Publication: Russia and Eurasia Review Volume: 2 Issue: 6

by Philip Hanson

Post-communist change in Russia includes, among many other things, changes in Russia’s commercial dealings with the outside world. The part of the outside world that exerts the strongest gravitational pull on the Russian economy, by virtue of its location and its economic size, is Europe–chiefly, but not exclusively, the present European Union of fifteen states. How are Russia’s economic ties with Europe developing? Is it reasonable to envisage some sort of Russian ‘integration into Europe’ over the next decade or so? Russia and the EU have, after all, an array of formal relations: a Partnership and Cooperation Agreement, official ‘strategies’ toward one another, six-monthly summit meetings, and an agenda that includes the creation of a Common European Economic Space spanning Russia and an enlarged EU. Yet this relationship is problematic.

It is clear that Russia is rejoining the trading world. It now has by global standards a small, open economy. Its 2002 GDP of about US$350 billion (with rubles converted to dollars at the current exchange rate) puts it on a par with some of Europe’s smaller economies. (At purchasing power parity, that is, taking into account domestic prices, Russia’s GDP is estimated at US$1,100 billion by the World Bank.) Merchandise exports plus imports work out at 48 percent of that GDP, making the Russian economy, on that measure, about as open as Germany. This is a huge change. In the depths of Stalin’s ‘Socialism in One Country,’ on the eve of World War II, Soviet foreign trade was no more than 1 percent of GDP.

In other respects, however, Russia’s integration into the world economy is still rather limited.

Import tariff levels are not high (a weighted average of 10.05 percent in early 2002), but there are some high individual tariffs–on autos, for example. More strikingly, there are still some export duties, notably on oil, which reflects a gulf between world and domestic energy prices reminiscent of the days of central planning. Domestic gas and oil prices are, respectively, about 15-30 percent of the world price, due to a combination of limits on export capacity and the government’s desire to protect domestic consumers.

Partly through the deliberate choice of local elites, Russia is much less open to foreign investment than it is to trade. The UN Conference on Trade and Development (UNCTAD), in its 2002 survey of foreign direct investment, put Russia 104th out of 140 countries on its performance in attracting FDI. Russia has been rather more conspicuous as an exporter of capital, but that is bad news for a poor country.

So far as the movement of people is concerned, there is more, and easier, crossing of Russia’s borders than there used to be of Soviet borders. In 2001 the EU15 countries together issued about one million visas to Russian citizens, and visitors to Russia have increased in number as well. Nonetheless, bureaucratic hassles remain, and last November Russia tightened its procedures. For most people it is easier to get, say, a Japanese or Indian visa than a Russian one.

This is the background against which Moscow and Brussels have begun to talk about a Common European Economic Space. What this means is still being discussed. One might expect it to mean at least a free trade area, but it probably does not. Whatever it is, Russia’s reclassification by Brussels as a market economy, and Russia’s accession to the World Trade Organization (WTO), are prerequisites for it. How it would fit with European Commission President Romano Prodi’s proclaimed but vague ‘Proximity Policy’ for all EU neighbors is completely unclear.

For policy makers in Moscow, the EU is proving to be a difficult and frustrating partner. Here are some examples.

Market-economy status was expected to give Russia some protection against what was in practice unilateral imposition by the EU of anti-dumping controls on Russian goods. Yet no sooner had that market-economy status been achieved, in November of last year, than the EU amended its anti-dumping legislation so that some of the protection was taken away.

In the negotiations over WTO accession the European Commission has been particularly tough on the subject of Russian domestic energy prices. Initially, Brussels demanded an equalization of Russian domestic and world electricity and gas prices. This was excessive. Very low domestic energy prices do indeed amount to a form of subsidy to Russian manufacturers. However, the equilibrium exchange rate of the ruble, like that of other developing-country currencies, is well below purchasing power parity. So if ruble energy prices inside Russia were made equal to world prices at the exchange rate, those energy prices would in fact be high relative to non-energy prices, in international perspective.

