Ukraine between the EU and the EAEU. Quo vadis Kiev?

_ Yuri Kofner, chair, Eurasian sector, CCEIS, Higher School of Economics (Moscow); research assistant, IIASA (Vienna). 20 June 2017.

More than a year after the entry into force (January 1, 2016) of the economic part of Ukraine’s association agreement with the EU (the deep and comprehensive free trade zone agreement, DCFTA), [1] it is possible to draw some conclusions about the first results of the “European choice”, made by the Kievan political elite.

Missed opportunities of Ukraine’s cooperation with the Eurasian Economic Union (EAEU)

The economic harm of the EU-Ukraine DCFTA and the potential advantages of Ukraine would have joined the EAEU (then the BY-KZ-RUS Customs Union and United Economic Space, but for coherence we shall use the term “EAEU”), were clearly demonstrated in a report published in 2012 by the Eurasian Development Bank (EDB). [2]

Here it is worth acknowledging that for a more actual analysis of the consequences of a potential resumption of economic cooperation between Ukraine and the Eurasian Economic Union, more contemporary research would needed. Unfortunately, neither the EDB, nor the Eurasian Economic Commission (EEC) have the mandate to conduct such a study, since for this they would need an official request from Kiev. In the current political circumstances, such a request is unlikely to come.

Nevertheless, according to the report, we can say, that, if Ukraine had joined the EAEU in 2013, the share of machine manufacturing in Ukraine’s GDP would have increased by 2030 from 6% to 9%. The share of machinery and equipment in Ukraine’s exports to the EAEU member-countries would have championed 20%. In the structure of Ukraine’s total exports to the EAEU, the share of aviation equipment would have increased to 7%. The share of shipbuilding products in the structure of Ukraine’s exports to the Eurasian Union would have doubled, while the share of other machine-building products would have increased by 11.8%. In the case of Ukraine becoming a member state of the EAEU, its GDP would have been 6% -7% higher by 2030 than in the baseline scenario.

As noted by economists many times over, after the three initiating countries – Belarus, Kazakhstan and Russia, Ukraine, out of all the other post-Soviet countries, would have been and still is the most desirable member state for accession to the Eurasian Economic Union. Second only to Russia, it had the largest population of 44.3 million people. If Kiev had joined the EAEU, the country would have constituted 1/4 of the Union’s total population. Upon accession, it would raise the total population of the Eurasian Union to 223.3 million, which would have been three quarters of 300 million – a population level that many economists believe to be the necessary threshold for making a regional integration bloc an independent player in the global economy. For a long time, Ukraine was the largest economy in the post-Soviet space, second only to Russia. In 2013 its GDP adapted to current prices amounted to 134.9 billion US dollars (5.6% of the EAEU’s overall GDP), and with a GDP per capita (PPP) of $ 8200. [3]

Difficult conditions of the EU – Ukraine Association Agreement

However, as we know, it did not work out. The regime, that took power following the Euromaidan coup d’état, enforced a sharp and unfathomable policy towards European integration, which led to results, that were opposite from beneficial. From a record $ 183.3 billion in 2013, Ukraine’s gross domestic product collapsed by 28.1% in 2014 and again by 31.3% in 2015 to only $ 90.6 billion, which is comparable its 2005 level. At the same time, total exports not only fell sharply but also deteriorated in quality and diversity. The share of primary goods, oil and grain increased both in exports and in the overall economic structure of Ukraine. During the same period, exports of machinery goods fell by 270% from $ 10.3 billion to 3.8 billion. In 2013, machinery accounted for 16.3% of Ukrainian exports. In 2015 it constituted only 11.6%. Simultaneously, the share of crop products in exports increased from 14% to 21%, the share of fats and oils – from 5.5% to 10.8%. [4]

Researchers from the Vienna Institute for International Economic Studies (wiiw) acknowledged in a recent study, that the implementation of EU regulation and other requirements of an association agreement would impose significant financial strains: both in direct costs to the state budget and in indirect losses for Ukrainian enterprises and the economy as a whole. [5]

For example, Kiev is obliged to adopt over 300 EU legal acts, mainly in the fields of agriculture, technical standards, labor law and financial services.

Investment costs that will be required for Ukrainian enterprises to be in line with the technical standards (TBT) and phytosanitary measures (SPS) of the EU will be significant. The highest costs will be associated with the approximation of technical regulations and standards, requirements for conformity assessment and labeling, phytosanitary regulations and animal health.

