The Shape of the New Europe: Vertical Product Differentiation, Wage and Productivity Hierarchies

1 Introduction The current process of east-west European integration is a particularly striking example of the re-emergence of strong trade and, more generally, production linkages between two groups of economies which, albeit geographically close to each other, have had minimal trade and FDI links over a forty-year period. The rapid and deep liberalization of external relations after 1989 (accentuated by the decline of economic activity in ex-CMEA countries due to 'transformational recessions') has led to a dramatic process of trade reorientation and also to a rapid build-up of pressures towards a new pattern of specialization in accordance with global market pressures, mostly in conformity with predictions made by traditional trade theory. Thus, strong deficits in skill-and technology-intensive branches emerged, an accentuation of specialization towards labour-intensive branches and a decline of capital-intensive branches could initially be observed in central and eastern Europe's trade specialization with the west (see the evidence in However, at the same time as global market pressures redirected industrial and trade specialization in the central and east European (CEE) countries in conformity with comparative levels of economic development, factor endowments, etc., there was also evidence of the impact of the embarkation of some of the CEE countries on a process of catching up with more advanced western European economies (in organizational/institutional, technological and product-quality terms). Two forces have thus been operating alongside each other: (a) the accentuation of patterns of inter-industry specialization, following the strong liberalization of trade, and (b) the beginnings of a process of catching up (very differentiated across the different CEE countries) which is traditionally associated with a decline in strong patterns of inter-industry specialization and an increase in intra-industry trade (for details on this argument and evidence, see Landesmann, 1995).