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Eastern Europe

David Barrett

Heather Roper

and Ali Abdalla

ABARE Research Report 93.20

-

ABARE

O Commonwealth of Australia 1993

This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Major extracts or the entire document may not be reproduced by any process without the written permission of the Executive Director, ABARE.

ISSN 1037-8286 ISBN 0 642 20059 9

Barrett, D., Roper, H. and Abdalla, A. 1993, Eastern Europe andAustralian Wool Exports, ABARE Research Report 93.20, Canberra.

Australian Bureau of Agricultural and Resource Economics GPO Box 1563 Canberra 2601

Telephone (06) 272 2000 Facsimile (06) 272 2001

ABARE is a professionally independent economic research organisation.

Cover photograph: Ben Wrigley Photography Cover design: Lesley Boulton Design

ABARE project 7238.101

Foreword

Czechoslovakia, Poland and Hungary were traditionally the major textile manufacturing countries in Eastern Europe. In the 1990s, however, wool textile production in all countries of the region has fallen sharply in response to reduced domestic demand and limited access to traditional export markets. Consequently, wool imports by Eastern Europe have dropped significantly. Australia's wool exports to the region fell by 88 per cent to only around 5000 tonnes over the period 1988-89 to 1992-93. The principal aim in this report is to examine the institutional reforms taking place in Eastern Europe and assess their implications for the wool textile processing sectors and, consequently, their impact on the demand for wool and wool textile products.

This research is an extension of previous work undertaken by Roberts, Sheales and Malarz (1991), who provided preliminary observations on developments in the Eastern European agriculture and textile industries in a study tour report. In addition, Sheales and Malarz (1992) evaluated the reforms in Poland (the largest importer of Australian wool in the region) and their impact on the wool industry. The project was funded by the Wool Research and Development Corporation.

The key conclusion from this report is that Eastern European countries are unlikely to increase their imports of raw wool until the second half of the decade and will not reach the levels of the late 1980s even by the year 2000. However, and more importantly for Australia, they will progressively become net importers of wool textiles over the next five to ten years. The Australian wool industry is also likely to benefit from increased raw wool exports to those countries that are able to expand their intra-industry trade with the region.

BRIAN FISHER Executive Director, ABARE

December 1993

Acknowledgments

The authors would like to acknowledge the helpful comments made by ABARE colleagues, Russ Reynolds, Teny Sheales, Ivan Roberts and Roger Rose, at various stages of this project.

Contents

Summary 1

1 Introduction 10

2 Economic reforms in Eastern Europe 11 Differing progress in the transition to market economies 11 Transaction costs 13 Elements of reform 15 Impediments and barriers to reform 23

3 Wool supply and processing Textile industries in Eastern Europe Production of wool

4 Demand, trade and foreign investment in wool textiles 35 Demand for wool by processing mills 36 Domestic consumption of textiles 37 Trade in wool and wool textiles 39 Eastern Europe's comparative advantage 43 Foreign investment 46 Credit and other forms of assistance 50

5 Projected developments and implications for trade 53 Projected developments 53 Implications for trade in wool and wool textiles 59

References 64

Boxes 1 Transaction costs 14 2 Elements of reform 16

v

Figures A Wool production in Eastern Europe in 1992-93 32 B Wool trade flows in Eastern Europe before reforms 36 C Wool trade in flows in Eastern Europe since reforms 37 D Projections of domestic wool consumption 56 E Projections of domestic wool production 57 F Projections of Eastern European net trade in raw wool 60 G Projections of Eastern European net trade in semiprocessed

and manufactured wool textiles 61 H Projections of Eastern European net trade in wool products 62

Tables 1 Key economic statistics for Eastern Europe 2 Paid employment in textile manufacturing 3 Mill consumption of textile fibres for selected Eastern

European countries in 1989 4 Mill consumption of textile fibres 5 Total production of yarns by the wool textile industry 6 Production of woven woollen fabrics 7 Production of woven cotton fabrics 8 Production of rayon and acetate filaments and fibres 9 Wool production in Eastern Europe 10 Sheep numbers in Eastern Europe 11 Consumption of wool by the wool textile industry at the

spinning stage 12 Per person consumption of apparel fibres in selected

countries 13 Wool imports by Eastern European countries 14 International labour costs in textile manufacturing 15 Economic growth rate assumptions 16 Population projections for Eastern Europe 17 Projections of Eastern European wool consumption,

production and imports

Summary

Textile manufacturing The former Czechoslovakia, Poland and Hungary were traditionally the major textile manufacturing countries in Eastern Europe. In the 1990s, however, wool textile production across all countries has fallen sharply in response to reduced domestic demand and limited access to traditional export markets. Con- sequently, wool imports by Eastern Europe have declined significantly, with Australia's wool exports to the region dropping by 88 per cent to 5066 tonnes over the period 1988-89 to 1992-93.

Wool textiles are only a small proportion of the textile industries in Eastern Europe, accounting for around 20 per cent of the total value of production and employment in the textile sector. In 1989 wool accounted for around 5 per cent of total fibre use in Poland, the former Czechoslovakia and Hungary. Production of wool yarn and woven wool fabrics declined substantially (45 per cent) in the first two years of the 1990s from the levels before the economic reforms were introduced.

Under the previously centrally planned economic system, the textile industries in Eastern Europe were characterised by large vertically integrated enterprises which were geared to producing large batches of a relatively poor quality and uniform style. Most textile enterprises in Eastern Europe operated with production subsidies from the central government and imports of textile products were restricted. Consequently, these industries were largely sheltered from the rest of the world, and were geared to supplying the domestic market and the former Soviet Union. Most of the textile firms

Wool textile activity in Eastern Europe has fallen sharply

Production of wool yarn and woven

wool has dropped

Textile industries are outdated and

inefficient

Eastern Europe and Australian wool exports 1

Raw wool production is minor, and falling

. . . this is likely to continue

Eastern European demand for clothing and textiles is low

- -

(except in the former Czechoslovakia and Poland) were inefficient and operated with outdated technology compared with that used in Western textile firms.

Eastern Europe is a relatively minor wool producing region, accounting for around 3 per cent of world greasy wool production. Around 60 per cent of the total wool production in the region is produced in Romania and Bulgaria. Wool production for the whole region declined by 30 per cent to 80 000 tonnes greasy over the period 1989-90 to 1992-93.

The reduction, and in some cases the removal, of most subsidies in the sheep and wool sector is likely to increase the costs of wool production relative to other competing agricultural enterprises. As a result, there is likely to be a further shift of resources out of sheep production. Most sheep -being dual purpose, producing both meat and wool - have been dependent on subsidised grain feeding during the winter months. However, the conversion of grain to meat and wool by sheep is low compared with the feed conversion rates for pigs and poultry. Con- sequently, the withdrawal of subsidies on feed grains is likely to result in a contraction of the sheep industry relative to pigs and poultry.

The consumption of wool textile products in Eastern Europe is low when compared with the consumption of wool in developed Western countries. In 1990 average consumption of wool in Eastern Europe was 0.5 kg per person. In developed European countries, by comparison, wool consumption per person was 2.2 kg in Switzerland, 1.8 kg in western Germany, 1.4 kg in Italy, 1.3 kg in the United Kingdom and 1.1 kg in France. The removal of consumer subsidies and the decline in real incomes in recent years has led to further falls in the demand for clothing and textiles in all countries of Eastern Europe.

ABARE research report 93.20

Given the relatively low per person consumption of wool in Eastern Europe there would seem to be potential for significant gains in consumption in the longer term. Important factors influencing demand over this period will be economic growth, population increase, technological change, and changing price relativities between fibres. Because there tends 16 be a close link between wool consumption per person and income per person, an increase in economic growth in the second half of the 1990s is expected to have a positive impact on wool consumption.

Trade and foreign investment Historically, processing mills in Eastern Europe have sourced around half their raw wool requirements from imports - although dependency on wool imports has varied considerably between individual countries. Poland, the former Czechoslovakia and the former Yugoslavia have been the major markets for Australian wool, accounting for around 95 per cent of exports to the region. Australian wool exports to Poland dropped from 16 000 tonnes (greasy) in 1988-89 to 1100 tonnes in 1992-93 while, over the same period, Australian exports to the former Czechoslovakia fell from 10 700 tonnes to 3400 tonnes and to the former Yugoslavia fell from 13 000 tonnes (greasy) to 86 tonnes.

The Council for Mutual Economic Assistance was dismantled in 1990 and this has had a major impact on trade in the region. The Council was responsible for coordinating trade between the member countries, which included the former Soviet Union, the former East Germany, Poland, Hungary, the former Czechoslovakia, Romania, Bulgaria, Mongolia, Vietnam and Cuba. These trading arrangements accounted for the major part of the trade in textile products. Their collapse has been an important factor contributing to the substantial fall in demand and consequently the decline in textile

. . . but is likely to increase if reforms

lead to growth in incomes

Australian wool exports to Eastern

Europe have dropped sharply

. . . largely as a result of the

collapse of Eastern European trading

arrangements

Eastern Europe and Australiarz ~vool exports 3

Reforms are aimed at establishing market economies

But there are impediments to reform

. . . including poor infrastructure and high transaction costs

production in these countries. However, even prior to these changes, many countries were diversifying both their exports and imports outside the Council for Mutual Economic Assistance area.

Economic reforms Since 1989 the countries of Eastern Europe have been implementing political and economic reforms to transform their centrally planned economies to market based economies. The pace of economic reform has been most rapid in Poland, the former Czechoslovakia and Hungary, while Romania, Bulgaria and the former Yugoslavia are much less advanced in this process. All countries in the region have experienced a sharp contraction in their economies, high rates of inflation and increasing unemployment. However, Poland, the Czech Republic and, to a lesser extent, Hungary, are beginning to emerge from the severe economic downturn of recent years.

Although the initial phases of the reform processes have been implemented, there are still a number of impediments constraining the development of well functioning markets.

Most of these impediments are related to developing and implementing the necessary market economy infrastructure and minimising transaction costs. These costs are extremely high in the early stages of the transition to a market economy. For example, because the financial sector remains relatively undeveloped, access to capital for industry restructuring and modernisation is limited. Governments still need to create a complete and consistent legal framework to guide business activity; develop competitive market institutions in areas such as financial services, domestic trade, transport and telecommunications; and create accounting, auditing and other information systems.


Consequently, until these are fully established, the economic costs associated with market transactions are expected to remain relatively high.

A key element of the reforms has been the transfer of property rights from the state to private owners. Legal and institutional structures need to be established to enable property rights to be allocated and protected. This has been particularly important for the privatisation of state enterprises and the restitution of property confiscated under the previous regimes. All countries of Eastern Europe have commenced transferring ownership of state assets to the private sector. However, there are quite different strategies in the privatisation programs, and progress in their implementation varies between countries. One of the issues confronting the respective governments is the extent to which large, and generally inefficient, enterprises should be restructured prior to privatisation.

In Poland, the Czech Republic and Hungary there has been considerable progress in small scale privatisation, mainly in the retail and service sectors. The growth in these sectors has been stimulated by the establishment of new firms. The privatisation of large state enterprises (including those in the textile industries), which account for the bulk of industrial output, is proving to be much more difficult. In most countries many enterprises have been transformed into joint stock companies prior to privatisation.

Projected shifts in wool trade Given the many impediments which continue to inhibit the development of fully functioning market economies, it is likely to be some years before the textile industries in Eastern Europe are restructured and modernised. Prior to the collapse of the Council for Mutual Economic Assistance trading system under which the former Soviet Union was a major

. . . and establishing and

maintaining private property

Privatisation of state assets is part

of reforms

Eastern Europe is unlikely to increase imports of raw wool until the late 1990s

Eastern Europe and Australian wool exports

. . . but trade in wool textiles is likely to increase as Western countries take advantage of lower wages in Eastern Europe

. . . Australian wool exports to these third countries should increase

market for Eastern European textiles, the countries of Eastern Europe were importers of raw wool and net exporters of wool textiles. The key conclusion from this report is that Eastern European countries are unlikely to increase their imports of raw wool until the second half of the 1990s and will not reach the levels of the late 1980s even by the year 2000. However, and more importantly for Australia, they are expected to progressively become net importers of wool textiles over the next five to ten years.

Two factors driving these expected outcomes are, first, the impact of substantially lower wool production in Eastern Europe and, second, a recovery in domestic demand as these economies begin to grow and achieve efficiency gains from their economic reforms. At the same time, these countries, in particular Poland and the Czech Republic, are likely to increase their trade in wool textile products with the countries of Western Europe and with the United States. Firms from some Western European countries, for example Germany and Italy, are engaging in outward processing to take advantage of the lower labour costs in garment manufacturing in Eastern Europe. This involves exporting partly processed wool products for manufacture into completed garments which are then exported back to the country of origin.

