Russia’s economic interests and the EU’s DCFTA with Ukraine

The EU and Russia are engaged in a consultation on whether the EU’s new Deep and Comprehensive Free Trade Agreements (DCFTA), which form part of the Association Agreements about to be signed on 27 June with Georgia, Moldova and Ukraine[1], give any legitimate cause for concern for Russia. Around the time when Putin persuaded Yanukovich to renege on signing the DCFTA at Vilnius, in November 2013, there were arguments put out by the Russian side to this effect. Given the imminent signature now of these DCFTAs it is time to put these various stories to rest.

It has been publicly argued several times by Putin that Russia would be flooded with goods from the EU. This argument is false, since it ignores the ‘rules of origin’ applied by all WTO members, which include Russia, Ukraine and of course the EU itself. Goods exported to Ukraine from the EU tariff-free by virtue of the DCFTA, and which then might be sold on into the Russian market, would still be treated as ‘made in the EU’ and therefore subject to Russia’s import tariffs that apply to the EU (its WTO-bound m.f.n. tariffs). The only exception to this would be if the goods were intermediate products, which might then be substantially transformed in Ukraine into different final products, with a significant Ukrainian value-added. In this case the products would have become ‘made in Ukraine’, and could benefit from the Russia-Ukraine free trade agreement (even if this in very imperfectly implemented on the Russian side). The rules determining whether the goods shift from ‘made in the EU’ into ‘made in Ukraine’ are very precise, and Russia would be able to withdraw preferences for Ukraine's exports if there was evidence of fraud.

A second argument relates to the fact that under the DCFTA Ukraine will progressively adopt EU technical product standards as it own national standards. The suggestion has been made that this would mean that Ukrainian enterprises exporting to Russia would be obliged to make these goods according to EU standards, and that this would hinder these traditional trade flows where Russia applies different standards. This argument is also false, since Ukrainian enterprises would only have to apply these standards to sales on their domestic market or to the EU, but they would remain entirely free to produce for export to Russia according to Russian standards, or to China in accordance with Chinese standards, etc. This is standard practice among WTO member states.

However this leads on to the question what standards are being adopted by the customs union of Russia, Belarus and Kazakhstan. While the answer here is not yet entirely clear, it is believed that the Eurasian Economic Commission is in practice going to apply many European and international standards, which would further dissolve the problem.

In practice the DCFTA with Ukraine only specifies 17 product standards for adoption under Ukrainian law within fixed time schedules, generally of three to five year. These particular products actually exclude the main traditional trade flows of manufactured goods between Ukraine and Russia, notably railway equipment and inputs into the Russian industrial-military complex (for example helicopter engines and parts for space rockets).

On the other hand Russia itself is taking steps to reduce its reliance on supplies from Ukraine. For the railway sector Russia has set targets for import substitution away from Ukrainian supplies, and Dmitri Rogozin, responsible for the Russian industrial-military complex, has announced objectives of moving rapidly to lessen reliance on supplies from Ukraine. These are clearly autonomous policy decisions being taken by the Russian side.

A more subtle economic argument is that the DCFTA would mean an erosion of Russia’s relative competitiveness for exports to Ukraine, since the EU will after  transition periods for Ukraine’s tariff cuts have free access to this market which it did not have before. However this argument is not a strong one for three reasons. First from the legal standpoint the making of free trade agreements between WTO member states is regulated by WTO rules, and the DCFTAs will be in conformity with these rules. Secondly, Russia’s exports to Ukraine are hardly competing with EU exports, given that gas is the predominant product, followed by supplies for Ukraine’s Soviet era nuclear facilities.  Third, Russia is itself creating preferential advantages for itself by bringing Kazakhstan into its customs union, requiring Kazakhstan to apply a higher external tariff that it would like, and thus creating a trade preference for Russian producers relative to the situation of EU exporters. 

However this last argument leads into the strategic issue for Russia's economic policy, namely its increasingly obvious need for economic modernisation of the non-commodity sector, and for this the 'Lisbon to Vladivostok' proposition advocated by Putin in various speeches is of the highest relevance, and this should ultimately involve high quality free trade with both the EU and Ukraine.   

All in all this rather laborious rehearsal of all conceivable technical arguments of possible concern to Russia reaches the conclusion that it is basically a non-story. But since the political context is so sensitive it is just as well to take the trouble to put unjustified fears and suspicions to rest. There remains however the bigger story of 'Lisbon to Vladivostok', which is at the higher level of strategic interests, and into which the EU-Ukraine DCFTA could fit perfectly well. 

[1] More precisely Ukraine has already signed the political part of its Association Agreement, with only the DCFTA remaining to be signed. Georgia and Moldova will sign the complete agreements.