Exploring the economics of the ‘Lisbon to Vladivostok’ idea concretely

By Michael Emerson, Associate Senior Research Fellow at the Centre for European Policy Studies, and Senior Research Scholar at IIASA

Any substantive common economic space from ‘Lisbon to Vladivostok’ would require the reduction or elimination of tariffs and key non-tariff barriers (such as technical product standards) within a wide-ranging free trade agreement (FTA). For the EU this seems to be an advantageous proposition from an economic standpoint. However, one would expect the pre-conditions posed by the EU for the opening of negotiations to be several and stringent, particularly in terms of political progress over the Ukraine conflict, Belarus’ membership of the World Trade Organization (WTO), and better compliance with WTO rules, with a reduction in protectionist policies in Russia especially.

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The issue of tariffs is of high political and economic significance, but still a conceptually simple matter. By contrast, the removal of non-tariff barriers is immensely complex, involving dozens or hundreds of regulations and thousands of product standards. We therefore examined the non-tariff issue in some detail [1].

Surprising as it may seem, the harmonization of product standards has actually already progressed as a result of the autonomous policy of the Eurasian Economic Union (EAEU) and its member states to adopt increasingly international and European standards. Around 30 sector-specific framework regulations have been adopted by the EAEU, based on EU directives, and backed up by some 5,830 product-specific standards, which are identical to those of the EU (to a large degree EU standards are identical to those of the International Standards Organization).

Therefore, at least for industrial products, there is already a promising basis for an agreement between the EU and EAEU. An important further step could be a mutual recognition agreement (MRA) for conformity assessment. This would mean that each party’s accredited standards agencies would be empowered to certify the conformity of their exporters’ products with standards required by the importing state, without further testing or certification in the importing country. An MRA would thus significantly reduce the cost of non-tariff barriers. An example of this type of agreement is the one between the EU and the US that has been functioning effectively without the scrapping of tariffs in an FTA.

It would also in principle not only be possible, but more plausible to establish a stand-alone MRA between the EU and the EAEU earlier than as part of a wider ranging free trade agreement that also scraps tariffs. This is because under the rules of the WTO, member states cannot enter into a free trade agreement with non-member states. This specifically concerns the situation of Belarus as the only  non-WTO member state of the EAEU. However, this limitation under WTO rules does not apply to MRAs of the type mentioned.

An MRA could of course also be incorporated into a more ambitious FTA that scraps tariffs. There is however also the fundamental question of whether the EAEU and its member states would consider this to be in their interests.

So far, this has been very unclear. In Russia, one hears the argument that an FTA with the EU would be too imbalanced in favor of the EU. Indeed, most Russian exports to the EU, such as oil and gas, are already being traded without tariffs. It should be noted that the EAEU is currently negotiating a ‘non-preferential’ agreement with China, which means that tariffs would not be eliminated. While the slogan ‘Lisbon to Vladivostok’ has featured in many speeches, there is much more caution on both sides when the practicalities of a FTA are considered.

It would still be possible for an FTA between the EU and EAEU to be sensitive to the concerns of the EAEU by being ‘asymmetrical’–meaning that while the EU could scrap its tariffs immediately, the EAEU might do this over a transition period of several years. An example of this is the EU’s deep and comprehensive free trade agreement (DCFTA) with Ukraine, which sees some of the most sensitive sectors getting transitional delays of up to ten years.

These scenarios cannot go ahead for the time being for the reasons already stated above. However, the main point is that there are well-specified concepts available for a possible agreement to scrap tariffs and non-tariff barriers between the two parties. For the EU this would be attractive as an economic proposition. Whether this could see consensus among EAEU member states is however not so clear.  A very narrow cooperation agreement that does not include free trade would be of limited interest to the EU.

References

[1] Emerson M & Kofner J (2018). Technical Product Standards and Regulations in the EU and EAEU – Comparisons and Scope for Convergence. IIASA Report. Laxenburg, Austria

Note: This article gives the views of the authors, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

Three IIASA papers on “Challenges and Opportunities of Economic Integration within a Wider European and Eurasian Space” will be presented in Moscow at the high-level conference “Prospects for a deeper EU – EAEU economic cooperation and perspectives for business” on 6 June. See event page.