The Australian wool industry is likely to benefit not only from increasing its raw wool exports to Eastern Europe toward the end of the decade but also from increased raw wool exports to those countries which are able to expand their intra-industry trade with the region. Overall, the value of wool exports to the Australian industry are projected to increase from $40 million in 199 1-92 to between $120 million and $140 million (in 1991 -92 dollars) a year by the year 2000. These gains, however, represent only a partial recovery of the losses in the value of Australian wool sales to the region since 1989 and would represent


Key projections for Eastern European wool a

Wool production 52.9 44.3 40.2 29.0 (26.0 - 32.0) 33.0 (30.0 - 36.0) Mill utilisation b 98.7 83.7 63.3 50.0 (45.0 - 55.0) 64.5 (59.5 - 69.5) Domestic consumption c 66.0 66.4 56.5 57.0 (51.0 - 63.0) 74.0 (68.0 - 80.0) Wool imports d 44.9 38.3 23.7 23.0(20.0 -26.0) 34.0 (31.0- 37.0) Wool exports d 3.7 2.6 3.6 2.0 (1.0-3.0) 2.5 (1.5-3.5) Net imports of wool textiles e -32.7 -17.3 -6.8 7.0 (6.0- 8.0) 9.5 (8.5 - 10.5)

a Eastern European countries include Poland, the Czech and Slovak Republics, Hungary, Bulgaria, Romania and the former Yugoslavia. b Mill consumption is defined as the consumption of wool at the spinning stage less the net trade in tops. c Domestic consumption is defined as wool available for domestic use. d Imports and exports consist of raw greasy wool converted to clean basis. Exports also exclude any re-exports of imports. e Net imports is defined as the net trade in processed and semiprocessed wool products and excludes net trade in raw wool. z Projection including range shown in parentheses. Sources: International Wool Textile Organisation (1992); International Wool Secretariat (1992); Food and Agriculture Organisation (1993); ABARE.

only around 2-3 per cent of the total value of Australian wool exports.

Since 1990-91 the ratio of wool to synthetic prices Demand for wool has fallen sharply and is not expected to increase textiles in Eastern very much over the medium term. This, combined Europe is likely with a forecast rise in income per person, is expected to increase to have a positive influence on the demand for wool textiles in Eastern Europe. An additional factor that is likely to lead to higher demand will be an increase in both the range and quality of textile products as consumers become able to purchase imported products. Overall, while total consumption of wool is expected to remain at the low levels of the early 1990s in the short term, it is forecast to increase over the medium term and to reach the levels of the late 1980s by the year 2000.

There is considerable uncertainty about these Foreign capitalfor outcomes, however. They will depend importantly restructuring and on the extent to which Eastern Europe countries can modernisation develop well functioning markets and the degree to is essential


Production, consumption and mill utilisation are expected to rise in the medium term

Final stages of garment manufacture are labour intensive

- - m 1 20 Wool production' * - - - - - ' ' kt clean

I I I I I I I I I I I I I I I I I

1984 1988 1992 1996 2000

which the textile industries can attract foreign capital for restructuring and modernisation. These findings are based on an assessment that these countries will continue to implement their economic reforms and that there will be a moderate increase in foreign investment in the wool textile processing industry.

Shifts in location of textile processing Traditionally, textile and clothing industries have been labour intensive. In many developing countries of Asia (for example, China), textiles and clothing industries have been given relatively high priority in order to earn foreign exchange through exports. Although technological developments have led to the substitution of capital for labour in the early (scouring and topmaking) and middle stages of fabric and garment manufacturing (spinning and weaving), the final assembly stages of garment and clothing manufacture are still labour intensive. Because of the relative low wage rates in Asian countries there has been a shift in the location of textile production from the traditional producing countries of Western Europe.

Wage rates in Eastern European textile industries are low relative to those in Western Europe, and it would


seem that Poland, the Czech Republic and Hungary have a comparative advantage in the final stages of garment and clothing manufacture. Although wage rates in the competing Asian developing countries are lower than those in Eastern Europe, proximity to Western markets would also favour the longer run competitiveness of Eastern Europe.

Limited access to markets in the industrialised economies is an important factor which is likely to constrain the development of the textile industries in Eastern Europe. Whereas international trade in raw wool is relatively free from trade restrictions, trade in textiles and apparel is heavily protected by restric- tive trade arrangements, such as the Multifibre Arrangement. However, Poland, the Czech and Slovak Republics and Hungary have negotiated Association Agreements with the European Com- munity and this is expected to lead to freer access for Eastern European textiles.

Because of the lack of internal capital generation, the restructuring and modernisation of the wool processing sector will depend importantly on foreign investment. However, the economic difficulties in Eastern Europe are likely to limit both domestic and foreign investment in the wool textile processing sector in the short term. As these economies gradually develop, there are likely to be increased opportunities for investment in textile processing facilities. Given that these countries appear to have a comparative advantage in producing labour intensive manufactured products, such as the manufacture of garments including wool apparel, Western European wool textile firms are likely to seek investment opportunities in these countries and undertake outward processing. Over the longer term these developments are expected to lead to increased intra-industry trade, particularly between the textile industries of Italy, Germany, Austria and Eastern Europe.


Eastern Europe has a comparative advantage in

these areas

Access to Western markets must be

improved

Western European firms likely to seek

investment in the Eastern European

textile industry

Since 1989 the countries of Eastern Europe have been dismantling the institutional and economic structures of their centrally planned economies and implementing reforms necessary for the operation of market economies. The transformation process includes the setting up of legal, institutional and commercial infrastructures to incorporate macroeconomic stabilisation, property rights, price liberalisation, privatisation of enterprises, the establishment of a commercial banking structure, and trade and foreign exchange liberalisation.

Although the pace of reforms and the strategies used to implement them varies between countries, each has experienced declining real wages, higher prices and the loss of much of their exports to the former Soviet market. The impact of the reforms has reduced textile production and consumption, and has depressed the wool industry in all Eastern European countries.

Prior to 1989 Eastern Europe imported around 75 000 tonnes of wool (greasy) a year, representing around 6 per cent of world trade in wool. Historically, Australia's share of this trade was around 60 per cent, which was comparable with Australia's share of world trade. However, Australia's exports to the region have fallen greatly in recent years, from 41 000 greasy in-1988-89 to less than 5 100 tonnes greasy in 1992-93.

The aim in this paper is to outline the reforms taking place in Eastern Europe and assess their implications for the wool textile industry. The extent to which the reform process will affect the demand for wool and wool products is likely to have important implications for the Australian wool industry and for wool processors and manufacturers throughout the world. The countries of Eastern Europe included in this study are Poland, Hungary, the former Czechoslovakia, Bulgaria, Romania and the former Yugoslavia. The former German Democratic Republic and the newly independent Baltic republics (Lithuania, Latvia and Estonia) have not been included because of the difficulties of obtaining specific published data relating to the wool textile industries in these countries.

10 ABARE research report 93.20

Economic reforms in Eastern Europe

Countries in Eastern Europe (Poland, Hungary, the Czech and Slovak Republics, Bulgaria, Romania and the former Yugoslavia) are experiencing major economic and social upheavals as a consequence of the economic and political reforms occurring since 1989. Over the past three years industrial production in these countries has fallen sharply. At the same time, rates of economic growth have been very low or negative.

Economic adjustment problems associated with the transition to market oriented economies have been exacerbated by the collapse of the former Council for Mutual Economic Assistance (CMEA) trading system, under which all countries in Eastern Europe had very close trading ties with the former Soviet Union. In this chapter, the key changes which are being implemented as part of the reform process in these countries are examined.

Differing progress in the transition to market economies The centrally planned economies of Eastern Europe were characterised by a number of features including: centrally determined and controlled prices; a lack of individual property rights; incentives that were unrelated to economic efficiency; a priority to maintain full employment; an absence of institutions for accounting and taxation purposes; a relative absence of market transactions; and regional trade agreements based on barter (Svejnar 1991). These features led to outcomes such as a misallocation of resources, obsolete infrastructure and capital equipment, and low productivity and income levels. These outcomes have been a feature of the textile processing sector in most Eastern European countries.

The incentive structures and limited market openness under the centrally planned system may have retarded the development of textile technology in Eastern Europe (except in the former Czechoslovakia) compared with what has occurred in Western European textile industries. Eastern European wool textile enterprises did not have the flexibility to adjust production in response to market signals and many did not have the technology to process fine wools. Consequently, most textile products tended to be limited in range and were, generally, of poor quality.


While the structures of the central planning system have now largely been abandoned in the region, progress in implementing the economic reforms has been mixed (Miller 1993). An important factor has been the political will to persist with the reform process despite the social and economic consequences. The pace of economic reform has been most rapid in Poland, Hungary and the former Czechoslovakia. Although Romania and Bulgaria are making efforts to apply market reforms, many obstacles are being encountered and, in most aspects, their reforms are less advanced. Civil war in the former Yugoslavia has impeded the continuation of reforms in that region. The inefficiencies associated with the former centrally planned system have resulted in major structural adjustments in most of the large scale industries, with many firms shedding labour.

Nevertheless, the greater economic freedom in countries such as Poland, Hungary and the former Czechoslovakia is resulting in rapid expansion of small scale enterprises, largely in the service sector, and this is absorbing some of the displaced labour. Relatively high levels of unemployment may lead to political pressures which could impede the pace and direction of the economic reforms over the next few years.

Poland has been pursuing a radical approach to the transition. This involves a fairly rapid implementation of market reforms, with the ultimate objective being to establish a full market economy. In 1989 Poland liberalised domestic prices through the reduction of subsidies to consumers and producers, together with the implementation of internal convertibility of the currency and the removal of controls on foreign trade. Following the initial 'shock', production fell sharply, real wages declined, inflation accelerated and unemployment began to increase. The economic situation was exacerbated by the collapse of the CMEA trade system.

Despite Poland's political problems, mainly reflected in the fear that the economic hardship might undermine the apparent public support for the reforms, the government's resolve to maintain its austerity program was important in obtaining continued international financial support. In November 1992 Poland renewed its extended arrangement with the International Monetary Fund, which released about US$770 million in funds.

There is some indication that Poland's economy is emerging from the downturn. Industrial production has risen since the middle of 1992 and the inflation rate has fallen (Economist, 13 March 1993, pp. 20-2). This economic environment is likely to be more conducive to foreign investment.


- -

The reforms in Hungary have been proceeding gradually for some time. While it was better prepared for the transformation, Hungary has been reluctant to move as quickly as Poland. The reforms have enabled Hungary to attract foreign capital which has enabled privatisation in some areas to proceed more effectively than in other Eastern European countries. In 1991 foreign direct investment was US$1.7 billion, a US$ 1.2 billion increase over 1990. The private sector and small firm economic activity grew by 100-200 per cent, with the number of private enterprises increasing fivefold between 1990 and 1992. In the first six months of 1992 foreign direct investment totalled US$642 million, 20 per cent more than in the corresponding period of 199 1, with inflows reaching US$4 billion since the reform process began. Despite this, a large proportion of Hungarian businesses has been kept in the state sector, suggesting that the economy is likely to be more mixed than in Poland (Penn 1992).

A somewhat more cautious approach to reform has been pursued in the former Czechoslovakia. Subsidies and controls over most prices were removed. Structural and institutional changes to foreign investment, tax reform, internal currency convertibility, the financial and banking system and the legal and administrative measures supporting a market oriented economy were introduced. On 1 January 1993 Czechoslovakia was split into two republics, the Czech Republic and the Slovak Republic. The Czech Republic has pledged to continue the market reform program, while the Slovak Republic has essentially abandoned it (Miller 1993).

Transaction costs The countries of Eastern Europe have experienced major disruptions associated with the disintegration of the planning system. The transition involves fundamental changes in the behaviour of consumers and producers - the key economic agents of a market economy. The institutional infrastructure, which is normally taken for granted in a market economy has been largely absent in the centrally planned economies, including those in the textile processing sector. This infrastructure includes legal, financial and business structures; banking services for channelling savings into investment; accounting and taxation systems; and information systems on which buyers and sellers, producers and consumers make decisions.

Because markets are not yet operating properly, there are additional economic costs associated with market transactions. For example, buyers and sellers face relatively high transaction costs (see box 1). In contrast, in


a fully operating market economy these transaction costs are limited through the operation of competitive forces.

In the economics literature, transaction costs are defined in the context of a competitive market economy. Consequently, and strictly speaking, in the context of a planned economy, these costs would not exist and are replaced by administrative and enforcement costs (Hirshleifer 1980). In actuality, the costs of transactions in the planned economies of Eastern Europe, which

14 ABARE researclz report 93.20

were borne by producers and consumers, were high. Such costs included those associated with queuing, negotiating and, in some instances, bribing. The sheer complexity of planning the production and distribution of the multiplicity of items required in modern industrialised countries also imposes large information, administration and enforcement costs.

Elements of reform Key elements of the transition path which most countries in the region are following (Estrin 1992) are summarised in box 2. Large differences in initial macroeconomic conditions and varying experiences with market reforms in the past influenced the initial reform agenda in individual countries. For the most part, the governments of the respective countries have had 'to feel their way7 through the reform agenda while at the same time identifying and developing their own economic and social goals.

The transition to a market economy involves institutional changes as well as macroeconomic policies aimed at stabilising the economies of these countries (Fischer 1991a). The institutional changes include the development of a competitive private enterprise sector and price liberalisation; the creation of more efficient financial institutions and the liberalisation of financial markets; the deregulation of labour markets; and the establishment of a social safety net. Macroeconomic stabilisation policies which were supported by international financial institutions (for example, the International Monetary Fund) were implemented in conjunction with these microeconomic reforms.

Macroeconomic stabilisation and control At the commencement of economic transformation the countries of Eastern Europe implemented tight monetary and fiscal policies to contain the expected inflationary surge resulting from the freeing of prices and the depreciation of the exchange rate (which was considered necessary following trade liberalisation). One of the principal aims of such policies has been to eliminate the excess demand associated with commodity shortages which tended to be a feature of the centrally planned economies (inflationary overhang). These policies have resulted in varying degrees of success in achieving their objectives among individual countries. For example, the policies were most successful in reducing inflation or moderating its rise in Poland, the former Czechoslovakia and Hungary (table 1).


