Kyrgyzstan and the Customs Union

Al-Farabi News
Summary
Despite the stated economic benefits to Kyrgyzstan of joining the Customs Union of Kazakhstan, Belarus, and Russia, this move may actually prove harmful to the republic’s economic well-being.
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When Almazbek Atambayev was sworn in as president of Kyrgyzstan last December, he declared in no uncertain terms his intent to unite his country with the recently established Customs Union of Kazakhstan, Belarus, and Russia. But while Atambayev has trumpeted the economic benefits of strengthening Kyrgyzstan’s ties to Russia and the Commonwealth of Independent States, the move to join the Customs Union may in reality be harmful to the republic’s economic well-being.

 
The primary goal of the Customs Union is openly stated: regional protectionism. In 2010, a single customs tariff on imports into the union’s territory was created, introducing significant new obstacles to importing goods and materials from nonmember states. The most prominent achievement of the Customs Union to date, this tariff was meant to establish conditions that encourage domestic production and regional trade.
 
The single customs tariff was largely harmonized with Russian tariff rates—already at a high due to temporary increases prompted by the 2008 economic crisis—and had the effect of not only consolidating these trade obstacles but also spreading them to Kazakhstan, which had traditionally maintained much lower rates. The end result was the establishment of a significant average external tariff of 10.6 percent levied on imports from nonmember countries. 
 
While there are valid arguments to be made regarding the benefits of this protectionism for the three current member states, there is little to be said for the potential benefits for Kyrgyzstan. The Kyrgyz Republic’s economy is fundamentally different from those of the current members. While Russia, Kazakhstan, and Belarus all boast industrialized economies with developed domestic production sectors, Kyrgyzstan is largely an import economy. By some evaluations, one of the country’s two greatest economic activities is actually the import and reexport of Chinese consumer goods to other CIS countries. The current importance of this type of trade to the Kyrgyz economy cannot be understated; alone, the republic’s two major markets at Dordoi and Kara-Suu, both of which primarily act as reexport venues, account for approximately one-third of the nation’s GDP. 
 
It is this reexport trade more than any other part of the Kyrgyz economy that is most threatened by Kyrgyzstan’s potential accession to the Customs Union. This kind of trade has flourished in Kyrgyzstan not only because of its geographic proximity to China but also because of its low import tariffs. Currently averaging less than half of the single customs tariff average, Kyrgyzstan’s low tariffs allow goods to be obtained cheaply before they are reexported. The implementation of the single customs tariff would significantly raise the cost of importing these goods into Kyrgyzstan, thereby eliminating the country’s comparative advantage over the primary consumers of its reexports—Kazakhstan and Russia. 
 
Of course, some have made the argument that this type of middleman trade is a crutch, and that its elimination would spur the development of domestic production in Kyrgyzstan. But while it is true that Kyrgyzstan’s reliance on reexporting Chinese goods does not make for the most prosperous economy in the world, the effects of dismantling such a large part of the country’s economic activity would nevertheless be devastating to the population. 
 
The argument against Kyrgyzstan’s current reexport system also ignores the fact that domestic production is accelerating without the assistance of regional protectionism. The country posted an industrial growth rate of 27.5 percent in 2011—more than double the rate of any other economy in the CIS. Much of this growth is again thanks to the low tariffs imposed on imported Chinese goods and materials. The availability of cheap Chinese fabric, for example, has turned domestic garment production into a thriving export trade; currently, 90 percent of all garments produced in Kyrgyzstan are exported to Russia. 
 
While President Atambayev has asserted that accession to the Customs Union would allow his country to become “the sewing machine for the countries of the Eurasian Economic Community,” the fact of the matter is that Kyrgyzstan already occupies that position. Joining the union will only hurt this accelerating economic sector by raising the cost of importing Chinese materials and once again eliminating one of the republic’s few comparative advantages.
 
The price increases on goods will not, however, apply only to goods used for export. The cost of any goods imported from countries outside the Customs Union for domestic consumption will go up as well. One of the most commonly cited fears with respect to these increases is that medicine, which currently enjoys a 0 percent duty, will become unaffordable for most Kyrgyz citizens. When compounded by the loss of livelihood that will arise from the damage done directly to production and the reexport business by tariff increases, the negative impact on Kyrgyz society could be profound. 
 
What may be the strongest argument for Kyrgyzstan to pursue membership in the Customs Union has very little to do with the country’s domestic economy. Seventeen percent of Kyrgyzstan’s GDP in 2009 was drawn from remittances from Kyrgyz migrant laborers working in Russia. And under the Customs Union, those remittances could potentially increase as obstacles to working in Russia decrease. By Russian federal law, as of January 1, 2012, citizens of any Customs Union member state may work in Russia without receiving work permits, and all quotas on migratory labor have been removed
 
But while the short-term appeal of increased access to Russian jobs is obvious, the long-term effects of this development could very well be devastating for Kyrgyzstan. If the goal of joining the regional alliance is indeed to aid the long-term development of domestic production, the country’s leadership has an important question to confront: If the domestic economy is damaged at the same time as barriers to migration are lowered, who will remain to do the hard work of founding new industries and reconstructing the economy?
 
In the end, economic considerations may have less sway over Kyrgyzstan’s accession to the Customs Union than political factors. The country that stands to benefit most from the expansion of the union is Russia, which, as the region’s largest economy, has a vested interest in encouraging neighboring states to pursue cooperative economic policies. This is especially salient in the case of Central Asia, where China has been demonstrating increasing economic interest. As such, Kyrgyzstan is likely to face significant pressure from the Russian Federation should it waver in its intent to join the Customs Union. 
 
President Atambayev is all too familiar with the political implications of Russia’s economic leverage. The Kremlin’s decision in 2010 to stop providing fuel subsidies to Kyrgyzstan is largely seen as a key factor leading to the destabilization and overthrow of the regime of former president Kurmanbek Bakiyev. Now, the Kyrgyz president finds himself leading a country that is still plagued by the ethnic and north-south divisions that led to unrest and bloodshed in the months before his election; should Russia resort to similar economic tactics, it is highly unlikely that Atambayev would have the domestic political capital to hold on to power.
 
Thus, Kyrgyzstan’s accession to the Customs Union, despite its potential economic consequences, seems preordained. The republic, and its leader specifically, simply cannot afford to become politically alienated from Moscow. And if Atambayev’s post-election declarations demonstrate anything it is that he completely understands the reality of the situation.
 
But while Kyrgyzstan’s economic future in the context of the Customs Union does not inspire great optimism, there is a wild card in play. As Russia prepares to join the World Trade Organization after clearing the last major hurdle in an eighteen-year-long bid, the strength of the Customs Union’s protectionist policies may falter. Indeed, one of the primary stipulations of Russia’s accession to the WTO is that its average tariff ceiling—and, by extension, the average tariff ceiling throughout the Customs Union—be lowered to 7.8 percent. 
 
Still, exactly how Russia’s accession to the WTO will affect the state of its regional trade agreements is, at this point, largely unknown. And while these new conditions may be a small step forward in alleviating some of the burdens that Kyrgyzstan will face as a new Customs Union member, they may not be enough to save the republic from some of the harsher economic consequences it is likely to confront.
End of document
 
Source http://carnegieendowment.org/2012/05/01/kyrgyzstan-and-customs-union/aleg

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