75656 FEBRUARY 2013 • Number 108 What Promises Does the Eurasian Customs Union Hold for the Future? Francisco G. Carneiro Established in 2010, the Eurasian Customs Union (ECU) carries significant economic weight as three of its member countries represent a potentially large consumer market. Drawing on existing literature that has studied the likely impacts of the ECU in Central Asia, this note discusses the ECU’s pitfalls and potential benefits. After briefly describing the main features of the ECU, this note assesses whether the changes introduced after its establishment have benefitted all of its members equally, and concludes with a discussion of what will need to change to achieve the ECU’s full potential. Available evidence suggests that the Russian Federation has been the main beneficiary in the short term, but that there are several benefits to be gained by other members in the medium to long term. Full realization of these benefits, however, will require political commitment and steadfast action to reduce nontariff barriers (NTBs), improve trade facilitation, and reduce the costs of trading across borders in the region. What Are the Main Features of the Eurasian the initial common external tariff schedule reflected the Rus- Customs Union? sian schedule.2 These exceptions are, however, expected to be removed in phases by 2015. Furthermore, the ECU has deter- The ECU, formed by Belarus, Kazakhstan and Russia, was es- mined rules regarding sanitary and phytosanitary standards tablished in January 2010 and is part of the Eurasian Eco- to be applied to exports and imports of goods among the three nomic Community. It carries significant economic weight, countries. mostly because its three member countries represent a poten- tially large consumer market with a total population of 167 Political economy dimensions of the ECU million, an estimated total gross domestic product (GDP) of The ECU is seen by many as a deliberate attempt by Russia to US$2 trillion, and a goods turnover of approximately US$900 reintegrate the former Soviet republics under Moscow’s influ- billion. Armenia, the Kyrgyz Republic, Tajikistan, and Uz- ence and counteract the economic expansion of China and bekistan are potential participants.1 the European Union in Eurasia. The Commonwealth of Inde- Almost immediately after forming the ECU, Kazakh- pendent States (CIS) area has a somewhat limited economic stan, Russia, and Belarus started applying a common external importance for the Russian economy: the area accounts for import tariff. In addition to adopting a common external tar- less than 14 percent of Russia’s trade and less than 1 percent iff, internal border controls were removed, first between Rus- of Russia’s investments. Russia’s economy is much more close- sia and Belarus, and then between Kazakhstan and Russia. ly tied to the European Union (EU), its larger trading partner. With a few exceptions in each of the three member countries, However, the ECU creates an opportunity for Russia to ex- 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise pand its exports and its presence in Central Asia at the ex- (v) Deeper regional integration can help member countries pense of exports from other countries, such as the European strengthen their economic and political institutions. Union and China. (vi) Integration can encourage the liberalization of service As argued by Wisniewska (2012) and Dragneva and Wol- markets. czuk (2012), Russia’s interest in the region has been motivat- A common tariff with unequal consequences ed mainly by political reasons. While there have been various Despite these potential benefits, there are some risks to join- past attempts to reintegrate the newly independent republics ing a trade bloc that have become a concern in the context of of the former Soviet Union, these have not been very success- the ECU. The first of these concerns is that a relative change ful. At the same time, the EU, which in the mid-2000s in tariff barriers can divert trade from more efficient external stepped up its engagement in the post-Soviet countries, has exporters to less efficient ones.6 As argued by Tarr (2012), gradually become the synonym of modernization and gover- since the common external tariff was in essence a reflection of nance standards in the region.3 It is in that context that Russia the import duties adopted by Russia, the ECU did not have sees the ECU as a way to compete in a domain where the EU much of an impact on tariffs there. The big change took place has been dominant until now.4 Russia has repeatedly reiterat- in Kazakhstan, where the tariff structure was much lower ed the economic benefits of the ECU, which follows a rules- than in Russia before the country joined the ECU. The