A factor limiting effective monetary policy has been that state enterprises have not perceived themselves to be subject to 'hard budget constraints'. High interest rates - a policy instrument used to dampen demand - have not induced many enterprises to reduce their borrowings as they have not expected to be called on to repay their debts. Prior to the reforms governments were prepared to subsidise or continually refinance loss making enterprises. Such practices were referred to as 'soft budget constraints'. Until recently, bankruptcy laws had not been invoked.


Associated with this behaviour is the observation that the enterprises in centrally planned economies were faced by a structure of incentives inappropriate to inducing free market operations. The lack of ownership of capital by private individuals, the political power vested in labour unions and little or no competitive pressure were elements of a structure that made the behaviour of state firms inert and conservative.

The period since the reform process began is characterised by deteriorating economic conditions: portrayed in a combination of lower production, higher inflation levels (largely due to price liberalisation), and increasing unemployment. (Although there was officially no unemployment before the reforms, disguised unemployment could have been widespread.) The expected movement in the economic indicators for 1992 and 1993 shows

1 Key economic statistics for Eastern Europe Percentage change from previous year

Bulgaria Czechoslovakia Hungary Poland Romania

Gross domestic product 1986 4.2 2.6 1.5 1.5 3.0 1989 -1.9 1.9 0.5 -1 na 1990 -9.1 -0.4 -3.3 -11.6 -7.4 1991 -17.0 -16.0 -10.0 -9.0 -14.0 1992 s -10.0 -8.0 -4.0 1 .O -15.0 1993 f 4 . 0 0 0 4.5 -9.0

Inflation rates 1986 1.3 0.5 5.3 18.0 0.3 1989 4.4 1.4 19.6 700.0 na 1990 26.3 10.0 28.4 585.8 4.2 1991 334.0 58.0 35.0 70.0 161.0 1992 s 80.0 11.0 23.0 52.0 200.0 1993 f 60.0 16.0 15.0 35.0 95 .0

Unemployment 1986 0 0 0 0 0 1989 0 0 0 0 0 1990 1.6 1 .O 1.6 6.1 0 1991 11.7 6.6 7.5 11.5 2.7 1992 s 15.0 8.0 13 15 6.0 1993 f 15.0 11.0 17.0 17.0 12.0

s Estimate. f Forecast. na Not available. Sources: Corbo, Coricelli and Bossak (1991); OECD (1993a,b).


significant improvements in the growth rates of output and a general decline in inflation rates (table I).

Macroeconomic instability was most acute in Poland in 1989, with inflation running at 700 per cent. Poland's inflation rate declined to 70 per cent in 1991 and is forecast to decline to 35 per cent in 1993. After sharp declines in the first two years of the 1990s, Poland's output is expected to increase by 2 per cent a year during 1992 and 1993.

Since the reforms in the former Czechoslovakia did not start until 1990, the decline in gross domestic product between 1989 and 1990 was only 0.4 per cent, compared with declines of 11.6 per cent in Poland and 3.3 per cent in Hungary, during the same period. However, gross domestic product in the former Czechoslovakia declined by 16 per cent in 1991. Inflation rates increased from 10 per cent in 1990 to 58 per cent in 1991 and were estimated to be about 11 per cent in 1992. Both inflation rates and the decline in output in the former Czechoslovakia and Hungary reached their peak in 1991. Thereafter, the two countries have shown signs of recovery, with the decline in output expected to cease by 1993.

The extreme inflation and rapid reduction in incomes associated with the initial stages of transition appear to be giving way to a period of lower inflation and reduced downward pressure on incomes. Nevertheless, tight monetaly and fiscal policies appear necessary to contain the still relatively high inflation rates. Further elimination of subsidies and movement toward trade liberalisation to bring domestic prices into line with international prices will, in most cases, entail a depreciation of the exchange rate. These measures could easily lead to high rates of inflation, if stringent fiscal and monetary policies are not in place.

Institutional reforms

The financial sector Developing a market oriented financial sector is an integral part of the reform process. Market institutions were absent in the planned economies, where the central planning system carried out the main roles that the financial sector plays in market economies. Under the centrally planned system the process of investment occurred through the government taxing enterprises and individuals, and directing funds from these taxes into investments in production or service enterprises. Investment was decided


by planners and allocated in the same way as all other inputs. The national bank or banking system had the function of providing credits to state enterprises and financing foreign trade. Domestic private savings were very small and most individuals did not have bank accounts.

All countries in the region have introduced a two-tier banking system by reorganising the commercial functions of their central banks - a national bank fulfilling the reserve bank functions and commercial banks fulfilling deposit and credit needs. The main constraint on a more effective operation of the banking sector is that the commercial banks have been left with a large portfolio of non-performing assets from the enterprise sector. As a result, the banks have limited themselves largely to the provision of short term credit for businesses. Due to this, there has been a significant development of small businesses utilising relatively small amounts of capital but generating savings for their own expansion. However, investment that is occurring in medium and large businesses is still undertaken by governments using taxation funds (which are declining due to budget constraints), while some is externally funded by foreign firms and special credits through the World Bank and other international financial institutions.

Independence of the central banks from the government was legally established in Hungary and Poland in 1991 and on 1 February 1992 in the former Czechoslovakia. Procedures have been established for central bank supervision of the new banking system and for carrying out monetary policy.

The undeveloped finance sector is an important constraint to domestic investment in textile enterprises from privately generated capital. Given low domestic savings it is unlikely there will be sufficient internal capital to meet the restructuring needs of the textile industries. Therefore, the restructuring process will depend on obtaining overseas capital and Western textile technology for upgrading and modemising textile processing plants. Of course, this investment will depend on the longer term viability of particular enterprises. Difficulties in attaining such investments have been accentuated by the fall in domestic demand for textile products, greater competition from apparel and textile imports and limited access to Western markets.

Property rights During the previous Eastern European regimes nearly all rights to resources were owned by the state and the property rights were allocated through planning mechanisms which took little account of efficiency in production, consumption and trade. A system of allocating and protecting property

Eastern Europe and Ausrralian wool exports 19

rights is crucial for the efficient operation of these economies. Otherwise, resources will be prevented from flowing to those with a comparative advantage in using them, resulting in an overall loss to society (De Alessi 1980).

The political difficulties associated with establishing a system of clearly defined property rights, together with the accompanying rules to protect these rights, have seriously impeded the privatisation process in the region. The slow progress in reassigning property rights has stemmed mainly from the conflict of interests among different groups and between local and central governments. Disputes between local and central governments in this regard were already a problem in Hungary and Poland and are likely to increase in the Czech Republic as the privatisation process progresses (OECD 1992a).

Clarification of the rights of different groups is necessary if privatisation is to proceed. Under previous legislation, rights to use the resources in state enterprises were given to employee representative groups. These groups, particularly in Hungary and Poland, are reluctant to forgo these rights and, in many cases, have aborted government efforts for change.

All Eastern European countries are facing the issue of restoring property, confiscated under previous regimes, to its original owners. Among these countries, Poland has the least problem, as most land was left in private ownership, thus substantially reducing restitution demands. The policy adopted in Poland is to compensate former land owners without restitution. Hungary has been trying to follow suit, but political pressures for restitution are much greater there. Although restitution has been continuing in the former Czechoslovakia, claims can be denied under current policy.

Some progress has been made in all countries of Eastern Europe in establishing the legal framework within which the various forms of business organisation and ownership are recognised. This has helped promote the expansion of the private sector in some countries. For example, private sector activity has reached 30 per cent of gross domestic product in Hungary (OECD 1992b) and 50 per cent of output in Poland (Financial Times Survey, 17 June 1993, p. 2). However, in many countries complementary laws need to be enacted to ensure that a private sector can operate effectively. For example, in many countries, accounting standards and tax systems need to be developed and the question of land ownership and transfer needs to be addressed.


Price and market reform Removal of price controls is an essential step in market reform. Under the centrally planned system, most consumer items were priced well below the cost of production as subsidies were widely applied. Since 1991, virtually complete liberalisation of consumer and producer prices has taken place in these countries (OECD 1992b), although Hungary has been approaching reforms in this area somewhat more slowly than other countries. However, building a competitive market system involves not only freeing up prices, but also increasing the openness of these markets by implementing a convertible currency and easing controls over foreign trade.

There may be limited efficiency gains from immediate price liberalisation under a monopolistic structure and a weak financial system. Although efforts have been made to privatise state monopolies, very limited success has been achieved so far. Where they have been privatised, private monopolies have largely taken the place of public monopolies.

Since 1991, sharp increases in real prices of apparel and textile products following price liberalisation have led to reductions in domestic use of these products. In the former Czechoslovakia, consumer purchasing power fell by around 30 per cent, while the share of domestic textile and apparel consumption in total textile production was estimated to have declined from 30-40 per cent in 1990 to 16 per cent in 199 1 (Roberts, Sheales and Malarz 1991).

Enterprise restructuring and privatisation All countries of Eastern Europe have commenced the transfer of ownership of most state assets to the private sector. However, there are quite different strategies in the privatisation programs and progress in their implementation varies between countries. One of the issues confronting the respective governments is the extent to which large, and generally inefficient, enterprises should be restructured in order to make them salable businesses prior to privatisation (OECD 1992a).

In addition, there are constraints impeding the progress of reforms. One issue, mentioned earlier, is maintaining the social and political support for privatisation. This could become increasingly difficult as the level of unemployment rises in response to industry restructuring. In addition, enterprise reform is also being impeded by the lack of adequate laws to protect rights over the sale and purchase of goods and assets.


The commercialisation of state assets involves a number of issues and difficulties. One issue is whether shares in enterprises should be sold or distributed to the population. In 'selling off' state enterprises one objective of the respective governments is to maximise revenue. However, domestic savings are low in most countries and given the weak financial and banking structures there is insufficient accumulation of capital and a lack of the necessary financial intermediaries to consolidate and mobilise individual savings to enable investment in the state assets. Also, there would be no new capital generated by selling these enterprises when coupons are used. A rapid sale of these assets all at once would most likely lead to reduced government revenues as investors - both domestic and foreign - have limited funds which they may be prepared to invest in each country at a given time. This process is further complicated by the deterioration in the economies of these countries over the past few years (as reflected in substantially lower output and profitability, and hence asset valuation). Hence, valuing these assets has proved to be extremely difficult.

There has been considerable progress in small scale privatisation, mainly in the services sector - for example, in retail, catering and other services. Most of these firms are being sold. In Poland around 80 per cent of small state retail outlets have been privatised. In Hungary and the former Czechoslovakia, progress has also been made in privatising small firms. By July 1992 almost 30 000 small businesses in the former Czechoslovakia had been sold, chiefly through public auctions. Initially, the Czechoslovak government had expected to privatise its small businesses (which totalled 100 000) within two years. However, this process has been delayed because of restitution claims. Of the 13 000 joint ventures established in Hungary, a third are the result of privatisation.

The growth in the retail and services sectors in the economies of these countries has been stimulated by the establishment of new firms. It has led to a some recovery in production in the Polish economy, a rapid increase in Hungary's trade with the major developed countries, and a decline in unemployment in the former Czechoslovakia (Economist, 19 December 1992, pp. 47-8).

The privatisation of large state enterprises (including those in the textile industries), which account for the bulk of industrial output, has proven to be a lot more difficult. In most countries, many enterprises have been transformed into joint stock companies prior to privatisation. However, this initial preprivatisation ownership structure is transitional, because the


respective governments still retain a large ownership share and because the holding companies will eventually be phased out. The transition process from corporatisation to full private ownership is likely to take several years and, in some cases, up to a decade or more (Fischer 1991b).

In the former Czechoslovakia and Poland, privatisation of the larger firms is proceeding albeit at a slow pace. Of the 8500 state enterprises in Poland at the end of 1990, 17 14 enterprises had been privatised by mid-1992 through liquidations, worker or management buyouts and the establishment of joint ventures (GATT 1992). In 1992 the former Czechoslovakia likewise transferred the property of 1491 joint stock companies (valued at US$10.5 billion) to the 8.5 million citizens who bought into the scheme.

The Czechoslovak government envisaged that of the 4100 state enterprises and agricultural cooperatives, about a quarter would remain in state hands, a quarter would be divested through public offerings and the remainder through voucher privatisation, a method by which investment shares in these enterprises are allocated to the public. Privatisation funds have emerged and these are competing for the deposits of voucher holders.

In Hungary, greater emphasis is being given to privatisation initiated by the firms themselves. There has been a degree of 'spontaneous' privatisation which has had employees of state enterprises assuming a share of the company. As part of administrative reforms in Hungary in the mid-1980s, enterprises were given a greater degree of autonomy. This forced many firms to seek additional sources of finance either directly with banks or foreign investors.

Privatisation of state enterprises has, however, proceeded rather slowly, reflecting the more gradualist approach to reform generally adopted by the Hungarian government. For example, the government has sold about 200 of its 2000 companies - 160 of these to foreign interests. With foreign investment slowing, the government is considering a voucher scheme, similar to that operating in Poland (Economist, 19 December 1992, pp. 47-8).

Impediments and barriers to reform Although the initial phases of the reform process have been implemented, there are still a number of impediments and barriers which are slowing the development of well functioning markets. Most of these impediments centre


- - - -

around developing and implementing the necessary infrastructure. Govern- ments still need to create a complete and consistent legal framework to guide business activity; develop competitive market institutions in areas such as financial services, domestic trade, transport and telecommunications; and create accounting, auditing and other information systems which are consistent with those that have developed in market economies.

