Ukraine has to make a choice

Meeting the EU's expectations seems much easier than Russia's (Victor Yanukovich, president of Ukraine and Herman van Rompuy, President of the European Council (CC BY President of the European Council)

There are many signs that the fate of Ukraine standing at the European crossroads is going to be resolved soon. And the choice is not just an economic profit and loss account of integration with the EU or Russia.

Carrying a heavy load of political internal conflicts, Ukraine has long been under pressure of Russia trying to induce the country to accede to its integration organisations established within former Soviet Union. Nonetheless, Ukrainian elites do not give up the long-term project of integration with the EU. After the Verkhovna Rada of Ukraine had passed laws bringing it closer to the conditions set by the EU and the Ukrainian government had approved the EU-Ukraine Association Agreement, the path to signature at the November Eastern Partnership Summit in Vilnius stands open. It is doubtful that the incarcerated Julia Tymoshenko could be an impediment to such an important process for Europe.

Economic integration of former Soviet Union

The Russian counter-proposal was to incorporate Ukraine in the Customs Union (CU) dating back as far as 1995 when the leaders of Russia, Kazakhstan, Belarus, Kyrgyzstan, Uzbekistan and Tajikistan signed an agreement on establishing the CU transformed into the Euro-Asian Economic Community (EAEC or EurAsEc) in 2001, to which Moldova, Ukraine and Armenia acceded in 2002-2003 as observers. The project, which was aimed at creating a single market and a single economic area, did not go beyond agreements on joint development of fuel and energy balance and regulations on grain supplies to state members – and in fact remained dead.

2006 saw a decision about creating the CU composed of only three states, which were determined to implement this initiative, i.e. Russia, Belarus and Kazakhstan. In 2007, it was decided that the CU will be formed over three years within which the CU Commission will be established – a supranational body, in which Russia obtained 57 per cent of votes, and Belarus and Kazakhstan – 21.5 per cent each. The proportions already showed the true significance of partners and the chances of equal collaboration among them.

In 2009, the leaders signed ca. 40 agreements forming a legal basis for the future CU, however spring 2010 witnessed a serious differences of opinion between President Lukashenka and Vladimir Putin, and the latter declared that the Common Economic Space may well be established without Belarus. The difficulties were overcome and in July 2010 the Customs Code entered into force in those three states. In April 2011, customs control was abolished at Russian and Belarusian border, and in July 2011 – at Kazakh border.

On 1 January 2012, the Common Economic Space was created in three CU states, and in July the same year, integration principles (adopted in 18 November 2011) began to take effect. They envisage zero VAT rate and no excise tax on a basis of export documents. In imports to the Russian Federation from Belarus and Kazakhstan, VAT and excise tax is charged by Russian tax authorities. Services provided by their partners in the Russian Federation are either taxable or exempt from tax or subject to tax relief in accordance with Russian legislation.

Since December 2010, the idea of creating the Euro-Asian Union on a basis of the Common Economic Space has begun to gather momentum. In the autumn 2011, during the election campaign, Putin published an article entitled “The New Integration Project of Eurasia – a Future that is Being Born Today”. Without hiding his ambitions, he said that the Euro-Asian Union would help Russia gain a new status of “one of the poles of the contemporary world”. Nevertheless, while in July 2011 he claimed that with such pace of the project the Euro-Asian Union should become reality in 2013, as early as in October 2013, in consequence of opposition from Kazakhstan against the “Euro-Asian Union” name – he had to slow down and declare that the idea should be implemented on the threshold of 2015. On 18 September 2012, the Majilis (Kazakh parliament) representatives voiced their opposition against the planned supranational political structure of the Euro-Asian parliament, which was suggested by the speaker of the State Duma of the RF, Sergey Naryshkin. They declared that the creation of such body threatens the sovereignty of their country and cannot even be decided in a referendum, since it is against the Constitution. Also other elements of the common economic policy, such as single currency, are getting nowhere. Leaving aside the energy commodities sold for USD or EUR, the RUB domination across all goods groups is overwhelming. Its share in trade of the three states accounts for as much as 90 per cent.

Russia does not ease its pressure on the former Soviet Union states (for example: the re-imposition of embargo on Moldovan wine exports to Russia witnessed in September 2013 sparked by the pro-European course of the current Moldovan authorities). In the case of Armenia, whose almost all economic sectors have come under control of Russian companies, the policy bears the desirable fruit. On 3 September 2013, Armenian President, Serge Sargsyan, declared its readiness to join the Customs Union.

