by Anders Aslund, Peterson Institute for International Economics
Testimony at the Hearing on EU Economic and Trade Relations with Russia, Committee on International Trade, European Parliament, Brussels
November 21, 2006
The author thanks Julija Remeikaite for excellent research assistance and C. Fred Bergsten and Gary Hufbauer for valuable advice.
From 2000 to 2003 President Vladimir Putin made Russia's World Trade Organization (WTO) accession one of his key priorities, but after he failed to reach his self-imposed deadline of 2003, his interest wavered. Russia is already a market economy so WTO membership does not imply systemic changes as great as in China. Given that Russia's primary export products are not sensitive to protectionist measures, WTO membership is also of less economic significance, but the positive effects on the Russian economy from WTO accession would be substantial. The bilateral negotiations with the United States became a major stumbling block, but they have been concluded. Bilateral settlements with Georgia and Moldova are elusive because of Russia's politically motivated trade embargos against these two states. Substantial work remains to be done in the multilateral negotiations concerning the enforcement of intellectual property rights legislation, domestic agricultural subsidies, the role of state enterprises in the Russian economy, and possibly the low regulated domestic Russian price of natural gas. The most worrisome question is to what extent President Putin himself maintains his prior commitment to the WTO. Positively, no single country opposes Russian membership of the WTO in principle. The European Union has a clear interest in Russia joining the international world trading system. Using the augmented version of the Rose gravity model, we estimate that Russian total two-way trade in manufactures could double from $187 billion (in 2005) to $352 billion. As the European Union is by far Russia's biggest trade partner, the European Union stands to gain greatly from Russia's accession to the WTO.
Russia applied for membership in the General Agreement on Tariffs and Trade (GATT) in 1993, but throughout the 1990s negotiations were slow and formal. Soon after Putin became president in 2000, he energized Russia's half-hearted attempts to enter the WTO. He made a commitment that Russia would accede in 2003. Now in 2006, Russian officials are talking about joining in one year's time, as they talked in the late 1990s.
Formally, Russia is getting ever closer to accession. After concluding a bilateral protocol with the United States this month, only three bilateral protocols on market access out of 58 are outstanding, namely with Moldova, Georgia, and Costa Rica. Even if Russia, contrary to expectations, would conclude all these bilateral protocols before the end of 2006, substantial work remains on the multilateral WTO memorandum, which is likely to take most of 2007.
Recently, Minister of Economic Development and Trade German Gref expressed doubts that Russia could join the WTO even in 2007, and last spring President Putin's economic adviser and G-8 sherpa Igor Shuvalov even warned that Russia may withdraw its application to join the WTO and then it would revoke all commitments that it has made, conditional on its joining the WTO.
This testimony focuses on the policy side of Russia's WTO accession. The first section discusses Putin's first term, 2000–2003, when he strongly supported WTO entry, and the Russian interests concerning the WTO. The second section considers the period 2004–06, when Putin lost interest in further market reform. This loss of interest is particularly apparent in his recent pronouncements that oppose a market economy. The penultimate section examines Russia's prospects for WTO accession, and the final section makes recommendations for EU policy on Russia's accession to the WTO.
Putin Embracing WTO, 2000–2003
Putin became president in 2000 and made Russia's early entry into the WTO one of the priorities in the large economic reform program that his chief reformer German Gref elaborated. Putin and Gref have spoken widely about the importance of Russia acceding to the WTO. Russia's changed policy to the WTO can be entirely credited to these two men. Previously, a few prominent reform ministers emphasized the WTO, Yegor Gaidar, Boris Fedorov, Yevgeny Yasin, and Yakov Urinson, but they never received strong support from the president or the prime minister.
President Putin made the end of 2003 the goal for Russia's accession to the WTO. The time was chosen realistically. It was also targeted to fall within Putin's first term and with a parliament that supported him fully. Putin made Russia's entry into the WTO one of the main themes of all his international meetings and encountered general support. No country has opposed Russia's joining the WTO. The issue has only been conditions.
One explanation for Russia's new interest in the WTO was intellectual maturity. Several of the internationally oriented Russian economists and economic politicians had realized the significance of the WTO for Russia, and finally they managed to make it state policy. Possibly, China's entering the WTO was the decisive reason for Russia's turnaround. Russians started wondering if they had missed out on something important when China and the West paid so much attention to China's accession to the WTO.
