Transitional Arrangements for Trade and Payments Among the CMEA Countries
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

The CMEA countries are starting to conduct their trade at world prices and in convertible currencies. These are crucial steps in economic reform but will worsen Eastern Europe’s terms of trade and drive it into current account deficit with the U.S.S.R. Proposals have been made for a payments union, resembling the European Payments Union of 1950–58, to ease the transition. Such an arrangement would not function well if it included the U.S.S.R., which would be a persistent creditor. Other ways must be found to deal with the transition.

Abstract

The CMEA countries are starting to conduct their trade at world prices and in convertible currencies. These are crucial steps in economic reform but will worsen Eastern Europe’s terms of trade and drive it into current account deficit with the U.S.S.R. Proposals have been made for a payments union, resembling the European Payments Union of 1950–58, to ease the transition. Such an arrangement would not function well if it included the U.S.S.R., which would be a persistent creditor. Other ways must be found to deal with the transition.

The framework for trade in Eastern Europe has disintegrated. It was decisively rejected by the governments of Eastern Europe and by the U.S.S.R., for somewhat different reasons. All of the governments favor trading arrangements that emulate those in the rest of the world. Trade should take place between individual enterprises, not be monopolized by governmental entities. Trade should be conducted at world prices, and payments made in convertible currencies (which means that imbalances would normally be settled in those currencies). Agreement was reached in principle on these objectives in January 1990 at the Sofia meeting of the Council on Mutual Economic Assistance (CMEA), and the U.S.S.R. sought to implement the arrangements fully by the beginning of 1991. There is concern in Eastern Europe, however, and among Western observers, about the costs of moving quickly to the new regime.

A shift to trade at world prices will worsen Eastern Europe’s terms of trade and drive it into current account deficit with the U.S.S.R. Under the new regime, moreover, a deficit with the U.S.S.R. will have to be settled in convertible currencies, which will be difficult. The countries of Eastern Europe cannot readily earn or borrow more in the West. In fact, they must spend more in the West to buy capital goods for economic modernization.

Some of the countries of Eastern Europe have made short-term bargains with the U.S.S.R. to finance their prospective current account deficits. Thus, Czechoslovakia and Hungary expect to draw down balances built up when they were running current account surpluses. The balances are denominated in transferable rubles (TR) but will be converted to U.S. dollars at exchange rates reported to approximate $0.90 = TR 1. (They will thus receive fewer dollars than they would have obtained at the official exchange rate prevailing when they acquired the balances but more than they would obtain at recent cross rates.)

Some observers believe, however, that longer-term arrangements are needed. These might be modeled on the European Payments Union (EPU), which helped Western Europe to move from bilateral trade before 1950 to current account convertibility in 1958. The suggestion has been made by a number of individuals and organizations, including the Economic Commission for Europe, in its Economic Survey of Europe 1989–90.1

The analogy is intriguing but may be deeply flawed. There are large differences between the postwar situation in Western Europe and the present situation in Eastern Europe. They are reviewed in this paper, which reaches the conclusion that an Eastern European Payments Union (EEPU) is not a good way to manage the transition to the new trading and payments regime.

An EEPU that excluded the U.S.S.R. might not be very useful, as there may be far less scope for trade expansion in Eastern Europe than there was in Western Europe after World War II. Trade and payments have been conducted bilaterally in the CMEA area, but that has not been the principal reason for the low level of trade among the countries involved. In Western Europe, by contrast, bilateral payments arrangements depressed trade significantly in the late 1940s, and the multilateralization achieved through the EPU fostered liberalization, regionally and globally.

An EEPU that included the U.S.S.R. would not work well, because the U.S.S.R. would be a “structural creditor” in the years ahead and would have to lend to Eastern Europe through the EEPU. The EPU had structural creditors too, but Marshall Plan money was used to indemnify them for the dollars they sacrificed by lending to their partners. The same point can be made more vividly. Because the United States was not a member of the EPU, the “dollar shortage” faced by Western Europe was financed outside the EPU. If the U.S.S.R. were a member of an EEPU, the “ruble shortage” facing Eastern Europe would be financed automatically within the EEPU.

This paper has four parts. The first describes the old framework for trade and payments among the CMEA countries and the actual trade pattern. The next part reviews the main objections to that framework viewed from the perspectives of the U.S.S.R. and of the Eastern European countries—Bulgaria, Czechoslovakia, Hungary, Poland, and Romania—denoted here as the CMEA5. It also examines the outlook for CMEA trade, focusing on the effects of shifting to world prices and using convertible currencies. The third part of the paper describes the EPU and assesses its contribution. The final part shows how an EEPU might work, with and without the U.S.S.R. It is, on balance, critical of proposals to create an EEPU, but it stresses the need for balance of payments financing to help the CMEA5 adjust to the impending shift in their terms of trade and the switch to convertible currency payments.

I. The CMEA System

For more than forty years, most of the trade among the CMEA countries was conducted on a government-to-government basis. The framework for trade between each pair of countries was defined by five-year agreements, which were supplemented by annual protocols fixing the quantities and prices of the products to be traded.2

Prices and Payments

The prices of primary commodities, most notably exports of oil and gas from the U.S.S.R., were based on world prices but tended to lag behind them; under the so-called Bucharest formula, adopted in 1975, a five-year moving average of world prices was used to obtain a dollar price, which was converted to TR at the official exchange rate (about $1.60 = TR 1). The prices of other goods were negotiated individually. Furthermore, the prices used in CMEA trade were not always linked very closely to home prices—the prices received by the producers of exports and those paid by the purchasers of imports. Trade flows were taxed or subsidized in opaque and complex ways. Home prices, however, did not reflect opportunity costs, and there is no way to know whether the implicit trade taxes and subsidies compounded or reduced distortions in real resource allocation.

After 1964 most of the payments between CMEA countries took place in TR, on the books of the International Bank for Economic Cooperation (IBEC) in Moscow. Exporters were paid in their countries’ own currencies, and importers made their payments in their own currencies, but the corresponding payments between CMEA countries were made in TR, by crediting and debiting IBEC accounts. The transferable ruble, however, was not truly transferable, let alone convertible. If Poland built up a credit balance with IBEC by running a trade surplus with Hungary, it could not use the credit to finance a deficit with Bulgaria. For this and other reasons, each CMEA country sought to balance its trade bilaterally with each CMEA partner. This was, indeed, the normal expectation, even when a country had built up a credit balance. It could draw that balance down when it ran an unexpected deficit with its partner, but it could not always plan to run one.3

The transferable ruble was supposed to become transferable, as its name implies, and plans to make it so surfaced periodically, but they were never implemented. This failure raises an interesting question. Was the bilateral character of CMEA trade due to the nontransferability of the TR, or was it the reflection of more basic obstacles to the multilateralization of that trade? Without answering this question, it is hard to forecast the short-run and long-run effects of changing the CMEA payments system. To answer it carefully, however, one must first examine the actual pattern of trade.

