Background

In March 2000 at the Lisbon meeting of the European Council the EU set itself a new strategic goal for the next decade: 'to become the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion' (European Council 2000). Most of the measures taken so far to accomplish that goal seem to be elements of the first of the overall strategies designed in Lisbon, and they seem to aim mainly at strengthening the infrastructures and at developing the institutional and juridical conditions for improved innovation and competitiveness on the Internal Market (Bannermann 2001). Those policies, however correct and important, will only be successful if they are conducted under careful analysis of different factors influencing competition in the EU. One of three factors is undoubtedly the changes in the competitive environment of the European companies stemming from the growing integration of candidate countries' industries into the EU economy. The consequences of that process seem to be even more important for the implementation of the second and the third of the Lisbon overall strategies.

The new situation in which EU industries have found themselves can only be fully understood if one looks at changes in international competitiveness that have taken place in the recent decade. The importance of these developments for the integration process has been commonly acknowledged (for example, by the Copenhagen European Council in June 1993) despite the ambiguous character of competitiveness as an economic category. An unbalanced pace of competitiveness changes in different countries is reflected in differences in the growth rates (Porter 2000), in different tempos of structural change, in the specialisation processes, and in the phenomena that can be observed on the labour market. It is in fact one of the major factors determining the unevenness of the integration processes in their spatial (regional), industrial, and social dimensions. Consequently, any attempt to assess the results of the impact of the entry of new member states on the welfare system of the EU and on its economic and social cohesion needs and economic growth to take changes in competitiveness into consideration. However, most of the existing literature seeking to identify the 'losers' and the 'winners' of this process attach the most attention to the distributional impact of accession through the Common Agricultural Policy or the structural funds or the Cohesion Fund of the Union (see e.g. Baldwin, et. al. 1997; and Daviddi, et. al. 1997).

Firms in the most advanced candidate countries have now gone through a decade of market based reforms and have accumulated a great deal of experience in operating in a market economy and a competitive international environment. They have been subjected to fierce competition on the domestic and international (particularly European) markets and some degree of differentiation has already taken place amongst them. However, there has been little evidence of how these changes would influence the sectoral integration of the candidate countries with the EU: which industries would participate in this process and which would stay in a sort of isolation, an issue that is vital to the future course of events in the enlarged European Union. It is therefore crucial to investigate the extent to which these firms have improved their competitive position (by raising their efficiency or productivity) vis-à-vis firms in market economies and therefore to estimate the impact of these changes on the integration processes. In other words, to find out to what extent the production potential of candidate states has really become a part of the new Single Market. Over the past decade, international trade patterns have changed significantly in those countries, with EU trade not only replacing the former CMEA trade but also dominating foreign trade transactions in general. This miraculous reorientation of trade (both imports and exports) is a sign of the integration of these economies into the EU economy and the improved competitiveness of their firms. The single most important factor in this process has been the competitive pressure to which enterprises in transition economies have been subjected. With the change from a 'soft budget constraint' regime under state ownership, with massive subsidies and guaranteed markets, to a competitive economy, these firms have had to change their behaviour and performance to survive in the new environment.

The enlarged Single European Market will bring new challenges for competition policy. The Lisbon Summit concluded that 'fair and uniformly applied competition and state aid rules are essential for ensuring that businesses can thrive and operate effectively on a level playing field in the internal market', urging the Council, the Commission and the member states to 'further their efforts to promote competition and reduce the general level of State aids, shifting the emphasis from supporting individual companies or sectors towards tackling horizontal objectives of Community interest, such as employment, regional development, environment and training or research' (European Council 2000). However, the very first year since the Lisbon strategy was adopted showed that it will not be easy to meet the ambitious goals, such as the one set in a joint letter of Tony Blair and Jose Maria Aznar, who in October 2000 called for the current level of state aid at 1.1 per cent of EU GDP to be cut to 0.9% by 2003, and to 0.7% by 2005 (Bannerman 2001). The question arises how will the new members fit into this process given their different commitments to privatisation, attitudes to FDI, continued selective use of protectionist measures, barriers to the entry of new firms etc. (see Weichenreider and Sinn 1997).

The integration of transition economies with the EU influences changes in labour market, especially its demand side. It creates new challenges and becomes the key factor determining choices in EU economic policy. On one hand, inclusion of candidate countries with abundant labour force and high unemployment rate requires stimulation of competitiveness improvements and financial support from the EU. But as experience revealed increased financial transfer can be used for financing consumption and dependency on aid can arise. A danger of favoring of looking for aid more than increasing competitiveness requires identification of challenges to EU and choices of economic instruments stimulating competitiveness change. On the other hand important changes on the supply side of labour market of candidate countries, i.e. changes in quality and competitiveness of labour force has been taking place. It will be conducing to solve some problems in demand side of labour market in candidate and the EU countries and will impact the nature and scope of migration within enlarged EU.

