Armenia’s economic choice: Customs Union vs. DCFTA?

This article was originally commissionned and written as part of a Series for the Germany-based newspaper “Deutsch Armenische Korrespondenz” in December 2013

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On the third of September, Armenian president Serj Sargsyan’s announcement that Armenia will join the Russian-led Customs Union sent shockwaves across Yerevan, Brussels and Moscow. Up to that point, Armenian diplomats had been hard at work negotiating a Deep and Comprehensive Free Trade Agreement (DCFTA) and Association Agreement (AA) with the European Union, alongside fellow European Eastern Partnership (EaP) member-states: Moldova, Ukraine and Georgia. (Though Azerbaijan and Belarus are nominally EaP members as well, their autocratic systems barred them from further European integration). This statement has had and still has a number of political, social and economic impacts; though it should be enough to focus solely on the economic aspects.

Though the main reason forwarded by Yerevan was security (despite, ironically, denying any pressure from Moscow), a number of Armenian officials circumspectly mentioned a number of economic benefits to joining the Customs Union over the DCFTA; while others have criticised it as an economically backward system designed to protect the inefficient and increasingly uncompetitive Russian market, while offering little incentives for trading partners.

Defining the Customs Union:

The Customs Union, which is seen by many as the pet-project of Russian strongman Vladimir Putin’s nostalgic plan for creating a Soviet Union 2.0, came into existence on the first of January 2010. The Union is comprised of countries routinely criticised for their lack of democratic development; Russia, Belarus and Kazakhstan are set to abolish customs fees between them. They have also signed a memorandum to work towards further integration, and the eventual creation of a Eurasian Union, supposedly modeled on the European Union, encompassing most of the former soviet states. The combined economies of the three countries currently signed on to the project makes up roughly 3% of the world’s GDP with 2.1 trillion dollars, compared to the European Union’s share of a quarter of the world’s GDP, with 17 trillion dollars generated. It is also important to understand the founding motivations of the Customs Union vis-à-vis the European Union, and its Eastern Partnership. The Customs Union is largely an instrument of Russian soft-power, The EU, by contrast, was founded primarily as part of cooperation between equal European states, with mutual economic benefit in mind. 

Questions about accession:

During Armenia’s negotiation process, EU diplomats had made it abundantly clear that Armenia could not join two different unions, due to the conflicting customs regulations, yet Armenia hasn’t reneged on its claim that it can join both nevertheless. It is still unclear how Armenia plans to join the Customs Union, despite the president’s memorandum, due to constitutional blocks and the fact that Armenia lack of common borders with the Union wouldn’t allow it to share in the benefits of tariff-free trade.

The stated economic benefits:

Think tanks, such as the Yerevan-based  Integration and Development NGO, headed by Aram Safarian, have loudly claimed that CU accession would bring large and immediate benefits for Armenia. This, it is claimed, will be done through Russian investment in Armenia’s transport and energy sectors. Indeed, Russia has pledged to invest some €350 million dollars to upgrade Armenia’s railway system, as well as a promised €75 million in investments by the Eurasian Development Bank which Safarian says will boost Armenia’s economy by 0.4% as well as investments in Armenian nuclear energy, and a 30% reduction of the price of gas, which, it is claimed, would immediately help Armenia’s economy grow by 1%. 

Furthermore, the “Integration and Development” Think Tank, claims that a fourth factor, labour migration, caused by Russia’s easing of visa regulations for Armenian citizens, would boost Armenia’s GDP by .25%. Safarian goes on to say that Customs Union accession would benefit Armenia with an immediate 4% boost, and a longer-term stable economy growth perspective of some 2.3%. 

Finally, Armenian economists such as Ashot Tavadyan have also made the argument that because Armenia’s products are simply not yet ready to compete on a European Market, the Customs Union would serve as a sort of ‘incubation’ period to help such export industries grow.

 Weighing Pros and Cons of choosing Moscow over Brussels

Though it should be noted that the European Union is currently dealing with its own monetary crisis, as well as a continent-wide recession, its prospects for growth seem much healthier than that of Moscow. As mentioned, above, the European Union still remains the largest single market, with the world’s largest GDP.  as such, the Rotterdam-based think tank and private consultancy firm Ecorys estimates that the impact of the DCFTA on Armenia would have lead to €146 million in national income gains (with €74 million in income gains for the EU).This would be measured as long-term a 2.3% increase in Armenia’s GDP. Armenia’s exports to the EU would have been expected to increase by 15.2% and imports by 82%

Though at first glance, it may seem that the Customs Union would offer more immediate benefits to Armenia, with comparable long-term growth prospects, it is important to consider certain issues before making such a conclusion:

It is important to note that most positive economic predictions for Armenia’s entry into the Customs Union seem to rely entirely on GDP projections, which does not give much insight on true economic or human development within the country; not to mention that economists such as Aram Safarian see labour migration as a positive boost to the economy, instead of seeking the reduction of outward migration as a sign of economic growth.

1-One must assume that the investments promised by Russia would actually come, and if so, be directed through the right channels. This is important because Russia has promised Armenia investment in the past (promising to invest some €165 million in the railway network within 5 years in 2008, for which most of the promised money is still missing).

