Let’s Stick Together: Pros and Cons of the Tripartite Customs Union in the CIS

By: Ralph De Haas Senior Economist

Authors: Ralph De Haas, Alex Plekhanov
As of January 2010, Russia, Kazakhstan and Belarus apply a common external customs tariff (CET) to imports from third countries. The CET is mainly based on the Russian duties that prevailed until last year. Since these were the highest among the three countries (Figure 1) there have been significant duty hikes in Belarus and Kazakhstan. For example, in Belarus the import duty on a 2003 car with a two-litre engine increased from 800 to 8,000 euros. Duties on televisions doubled. In Kazakhstan, average tariffs increased from 6.2 to 10.6 per cent. Why did the three countries follow this route?

Figure 1  Average level of import duties in international perspective

Abstracting from geopolitical considerations, the economic reasons differ per country:

Russian manufacturers profit from the common external tariff. By heightening the ‘common tariff wall’, Russian producers of cars, trucks, buses, flat metals and metal pipes, dairy products, and milling products face less competition in Kazakhstan and Belarus because producers from third countries (such as China and Southeast Asia) have been put at a disadvantage;

Belarus may benefit from uniform pricing of energy for Russia and Belarus. Minsk expects to no longer have to pay duties on the oil that it imports from Russia, refines, and then exports to the EU or back to Russia. The likelihood of this will be higher if Belarus agrees to sell significant stakes in two large oil refineries, modern and close to the EU market, to Russian companies. Negotiations are ongoing;

Kazakhstan seeks to boost exports of commodities. Kazakhs producers can now supply the Russian market with metals, petrochemicals, and coal without paying customs duties.

If the customs union remains in place, there may be economic benefits to the extent that the removal of internal tariffs and non-tariff barriers increases trade (trade creation), boosts international competition, and allows firms to serve a larger market and hence produce more efficiently by exploiting economies of scale.

However, the regional nature of the union may lead to negative effects that may overshadow its benefits. In particular, the CET may act as a shield to protect local manufacturers from ‘real’ outside competition. Regional customs unions can lead to ‘too much’ trade between the countries involved and not enough trade between the bloc and the outside world. Such trade diversion can lead to substantial welfare losses, which is what happened in regional customs unions in Latin America and Africa. Consumers either have to pay more for high-quality products from outside the union (because of the higher CET) or have to put up with inferior products.

Trade diversion is also likely to happen in the CIS customs union. In particular for Kazakhstan there is a risk that trade will be diverted from more efficient exporters (China and other Asian exporters pur sang) to less efficient producers in Belarus and Russia. Due to the large hike in the CET for cars, Kazakh consumers will have to pay more for imported Asian cars. Alternatively, they have to switch to potentially inferior cars produced inside the customs union. In both cases there is a welfare loss.

In addition, Kazakhstan has negotiated higher CET tariffs on food products that the country imports (rice, starch, edible oil, dairy products) but would like to produce domestically (import substitution). This means that local producers of rice and starch have become shielded from competition from mainly Thailand and China, respectively. This will come to the detriment of consumer purchasing power, as Kazakhstan does not seem to have an obvious comparative advantage in rice production.

For these reasons, economic simulations suggest that the entrance of Kazakhstan into a regional customs union may lead to significant welfare losses (Tumbarello, 2005; ADB, 2006). Kazakhstan has nevertheless entered the union because President Nazarbayev has been a strong proponent of regional integration, explicitly referring to the success of the European Union in allowing poor member states (Ireland, Spain, Portugal) to converge to higher income levels. However, the example of the EU is misleading since a customs union among relatively poor countries – unlike one among relatively rich countries – is likely to lead to divergence rather than convergence among the countries joining the union. This is the case because the ‘winners’ in a customs union tend to be those countries that in terms of comparative advantage are closest to the world average. So in a rich-country club, the winners are the poorer countries with labour-intensive industries that get protected from the rest of the world. In a poor-country club, the winners are the richer countries with a production structure that is closest to the world-average (Venables, 2003).

Applied to the tripartite customs union, this means that Kazakhstan has probably the most extreme economic dependency on commodity exports with only a very limited contribution of manufacturing. While Russia’s economy is commodity-driven as well, it has a more developed manufacturing industry than Kazakhstan. Since the economic structures of both Belarus and Russia are closer to the world average, they will profit most from the protection offered by the customs union and the access to the larger common market. In contrast, while Kazakhstan may profit from an expansion of its metals, oil, unprocessed food, and other commodity exports to Belarus and Russia, the customs union will also lock it further into its commodity dependence and hamper economic diversification. The likely impact of the customs union on firms in Belarus and Kazakhstan can be summed up as follows:

Belarus

Belarus has been able to negotiate higher CET import duties on trucks, electrical engines and equipment, and a number of other key Belarusian export products. This has increased the relative competitiveness of these key Belarusian products in the Russian and Kazakh markets;

Some increased attractiveness of sectors where trade barriers with respect to inputs have been reduced (pharmaceuticals) as Belarusian producers of these products now face lower production costs;

On the negative side, the union will adversely affect the effective purchasing power of consumers through its impact on key consumption items subject to import duty hikes, such as passenger cars and television sets. In addition, the relative competitiveness of certain products in the Russian market will decline (buses, certain household appliances).

Kazakhstan

Producers of certain commodity-related industries (metals, petrochemicals, coal, unprocessed food) may profit from the customs union as they will be able to supply the Russian market without paying customs duties. The customs union may thus result in a need for additional investments in primary agriculture, chemical industry, mining and metals processing as well as in infrastructure projects to allow these products to reach the Russian and Belarusian markets;

The formation of the customs union does not bode well for Kazakhstan’s diversification efforts as non-competitive manufacturing may be put under pressure. Kazakh manufacturers and agroprocessors have lost protection from Russia and Belarus and will start to feel the competitive pressure of relatively high quality and cheap Russian and Belarusian products. Many Russian manufacturers are already present in Kazakhstan and may start to compete harder with local producers, especially in agriculture and foodstuffs;

In sectors like automobiles, where Kazakhstan imports from multiple countries, consumers may find themselves with less choice as Russian exports supplant, for example, Asian and European cars. The new common tariff for imported cars is 25 per cent compared to 10 per cent until last year. Furthermore, Ford, Toyota, Renault and Hyundai already have production facilities in Russia. The customs union means that they are likely to use these existing facilities to serve the whole region rather than establish new ones in Kazakhstan.

References

ADB (2006), Central Asia: increasing gains from trade through regional cooperation in trade policy, transport, and customs transit.

Tumbarello (2005), Regional trade integration and the WTO: which is the right sequencing? An application to the CIS, IMF Working Paper No. 94, Washington D.C.

Venables (2003), Winners and losers from regional integration agreements, Economic Journal, 113, 747-761.

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