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Under central planning, the countries of central and eastern Europe and the former Soviet Union were the victims of misdirected integration. The potential gains from liberalisation were accordingly large. The expansion of the European Union has been central to the process of reintegration into the global economy of many countries of the region. This is clearly the case for the eight transition countries that will become EU members in 2004, as well as for Bulgaria and Romania, which could join the EU as early as 2007.

The accession of some transition countries to the European Union while others remain outside will have a significant impact on the structure of trade and capital flows as well as on the pattern of migration, both legal and illegal. EU expansion is likely to have both trade creating and trade diverting effects. It will also influence investor assessments of the business environment in the transition countries and therefore the pattern of foreign direct investment (FDI) and other cross-border capital flows. Implementation of EU external border controls by the new members will alter the pattern of seasonal and permanent migration among transition countries as well as between transition economies and existing EU member countries.

There is a danger that EU expansion may reinforce the marginalisation of some of the Commonwealth of Independent States (CIS) countries so that they remain on the fringes of the international economy with relatively little foreign investment and little opportunity for legal migration. Further integration of the large CIS countries, particularly Russia but also Kazakhstan and Ukraine, into the international economy is necessary to avoid this outcome. This can be achieved through accession to the World Trade Organization (WTO) along with greater regional cooperation by the smaller CIS countries with their larger neighbours.

The transition countries have continued to make progress in structural and institutional reform over the past year. The countries of central eastern Europe and the Baltics (CEB) moved further forward from their already advanced position as they finalised the accession negotiations with the European Union. However, EU accession is not the end of the transition process. Reforms in the new member countries will have to continue– especially in the financial sector, public administration and the business environment– if they are to be competitive in the single market.

The prospect of further economic integration has also encouraged reform in other countries with aspirations for closer ties with the EU. Most notably this has been evident in south-eastern Europe (SEE), where the leading reformers continued to catch up in 2002–03. However, countries such as Bosnia and Herzegovina and Serbia and Montenegro are improving from a very low base and their reform achievements are still fragile. Russia has made progress on a number of fronts although the implementation of reforms remains an issue. Elsewhere in the CIS, reform progress has been uneven– with encouraging developments in some countries and virtual stagnation or backtracking in others– and the transition process continues to be held back by poor governance and weak institutions.

These divergent patterns of economic reform are mirrored by political developments. The advanced transition countries are in the process of developing high levels of liberal, constitutional democracy while the countries that lag behind in transition are increasingly characterised by weak constitutional orders and, in some countries, political repression. The evidence suggests that there is a strong link between the depth of democracy and the level of economic reform, particularly with respect to the institutional aspects of transition. While a handful of countries with less liberal political regimes have made significant progress in transition over the past years, this progress has been limited to initial phase reforms– price and trade liberalisation and smallscale privatisation. Only countries that have established high levels of political and civil liberties and the effective rule of law have made significant progress in the more crucial area of institutionbuilding or "second phase" reforms.