The transition will be particularly burdensome for small and medium-sized enterprises, which dominate the Eastern European economies of the former USSR. They are likely to face market share losses and a reduction in profits. Just for reference: according to the Global Competitiveness Report of the World Economic Forum for 2016-2017 Ukraine ranks 85th out of 138 countries, and its rating has been falling for the last few years.

The outflow of a large part of Ukraine’s labor force to Western Europe as well as structural transformations (deindustrialization) that are expected in connection with the EU AA will also have a negative effect on the country’s labor market.

For example, in Romania, which became an associate member of the EU in 1995 and a full member state in 2007, unemployment increased by more than 20% between 2000 and 2015 (more than 2 million people), mostly in the field of agriculture.

The agro-industrial sector has always been of great importance in Ukraine, both economically and culturally. Here, the export restrictions to the European market, which has been traditionally heavily protected, have proven to be especially burdensome. In addition to high safety standards (SPS), price quotas (TRQ) that protect some product categories. Here one could observe two extremes: Quotas were either not used at all because of the inability to comply with EU food safety standards and the lack of experience of operating in the EU market. Alternatively, the annual quotas for products that still met the EU’s safety requirements have often been exhausted in the first 2-3 months of the year. This is how it was with honey, grain, tomato products, grape juice and sugar.

Kiev’s notorious “European choice” had disastrous consequences for ordinary Ukrainians. GDP per capita fell from $ 3969 in 2013 to $ 2052 by the end of 2016, which is comparable to developing such as the Republic of the Congo, Djibouti and Laos. [6]

Principles of further cooperation between Ukraine and the Eurasian Union

In other words, instead of becoming one of the largest processing and manufacturing centers of the Eurasian Union, and, subsequently, an industrial and logistics hub of the wider economic space from Lisbon to Vladivostok, Ukraine, at its Transatlantic zeal, has practically become a Third World country specializing in the export of primary agricultural products.

Nevertheless, what is to be done? We must move on, based on the conditions that are given now and look forward to a probable future. What could be the configuration of Ukraine in the possible trade and economic architecture of Greater Eurasia? On what principles could the cooperation between Kiev and the EAEU be based?

First, dialogue on potential trade and economic cooperation between Ukraine and the EAEU could be conducted both in parallel and still depending on the systematic implementation of the Minsk-2 agreements.

Secondly, Ukraine’s potential cooperation with the Eurasian Economic Union and further participation in the possible creation of a common economic space from Lisbon to Vladivostok should happen exclusively on the voluntary initiative of the Ukrainian peoples.

Well, of course, here we should note that it was not Moscow, but Brussels, that in 2013 excluded any possibility of combining Ukraine’s “European path” with potential economic cooperation between Kiev and Eurasian Union. It was Brussels that stated that participation in the EU free trade zone would exclude any cooperation with the EAEU and that Kiev had to make a final decision “either – or”. Russia and the Eurasian Economic Commission on the other hand have repeatedly stated that they were always open to the idea of a common economic space from Lisbon to Vladivostok, and that it would be possible to combine Ukraine’s “European choice” with the Eurasian integration process.

The whole problem lay in the fact that the establishment of a free trade area between Ukraine and the European Union could lead to unhindered redistribution of EU goods to the EAEU market through the CIS FTA. Therefore, the raising of customs duties on the part of Russia for Ukraine on January 1, 2016 was a forced reaction, not as a punishment for Kiev, but as the only means to protect Russia’s producers. The Kremlin always tried to bring this problem to the attention of Kiev and Brussels. Yet, without results.

Technically, it is possible to link the EU and EAEU/CIS free trade zones by implementing the “rules of origin” institution. This would prevent the re-export of European goods “disguised” as Ukrainian goods. The “rules of origin” practice successfully operates in FTAs all over the world. However, in the first place this would have required negotiations and the creation of a tripartite working group (EU – Ukraine – EAEU) to jointly determine these rules of origin and other details of conjugation. In the near future is seems possible that a similar format might be applied for the creation of the FTA between the EAEU and Serbia, a country, which signed the Stabilization and Association Agreement with the EU in 2008. [7]

The third point to be taken into account is the weak economic situation of post-Euromaidan Ukraine. In this regard, it is necessary to seriously consider the conditions for Ukraine’s potential cooperation with or even participation in the Eurasian Economic Union.