One unheralded achievement of Russia’s economic transformation is that the country can once more, as in Tsarist times, export grain when good weather produces a bumper harvest, as in the past two years. And it can do so without (as Stalin did) simultaneously starving its own people. The EU, however, is not about to reform its Common Agricultural Policy, so Russian grain exporters encounter barriers in entering EU markets.

Many issues such as these can be resolved in time through negotiation. And nobody seriously contends that Russia itself does not have a lot to do to make its economy more genuinely open and competitive. But two underlying problems exist on the EU side of the dialogue: EU protectionism and Brussels’ chronic interventionism.

Anti-dumping measures, quotas and other constraints currently limit Russian sales of steel, some basic chemicals and farm products into Western Europe. Russian commentators–not all of them the paid mouthpieces of Russian business interests–argue that the EU is happy to have Russia as a source of cheap energy but is in effect hindering Russian economic diversification. Never mind that the most severe impediments to greater efficiency among Russian producers lie inside Russia itself: EU protectionism does not help.

In this context, the European Commission’s emphasis on Russia bringing its laws and regulations in line with those of the EU (the EU’s acquis communautaire) has so far been too strong. If that is what a Common European Economic Space depends on, and not on genuinely free trade, the ‘Common Space’ is not a good idea.

It is one thing to adopt the acquis as a condition for joining the EU, as Poland and the other accession countries have done. The benefits of doing so merely to be a close business partner of the EU are much less obvious. Indeed, as Vladimir Mau and Vladimir Novikov, two liberal economists, argued in Voprosy ekonomiki last year, quite a lot of the highly regulatory acquis–such as the chapters on social policy and the environment–would be damaging to Russia’s economic health. Mau and Novikov reviewed the thirty chapters of the acquis notionally applicable to Russia, and concluded that only half-a-dozen were suitable for Russia at this time.

Even if all or most of the acquis were desirable for a liberal economy, a situation in which one state tailors its laws to those of another without any power to influence those laws would still entail a troublesome juridical inequality. That is one reason why Switzerland has opted out of the European Economic Area, and it presents difficulties for Norway, the other non-EU West European country of any size that operates closely with the EU. For a touchy ex-superpower, such asymmetric arrangements are not recommended.

For these reasons, many members of the Russian policy-making elite are now, in British political terms, Eurosceptics. However, Russia, with the bulk of its population west of the Urals and its CIS neighbors all economically weak, is stuck with Europe. In the first nine months of last year 55 percent of Russian trade was with Europe in the wider sense: the present EU15, Central and Eastern Europe (most of it scheduled to join the EU in 2004) and Norway and Switzerland. In geostrategic terms (possibly excepting the current Iraq crisis) Moscow may find Washington easier to get on with than Brussels. But less than 5 percent of Russia’s trade is with the United States. Even the largest possible increase in Russian oil sales to the United States (and that is not going to be very large) would not greatly change that situation.

What is needed in Brussels is more flexibility. Other countries (the United States, South Korea and Singapore, for instance) are successful trade partners of the EU without having signed up to the acquis or to anything much resembling it. Historically, it has not been the case that joining the world economy is like joining a fraternity house or a Masonic lodge: you do not necessarily have to sign up to rules set by the existing members. When Japan ended its semi-isolation after the Meiji Restoration, it did not conform to free-trade orthodoxy but was protectionist and also excluded foreign direct investment. When Canadians got their industrialization going in the 1890s, they put high tariffs on U.S. goods precisely in order to stimulate U.S. direct investment into their country (creating what Canadian nationalist intellectuals three generations later would deplore as a ‘branch-plant economy’).

Joining the EU is like joining a secret society–complete with hazing (being beaten over the head with all the chapters of the acquis). But that is not on the agenda for Russia in the foreseeable future. Meanwhile, it is in both Russia’s and the EU’s interest to minimize the barriers to trade and investment between them, and not to get hung up on the export to Moscow of Brussels’ imposing array of regulations.

Philip Hanson is an emeritus professor of the political economy of Russia and Eastern Europe at Birmingham University in England.