The Structure of CMEA Trade

Central planning tends to be biased against foreign trade. Planners crave certainty, and foreign trade, even between planned economies, involves uncertainty. It is hard to plan production, harder still to plan consumption, and very hard to plan the differences between them. To plan trade between two countries, moreover, the planners have to match the two countries’ differences, imparting more uncertainty to each country’s plan.

Nevertheless, the countries of Eastern Europe are heavily dependent on foreign trade. Numbers for Hungary and Poland are shown in Table 1, along with those for three other European countries. Hungary and Portugal are similar in size; so are Poland and Spain. But Hungarian exports are larger than Portuguese exports, relative to output, and Polish exports are larger than Spanish exports, although incomes are lower in Hungary and Poland—far lower in Hungary than Spain.4 Comparable data are not available for the other CMEA countries, but imports per capita by Bulgaria and Czechoslovakia do not differ greatly from those of Hungary, and the figures for Romania and Poland are not very different either, although lower than the rest.5

Table 1.

Openness, Income, and Size of Selected European Countries, 1988

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Sources: International Monetary Fund (1990) and World Bank (1990a).

Exports account for large shares of output in some of the countries’ key industries. In Bulgaria, for instance, exports accounted for 60 percent of total machinery output in 1987 and for 30 percent of the output of manufactured consumer goods. In Poland, they accounted for 27 percent of machinery output and for 31 percent of the output of building materials.6

Nevertheless, the CMEA countries trade less with the outside world and more with each other than one might expect, given their small share of world trade (less than 4 percent of world exports in 1989). The distribution of their trade is shown in Table 2, and bilateral trade flows are shown in Table 3. Three features stand out immediately.

Table 2.

Trade Among the CMEA Countries, 1989

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Sources: Author’s calculations using data in Economic Commission for Europe (1990a) and unpublished data provided by the Economic Commission for Europe.Note: CMEA countries include the CMEA5 plus the U.S.S.R.; trade flows between CMEA countries are valued at a common exchange rate ($0.50/ruble).
Table 3.

Bilateral Trade in the CMEA Area, 1989

(Percentage of total exports to CMEA5 and U.S.S.R.)

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Source: See source note for Table 2.Note: Entries are averages of percentages computed from the exporting countries’ trade data and from the importing countries’ data. Therefore, entries will not agree exactly with those obtained from any single country’s data.
  • The shares of intra-CMEA trade are quite high but differ from country to country, ranging from 57 percent of total Bulgarian exports and 42 percent of Bulgarian imports to just 20 percent of total Romanian exports and 30 percent of Romanian imports.7

  • The U.S.S.R. dominates intra-CMEA trade. Its shares in its partners’ trade are uniformly high, ranging from 85 percent of total Bulgarian exports to the CMEA countries and 80 percent of Bulgarian imports to 65 percent of Czechoslovak exports and 63 percent of Czechoslovak imports.

  • The other bilateral trade flows are small. The largest numbers in Table 3 are for Polish and Hungarian exports to Czechoslovakia, which account for 18 and 15 percent, respectively, of total Polish and Hungarian exports to the CMEA countries, and for Czechoslovak exports to Poland, which account for 17 percent of total Czechoslovak exports to its CMEA partners. (One should remember, moreover, that Polish, Hungarian, and Czechoslovak exports to the CMEA countries account for comparatively small shares of those countries’ total exports.)

Concerns have been expressed about the possibility of a sharp fall in the volume of intra-CMEA trade, due to reductions in output in some CMEA countries and impending shifts in demand to imports from the outside world. These matters are discussed below. Note for now, however, that apart from trade with the U.S.S.R., this trade is small.

There has also been discussion of prospects for expanding trade among the CMEA5. The commodity composition of that trade, however, leads one to doubt that it can grow rapidly. The economies of the CMEA5 are complementary to the Soviet economy; they export machinery and other manufactured goods and import primary products from the U.S.S.R. But they are competitive with each other; they export similar goods and thus export small amounts.

This is, of course, the answer to the question posed at the end of the previous section. The nontransferability of the TR was not the main reason for the bilateral pattern displayed by CMEA trade or the low level of trade within Eastern Europe. The pattern reflected the “socialist division of labor” imposed by the U.S.S.R. in the early years of the CMEA, which created the complementarities between Eastern Europe and the U.S.S.R., promoting bilateral trade with the U.S.S.R. but limiting specialization within Eastern Europe. Bilateral government-to-government bargaining also helped the U.S.S.R. exploit its monopoly power in the postwar period.8 As a practical matter, moreover, it would have been hard to conduct multilateral bargaining on the product-byproduct basis that typified dealings among CMEA countries.9

In brief, there was not much interest in making the TR transferable because bilateralism was deeply rooted in the industrial structure of the CMEA area and in its trade policies and practices, and there was little interest in multilateralism.

Tables 4a and 4b document some statements made above concerning the pattern of CMEA trade and the basic causes of bilateralism.10 Note, first, that exports to socialist countries are much more sharply concentrated than exports to nonsocialist countries. In the case of Czechoslovakia, for instance, exports of machinery and transport equipment account for nearly 60 percent of total exports to socialist countries but for only 21 percent of exports to other countries. Conversely, exports of other manufactured goods account for only 29 percent of exports to socialist countries but for 42 percent of exports to other countries. Similarly, exports of investment goods account for a full 65 percent of total Bulgarian exports to socialist countries but for only 24 percent of exports to other countries.

Table 4a.

Commodity Composition of CMEA Trade

(Percentage of total exports or imports)

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Source: National trade statistics.Note: Czechoslovak data for 1989; Hungarian data for 1987; Polish data for 1988. Detail may not add to total because of rounding.
Table 4b.

Commodity Composition of CMEA Trade

(Percentage of total exports or imports)

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Source: National trade statistics.Note: Bulgarian data for 1989; Romanian data for 1988. Detail may not add to total because of rounding.

Not shown separately.

The CMEA5 buy most of their oil and other fuel imports from the U.S.S.R., but most of their food and agricultural imports from nonsocialist countries. Their imports of machinery and other manufactures, however, come from both socialist and nonsocialist countries (and account for similar percentages of their total imports from each country group).

Detailed data for Hungary and Poland, shown in Table 5, say more about these patterns. Both countries export machinery and other manufactured goods to the U.S.S.R. and the rest of Eastern Europe, but they buy less of them from the U.S.S.R.; their manufactured imports from socialist countries come mainly from their partners in Eastern Europe.

Table 5.

Commodity Composition of Hungarian and Polish Trade with CMEA Countries

(Percentage of total exports or imports)

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Source: National trade statistics.Note: All data for 1987. Detail may not add to total because of rounding.