Fourthly, we must also emphasize that Ukraine’s cooperation with the EAEU would be conducted exclusively in the economic sphere. The Eurasian Economic Union does not imply any political, military or ideological interactions. Any potential economic cooperation between Kiev and its Eastern partner does not in any way infringe on its foreign policy choice.

Potential solution: the EU – EAEU common economic space

In the short term, Ukraine is unlikely to withdraw from its association agreement with the European Union. Moreover, Kiev is even less likely join the Eurasian Union. In this regard, a solution from the current impasse may be the creation of a common economic space between the EU and the EAEU with Ukraine in the center.

According a recently published report by the Munich-based Ifo Institute [8], the Ukrainian economy in principle would benefit from the creation of such a common economic space (in their scenario – form a free trade zone) between the European Union and the Commonwealth of Independent States.

In this case, compared to the baseline scenario net income in retail trade would grow by 3% (in 2016 this sector accounted for slightly less than a quarter of Ukraine’s GDP – 13%), in electricity production by 8% (17%) and in smelting of ferrous metals by 33% (2.5%). At the same time, inflation would be likely to fall by 1.2% and GDP would increase by 4.7%. Each Ukrainian’s net wealth would increase by € 90. The country would also become more integrated into international trade flows.

***

Ukraine’s post-Euromaidan regime has been relentlessly pushing its European integration policy. It is an agenda, which is leading the country towards an increasingly narrowing economic impasse. The likely beneficial accession chance of Ukraine to Eurasian Economic Union has been missed. At this stage, this option has become even more unlikely, both due to Kiev’s political decision and due to the conditions of the EU – Ukraine AA/DCFTA. At the same time, the concept of creating a common economic space from Lisbon to Vladivostok (within the broader idea of the Greater Eurasian Partnership) might become a reality within the next 10 years. Moreover, this could happen regardless of the will of Kiev. Not because of Russia, but because German and French business interests. Which role will the Ukrainian economy play in this new Greater Eurasian architecture?  This is the real question, to which Kiev should find its answer.

Notes:

[1] http://www.consilium.europa.eu/en/documents-publications/agreements-conventions/agreement/?aid=2013005

[2] Comprehensive assessment of the macroeconomic effect of various forms of deep economic cooperation between Ukraine and the countries of the Customs Union and the Common Economic Space within the framework of the Eurasian Economic Community. – Moscow: CSI EDB. 2012 – 168 pp. // RUS:  Kompleksnaya otsenka makroekonomicheskogo effekta razlichnykh form glubokogo ekonomicheskogo sotrudnichestva Ukrainy so stranami Tamozhennogo soyuza i Yedinogo ekonomicheskogo prostranstva v ramkakh YevrAzES. — M.: TSII YEABR. 2012 g. — 168 s.

[3] Kofner Yu.Yu. EAEU in the global economy and directions of integration in Greater Eurasia / Eurasian economic integration: the potential and resources of development: a collection of theses of the competitive works of the participants of the IV International competition for the best scientific work among young scientists / ed. Dr. econ. Sciences, prof. I.A. Maksimtseva. – SPb .: Publishing house of SPbSEU, 2017. – 86 – 88 p. // RUS: Kofner YU.YU. YEAES v global’noy ekonomike i napravleniya integratsii v Bol’shoy Yevrazii / Yevraziyskaya ekonomicheskaya integratsiya: potentsial i resursy razvitiya : sbornik tezisov konkursnykh rabot uchastnikov IV Mezhdunarodnogo konkursa na luchshuyu nauchnuyu rabotu sredi molodykh uchenykh / pod red. d-ra ekon. nauk, prof. I.A. Maksimtseva. – SPb.: Izd-vo SPbGEU, 2017. – 86 — 88 s.

[4] http://www.vz.ru/economy/2017/2/22/858364.html

[5] Adarov A .; Havlik P. Benefits and Costs of DCFTA: Evaluation of the Impact on Georgia, Moldova and Ukraine. Vienna .: Joint Working paper. Vienna Institute for International Economic Studies (wiiw); Bertelsmann Stiftung. December 2016. – 120 p.

[6] Ibid.

[7] http://www.consilium.europa.eu/en/documents-publications/agreements-conventions/agreement/?aid=2007137

[8] Freihandel von Lissabon bis Wladiwostok: Wem nutzt, wem schadet ein eurasisches Handelsabkommen? – Muenchen. Ifo-Institut. Maerz 2016. – 124 S.

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