Effects of WTO Accession on the Russian Economy

May 28, 2003

Ksenia Yudaeva, a leading expert on Russian trade policy and a new Scholar-in-Residence at the Carnegie Moscow Center, presented her analysis of Russian WTO negotiations at a session moderated by Senior Associate Anders Åslund held on May 28, 2003 at the Carnegie Endowment for International Peace. Yudaeva divided her presentation into four sections: the history of Russia's WTO negotiations; current barriers to accession; potential effects of Russia's entry; and reasons why negotiations are stalled.

Russia applied for membership to the WTO in 1993, when it had no trade regime, tariff schedules had been abolished, and the economy was in a state of upheaval. In 2000, Russia's newly elected president Vladimir Putin designated WTO membership a priority for his government, a goal that was bolstered by renewed Russian cooperation with the United States after September 11th. Putin's determination met with uncertainty and opposition in Russia; those who opposed accession mobilized more quickly and effectively than supporters. This increased attention to negotiations, instead of leading to greater openness, has resulted in protectionism on the part of the Russian government, particularly with regard to agriculture. Whereas Russia previously pursued accession as a top priority and seemed willing to accept attendant sacrifices, it now demands clearly defined terms and desires accession less urgently, having recently acquired market economy status. Maxim Medvedkov, Russia's Deputy Economy Minister and lead WTO negotiator, recently stated that he expects accession sometime in 2007.

Current obstacles to accession include Russia's domestic gas prices, tariff lines on automobiles, and the financial, agriculture, and aircraft sectors. The EU originally asked Russia to raise its gas prices by five to six times, but now demands total reform of the industry. Russia disputes the validity of the stipulation, claiming that internal reform of the gas sector is a matter of national sovereignty. The main issue in the financial sector is foreign access to the insurance industry. The Ministry of Finance offered draft legislation requiring insurance companies to decrease limits on foreign investment. Last week, however, the daily Russian paper Kommersant reported that the Ministry has abandoned the legislation in the belief that it did not help obtain concessions from the WTO. The aircraft industry is divided, as some firms want to speed accession while others seek greater state support, which the Ministry of Finance seems to favor.

Yudaeva queried whether these obstacles are real economic challenges or the result of political lobbies preventing compromise. Drawing on a study conducted jointly by CEFIR and the Carnegie Moscow Center, she assessed the potential effects of the tariff changes in the short run on output and employment, and effects of accession on firm productivity, consumers and foreign direct investment (FDI). Many people believe WTO accession and trade liberalization will increase unemployment. Using data collected from Russian firms between 1996 and 2000, the study found that the most active lobbying industries-including the machine building industry-are also the most sensitive to tariff changes. With a uniform tariff reduction of one percent, a decline in industrial employment of one percent or more would occur in four of Russia's eighty-nine regions, while a decline of between 0.5 percent and one percent would occur in seven regions. The remaining regions would suffer a decline of less than 0.5 percent. This data suggests that substantial rises in unemployment are not likely to result from WTO accession. Russia's average tariff, which is now between 12 and 14 percent, would be decreased by 2 percent in case of accession. Studies conducted by the Higher School of Economics and the National Investment Council similarly concluded that WTO accession would not significantly affect unemployment rates. In the long run, the effects of accession on employment seem positive but small. Yudaeva explained that these results should not come as a surprise: exchange rates have a larger effect on the economy than tariff rates due to the importance of oil prices, and tariff rates have fluctuated several times in recent years with little effect on output or unemployment.

Next, Yudaeva discussed the effects of increased import and FDI competition on productivity. While non-competitive domestic firms are crowded out of the market by increased competition, those firms that survive learn to restructure more quickly and effectively, and make better use of technology and management strategies. Imported goods improve the quality of domestic goods, and FDI in consumer industries improves the productivity of domestic firms. An example is IKEA, which now works with domestic producers and invests in their firms. Displaying a graph of "Total factor productivity" (TFP) of Russian firms, with sectors divided according to their position in trade, Yudaeva noted that import-competing firms fare no worse than other firms.

Increased import competition also produced positive effects on Russian productivity. If imports to an industry rise by one percentage point, then on average productivity increases by 0.12 percent. Improved in access to foreign imports also positively effect TFP. While it is commonly assumed that complex industries will suffer from market reforms, the study found that negative effects from import competition in these sectors ceased after 1998.

A decrease in tariffs would also benefit consumers. If tariffs were to drop to 5 percent, the average Russian family would see a 5 percent decrease in annual spending, equal to roughly $20 a year.

Many in Russia believe that WTO accession will scare off foreign investors, thinking that tariffs must be raised to increase FDI. A close examination of FDI inflows from OECD countries to developing countries, however, reveals that WTO accession will result in an average $4 billion increase in FDI from developed to developing countries, roughly equal to Russia's overall inflow in 2001. Russia could thus increase its FDI-to-GDP ratio considerably by joining the WTO.

The strong lobby protecting the financial sector characterizes it as an "infant" industry that would suffer from liberalization. The lobby even argues that liberalization will intensify capital flight. While many Russian economists would argue that certain industries must be protected to become competitive before Russia joins the WTO, "no economist would protect this sector," Yudaeva said. An important task is to open foreign bank branches, essentially prohibited today. The study found a positive correlation between GDP growth and the number of foreign banks in Russia. Liberalizing the services sector, according to a different study, could result in medium-run gains of 6.8 per cent of consumption.

