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Economic Effects of Belarus' Participation in the CIS Countries Customs Union in 1995 - 2000

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Economic Effects of Belarus' Participation in the CIS Countries Customs Union in 1995 - 2000 КОНСОРЦИУМ ЭКОНОМИЧЕСКИХ ИССЛЕДОВАНИЙ И ОБРАЗОВАНИЯ - РОССИЯ И СНГ ECONOMICS EDUCATION AND RESEARCH CONSORTIUM – RUSSIA AND CIS Irina Tochitskaya, Ernest Aksen Economic Effects of Belarus’ Participation in the CIS Countries Customs Union Abstract In 1995 three countries of the former Soviet Union (Russia, Belarus and Kazakhstan) established a Customs Union, which Kyrgyzstan and Tadjikistan joined later. After the passage of five years since the Customs Union formation, it is essential to assess the implications of Belarus’ membership in this Customs Union. The objective of this project is the analysis of the costs and benefits of the Belarus’ participation in the Customs Union of the CIS countries based on the study of the static and dynamic economic effects and their impact on the nation’s welfare, and the Belarus’ economy growth rate. As the evaluations of Belarus’ participation in the Customs Union by the country’s government and political opposition are completely opposite, a politically independent analysis is of principal importance. Final Report ECONOMIC EFFECTS OF BELARUS’ PARTICIPATION IN THE CIS COUNTRIES CUSTOMS UNION Irina E. Tochitskaya, Ernest M. Aksen Research Grant R00-4431 Final Report Abstract: The authors analyze the static and dynamic economic effects of Belarus' participation in the CIS countries Customs Union in 1995 - 2000. Utilizing the set of methodologies proposed in literature it was proved that Belarus’ membership in CIS regional trade arrangement results in trade diversion effects especially in the group of medium and high-tech products. Econometric evaluation focuses on the assessment of the impact of the Customs Union on revealed comparative advantage, which was calculated for group of medium- and hi-tech products as easily interpretable measure of their competitiveness and efficiency of production. Two sets of independent variables have been used: those reflecting possibility of technology, knowledge transfer and those reflecting regional integration. It is shown that Belarus’ participation in the Customs Union does not facilitate the improvement in the domestic exports structure, the formation of the new comparative advantages both in trade with CU member countries and the rest of the world. JEL classification: F14, F15 Keywords: Regional economic integration; Static effects; Dynamic effects 1. Introduction The last ten-fifteen years have been evidence of the trend towards new wave of regional economic integration. Turning into the dominant factor of the world trade, regionalism affects both economic and political relations between countries, confronting them with the choice should they enter trade agreement, which form of integration should be preferred and who should be a partner. Such questions have been discussed among new independent states after break up of the USSR. The impetus for the creation of regional arrangements among CIS countries was the aspiration to maintain and restore the economic ties as well as desire to remain in traditional export markets and to decrease the competitive pressure from the rest of the world by using high external trade barriers. As a first attempt of trade cooperation the protracted process of CIS counties Free Trade Zone formation should be considered. Besides in 1995 three countries - Belarus, Kazakstan and Russia - established a Customs Union (it was renamed in Eurasian Economic Community in 2001) that Kyrgyz Republic and Tajikistan agreed to join in 1996. Belarus membership at this regional agreement strongly affects the county's economy. First, it was accompanied by a reorientation of trade flows towards the members of the Customs Union. According to Belarusian trade data in 1995 the country exported 54% of goods outside the trade block, yet in 2000 this figure fell to 46%. The same tendency occurred in imports where the share of the rest of the world decreased from 54% in 1995 to 36% in 2000 (table B1). As to the trade with traditional CIS partners (non-members) the 2000 share of the country's exports (14%) and imports (7%) were almost two-time lower than the corresponding 1995 level. However, according to EBRD estimations all transition economies should amount no more than 11% of Belarus external trade while EU countries - up to 60% (EBRD, 1999). Second, the Customs Union members negotiated a common external tariff based on Russian tariff system. As a result Belarusian average unweighted tariff rose in 1995 -2000 from 12.3% to 13% and in manufactured products up to 15%. Since more than six years passed after Belarus’ joining the Customs Union, it is useful to make more detailed analysis of the implication of above trends on Belarusian economy and assessment whether membership in the CIS countries CU is an efficient element of the national development strategy. 