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Final Report Summary - INDEUNIS (Industrial Restructuring in the NIS: experiences of and lessons from the new EU Member States)

While the issues of industrial and trade restructuring, Foreign Direct Investments (FDI) patterns and policies, and economic (EU) integration - all crucially relevant in order to estimate the extend of change in the Eastern European transition economies and identify the remaining policy challenges - were analysed in both theoretical and empirical literature, there was very little comparative research covering both groups of countries. Neither was there sufficient awareness within the Newly Independent States (NIS: Russia, Ukraine, Belarus, Kazakhstan and Moldova) about the successes of the new member states (NMS) in attracting FDI, restructuring their industry, and - last but not least - establishing proper domestic institutions such as properly rights, regulatory structures and the quality of legal and administrative systems.

The contribution of the project was to fills these gaps via creating an international research consortium analyzing a broad spectrum of above issues, with the aim of formulating clear-cut conclusions and policy recommendations.

Within six scientific work packages, the research consortium will investigate the following key topics: Patterns of industrial restructuring and trade specialization in the NMS and the role played by (FDI) and EU integration.

Restructuring and integration can be seen as two sides of the same transition coin. Russia and other NIS made considerable progress in both areas. It was generally agreed that while the NIS lagged behind the NMS in reforms and restructuring, the transition paths followed were fairly similar. As the project demonstrated, both groups of countries underwent during the last one and half decades an overlapping sequence of structural change, roughly in four stages:
- Geographical reorientation of trade.
- Change of commodity composition in output and trade.
- Integration into European (and global) markets based on comparative advantage.
- Beginning of shifts up the ladder of comparative advantage.

It was agreed that in the NIS, essential reforms started with a five- to ten-years delay. This was for many reasons, including extended policy debates, opposition of old and new vested interests, local conflicts and the absence of EU accession perspective. That perspective was important for the NMS, as it reinforced the political determination to proceed with reforms.

The above points led to two simple policy recommendations for the NIS:
- Follow the reform path of the NMS and complete policy transition.
- Look for the best available external anchor.

The lack of an accession anchor also meant that other available and compatible anchors should be attached. The policy choices are best seen as a set of non-exclusive options:
- Proceed with the liberalization and institutional development process as the NMS did.
- Provide more government budget for renewing and expanding infrastructure in roads, telecommunications and scientific research.
- Establish an Industrial Policy (IP) to promote priority sectors, hi-tech exports, using budgetary and tax-relief mechanisms.
- Use tariff and other protection under an IP policy for temporary support to infant-industries or a revival of old industries.

The bottom line on the experience of structural change and policy implications for the future was that the NMS were very successful. The major component of NMS success was the steady progress in market reforms, including liberalization, all with a small lag in institutional development. A second component of NMS success, the EU accession anchor was not in the medium-term likely for any of the NIS.

The experience of NMS demonstrated that the creation of general economic circumstances favourable for both foreign and domestic investors is crucial. In the creation of such conditions, progress in the NIS was rather limited and without such progress, sustainable economic, industrial and trade development could not be achieved.

The Russian government endorsed long-term development strategies for several industries and set national priorities for mid-term development. These were, however, not sufficiently supported by any effective policies for encouraging investments in the priority areas and failed to markedly redirect the overall economic policy.

The weakness of FDI inflows into the NIS was recognized as a serious deficiency. Though FDI could not be the predominant source of investment financing, they played multiple important roles in the NMS. Empirical analysis demonstrated that industrial integration through FDI led to considerable increases in productivity, technology and quality, as well as in sales and exports whereas the evidence for positive spillovers to domestic economy was not straightforward.

The conditions of a desirable development between the enlarged EU and the NIS included further mutual liberalization and encouragement of industrial cooperation, where the stronger side - i.e. the EU - had to be the initiator. The contrasting view was that Russia was different from both NMS and other NIS: it is big and does not want to be integrated with the EU. According to this view, Russia should develop its own integration space covering a large portion of the post-Soviet area and regenerate the multisectoral economic structure aimed, in the first place, at the domestic market across the entire CIS.

Both Russia and the EU should develop a coordinated policy of neighborhood. Single Economic Space (SES) integration should be an interface project between the EU and the CIS, as a part of gradually evolving concept that could be labeled the Common European Economic Space (CEES). On this space, prerequisites for free capital flows, cross-border investments in productive and infrastructure projects should be established.

Although the CEES was economically preferable, it was for various reasons not a realistic option. However, this did not preclude pursuit of partial integration steps in selected areas of common interests. Among these were such urgent issues as: energy supplies, further liberalization of trade and investment flows, labour market challenges affecting European growth and competitiveness, institutional developments and further markets integration.

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