **_even ifthe presentations ar less_** _than_ **_fully_** _polished._ **_The_** _papers rarry_ **_the_** _names of_ **_the_** _authors and should be_ **_used_** _and_ **_cited_** _accordingr._ **_The fndings, interpretations,_** _and concdusions_ **_are_** _the_ **_authors' own and_** _should not_ **_be attributed_** _to_ **_the_** _World_ **_Bank. its Exective_** _Board of_ **_Directors_** _or any of_ **_its mrenber countrie_**

Produced by the Policy Research Dissemination Center