Competitiveness of industrial branches is an unequivocal notion. This is due to the fact that a formalised competitiveness theory has not been devised so far and the relevant theoretical background is lacking . Within the variety of models of competition, only the model of imperfect competition can serve for the analysis of competitiveness. Schumpeter's conception of creative destruction in which competitiveness leads to the introduction of innovations on the market merits special attention.

Despite the lack of theoretical background for analysing competitiveness, there are numerous definitions of competitiveness in the literature. For the purpose of this research proposal we will define competitiveness as the "ability to sell" (Balassa 1964) or ability to compete on a free and firm market (Report on Industrial Competitiveness 1985). We assume that competitiveness is the manifestation of international competition and the reflection of its outcomes - the market power of companies. Competitiveness is also not easily measured - there are different measures used and each of them has its own shortcomings. In the literature there are many approaches to competitiveness (Dlugosch et al., 1996, Dollar and Wolff 1993, Rapin and Avery 1995): trade approach (Navaretti 2000), growth approach (World Economic Forum), macro (Myant 1999) and microeconomic approach (Porter 2000). Traditional trade theory focuses on comparative advantage of the investigated unit. Thus for a country or a sector, trade balance and revealed comparative advantages are used as indicators of competitiveness. For a micro economist, competitiveness is usually associated with microeconomic efficiency measured by productivity or labor unit cost. For a macroeconomist, it is related to the movement of real exchange rate and sectoral imbalances in trade flows (trade or current account balance) and economic growth. Another method used to evaluate the international competitiveness is to calculate market shares of branches in the world trade. In the literature on transition countries, changes in import penetration rate are often considered to be an indicator of changes in competitiveness. Each of these approaches to competitiveness suffers from some shortcomings. For example the interpretation of current account balance as a measure of competitiveness is rather ambiguous. In some approaches current account deficit is interpreted as a sign of low competitiveness (Kawecka-Wyrzykowska 1999). In the so-called intertemporal approach and under certain conditions (Obsfeld and Rogoff, 1994), current account surplus (or deficit) determined by capital flows, can be regarded as a sign of high (or low) competitiveness. Vast inflows of capital can indicate that wage levels are low in a country and in this respect the economy is competitive.

Balassa's indicator used for the assessment of changes in the structure of trade flows is a measure of specialisation rather than of competitiveness. Estimates have found only a weak correlation between changes in effectiveness and changes in specialisation, as measured by the revealed comparative advantage (RCA) indicator (Ofer 1992, Kaldor 1978, Alzona et al. 1993)

Since there is no consensus as how to measure competitiveness, a variety of different indicators may be employed to highlight the competitiveness of an individual sector. As far as transition economies are concerned, the following three approaches can be distinguished:

Performance competitiveness (measured for industries at the two-digit-level of aggregation) which is based on a sectoral trade balance indicator, import penetration or market share (Kawecka-Wyrzykowska, 1999);
Exports competitiveness (measured as unit export value or price competitiveness, price and quality position on EU market - Landesman and Burgstaller 1997, Marczewski 1998, Landesman 1996 or RCA - Misala 1995);
Factor competitiveness (measured as unit labour cost, wages - Havlik 1998, Aiginger 1998).

The research on competitiveness in transition economies has, until now, been either partial (i.e. dealing with some aspects of competitiveness) or very general (conducted at high levels of data aggregation). There is no analysis which brings together the performance competitiveness and factor competitiveness of transition economies to evaluate changes in their competitive position in the single EU market, and to identify non-competitive branches which may be competed out of single market.

What is more, no research so far has demonstrated an appreciation of the inappropriateness of using measures of competitiveness changes normally employed in the analysis of developed economies for the investigation of the so-called emerging markets, undergoing processes of internal and external liberalisation. Problem of the impact of state aid and protection on evaluation of competitiveness was raised in the literature (Feenstra 1989, Martin, Valbonesi 2000). There were some studies (G. Klepper, F.D. Weiss 1992) measuring the impact of distortions on evaluation of changes in competitiveness of some OECD countries. This issue is commonly neglected in the literature on competitiveness of transition economies even though in case of these countries impact of changes in protection and state aid on the evaluation of competitiveness deserve special care. The opening of the candidate countries' markets as a result of the Europe Agreements, accompanied by the reduction of state aid and lowering of the effective protection levels, distorts the picture of competitiveness change obtained through traditional measures of effectiveness and market power. This is because the reforms have reduced firms' value added - and indirectly their market share - despite the progress in microeconomic effectiveness many industries have achieved. In these cases the efficiency growth has been too small to compensate for the liberalisation. Therefore our project shall take into consideration the impact of these external factors when estimating the competitiveness changes.

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