43 the probability of such an outcome is rather small. In the transition economies<sup>of Easternand</sup> Central Europe, it was the collapse of central planning rather than trade<sup>liberalizationthathas</sup> brought about industrial devolution and contraction in industrial activity<sup>duringthe initialstages</sup> of transition. In fact, countries that adopted a gradual approach to liberalization and macroeconomic stabilization experienced a deeper and more prolonged<sup>transformational</sup> recession than those that followed the path of radical liberalization. Zeroing tariff rates on industrial imports from the EU had not led to a catastrophic relocation of industries<sup>in transition</sup> economies that signed the Europe Association Agreements. Even though<sup>SEE-5countrieshave</sup> yet to open their markets fully to competition from imports from the EU,<sup>theyhad already</sup> undergone readjustment due to the shift to market clearing prices and the<sup>collapseofcross</sup> subsidies. Hence, it seems that accelerated liberalization in conditions of market access<sup>is</sup> unlikely to impose painful adjustment.

Yet, vigorously pursed structural reforms improving the business climate and the quality of public administration, including tax and customs administration, are indispensable<sup>totrigger</sup> growth and readjustment of production structures to take advantage of opportunities<sup>offeredby</sup> European and international markets. While this does not guarantee a massive<sup>inflowof FDI or</sup> surge in domestic investment, it certainly increases their probability. As empirical<sup>evidencefrom</sup> Ireland (Barry 1996) or Poland (World Bank 1997) strongly suggests, FDI<sup>areparticularly</sup> important in assuring that engagement in a preferential trading arrangement with<sup>thehighly</sup> developed EU do not lead to a catastrophic relocation of industries.

# **CONCLUDING COMMENT**

While the SA process provides general guidelines for the development of economic ties among SEE-5 countries, it leaves many issues open to negotiations and different solutions.<sup>Inexchange</sup> for EU assistance, prospect of EU accession, and continuation of preferential<sup>accesstoEU</sup> markets, SEE-5 governments have to upgrade their institutions and governance<sup>toEuropean</sup> standards, engage in mutual regional cooperation including free trade and establish<sup>free trade</sup> areas with the EU. Respective schedules and details of FTAs among SEE<sup>countrieshavebeen</sup> left to negotiations with the latter already resulting in the MOU and the recent completion of most bilateral FTAs among the signatory countries.

The paper examined benefits to SEE-5 of trade liberalization along these two dimensions and suggested conditions under which gains could be maximized. These conditions<sup>couldbe</sup> summarized as follows: First, SEE-5 countries should implement tariff reductions<sup>onimportsof</sup> industrial products from the EU at the same time when they fully implement SEE-5 FTAs.<sup>This</sup> would have two important consequences: it would reduce dangers associated with<sup>South-South</sup> integration (i.e., relocation of industries to more developed partners), and even<sup>upconditionsin</sup> access for EU exporters to those they face in other SEE countries-Bulgaria<sup>and Romania.</sup> that gains-especially during the early stages of integration-will be distributed in<sup>favorofa more</sup> developed partner-the EU. Traditional trade models suggest that capital<sup>and/or labormobilitybrings</sup> convergence thanks to changes in relative prices brought about by lower<sup>import pricesand improved export</sup> prices, and a higher marginal product per capita attracting higher investment<sup>andgrowth(Baldwin1989).</sup> On the other hand, economic geography models suggest that firms operating<sup>undertheconditionsof</sup> imperfect competition and economies of scale, i.e., in increasing returns-to-scale industries, tend to cluster together drawn by the availability of supplies due to the higher concentration of<sup>demand(Krugmanand</sup> Venables 1993). This would point to the inevitability of relocation of industrial activity<sup>tohighly</sup> developed countries with high concentration of demand.