Problems and Prospects in East-West Trade: If the political and economic barriers continue to fall, rising real income in Eastern Europe will push demand for imports above the 11 per cent annual increase of the past decade.

Contributor Notes

An article in our last issue described the recent course of trade between East European countries and the rest of the world. This article considers factors that will influence future trends.

This paper focuses on the subject of development and income distribution, and suggests a method whereby economic development can be skewed in favor of the poor. The paper underscores that improvements in the distribution of income can be achieved by applying shadow cost significantly below money cost to determine the social cost of employing members of low-income groups and to use the social consolidation strategy in the choice of technology in the physical construction of projects. The application of this method would result in the more extensive use of labor instead of capital equipment.


This paper focuses on the subject of development and income distribution, and suggests a method whereby economic development can be skewed in favor of the poor. The paper underscores that improvements in the distribution of income can be achieved by applying shadow cost significantly below money cost to determine the social cost of employing members of low-income groups and to use the social consolidation strategy in the choice of technology in the physical construction of projects. The application of this method would result in the more extensive use of labor instead of capital equipment.

Geoffrey Tyler and Hubert Neiss

Historically, trade between Eastern Europe and the rest of the world has been profoundly influenced by politics—for instance, the relaxation of East-West tensions that has occurred since the early 1960s was an important factor in increasing this trade. The evidence of recent years suggests that political impediments may continue to decrease in importance in the years immediately ahead. While it would be idle to assume that the political factors will vanish completely, it is useful to see what the future looks like if we consider economic factors only.

Bilateral arrangements

A major impediment to East-West trade is the stress on bilateral trading arrangements. In part this emphasis has resulted from the centralized system of planning and the consequent ease of establishing quantitative trade plans. What appear to be firm commitments by the two bilateral partners fit in well with foreign trade plans. However, the rigidity inherent in bilateralism, especially of the type common to East European countries, has limited the volume and character of trade with the rest of the world. First, the volume of imports into East European countries has tended to be limited to the volume of their exports. Second, the rigidity of quota lists has, at least in the past, often prevented East European countries from choosing those imports that would have the greatest marginal value to their economies. Third, it is probable that the economic cost of negotiating and administering bilateral agreements has been heavy. There is, however, evidence that East European countries are tending to move away from the stricter forms of bilateralism, not only in trade among themselves, but even more so in trade with the rest of the world. The number of bilateral payments agreements between the two groups of countries has decreased, especially those with the Western industrialized countries. In addition, trade agreements have tended in recent years to become less rigid in terms of quotas and fixed commodity lists.

Export capacity

Another impediment relates to the export capacity of East European countries. Production in Eastern Europe is not well adjusted to the production of goods suitable to meet demand in external markets, especially in the developed countries. The range of products is limited, quality does not always meet foreign requirements, marketing and servicing facilities are not fully developed, and the more limited availability of export credit makes it difficult for the Eastern countries to compete. Moreover, the industrialized countries are sophisticated shoppers; their import demands change rapidly. The East European countries, with their centralized longer-range planning, are not well adapted to producing for such markets. This is particularly true of the market for consumer goods. The East European manufacturers have little experience in such fields and may also be less able to accept the risks inherent in trying to capture the market.

But this difficulty too may be declining. East European countries have endeavored to restructure their economies, partly in order to provide a greater volume of exports to Western markets. Moreover, they now enjoy increasing flexibility in planning investment and production. Joint ventures are being established with Western enterprises, often with the specific aim of producing goods that can be sold in export markets in the West. All these developments—by their nature relatively slow—will in the long run help to expand the export capacity of Eastern Europe. In addition, the increased exploitation of natural resources may in some cases significantly increase export capacity, at least in the medium term.

Economic interdependence

Even so, we are not at the end of the difficulties. A further limitation on the growth of East-West trade is the East European countries’ policy of substantial economic interdependence. This leads to long-term commitments in production specialization and subsequent fixed trade patterns within the group. Clearly this pre-empts trading opportunities with the rest of the world in both directions.

While the problems arising from bilateralism and export capacity may be reduced in the future, the impediments implicit in the concept of economic interdependence may be more deep-rooted. Current planning in the East European countries is based on the assumption of continuing and even increasing close integration within the group, with plans for further integration extending into the 1980’s. It is possible, of course, that modifications will be made which reduce the adverse impact of economic integration on trade with Western countries, but any such measures lie in the future.

Internal pricing

The internal pricing system in East European economies is another major problem facing their exporters. In general, domestic prices converted at official rates of exchange bear no direct relation to world prices and a variety of means are needed to allow enterprises to export and import without suffering losses or making excess profits. A typical arrangement is a system of levies and subsidies, which vary for each product, and which are used to equate domestic and external prices. However, such systems are at best imperfect. Their inflexibility creates problems for enterprises when both domestic costs and world market prices are changing. Moreover, these systems tend to remove much of the incentive for an enterprise to export and it is often necessary to distort the basic system still further to add such an incentive.

