On November 21 2013, Ukraine suspended preparations for signing the Deep and Comprehensive Free Trade Agreement (DCFTA) with the European Union (EU) at the Third EU-Eastern Partnership Summit in Vilnius on November 28-29. In 2010, the Russian Federation, Belarus and Kazakhstan formed the Eurasian Customs Union (ECU) and have invited Ukraine to become a member. This has become a politically charged issue, generating great uncertainty that is likely to have negative consequences for investment and economic activity (see Handley and Limão 2013, Shepotylo 2013). While apparently rejecting the DCFTA with the EU for the time being, Ukraine has suggested the formation of a joint commission to promote trade between Ukraine, Russia and the EU. We argue in this column that Ukraine should propose new institutional mechanisms to identify concrete policy initiatives that will reduce trade costs for firms in Ukraine as well as ECU and EU-based enterprises.
Economic integration with neighbouring markets has been an effective component of growth strategies of many countries. Free trade agreements (FTAs) such as the DCFTA offer one path towards greater regional integration; customs unions are another. An FTA allows members to retain full independence and sovereignty regarding external tariffs on third countries, while the parties provide tariff free access to imports originating in their countries. A customs union requires members to adopt the same trade policy, i.e., the same external tariffs. This constraint has serious implications. Membership of the ECU will preclude Ukraine from negotiating free trade agreements with other countries, including dynamic emerging markets around the globe. Ukraine would not be able to offer tariff free access to imports from the EU: membership in the ECU is incompatible with the DCFTA. ECU membership would also mean that Ukraine would have to increase its tariffs, because the ECU common external tariff is higher than those Ukraine committed not to exceed when it joined the WTO. Following ECU membership, WTO members would have the right to impose compensatory tariff increases against Ukrainian exports if ECU members were unwilling to lower their bound tariffs. Additionally, Ukraine would lose from increasing tariffs as this would increase the costs of imports, generate anti-export bias and make it more difficult for Ukrainian firms to participate in international supply chains.
Deepening trade relations with the ECU
Policy reforms around the globe and technological changes have made it much easier for firms to specialise in specific production activities that are part of an international production process. Firms today can sell to the world market without having to have access to a variety of efficient domestic input suppliers or needing to rely on domestic demand – they can import intermediate inputs and contribute to the production of goods and services that are sold in world markets. Competitiveness in today’s global economy requires participation in supply chains.
Firms’ to do so depends on the level of prevailing trade and operating costs. Unfortunately, Ukraine performs poorly in measures of international trade institutions, being 137th out of 185 countries in the Trading Across Borders index in the World Bank’s Doing Business indicators. Trade costs are determined by many factors including trade policies, the efficiency of border management, the quality of transport and logistics services, product regulation, and so on. Uncertainty regarding the treatment of products at borders and along transport routes can have a major impact on supply-chain efficiency and investment. A key challenge is ensuring that regulatory policies help improve competitiveness and foster deeper integration with neighbouring markets. Recent research suggests that improving trade facilitation performance and related transport and communications services halfway towards the global best practices could increase real incomes in Ukraine by 25% and increase exports by more than 50% (Ferrantino and Tsigas 2013).
Ukraine currently has free trade status (with certain exceptions) with the members of the ECU, but significant non-tariff barriers exist. The border clearance problems in August 2013 dramatically highlighted longstanding trade facilitation problems. Addressing these problems requires expansion of the ‘deeper’ aspects of trade agreements, which can be facilitated through the application of a supply chain-centred approach to lowering trade costs with Russia and the ECU. Research has shown that the greatest benefits from preferential trade agreements come from the deep aspects of the agreements, not from the preferential tariff liberalisation. Analysis of the potential gains for Ukraine from trade reforms suggest that lowering trade costs created by regulatory policies will generate much larger gains than changes in import tariffs (see, e.g., Institute for Economic Research and Policy Consulting 2011).
There are many potential vehicles for closer relations with Russia and the ECU based on intergovernmental trade agreements, including:
- Cooperation on better border control procedures to facilitate trade,
- Provision of rights for foreign investors in services,
- Mutual recognition of standards and technical regulations,
- Agreement to accept the certification of conformity assessment authorities in the partner country,
- Exclusion of antidumping actions against firms in partner countries, and
- Mutual recognition of the qualifications of professionals such as lawyers, accountants and engineers.
Negotiation of agreements in all of these areas and others will mutually benefit Russia, Ukraine, Belarus and Kazakhstan. In some areas this would bring trade relations with the ECU closer than with the EU even after ratification of the DCFTA with the EU.
A supply-chain approach
Building the political support needed to move forward on this agenda requires concerted action with the private and public sectors working together. The focus should be on cutting across prevailing regulatory ‘silos’ and identifying how policies affect the movement of products along supply chains, and measuring performance; for example, clearance times at borders and number of inspections (Hoekman and Jackson 2013).
One way of determining priorities and defining an action agenda that will benefit industries on both sides of the border is through the creation of ‘supply-chain councils:’ public-private partnerships that involve the active engagement of the business community, economic policy officials, and regulators, organised around the supply chain as a whole in a sector or area of trade (Hoekman, Jensen, and Tarr 2013). Reducing supply-chain barriers is not straightforward as there may be several or even many policies that generate impediments. If one policy problem is addressed, another may become binding. To be effective in lowering supply-chain barriers a comprehensive and integrated approach is needed, one that generates information on sources of frictions through regular assessments of regulatory trade barriers and costs, and generates concrete action agendas and proposals for reforms.
A supply-chain-council approach would focus on identification and agreement on the main sources of supply-chain frictions at a given point in time – from both a Ukraine and ECU perspective – and on actions to resolve them. A public-private partnership approach may be more effective than purely inter-governmental mechanisms by mobilising the engagement and support of business on both sides. Business representatives and industry organisations have hands-on knowledge of the impacts of regulatory policies and firms on both sides are likely to have many common interests in lowering trade costs. Trade negotiators could incorporate proposals from these councils with the confidence that they have the support of the business community.
Authors' note: This article is based on a paper that was used as background material for the talk of Mr. Pascal Lamy at the 10th Yalta Annual Meeting on September 21, 2013. Documentation, references and tables may be found in the longer version at the website http://yes-ukraine.org/. Financial support from the Yalta European Strategy (YES) is gratefully acknowledged. The authors alone are responsible for the views and accuracy of the paper.
Ferrantino, M and M Tsigas (2013), “Enabling Trade in Ukraine”, USITC Research Note RN-2013-07A.
Handley, K and N Limão (2013), “Does policy uncertainty reduce economic activity? Insights and evidence from large trade reforms”, VoxEU.org, November 21.
Hoekman, B. and S Jackson (2013), “Reinvigorating the trade policy agenda: Think supply chain!” VoxEU.org, January 23.
Hoekman B, J Jensen and D G Tarr (forthcoming), “A Vision for Ukraine in the World Economy”, Journal of World Trade.
Institute for Economic Research and Policy Consulting (2011), "Ukraine’s Trade Policy Choices: pros and cons of different regional integration options", Kiev: IER.
Shepotylo, O (2013), “Export potential, uncertainty, and regional integration: choice of trade policy for Ukraine”, Kyiv School of Economics.