Can the CMEA5 expand their trade with each other? Can they perhaps promote intra-industry trade in machinery and other manufactures? Hardt (1990) and Lavigne (1990), among others, are optimistic on this score—perhaps too optimistic. The Economic Commission for Europe (ECE) has tried to measure the technological intensity of trade in engineering goods, and some of its results are shown in Table 6. The exports and imports of Eastern Europe and of the U.S.S.R. are far lower in technological intensity than those of most other countries. These results suggest that they can meet their partners’ needs—that each of them can export more low-tech goods. But they need goods of higher technological intensity to raise their productivity. Therefore, they must import less from their CMEA partners and more from the rest of the world.

Table 6.

Exports and Imports of Engineering Goods by Technological Intensity, 1987

(Percentage of total exports or imports)

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Source: Economic Commission for Europe (1990b, Tables 7.8 and 7.9).Note: Figures do not always add to 100 percent because some goods in the totals have not been classified.

There may be some scope for expanding trade within Eastern Europe, but not by more intensive intra-industry specialization in machinery. On the contrary, the CMEA5 should probably aim at making their trade with each other more like their trade with the outside world—more broadly diversified across product categories rather than more concentrated on the narrow range of goods that they have been trading with each other. This is the most sensible interpretation that can be attached to the view expressed by the ECE, which argues that “there are significant comparative advantages embodied in the resource endowments of the individual economies that, with the proper institutions and policies, could be exploited more fully to the benefit of welfare levels in the region and elsewhere” (ECE (1990b, p. 3–72)).

II. Objectives and Effects of Economic Reform

For reasons already mentioned, central planners tend to be strongly trade averse. Imports are a necessary evil—the source of last resort for basic raw materials and other inputs that cannot be produced at home in quantities sufficient to meet domestic needs. Exports are needed to pay for imports, but they are released reluctantly because of domestic shortages.

Western views are different. Trade is admired as an “engine of growth,” and international competition is regarded as a powerful antidote to domestic inefficiency. The appeal of these views is so strong that protectionists have had to recast their arguments. Tariffs and other trade barriers, they say, should be used strategically to open other countries’ markets—to promote rather than restrict competition—and to offset the “unfair” trade practices that others use to appropriate the gains from trade.

The Changing Role of Foreign Trade

Current views in Eastern Europe lie between these extremes, even in countries strongly committed to building market economies. The need for more imports is readily acknowledged. Imported capital goods embody the technologies that Eastern Europe needs to raise productivity; imported consumer goods widen workers’ choices, raising real incomes and incentives. The need for more exports is also acknowledged, not only to pay for more imports but also to win large markets in which to exploit economies of scale. The domestic dimensions of reform, however, have attracted more attention than the external dimensions, although Poland and Hungary have acted boldly to liberalize their trade and payments.11

The domestic focus is understandable. The challenges are enormous and greatly complicated in most countries by huge macroeconomic problems. More attention to the external side, moreover, would require faster action on the macroeconomic side. Otherwise, the liberalization of trade and payments would allow excess domestic demand to produce current account deficits, and an attempt to limit them by devaluation would increase inflationary pressures at home.

It is, of course, essential to create the institutions that make a market economy work. Property rights must be defined and liberalized to encourage the creation of new enterprises and permit them to function effectively. It is especially important to promote wholesale trade, in order to replace old methods for allocating inputs and bringing goods to market. It may be useful, however, to give more attention to the external side when thinking about reform. Trade can be an engine of growth for the small economies of Eastern Europe, just as it has been for those of East Asia. Furthermore, domestic reform can be accelerated by “importing” world markets and world prices. World markets for intermediate goods can substitute in part for deficient domestic markets, and the use of world prices for those goods would be more sensible than the laborious rationalization of domestic prices that appears to be contemplated in the U.S.S.R. A two-step reform, moreover, involving a move to domestic market prices, then to world prices, would be far more expensive than an immediate move to world prices; it would require two sets of shifts in resource allocation.

To import world markets wholeheartedly, the governments of Eastern Europe will have to make large changes in their trade and payments systems. Purists would probably insist that they must move entirely to free trade. Pragmatists would probably argue that they must achieve current account convertibility and dismantle their quantitative trade controls, including their import-licensing arrangements. This would be a “big bang” indeed—bigger even than in Poland—and the governments of Eastern Europe are not ready for it. They would probably say, with some justification, what Lord Cherwell said when he was asked what would happen if Britain made a “dash for convertibility” by allowing the pound to float in the early 1950s:

If a 6 percent Bank Rate, 1 million unemployed, and a 2/- loaf are not enough, there would have to be an 8 percent Bank Rate, 2 million unemployed, and a 3/- loaf. If workers, finding their food dearer, are inclined to demand higher wages, this will have to be stopped by increasing unemployment until their bargaining power is destroyed. This is what comfortable phrases like ‘letting the exchange rate take the strain’ mean (Kaplan and Schleiminger (1989, p. 166)).

It can indeed be argued that the problems of Eastern Europe will be more obdurate than those of Western Europe forty years ago, that the adjustment process will be more painful, and that the social tolerance for pain may be lower.12 The process will have to be gradual, and debate will continue between those who would step on the accelerator to reap the benefits sooner and those who would step on the brakes to reduce or defer the costs.

Some Effects of Reforming CMEA Trade

Although governments in Eastern Europe have tended to focus on domestic dimensions of reform, they have agreed in principle to move to the use of world prices in CMEA trade and to convertible currency payments. Some of them, moreover, are ready to let world prices influence domestic prices, which must be done to import world markets and world prices. The U.S.S.R. is even more eager to move to world prices, but for different reasons. Soviet reformers are more domestically oriented than their counterparts in Eastern Europe, even those who want to move quickly to a full-fledged market economy. They seem sometimes to believe that a set of market-clearing prices can be made to rise from the ruins of the planned economy, like the Phoenix from the ashes. But the U.S.S.R. expects to gain commercially from a shift to world prices.

A shift to world prices and to the use of convertible currencies will have two effects. First, it will raise the prices of fuels and other raw materials in CMEA trade. Second, it will cause a shift in demand from many manufactured goods produced by the CMEA countries to more attractive goods produced by other countries. If they must use convertible currencies to pay for imports from their partners, CMEA countries will have less incentive to buy from each other when they can get better goods elsewhere.

To estimate the effects of these developments, one has first to measure the differences between the prices presently imbedded in CMEA trade data and the corresponding world prices. This is quite difficult, even for fuels and other commodities with well-known world prices. Consider two ways to measure the relevant oil price.

First, if the Bucharest formula had been applied mechanically in 1989, the CMEA countries would have paid between TR 9.1 and TR 12.2 a barrel. (The low figure uses a three-year moving average of world oil prices, the high one uses a five-year moving average, and both use the official exchange rate between the TR and the dollar.) But the CMEA countries compile their trade data in a way that involves implicit use of the cross rate between the TR and the dollar. In the case of Poland, that rate was about $0.34 = TR 1 in 1989, which means that the dollar price of oil imbedded in Poland’s trade data would have been between $3.10 and $4.15 a barrel. In the case of Czechoslovakia, however, the cross rate was $0.66 = TR 1, and the dollar price imbedded in its data would have been between $6.00 and $8.05 a barrel.

