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Will recent EU Association Agreements encourage institutional change?

Richard Frensch (Regensburg)

Recent EU Association Agreements, concluded with Ukraine, Moldova and Georgia, are steps towards deeper liberalization to foster trade and encourage welfare gains from more trade. Of course, there is also much implicit hope that more trade will pave the way for better institutional arrangements to secure gains from trade, i.e., to positively impact the quality of those countries’ domestic, especially legal,  institutions, as usually summarized by the Rule of Law.

In the newly released IOS Policy Issue No. 6, IOS economist Richard Frensch dampens these high expectations. During the early nineties, most central, east and southeast European countries set on liberalizing their economies, including trade. This happened during a phase of intensifying globalization of fragmented production processes, enabling firms from the region to join east-west European vertical production networks. Thus, the effects of liberalization on countries’ trade patterns show up most prominently in newly traded parts, components, capital goods and transport equipment. Apart from well-known welfare gains from more trade, this specific pattern of specialization and trade – most prominently observed in Hungary, Poland, the Czech Republic and Slovakia – can be argued to have assisted in bringing about fundamental institutional consequences. This happened by increasing the demand for better legal institutions to enable the participation in complex production processes that are dependent on the existence of good legal institutions to ensure contract enforcement and property claims. The positive impact of liberalization-induced participation in east-west European vertical production networks on the Rule of Law was reinforced by developing political institutions and legal traditions, but potentially in conflict with other patterns of specialization that do not favor a positive legal institutional change, such as specifically a specialization on primary production (see figure).

According to this line of argument, whether or not recent steps taken towards deeper trade liberalization by EU Association Agreements, concluded with Ukraine, Moldova and Georgia, will help to not only increase welfare by trade gains, but by improving the Rule of Law will depend on the nature of “more openness” emanating from this further liberalization: will these countries’ firms join international production networks of fragmented, globalized production processes, or will their dependence on primary products rather be increased, because this is all they have to offer, at least in the short and medium term?

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