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# **2. TRADE DIMENSION OF STABILIZATION AND ASSOCIATION PROCESS: POTENTIAL RETURNS AND PITFALLS**

Policy-induced integration into the EU is the most important aspect of the overall SA process, as it commits SEE-5 countries to upgrading institutions and policies to European standards and governance. It also serves as an anchor assuring greater public support and, thereby, facilitating implementation of structural reforms. In addition, various EU-funded programs of bilateral assistance tied to the progress in convergence of respective SEE-5 economic regimes to EU institutions and policies provide an extra incentive to implement structural reforms. While potential returns are huge to all participants of this process, they do not come by default and require a number of complementary policy measures. This section identifies benefits as well as points to dangers associated with the trade component of the SA process, if not accompanied by a simultaneous movement in two other dimensions of trade liberalization-FTAs among SEE-5 countries and MFN liberalization.

The SA process yields several benefits to SEE-5 countries usually associated with the "North-South" integration. In general, it provides strong incentives to a 'South' country to become gradually like a 'North' country in terms of institutions and policies. These incentives derive not only from aspirations to accede to the EU, which calls for the convergence of domestic regimes to the _acquis communautaire_ but also from opening of the economy to competition from imports from the EU and better access to EU markets. The latter may contribute to the increase in foreign investment inflows.

In contrast to countries that signed Europe Association Agreements with the EU, until recently SEE-5 countries had experienced little, if any, external pressure to open their economies to competition from imports and introduce business friendly regulations. The weakness of autonomous trade preferences<sup>2</sup> (ATPs) offered by the EU to some Balkan countries prior to the introduction of the SA process was that they did not contain any mechanisms that would induce politicians to liberalize their economies and establish business friendly environment. In a nutshell, prior to the introduction of the SA process, ATPs created new opportunities for trade expansion on a bilateral basis but did not provide direct incentives to change the domestic business environment. The SA process changes it, as SEE-5 will be entitled to take advantage of the benefits offered only in so far as their policies meet certain criteria.<sup>3</sup> The introduction of the 'conditionality-ridden' SA process has very important positive implications for their reforms and in particular for foreign trade and investment regimes' liberalization. First, it provides guidance and incentive to SEE-5 governments to undertake measures that would align their economic regimes with the EU _acquis communautaire._ While full harmonization with the _acquis_ requires rather sophisticated administrative capacities, starting the harmonization process, for instance, with customs procedures and streamlining the barriers to entry to business activity does not require substantial resources. These are 'win-win' cases, as the introduction of these measures has the potential to improve governance, business and investment 2 The EU-having repealed the 1980 Cooperation Agreement with the former Socialist Federal Republic of Yugoslavia, which offered the SFRY preferential access to its markets under autonomous trade preferences (ATP regime)-continued providing ATPs to some countries of the former SFRY. Bosnia and Herzegovina and Croatia were under the ATP regime reviewed annually, while FYR Macedonia has benefited (as of I January 1998) from preferential market access under bilateral Cooperation Agreement. For the discussion of concessions offered under the ATP regime, see Box 3.2. (p. 60) in World Bank 2000b.

3 For a more detailed discussion, see Michalopoulos (2003).