While there has been an expansion of small sized firms, particularly in Poland, difficult access to capital (both domestic and foreign) is slowing the restructuring and privatisation process of medium and large firms. This process is necessary for the generation of employment and the provision of a larger tax base. The financial sectors remain undeveloped in all economies as the functions of domestic and foreign banks remain limited. This is particularly important for the textile sector where investment in capital equipment is necessary to modernise existing plants.

The textile industry has so far been slow to adjust to the new market conditions. This appears to be due partly to the lack of well defined private property rights and incentives and partly to large inflexible production structures. Such structures are costly to convert to more flexible ones capable of competing effectively in a market that demands variety and high quality products and where market requirements are continually changing. In addition, the privatisation of the large, vertically integrated, state textile enterprises remains an obstacle to the restructuring of this sector.

In the longer term, however, most of these impediments will decrease as individuals and firms adjust to conditions which facilitate a more competitive market environment. This likely reduction in impediments is expected to lead to increased investment, provide the economic bases for the entry and exit of firms in the textile sector and enhance the development of new products and markets.

In conclusion, while the reforms have centred on improving resource allocation in the economy, particularly at an enterprise level, the development of well functioning markets depends on removing the remaining impediments of the centrally planned system. This involves not only altering the institutional structures but also the attitudes and behaviour of producers and consumers.


Wool supply and processing

Eastern Europe has had a relatively strong tradition in textile and clothing manufacture, with the former Czechoslovakia, Poland and Hungary being the main centres of textile activity in the region. These industries were internationally competitive until the introduction of central planning after the Second World War. Since then they have been largely sheltered from competition from outside the Council for Mutual Economic Assistance group of countries and have been geared to supplying the domestic and the former Soviet markets. This reflects the policies of self-sufficiency pursued in the region, and the trade agreements with the former Soviet Union. Neither provided incentives to improve the competitiveness of these industries, resulting in outdated technology and managerial practices.

The textile industries in Bulgaria and Romania were developed under the Soviet type economic system and are even less sophisticated than those in the rest of Eastern Europe.

The wool textile sector in Eastern Europe has followed a pattern of development similar to that of the rest of the textile and clothing industries. It sourced part of its raw material requirements from domestically produced wool, with varying degrees of dependence on imports among individual countries. For example, the development of the wool textile industry in the former Czechoslovakia, Poland and the former Yugoslavia depended importantly on imports of wool, principally from Australia.

The reforms currently being implemented in the countries of Eastern Europe have already had a great impact on the wool textile sector. This has been reflected in lower domestic demand and sharp falls in production. This, combined with a shortage of hard currency to pay for imports of raw materials, has led to a large reduction in wool imports to the region.

Textile industries in Eastern Europe The textile and clothing industries in Eastern Europe accounted for around 7.6 per cent of the gross value of industrial output in 1988 (the latest year for which data are available), although this varied somewhat between individual countries. Paid employment in textile manufacturing represented


13 per cent of total paid employment in the manufacturing sector for the former Czechoslovakia and Hungary. Employment in the Polish textile industry was slightly higher, at 15 per cent of the total paid employment in manufacturing (table 2).

Under the central planning system the textile and clothing industries were characterised by large vertically integrated enterprises. The majority of wool textile plants were designed to process large batches of inputs to fairly standard specifications. This contrasts with the industry structure in the West where topmaking is typically separate from spinning, and is often taken on a merchant or commission basis (Sheales and Malarz 1992).

The industry sh-ucture of the later stages of textile processing in Eastern Europe was also characterised by relatively large plants. For example, around 50 per cent of Polish domestic clothing production was concentrated in the state sector which was dominated by relatively large companies, each employing an average of over 1000 employees. In contrast, in Italy 69 per cent of garment output is produced by small companies with less than 100 employees. This industrial structure in Eastern Europe has slowed the rate of restructuring in textiles compared with other manufacturing industries.

Wool textiles are a small component of the textile industries of Eastern Europe. For example, in Hungary in 1988 the wool textile industry accounted for 20 per cent of the gross value of textile production and 21 per cent of textile employment. The turnover value of the Polish wool textile

2 Paid employment in textile manufacturing

Number employed Year in textile sector a

Czechoslovakia 1989 Hungary 1989 Poland 1989 Yugoslavia 1989 Romania 1989 Bulgaria 1986

Proportion of total employed in

manufacturing

a Includes employment in the manufacture of textiles and the manufacture of woven apparel. Source: International Labour Office (1991).


industry accounted for 19 per cent of the total turnover value of the textile and clothing industries in Poland (Economist Intelligence Unit 199 lc).

The predominant fibres used by textile mills are cotton and synthetic fibres, which collectively account for three-quarters of total fibre use by textile mills in Eastern Europe. Wool accounts for only a small percentage of total fibres used by textile mills. For example, wool use as a percentage of total fibre use varied between 2.5 per cent for Hungary and 6.7 per cent for the former Czechoslovakia (the comparable figure for Poland was 4.5 per cent) (table 3). The proportion of wool used by mills declined during the 1980s reflecting increased use of other fibres such as synthetics.

While the quantity of raw or semiprocessed wool used by the industry is small relative to the use of other fibres, wool is often blended with manufactured fibres to produce the final product. Wool accounts for only around 20 per cent of the raw materials used in the wool processing sector (the rest being manufactured fibres).

Total fibre use in Eastern Europe declined by 22 per cent over the period 1989 to 1992. Wool and synthetic fibres use fell by 29 per cent and 27 per cent respectively over the same period (table 4). It may be noted that the percentage decrease in the use of cotton and artificial fibres was less pronounced than the percentage falls in the use of wool and synthetics.

The decline in the mill use of wool has been most dramatic in Poland, the former Czechoslovakia and the former Yugoslavia where wool use decreased by an average of 36 per cent between 1989 and 1992. Over this period the rate of decline in the use of wool, artificial fibres and synthetic fibres was greatest in Poland.

3 Mill consumption of textile fibres in selected Eastern European countries in 1989

Fibre type Unit Poland

Wool % 4.5 Cotton % 40.4 Flax % 3.9 Artificial % 16.4 Synthetic fibres % 34.8

Mill consumption kt 445.6

Source: International Wool Secretariat (1992).

Czechoslovakia Hungary

Eastern Europe and Australian wool exports 2 7

Between 1988 and 1991, the production of wool yarn (including wool blended yarns) declined by about 50 per cent to 132 000 tonnes (excluding Romania) and that of woven wool fabrics by 48 per cent to 169 million square metres, with most of the fall occurring since 1990 (tables 5 and 6). The contraction in wool textile activity, as indicated by the decline in woven woollen fabrics, continued in the first six months of 1992.

In common with other sectors of the economy, the contraction in output has been associated with a reduction in domestic demand and the loss of exports to the former Soviet Union. For example, the former Czechoslovakia's exports of textiles and clothing to the former Soviet market had accounted for 30 per cent of total production. In 1991 this virtually disappeared and domestic sales declined by 50 per cent (Hospodarske Noviny 1992).

4 Mill consumption of textile fibres

Unit

Bulgaria 1989 kt 1991 kt

% change

Czechoslovakia 1989 kt 1991 kt

% change

Hungary 1989 kt 1991 kt

% change

Poland 1989 kt 1991 kt

% change

Romania 1989 kt 1991 kt

% change

Yugoslavia 1989 kt 1991 kt

% change

Total 1989 kt 1991 kt

% change

Wool Cotton Flax Artificial Synthetic

fibres fibres Mill consumption

na Not available. Sources: International Wool Secretariat (1992); International Wool Textile Organisation (1993)


The decline in production was not restricted to wool (tables 7 and 8). Production of woven and mixed cotton fabrics (table 7), was fairly steady during the period prior to the reform. However, sharp declines were experienced in 1990, 1991 and 1992 in all countries of the region. In those three years, total production fell by 23 per cent, 34 per cent and 26 per cent to be respectively 2363,1556 and an estimated 1150 million square metres.

1 5 Total production of yarns by the wool textile industry a

Bulgaria Czechoslovakia Hungary Hungary c Poland Romania Yugoslavia

Total

Decline b 1989-90 1990-91

a The data include both wool and other fibres. b Calculated from production figures before rounding c Yarn consisting predominantly of wool na Not avalable Source International Wool Textile Organlsatlon (1992)

6 Production of woven woollen fabrics a

Decline c 1989 1990

1985 1986 1987 1988 1989 1990 1991 1992b -90 -91

million square metres % %

Bulgaria 36 42 41 45 37 34 18 14 8.2 48.0 Czechoslovakia57 59 58 59 59 58 44 na 2.2 23.3 H W ~ W 23 22 21 16 17 10 7 2 37.4 36.8 Poland 105 103 99 101 97 65 44 35 33.1 31.7 Yugoslavia 102 108 105 104 100 83 56 26 17.4 32.1

Total 322 333 324 325 310 249 169 na 19.4 32.3

a The data refer to woollen and worsted fabrics and mixed woollen fabrics, in the piece before undergoing finishing processes such as bleaching, dyeing and are expressed in million square metres. b Estimate based on first six months data. c Calculated from production figures before rounding. na Not available. Source: United Nations (1992).


Aggregate production of rayon and acetate filaments and fibres in the former Czechoslovakia, Poland and Hungary recorded consecutive declines of 26 per cent in 1990 and 22 per cent in 1991 (table 8). The lower percentage decline in 1991, compared with that in the previous year, was due to a less marked fall in Polish production of rayon and acetate filaments and fibres and of woven cotton fibres in 1990.

All firms in the Hungarian textile industry are eligible for privatisation. That is, textiles are not a sensitive sector where the government wants to retain

7 Production of woven cotton fabrics a

Decline c 1989 1990

1985 1986 1987 1988 1989 1990 1991 1992b -90 -91


Bulgaria 349 348 352 361 358 276 125 88 23 55 Czechoslovakia659 656 655 652 667 655 450 381 2 31 Hungary 287 292 292 294 251 205 124 85 18 40 Poland 828 817 745 781 756 427 290 231 44 32 Yugoslavia 336 386 368 359 331 266 155 44 20 42 Romania 700 731 710 689 709 533 412 319 25 23

Total 3 158 3 230 3 122 3 136 3 072 2 363 1556 1 150 23 34

a The data refer to woven cotton fabrics and mixed cotton fabrics in the piece before undergoing finishing processes such as bleaching, dyeing and are expressed in million square metres (mm2). b Estimate based on first six months data. c Calculated from production figures before rounding. Source: United Nations (1992).

8 Production of rayon and acetate filaments and fibres a

Decline c 1989 1990

1985 1986 1987 1988 1989 1990 1991 1992b -90 -91


Czechoslovakia55.2 55.2 na na 60.4 56.9 46.0 na 6 19 Hungary 5.5 5.4 4.1 4.2 4.3 4.1 3.2 na 5 22 Poland 70.9 72.5 73.3 74.3 66.7 36.2 26.9 24.1 46 26

Total 131.6 133.1 na na 131.4 97.2 76.1 na 26 22

a Includes continuous filaments and discontinuous fibres; data not available for other Eastern European countries. b Estimate based on first six months data. c Calculated from production figures before rounding. na Not available. Source: United Nations (1992).


some control. With plant closures and restructuring of the textile industry in Hungary, employment in this sector has fallen by 50 per cent to around 10 000 people.

Restructuring and privatisation of the Czech textile industry is expected to result in the breaking up of existing processing mills into 50-60 companies. In the wool processing sector there were around 20 large processing plants. Restructuring is expected to lead to the closure of 60 per cent of the wool scouring plants, leaving only two or three plants.

In Poland there were 46 wool processing plants, 30 of which processed wool under the woollen processing system. Restructuring of the Polish textile industry (in which vertical integration of wool textile firms has been high) will initially be constrained by their inability to respond quickly to market signals (given the price liberalisation reforms). Some disaggregation of existing firms into specialist scouring/top making, spinning, weaving and finishing operations would result in a more flexible industry. Greater specialisation may result in improved quality of output and lead to the development of more competitive firms (Sheales and Malarz 1992).

Production of wool The removal of producer and consumer subsidies, privatisation of state enterprises, price liberalisation and reform of the financial sector have important implications for the structure of sheep farming and hence raw wool production in Eastern European countries. The privatisation programs have meant that many of the large state farms are being broken up into smaller land holdings. This process has occurred more rapidly in Romania and Bulgaria than elsewhere in Eastern Europe. In Romania, for example, the large cooperative farms have been broken up into numerous small scale farms averaging only 1.6 hectares. Privatisation of state agricultural enterprises in Hungary has enabled former owners of agricultural land to reclaim it, provided the land is used for agriculture. On the other hand, in Poland about 80 per cent of farm land was already owned by private land holders. The breakup of large state enterprises into relatively small plots has, in some cases, caused losses in production economies of scale.

Eastern Europe is a relatively minor wool producing region, accounting for around 3 per cent of world greasy wool production. In 1992-93 greasy wool production in the region was 80 000 tonnes (table 9) of which 61 per cent was produced in Romania and Bulgaria (figure A). Wool production in the


A Wool production in Eastern Europe in 1992-93

Czechoslovakia 5% E ABARE

former Czechoslovakia, Poland and Hungary was only 21 000 tonnes greasy in total in 1992-93.

