What Determines Sectoral Trade in the Enlarged EU? Helena Marques and Hugh Metcalf* Abstract In this paper, we estimate a sectoral gravity model for trade within a heterogeneous trade bloc, the enlarged EU, comprised of a high-income group (wealthiest EU), a middle-income group (Greece, Portugal and Spain), and a low-income group (new Central and Eastern European member countries). The estimation was conducted on sectors with different degrees of scale economies and skill-intensities in the presence of transport costs. The results offer support for the call to incorporate trade theories based on both endow- ments and scale economies. In addition, whilst integrating poorer countries is beneficial for all of the participants in the bloc, there is still a role for a redistribution policy, such as the EU’s Regional Policy, which should comprise a mix of policies, focusing on both income and education/skills, together with infra- structure development. 1. Introduction The globalization phenomenon has been accompanied by a great deal of regionaliz- ation, whereby countries have joined regional trade blocs with varying degrees of heterogeneity. Two of the most important regional trade blocs, the NAFTA in the American continent and the EU in the European continent, integrate countries at dif- ferent levels of development. In the case of the EU, such heterogeneity has just been aggravated with the May 2004 Eastern enlargement. Ten countries have become members of what was already one of the largest trade blocs in the world, and two more (Bulgaria and Romania) may be admitted by 2007. Except for the Mediterranean islands of Cyprus and Malta, the new and potential members are Central and Eastern European Countries (CEECs), 1 which started a process of economic transition more than a decade ago. During the transition period, East–West trade was progressively liberalized under the Europe Agreements signed between the EU and each of the CEECs. However, such liberalization has not produced uniform results either at the country or at the sectoral level. More specifically, not only the CEECs have been trading far more with the richer (Northern) than with the poorer (Southern) pre- enlargement EU members, but also the Europe Agreements sheltered the so-called sensitive sectors, such as motor vehicles and textiles and clothing, from liberalization (Baldwin, 1994). Given the different characteristics of the countries and sectors involved in the liberalization process, we can expect trade in heterogeneous industrial sectors within Review of Development Economics, 9(2), 197–231, 2005 *Marques: Department of Economics, Sir Richard Morris Building, Loughborough University, Lough- borough LE11 3TU, UK. Tel: + 44 1509 222 704; Fax: + 44 1509 223 910; E-mail: h.i.marques@lboro.ac.uk. Metcalf: Newcastle-upon-Tyne Business School, Ridley Building, University of Newcastle, Newcastle upon Tyne NE1 7RU, UK.Tel: + 44 191 222 8648; Fax: + 44 191 222 6548; E-mail: h.r.t.metcalf@ncl.ac.uk. We gratefully acknowledge the valuable comments of the anonymous referees, as well as those of the partici- pants in a seminar at the University of Newcastle-upon-Tyne, the 2003 EEFS Conference (University of Bologna, Italy), the 2003 ETSG Conference (University Carlos III, Madrid, Spain), and the Inter-American Development Bank’s Euro-Latin Study Network 2003 Conference on Integration and Trade (University Pompeu Fabra, Barcelona, Spain).Any remaining errors are our full responsibility. © Blackwell Publishing Ltd 2005, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA