Ukraine’s Choice and Russia’s Objections: DCFTA vs. Customs Union

Deep and Comprehensive Free Trade Area (DCFTA) is seen as one of the most important carrots for countries of the Eastern Partnership. Ukraine’s negotiations with the EU over the Association Agreement, which contains the DCFTA, were concluded at the turn of the year 2011. On the opposite shore stands the offer of Customs Union, consisting of Russia, Belarus and Kazakhstan. In the following article, I will briefly analyze possible outcomes of finalization of one or another in the light of most recent developments.

Two important meetings of Ukrainian President Viktor Yanukovich have lately taken place – first one with European leaders and, second, with President of the Russian Federation Vladimir Putin, on 25 February and 4 March respectively. Outcomes of both meetings are in line with Ukrainian long-term ambiguous position. In Europe, President Yanukovich had reaffirmed “engagement in the political association and economic integration”[1], in Russia he lamented about reduction of trade between Ukraine and member states of the Customs Union. [2]

Losing hurts more than not receiving

“It is a political choice of Ukraine and we will respect any choice,” [3] said Vladimir Putin before the meeting. But can Russia afford such development? What would association with the European Union cause to Ukraine-Russia relations? Unfortunately, it would bring disassociation. What would conclusion of DCFTA bring? I will argue that it will counter Russian objective to establish strong regional free trade community. To solve the riddle whether Ukraine would be able to join both, the answer was given by European Commission President Jose Manuel Barroso, stating: “one country cannot at the same time be a member of a customs union and be in a free trade area with the European Union.” [4] On the other hand, without Ukraine, the Customs Union and further integration projects of Russia may be unsustainable in the long term. [5]

Loosing Ukraine would be a great hit for Russia, and although we see that Russia will (have to) respect Ukraine’s decision, there are early warnings that are pointing at expectation that EU should respect Russian interests. [6] It can be seen that tension surges as the conclusion of the DCFTA approaches. Moscow and Brussels were never so active in their policies towards Ukraine. Moscow just needs to keep the door open.

DCFTA: Costs and benefits

It is utmost difficult to predict exact outcomes of the DCFTA, because it remains closed to public. What we, however, can anticipate are several effects that go hand in hand with major liberalization of tariffs. Many reasonable questions emerged, regarding Ukraine’s ability to compete on the European market and ability of domestic producers to carry the burden of competition inflow. How might the whole picture look like?

One of the most important things is that the EU committed to remove agricultural export subsidies in the trade with Ukraine. Also, DCFTA intends standard defense measures according to WTO norms. Thresholds for specific products will protect Ukraine’s market, and in case these are exceeded, trade defense measures are to be applied. This gives Ukraine some guarantee, that its market would not be flooded by European subsidized goods, wiping out domestic companies.

Benefits and costs of Ukraine joining DCFTA were identified by Veronika Movchan and Volodymyr Shportyuk [7], who have, in my opinion, very clearly managed to model possible result.

Firstly, by joining DCFTA, Ukraine would open its door to improved welfare by better access to variety of products, stricter product security, higher incomes in long-run owing to new business opportunities. Secondly, Ukraine would acquire duty free access to incomparably bigger market, in comparison to the Customs Union, increasing its potential economic gains. Thirdly, better access to other markets, through harmonization with internationally accepted EU standards. Finally, it would improve its domestic investment climate, as EU regulations are recognized and more attractive for foreign investors.

On the other hand, as I mentioned, Ukraine would have to tackle higher domestic competition. Restructuring of market and reallocation of factors of production may in the short-term seem very painful and it “should” benefit Ukraine in the long run. Unfortunately, such outcomes are veiled in the uncertainty of the future and entrance of new variables, which were not taken into account, may dramatically change the final picture. Secondly, Ukraine would have to withstand increased standard obedience costs, due to stricter rules. Also costs of legal and administrative adjustments may seem rather high for the moment. Finally, it would have to provide resources to mitigate effects associated with labor reallocation.

