Saturday, July 26, 2014
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Post-Soviet Free Trade

Ever since the Soviet Union collapsed, the independent states that emerged from the wreckage have tried to sort out their trade relations. But the flow of goods between countries continues to contract even more than it should. What is needed is free trade.

The twelve members of the Commonwealth of Independent States (CIS) concluded an Agreement on a Free Trade Zone in 1994, but it does not work. Whenever one member is successful in exporting to another, the importing member soon imposes quotas or prohibitive tariffs, impeding economic development.

The simple solution is a mechanism for conflict resolution. The World Trade Organization (WTO) has a well-functioning arbitration court with accepted penalties that could be utilized, but only four CIS countries (Kyrgyzstan, Georgia, Moldova, and Armenia) have joined the WTO. The largest CIS economies-Russia, Ukraine, and Kazakhstan-should hurry up and join as well. Alas, instead of adapting tried and tested mechanisms, various CIS countries invent ever more complex schemes, such as the five-state Customs Union, which was renamed the Eurasian Economic Community last year, when its failure became evident.

The latest invention is the recent declaration by the Presidents of Russia, Belarus, Kazakhstan, and Ukraine to start negotiations on forming a "Unified Economic Space." Three ideas are contained in this nebulous term: a customs union, coordination of accession to the WTO, and a currency union. None of these will benefit any participant.

A CIS customs union failed already, and will fail again in the future. It delivered no freer trade than the CIS free-trade zone. No participant harmonized its customs with anybody else. Russia refuses truly to accept the sovereignty of the other CIS states, and instead wants only to impose its own customs policy, which the others do not accept. Now the four presidents propose an independent supranational commission for trade and tariffs in order to forge a common customs policy. But there is no reason to believe that this will work any better.

Simply put, these countries have different foreign-trade interests. A country that does not produce a product has no interest in its protection, while countries that do have protectionist interests. For instance, Russia's automotive and aviation industries insist on high import tariffs, while Kazakhstan produces neither cars nor airplanes. Russia's high import tariffs on cars would impose an unjustified consumer tax on Kazakhs.

Coordination in accession to the WTO sounds good, but would actually delay membership by several years at a time when speed is vital. It is much more difficult for Russia, with its large and complex trade, to enter the WTO than it is for Ukraine and Kazakhstan. Russia must conclude bilateral protocols with no less than 67 countries, compared with 22 for Ukraine.

Any coordination through a customs union would reopen concluded negotiations. Indeed, Russia has demanded that Ukraine revoke the 11 bilateral protocols for WTO accession that it already signed.

Meanwhile, until Russia, Ukraine, and Kazakhstan accede to the WTO, the trade situation within the CIS will not improve. If they would stop "cooperating" and start competing to be the first to enter the WTO, all three countries could be members within a year.

The worst idea is the currency union. All twelve CIS countries had a currency union in 1992 and 1993. It was an unmitigated disaster that ended in hyperinflation. The fundamental problem was that each country had a central bank that issued ruble credits, because no country was prepared to accept central-effectively Russian-control over its monetary policy.

Why repeat that catastrophe? None of the political preconditions has changed. No CIS country would accept a Russian monopoly on the emission of a common currency, and without a central monopoly on the emission of money, a currency union cannot work.

Even if a currency union could work technically, it makes little economic sense, for several reasons:

First, a currency should be tied only to a currency with a substantial record of stability, whereas the CIS has seen the world's greatest currency instability in the last decade;

Second, a currency should be pegged only to a currency that is dominant in its foreign trade. Russia accounts for just about a quarter of Ukraine's foreign-trade turnover;

Third, a currency union should be undertaken with a large, differentiated economy with substantial financial depth. But these economies are small, and most are not highly diversified;

Fourth, the members of a currency union should have similar economic structures or at least have business cycles that move in parallel. Given Russia's dependence on exports of oil and natural gas, and Ukraine's status as a major energy importer, the two countries' business cycles are likely to diverge rather than overlap. Whereas Russia would require devaluation when oil prices fall, Ukraine could consider revaluation.

In short, none of the ordinary prerequisites for a currency union is in place, and the only rationale appears to be Soviet imperial nostalgia.

For the last three years, Russia, Kazakhstan, and Ukraine have been economically successful, with Russia and Ukraine boosting average annual economic growth rates of 6% and Kazakhstan around 11%. Sound market-based thinking has driven their domestic economic policies. None of them can afford to fool around with economic nonsense in their trade policy.

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