 2- Virtually all of the economic benefits predicted by pro-Kremlin analysts, or promised by Moscow, lie in energy and infrastructure, sectors already dominated by Russian state-owned corporations, as opposed to private sector investments. Though the EU was prepared to negotiate a financial aid package at a Donors Conference for Armenia scheduled for 2014, the majority of projected circular investment would have been in the private sector. 

 3- The nature of trade should also be investigated. For instance, not only is the EU common market the single largest trading partner of Armenia, consisting of 35.5% of Armenia’s exports and 25.5% of Armenia’s imports, (these figures would increase if one includes the other DCFTA signatories: Ukraine, Moldova and Georgia, who account for 6.6% of Armenia’s exports, and some 20% of Armenia’s imports) but it is also very diverse. Armenia exports diamonds, manufactured goods, crude materials, beverages, tobacco, chemicals, financial services and commodities, where as the EU is the source of the bulk of Armenia’s imports of consumer goods, machinery and so on.

On the other hand, the Customs Union countries were the destination for only 16.79% of Armenia’s exports for 2012; mostly trade with Russia (Belarus and Kazakhstan received 0.51% and 0.28% respectively)  account for a mere 28.30% of Armenia’s imports (Belarus and Kazakhstan providing 0.28% and 0.01% of goods, mostly Kazakh chocolate, respectively). And unlike Armenia’s links to the EU, the lion’s share of trade with Customs Union countries consists of oil and gas imports from Russia, as well as some food products, and agricultural machinery from Belarus. Thus, one could surmise that Armenia’s joining the Customs Union would have very little direct benefit to the consumers, who will instead be paying higher premiums for goods imported from outside the Customs Union’s boundaries, leaving them with less money for more important purchases. 

 Armenian exports to Russia are almost entirely within the wine, cognac, dried fruit and mining sectors, virtually all of which have been monopolised by government-connected commodity-based cartels. Thus, in this sense, some sectors of the Armenian economy would benefit from Customs Union entry: those that are entirely usurped by the Oligarchy. 

 4- It is also important to consider the State of Russia’s economy, and its impact on Armenia. Russia has shown negative economic indicators in the first two quarters of this year, implying a recession, which is part of a greater trend of relative economic decline. This can be attributed to Dutch Disease due to a lack of diversification of the Russian economy, largely driven by oil, as well as the country’s underdeveloped, and largely inefficient financial sector. Armenia’s close relationship with Russia means that Yerevan has duplicated a lot of Moscow’s policies, which has resulted in a drastic reduction in Foreign Direct Investment (FDI) in the country over the last two years. In his October 2013 blog, Economist Samson Avetian assessed figures on the state of Russia’s economy, claiming that Russia’s economic problems are quite structural in nature, and that Russia is in dire need of enhanced economic management and reforms. He emphasized the negative impact on Armenia, saying 

“Given that Russia is a key trading partner to Armenia, weakness in the Federation is clearly unfortunate. Especially given that significant part of Transfers/Remittances originate from there. Many of the impediments the country suffers are prevalent in Armenia as well. Unfortunately, and with continued absence of reforms and improved economic management, Armenia is expected to not only be impacted by external economic weakness but is left much exposed to the slowdown abroad.” 

5- One of the more direct benefits that Armenia would receive from joining the Customs Union would be the reduced price of natural gas. Indeed, Moscow has offered Armenia to pay the same internal Russian cost of gas with the addition of transport fees. This would come as immediate relief for many hard-pressed Armenian families, but the effect on economic output, despite what pro-Kremlin analysts have claimed, would be negligible; since goods produced with Russian natural gas would be considered as ‘price dumping’ when exporting to the EU, and would be fined anyway.

 6- Another element that hasn’t been directly considered when ascertaining Armenia’s economic prospects when choosing an economic block, is the change in infrastructure required. The EU demands a certain amount of institutional reform and modernisation from potential member states, which it is prepared to assist in attaining. This includes reduction and streamlining of bureaucracy, reduction of taxes, ease of doing business and so on. This has an unmeasured potential impact on economic growth, since it would encourage FDI as well as pan-european business cooperation. Whereas the Customs Union has no requirements in terms of political, economic and bureaucratic reform.

Conclusions:

Image Though Republican Party of Armenia (RPA) officials are currently scrambling to flaunt the economic advantages of Armenia’s potential Customs Union accession, they are still unable to answer the constitutional, geographical, financial and economic concerns that they themselves had been citing prior to September 3rd as impediments to Customs Union accession. Though it is difficult to predict what will happen, one can also take note of the fact that both Kazakhstan and Belarus have recently expressed disgruntlement and desire to leave the organization. The actual benefits would be shared by a small minority of people in Armenia, while others would see price increases in their daily purchases. The only actual calculable benefit that Armenia would get is avoiding the economic sanctions that a vengeful Russia would impose, by threatening to deport labour migrants, and banning Armenian products, which would devastate Armenia’s already Moscow-dependent economy. 

 

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