At about the same time, the Russian businessmen woke up. Russia's need for membership in the WTO was growing because of structural changes in the Russian economy: Ninety percent of what the Soviet Union exported to the West was oil and natural gas. Now these raw materials account for about 60 percent of Russia's exports, while intermediary goods such as metals and chemicals (comprising one-quarter of exports) have grown in share. The steel exporters took the lead. Russia's steel industry has been consolidated and restructured, with the four biggest and best companies now producing four-fifth of Russia's steel. They have improved and expanded output, but import quotas strictly regulate Russia's exports both to the European Union and the United States, which would not be legal if Russia were a member of the WTO. Major competitors to Russia on the steel market are steelworks in Poland and the Czech Republic, which now belong to the European Union. Russian chemicals are often subject to antidumping actions in the European Union, and the penalty rates tend to be twice as high as those for EU accession countries, but Russia has no means to complain. As one industry after another takes off, such examples will multiply.
In parallel, the new big businessmen joined the old Russian Union of Industrialists and Entrepreneurs (RSPP), which had traditionally been the fortress of the old state enterprise directors. They swiftly made RSPP their central organization for advocacy and lobbying, and the modern exporters came to dominate it. Alexei Mordashov, the young CEO of Severstal, one of the big restructured private steel companies, became the chief spokesman of the RSPP on trade issues, and he provided an industrial backbone for WTO entry. The oil exporters were also positive, though the issue was not central to them.
Little could happen, however, until the old Ministry of External Economic Relations was abolished. It was merged with a number of other ministries into the new giant Ministry of Economic Development and Trade, headed by German Gref. A substantial group of young and competent trade negotiators was developed, which could pursue the WTO negotiations more seriously. Russia's chief trade negotiator is Maxim Medvedkov.
Since the beginning of 2000, an influential group has been mobilized in favor of Russia's early accession to the WTO. In the government, it has been slim, consisting of the president, Minister Gref, and Minister of Finance Alexei Kudrin, who became head of the Russian working group in the WTO. A second group consisted of about three-quarters of the new big businessmen in the RSPP, notably the steel exporters. A third constituency of considerable strength was liberals in Russia's parliament. A fourth group of liberal academic economists was also emerging, and they produced a range of studies on the effects of Russia's accession to the WTO.
Soon, however, resistance against Russia's entry to the WTO also arose. It had four centers. The main opponent of an early WTO entry was the top businessman Oleg Deripaska, CEO of the giant Russian Aluminum company, owner of one of Russia's big car companies, Rospromavto, and previously of one of Russia's big airplane-producing companies. Deripaska's two concerns were protection for the car industry and aviation. He mobilized Russia's car industry in opposition to the WTO, persuading the Russian government to slap prohibitive customs tariffs on second-hand Western cars, the actual competition to obsolete Russian cars. He was also pushing for substantial tariffs on imported civilian airplanes. Deripaska made the standard infant industry argument that these manufacturing industries need a substantial period of transition to adjust to freer trade and that the conditions of entry are more important than an early entry. In fact, Deripaska got pretty much what he wanted, though the tariffs, especially in aviation, might have to be adjusted in the WTO negotiations. For the last couple of years, he has refrained from saying much about the WTO.
Another center of resistance was the Russian Chamber of Commerce and Industry, which represents the old red directors and is chaired by former Prime Minister Yevgeny Primakov. As Deripaska, they argued that Russia primarily exports commodities, which enjoy easy access to the world market in any case. Market access for manufactured goods is not very important, because manufacturers can barely keep up with quickly rising domestic demand, while the opening of the Russian market for more imports of manufactured goods would harm domestic manufacturers. This infant industry argument is applied also to processed foods, pharmaceuticals, chemicals, and light and electronic industries. Interestingly, the bulk of Russia's extensive machine-building sector does not call for protectionism. Yet, the old red directors have lost out both economically and politically, and their resistance to the WTO appears to have surprisingly little impact. All these concerns are minor.
A third industrial lobby that objects to the WTO is agriculture. Minister of Agriculture Alexei Gordeev is a strong and able representative of this protectionist lobby. There are primarily two issues. One is that the WTO accession implies a capping of state aid to agriculture. Although Russian agriculture receives very small subsidies today, the agrarians want to keep the option open for larger subsidies in the future. This issue is determined in the multilateral memorandum, and it will probably be the last issue to be resolved. Animal husbandry raises increasing problems, as one part after the other of this previously devastated sector revives. The Russian veterinary services have raised doubts about Western imports of chicken, pork, and beef. When the European Union slapped quotas on Russia's exports of grain to the European Union in early 2003, Russia responded with the introduction of quotas on various kinds of meats, notably on pork, whose production is also developing swiftly. But agriculture is usually the last issue to be settled in trade negotiations, as was the case in the bilateral US-Russian negotiations on market access.