Between 1985-86 and 1992-93, wool production in the region declined by 32 per cent, reflecting a fall in sheep numbers in most countries (table 10). Throughout the region the domestic breeds have been upgraded using merino type breeds, which now account for about half of the flocks in the former Czechoslovakia, Poland and Hungary.

Despite the introduction of merinos, most sheep are dual purpose - producing both meat and wool. Consequently, a large proportion of the clip consists of coarse wools which are used primarily in non-apparel products.

9 Wool production in Eastern Europe

Bulgaria 34 33 32 3 1 39 26 24 22 Czechoslovakia 5 5 6 5 6 5 5 4 Hungary 11 10 10 10 9 7 8 7 Poland 17 18 17 16 16 15 11 10 Romania 4 1 40 39 38 35 33 30 27 Yugoslavia 10 10 10 10 10 10 10 10

Total 118 116 112 110 115 96 88 80

Source: International Wool Textile Organisation (1993).


Furthermore, clean yields from the wool clips have been relatively low, varying from 38 per cent in Hungary to 54 per cent in Poland. By comparison the clean yield for Australia averaged around 66 per cent in 1992-93.

Despite the centralised planning system, a large proportion of the flock in Eastern Europe has been held privately. Polish agriculture has a structure that differs from that in Hungary and the former Czechoslovakia, where large farms predominate. For example, in Poland, around two-thirds of the flock are reared on small farms. In the other countries of the region most sheep have been held on state farms: the former Czechoslovakia, 62 per cent; Hungary, 76 per cent; Bulgaria, 68 per cent and Romania, 50 per cent.

Under the central planning system the costs of wool production were relatively high as governments provided incentives (financial grants and assistance with housing and farm buildings) to increase sheep numbers on both state and privately owned farms. However, in most countries these programs did not significantly increase sheep numbers.

Sheep and wool production represents a relatively small component of agriculture in Eastern Europe. The reduction, and in most cases the removal, of production subsidies in the sheep industry is likely to reduce returns from wool production to existing farmers. Although it has not been possible to identify the change in the relative profitability of competing enterprises, it appears there is likely to be a further shift of resources out of sheep production. Where subsidised grains were previously fed to sheep during winter, these are likely to be diverted to pigs and poultry which are more efficient converters of grains to meat. Besides, pig and poultry meats are the

1 0 Sheep numbers in Eastern Europe

Census 1985 1986 1987 1988 1989 1990 1991 month -86 -87 -88 -89 -90 -91 -92

million million million million million million million

Bulgaria Jan. 9.7 9.6 8.9 8.6 8.0 7.1 6.7 Czechoslovakia Jan. 1.1 1.1 1.0 1.1 1.0 1.0 0.9 Hungary Dec. 2.5 2.3 2.3 2.2 2.1 1.9 2.3 Poland June 5.0 4.7 4.4 4.4 4.2 3.9 2.4 Romania Jan. 17.3 17.0 16.8 16.2 15.4 14.1 13.5 Yugoslavia Jan. 7.7 7.8 7.8 7.6 7.6 7.4 7.5



main meat types consumed in Eastern Europe, accounting for 80 per cent of total meat consumption. Mutton and lamb, on the other hand, account for only 2 per cent of total meat consumption in Eastern Europe.

Evidence of the shift in livestock numbers is that the sheep flock in most Eastern European countries has declined in the past two years, while pig numbers have increased in Poland, Hungary and Romania (FA0 1992a,b).

In addition, the change in relative prices between sheep meat and wool may also lead to a shift toward lamb and mutton production over the longer term. This is likely to occur if there is increased trade in sheep meat with the European Community which, through its Common Agricultural Policy, provides support for sheep meat and not wool. (The Association Agree- ments which Poland, Hungary and the Czech and Slovak Federal Republics signed with the European Community in December 1991 allow for increased access to the EC market, and in the longer term these countries

I are seeking membership of the European Community - Roberts, KortegC and Tie 1993.) A shift toward mutton and lamb production would most likely lead to a decline in the proportion of fine wools in the national clips.

Investment in new technologies and plant and equipment, together with access to capital markets, is likely to lead to improved productivity of agriculture in Eastern Europe. Clean wool yields and wool production per sheep should improve over the longer term. However, the agricultural policies of the individual countries and the prospect of some of these countries joining the European Community will also be important in influencing the level of investment in agriculture in these countries.

In summary, wool production in Eastern Europe is expected to remain at relatively low levels through the remainder of this decade. On the other hand, there is likely to be an increase in textile production from the low levels of the early 1990s as the economies of Poland, the Czech Republic and Hungary recover from the severe economic downturn of recent years. However, because of inadequate domestic sources of investment, the restructuring process is likely to depend on substantial foreign investment to modernise plant and equipment. Furthermore, the potential for increased intra-industry trade in textiles is likely to be important in enhancing the restructuring process. Some of the key factors influencing these developments are discussed in the following chapter.


Demand, trade and foreign investment in wool textiles

The aim in this chapter is to assess the impact of the reforms in Eastern Europe on wool imports. Some of the factors that are likely to influence the demand for wool textiles in Eastern Europe, the trade in wool and wool textiles, and the level of foreign investment in the textile industries are also examined.

Historically, processing mills in Eastern Europe have sourced around half their raw wool requirements from imports - although dependence on wool imports varied considerably between individual countries. The use of raw wool by processing mills is determined by the final product demand at the retail level in both domestic and export markets. However, this derived demand for wool is complex because wool is blended with other fibres, such as synthetics, to produce a finished product.

The organisation of wool trade in Eastern Europe prior to the implementation of economic reforms is shown in figure B. Under a centrally planned economy the state set targets for production, imports and exports, with the balance determining domestic consumption. Trade was controlled by a single import/export authority.

The traditional Council for Mutual Economic Association (CMEA) system of trade and payments was dismantled in 1990. All countries effectively eliminated the state monopoly of foreign trade, and reduced import restrictions. A new trading system, based on convertible currency settlements and world market prices, was introduced in January 1991. These trade reforms resulted in the collapse of the intraregional trade of which the former Soviet Union was the principal market. The CMEA trading arrangements were also an integral part of the trade in textile products, and their collapse has been a major factor contributing to the fall in demand in these countries. However, even prior to these trade reforms, many countries had diversified exports and imports to countries outside the CMEA.

With the liberalisation measures there is a potential for increased trade in textile products. At the same time, the move toward establishing market economies has increased openness to foreign investment. With the apparent comparative advantage of some Eastern European countries in the later


B Wool trade flows in Eastern Europe before reforms

stages of textile processing, there is also likely to be a shift in the location of textile processing from Western Europe to this region. These factors have implications for the demand for wool not only in Eastern Europe, but also in third country markets.

The emerging structure of the wool textile industry in Eastern Europe is shown in figure C. Key features shown are the breakup of the large state textile enterprises into smaller enterprises and the expansion and diversification of trade following its liberalisation.

Demand for wool by processing mills Between 1988 and 1992, the consumption of wool by the textile industry in Eastern Europe declined by 44 per cent to 58 000 tonnes clean (table 11). Most of this decline occurred in the countries where the reform process is most advanced, reflecting the industrial restructuring which is taking place. For example, aggregate mill consumption of wool in the former Czechoslovakia, Poland and Hungary fell by 62 per cent to 20 900 tonnes (clean) in total between 1988 and 1992.


1 C Wool trade flows in Eastern Europe since reforms

Domestic consumption of textiles Eastern Europe has been a relatively small and declining market for wool textiles. In 1990 the quantity of wool available for apparel use in Eastern Europe was 66 400 tonnes (clean), which represented a 40 per cent decline on the amount of wool consumed in 1980. By comparison the consumption of apparel wool in the European Community, Japan and China in 1990 was 420 000 tonnes (clean), 174 000 tonnes (clean) and 212 000 tonnes (clean), respectively (FA0 1993). Wool consumption has declined further since the commencement of economic reforms in Eastern Europe.

Apparel wool consumption per person in Eastern Europe declined from 0.6 kg in 1987 to 0.5 kg in 1990 (table 12). In 1990 wool consumption in individual countries varied from 0.3 kg in Poland to 1.0 kg in the former

Eastern Europe and Australian wool exports 3 7

Consumption of wool by the wool textile industry at the spinning 11 stage Clean weight

Bulgaria 14.6 14.5 13.3 13.5 10.8 8.3 Czechoslovakia 21.8 24.6 22.4 20.4 16.1 9.9 HunPV 6.7 5.9 4.2 2.3 2.1 0.9 Poland 25.0 24.8 21.5 13.2 10.6 10.1 Romania 17.4 17.9 17.5 17.4 15.9 14.5 Yugoslavia 16.8 15.7 15.1 14.0 11.2 14.3

Total 102.3 103.4 94.1 80.8 66.7 58.0


Czechoslovakia. While wool consumption per person declined in most countries of Eastern Europe, consumption per person in the former Czechoslovakia and the former Yugoslavia actually increased over this period. Average per person consumption of wool in the countries of the European Community (1.3 kg) in 1990 was around one and half times greater than the average per person consumption of wool in Eastern Europe (0.5 kg) (FA0 1993). Comparable per person consumption of wool in the developed European countries in 1990 was 2.2 kg in Switzerland, 1.8 kg in West Germany, 1.4 kg in Italy, 1.3 kg in the United Kingdom and 1.1 kg in France.

Wool's share of total apparel fibre consumption has also declined in Eastern Europe: from 6.6 per cent in 1980 to 5.2 per cent in 1990 (FA0 1993). By comparison, wool's share of total apparel fibre consumption in the European Community was around 6.8 per cent in 1990.

It may be noted that in 1990, per person consumption of total apparel fibres in Eastern Europe was only 11.4 kg which was considerably less than the per person consumption of total apparel fibres in most Western European countries. These differences in total apparel fibre consumption reflect the lower use of synthetics and cotton in Eastern Europe. Furthermore, the consumption of cellulosic fibres in Eastern Europe accounted for around 15 per cent of total apparel fibre consumption in 1990: almost double the figure for most Western European countries.

The differences in consumption patterns of particular apparel fibres between countries is likely to reflect price and income differences as well as the availability of a greater range and higher quality of wool textile fabrics in


1 2 Per person anrumption of apparel fibres in selected countries a

Wool Synthetics b Cellulosics c Cotton Total d

1987 1990 1987 1990 1987 1990 1987 1990 1987 1990

Bulgaria 0.8 0.7 6.6 6.0 0.6 0.6 6.4 4.9 14.5 12.3 Czechoslovakia 0.6 1.0 7.6 8.2 3.0 2.4 4.8 4.3 16.6 16.6 HWZW 0.8 0.7 3.4 2.8 2.3 1.7 4.6 3.5 11.2 8.9 Poland 0.5 0.3 3.8 2.6 2.4 1.0 4.5 3.4 11.6 7.8 Romania 0.5 0.5 6.3 5.3 3.0 2.3 1.4 2.0 11.7 10.5 Yugoslavia 0.4 0.6 4.6 5.6 1.5 1.6 4.0 4.4 10.9 12.4

China 0.2 0.2 1.4 1.9 0.2 0.1 3.7 3.3 5.6 5.7 West Germany 1.8 1.8 7.5 9.5 2.0 2.4 9.3 12.2 20.6 26.1 UnitedKingdom 1.8 1.3 9.6 9.5 1.4 1.3 6.2 7.0 19.1 19.2 Italy 1.3 1.4 6.1 7.2 1.6 1.6 9.1 7.9 18.3 18.1 France 1.1 1.1 6.3 6.8 1.4 1.5 6.4 7.5 15.2 16.9 Netherlands 1.7 1.3 7.0 7.6 2.1 2.7 8.0 10.1 19.0 22.2 Ireland 1.2 3.1 12.8 10.8 0.3 1.0 5.2 10.8 19.7 26.1 Switzerland 2.5 2.2 7.0 7.1 1.2 1.3 11.4 10.5 22.3 21.4 Japan 1.7 1.4 7.9 9.7 1.6 1.6 9.6 9.3 20.8 22.2

a Available for domestic use. b Synthetics refer to fibres produced through a polymerisation process, such as acrylic fibres, polyamides and polyesters, but excludes polyolefine and textile glass fibres. c Cellulosic fibres refer to continuous garment and discontinuous fibres produced by the viscose, acetate and cuprammonium processes, including high tenacity and triacetate types. d Includes flax. Source: FA0 (1993).

developed market economies. It may also reflect life style differences and traditional patterns of fibre use (Malarz, Connolly, Barrett and Tran 1992).

The demand for wool and wool products has fallen largely as a result of the removal of consumer subsidies and a fall in real wages. The erosion of purchasing power and higher prices have restricted consumer expenditure to essential items such as food, leaving a smaller proportion for purchases of semidurable items such as wool clothing.

Trade in wool and wool textiles Traditionally, the principal wool importing countries in Eastern Europe have been the former Czechoslovakia, the former Yugoslavia and Poland. Romania and Bulgaria are the predominant wool producing countries in the region and their dependence on wool imports has been quite low - only around 10 per cent of wool requirements in both countries were imported. Similarly, Hungary's reliance on imported wool has been around 15 per cent.


In contrast, the wool textile industries in the former Czechoslovakia and Poland have depended much more on imported wool, importing around 90 per cent and 60 per cent respectively of their total wool requirements.