To conclude, Ukraine will surely profit in the medium and long run, mostly after overcoming high entry costs. The EU is very willing to share these costs to diminish Ukraine’s burden. Whatsoever, Ukraine should not go into red numbers neither in the short run, as benefits of concluding DCFTA can be considered relatively high even in short-run expectation. The most important moment, in my opinion, is that DCFTA, though part of the intended Association Agreement (AA), has to be ratified only in the European Parliament. Compared to the AA, which has to be ratified by all national parliaments, we can envisage fewer obstacles in DCFTA case. We can expect Ukraine to push as much as possible to conclude DCFTA without the AA and see EU’s powerful opposition. DCFTA is widely considered the strongest carrot to make Ukraine meet EU’s conditions.

The Customs Union: Costs and benefits

The Customs Union is a major integration project of Russia, connecting its market with Belarus and Kazakhstan. As I have mentioned above, I do not think that any integration model in the region would be successful without incorporation of Ukraine. Possibility of Ukraine joining the Customs Union is usually mentioned in connection with Ukraine-Russia gas deals and disputes, because the question of cheap gas is crucial for Ukraine.

Findings of Veronika Movchan and Ricardo Giucci in their recent study, mention several costs and benefits of Ukraine joining the Customs Union [8]: The major benefit of the Customs Union for Ukraine would be cheaper energy. It would undoubtedly be a great benefit for Ukraine, although it has to be compared with the alternative of diversification and increase of efficiency in the former case. Secondly, Ukraine would gain from elimination of customs control, lowering trade costs, which would cause boost in trade and better prices. However, this can be considered only a limited advantage, as Ukraine already enjoys free trade with the CIS countries. Thirdly, Ukraine’s voice would be more powerful, with stronger bargaining power. However, it would also have to face multi-stage bargaining processes and accommodate its interests with those of the Customs Union. [9]

Among biggest flaws, we can foresee certain extent of loss of Ukraine’s independence in its trade policy, including right to continue negotiations on DCFTA. Secondly, potential burden of renegotiations and compensations within the World Trade Organization, owing to the fact that Ukraine’s tariffs are recently lower than those of the Customs Union. This point contains a possible threat that several countries would have a right to ask for compensation or impose additional duties on Ukraine’s goods and services, lowering its final surplus of joining Customs Union. And finally Ukraine would face a slower pace of modernization, due to higher tariffs on investment imports from the EU, which would hamper renewal of fixed assets and import of new technologies.

There are, however, alternative analyses, mentioned by President Vladimir Putin on the last meeting, showing that Ukrainedegree of integration.could comprise by 1,5%-6,5% to the growth of Ukrainian GDP, depending on the ident Vladimir Putin, of fixe’s accession to the Customs Union could comprise by 1,5%-6,5% to the growth of Ukrainian GDP, depending on the degree of integration. [10] It is very hard to choose which model predicts more precise numbers; therefore I think that it is over one’s head to say that one scenario is strictly dominant over the other.

Ukraine is pushing as much as possible for the revision of the “famous” gas agreement with Moscow. Although it is clear that cheaper gas from Russia may only materialize if Ukraine joins the Customs Union. “Experts close to the presidential administration in Kyiv assure that trading the country’s independence in trade policy in the short run and possibly economic independence in the long run is not on the agenda.” [11] Anyhow, it is hard to conclude that Ukraine’s membership in the Customs Union would bring sustainable and decisive long-run benefits.

Political Choice: Under-Theorized Variables

Ukraine’s strategy of balancing in the middle would probably not last very long. Although both sides are squeezing Ukraine to take a final decision, I do not think that it will take place in the closest future. I am sincerely afraid that we will witness creativity of Ukrainian decision-makers as we have seen in the case of NATO. However, this prediction could be true only if Russia would perceive Ukraine joining the DCFTA as the same threat to its national interests, as Ukraine’s accession to NATO. My presumption is that even despite very calm words addressed by President Putin on the last meeting, Russia will use all its peaceful capacities to ensure that Ukraine will join the Customs Union, or at least not join the DCFTA.