Foreign direct investments in Eurasia: too little and from the wrong places?

By Peter Havlik, senior economist and former deputy director at the Vienna Institute for International Economic Studies.

Foreign direct investment (FDI) has been the main driver of restructuring and modernisation of many countries’ economies. In Central and Eastern Europe, FDI has been instrumental in both privatisations of state-owned enterprises and in launching new investment projects. FDI flows in manufacturing have created modern, competitive, export-oriented industries and generated export revenues. However, FDI flowing into the services sectors (including finance and insurance but especially retail trade and real estate) have been more controversial since they boost import demand rather than create new export opportunities.

Global FDI flows are highly volatile and there is no straightforward explanation for such fluctuations. In 2016, FDI to Russia went up sharply, partly because of a single large transaction related to the oil company Rosneft; flows to Kazakhstan recovered as well. FDI flow into Ukraine also increased in 2016, primarily due to bank recapitalisations (reorganization of how a corporation finances its assets) and the privatisation of some companies with the participation of institutional investors such as the European Bank for Reconstruction and Development. FDI flows to Georgia were relatively high in 2014-2016, presumably thanks to the implementation of the Deep and Comprehensive Free Trade Areas (DCFTA), three free trade areas established between the EU, and Georgia, Moldova, and Ukraine. A similar trend, albeit at a much smaller scale, was observed in Moldova.

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DCFTA countries have been laggards with respect to attracting FDI, largely due to ‘frozen’ conflicts over disputed territories and a poor investment climate in general. Moreover, FDI in the DCFTA countries, similarly to Russia, have a skewed geographic origin: in Ukraine, for example, more than 30% of FDI stocks originate in Cyprus; the share of FDI from Western Europe was just 36% of total FDI stocks in 2016. The extremely high shares of Cyprus and other offshore destinations indicate that this kind of FDI most likely just represents a recycling of domestic capital flight— when assets or money rapidly flow out of a country—and possibly also tax evasion. One can probably safely assume that this kind of FDI is also not particularly conducive to upgrading and modernising the economy. Progress towards institutional reforms in general would therefore instead result in diminishing the shares of FDI that originates from offshore.

The experience of EU countries in Central and Eastern Europe (EU CEEs) indicates that FDI inflows have significantly contributed to the modernisation and restructuring of their economies (about 80% of FDI there originates from Western Europe in contrast to less than 40% in Russia and Ukraine). FDI in the manufacturing industry, business services such as IT, software development, and logistics, has been especially beneficial. Such investments have been particularly welcome as they help to establish competitive export-oriented industries (the successful German-CEE automotive cluster is a case in point). After EU accession, foreign investors have to be treated as domestic ones. Recently, though, a renewed economic nationalism in some countries, such as in Hungary and Poland, has resulted in selective treatment of investors by economic sectors, causing a de facto restriction of foreign investment in banking, trade, etc.

However, it is not just the volume of the registered FDI and its origin that matter; its sectoral composition, investors’ motives, and other FDI structural and ‘quality’ characteristics are also important. In EU CEEs, the bulk of FDI has been concentrated in manufacturing, trade, and financial services: each of these three broad sectors account for about 20-30% of total FDI stocks. In this respect, the DCFTA countries are not very different from Hungary, Poland, Romania, or Slovakia. As far as Eurasian Economic Union countries are concerned, most FDI has been concentrated in energy and mining sectors (especially in Kazakhstan and Russia). In Moldova, Ukraine, and Romania, there are some (small) foreign investments in agriculture. The energy sector is an important FDI target in Georgia, Moldova, and Romania (there are no comparable data for Belarus).

How to explain the huge differences in various FDI structural characteristics across individual transition countries? A number of factors definitely play a role: geography, size of the country, resource endowments, costs and skills of labour, government FDI policies and the investment climate in general. According to the latest World Bank Ease of Doing Business survey for 2018 (published on 31 October 2017 and registering big shifts in ranking scores), Eurasian Economic Union and DCFTA countries received the following ranking (out of 190 countries surveyed): Georgia (9), Poland (27), Russian Federation (35), Kazakhstan (36), Belarus (38), Slovakia (39), Moldova (44), Romania (45), Armenia (47), Hungary (48), Azerbaijan (57), Ukraine (76) and Kyrgyzstan (77). Russian Federation, Kazakhstan, Belarus and Georgia were among the top 10 countries which have managed to improve their ranking recently.

