When choosing means losing

East or west? In which directions should the market be adjusted?
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Ost oder West? In welche Richtung sollen die Handelsnormen angepasst werden?

The trade relations of the six countries of the Eastern Partnership is a complex web of discrepancies. They have assigned different association agreements with Russia and the EU. The coexistence of these two models of economic integration poses challenges - and problems.

Background

In the decade following the collapse of the Soviet Union, the six countries of the Eastern Partnership (EaP) – Armenia, Azerbaijan, Belarus, Georgia, Moldova, and Ukraine – did sign trade agreements for the former Soviet region. In the end, a dual-track process resulted in the establishment of the Commonwealth of Independent States Free Trade Area (CISFTA) in 2011, and, on 1 January 2015, the Eurasian Economic Union (EAEU) was launched.

Georgia, Moldova, and Ukraine have signed Association Agreements (AAs) with the EU including Deep and Comprehensive Free Trade Areas (DCFTAs), notwithstanding, Moldova and Ukraine decided to remain part of CISFTA. Armenia and Belarus joined the EAEU and CISFTA, and Azerbaijan has decided not to pursue economic integration with either bloc.

Between two models

The trade relations form a complex web with both patterns and discrepancies. For Armenia, Azerbaijan, Ukraine, Moldova, and Georgia the EU is the most important trading partner. However, for Belarus’ Russia is number one, and for Armenia, Ukraine, and Moldova Russia is in second place, for Azerbaijan in third and for Georgia in sixth place.

None of these countries have an interest in diminishing their trade with Russia. Armenia, Georgia, and Moldova receive substantial remittances from citizens working in Russia. Armenia, Moldova, Ukraine, and Belarus are also dependent on Russian energy supplies.

The coexistence of these two models of economic integration poses challenges that, thus far, have been underestimated. This includes elements of the treaties that may hinder smooth trade relations with the other Union respectively.

For the EAEU, this is the case with the high tariffs prescribed by its customs union and the loss of sovereignty inherent in the adoption of a common external tariff. Once a country has acceded to the EAEU, this incompatibility can only be overcome through direct negotiations between the EU and the EAEU – yet, so far, given the economic and political tensions between the two sides and the fact that neither Belarus nor Kazakhstan are members of the World Trade Organisation (WTO), such talks have been impossible.

In principle CISFTA, the second track of Eurasian integration, is compatible with other free trade zones and does not preclude the EU’s DCFTAs. A safeguard clause allows parties to suspend preferences if an increase in imports damages the domestic industries of other members.

DCFTAs include a wide range of provisions related to the EU’s internal market, including industrial standards, services, investments, competition, energy, and intellectual property rights. Several sections of the texts may be adapted to the needs of the respective signatory, taking into account the specific economic situation. Some measures with a potential economic impact, such as visa liberalisation for workers, are settled separately.

Short-term costs, long-term gains

DCFTAs do no prevent signatories from entering into preferential trade agreements with Russia or other countries. On the other hand, EU standards that are part of the DCFTAs may prevent Ukraine, Moldova, and Georgia from importing some non-energy products from Russia once Russian standards are revoked. However, DCFTAs do not include a deadline for their withdrawal and a long period of co-existence is expected.

Trade and economic analysis of these countries shows that, over the long term, their GDP growth rates have largely converged – and so have their trade deficits (with the exception of Azerbaijan, whose trade surplus has grown at a fast pace).

Over its first four years the economic results of the Eurasian Customs Union (EACU) have been mixed. For many post-Soviet states, however, economic agreements are not just about trade, as freedom of movement with Russia remains vital for many of them, and so do Russian energy supplies.

For all Eastern Partners signing AAs, the reforms required by the agreements result in short-term costs related to greater domestic competition, mitigation costs for the rise in unemployment, compliance costs for new legal obligations, and standard obedience costs.

In the long run, however, Ukraine’s AA should yield a GDP growth of 11.8%. On the other hand, had Ukraine acceded to the EAEU, it would have lost 3.7%. Moldova is expected to gain between 5.4% and 6.4% of GDP growth because of the AA. Had Moldova joined the EAEU, it would have lost 9.7%. Georgia will achieve an estimated long-term gain of 4.3% of GDP (the country never considered becoming part of the EAEU).

Russian retaliations

However, studies of the benefits of DCFTAs have failed to consider the effects of Russian countermeasures. For example, Moscow has reacted to the AAs by abolishing existing trade preferences, through trade bans on meat and agriculture products, and by threatening to obstruct the movement of foreign workers to Russia.

Russia will suspend preferences for Ukraine once its DCFTA takes effect; for Moldova this has already happened. Russia and Georgia are currently in talks about a possible suspension of the trade preferences instituted under their 1994 bilateral treaty.

Moscow has declared that, over ten years, the end of trade preferences is likely to cost Ukraine € 165 billion – € 31 billion more than Ukraine’s GDP. There is no comprehensive estimate for the cost of Russian measures to Moldova. However, if remittances from Moldovans working in Russia are affected – in 2013 they accounted for 9.3% of Moldova’s GDP – or Moldova’s import of Russian energy, this could cause serious damage to the country’s economy.

Georgia’s trade with Russia accounts for only 6.6% of the country’s balance. Still, if trade preferences were to be abolished the repercussions could be severe. Like Armenia and Moldova, Georgia benefits from substantial remittances – they represent around 4.5% of its GDP – and any effort by Russia to curtail this would be very harmful indeed.

The nature of the Eastern Partner countries’ trade with Russia is qualitatively different from their trade with the EU. At least in the short term, it is unlikely that increased trade with the EU could compensate Ukraine and Moldova for a loss of trade with the Eurasian Economic Union.

Solving trade conflicts – preserving trade links

Trade links with both the EAEU and the EU would be best for the Eastern Partnership countries. For them it is of key importance to remain part of CISFTA (except for Georgia, which has never been a member).

While the EU has declared that DCFTAs do not prevent partners from continuing to trade with Russia, the agreements do include some elements that, eventually, may penalise imports from Russia.

In the very long run, and once reforms are fully implemented, DCFTAs may result in diversification and restructuring, which, in turn, could open new markets to exports from Eastern Partnership countries and balance their trade deficits. This, however, will require adjusting production – away from the Russian and towards the EU market. To achieve this it will be necessary to attract private investment and also receive public aid in order to update infrastructure.

On balance, if possible regulatory conflicts between the EU and CISFTA can be averted, the result would be a significant increase in trade for all parties. However, this can only be achieved in a political situation conducive to such solutions.