World based regime consistent with the World Trade Organization Bank (2012) estimates that as a result of implementing the (WTO) and has adopted modern norms and an ambitious common external tariff of the ECU, with a few exceptions, institutional setup. the tariffs of Kazakhstan have increased from an average of The three member states have also taken steps to embed 6.7 percent to 11.1 percent on an unweighted basis, and 5.3 the ECU within a broader framework for enhanced economic percent to 9.5 percent on trade-weighted basis. integration by establishing on January 1, 2012, the Single The direct impact of a higher external tariff on Kazakh- Economic Space. The legal basis of the ECU and the Single stan and Belarus was felt, for example, in the form of a sub- Economic Space is expected to be fully in place within three stantial increase in the imports from Russia and the displace- years so that the Eurasian Economic Union can be launched ment of imports from the EU and China. In that context, Tarr on January 1, 2015. The Single Economic Space envisages a (2012) argues that Russia benefitted by expanding its exports, common market of goods, capital and labor, and the opera- even if they were not competitive, while Kazakhstan and Be- tion of common macroeconomic competition, financial and larus were deprived from importing higher quality goods other regulations, including harmonization of policies in ar- from Europe. Isakova and Plekhanov (2012) estimate that Ka- eas such as energy and transport.5 zakhstan’s imports from China saw an even more significant Is the ECU Benefitting All of Its Members decline in response to the higher ECU external import tariff. Equally? This is also a view shared by the EBRD (2012, 70), which rec- ognizes that: There are several benefits to a trade bloc that make joining ap- To date, the Customs Union appears to have pealing. Some of the most obvious ones are the removal of had tariff-related trade creation effects only for trade barriers and potential access to a larger consumer mar- Russia, as reduction in external tariffs have been ket. However, there are some risks too, including trade diver- associated with higher imports from selected sion and asymmetric treatment within the bloc. trade partners outside the Union. Potential economic benefits of greater trade integration Three scenarios for the future In its recent 2012 Transition Report, the EBRD identifies some In a recent report, the World Bank (2012) arrived at similar likely short- and long-term impacts of increased regional eco- results by estimating a 57-sector computable general equi- nomic integration that the ECU can bring about. These ben- librium (CGE) model for the case of Kazakhstan. The efits are grouped in the following six categories: Bank’s assessment indicates that not only has the ECU ben- (i) Lower tariffs and the removal of NTBs should increase efitted Russia the most, but also that Kazakhstan has experi- trade and enhance consumer choice. enced losses in real income, wages, and returns on capital as (ii) Producers within a regional integration grouping, includ- an immediate result of the ECU, while the expected easing ing the ECU, can benefit from increased market size. of NTBs and improvements in trade facilitation remain a (iii) Exporting within a regional area may serve as a first step distant objective. Nonetheless, the report simulates the ex- toward the expansion of exports worldwide. pected impacts of three possible scenarios: (i) a baseline sce- (iv) Countries within a regional integration area can build nario to estimate the impact of what has actually been im- cross-border production chains by leveraging each other’s plemented as a result of the introduction of the ECU; (ii) a comparative advantages and subsequently exporting the pessimistic outlook scenario, which assumes that Kazakh- finished product outside that area. stan will fully implement the common external tariff by 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise eliminating the remaining exceptions, but does not realize licensing or quotas on imports or exports; state control or mo- any reduction of its trade facilitation costs or reductions in nopoly control of imports or exports; state subsidies on pro- NTBs; and (iii) an optimistic outlook scenario, where it is duction or exports; and technical regulations, including sani- assumed that Kazakhstan fully implements the common tary and phytosanitary (SPS) measures that may be barriers to external tariff and that trade facilitation costs and NTBs are trade. Although the challenge of addressing the standards substantially reduced in the ECU. problems and other NTBs is very large (box 1), reduction of In the baseline scenario, with the tariff changes that took