Even despite all the facts, I would like to avoid normative judgments, whether Ukraine would be better off here or there. Moreover if we think in the borders of real politics, it is also irrelevant, and in terms of Ukraine’s societal split – impossible to say. “There is general consensus among local elites that integration with the EU is a civilizational choice, while maintaining good trade relations with Moscow, Minsk and Astana is economically important for Kyiv.” [12] Final decision, given that there will be one sometime in the future, would be heavily influenced by several factors, which are in most studies insufficiently analyzed and taken into account:

Firstly, being quite pessimistic towards decision-makers, the final decision would be influenced by very unpredictable egoistic short-term gains of Ukrainian elites. Anyhow, this opens a completely new debate about Ukrainian electoral system, if the expected gain is re-election; or about state of corruption, if the expected gain is money and power. Secondly, ability of European diplomats and leadership to cooperate with Ukraine even despite all the imperfections perceived in the political dimension (good governance, democracy, rule of law, etc.). Thirdly, ability of Russian diplomats and leadership to use appropriate pressure would also play important role. Too much pressure could lead Ukraine to a desperate situation where it would seek diversification for any cost and would blindly try to promote cooperation with the EU. In contrary, insufficient pressure might result into loss of Russian position in the integration momentum and also cause Ukraine’s turn to the EU. Finally, lobbyist pressures of businesses, for which one or another would result into substantial gains.

None of these variables are possible to be grasped in any prediction or model to show us how they would contribute to the final picture of Ukraine’s heading. Therefore, frankly said, the final decision would be even more political then we expected. Nonetheless, it is inappropriate to point fingers at Ukrainian decision-makers for balancing in the middle – their approach is, willingly or accidentally, only reflecting the split in the society.

Thank you for reading my article! In case you had any questions, please feel free to contact me on m.b.lukac@gmail.com.

[1] Council of the European Union 16th EU-Ukraine Summit: Joint Statement. Brussels, 25 February 2013, p.1.

[2] Putin notes reduction in Russia-Ukraine trade. KyivPost, 4 March 2013. Available on-line: http://www.kyivpost.com/content/ukraine/putin-notes-reduction-in-russia-ukraine-trade-321265.html

[3] Валерий Калныш: Жизнь на шпагате. Коммерсант, Журнал "Огонёк", №9 (5269), 11 March 2013. Available on-line: http://kommersant.ru/doc/2139915?isSearch=True

[4] Barbara Lewis and Adrian Croft: EU leaders give Kiev until May to prove it wants to look West. Reuters, 25 February 2013. Available on-line: http://www.reuters.com/article/2013/02/25/us-eu-ukraine-idUSBRE91O0U420130225

[5] Tapiola, Olga-Shumylo: Ukraine at the Crossroads: Between the EU DCFTA & Customs Union. IFRI: Russie.Nei.Reports No.11, Russia/NIS Center, Paris, April 2012.

[6] Actually Russian tendency to use the language of interests, and similarly EU inclination to mask its interests in language of norms, contribute to blurriness of the relationship. Identified in Joan DeBardeleben (2012) Applying constructivism to understanding EU-Russian relations. International Politics, Vol. 49, 4, pp. 418-433.

[7] Veronika Movchan and Volodymyr Shportyuk: EU-Ukraine DCFTA: the Model for Eastern Partnership Regional Trade Cooperation. CASE Network Studies & Analyses No.445. Warsaw: CASE – Center for Social and Economic Research, 2012. Available on-line: http://www.case-research.eu/en/node/57857

[8] Veronika Movchan and Ricardo Giucci: Quantitative Assessment of Ukraine’s Regional Integration Options: DCFTA with European Union vs. Customs Union with Russia, Belarus and Kazakhstan. Berlin/Kyiv: Institute for Economic Research and Policy Consulting. November 2011. Available on-line: http://www.ier.com.ua/files/publications/Policy_papers/German_advisory_group/2011/PP_05_2011_eng.pdf

[9] Movchan and Giucci, 2011.

[10] Роман Ошаров and Тарас Бурноc: Путин позвал Украину в Таможенный союз. Голос Америки, 4 March 2013. Available on-line: http://www.golos-ameriki.ru/content/cis-russia-ukraine-putin-yanukovich-meet/1615128.html

[11] Tapiola, 2012, pp. 24.

[12] Ibid, pp. 23.