What is then the choice of Ukraine oscillating between the two poles? What are its short and long term interests? Should it go for quick profits promised by Russia after the CU accession and later the Euro-Asian Union accession or take the long path of joining the EU without a clear perspective of full integration with the EU?

The reasons behind the choice

Theoretically, the benefits of joining the CU are justified by general economic rights of market extension: reduction of goods prices through reduction of cost of transportation of commodities and exports of the country’s finished products; development of competition in the single market through equalisation of the economic development among state members and the entry of new Common Economic Space members on the market, increase in average wage through reduced cost and increased efficiency, increased output through higher demand and life standards of the entire Euro-Asian Union population related to price reductions and increased employment in the goods/services import-and-export-oriented developing companies or better cost-effectiveness of new technologies and goods thanks to market extension.

Optimists believing in Ukraine’s bright future through the CU accession say that the financial benefits would include access to the 170-million CU market (which would help increase exports by USD 5-9bn), reduce oil and gas prices (which would generate savings in the region of USD 3-6bn p.a.). The simultaneous lifting of Russian customs levies on hydrocarbon exports would improve Ukraine’s trade balance by USD 2.9bn. (with USD 180 per 1,000 cubic metres, just as in trade with Russia or Belarus, exports would have come to USD 5bn. – the same amount as the deficit in trade with Russia in 2010). Extra profit of USD 1bn would be generated by the lifting of technical barriers. In the situation where Russia claims contractual penalties from Ukraine to be paid this year (USD 7.1bn) for taking smaller deliveries of Russian gas quantities (the exports contract provided for a take or pay formula, i.e. a necessity to pay for the entire contracted gas no matter if taken – and without re-exporting option), the offer of joining the CU is tempting for the weak Ukrainian economy.

Following the reduced prices of energy carriers, new development opportunities for the energy industry arise, such as metallurgy, construction of machinery and equipment, chemicals, and this will produce jobs. Increased output and exports would enable the country’s financial stabilisation and provide stable demand for UAH. Total benefits for Ukraine from the Common Economic Space would fall within USD 6-10bn. This would produce GDP growth of 1.0 per cent p.a., and over a decade would increase the total economic activity by 17 per cent of GDP. The advocates of Ukraine’s development within post-Soviet standards also see it as a privilege to become independent of new requirements set by the IMF that demands that gas prices for households be increased and pensions and social security benefits be frozen. They also claim that Ukraine’s accession to the Common Economic Space corresponds to the global integration processes, covering countries with close historic ties, similar economic structure (Middle America, South Africa, Eastern Caribbean, EU etc.) without prejudging the loss of sovereignty. Such integration would correspond to most sentiments of the Ukrainian society bound to the Orthodox Eastern Slavic civilisation.

There are also heavy arguments against Ukraine’s accession to the CU, chiefly, albeit not only, political. One of them is the growing influence of Russia in Ukraine, both internally and externally. If Ukraine joins the Euro-Asian Union (of which the CU is the first phase), some powers of political authorities would have to be passed on to the supranational body. Another element of such move would be the strengthening of authoritarian tendencies, which are still seen in Ukraine. This would reinforce the criticism of the world public opinion and deepen the isolation from the pan-European processes.

In the economic sphere, there are also negative aspects of integration with the Common Economic Space. Given the reduced prices of energy commodities there would probably be disputes within the WTO since these would be perceived as hidden subsidising of the economy, and entail sanctions. Another negative aspect is loss of a 50-million EU market for Ukrainian goods. The EU is currently the largest commercial partner of Ukraine. The Russian share in trade stands at ca. 40 per cent, and leaving aside energy commodities, the trade accounts for ca. 23 per cent while the trade with the EU is more than 32 per cent. EU countries are also major investors in Ukraine, and their combined investments are several times higher than Russian. The CU accession would also hit national manufacturing, since it would mean the necessity to increase customs levies on goods which Ukraine could import at low prices, and this is because the products are not manufactured at home, and also the necessity to lower customs levies on goods that could be replaced with domestic products. The cumulative consequence of the accession to the CU for the economy would be giving up of the upgrading of the country’s economy since reduced prices for energy carriers would eliminate any incentives for efficient, energy-saving management.