In conclusion, the analysis from the forthcoming IIASA Fast Track FDI study implies that Eurasian Economic Union and DCFTA countries have not been particularly attractive for foreign investors; and if ‘round-trip’ inflows from offshore are excluded this issue is even more evident. This goes a long way to explaining why restructuring in the region has stalled. This pattern can change only with marked improvements in the domestic regulatory environments and investment climates. FDI inflows should also be promoted by pro-active government policies (at national and regional levels) which focus on attracting FDI in manufacturing and business services in order to assist restructuring and modernization.

Note: This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

Not a heron: the Eurasian Economic Union should ‘stand on two legs’

By Evgeny Vinokurov, Director of the Centre for Integration Studies at the Eurasian Development Bank, member of the IIASA-led project, Challenges and Opportunities of Economic Integration within a Wider European and Eurasian Space

An Italian nursery riddle goes: “Why does the heron stand on one leg? Because if it takes away the second leg, it will fall down!” An ornithologist will tell you that herons have incredibly strong legs. The EAEU, consisting of Armenia, Belarus, Kazakhstan, Kyrgyzstan, and Russia is not a heron – it does need to stand firmly on two legs. In this case, one leg is the European Union, and the other leg is the People’s Republic of China. An economist will tell you that the strength of “economic legs” underpinning the countries which make up the Eurasian Economic Union (EAEU) can be described, at best, as fair to middling: the heavy reliance on oil and gas is not particularly wholesome. That is why Russia and its EAEU partners need to establish close economic ties with both the EU and China.

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Both partners are critically important for the EAEU. The EU remains its largest trade partner: in 2016 it accounted for 50% of total exports from, and 41% of total imports to the Eurasian Union. EAEU member states are interested in expanding the inflow of European investment capital, transfer of EU technologies, and stable EU demand for energy. The EAEU, in turn, is the third largest EU trade partner (after the US and China); accordingly, the EU may be interested in liberalization of trade with the EAEU (establishment of a free trade agreement), reduction of non-tariff barriers in EAEU member states (with a view to increase EU exports), and stability of EAEU power supplies.

At the same time, the EAEU’s “turn to the East” is slowly gaining momentum: Asia-Pacific Economic Cooperation (APEC) countries,first and foremost, China and Association of Southeast Asian Nations  (ASEAN) countries, are beginning to overtake the EU. By the end of 2016, the Eurasian Union had imported 1.5% more goods from APEC countries (42.3% of total imports, mostly from China, Korea, and ASEAN countries) than it did from EU countries. It is also important for EU investors to understand that they are exposed to an ever-increasing risk of losing EAEU markets due to the inflow of capital from the leading Asian economies.

These matters have been subjected to rigorous applied analysis in Challenges and Opportunities of Economic Integration within a Wider European and Eurasian Space, a project initiated by IIASA in 2014. It advanced an independent dialogue platform to facilitate interaction between representatives of supranational bodies, expert and business communities of the two unions. The project is designed to help its European and Eurasian participants find common ground with respect to a possible inter-union trade and economic agreement.

According to project publications , it is advisable to reach a comprehensive agreement covering a much broader range of partnership domains than that associated with a standard free trade area. According to the latest calculations by European and Russian experts, an EU-EAEU free trade agreement would produce a positive impact. However, experts from the Information and Forschung (IFO) institute in Munich point out that EAEU agriculture and automotive industry may suffer heavy losses. This demonstrates that it is necessary to work out a quite structurally complex solution offering asymmetric advantages to the two sides.

Relations with China display completely different patterns. Two following “tracks” are especially important.

The first relates to the ongoing negotiations on a non-preferential agreement on trade and economic cooperation between the EAEU and China, envisaging reciprocal minimization of barriers in customs regulations and the financial sector, and intensification of investment cooperation. Talks have already been underway for one year, and are expected to continue for another year or two.

