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14 January, 2014 14:36   ▪  

Expert: Customs Union between Ukraine and Russia is not economically feasible

Economic considerations make a Customs Union less likely than the politics would suggest, says Caroline Freund, senior fellow at the Peterson Institute for International Economics.

Russia’s recent promise of $15 billion in assistance, coupled with cheap gas—both blandishments in exchange for Ukraine turning its back on deeper integration with the European Union—have raised the specter of Russia and Ukraine forming a customs union. Indeed, news sources initially claimed that Customs Union membership was part of the deal presented by Moscow.

Though both governments have denied it, many analysts still believe a Customs Union is on the horizon. But “economic considerations make a customs union less likely than the politics would suggest,” Caroline Freund claims. There are several important reasons for that, she says.

First, according to Freund, trade between the two countries has declined steadily since Ukraine’s independence. Russia’s share of Ukraine’s exports fell from 40 percent in 1994 (the first year exports were independently recorded) to 26 percent last year. Ukraine’s share of Russia’s exports fell from 11 percent to 3 percent over the same period. The current agreement, which does little to expand trade, is unlikely to reverse this trend.

Second, a customs union would demand that Russia significantly lower trade barriers faced by non-members. In a Customs Union, members harmonize external tariffs at the same level; this is distinct from a free trade area, where countries unilaterally set external tariffs. In order to comply with the rules of a customs union, Russia would have to lower its tariffs to Ukraine’s levels, or Ukraine would have to raise its tariffs to Russia’s levels, or some combination of the two. 

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“Were a Russia-Ukraine customs union to come into effect, rules established by the World Trade Organization (WTO), would prevent Russia from dictating the level of protection. (Both Russia and Ukraine are members of the WTO, and upon joining they committed to ceiling levels for many tariff lines—so-called bound rates.) Ukraine’s WTO commitments rule out any upward adjustment of its bound tariffs. And, though the WTO allows trade blocs, it has strict rules to prevent them from raising external tariffs and becoming stumbling blocks to free trade,” Freund says. This means that unless WTO rules are flagrantly violated, which could invoke costly retaliation from the rest of the world, a customs union between Russia and Ukraine would require significant liberalization by Russia. 

In her opinion, Russia would find it nearly impossible to lower tariffs on products from other trading partners, as welcome as that might be for the rest of the world.

A Russia-Ukraine Customs Union would pry open the Russian goods market for exporters, but it would be even more valuable to the rest of the world if it were able to claw back restrictions in the service sectors, especially energy and banking, which were largely exempted from Russia’s WTO commitments. Ukraine is more open, but it remains to be seen whether and how energy and financial services would be liberalized in a potential Customs Union.

It is difficult to see economic developments progressing to the extent that a Customs Union between Russia and Ukraine becomes more economically feasible over the next few years. Achieving such an agreement would require a reversal in export trends and significant additional Russian liberalization, far beyond current WTO commitments.

“This suggests what should have been obvious all along—that Putin’s motive in recent negotiations with Yanukovych has been primarily to prevent closer ties between Ukraine and the European Union,” Freund suggests.

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