Energy reform is the only real obstacle to accession from the economic perspective, but the issue also reveals a divide between the prime minister and his ministries. The delay in accession is largely due to the absence of a reformer who views WTO accession as major goal. Medvedkov is a civil servant rather than a reformer. Electricity reform is moving slowly but visibly only because Anatoly Chubais pushes it, and WTO accession needs a similar figure. The technical organization of the negotiations also slows the process. Russia's technique is a hybrid of the Chinese and American methods: like China, Russia operates with too much secrecy, and like the United States, negotiations are conducted with a strong bias toward producers who oppose WTO accession.

Discussion:
The first questioner asked whether Putin acted as the reformer Yudaeva said was necessary, given that he was committed to accession in the beginning of his tenure. Yudaeva replied that Putin did not understand the complexities of WTO negotiations when he first took office, believing that he could simply "call up President Bush" to gain membership. While desiring the symbolic value of WTO membership, Putin became less interested as he realizes the difficulty of the process.

With regard to Yudaeva's point that a drop in tariffs leads not to a drop in FDI, but in fact led to an average increase of $4 billion in FDI for new members of the WTO, a participant asked whether there were countries whose FDI decreased after WTO accession. Was there correlation between drop in tariffs and FDI? Which of these countries most resembles Russia? Yudaeva replied that the FDI increase was a reaction to WTO accession, not simply to a decrease in tariffs. Mexico garnered FDI growth from WTO accession. More work on individual country cases is required. Åslund added that automobile companies always argue that they will invest only with substantial protection. The car companies play an important role in the Russian discussion, as over ten million people are involved in the industry in Russia. Yudaeva pointed out that FDI in the car industry is often 'fake' FDI, citing the BMW factory in Kaliningrad which assembles parts produced elsewhere, and thus does not improve production capacity or technology in Russia. "Real FDI would improve Russia's technological capital," she said.

Another question concerned whether exports would increase after Russia's accession, noting that some supporters of the Russian accession are interested because Russian goods are discriminated against in foreign markets. Would Russia negotiate for a transition period to decrease its tariffs? Yudaeva replied that producers compose the major pro-accession lobby, as they suffer most from anti-dumping cases. Russia loses $2.5 billion in anti-dumping cases annually. Exports of some goods will rise, but perhaps not substantially. There is no controversy about which exporters will benefit, but about how much they will benefit. The immediate gain in exports will not be high, and the decline in anti-dumping cases will not be large. A conflict exists between Russia and EU because Russia has a comparative advantage in industries declining in the EU, including steel and fertilizers. The EU is trying to raise obstacles to Russian exports in these sectors. Both exports and imports should rise as Russia already has a large current account surplus.

A query probed the interconnection between Putin's growth target and interest in WTO accession. Yudaeva replied that the study "is agnostic about the growth rate," but she believes that Russia will continue growing, which would further reduce the employment costs of accession. The Russian negotiating team is concerned that if Russia fails to gain accession before the end of the Doha round, it will face additional requirements, as happened to China. Despite their statements, negotiators would like Russia to accede before the end of the Doha round. After the parliamentary and presidential elections, the topic may be revived, but Russia is not ready politically to make concessions. Jackson-Vanik will always be a priority; the problem now is political and symbolic. Its existence costs Russia a great deal, but its abolition costs nothing.

Yudaeva was asked whether a "worst-case scenario exists" in which Russia would not gain entry to the WTO. She suggested that Russia will definitely become a WTO member, but the process could take quite a while, as society is not united. Other countries claim to support Russia's accession but continue to defend their declining industries against Russian competition. In the Chinese case it was the opposite: China became so important that the U.S. lobbied for its membership. Yudaeva noted that the Russian State Customs Committee has started to reform itself with the goal of improving tariff collection. They succeeded admirably in improving the collection rate, but have yet to make Russian tariff policy more transparent or align it with WTO requirements.

A question was raised whether Russia's accession had slowed because Putin had second thoughts about the effects of accession, or because power had shifted from the president to the oligarchs. Yudaeva countered that "major oligarchs don't care about WTO accession, because Russia's greatest oligarchs are in oil and gas, and WTO accession will have a very small effect on these two sectors." Rather, she suggested, those oligarchs who oppose accession are strong and stated their concerns clearly to the president, while no major oligarch supports accession.

Could compensation be offered to those who would suffer from accession in the short term? Yudaeva said that Russia does not have the political power to compensate losers with subsidies or other benefits. Those who fear accession do so because "they know that no transfers from winners to losers can be made. Losers will have to be losers and winners take it all." Formal estimates of long term effects suggest that the largest benefits will derive from liberalizing the services sector. Long term effects from tariff policy changes will be small.

The final question concerned whether Putin's attitude to WTO accession would be influenced by his desire to protect national security, particularly with regard to Chinese immigration and support of employment generating industries. Yudaeva noted that the Chinese demand for free migration disappeared one month after it was tendered. While Russia cares about Chinese immigration in terms of security, WTO accession is viewed more as an economic than a security concern. Russia's recent shift from liberalization to protectionism has emerged in response to increased American protectionism.

Åslund closed by noting that Ikea is now the biggest exporter of furniture from Russia. Yudaeva's presentation bore out a paradox: A broad free trade ideology exists in Russia. The effects of free trade are positive and the Russian economy is open, with exports amounting to one third of the Russian GDP. Yet trade policy is not perceived as important in official circles. There is a deficit of trade lawyers, and the Minister of the Economy German Gref's recent two-month illness has coincided with a declining interest in the WTO. Finally, Åslund suggested that Ukraine's realization that the WTO is important might spur Russia into action just as China's entry pushed it to take the WTO seriously. Ukrainian ambitions might act as a catalyst for Russian entry even sooner than the Russian leadership realizes.

Summary prepared by Anne O'Donnell, Junior Fellow in Carnegie's Russian and Eurasian Program.