The second track deals with realization of the One Belt One Road  initiative. It involves implementation of large-scale joint infrastructure projects, primarily in transportation.  EAEU’s participation in the One Belt One Road initiative is very promising for its member states, especially for Russia and Kazakhstan, which need to remove infrastructural limitations inhibiting railroad carriage of containerized cargoes.  The EAEU continues to face the issue of insufficient investment capital allocation to container logistical hubs. Kazakhstan will also need to eliminate bottlenecks in its transportation and logistics infrastructure, primarily by building modern container terminals. These are but several of the numerous problems facing the EAEU.

We are looking at One Belt One Road in the broad Greater Eurasia context. Higher efficiency of Greater Eurasian land transportation corridors could enhance trade and generate numerous industrial opportunities. This is particularly relevant for landlocked countries and regions (all Central Asian countries, Russian Urals and Western Siberia).

Russia and its EAEU partners need to establish close economic cooperation ties with both the European Union and China. The EAEU will have to learn to balance between those two poles, making ample use of economic vistas presented by the tripartite cooperation setup, and “capitalize on contradictions.” If the EAEU manages to reach this overarching goal, its foreign economic policy would be successful.

This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.

A new vision of Trans-Eurasian transportation

By Katherine Leitzell, IIASA Science Writer and Press Officer

The Trans-Siberian Railway is the longest railway in the world, connecting Moscow with Vladivostok and the Sea of Japan. Built at the turn of the 19th century, the railroad network connected remote Eastern Russia with the rest of the country, and created the first overland link between Europe and Asia.

In a meeting last week at IIASA, Russian researcher Yury Gromyko presented an equally ambitious transportation “megaproject” for the next century: the Trans-Eurasian Belt of Razvitie (Development in Russian), or the TEBR. The project, led by a group of leading Russian intellectual centers, would provide a new transportation network between markets in Europe and Asia, including high-speed rail, roads, as well as infrastructure such as pipelines and telecommunications networks.

Maglev trains, like this one in Shanghai, would be one component of the envisioned TeBR project. © 06photo | Dreamstime.com

Maglev trains, like this one in Shanghai, would be one component of the envisioned TEBR project. © 06photo | Dreamstime.com

Yet in Gromyko’s view the TEBR is also a development project that would bring new opportunities for trade and employment to the entire corridor of the construction. Gromyko described the project as a “New Future Zone,” which could revolutionize trade and economic development across Eurasia.

If the TEBR succeeds, Gromyko envisions new networks of smart cities in eastern Russia based on innovative technologies and new industries that would stem the tide of migration towards Moscow, instead pulling a new generation eastwards. “We need millions of young people to move to the Russian Far East. To attract them, there would need to be exciting jobs and affordable housing,” said Gromyko.

Gromyko presented the project at a workshop entitled, Development of Transport and Infrastructure in Eurasia. The meeting brought together transportation experts from across Eurasia to discuss visions for future development of the continent, and the key role of a multi-infrastructure approach in that development. Multi-infrastructure presupposes integration of different infrastructures from transportation to energy and telecommunications.

“Transportation and infrastructure are simply integral to economic development,” explains Michael Emerson, a senior researcher in the project who splits his time between the Centre for European Policy Studies (CEPS) and IIASA. “You cannot have one without the other.”

Credit: Russian Academy of Sciences

Credit: Russian Academy of Sciences

The event was the 5th in a series of scoping workshops arranged as part of the IIASA-coordinated project, Challenges and Opportunities of Economic Integration within a wider European and Eurasian Space, following previous workshops focused on research methodology, trade policy, non-tariff barriers, and energy. In addition to transportation and infrastructure projects, participants discussed investment and finance options for such major international efforts, as well as the challenges and opportunities of drawing private investment for long-term investments in infrastructure.

Several more scoping workshops are planned on different dimensions related to economic regional integration, explained project leader Elena Rovenskaya, the director of IIASA’s Advanced Systems Analysis Program. They create the foundation for the research phase involving researchers, business leaders, and policymakers from across Eurasia.

More information
Project: Challenges and Opportunities of Economic Integration within a Wider European and Eurasian Space 

Note: This article gives the views of the author, and not the position of the Nexus blog, nor of the International Institute for Applied Systems Analysis.