NTBs could potentially bring substantial benefits to ECU place with the ECU, the average tariff rate in Kazakhstan in- member countries. In the case of the ECU and the CIS, Tarr creases by 78 percent, imposing a higher cost to import from (2012) argues that SPS conditions and technical barriers to outside the ECU and the CIS, and diverting trade to these re- trade are even more important than in other regions of the gions. This increases import costs for businesses and consum- world. ers, and under the tariff umbrella, resources are shifted to ar- Evidence from the 2009 round of the Business Environ- eas of inefficient production. Under these circumstances, ment and Enterprise Performance Survey that was concluded Kazakhstan loses about 0.2 percent in real income per year as just before the ECU was established suggests that improve- a result of participation in the ECU, and real wages are de- ments are needed in customs procedures in the region. As re- pressed by 0.5 percent while the real return on capital in Ka- ported by the EBRD 2012 Transition Report, approximately zakhstan drops by 0.6 percent. Kazakhstan also trades less 30 percent of the firms in Belarus, Kazakhstan, and Russia with the rest of the world, resulting in less imported technol- that traded across borders viewed these procedures as a seri- ogy from the more technologically advanced EU, which is ous problem, while only around 10 percent did so in the new likely to lead to a loss in productivity gains in the long run. EU member states. The EBRD argues that a number of im- The pessimistic scenario is in essence very close to the base- portant NTBs within the Single Economic Space have yet to line, because Kazakhstan is expected to lose about 0.3 percent a year in real income, with similar impacts as in the baseline in regards to real wages and returns on capital. Box 1. Two Weights and Two Measures In the optimistic scenario, the Bank makes an optimistic Russia requires many imported products to have a certifi- assessment of how much the ECU may lower trade facilita- cate of conformity issued by its Federal Agency for Techni- tion costs to trade and how much Kazakhstan can benefit cal Regulation and Metrology. Russia does not recognize from a reduction in NTBs. Lower trade facilitation costs and internationally accepted certified products and undertakes NTBs both save resources and thus reduce the costs of im- their testing and mandatory certification in accordance with porting and exporting. Under these circumstances, the esti- Russian standards. Certificates of product conformity issued in Kazakhstan for Kazakhstani exporters will often not be mated impact is an increase in real income by about 1.5 per- recognized in Russia. Further, producers in Kazakhstan of- cent of consumption per year. The reduced trade facilitation ten have to produce to one standard for the domestic mar- costs would represent about 93 percent of the gain in con- ket, another standard for exports to Russia, and potentially sumption. In this scenario, the gains from the reduced NTBs other standards for other markets, raising their production roughly offset the losses from the full implementation of the costs. Finally, some Kazakhstani food exporters have report- common external tariff.7 ed situations in which they were required to pay Russian agencies for inspections of their facilities, under threat of What Will Need to Change to Ensure denial of market access, and they have alleged that the in- Realization of the Full Potential spection fees appeared excessive. Although Kazakhstan has also formally announced its of the ECU? intention to convert to EU standards, the country has a mix Previous attempts at regional integration in Central Asia have of standards including domestic, GOST,a EU, and interna- tional standards. GOST standards, however, still dominate. failed and the success of the ECU is not guaranteed. A num- Kazakhstan and the other members of the ECU maintain ber of difficulties that stood in the way of success in the past their own lists of goods subject to mandatory regulation. The remain prevalent today and may even have been exacerbated. integration of these lists was still very limited as of 2011. These include NTBs, trade facilitation, and border crossing Thus, those importing into Kazakhstan also face problems. problems. What needs to be done, and what needs to be tack- Kazakhstani businessmen allege that the problems are less led first to ensure ECU success? severe for imports into Kazakhstan than for their exports to Russia, but nonetheless, they raise the costs of importing Address NTBs first into Kazakhstan, which raises the costs of doing business in Available evidence seems to suggest that in order for the ECU Kazakhstan. to