Second, an average oil price can be extracted directly from Poland’s trade data; when converted from zloty into dollars at the commercial exchange rate, it works out at about $5.30 a barrel in 1989, which was roughly 30 percent of the world price. But Bulgarian figures for 1989 put its import price at 45 percent of the world price when Bulgaria’s cross rate is used to convert it into dollars.

To complicate matters, some of the countries’ trade data do not segregate oil from other fuels, and there is reason to believe that implicit import prices for coal and natural gas have been closer to world prices than the price of oil. Hence, the illustrative calculations described below assume that the shift to world prices would have raised implicit energy prices by an average of 150 percent in 1989.13

Information on other commodity prices is scarcer, but the use of the Bucharest formula in the manner described above for oil suggests that there would have been large increases in the prices of iron ore and nonferrous metals, because the import prices for those goods were lower, compared to world prices, than the price of oil. The prices of chemicals, by contrast, seem to have been closer to world prices. Accordingly, the calculations described below assume that the shift to world prices would have raised the prices of minerals by 200 percent and raised the prices of chemicals by 50 percent.

It is far harder to estimate the change in the prices of manufactures. It is widely believed that they are overpriced in CMEA trade and would have to fall sharply to offset the forthcoming shift in demand. Recent research on Hungarian prices, however, suggests that the prices of manufactured goods in CMEA trade may already be much lower than world prices of similar goods.

Marrese and Wittenberg (1990) have calculated dollar unit values for goods traded between Hungary and the West relative to forint unit values for goods traded between Hungary and the U.S.S.R.14 Their figure for Hungarian exports of machinery is $0.0385 = Ft 1 in 1987, whereas the commercial exchange rate was $0.0213 = Ft 1. Suppose, then, that Western buyers had been free to purchase Hungarian goods at the forint prices paid by Soviet buyers. They should have been willing to pay about 80 percent more for the forint than the commercial rate, which says, in turn, that the forint prices of Hungarian goods sold to the U.S.S.R. were far lower than the forint prices of goods sold to the West.

For this and other reasons, the calculations summarized below do not make large adjustments in the prices of manufactured goods. They assume a 15 percent reduction in the prices of machinery and transport equipment had the shift to world prices occurred in 1989, but no changes in the prices of other manufactures. All of the foregoing suppositions are summarized below.

For Czechoslovakia, Hungary, and Poland, which use the Standard International Trade Classification (SITC):

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For Bulgaria and Romania, which use the CMEA classification:

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These price changes were applied to the trade data shown in Tables 4a and 4b to generate the estimates in Tables 7 and 8.15

Table 7.

Estimated Effects of Shifting to World Prices on the 1989 Terms of Trade and Trade Balances

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Table 8.

Estimated Effects of Shifting to World Prices on 1989 Current Account Balances

(In millions of U.S. dollars)

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Note: Data in TR converted to U.S. dollars at national cross rates.

Every country under study would have suffered a large deterioration in its terms of trade with the CMEA area. It is largest for Hungary, at 37 percent, and smallest for Poland, at 23 percent. Each country would also have experienced a large deterioration in its trade balance with the CMEA area, ranging from $3.6 billion for Czechoslovakia to $1.5 billion for Poland.16 Therefore, each country would have run a large current account deficit with the CMEA area, mainly with the U.S.S.R. These would have ranged from $2.8 billion for Czechoslovakia to $1.0 billion for Bulgaria.17

These are not forecasts for 1991, when the shift to world prices will be taking place. They ask how the shift would have affected each country’s terms of trade and trade balance if it had taken place in 1989, and they make no allowance for compensating changes in the quantities of exports and imports or for changes in earnings from services. Nor do they allow for many other factors that are likely to affect the underlying trade flows, including the output and exchange rate changes that occurred in 1990, the increase in the price of oil following the Kuwait crisis, and the worsening of economic conditions in the U.S.S.R., which may dominate the rest.18

Since the U.S.S.R. can expect to run current account surpluses with Eastern Europe, it has an obvious reason for wanting to use convertible currencies for settling CMEA payments; it wants to use its surpluses with the CMEA5 to cover its deficits with the rest of the world. That is why it was willing to countenance the demise of the TR. The interests and objectives of the CMEA5 are less clear. They want to denominate their payments in convertible currencies but not necessarily to make settlements in them. In other words, they were ready to replace the TR with a truly transferable means of payment but reluctant to shift immediately to a fully convertible means of payment.

The distinction between transferability and convertibility is a matter of degree. When a particular means of payment can be transferred freely to any entity in any country in exchange for goods or services, financial assets, or another means of payment, it is fully convertible. Yet the difference of degree is crucial to the subject of this paper, which is concerned with the distinction between an external means of payment that can be transferred freely among the CMEA countries to pay for goods and services traded by those countries and one that can be swapped for fully convertible currencies and thus used for purchases from the outside world. (It is also important to distinguish between the use of a convertible currency for external settlements and convertibility of the domestic currency. Convertible currencies can be used for settlements without making the domestic currency convertible in any meaningful way. The countries of Western Europe made settlements in gold and dollars—among themselves and with other countries—long before making their own currencies convertible, even for current account transactions.)

Because the TR was not transferable, the CMEA countries could not make multilateral settlements, and bilateral balancing was inevitable. Insofar as the TR is replaced by a transferable means of payment, multilateral settlements will take place automatically and bilateral balancing will not be necessary. The CMEA countries will have no incentive to cut their exports to countries with which they have surpluses or raise them to countries with which they have deficits.19 Nevertheless, they may cumulative creditor under a bilateral payments arrangement) might seek to raise its imports rather than reduce its exports; conversely, a country that anticipates a deficit with one of its partners (or is a have an incentive to export as little as possible to other CMEA countries and to import as much as possible from them, to keep goods at home for domestic consumption or sell them to outsiders for convertible currencies. Insofar as the TR is replaced by a fully convertible means of payment, by contrast, there will be no incentive to discriminate between trade with other CMEA countries and trade with the outside world.

The conventional assessment of postwar experience in Western Europe, reviewed in the next part of this paper, would lead one to recommend an immediate move to transferability. The bilateral balancing of trade in Western Europe was viewed as a major obstacle to economic recovery, and the multilateralization of trade that followed the advent of transferability under the aegis of the EPU was viewed at the time as making a major contribution to trade liberalization and thus to the growth of trade in the 1950s. Analogies are dangerous, however, and three caveats are in order.

First, the coverage of transferability was much larger in the case of Western Europe than it would be in the case of Eastern Europe. The EPU included the entire sterling area and the overseas dependencies of France, Belgium, and Portugal. Therefore, it covered most of Africa and Asia, as well as parts of the Western Hemisphere.20 The metropolitan members, moreover, were much larger economically than the CMEA countries are today. They accounted for 35 percent of world exports in 1950, while the CMEA countries accounted for less than 4 percent in 1989.