Australian exports to Eastern Europe declined by over 80 per cent, from 24 700 tonnes clean equivalent in 1989 to 5100 tonnes in 1992 (table 13). Prior to the reforms, Poland was an important customer for Australian wool, buying over three-quarters of its imported wool from Australia. While imports from Australia in 1989 were 8200 tonnes, valued at $A79.4 million, in 1992 they dropped to only 500 tonnes, valued at $A2.5 million.

The former Yugoslavia and the former Czechoslovakia were the next largest importers of raw wool in Eastern Europe after Poland. However, since 1990, the former Yugoslavia's wool imports from Australia, although declining, were well above imports by both Poland and the former Czechoslovakia. In 1989, the former Yugoslavia imported 9600 tonnes clean equivalent of greasy wool from Australia, but wool imports declined to 2100 tonnes in 1992 and are expected to have been negligible in 1993. Imports by the former Czechoslovakia declined from 6100 tonnes, to 2300 tonnes over the same period.

13 wool imports by Eastern European countries Clean weight

Poland - from Australia

Czechoslovakia - from Australia

Hungary - from Australia

Bulgaria - from Australia

Yugoslavia - from Australia

Romania - from Australia

Total - from Australia

a Year ending 30 June of the year shown. na Not available. -negligible. Sources: International Wool Textile Organisation (1992); Australian Bureau of Statistics (1992).


- - - - - - - -

Australia, until the mid-1980s, held about a 50 per cent share of the former Czech market, with New Zealand, Uruguay and the United Kingdom evenly supplying most of the balance. Since then Australia's share of this market has declined to around 24 per cent. Hungarian imports of wool from Australia were only 100 tonnes in 1989 and ceased in 1992.

Emerging trade relationships There has been a major reorientation of trade in all products toward market economies. This is a consequence of the reduction in sales to traditional CMEA markets and the growing pressure from Eastern Europe for the European Community and, to a lesser extent, the United States, to accept more of their products. In 1991, exports from the former Czechoslovakia and Hungary to market economies accounted for 60 per cent and 70 per cent, respectively, of their total tradable products. A similar pattern of trade emerged in Poland where the value of exports of all products to the European Community was 56 per cent of total export value in 1991. This general shift in trade toward market economies has also been reflected in the trade in textiles, particularly with the European Community.

At the same time, there has been a marked increase in the role of the private sector. This is a result of the establishment of new firms in the retail and services sector, combined with the privatisation of the majority of small state retail outlets in Poland, Hungary and the former Czechoslovakia, as discussed in chapter 2. For example, in Poland, while total exports rose significantly following the devaluation of the currency, the private sector share of exports also increased from 8 per cent to 25 per cent between 1990 and 1991.

Some progress has also been made toward reducing barriers to trade which have, in the past, restricted Eastern European access to world markets. For example, in March 1990 the European Community announced that quotas for Polish textiles and clothing would increase by 23 per cent in 1990-91 and Czech quotas by 13 per cent (Economist Intelligence Unit 199la). Similarly in September 1991 the US administration removed import quotas on Czech wool and blended fabric. This was followed by improved access for textile imports from Poland and Hungary.

These changes, combined with the Interim Association Agreements discussed below, which have been in place since March 1992, have had a positive impact on the redirection of Eastern European trade.


In addition, the 'Visegrad three' - the former Czechoslovakia, Hungary and Poland - agreed in late 1991 to complete negotiations on a free trade area among themselves. On 1 March 1993 these countries started implementing the free trade agreement signed in Kracow on 21 December 1992. The agreement provides for the gradual reduction in quotas for imported and exported commodities as well as customs duties and the creation of a free trade zone over a period of two to eight years. For Poland, the agreement stipulates that 50-55 per cent of Polish industrial exports will gain duty free access to Hungarian markets and 55-60 per cent to Czech and Slovak markets. These four countries have also been negotiating free trade agreements with the European Free Trade Association (Edes 1993).

Trade agreements with the European Community and the United States In 1991, Poland, the former Czechoslovakia and Hungary negotiated Association Agreements with the European Community. These agreements provided for Most Favoured Nation treatment for each country (this essentially means that EC imports from these Eastern European countries are subject to much lower duties than imports from other nations which do not have Most Favoured Nation status), established timetables for the phasing out of most quantitative restrictions, created a framework for further negotiations on agricultural products, and committed the parties to commercial cooperation. In addition, Poland, the Czech Republic and Hungary are hoping that these agreements will lead to full EC membership by the year 2000 (Economist, 13 March 1993, pp. 20-2).

Although the Association Agreements have yet to be ratified by the parliaments of the EC member states and the parliaments of Poland, Hungary and the former Czechoslovakia, Interim Agreements have been in place since 1 March 1992. In addition, the European Community has now renegotiated the EC Agreement with the governments of the Czech and Slovak Republics. It is expected that all four Association Agreements will be effective from 1 January 1994.

Under the Association Agreements, EC tariffs on textiles and clothing imports will be eliminated over a five year period, and as a result it is likely that EC imports from these countries will increase by up to 30 per cent. The elimination of quantitative restrictions under the Multifibre Arrangement, maintained by the European Community on its imports of textiles and clothing from Poland, Hungary and the Czech and Slovak Republics, is linked to the outcome of the Uruguay Round of the General Agreement on Tariffs and Trade.


World trade in textiles and apparel is controlled by the Multifibre Arrangement, which effectively limits the quantities that Eastern Europe and other low cost textile and clothing producers in developing countries can export to certain major consuming markets. The Multifibre Arrangement is a system of 'voluntary' export quotas on textiles and clothing agreed between most major developed importing nations and the developing exporting nations. Although inconsistent with many of the GATT principles, the Multifibre Arrangement is ratified under the General Agreement.

Although there is a current proposal to phase out the Multifibre Arrange- ment over ten years, an agreement is not expected until December 1993. If this agreement were to result in the freeing up of restrictions on international trade in textiles and clothing, the European Community has agreed to eliminate such quantitative restrictions on imports from the above countries in half the phasing out period agreed to in the Round, subject to a minimum of five years. However, access to the US market will remain restricted until the end of the phase out period.

While the interim agreements have gone some way toward improving access to the EC markets, the most significant gains for Eastern Europe will not accrue until quantitative restrictions are totally removed.

Trade with Eastern Europe has traditionally been a small part of total US trade, but since the political and economic upheaval in these countries in 1989, the potential for trade and investment has improved substantially. US trade agreements have been made with each country of the region (Poland, Hungary, the Czech and Slovak Republics, Romania and Bulgaria). All countries have been allocated Most Favoured Nation status, with the exception of Romania (Hardt and Kaiser 1992).

Eastern Europe's comparative advantage Traditionally, textile and clothing industries have been characterised as labour intensive. In many developing countries of Asia (for example, China), textiles and clothing industries have been given relatively high priority in order to earn foreign exchange through exports. Although technological developments have led to the substitution of capital for labour in early stage processing and to a lesser extent in spinning and weaving, the final assembly stages of garment and clothing manufacture are still labour intensive. Because of the relatively low wage rates in some Asian countries

- -- --


there has been a shift in the location of textile production, particularly in clothing manufacture, from the traditional producing countries of Western Europe to Asia.

A similar shift in the pattern of textile trade between Western European textile firms and Eastern European firms is likely to emerge. Eastern Europe's comparative advantage in textile processing arises from the low cost of labour relative to the prices of other factors of production (such as capital) in Eastern Europe compared with the relative cost of labour to the prices of other factors in developed countries. For an explanation of the concept of comparative advantage see Wittwer and Connolly (1992, p. 57).

Due to competitive forces in international markets, capital transfers from the developed countries to Eastern Europe and to the other developing countries should continue up to a point where the marginal cost of both labour and capital would equalise between the trading partners (Collins and Rodrik 1991). Since certain processes in textile production are labour intensive, it is likely there would be a comparative advantage in these textile processes (table 14). As long as the cost of labour in the countries of Eastern Europe is less than that in other textile producing countries, there is likely to be a transfer of capital to these countries (Eastern Europe) for investment.

Due to the region's proximity to markets, textile manufacturers from neighbouring Western European countries have already started to relocate some of their activities to Eastern Europe. With the freeing up of trade, and the continued implementation of reforms, a more secure environment for investment in the region will result in capital from high labour cost Western economies flowing into these industries.

Between 1982 and 1989, the average wage in textile manufacturing for Eastern European countries rose by about 15 per cent, compared with respective increases of 46 per cent and 160 per cent for the group of developed countries and South Korea during the same period (table 14). The average for the whole period in Eastern Europe was a seventh of that in the group of developed countries and half of the wage rate in South Korea. As wages are expressed in terms of US dollars, it is most likely that the declines in labour costs in some countries such as Canada, New Zealand, Austria and Germany were due to movements in exchange rates in these countries.

Among the country groups, the other Asian countries - China, India, the Philippines and Myanmar (previously Burma) -have the lowest wage rates


14 International labour costs in textile manufacturing Monthly

US$ Developed countries Australia a 1120 New Zealand 659 Austria 544 Germany 805 Sweden 1051 United Kingdom 555 United States 944 Canada 1325 Japan 682 Average 854

East Europe Czechoslovakia na 157 136 135 157 177 174 170 na HWTW 99 88 88 91 105 111 123 119 137 Poland 113 143 136 123 122 101 114 132 na Romania 143 127 110 140 150 165 177 177 na Yugoslavia 190 139 123 111 155 162 119 180 na Average 136 131 119 120 138 143 141 156 na

South Korea 203 215 224 225 244 300 400 527 597

Other Asian China a na na na 30 30 31 na na 32 Philippines 99 82 73 82 84 92 na na na Myanmar a 23 19 19 19 23 27 54 62 na India 65 61 66 42 69 na na na na Average 6 2 b 5 4 b 5 3 b 4 3 51 5 0 c n a na na

a Includes footwear. b Excludes China. c Excludes India. na Not available. Sources: Calculated from International Labour Office (1991); International Monetary Fund (1993).

in textile manufacturing. During the period 1982 to 1987, the average wage in this group of countries, compared with that in the Eastern European countries, ranged between about a half at the beginning of the period to about a third toward the end of the period. Low wage rates in these Asian countries indicate that there is potential for capital investment in their textile manufacturing, similar to the Korean case.

However, a history of well developed textile industries in Eastern Europe, a relatively well educated work force and the proximity to major consuming markets are among the factors which are likely to favour the expansion of the Eastern European industry in the long run.


Apparel manufacture is highly labour intensive and as such has significant potential for expansion in Eastern Europe. As incomes begin to rise it is expected that domestic consumption of wool and other textile products will increase, resulting in further growth in processing of textiles and apparel within the region. Furthermore, it is expected that as the large vertically integrated structures in the textile industry are privatised, the quality and the range of products available will increase. This, coupled with improved openness and access to world markets and technologies, could result in higher capital accumulation rates in the industry, thus facilitating additional investment.

Foreign investment Under the centrally planned system the textile enterprises were large, vertically integrated factories that typically employed thousands of workers. The wool producing mills were equipped to process large quantities of relatively homogeneous products for both the domestic and former CMEA markets. With the loss of these markets and the increasing dependence on producing a higher quality product for Western European markets, a substantial amount of restructuring is required to modernise technology, upgrade plant and equipment and to eliminate unprofitable elements of production and distribution processes.

One of the key problems in all the Eastern European countries is the lack of finance either to pay for imports in hard currency or for investment. This effectively means that Eastern Europe is dependent on high levels of foreign investment to enable restructuring to proceed. However, since the reform process began very few textile and clothing industries have attracted the necessary foreign capital for restructuring. This is particularly the case in Poland where very few of the large plants have undergone any real structural change aside from a substantial reduction in output and employment over the past three years, largely it appears because of capital shortages and weak demand.

Furthermore, the overriding decision to invest in the textile and clothing industries will be determined by the relative returns on this investment with respect to the returns that may be obtained from alternative investment activities. There are several other factors which currently affect the decision to invest in textiles and clothing: the structure of the industries; their inability to respond quickly to changing demands in the market; the high risks associated with investment in an industry which has limited access to


Western markets; uncertainty about the privatisation program; and the still relatively unsophisticated financial and telecommunications infrastructure.

As discussed earlier, Eastern Europe has a comparative advantage in those sectors which are highly labour intensive, such as apparel manufacture. For the wool textile industry, later stage processing offers the greatest opportunities for investment. Early stage wool processing such as scouring and topmaking is less likely to attract investment because of environmental concerns and the high capital costs required to upgrade scouring equipment. In addition, Poland has been able to import wool tops from the European Community at a more competitive price than imports of wool from Australia. For example, wool tops are subject to a 5 per cent tariff as well as a 22 per cent value added tax payable at the border. However, if the wool importer can provide evidence that the wool tops were produced in the European Community no duty applies. Furthermore, wool importers can apply to have the value added tax refunded if the wool is re-exported as a processed product. This effectively reduces the potential returns from investing in Poland's own early stage wool processing sector.

To attract foreign capital, many of the Eastern European countries provide incentives for joint ventures with foreign capital. In particular, foreign investment laws in Eastern Europe provide discretionary tax relief for certain investments; these tax breaks, however, vary from country to country. In the case of Hungary, if the foreign share of a joint venture's original capitalisation reaches 20 per cent or five million forints (equivalent to $A85 400, 14 July 1993) and the joint venture pursues an activity of 'particular importance to the Hungarian economy', the Hungarian Council of Ministers has the discretion to grant it a larger tax incentive. In some cases this has been for a period of up to ten years. Similarly, the Polish Council of Ministries has the discretion to extend a joint venture's tax exemption from three to six years. The law in the former Czechoslovakia also allowed the granting of extended tax breaks to joint ventures with foreign participation, generally limited to two years (Oliver and Eichmann 1991).