benefit all of its members, it will be essential for them to Source: World Bank 2012. a. GOST refers to a set of technical standards maintained by the Euro-Asian work together to reduce trade facilitation and border crossing Council for Standardization, Metrology and Certification (EASC). costs as well as NTBs. Among the most important issues are 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise be fully removed. In particular, technical and sanitary regula- stan would likely reap similar gains from WTO accession, tions need to be harmonized, and, in many cases, firms are about 6.7 percent of GDP in the medium term. For both still subject to national-level inspection and certification of Russia and Kazakhstan, liberalization of barriers to foreign their produce. In addition, the legal regime governing imports investment in business services, which contributes to the into the ECU, which is underpinned by national and suprana- competitiveness and productivity of Russian and Kazakh- tional legislation, is complicated and may entail increased stani manufacturing, is the major source of gains from WTO compliance costs. Furthermore, there is a clear need to reduce accession. NTBs for export and import trade between ECU members and other countries. Conclusion Lower the cost of trading across borders At this stage, while the ECU and Single Economic Space ar- According to the World Bank 2013 Doing Business Survey,8 rangements are certainly steps in the right direction, there is the three members of the ECU are ranked in the bottom third still a long road of reform, institutional change, and political when it comes to trading across borders, with Kazakhstan commitment ahead. The multiple, positive impacts of in- ranked 182nd, Russia 162nd, and Belarus 151st in the world out creased trade integration that can potentially benefit ECU of 185 countries. These rankings are due mainly to high costs members will only materialize with meaningful improve- (measured in U.S. dollars per container), the time it takes to ments on NTBs and the development of market-oriented in- export and import (measured in days), and also the large stitutions to pave the way for improvement in the business number of necessary documents. In the case of Kazakhstan, environment and trade facilitation in the region. the higher border costs are partially the result of the natural Russia’s recent WTO accession is likely to play a positive geographic disadvantage of being both landlocked and far role in this context. Russia’s accession has the potential to sig- from the major markets of the world, notably the EU. On the nificantly boost the positive impacts of the ECU in the region. other hand, the higher costs are also partially the result of Most importantly, as a result of Russia’s accession, the ECU weak institutions. However, the poor score of the three coun- tariff is expected to fall by about 40 to 50 percent. This will tries on the number of documents required for importing and reduce significantly the transfers from Kazakhstan to Russia exporting, which may also reflect red tape in the acquisition and lower the trade diversion costs for Kazakhstan. In addi- of documents, is unrelated to geography and can potentially tion, the ECU will be expected to adapt its rules on standards be improved by a better institutional framework. to conform to commitments Russia made as part of its WTO So far, progress on defining common technical regula- accession agreement. tions and SPS conditions throughout the ECU has been very Looking forward, besides addressing NTBs and border slow. But if progress could be made in this area, it would lead issues, ECU members should look for opportunities farther to substantial benefits in terms of reduced production costs east. The World Bank is conducting research that will shed for exports and imports. In sum, the ECU could lower border light on important factors that could help ECU members costs by: (i) eliminating trade borders within the union, (ii) move in that direction. The forthcoming flagship report on reducing the number of documents required for importing Eurasian growth and the Country Economic Memoran- and exporting and the difficulty in obtaining the documents, dum for Kazakhstan will assess, for example, what types of and (iii) reducing corruption on the roads within the ECU. products ECU members would be most competitive on; Expect the most from WTO accession what markets they should consider joining or gaining access Both Russia and Kazakhstan can expect to reap substantial to; whether they have the right endowments to be competi- gains from their cumulative commitments for WTO acces- tive with new products and in new markets; and, most im- sion. Jensen, Rutherford, and