Second, transferability by itself should eliminate discrimination in intra-CMEA trade, but it may not contribute greatly to trade liberalization. No CMEA country will want to run a current account surplus with the rest, even as a group, if it has a deficit with the outside world. By implication, the size and automaticity of future credit arrangements may have more influence on trade liberalization than the shift to transferability itself. The importance of this point is underscored by the EPU experience. The credit arrangements of the EPU were much harder to negotiate than the clearing arrangements, and it might have been impossible to reach agreement if the United States had not used Marshall Plan money to make “side payments” to countries such as Belgium that expected to be creditors in the EPU.

Third, even if transferability leads to trade liberalization, there may not be a rapid increase in trade among the CMEA5. There are opportunities for trade expansion, along the lines mentioned earlier, but it may take a long time to exploit them. An extensive restructuring of output will be needed at a time when the countries of Eastern Europe are more urgently concerned with acquiring Western markets, for political as well as economic reasons.

It is also worth noting that Western Europe had well-functioning domestic markets in the 1950s and did not need to import them from the outside world. Hence, rapid progress toward current account convertibility was less urgent for Western Europe than it is for Eastern Europe.21

III. The European Payments Union

The currencies of Western Europe were not convertible in 1950, even for current account purposes, and transferability was strictly limited outside the sterling area and similar zones. Payments for trade in Western Europe took place through a network of bilateral agreements having built-in credit lines. Payments for imports were centralized at the central bank level and were cleared at the end of each month by netting credits against debits. Balances were settled bilaterally by building up a creditor and debtor position until the limit of each credit line was reached. After that, the deficit country had to pay gold or dollars to the surplus country. Attempts were made to multilateralize these arrangements in 1948 and 1949, using small amounts of Marshall Plan money, but were not very successful.22

Industrial production had recovered handsomely in Western Europe and was above its prewar level in 1950, except in Germany, but the growth of output was slowing down. Furthermore, the volume of trade was far below its prewar level, and trade liberalization was widely viewed as a precondition to the further growth of output. But trade could not be liberalized easily unless payments were liberalized too, which is why the EPU was organized.

Structure and Functioning of the EPU

The design of the EPU was influenced by the bilateral arrangements it replaced. Importers of goods from other EPU countries continued to make payments in their own countries’ currencies, and bilateral balances were built up at each country’s central bank. At the end of each month, however, the Bank for International Settlements (BIS), which served as agent for the EPU, collected and consolidated those balances and converted them into a single number for each member country—its surplus or deficit for that month vis-à-vis the EPU. This multilateral clearing obviated the need for each country to make a bilateral settlement with every other country; it had merely to settle its surplus or deficit with the EPU.

The form of the monthly settlement depended on the country’s balance for the current month and its cumulative position compared to its EPU quota. (A country’s cumulative position was the sum of its monthly surpluses and deficits from the first month on, not what it had lent or borrowed in the course of settling them.) When a country had a cumulative deficit, it received or made gold payments, depending on the sign of its balance for the current month, in keeping with the schedule for cumulative deficits shown in Table 9, and settled the rest of its monthly balance by granting or receiving credit on the books of the EPU. When a country had a cumulative surplus, it received or made gold payments in keeping with the schedule for cumulative surpluses.

Table 9.

Initial Schedule of Settlements in the EPU

(Percent of current deficit or surplus)

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When a country had a cumulative deficit and went on running deficits, it had to make larger gold payments to the EPU and received less credit; when its cumulative deficit was equal to its EPU quota, it ran out of credit and had to settle completely in gold. The rules for countries with cumulative surpluses were less clear. When a country’s cumulative surplus was equal to its quota, it could not count on earning gold in an amount equal to its subsequent surplus, because it could be asked to give more credit to the EPU.

This open-ended obligation helped to protect the liquidity of the EPU. Nevertheless, the EPU could expect to experience gold losses from time to time because of asymmetries built into the system. It would experience a gold loss if the countries having deficits in the current month were at the low end of the schedule for cumulative deficits. Their gold payments would be small compared to the payments that the EPU would have to make to the corresponding surplus countries. The same thing could happen if the countries running deficits had large quotas and those running surpluses had small quotas (unless the surplus countries granted extra credits). To deal with these possibilities, the United States put $350 million of Marshall Plan money into the EPU, which proved to be sufficient.

The EPU agreement was renewed periodically, and major changes in the schedules were made on two occasions. In July 1954 the schedules for cumulative surpluses and deficits were unified, using a flat 50 percent gold ratio for all quota ranges; in August 1955 the uniform ratio was raised to 75 percent. These changes “hardened” EPU settlements; they reduced the gap between the terms for settling imbalances within Western Europe and the terms for settling them with the dollar area—the convertible currency countries of that era.

The operations of the EPU are summarized in Table 10, which shows the grand total of bilateral balances that were reported to the BIS, those that were settled multilaterally, those that were reversed as countries that ran deficits offset them with surpluses, and those that had to be settled with the EPU itself, by gold and dollar payments and EPU credits. The credit figure is very small but understates the role of credit in the EPU system. It shows what was outstanding when the EPU was terminated, not what was extended from month to month or year to year. In 1951–52, for example, one of the more active years, net credits accounted for 44 percent of total settlements, compared with only 16 percent for the longer period covered by Table 10 (Triffin (1957, Table 26)).

Table 10.

EPU Settlements, 1950–58

(In billions of U.S. dollars)

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Source: Kaplan and Schleiminger (1989, Table 10).

Contribution of the EPU

Western Europe made remarkable progress during the EPU years. Trade was liberalized rapidly and expanded hugely. In 1950, 44 percent of private trade in Western Europe was subject to quantitative controls, along with 89 percent of trade between Western Europe and the dollar area; by 1959, the figures had fallen to 11 percent for trade in Western Europe and to 28 percent for trade with the dollar area.23 Intra-European imports grew from $10.1 billion in 1950 to $23.3 billion in 1959, and imports from North America grew from $3.9 billion to $6.1 billion. (Data from Kaplan and Schleiminger (1989, Table 8).) In 1958, moreover, the major countries of Western Europe made their currencies convertible for current account purposes, and the EPU was terminated. It is hard, however, to assess precisely what the EPU contributed to these results.

The EPU did contribute to the multilateralization of settlements within Western Europe and to the conservation of official reserves. Under the interim arrangements of 1948 and 1949, bilateral balances totaled $4.4 billion, of which $1.3 billion was settled in gold and dollars, $3.0 billion was financed with bilateral credit, and only $0.1 billion was offset multilaterally (Triffin (1957, pp. 156–57)). In the first year of the EPU, by contrast, bilateral balances totaled $6.0 billion after applying Marshall Plan aid, of which only $0.8 billion was settled in gold and dollars, $2.2 billion was financed with EPU credit, and $3.0 billion was offset multilaterally (Triffin (1957, Table 26)).

