_ Yuri Kofner, junior economist, MIWI – Institute for Market Integration and Economic Policy. Munich, 23 January 2021.

A special relationship

The post-Soviet space is a prime example of the lived concept of the economic integration of different speeds and of a “Eurasia of concentric rings”. There is the CIS free trade area, then the Eurasian Economic Union (EAEU), and last but not least the Union State between Belarus and Russia; not to mention some other (security) political regional-multilateral organizations, e.g., the CSTO.

The Union State was formally founded in 1999. Its ultimate goal is to create a supranational confederation between Belarus and Russia. At present, many of its tasks have been achieved within the framework of the EAEU, in which Armenia, Kazakhstan, and Kyrgyzstan also participate, e.g., a customs union, a joint foreign trade policy, a common labor market, etc.

Only in some areas does the Union State’s depth of integration goes further than the EAEU, for example with a single educational space.

Belarus is immensely dependent on Russia and the EAEU for foreign trade. A brief analysis of the data from WITS (Comtrade)[1] shows that goods trade with the former amounts to half the country’s global trade, while trade with the other EAEU members adds only one percentage point to that share. On the other hand, Russia is by far less dependant on its partner, which, however, still accounts for 5 percent of the Russian trade structure, while trade with the EAEU in total makes up almost 9 percent. This is logical since Russia’s economy is 29 times larger than that of its Belarussian neighbor.

However, this asymmetry does not mean that Belarus is disadvantaged by it. On the contrary, apart from trade in energy carriers, the country has a solid balance of payments surplus with the EAEU, which on average accounts to 12 percent of Belarusian GDP. Minsk is thus one of the biggest net winners of Eurasian economic integration.[2]

A core element and also an informal precondition of the special close partnership between Minsk and Moscow was the provision of cheap oil and gas prices by the latter to the former, which in fact amounted to significantly subsidizing the Belarusian economy. Russia delivered crude oil to Belarus without adding the usual export tariff, which means that the price was on average 30 percent below the world trade price. Minsk then re-exported around a quarter of the amount delivered and could keep the Russian export tariff for itself. The rest was processed into various gasoline products in Belarusian refineries and then also exported.

As part of its industrial policy modernization, Moscow in 2019 introduced the so-called “tax maneuver”, which by 2024 aims to exchange the export tariff with an extraction tax. The German think tank “Berlin Economics” estimates that by 2024 this change will cost the Belarusian economy around 1.5 percent of its GDP and reduce budget revenues by around 15 percent.[3] At the same time, however, Russian oil refineries have the right to compensation (subsidies) from the Russian state.

Minsk repeatedly criticizes Russian violations of the principle of equal economic conditions, which it believes should be the foundation of Eurasian economic integration.

To the foreseeable displeasure of its partner, the Kremlin replied that the guarantee to Belarus of Russian domestic prices for oil and gas was not part of the treaties on the EAEU or the Union State. As a condition for the provision of such domestic prices, Moscow proposed a renewed attempt at drastically deeper integration within the Union State, which would include the unification of fiscal, tax, industrial and possibly even monetary policies. In effect, Moscow proposed unification into a single country, which has always been the official ultimate goal behind the Union State.

Methodology

As part of this debate, the author would like to conduct a thought experiment and econometric simulation to assess the potential trade and welfare effects if Belarus and Russia were indeed to voluntarily unite into a single country – the Union State.

In order to do this, the author will use a gravity trade model first developed by Anderson (1979)[4], and further augmented by Santos, Silva et Tenrenyo (2006)[5] on consistency with heteroskedasticity and accounting for zero trade flows; by Fally (2015)[6] on using fixed effects to match multilateral resistances consistent with structural terms; and by Anderson, Larch et Yotov (2015)[7] on using Poisson pseudo-maximum likelihood estimation (PPML). The latter also introduced a three-step estimation procedure with a baseline scenario, a counterfactual scenario, and a full endowment general equilibrium, – all of which will be applied in this simulation.

