Russia and the European Union

On May 5, 2004, the Carnegie Endowment for International Peace hosted a meeting on the impact of the May 1 expansion of the European Union to 25 member-states on Russia. The panelists were Dr. Françoise Le Bail, Director in the Directorate General for Trade of the European Commission, Prof. Pekka Sutela, head of the Bank of Finland Institute for Economics in Transition (Bofit), and Dr. Ksenia Yudaeva, Scholar-in-Residence at the Carnegie Moscow Center. Dr. Anders Åslund, Director of the Russian and Eurasian Program at the Carnegie Endowment, moderated the session.

Dr. Le Bail began by pointing out that, on May 1, the share of the European Union in Russia’s foreign trade rose from about 35 percent to over 50 percent. Thus, one of the first consequences of the EU’s expansion is an increase in the importance of EU-Russia relations. Moreover, the Russian president, Vladimir Putin, has given economic issues priority in his policies.

EU enlargement represents a tremendous opportunity to improve relations between the European Union and Russia. For instance, with the expansion, Russia will now benefit from lower tariffs, which have been reduced from an average of 9 percent to an average of 4 percent. The EU’s expansion has also created a market of over 450 million consumers, without barriers to trade. This market operates under a single set of business rules, making it easy for businesses to operate across internal EU borders. From May 1, the EU represents 20 percent of world trade.

Paradoxically, however, Russia saw EU enlargement with mixed feelings. Russians complained about the rise of aluminum tariffs in Hungary and highlighted the problem of transit to the Kaliningrad Region, which is now surrounded by EU member-states. The EU addressed some legitimate Russian concerns, for example raising the quota of steel imports from Russia. A system has been worked out to facilitate the transit of goods from Kaliningrad to the rest of Russia. New anti-dumping solutions have also been worked out, with duties extended to the new member-states. The Partnership and Cooperation Agreement (PCA) of 1994, which regulates relations between Russian and the EU, has also been extended to the ten new EU members.

EU-Russia relations are more economic that political. The EU relies on Russia for 20 percent of its energy needs, and hence the EU looks at its relationship with Russia in an economic light. Moreover, the EU and Russia share over 2,000 km in common borders. On the other hand, the volume of trade between the United States and Russia is comparable to that between the U.S. and Costa Rica. Thus, Russia sees the EU as a close neighbor useful for trade, but finds a politically stronger interlocutor in the United States.

The EU has two priorities in its relations with Russia: to facilitate Russia’s entry into the World Trade Organization (WTO), and to foster a more open gas market in Russia. WTO negotiations between the EU and Russia have been accelerating. The EU Trade Commissioner, Pascal Lamy, met the Russian Economic Development and Trade Minister German Gref recently. Russia wants to accede to the WTO quickly, and the EU wants it to join on sustainable terms.

The other outstanding issue, energy, is a difficult one. The EU would like Russia to raise the price of natural gas paid by industry, at least to the level of cost recovery. The current situation, where Gazprom sells Russian enterprises gas at a loss, is not congruent with a market economy. Understandably, the price and distribution of gas is a strategic issue for Russia. However, Russia does seem to be prepared to budge on its demand for the free transit of gas to the old members of the EU. There still appear to be some difficulties on Russia’s path to becoming a full market economy. For example, Russia seems to be considering the restoration of a monopoly on telecommunications.

At the 11th EU-Russia summit in St. Petersburg, held in May 2003, it was decided to build four common spaces between the EU and Russia: an economic space, an external security space, a justice and home affairs space, and a common space for education, research and culture.

The EU’s Wider Europe Initiative, introduced in March 2003, presents the EU’s neighbors to the east and south, including Russia, an opportunity to gain greater access to the EU common market, without the prospect of membership. This initiative is a consequence of enlargement, and an attempt to avoid the recreation of dividing lines on the continent. So far, there has been no great enthusiasm in Russia for this proposal. Understandably, Russia does not want to be lumped together with countries like Moldova. Thus, the key to improving EU-Russia relations lies in the bilateral development of the four spaces mentioned earlier.