Furthermore, Kaplan and Schleiminger (1989) argue convincingly that the Managing Board of the EPU contributed importantly to the solution of major balance of payments problems, including the German crisis of 1951, which erupted right after the EPU began to operate. The Board made supplementary credit available to countries that had exhausted their EPU credit lines, and it monitored their domestic policies more closely than the International Monetary Fund (IMF) does today.24

Finally, the EPU helped to keep its member governments “on track” as they moved toward convertibility. The hardening of settlements within the EPU, described above, diminished the practical distinction between transferability and convertibility, because gold and dollars became more important in EPU settlements. Furthermore, discussions in the EPU Board helped the governments to formulate a common approach to convertibility.

The multilateralization of payments and the credit arrangements of the EPU were viewed at the time as preconditions for trade liberalization within Western Europe, and the hardening of EPU settlements probably encouraged liberalization with the dollar area. It is essential, however, to distinguish between necessary and sufficient preconditions. Trade liberalization was achieved during the life of the EPU, but it was monitored separately by the Organization for European Economic Cooperation. There was an agreed schedule for removing quantitative trade controls, and strong pressure was brought to bear on governments that fell behind. Liberalization was deemed to be part of the larger process of European integration, which was strongly supported in Washington as well as in Europe. If European governments had not been agreed on the need for liberalization per se and not been prodded by Washington when their own energies flagged, the payments arrangements of the EPU might not have done the job. The timid might have held back the rest, slowing the pace of liberalization.

One more point should be made. The circumstances and intellectual environment of the 1950s worked to rule out a “dash for convertibility” by Western Europe. The British thought briefly about floating the pound and making it convertible unilaterally, but Washington objected, partly because it opposed the delay of trade liberalization on which the plan was predicated (Kaplan and Schleiminger (1989, chap. 10)). Therefore, the contributions of the EPU should be appraised as they were above, by comparing the payments regime of the 1950s with the bilateral regime that preceded it. A different frame of reference is needed, however, to assess the potential contributions of an EEPU. The CMEA system has disintegrated, and the TR is defunct. Hence, the contributions of an EEPU should be appraised by comparison with the use of convertible currencies for CMEA settlements.25

IV. An Eastern European Payments Union

A payments union for the CMEA countries could follow the basic design of the EPU. Each country would have a quota, based on its trade with the others, and its rights and obligations would be defined by its cumulative surplus or deficit compared to its quota. The workings of an EEPU can be illustrated by a simple numerical example. In this particular example, 50 percent of each member’s surplus or deficit is settled by giving or getting credit, and the other 50 percent is settled in convertible currency (the formula adopted by the EPU in 1954).

Functioning of an EEPU

Consider a hypothetical EEPU comprising four countries, Czechoslovakia, Hungary, Poland, and the U.S.S.R., and these bilateral balances, as shown in Table 11.

Table 11.

Bilateral Balances to Be Settled in a Hypothetical EEPU

(In millions of U.S. dollars)

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The balances are expressed in millions of dollars, and the description that follows assumes that payments and credits are likewise expressed in dollars, but other convertible currencies could be used instead. (It would also be possible to use the SDR or ECU as the unit of account.) Begin with the case in which the countries’ cumulative surpluses and deficits are smaller than their quotas, so the countries with surpluses during the current month will give credit to the EEPU, and the countries with deficits will get credit.

Under the old CMEA system, bilateral balances like those shown above would have appeared and remained on the books of IBEC (and would have been expressed in TR rather than dollars). Czechoslovakia would have built up its credit balance with Hungary or run down its debit balance, and so on. With settlements in convertible currencies, by contrast, Czechoslovakia would receive $300 million from Hungary but pay $50 million to Poland and $200 million to the U.S.S.R., so its total dollar holdings would rise by $50 million. With an EEPU, bilateral balances would be consolidated, so that Czechoslovakia would have a $50 million surplus. Hence, it would receive $25 million in dollars from the EEPU (half of its monthly surplus) and extend $25 million in credit to the EEPU. Poland, by contrast, would have a $300 million deficit, would pay $150 million to the EEPU, and would receive $150 million in credit.

This process would go on, month after month, until one of the members reached its credit ceiling. If that country had a cumulative surplus, its subsequent monthly surpluses would be settled entirely by dollar payments from the EEPU, and the EEPU could thus experience a net outflow of dollars; if it had a cumulative deficit, its subsequent deficits would be settled entirely by dollar payments to the EEPU, and the EEPU could experience a net inflow of dollars.

An EEPU might seem to be disadvantageous for Czechoslovakia and the U.S.S.R.—the surplus countries in this hypothetical example. If settlements were made entirely in convertible currencies, Czechoslovakia would earn $50 million from its partners, rather than $25 million from the EEPU, and could use the extra dollars to import more from the outside world. If it expected to run such surpluses steadily—to be a “structural creditor” in the EEPU—it might not want to join. If it did not join, however, its partners might have to cut down their imports from it, in order to reduce their dollar losses. Furthermore, surpluses do not always last. A country with a surplus this year may have a deficit next year, and the credit facilities of the EEPU would reduce the dollar losses resulting from that deficit.

Membership, Quotas, and Capital

Who would belong to an EEPU? How big should the quotas be? How much capital would be needed?

It would be extremely hard to include East Germany (formerly the German Democratic Republic) in an EEPU, because it uses a convertible currency. There would be huge technical difficulties, as the trade and payments of East Germany would have to be segregated from those of Germany as a whole (and those of the rest of the European Community), in order to measure and settle its monthly balance with the CMEA countries. German unification may cause serious problems for some CMEA countries, and special remedies may be needed, including, perhaps, medium-term credits to avoid a sharp fall in German imports from the CMEA countries. It may be best to handle these matters bilaterally, however, between Germany as a whole, on the one hand, and the individual CMEA countries, on the other. Therefore, the discussion that follows, dealing with EEPU quotas and capital, will concentrate on two possibilities: a “large” EEPU comprising the CMEA5 and the U.S.S.R., and a “small” EEPU confined to the CMEA5.

When the EPU was being negotiated in 1950, a benchmark was needed to bargain about quotas. With two exceptions (Belgium and Switzerland), quotas were set at 15 percent of each member’s visible and service trade (the sum of its exports and imports) with the rest of the EPU area in 1949. It is hard to apply this formula to an EEPU, because there are gaps in the data on trade in services. As an approximation, suppose that quotas were set at 20 percent of each member’s visible trade with the others in 1989.26 The quotas for a large EEPU, including the U.S.S.R., and for a small EEPU, excluding it, are shown in Table 12.

Table 12.

Hypothetical Quotas for an EEPU

(In millions of U.S. dollars)

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What do these numbers say about the capitalization of an EEPU? How many dollars would it have to hold to honor its obligations fully? Its exposure to net dollar payments can be measured by asking what would happen if the member with the largest quota ran a long string of deficits, the one with the smallest quota ran a long string of surpluses, and no other country had a surplus or deficit. These imbalances would minimize the dollar receipts of the EEPU and maximize its dollar payments. A large EEPU would have to start out holding $2.3 billion (half of the difference between the quotas of the U.S.S.R. and Romania), an amount that would equal about 18 percent of total quotas. A small EEPU would have to start with only $245 million, an amount that would equal about 11 percent of total quotas. (Recall that the EPU began with $350 million, an amount equal to 9 percent of total quotas.) But the big figure for the large EEPU is based on an unrealistic supposition; the U.S.S.R. is likely to run surpluses, not deficits, which means that the EEPU would gain dollars rather than lose them.