As a result of these tax incentives there has been a substantial increase in joint venture activity, particularly in the spinning, weaving, knit and garment making sectors. For example, the Italian textile and garment producers are now among the most active investors in Eastern Europe, with low labour costs given as one reason for the choice of location. In addition, transport has an impact not only on total costs but also on the quality of


service that can be offered to customers. Although Italian companies first started producing garments offshore in Tunisia and Egypt, shipment from a North African location does involve either costly air freight or container- isation for sea passage. Eastern Europe has the advantage that products can be transported to most Western European countries at a relatively low cost (International Textiles 1993).

Supply and distribution opportunities in the country of location are of considerable importance for the longer term profitability of the investment. Initially, all or most yarns or fabrics processed in the offshore plant may have to be imported from the home country and finished products brought back for sale in Western markets. If, over time, increased volumes of semiprocessed materials of appropriate quality can be supplied from local manufacturers, profitability and flexibility will be improved. If, in addition, a significant market for finished products can be created in the country of location, the viability of the operation as the real cost of labour rises will be maintained. In these respects, Eastern European countries appear more promising than most North African locations (International Textiles 1993).

In late 1992, the Italian Legler-Polli group announced that it was preparing to shift production of denim fabrics from an old mill in Switzerland to a new plant in Poland. The new Polish factory is intended to start up with a workforce of 1400, with the likelihood of further expansion at a later date (International Textiles 1993). Similarly, the Italian company Cantoni has not only acquired the Budapest weaving and finishing mills of the textile works of Kob6nya in Hungary, but in 1990 it entered into a joint venture with the Clothing Industry Cooperative of Szolnok for the production and distribution of clothing. Both the technology and materials are supplied by the Italian company (Economist Intelligence Unit 1991~).

Wool processing industries in both Poland and the former Czechoslovakia have shown interest in entering into joint ventures in stockpiling and processing of Australian wool in these countries.

Growth in outward processing While there has been a substantial increase in trade with market economies since the reform process began, exports of textiles and clothing made directly from the raw material have been quite small. However, there has been considerable growth in the export of textiles and clothing made from imported fabric or ready cut pieces of garments (outward processing). In


1991 the share of outward processing in total textile and clothing exports for Poland, Hungary, Romania and the former Czechoslovakia were 93 per cent, 90 per cent, 88 per cent and 63 per cent respectively (Textile Asia 1 992).

Low labour costs in Eastern Europe, and close proximity to major consuming markets have encouraged the move toward outward processing by EC firms - particularly those manufacturers in Germany, France, Italy, the Netherlands and the United Kingdom. In addition, the outward processing trade in the European Community has been regulated through the establishment in 1982 of a Common Tariff Procedure giving preferential treatment to clothing firms involved in outward processing. Under the procedure, outward processing firms pay an import duty only on the value added, during processing, to the reimported garment. Such imports are also subject to more liberal import restrictions under the Multifibre Arrange- ment. In order to avoid customs duties or quantitative restrictions on imports, the outward processing trade must be declared as such.

To qualify for this preferential treatment, the material used has to be of EC origin, and must involve only EC manufacturing firms. It excludes the activities of wholesalers and retailers. Special quotas are available to EC manufacturing firms for these arrangements. Any outward processing imports over and above these special limits are charged duty on the full import value (Economist Intelligence Unit 199 1 b).

Poland and the former Czechoslovakia in particular have increased their outward processing activities as a result of the continuing hostilities in the former Yugoslavia. In 1991, EC textile exports for outward processing to Hungary grew by 14 per cent, to Poland by 50 per cent and to the former Czechoslovakia by 76 per cent. Imports of clothing from these countries grew by 24 per cent, 49 per cent and 98 per cent respectively (Anson and Simpson 1992).

The outward processing strategy is, however, restricted to the assembly of middle to low cost products or to those with long fashion cycles. Wool apparel items, such as men's woven suits and trousers, which are of classic design and less influenced by rapid changes in fashion, are an example of garments which can be successfully produced using this strategy.

Despite some limitations in the use of this strategy, it is expected that in the short to medium term there will be an expansion in outward processing. It


is not subject to quantitative restrictions and it is particularly suited to joint venture investment because very little capital is required. In the longer term the importance of the outward processing strategy may be eroded as labour costs increase and private textile and clothing companies emerge in response to ratification of the Association Agreements.

Credit and other forms of assistance Although joint ventures and to a lesser extent direct foreign ownership have provided an external source of capital for industry restructuring, access to working capital to purchase raw materials remains a problem for mills. To some extent credit facilities and direct assistance have complemented investment activities, particularly in the wool textile sector in these countries.

Since 1981 the Australian government, in the national interest, has guaranteed a 240 day rollover credit facility for Polish wool purchases up to $A200 million. This facility recently expired, however, following discussions between the Export Finance Insurance Corporation (which acts as the Australian government agent), Polish authorities and officials from Bank Handlowy (the Polish central bank).

The high interest rates charged by Polish banks to underwrite letters of credit needed to purchase wool (up to 60 per cent a year) have made the cost of wool purchases prohibitive and consequently the facility has not been effectively used in recent years. It is likely that if a specific need for import credits arises in the future Bank Handlowy would review the credit facility on a case by case basis. The Export Finance Insurance Corporation is, however, prepared to consider individual requests for guaranteeing exports on its own account. In contrast, credit guarantees for the former Czechoslovakia have traditionally been provided by the Corporation under its own account.

In Poland there has been a general reluctance by banks to provide credit to the textile sector. This includes restrictions by Bank Handlowy on loans and related exposures. However, in the former Czechoslovakia Centratex, one of the main importers of Australian wool offers a range of agency services which includes the provision of credit for up to 70 per cent of the delivery cost, with bank finance making up the balance.

Some concern has been expressed over the issue of iirevocable letters of credit, which are a widely used method of payment for wool imports in the

50 ABARE resenrch rtport 93.20

former Czechoslovakia. Since payment is required prior to the shipment of wool, irrevocable letters of credit can be an expensive way of trading, particularly if the wool buyer has to borrow funds to cover the cost of the long transport time between purchase and delivery. For example, it takes an average of two and a half months to receive wool from Australia compared with 14 days from South Africa. To overcome this problem the Export Finance Insurance Corporation agreed in 1992 to extend cover on 'cash against delivery' terms for Centratex (the major importer) - which effectively means that buyers pay for wool when it reaches its final destination.

However, the availability of more liberal credit provisions on sales of Australian wool to these markets would carry relatively high commercial risks due to the current limited demand for processed products from Eastern Europe (Sheales and Malarz 1992). Furthermore, providing wool on a credit basis could retard the process of restructuring in some firms. It is likely to be potentially more useful for Australia to provide assistance in areas of technology transfer and to place pressure on importing countries to reduce their barriers on imports of textiles and clothing.

The benefits to Australia that are expected to arise from assisting wool processing industries in Eastern Europe are similar to those that could be expected from assistance to the Chinese wool processing industries, as detailed in Young and Moir (1990). For example, assistance to the processing sector in the form of a transfer of a specific technology or the training of personnel may increase the efficiency of the industry, resulting in lower production costs. If cost reductions are passed on to domestic or overseas consumers as price reductions, demand for wool products may increase and, in turn, may increase the demand for raw or semiprocessed wool, wool yam or wool fabric. In addition, if assistance is designed to upgrade the quality and widen the product range of wool garments the demand for these items may also increase.

The International Wool Secretariat has been involved in negotiations with the European Bank for Reconstruction and Development on ways to provide targeted assistance to the wool and textile industries in Poland and the former Czechoslovakia. The assistance is focused on the reconstruction of mills in Poland and on modernisation (technologically improving the performance of plants) and reorganisation of industry in the former Czechoslovakia, to make it more responsive to reforms (producing high quality woolmark goods and increasing exports). International Wool


Secretariat activities in Eastern Europe are specifically aimed at improving processing efficiency, improving quality via the woolmark licensing program, and increasing product variety and aesthetics. However, the level of future assistance will depend on the availability of International Wool Secretariat funds over the next few years.

In addition, while the European Bank for Reconstruction and Development could still make loans in Central and Eastern Europe, on commercial terms, it is experiencing difficulty finding viable projects in the textile sector that meet its terms and conditions. The former Australian Wool Corporation has also periodically undertaken seminars in Eastern Europe aimed at improving the knowledge of wool specification and processing performance.

Enterprise funds have been established by the US Congress for Poland, Hungary, the Czech and Slovak Republics and Bulgaria. The intention of the funds is to promote market reforms by providing technical assistance and capital for starting up new firms and modernising viable established enterprises that have been privatised.

Furthermore, all Eastern European states now belong to the International Monetary Fund and World Bank and are thus eligible to receive technical and financial assistance in support of their efforts to establish market economies (Hardt and Kaiser 1992). For example, two textile enterprises, one of which is a woolmark carpet licensee (Dywilan) located in Lodz, the centre for the Polish wool textile industry, are to share credits of US$5.5 million from the World Bank to finance restructuring programs. The loans are part of a US$200 million credit package being offered through the World Bank to assist textile and chemical enterprises in the Lodz area.

The provision of credit for both restructuring and working capital is likely to remain an issue for the textile and clothing industry in Eastern Europe for some years.


Projected developments and implications for trade

The purpose in this chapter is to draw together the conclusions of the previous chapters and to develop medium term projections of the major trends in the wool textile industry in Eastern Europe. Projections of wool production, domestic consumption and trade in raw wool, semiprocessed and manufactured wool products to the year 2000 are provided.

There is considerable uncertainty about the pace of the economic reforms and the implications of this for the restructuring of the wool textile sector and the demand for wool and wool textiles in Eastern Europe. In addition, with the opportunities for these countries to trade, their textile industries are now more exposed to the changes in the international trading environment that will play an important role in influencing future industry developments in Eastern Europe. The projections presented below provide a guide to the likely direction of change in the wool textile industry in Eastern Europe.

Projected developments Although the economies of some countries, for example Poland and Hungary, are showing signs of emerging from the severe downturn in economic activity, the other countries are continuing to experience reductions in incomes and output. The rate of economic growth through the remainder of the 1990s will depend importantly on the establishment of efficiently operating markets as well as on the level of capital investment. Given the low level of domestic savings, restructuring and modernisation of the industrial base will require significant levels of foreign investment. As incomes in these countries are currently low relative to those in most developed industrialised countries, it is likely to be some time before the levels of income in these countries approach those of the developed industrialised countries.

It is also expected that the reforms and the pace of adjustment in the wool textile industries will be more rapid in Poland, the Czech Republic and Hungary than in the other Eastern European countries. This has been reflected in the differential rates of adjustment and growth in the wool textile sectors between these countries and Bulgaria, Romania and the former Yugoslavia.


Domestic consumption The important factors influencing demand over the projection period will be economic growth, population growth, technological change, and changing price relativities between fibres.

In this study it is assumed that the annual rate of economic growth for Poland, the Czech Republic and Hungary will increase to 3 4 per cent in the second half of the decade (table 15). For Bulgaria and Romania, on the other hand, the rates of economic growth are expected to be considerably lower, reaching only between 1 and 2 per cent over the same period. The former Yugoslavia is also expected to have a similarly low rate of economic growth over the projection period. Because there appears to be a positive relationship between income per person and total fibre consumption per person, the projected economic growth rates are likely to lead to increased consumption of textiles in these countries over the medium term.

However, it may be noted that the growth rate in the consumption of textiles tends to decline as income per person increases beyond a certain level. Given the relatively low consumption of textiles in most Eastern European countries (see table 12) it is likely to be several years, and probably beyond the projection period of this study, before the rate of growth in consumption of textiles begins to decline as income per person increases.

Population changes in Eastern Europe will be an important factor influencing the consumption of textile fibres over the medium term. It is assumed that the growth in population in this region will be only 3 per cent over the period 1992 to 2000 (table 16). Different rates of economic growth combined with shifts in ethnic population groups (following the political

15 Economic growth rate assumptions a

Former Czechoslovakia -16.0 -8.0 0 2.0 3.0 4.5 4.5 Hungary -10.0 4 . 0 0 0.3 3.0 3.5 3.5 Poland -9.0 1.0 4.5 3.0 3.0 3.5 3.5 Romania -14.0 -15.0 -9.0 4 . 0 1.0 1.5 2.0 Bulgaria -17.0 -10.0 4 . 0 2.0 1.0 1.5 2.0

a Growth rates over the period 1995 to 2000 are ABARE assumptions. Sources: OECD (1993b); ABARE.


and economic changes) could affect net migration patterns and the rate of population changes in individual countries.

In most countries of Eastern Europe the removal of subsidies on consumer items has resulted in price increases for textile products. Although it has not been possible to identify the changes in relative prices between competing textile products, it is unlikely that wool prices will increase markedly before the end of the decade. In these circumstances wool prices are expected to remain competitive with those of synthetic fibres and cotton over the projection period. An additional factor that could lead to higher demand will be the availability of a greater range and better quality of textile products as consumers have the opportunity to purchase imported products as well as improved locally made textiles.

The pattern of consumption of apparel textile fibres in Eastern Europe is likely to change as these economies grow and develop closer trading and cultural links with Western European and other developed countries. Total consumption of textile fibres is likely to increase and there is also likely to be a shift in the pattern of textile consumption to one that might more closely resemble the pattern of fibre consumption in developed Western economies.

In the short term, domestic wool consumption will continue to be constrained by the relatively slow rates of economic growth and consequently per person consumption of textiles could fall even further. Over the medium term, however, the factors discussed above are expected to lead to higher consumption of wool textile products in Eastern Europe. By the year 2000 domestic wool consumption is projected to reach around 74 000 tonnes

1 6 Population projections for Eastern Europe

Former Czechoslovakia 15 725 15 770 15 820 15 875 15 935 16 303 Hungary 10558 10550 10 545 10 543 10544 10604 Poland 37800 37844 37913 38009 38134 38889 Former Yugoslavia 23 976 24 109 24 240 24 370 24 497 25 112 Romania 23 397 23 525 23 652 23 777 23 902 24534 Bulgaria 8 911 8 899 8 898 8 908 8 923 9 004

Source: Urban and Trueblood (1990).


17 Projections of East European wool consumption, production and imports a

Wool production 52.9 44.3 40.2 29.0 (26.0-32.0) 33.0 (30.0-36.0) Mill utilisation b 98.7 83.7 63.3 50.0 (45.0-55.0) 64.5 (59.5-69.5) Domestic consumption c 66.0 66.4 56.5 57.0 (51.0 - 63.0) 74.0 (68.0 - 80.0) Wool imports d 44.9 38.3 23.7 23.0 (20.0-26.0) 34.0 (31.0 - 37.0) Wool exports d 3.7 2.6 3.6 2.0 (1.0-3.0) 2.5 (1.5 -3.5) Net imports of wool textiles e -32.7 -17.3 -9.8 7.0 (6.0-8.0) 9.5 (8.5 - 10.5)

a Eastern European countries include Poland, the Czech and Slovak Republics, Hungary, Bulgaria, Romania and the former Yugoslavia. b Mill consumption is defined as the consumption of wool at the spinning stage less the net trade in tops. c Domestic consumption is defined as wool available for domestic use. d Imports and exports consist of raw greasy wool converted to clean basis. Exports also exclude any re-exports of imports. e Net imports is defined as the net trade in processed and semiprocessed wool products and excludes net trade in raw wool. z ABARE projection including ranges shown in parentheses. Sources: International Wool Textile Organisation (1992); International Wool Secretariat (1990); Food and Agriculture Organisation (1993); ABARE.

(clean), equivalent to the level of the late 1980s (table 17). The rate of increase in wool consumption is likely to be greater in those countries where the economic reforms are most advanced and where the rates of economic growth are more rapid. Under these circumstances, total domestic wool consumption is expected to increase more rapidly in Poland, the Czech Republic and Hungary and less so in Bulgaria, Romania and the former Yugoslavia (figure D).

l D Projections of domestic wool consumption

1 Poland, Czech and Slovak Republics and Hungary

kt clean Bulgaria, Romania and Yugoslavia I I I I I I I I I I I T ~ l I l I I

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000


However, any marked changes in the underlying assumptions discussed above could have either a positive or adverse impact on domestic wool consumption over the projection period. For example, if the economic growth rates assumed in this study are not realised, the projections of domestic wool consumption are likely to be somewhat lower. On the other hand, if the assumed economic growth rates are exceeded, the projections of domestic wool consumption are likely to be higher (table 17).

Wool production The key factors influencing wool production in Eastern Europe over the medium term include the relative returns from wool and sheep meat compared with alternative enterprises; changes in input costs; and technological changes. There have been sharp falls in the sheep population as producers adjust to the removal of subsidies on wool production and the

I impact of dry seasonal conditions in 1992. Consequently, wool production in Eastern Europe is forecast to fall further before stabilising by the middle of the decade.

Projections of wool production for two groups of countries, differentiated according to their levels of economic reforms, are presented in figure E.

Wool production is forecast to continue to decline over the next two years to 29 000 tonnes (clean) in 1995, but then start to recover and reach 33 000 tonnes (clean) by the end of the decade (table 17). Despite heavy slaughterings of sheep over the past two years, additional slaughterings of breeding stock would lead to further falls in the sheep flock. This could arise

I E Projections of domestic wool production

kt greasy Poland, Czech and Slovak Republics and Hungary I I l l I / I I I I l I l l 1

1984 1986 1988 1990 1992 1994 1996 1998


from additional exports of sheep meats to Western European markets as producers seek to maintain their incomes following the removal of subsidies. A larger than expected decline in sheep numbers would result in wool production falling below the projected level. In the longer term some Eastern European countries may be able to expand their sheep meat trade with Western Europe as the region's trading relationships develop.

Furthermore, the proportion of finer type wools in the clip is likely to decline as the sheep population shifts toward meat type sheep. Consequently the proportion of coarse wools in the clip could be expected to increase. These types of wools are mainly used in the manufacture of interior textile products and therefore do not compete with Australian apparel wools.

Mill utilisation Due to the lack of internal capital generation, the restructuring and modernisation of the wool processing sector in Eastern Europe will depend on the level of foreign investment. This, in turn, will depend on the continuing implementation of the economic reforms which are necessary for creating a favourable foreign investment climate. However, there are considerable constraints to the development of well functioning market economies. These factors are likely to limit both domestic and foreign investment in the wool textile processing sector in the short term. However, as these economies proceed through the transitional phases to market economies, there are likely to be increased opportunities for investment in textile processing facilities.

Given the apparent comparative advantage in producing labour intensive manufactured products, such as wool garments, Western European wool textile firms are likely to seek out investments in Eastern Europe and undertake outward processing. Over the longer term this is expected to lead to increased intra-industry trade, particularly between the textile industries of Western and Eastern Europe.

The consumption of wool by processing mills has declined significantly in recent years, and is projected to fall further before increasing in the second half of the decade. Mill utilisation of raw wool is also projected to increase to 64 500 tonnes in the year 2000 as the textile industry emerges from the present restructuring (table 17). However, this is still only around the same level of mill utilisation of wool as recorded in 1991 and well below the level of 98 700 tonnes in 1987.


Mill use of raw wool is expected to remain low over the next few years because domestic wool production is not likely to recover to the levels of the early 1990s in the medium term. Therefore the projected increase in mill consumption of wool will depend partly on the extent to which mills are able to import wool.

The degree to which individual countries succeed in moving to market systems will influence the structure of the wool textile industry and the type of processing mills which are likely to emerge. The maintenance of high interest rates and the shortage of finance not only for plant modernisation but also for purchasing inputs such as wool and other textile fibres will impede the degree to which textile enterprises can expand production from the low base of the early 1990s.

However, as these countries achieve macroeconomic stability and an effective financial system develops (in most countries interests rates are not completely liberalised and do not fully reflect the demand for and supply of credit), access by textile firms to capital will improve over the medium term and this is likely to have a positive influence on textile production.

Implications for trade in wool and wool textiles A number of factors will influence the pattern of trade in wool and wool textile products in Eastern Europe over the medium term. Apart from the domestic demand and supply factors mentioned above, other factors include developments in the international wool market; liberalisation of world textile trade; restructuring of the wool textile industry in Eastern Europe; foreign investment and outward processing; and macroeconomic policies which impinge on the exchange rate. Also, the probable eventual entry of several Eastern European countries into the European Community is a factor that could foster investment in the region by EC textile companies.

For the projection years in table 17, imports of raw wool are derived by taking the difference between the volume of wool used by mills and that produced locally less any exports of raw wool. The net trade in raw wool is shown in figure F as the difference between mill utilisation and wool production.

This analysis shows that imports of raw wool to Eastern Europe are projected to increase from 24 000 tonnes (clean) in 1991 to around 34 000 tonnes (clean) by the year 2000, but would still be below the levels of the


Projections of Eastern European net trade in raw wool

Mill utilisation

kt clean I I I I I I I I I I I I I I I I I

late 1980s. Most of the growth in imports is expected to occur in Poland and the Czech Republic while raw wool imports to Hungary are forecast to increase but remain relatively small. However, due to the uncertainty of the underlying projections, the volume of imports projected for the year 2000 could still vary considerably. For example, if domestic wool production in the region declines further over the medium term, wool imports may be higher than projected. On the other hand, if restructuring and modernisation of the wool textile industry is slower than expected, wool import demand may be lower than projected.

Trade in semiprocessed and manufactured wool textile products was calculated by taking the difference between the wool used by processing mills and the domestic consumption of wool (figure G). In the case of semiprocessed wool products such as fabrics, which may undergo further processing in Eastern Europe, the net trade in wool would be zero if the final end product is re-exported. This would be the case for wool fabric which undergoes outward processing.

Over the projection period, Eastern Europe is expected to shift from being a net exporter of semiprocessed and manufactured wool products in 1991 to being a net importer of these products by 1995 and through to 2000. The main factors driving this outcome are the increase in domestic demand and expected lower levels of domestic wool production. Increased economic growth rates in the second half of the 1990s, moderate population growth and the availability of a greater range and better quality of wool textile products are the key factors leading to an increase in domestic wool consumption.


Projections of net Eastern European trade in semiprocessed and manufactured wool textiles 1

Wool consumption

kt clean I l l l l l l l l l l l l l l l l

1984 1986 1988 1990 1992 1994 1996 1998 2000

Nevertheless, by the year 2000 domestic wool consumption is projected to recover to only around the same level as the late 1980s. The recovery in domestic demand for manufactured wool products is expected to occur more quickly in those economies where the reforms are most advanced (Poland, the Czech Republic and Hungary).

At the same time, changes in the macroeconomic policies of these countries will be important in influencing trade in wool and wool textiles. During the early stages of economic reform most countries of Eastern Europe devalued their exchange rates (most countries have a pegged exchange rate regime, and while current accounts are fully convertible there are still restrictions on capital accounts) as part of their macroeconomic stabilisation policies to control the inflationary pressures associated with price and trade liberalisation. The exchange rate policy led to increased exports (exports became more competitive on international markets) while imports declined (imports became relatively dearer on domestic markets).

An appreciation of the exchange rate (which may arise as the economies of these countries stabilise and begin to grow) would lead to cheaper imports, including wool and wool textiles. On the other hand, an appreciation of a country's currency would result in exports being less competitive in international markets and thus would discourage export competing industries.

The exchange rate policies implemented by Eastern European countries will not only affect the value and volume of imports and exports but also the level of investment in import and export competing industries (as the relative returns in particular industries are affected).


wool consum~tion EABARE 1

1 20 Wool production

kt clean 1 1 1 1 1 1 1 1 1 1 l I I I I l l

1984 1986 1988 1990 1992 1994 1996 1998 2000

The projected total net trade in wool, including raw wool and semiprocessed and manufactured wool textiles, is shown in figure H as the difference between domestic consumption and wool production.

Based on the assumptions discussed above, the net gain in wool trade with Eastern Europe by the year 2000 is projected to be 25 000 tonnes (clean), of which Australia could be expected to supply 60 per cent. The value of wool exports to the Australian industry are expected to increase from $40 million in 1991-92 to between $120 million and $140 million (in 1991-92 dollars) a year by the year 2000. These gains, however, represent only a partial recovery of the losses in the value of Australian wool sales to the region since 1989 and would represent only around 2-3 per cent of the total value of Australian wool exports.

The Australian wool industry is likely to benefit not only from increased wool exports to Eastern Europe but from increased raw wool exports to those countries that are able to expand their intra-industry trade with the region. However, the consumption and production effects in Western European countries undertaking outward processing trade with Eastern Europe have not been considered in the analysis reported here. Western European wool textile firms are likely to increase semiprocessed wool output in response to lower production costs in the final stages of wool processing in Eastern Europe. This would increase total wool demand and such benefits would also accrue to wool exporters including Australia.

Given Eastern Europe's comparative advantage in labour intensive industries, there is expected to be increased investment in the later stages


of wool processing, particularly garment manufacturing. The relatively low wages in the Eastern European clothing manufacturing sector is expected to attract further investment from Western European wool textile firms.

In the short to medium term it is expected that outward processing, which is subject to more liberal EC import restrictions, will continue to expand and will provide the much needed hard currency to purchase raw materials. However, as this in part is a relocation of processing from the European Community and the former Yugoslavia, the overall increase in the demand for wool may not be large.

Another factor influencing wool textile developments in Eastern Europe over the medium term is the economic and political reforms which are taking place in the former Soviet Union. Given the previous close trading ties with the former Soviet Union, there is potential for expanded trade in wool products with that region if it can successfully implement its own market reforms. The economic reforms implemented in the former Soviet Union are much less advanced than those being undertaken in Eastern Europe and consequently economic recovery and industry restructuring in that region are likely to lag well behind that of Eastern Europe.

There are, however, many impediments to growth in the wool textile industry in Eastern Europe: limited access to Western markets; obsolete and outdated machinery and technology, which limits Eastern Europe's ability to compete with lower cost countries such as Asia; the production of low quality wool products, which limits the opportunity to compete in international markets; management which has insufficient marketing, accounting, exporting, importing and language skills to exploit the full potential of the textile industry; and a shortage of hard currency, which restricts the ability of mills to buy imported wool, machinery, dyestuffs and chemicals for processing.

Significant declines over recent years in sheep numbers, lower wool production in the region, and substantial excess capacity in the mills (although the technology is outdated), means that the potential for increased wool processing is very high. However, for this potential to be realised, substantial amounts of foreign capital are required for investment in plant and equipment. If this eventuates, Australian wool exports to the region could return to their previous levels.


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