Out of these spaces, the common economic space between EU and Russia has progressed the most. An action plan has been worked out that lists sectors for regulatory convergence. Russia’s general economic indicators are positive. However, the good macroeconomic picture hides the underlying fragility of the Russian economy. Russia still relies heavily on energy, and investment remains very low. Dr. Le Bail emphasized the fact that foreign investment in China over the past decade has been 40 times higher than in Russia.

Russian economic reforms have to be accelerated. As far as the EU in concerned, the appointment of Mikhail Fradkov to the post of Russian prime minister is “good news.” Mr. Fradkov spent two years as Russia’s ambassador to the EU, and thus knows the organization. It is also good that Russia’s key negotiators with the EU, German Gref and Aleksey Kudrin, have been retained in the new government. Thus, even though the situation in Russia remains fragile, it is going in the right direction. The pace of economic relations between Russia and the EU has accelerated, and the scope of future relations is extremely wide. Some difficulties do remain, however. In particular, the EU has so far not been able to persuade Russia to adopt some parts of the acquis communautaire, which would make it easier for Russia to trade with the EU.

Dr. Yudaeva began by highlighting the “huge asymmetry” that exists between Russian domestic and foreign policy when it comes to the priority given to economic issues. In domestic policy, economic reform is at the top of Mr. Putin’s agenda. On the other hand, geopolitical considerations, such as preserving Russia’s status as a former imperial power, is more important to Moscow than economic issues when it comes to foreign policy.

Russia’s sees relations with the EU to be much less important than bilateral relations with the EU member-states that carry the most political weight, namely France, Germany and, to some extent, Britain. Russia thus clearly emphasizes politics over economics. While NATO enlargement was seen by Moscow to be a very important event, Russia barely noticed the enlargement of the EU on May 1.

The Russian economy is growing, and Russia thus needs trade and foreign investment. Therefore, it ought to have a clear and structured economic policy. The appointment of Mr. Fradkov as prime minister is a positive development in this regard, because he is a specialist in foreign economic policy.

The EU has so far been on the defensive against Russia. Although overall tariffs have been reduced, the tariffs in those sectors where Russia concentrates its exports have actually gone up. Admittedly, the effect of these tariffs on the Russian economy is small. However, anti-dumping duties are applied to virtually all of Russia’s exports to the EU. Further, other non-tariff barriers hamper Russia’s trade with the union. Moscow’s position vis-à-vis Brussels is weak. As a result, negotiations between the two sides, for example, on the issue of Russia’s WTO accession, can drag on forever. Where measures are agreed upon, for example, in the case of the Common European Economic Space, they lack substance.

Russia missed the opportunity to remedy problems in the PCA of 1994. As usual, political considerations prevailed over economic ones. The rights of Russian-speakers in Latvia and Estonia, as well as the Kaliningrad transit issue, dominated Russia’s negotiating position. From a static perspective, some important economic results were also achieved by Moscow. Russia’s steel quota was increased, and some tariffs and anti-dumping duties were reduced. However, from a dynamic perspective, the very existence of anti-dumping duties directed at Russian goods can damage Russia’s growth prospects. The PCA is thus unfeasible in the long run in its present shape, and Russia will have to renegotiate its quotas several times.

The EU wants to continue protecting its businesses, but, at the same time, wants Russia to raise its domestic natural gas prices. It has not even considered the possibility of a deregulation of the Russian gas market causing prices to go down. Russia is not prepared to undertake any precise obligations as a condition to WTO accession.

A limited increase in Russian domestic gas prices is inevitable. The rise in demand, and continued inflation, make the current price increases too low. However, an increase of demand to the EU level is impossible, as the Russian economy would lose up to $7 billion a year if this happened. Rather, reforms in the Russian gas sector should begin with small steps, which would be more effective than large ones. To begin with, the state-controlled monopoly, Gazprom, should increase its transparency and improve its management. If the EU understands the position Russia finds itself in with regard to gas, Russia may, in turn, become more accommodating to the EU.

The EU should support those people in Russia who see their country as a part of Europe. Pressuring Moscow does not help those people. For its part, Russia lacks strategy in its approach to the EU. To improve the stability of the whole region, greater integration is needed between the EU and Russia, Dr. Yudaeva concluded.