The experience of the Customs Union

Arguments against accession to the CU are also produced by rather short experience of the CU members. In the CU operations, there are three key directions defining the goals of the Common Economic Space and the instruments of their attainment. This is the tightening of the economic integration through trade development, effected by the abolition of external customs control, reduction of commercial costs and simplification of procedures. The lifting of non-tariff barriers such as different technical standards (incl. veterinary and phytosanitary requirements) is a must. These goals are attainable only through in-depth institutional reform across all CU states.

What about the practical implementation of those goals? The Customs Union assumes introduction of a single customs tariff at its external border (with significant exceptions for each state, which should be eliminated by 2015). Russian tariffs, which were much higher than in the other two states, were taken as a basis. The CU states removed internal borders and all goods are circulating without customs control, however their Kazakh and Belarusian exporters keep complaining about the Russian authorities bypassing the tariff agreements to fight imports – predominantly through application of veterinary and phytosanitary regulations.

Currently, in Kazakhstan, in effect of the CU accession, the return on invested capital shrank by 0.6 per cent, and real wages by 0.5 per cent. The weighted average customs rate in Kazakhstan went up from 5.3 per cent to 9.5 per cent. (it was too high tariffs that were behind the total fiasco of the previous attempt to establish the Customs Union in 1996).

In the case of Belarus, the growth was not as pronounced, however it also hit the consumers’ interests, e.g. through levies on imported cars. This leads to shrinking imports (e.g. Chinese) but most of all increased imports from Russia, of often cheaper but poorer quality goods. The replacement of European imports with Russian goods means a serious income outflow from Kazakhstan to Russia.

In Kazakhstan, the Customs Union is even defined as an “ideal system” of draining the country’s capital. Exactly the same would happen in Ukraine since imports from all non-CU countries will go up much in price considering that the current weighted average import customs rate in Ukraine is 4.45 per cent, and in the CU – 9.43 per cent. Even more serious consequence of more expensive imports is more expensive access to high-tech equipment, which in the long run reduces the achieved efficiency. Despite a 30 per cent rise in trade, contraction would occur across almost the entire service sector for lack of protection of the sector as opposed to the manufacturing sector (textiles, furniture, machinery and equipment, automotive and transport industry). While very fact of growth of those industries is positive, the economy shows development disproportions resulting from improper allocation of resources caused by artificial preference for certain sectors.

The Belarusian case is special since the entire economy has long been subsidised by Russia (extraordinarily low oil and gas prices). Nevertheless, the CU membership does not shield the country against frequent conflicts with Russia. A few days ago, President Lukashenka, at a press conference in Moscow, declared that Belarus can leave the CU if Moscow fails to stop charging export customs levies from 1 January 2014 on oil products made from Russian commodity. Belarus must pay Russia USD 4bn p.a. for that. According to Lukashenka, if Russia meets this obligation, the Belarusians will be as affluent as people in the Emirates.

– We will not continue our CU membership if we cannot benefit economically from it – Lukashenka said.

A conflict within

The decision for the Russian or pro-European option is fraught with consequences, also on its intra-political arena. It may exacerbate tensions in relations between oligarch groups since their economic interests often diverge. While for some of them it is high gas prices that are beneficial – for others it is the low ones. Conflicts of interests among regions can also intensify. In the eastern and southern part of the country, there are fewer opponents of Ukraine’s EU accession (40.5 per cent) than opponents of the CU accession (40.9 per cent); in the western and central part the figure stands at 62.8 per cent and 37.8 per cent respectively).

The Ukrainian dilemma is not easy. The current state of its elites does not allow for significant determination in its aspirations to meet political and economic EU standards. No clear declaration as to the real accession to the EU, and only the signature of an association agreement (which does not produce fast direct economic effects) and no such guarantee for the future must evoke a serious dilemma. The Russian blackmail, pressure from Gazprom, a huge propaganda warning against imminent bankruptcy of Ukraine if the hazy agreement with the EU is signed, which will ultimately cut it off from the former Soviet Union, the support of political demonstrations of pro-Russian groups, the use of the Orthodox Church of the Moscow Patriarchate as a fundament of spiritual community of Slavs untouched by decadent Western culture contributes to the dilemma. The reasons of such Russian policy are clear. Unlike the EU, in the accession process, Russia does not set any qualitative economic or political conditions. The forcing of the “integration” process of former Soviet Union states should only prevent Ukraine from coming closer to the West and is an attempt to rebuilt Russian post-imperial space.

In such circumstances, the Ukrainian choice is fundamental not so much from the economic but political point of view. This is a choice of civilisation.

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