For the purposes of this model, the author constructed a new database, which includes data on bilateral manufactured goods trade flows for 169 countries in the year 2015, on bilateral distance and a contiguity dummy, based on three different datasets provided by the WTO[8], the CEPII[9] and the United States International Trade Commission.[10],[11]

One baseline scenario (status quo of trade flows) and a counterfactual scenario was defined (Formula 1):

Where Xij is merchandise trade flow trade flow from origin i to destination j; DISTij is the population-weighted distance between i and j; CNTGij is a contiguity dummy; BRDRij is a border / international trade dummy; BRDR_BLR_RUSij is a dummy for the borders / bilateral trade between Belarus and Russia; pi is the exporter fixed effects; cj is the importer fixed effects; eij is the error term. The counterfactual scenario(s) is implemented by setting the BRDR_CRFij dummy to zero.

Results

According to the results of the gravity model and general equilibrium procedure, if Belarus and Russia were to voluntarily unite into a single country – the Union State, then their exports would increase by 2.5 and 0.7 percent, respectively. The income of Belarussian manufacturers would increase by 7.4 percent. Thanks to greater competition, consumers in Russia would also benefit from lower prices.

As a result, from the point of goods trade, the implementation of the Union State would increase Russia’s real GDP by 0.3 percent, that of Belarus by 6.8 percent, which could create 49 thousand news jobs in the country.

Due to trade diversion effects, this unification would reduce the real GDP of Belarus’ neighbors – Ukraine, Latvia, and Lithuania – by between 0.06 and 0.08 percent. Gaining contiguity with Belarus would also have a slight positive effect on Kazakhstan, Kyrgyzstan and, Armenia, increasing their real GDP by 0.04, 0.02, and 0.01 percent, respectively.[12]

The hypothetical unification of Belarus and Russia into the Union State, as a potential further step in “Eurasian integration of different speeds” and a “Eurasia of concentric rings”, would thus not only benefit those two countries but the Eurasian Economic Union as a whole: Overall, the EAEU’s real GDP would increase by 0.5 percent.

Notes

[1] WITS (2021). World Bank. URL: https://wits.worldbank.org/

[2] Kofner Y. (2020). Who wins and who loses from the Eurasian Economic Union? MIWI Institute. URL: https://miwi-institut.de/archives/534

[3] Radeke J. (2020). The economic impact of the Russian oil tax maneuver. Berlin Economics. URL: https://www.german-economic-team.com/belarus/wp-content/uploads/sites/2/GET_BLR_NL_63_2020_en.pdf

[4] Anderson, J. E. (1979). A Theoretical Foundation for the Gravity Equation. The American Economic Review, 69(1), 106–116.

[5] Santos Silva, J. M. C. & Tenreyro, S. (2006). The log of gravity. The Review of Economics and Statistics, 88(4), 641–658.

[6] Fally, T. (2015). Structural gravity and fixed effects. Journal of International Economics, 97, 76–85.

[7] Anderson, J. E., Larch, M. & Yotov, Y. V. (2015). Estimating General Equilibrium Trade Policy Effects: GE PPML. LeBow College of Business, Drexel University School of Economics Working Paper Series, WP 2016–06, 1–24.

[8] Monteiro, Jose-Antonio (2020), “Structural Gravity Dataset of Manufacturing Sector: 1980-2016″, World Trade Organization, Geneva.

[9] Head, K. and T. Mayer, (2014), “Gravity Equations: Toolkit, Cookbook, Workhorse.”Handbook of International Economics, Vol. 4,eds. Gopinath, Helpman, and Rogoff, Elsevier.

[10] Borchert, I., Larch, M., Shikher, S., and Yotov, Y. (2020), “The International Trade and Production Database for Estimation (ITPD-E)”, International Economics, forthcoming.

[11] Tamara Gurevich and Peter Herman, (2018). The Dynamic Gravity Dataset: 1948-2016. USITC Working Paper 2018-02-A.

[12] In fact, the other EAEU member states should also benefit from trade creation effects caused by the increased economic weight of the newly created BLR-RUS Union State within the EAEU.