A fourth restive industrial lobby has been services. It falls into many small parts—intellectual property rights, retail trade, telecommunications, insurance, and banking. The infant industry argument is also used here. The United States has made intellectual property rights a key issue, as Russia is a haven of electronic piracy. Russia has adopted all the required laws, so the issue here is implementation—how many factories the Russian police close and that the equipment is really destroyed. The other big bone of contention is the service sector has been allowed more foreign ownership of insurance companies and banks. A tentative compromise was reached in July 2006 between the United States and Russia that branch offices of Western insurance companies would be allowed, but not of banks.
Several studies have examined the effects of WTO entry on the Russian economy. The vast majority of Russian households are expected to gain from WTO accession. According to World Bank assessments, welfare gains to Russia will be equal to 3.3 percent of Russian GDP in the medium term.1 In the long run, gains could be as high as 11 percent of GDP when benefits from an improved investment climate are realized. Perhaps surprisingly, the most significant effect (about 72 percent of the total medium-term welfare gains) will come not from improved market access but from Russia's own domestic liberalization of barriers to FDI in the business services sector (transportation, financial, and telecommunications), which is currently strictly protected by formal and informal barriers. Tariff reductions and ensuing improved resource allocation will account for about 18 percent of the total welfare gain, and improved market access due to more favorable treatment of Russian exporters in antidumping cases accounts for the remaining 10 percent of the total welfare gain.
According to the same World Bank study, the Russian manufacturing sectors most likely to expand as a result of WTO accession are ferrous and nonferrous metals and chemicals. These are sectors of revealed comparative advantage, and WTO membership should offer Russia better access to world market. Manufacturing sectors most likely to decline are machinery and equipment, food processing, light industries, and construction materials, the least competitive sectors in the Russian economy.
WTO accession became one of the major themes in the extensive institutional reforms that President Putin pushed through from 2000 till 2003. A major Western concern has been the weakness of the Russian legal system. Laws are not perceived as transparent or uniform, nor are they enforced. This applies especially to the cumbersome customs. Many major laws were adopted during this period, including a Tax Code and a new Customs Code (which came into force in January 2004). By and large, the Russian legislation had been brought into conformity with WTO regulations in 2003. The new Customs Code has helped to reduce the previously massive corruption and long delays in customs. A whole new legislation on intellectual property rights has been adopted. The legislative agenda was tense, but it was well managed, as the resistance to WTO legislation persisted in various government departments, while it has only been minor in the predominantly liberal parliament. In any case, a transition period of seven years is expected for Russia's entry to the WTO.
In 2002 Russia achieved a major breakthrough in its trade relations as first the United States and later the European Union declared Russia a market economy, which improves the country's ability to defend itself in antidumping cases, but it is formally unrelated to WTO accession. China is still not recognized as a market economy.
On the whole, Western complaints about current Russian policies are rather limited, since Russia is a reasonably free and open market economy, unlike China. Russia's problems with entering the WTO are often exaggerated, since Russia is a rather open market economy with average tariffs of 11 percent. Russia should get away with only a fraction of the commitments China had to undertake. In substance, the differences over Russia's entry conditions into the WTO were quite small, and most formal preparations had already been undertaken. By 2003 Russia was very close to join the WTO. The main issue was for the Russian leadership to focus on WTO membership and resolve the not very significant outstanding issues.
Putin's Loss of Interest in Reforms, 2004–2006
In March 2004 Putin was re-elected for a second term. Although the president remained the same, his policy changed profoundly. As Putin consolidated authoritarian power, the liberal market economic insignia of his rule faded as well.
An important first change for Russia's WTO negotiations was that he dismissed Prime Minister Mikhail Kasyanov for Mikhail Fradkov. The new prime minister actually made his career as an expert on WTO, at the time when Russia did nothing about the WTO. In 1993 he was appointed deputy minister for external economic relations with responsibility for WTO, but he stood out as the most passive of the many deputy ministers. Even so, he advanced quietly to become minister for external economic relations in 1997. After one year, his ministry was abolished, which was celebrated as a major attack on bureaucracy and corruption. After another year, he was appointed as head of the Ministry of Trade, which was eliminated in 2000, when it was merged with German Gref's new Ministry of Economic Development and Trade. In 2001 Fradkov was appointed head of the Tax Police, which was abolished two years later, another victory in the fight against bureaucracy and corruption. Then, Fradkov was demoted to ambassador to the European Union in Brussels, where he was not much noticed. On a visit to Brussels in early 2004, Gref gave ambassador Fradkov a scolding that he was the most incompetent Russian ambassador he had ever encountered. One month later, Fradkov became prime minister.