2 So far a large number of theoretical and empirical studies focus on the problems (welfare effects, labor migration, exchange rate agreements, real convergence and etc.), faced by regional blocs that were formed between high-income countries and developing countries or both of them (NAFTA). However literature considering the process of trade bloc formation among CIS countries and examining the issues arising within this regional group, in particular the economic and political effects on the partners is not extensive. The objective of this project is the analysis of the costs and benefits of the Belarus’ participation in the Customs Union of the CIS countries based on the study of the static and dynamic economic effects and their impact on the nation’s welfare, and the Belarus’ economic development. The modern approaches to the study of the regional integration rely on constructing the models estimating the changes in commodity prices, in volumes and structure of the production in different sectors, gains and losses of producers, consumers and the state resulting from the mutual elimination of the customs duties and creation of the joint customs barriers, as well as growth models including intermediate import as a conduit for technology and knowledge transfer. We propose to verify the following hypotheses based on these approaches: • The hypothesis about the appearance of the trade diversion effect in the trade in medium- and high-tech products due to significant reorientation of Belarus’ foreign trade flows to the Customs Union partner countries, first of all to the Russian Federation. • The hypothesis about the absence of “potential dynamic benefits” based on the assumption that the Belarus’ participation in the Customs Union does not facilitate the attraction of modern technologies and production factors to the economy, the acquisition of the new comparative advantages in high-tech sectors and are likely to retard Belarus’ economic transformation to high-R&D economy. 3 The paper is organized as follows. The next section introduces the review of literature; Section 3 explains the model specification issue; Section 4 describes the empirical methodology and contains results of the empirical estimations, and Section 5 concludes. 2. Review of literature The formation of the economic integration theory is associated with the works of J. Viner (1950), J. Meade (1955), R. Lipsey (1960) that have assessed the consequences of joining a regional trade agreement (CU, FTA) from the viewpoint of welfare effects of the removal of tariffs and the introduction of the common external tariff on trade. The reduction of the barriers increases the gain from trade in the case when the importer from the partner country substitutes less efficient (higher costs) domestic suppliers, the result is trade creation effect. Unlike this, trade diversion effect arises when the lower-cost imports from outside of the customs union (free trade zone) are displaced by the output of a partner country because of the distorting impact of the tariffs. The important question is whether negative net effect of trade diversion is inevitably generated outcome resulting in welfare reduction. This is still a much-discussed topic among trade economists. Lipsey (1957) and Bhagwati (1971) examined the issue of the welfare impact of RIAs on the assumption of zero demand elasticity in member-country and proved that wholly trade- diverting union may lead to a net increase in welfare. Kemp, Wan (1976) and Ohyama (1972) argued in the case of customs union that it is possible to enhance welfare adjusting the common external tariff at a level just proper to fix the initial extra-union trade flows. However as to the individual members, either outcomes (gain or lose) may occur. Panagariya (1999) provided the analogous result for a large union example keeping external tariffs at initial levels. 4 There is also “natural-trading-partner” hypothesis according to which trading partners are more likely to gain from regional integration agreements the higher is the intra-regional shares in total trade (Krugman, 1993). However, Schiff’s (1997) analysis provides an opposite conclusions: an individual country benefits more from RIAs if it imports less from its partner countries (with imports measured either in volume or as a share of total import). The result holds both in the small country and the large-country case. The standard techniques of estimating the impact of the above effects on the member countries’ welfare are the general and partial equilibrium models as well as econometric evaluations. The most applications were to the European Union and its extension, North American Free Trade Area (NAFTA) and Latin America trade agreements (Winters (1987);
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