Prof. Pekka Sutela began by noting the asymmetric nature of the Russian-EU relationship. While the EU accounts for over 50% of Russia’s foreign trade, Russia accounts for only 3% of the EU’s external trade. Thus, the EU should be highly important to Russia, and one would expect Russia to take the initiative in developing relations with the EU.
However, Russia chose to concentrate on political issues during the recently concluded enlargement process. Observers in the EU thus have a hard time understanding Russia and its goals, and the same can be said for Russia’s understanding of the EU, which is an organization that is hard to make sense of in any case. Moscow tends to use individual EU capitals to circumvent common EU policies. Paradoxically, Russia has the best relations with the EU members with which it trades the least.

Russia does not like the PCA as it stands, because it was negotiated at a time when Russia was very weak and thus made a number of concessions to the EU. However, neither Russia nor the EU is in a position to renegotiate the agreement now. However, they can simply let it fade by using it less and less. The EU has tried to update its policy toward Russia by unilaterally adopting a “common strategy” towards Moscow in 1999. Now, this strategy should be supplanted by a joint action plan worked out bilaterally between Brussels and Moscow. The EU has presented a draft of this plan to Russia. The draft aims to give substance to the “four spaces” mentioned by Dr. Le Bail.

While EU assistance programs are important, they should be tailored specifically to Russia. It is time to bury the EU’s Technical Assistance to the Commonwealth of Independent States (TACIS) program, because the CIS should no longer be regarded as one unit. Neighborhood policies of member-states bordering Russia are sometimes more important than EU programs run by Brussels. Finland’s Barents Sea initiative has been particularly productive. Cross-border cooperation should not be seen as being of secondary importance. While it does not do much for economic development, it does promote civil society at the grassroots level. It is important for the EU member-states bordering Russia to have friends in the civil society of Russian regions adjoining them.

Energy is the backbone for Russia’s economic development. As much as 20 percent of the EU’s oil, oil products and gas comes from Russia. The EU expects that Russia’s market share will increase. However, of the amount of gas the EU needs according to its long-term forecasts, only 10 percent can come from Russia, if one looks at Russia production projections. Geo-economics is similar to geo-politics. In both fields, people draw lines on a globe. In the former, these lines delineate civilizations, while in the latter they designate pipelines. However, both these fields are often divorces from reality. Geo-economists fail to take issues like supply, demand and financing into account.

The new EU member-states have a largely negative view of Russia because of historical circumstances. Thus, they could have a negative impact on the EU’s relations with Russia. On the other hand, it should not be forgotten that Russia is Europe’s growth center. While EU exports stagnated overall, they increased 9 percent a year both in 2002 and 2003. The new member-states may benefit from greater trade with Russia, as Finland has. Nevertheless, the old members are expecting some “trouble” from the new members when it comes to relations with Russia.

The entry of Russia into the WTO is an interest that the EU and Russia hold in common. However, while observers focus on Russia-EU talks relating to WTO accession, they do not pay as much attention to the demands that the United States and China may put forwards as a condition for Russia joining the WTO. It is Russian-U.S. and Russian-Chinese negotiations where one should be a fly on the wall.

In the question and answer session, Dr. Le Bail noted that the prices at which the EU buys Russian gas are not an issue, since they have been fixed until 2011. The EU has offered to invest in Russian pipelines, but Moscow has been unwilling to countenance this. Russia even rejected an EU proposal to build pipelines that would remain under Gazprom control after construction.

On the issue of Kaliningrad, she noted that the EU cannot offer the region a preferential trade status similar to that of Morocco or Tunisia. Moscow itself would be the first to reject such an idea, because Kaliningrad is a sovereign part of Russia. However, the EU can help Russia develop the region. Further south, while the issue of Ukraine’s possible accession to the EU is on the agenda within Ukraine, it is definitely not on the agenda of the EU. As for Russia, there has not been any sign from Moscow of an interest in joining the union. Russia has been a great power since the 17th century, and losing independence to Brussels would be a metaphysical problem for Russians.

Asked about the prospects for the Single Economic Space between Russia, Ukraine, Kazakhstan and Belarus, Dr. Yudaeva observed that the Space is not viable. A free trade agreement and customs union previously existed between some of these countries on paper, while in reality trade barriers between them have only increased. Each country in the Single Economic Space wants to pursue its own agenda, and as long as this continues being the case, the new grouping will not be successful.