The members of an EEPU might be willing to provide some of the capital, but most of it might have to come from Western governments or international institutions.

Benefits and Costs of an EEPU

What would an EEPU accomplish? If it had been introduced before 1990 to replace the bilateral arrangements based on the TR, it would have contributed to the multilateralization of CMEA payments and thus encouraged more efficient trade and specialization among the CMEA countries. But the shift to convertible currency settlements now taking place will do so too. In this sense, proposals for an EEPU represent solutions looking for a problem.

The case for an EEPU, then, must stand or fall on the contribution it might make to liberalizing trade and payments or, defensively, what it might do to keep trade from contracting in the face of impending balance of payments pressures. In other words, the credit facilities provided by an EEPU would be far more important than the clearing arrangements.

Two potential costs of an EEPU must be borne in mind, even though they cannot be quantified.

First, creation of an EEPU would probably interfere with the relaxation of exchange controls. A country participating in a payments union is obliged to centralize its payments to its partners; the central bank must record them on its books in order to report them to the agent for the union. That is, of course, the way in which the CMEA countries managed their accounts with IBEC. But some countries in Eastern Europe have already moved away from this sort of centralization. Exporters are paid in foreign currency and sell it to the central bank, unless they are authorized to retain and use it; importers buy foreign currency from the central bank, directly or by way of the foreign exchange market. (To this extent, of course, convertible currency settlements occur automatically; there is no need to arrange them on a government-to-government basis.) Creation of an EEPU, then, would involve a step backward—the recentralization of transactions with the other members.

Second, the creation of an EEPU might encourage the CMEA countries to liberalize their trade with each other at the expense of trade with the rest of the world, since EEPU credit could be used to finance imbalances within the CMEA area but not imbalances with the rest of the world. An intensification or prolongation of discrimination against the rest of the world would be unfortunate, because it would interfere with domestic reform. Recall the argument made earlier, that the CMEA countries should import world markets and world prices in order to accelerate the process of reform.

This second cost could be far higher than the first and much harder to control. Discrimination against goods from the outside world is, of course, the counterpart of preferential treatment for goods produced within Eastern Europe—the treatment that some experts recommend explicitly to prevent a contraction of trade in the CMEA area and the corresponding cuts in output and employment. There was an intensification of discrimination against the dollar area in the early years of the EPU, but it was reversed thereafter. The reversal, however, reflected the commitment to trade liberalization by the governments of Western Europe, as well as occasional prodding by the United States.

Participation in an EEPU would not require the CMEA countries to move together, in strict lockstep, to liberalize trade within Eastern Europe or with the outside world. The EPU countries did not do so in the 1950s. Market economies, moreover, have traded extensively with planned economies without planning or controlling their own trade heavily. The bilateral arrangement between Finland, a market economy, and the U.S.S.R., a planned economy, worked well for many years without forcing Finland to control the operations of Finnish firms trading with the U.S.S.R. (see Oblath and Pete (1985)). Yet a common approach to liberalization would perhaps be needed to keep an EEPU from discouraging trade with the outside world, and an attempt to formulate a common approach could conceivably retard trade reform in countries, such as Hungary and Poland, that have moved faster than the rest.

Turning from potential costs to potential benefits, a small EEPU would not be very powerful in promoting trade among its members. It would not be able to promise much financing, compared to the balance of payments needs of its members, since the level of EEPU lending would be tied mechanically to the level of imbalances among the CMEA5, and these are not likely to be large compared to prospective imbalances with the U.S.S.R. or the rest of the world. (The balance of payments effects of the “defection” of the German Democratic Republic may be much larger than the effects of liberalizing trade among the CMEA5.) Even if a small EEPU were successful in encouraging the CMEA5 to liberalize trade within Eastern Europe, the volume of trade might not grow very fast and would not lead to large imbalances within the area. Hence, the CMEA5 may be able to get along easily without an EEPU and should use convertible currencies to settle imbalances among themselves.

A large EEPU might be more effective. Its effectiveness in the short run, however, would reflect its contribution to the financing of prospective imbalances between the CMEA5 and the U.S.S.R. and would therefore depend on the willingness of the U.S.S.R. to lend to an EEPU. This possibility should not be ruled out. Participation would be costly for the U.S.S.R., which cannot readily forgo convertible currency earnings. Refusal would be costly too, however, because it would burden the countries of Eastern Europe with a serious balance of payments problem just when they are trying to stabilize and reform their economies. Furthermore, trade between the CMEA5 and the U.S.S.R. will continue to be mutually beneficial. Eastern Europe can provide manufactured goods that the U.S.S.R. will continue to require, and it would be expensive for the U.S.S.R. to divert its oil and other exports to more distant markets. The CMEA5 and the U.S.S.R. want to expand their trade with the West but should not want to disrupt their trade with each other.

It might be necessary to make “side payments” to the U.S.S.R. to induce it to participate in an EEPU, much like the payments made to Belgium in 1950, when it was reluctant to be a structural creditor in the EPU. In that case, however, the value of the exercise will come to depend on a judgment about the comparative merits of making balance of payments credit available to Eastern Europe through the U.S.S.R. and an EEPU and making that credit available directly, through the IMF and other institutions. A strong case can be made for following this second course (and thus attaching appropriate conditions to use of the credit), rather than setting up a new institution and compelling the governments of Eastern Europe to cooperate closely with the U.S.S.R. in monetary matters.

Debate about this issue, however, should not be allowed to obscure the fundamental problem posed by the impending shift to trade at world prices. Eastern Europe will experience a significant deterioration in its terms of trade with the U.S.S.R. and is likely to run large balance of payments deficits that will have to be settled in convertible currencies. The magnitude of the problem will depend on the speed with which the shift takes place—whether it occurs rapidly in 1991 or is phased in gradually. The problem could be mitigated, moreover, if the U.S.S.R. could be persuaded to make modest amounts of medium-term credit available on an ad hoc basis, and it might be prepared to do that even if it was not willing to join a full-fledged payments union. Whatever the size and timing of the problem, however, the countries of Eastern Europe will need help to solve it.

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*

Peter B. Kenen is Walker Professor of Economics and International Finance and Director of the International Finance Section at Princeton University. He holds degrees from Columbia and Harvard Universities. This paper was prepared while he was a consultant in the European Department. He is indebted to colleagues in the European Department, especially to Thomas Wolf, for advice and comments, and to papers by Peter Bofinger (1990) and Constantine Michalopoulos (1990), which examine the same subject.

2

For more on the CMEA system, see Wolf (1988), Schrenk (1990), and the sources cited in those works. The CMEA sponsored other forms of economic cooperation, but they lie beyond the scope of this paper.