Tarr (2007) estimated Russia’s portantly, whether they have the right set of institutions to gains from WTO accession in the medium term of about 3.3 succeed. percent per year of the value of its GDP, or more than 7 per- About the Author cent of Russia’s consumption. In the long term, when the positive impact on the investment climate is incorporated, Francisco Carneiro is Lead Economist in the Europe and Central the gains should increase to about 11 percent per year of the Asia Region in the Poverty Reduction and Economic Management value of Russia’s GDP. Further research by Rutherford and (PREM) Network of the World Bank, where he has worked on Tarr (2010) showed that virtually all households and regions other regions of the world as well. Before joining the Bank in would gain, but the regions that will gain the most are those 2003, he was a professor of economics in Brazil and worked as that are most successful at attracting foreign direct invest- an international consultant on economic policy and develop- ment and creating a good investment climate. Research on ment issues. Carneiro received his PhD in economics from the Kazakhstan by Jensen and Tarr (2008) shows that Kazakh- University of Kent in the United Kingdom in 1996. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Notes Gill, Indermit, and Martin Raiser. 2012. Golden Growth: Restoring the Lustre of the European Economic Model. Washington, DC: 1. See Krotov (2012) for a detailed discussion of the ECU’s World Bank. administration system. Isakova, Asel, and Alexander Plekhanov. 2012. “Customs Union 2. According to Wisniewska (2012, 1), the common import and Kazakhstan’s Imports.� European Bank for Reconstruction and Development, London. tariff introduced by the ECU coincides 80 percent with the Jandosov, Oraz, and Lyaziza Sabyrova. 2011. “Indicative Tariff import duties that were in force in Russia at the time of the Protection Level in Kazakhstan: Before and After the Customs ECU’s inception. Union (Part I).� Discussion Paper No. 5.3, RAKURS Center for 3. For a discussion of the European economic model, see Gill Economic Analysis, Almaty, Kazakhstan. and Raiser (2012). Jensen, Jesper, Thomas Rutherford, and David Tarr. 2007. “The Impact of Liberalizing Barriers to Foreign Direct Investment 4. See Dragneva and Wolczuk (2012) for a political economy in Services: The Case of Russian Accession to the World analysis of the EU governance model and its approach to Rus- Trade Organization.� Review of Development Economics 11 (3): sia. 483–506. 5. See EBRD (2012) for an assessment of the ECU and details Jensen, Jesper, and David Tarr. 2008. “Impact of Local Content Restrictions and Barriers against Foreign Direct Investment about the creation of the Single Economic Space. in Services: The Case of Kazakhstan Accession to the WTO.� 6. See Venables (2003) for a discussion of aspects related to Eastern European Economics 46 (5): 5–26. trade diversion. Krotov, Igor. 2012. “Customs Union between the Republic of Be- 7. These findings are similar to those presented by Jandosov larus, the Republic of Kazakhstan and Russian Federation with and Sabyrova (2011) in an analysis of pre- and post-ECU tariff the Framework of the Eurasian Economic Community.� World Customs Journal 5 (2): 129–28. rates in Kazakhstan. Jandosov and Sabyrova find that the tar- Rutherford, Thomas, and David Tarr. 2010. “Regional Impacts of iffs in Kazakhstan approximately doubled in 2011, and that Liberalization of Barriers against Foreign Direct Investment in tariff variations increased substantially after the creation of Services: The Case of Russia’s Accession to the WTO,� Review of the ECU. International Economics 18 (1): 30–46. 8. See http://doingbusiness.org/rankings. Tarr, David. 2012. “The Eurasian Customs Union among Russia, Belarus and Kazakhstan: Can It Succeed Where Its Predecessor References Failed?� New Economic School, Moscow. Venables, Antony. 2003. “Winners and Losers from Regional Inte- Dragneva, Rilka, and Kataryna Wolczuk. 2012. “Russia, the Eur- gration Agreements.� Economic Journal 113: 747–61. asian Customs Union and the EU: Cooperation, Stagnation or Wisniewska, Iwona. 2012. “The Customs Union of Belarus, Ka- Rivalry?� Chattam House Briefing Paper 2012/01, Chattam zakhstan and Russia: A Way to Strengthen Moscow’s Position House, Russia and Eurasia Programme. in the Region.� ISPI Analysis No 146, Instituto per gli Studi de EBRD (European Bank for Reconstruction and Development). Politica Internazionale. 2012. Transition Report 2012: Integration across Borders. London: World Bank. 2012. Assessment of Costs and Benefits of the Customs EBRD. Union for Kazakhstan. Report No. 65977-KZ, Washington, DC. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise