European Union Trade and Investment Flows U-Shaping Industrial Output in Central and Eastern Europe: Theory and Evidence

We undertake an analysis of the evolution of industrial output in Bulgaria, Hungary, Poland and Romania over the period 1989-1995. We theoretically and empirically model the growth dynamics of EU oriented output within sectors of industry, ex-post trade and market liberalization, as investment induced Schumpeterian waves of product innovation. Greater assess to the EU market and investors is estimated to have induced growth with increasing convexity over-time in all sectors of each country but particularly in traditionally larger sectors. This growth, unconstrained by the transition process, was in product categories that already exported to the EU before 1989. We estimate the growth dynamics of non-EU oriented output within sectors as unobservable deterministic sector and country specific heterogeneity. We demonstrate that the evolution of non-EU industrial output followed the pattern as that observed in CIS countries. The different shape in the industrial output of CEE compared to CIS countries is explained mainly by the evolution of traditionally EU oriented production that benefited greatly from increased access to the EU market and EU investors.