3

Bilateral balancing was carried even further. Attempts were made to balance trade in certain types of goods to conserve scarce supplies for domestic use or for export to Western countries in exchange for convertible currencies. Furthermore, separate accounts and exchange rates were used for commercial and noncommercial transactions. For a detailed account of the CMEA payments system, see van Brabant (1987).

4

The economic statistics of the CMEA countries are not as reliable as those of many other countries, because prices are not very meaningful. This caveat applies with particular force to the comparisons in Table 1 but must also be borne in mind when reading other tables in this paper. Trade data are extremely hard to compare, because the CMEA countries use different exchange rates between the TR and the dollar.

5

Trade data are from Economic Commission for Europe (1990a, chap. 2, p. 5); they are based on a common exchange rate ($0.50 per ruble) for the five countries. The actual figures are $845 for Bulgaria, $770 for Czechoslovakia, $850 for Hungary, $345 for Poland, and $250 for Romania. The figures for the other countries listed in Table 1 are much higher, at $1,715 for Portugal, $1,335 for Greece, and $1,735 for Spain (International Monetary Fund (1990)).

6

Output and trade data from PlanEcon Report, Vol. V (1989, pp. 27–28, 36–37, and 42–43).

7

The shares shown in Table 2 are smaller than those shown in several recent publications; see, for example, World Bank (1990b), where the 1988 figures range from 81 percent of total Bulgarian exports to 41 percent of total Polish exports. That is because those publications use official exchange rates and because they include trade with the German Democratic Republic.

8

The U.S.S.R. was not alone in using bilateral arrangements to maximize bargaining power. Kaplan and Schleiminger (1989, chaps. 3–4) note that the United Kingdom opposed the creation of the EPU partly because it wanted to promote the international use of sterling, but also because its bilateral payments arrangements gave it more bargaining power.

9

It is worth remembering that the early rounds of tariff cuts under the General Agreement on Tariffs and Trade used bilateral bargaining on a product-byproduct basis; “principal suppliers” of particular commodities swapped concessions with each other, then extended them to other countries via the most-favored-nation clause.

10

Two tables are needed because Czechoslovakia, Hungary, and Poland use the Standard International Trade Classification (SITC) to organize their trade statistics, but Bulgaria and Romania have not yet shifted to it.

11

Wolf (1990) examines the problems and progress of trade reform in the CMEA countries; Daviddi and Espa (1989) describe recent events in the U.S.S.R.

12

For a well-balanced comparison between Western Europe in 1950 and Eastern Europe in 1990, see Economic Commission for Europe (1990b, pp. 1–9 ff).

13

The corresponding changes in domestic prices will differ from country to country. In Hungary, for example, petroleum products have been taxed to keep domestic prices close to world prices, and a higher price for imported oil is thus likely to result in tax cuts, not higher energy prices. (In that case, however, higher import prices will reduce tax revenues and magnify the budgetary problem.)

14

The Marrese-Wittenberg calculations can also be used to compare Hungary’s terms of trade with the U.S.S.R. and Poland to its terms of trade with the market economies. In 1987, its terms of trade with the U.S.S.R. were 12.5 percent better than with the market economies, and its terms of trade with Poland were virtually the same as with the market economies. Since 1987, however, the forint has depreciated more sharply in terms of the dollar than in terms of the TR, and Hungary’s terms of trade with the U.S.S.R. have probably improved relative to its terms of trade with the market economies.

15

Romania is omitted from Table 8 for want of the relevant current account data.

16

The Czechoslovak figure may be too high. Czechoslovakia’s cross rate between the TR and the dollar was higher in 1989 than those of some other countries. Hence, the dollar prices implicit in its trade statistics may have been closer to world prices and should be adjusted by smaller amounts than those used in this paper. If this is true, of course, the current account deficit in Table 8 is likewise too high.

17

The figures in Tables 7 and 8 are not very sensitive to small changes in the assumptions about the prospective price changes. The computations were repeated on more pessimistic assumptions: that energy prices rise by 250 percent, the prices of other raw materials rise by 200 percent, and the prices of chemicals rise by 100 percent, while the prices of machinery and transport equipment fall by 30 percent, and the prices of other manufactures fall by 15 percent (rather than being unchanged). Here are the terms of trade and trade balance changes for the countries that report on the SITC basis:

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The terms of trade deteriorate more sharply and the trade balance effects are bigger, but the changes are not very different from those in Table 7.

18

It should be noted, however, that cuts in Soviet oil exports of the sort that occurred in 1990 will not reduce the balance of payments problems of the CMEA5. Those countries have to buy more oil on the world market, and they are reporting reductions in their exports to the U.S.S.R., which has cut back its imports because of its own balance of payments problem.

19

Instances of this sort occurred in 1989; see Economic Commission for Europe (1990b, p. 3-70) and Lavigne (1990, p. 14). It should be noted that bilateralism can induce many forms of discrimination. A country that anticipates a surplus with one of its partners (or is a cumulative debtor) might seek to reduce its imports rather than raise its exports. All of these possibilities distort trade, but some do not reduce it. The trade-reducing tendencies may dominate, however, when countries face excess domestic demand or current account deficits with the outside world. It is hard for deficit countries to increase their exports and thus hard for surplus countries to increase their imports.

20

This point is stressed by Tew (1988), who describes the global economy of the 1950s as a “binary world” comprising the dollar area and the EPU area. (Japan did not belong to either but was not a major trading country in the early 1950s.)

21

I owe this important point to John Williamson.

22

See Kaplan and Schleiminger (1989) and Triffin (1957), the main sources used in this and the next section.

23

The liberalization of trade with the dollar area deserves particular attention. Most discussions of the EPU (for example, Triffin (1957, pp. 203 ff)) say that the United States accepted more discrimination against it as the price it was willing to pay for European integration—one of the main objectives of the Marshall Plan. An intensification of discrimination did occur in the early years of the EPU, when liberalization within Europe took place more rapidly than liberalization with the dollar area. The latter was more dramatic in the end, however, and reduced discrimination against the United States.

24

The IMF itself did not have much influence on European policies in the early years of the EPU, partly because it had decided that countries receiving Marshall Plan aid should draw on the IMF only in “exceptional circumstances,” so that its resources would be available intact after the Marshall Plan had ended. On relations between the IMF and the EPU, see de Vries (1969).

25

This point must be borne in mind when appraising proposals such as those of Daviddi and Espa (1989) that were drafted before the Sofia meeting of the CMEA.

26

In the case of Czechoslovakia, service exports to the whole CMEA area (including the German Democratic Republic) amounted to 14 percent of merchandise exports in 1988, and service imports amounted to 5 percent of merchandise imports. Thus, the 20 percent figure used instead of the 15 percent EPU figure may make an overly large allowance for omitting services. But the 20 percent figure makes no allowance for the effects of shifting trade to world prices. The underlying trade statistics are those that were used to construct Table 3.