Even in this difficult field there is some progress. The trend is toward a rationalization of internal pricing, which leads to a more coherent relation between internal and world prices. Also, some steps have been taken in the trade and foreign exchange regimes to move to systems that are less complex and that reduce the insulation between domestic and foreign markets. Moves such as these, particularly in conjunction with more flexible domestic economic management, should increase the ability of East European countries to operate efficiently.


Managerial skill and experience can also present difficulties to East European countries in export markets. Because enterprises have in the past operated under systems of centralized planning and control—frequently with limited direct connection with Western markets—the flexibility needed for successful operation in export markets has often been lacking. This has been one of the reasons leading to insufficient export capacity. However, this impediment will diminish as time passes. A greater export effort itself is certain to increase the knowledge in East European countries of Western markets. Moreover, important elements of the various economic reforms in Eastern Europe are the improvement of managerial efficiency and greater autonomy for enterprises, including more autonomy in foreign trade.

Impediments in the rest of the world

External impediments to trade are—as in Eastern Europe—both political and economic. Political impediments in the West have varied from export embargoes of items that have been regarded as of direct or indirect military advantage to East European countries, to limitations on the availability of export credits and insurance on exports to these countries. Such political limitations have been declining in importance, particularly in recent years.

Another set of factors limiting the exports of Eastern Europe to the rest of the world has been tariffs and quotas. With the exception of Czechoslovakia, and more recently Poland, Romania, and Hungary, the East European countries are not members of the General Agreement on Tariffs and Trade. They have not, therefore, benefited from the automatic application of most-favored-nation treatment, and in a number of important prospective trading markets they have faced higher tariff schedules than competing countries. In addition, they have faced the additional barriers arising from the tariff and other preferences available to members of such groupings as the European Economic Community (EEC) and the European Free Trade Association. This has no doubt been of some significance given the importance of West European countries as export markets for Eastern Europe. Moreover, the EEC agricultural arrangements have had a particular impact on the export potential of those East European countries having large agricultural sectors that might otherwise find attractive markets in EEC countries.

Credit arrangements have also been an impediment. East European countries have sometimes been denied such arrangements; in other instances, their ability to borrow in Western countries has been limited for commercial reasons. Here again, the trend is clearly toward a reduction of these impediments. Legal barriers have gradually been reduced and commercial difficulties have decreased, partly as Western financiers have gained more experience in credit transactions with East European countries and partly as the network of institutional arrangements linking East and West have increased in both size and efficiency.

Finally, both East European and Western exporters have gained greater knowledge of their respective markets. This has meant that trade in both directions has become simpler and better adjusted to the markets on both sides.

Prospects for East-West trade

The prospects for increased East-West trade depend partly on the increase in effective demand in both sets of markets and partly on a further net reduction in impediments on each side.

There seems no reason to predict a slower growth in demand in the years ahead. Indeed, rising real income in Eastern Europe, and shifts in emphasis from investment to consumption, are likely to lead to higher demand for imports. In addition, it is probable that with the drive for increased efficiency, the structure of investment will require more and more specialized equipment that can in some instances best be obtained in the developed countries of the West. With motor vehicle plants and computers, to take only two examples, this is already happening.

While there is every reason to believe that demand for imports will increase rapidly in Eastern Europe, the real limitations in satisfying that demand will continue to be the East Europeans’ ability to find the necessary foreign exchange. This depends on their ability to export goods and services, or to obtain credits, or both. As far as services are concerned, tourism has been a small but rapidly growing source of convertible foreign exchange in a number of East European countries. Provided tourist facilities can be expanded, large increases in foreign exchange receipts should be possible.

With respect to credits, two factors operate. One is the ability to service debt. The past record of East European countries in this respect has been excellent and they have retained good credit ratings in capital markets. Moreover, recent years have seen a willingness on the part of East European countries to tap a wider range of sources than private Euro-dollar loans. The increasing network of financial connections that the East European countries are developing with the major financial centers will assist them in their borrowing.

The second factor is the ability of East European countries to service a higher level of foreign debt. Since relatively little information is available about the existing level and maturity structure of such debt, it is difficult to make a judgment on this question. Moreover, it is closely connected with the increase in gross foreign exchange receipts that the countries can achieve. However, although quantitative judgment cannot be made, it seems certain that scope exists for the group as a whole to increase its debt to the convertible currency area.

While invisible earnings and credits offer scope for increasing the import capacity of East European countries, export performance will be the major factor. As we have seen, there are many impediments to greater trade and it would be unrealistic to believe they will vanish in the foreseeable future. However, on balance, the trend has been for these to diminish in importance, and there is every reason to believe that this trend will continue, even though the changes that East European countries are initiating in their own economies will inevitably come about only slowly.

Since many elements in East-West trade are presently in a state of flux, attempts at elaborate quantitative forecasts have little meaning. However, it appears that conditions for East-West trade expansion are becoming increasingly favorable, although there are some delaying influences at work. Although a spectacular increase in the rate of growth is unlikely, East-West trade could easily expand in the years ahead at an annual rate higher than the trend of about 11 per cent experienced during the past decade.

Finance & Development, September 1973
Author: International Monetary Fund. External Relations Dept.