Structure and Dynamics of Trade in a Small Economy in Transition before the EU Accession: The Case of Czech Exports and Imports

Benacek, V., Prokop, L., & Visek, J.A. (2003). Structure and Dynamics of Trade in a Small Economy in Transition before the EU Accession: The Case of Czech Exports and Imports. IIASA Interim Report. IIASA, Laxenburg, Austria: IR-03-034

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Abstract

The basic objective of this paper is to design an appropriate structural model based on economic behavioral foundations and test it on data representing the determining factors of Czech trade specialization and growth. Policy recommendations based on the functioning of some policy instruments relevant to monetary policy decisions are also a part of the study.

In the empirical part of the analysis, we use alternative specifications of export and import functions estimated as panels for the EU and non-EU countries, disaggregated into 29 industries for 1993-2001. It is evident from our tests that the future of the Czech trade balance and GDP growth will hinge on ow the Czech economy substitutes its present comparative advantage in labor by building up its capital endowments, most notably its human capital endowments.

Although our tests confirm that the balance of trade was fundamentally influenced by the exchange rate, aggregate demand and tariff changes, the underlying fundamental factors relevant for a sustainable trade balance and an equilibrium exchange rate rest on supply-side capacities (such as changes in factor endowments, inflows of foreign direct investment (FDI), developments in productivity and wage rates, pricing policy of enterprises and the nature of competitiveness of domestic production), which are extremely closely related to export and import performance.

It seems evident that industrial policies (such as support for FDI, capital availability, the building-up of human capital or labor mobility and the promotion of domestic import substitution) can lead to significant changes in the nature of Czech exports and international competitiveness.

We can induce from our analysis that the fundamental restructuring of Czech enterprises in the period 1993 -2001 was driven by openness to trade, especially with the EU. While exports offered growth and employment, accelerating import penetration required the downsizing of many industries, which burdened the whole Czech economy with high adjustment costs. Now, in a period of economic structural stabilization and EU accession, the prospects for accelerated economic growth are much higher.

The seemingly low or even reversed response of trade intensities to real exchange rate appreciation can be explained by supply-side gains in the quality of products, productivity improvements, the buildup of human capital associated with FDI and the fast dynamics of intra-industrial trade, which had a low sensitivity to exchange rate fluctuations. Relative to the unwieldy performance of the state sector or the domestic production of the non-traded commodities, Czech export sector made a tremendous progress in competitiveness during 1993- 2001, showing high dynamics of growth, intensive level of structural adjustments and an accelerated seed of integration with the EU.

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