Putin's appointment of Fradkov as prime minister said everything about his second term. First, Putin wanted a weak and passive government. Second, he had no intention to undertake major new reforms. Third, he opted for going slow on WTO accession. Fourth, the siloviki (to whom Fradkov is counted) were to dominate over the reformers (Gref and Kudrin). In one single appointment, Putin transformed his reform government to a nonreform government. It mattered little that the reform ministers, Kudrin and Gref, remained in the government. Their power would never be restored.
Second, through the not very fair parliamentary elections in December 2003, the liberal parties and most independents lost their seats in parliament, and United Russia could rule without opposition. The parliament had disappeared as a liberal force pushing for WTO accession.
Third, the arrest of Mikhail Khodorkovsky, CEO of Yukos, in October 2003 and the subsequent destruction of Yukos, silenced the liberal business lobby. Businessmen stopped talking politics in public. As a result, lobbying disappeared into the backrooms and became much more nebulous. The WTO-positive RSPP faded. Mordashov, who is close to the Kremlin, stopped saying anything liberal. Deripaska, who obtained the car protection he had asked for, stopped arguing in public, and he sold his aircraft interests.
The domestic political stage for WTO negotiations changed completely as liberals and big businessmen, who had supported Russia's early WTO accession lost out. The only remaining pro-WTO force to be heard was Gref and his collaborators at the Ministry of Economic Development and Trade with some support from Kudrin. Russia's very slow progress in its WTO accession since 2004 is a natural consequence of Putin's political changes in late 2003 and early 2004.
The commodity boom has also contributed to the cooler Russian attitude to the WTO. Russia's GDP in current dollar terms has skyrocketed from $200 billion in 1999 to some $960 billion in 2006. Commodity exports have driven the growth. With a trade surplus of 14 percent of GDP and a current account surplus of 11 percent of GDP in 2005 and even more in 2006, Russia does not suffer much from exports barriers, and therefore its perceived need of the WTO has declined. After all, it mainly exports oil and gas that all want to buy and therefore not subject to protectionism. In 2004 oil and gas accounted for 45 percent of Russia's total exports, and this share has risen with rising oil and gas prices. Other commodities (metals, chemicals, and forestry products) accounted for another 23 percent. In addition, Russia has suffered little from protectionism in recent years—only about 1 percent of Russia's exports ($2.5 billion) are subject to antidumping measures in various countries. Therefore the steel and chemical companies have turned quiet, even if the situation is likely to change fast when the current long commodity boom finally ends. Yet, almost one-quarter of Russia's exports consists of metals, chemicals, and forestry products, which are highly sensitive to protectionism.
Most of the siloviki around Putin dislike the West, and increasingly Putin has allowed them to take over. The idea is that Russia is strong enough on its own, and if it needs cooperation it is better to cooperate with China, which is economically vibrant and does not ask any unpleasant questions. President Putin himself is increasingly inclined to China and turning his back on both the United States and the European Union. Judging from his public statements, Putin seems caught in a growth Darwinism, contemptuous of the slowly growing West, while enchanted with dynamic China. The Kremlin is also irritated with Western complaints about corruption and money laundering of the Russian elite as well as authoritarianism. These complaints concern both the European Union and the United States.
Putin's Rhetoric Turns against the Market Economy
Under President Putin there has been a buildup of grievances about Russia's political development, but the economy has appeared to remain safely in the free market zone where his predecessor, Boris Yeltsin, left it. Unfortunately, Putin's televised question-and-answer session with the nation on October 25, 2006, marked a radical departure from his prior market economy rhetoric.
Just as it was in the old Soviet days, the patriarchic state has authority over everything but responsibility for nothing. The economic essence of Putin's three-hour exposition was that he favored ethnic discrimination, trade and price regulation, higher custom tariffs, export taxes, state intervention, industrial policy, subsidies and, most of all, centralized micro-management. Conspicuously absent were ideas like deregulation, the rule of law, and private property rights.
The most dramatic turnaround concerned the WTO. In his annual presidential address on May 10, 2006, Putin advocated accession to the WTO, talking about the need for "more rational participation in the international division of labor" to make "full use of the benefits offered by integration into the world economy." This time, he did not even mention the WTO while proposing measures in direct contradiction to the organization's rules. For example, he called for increased subsidies for animal husbandry in agriculture, the stimulation of automobile production by raising customs duties, and higher export tariffs for lumber.
Rather than favoring the international division of labor, Putin is now advocating industrial policy, import substitution, and state subsidies for priority industries. As a boost to the forestry industry he suggested "the import of equipment" and the "development of the relevant branches of machinery manufacturing in Russia." For every industry mentioned, Putin referred to a specific national project or program to stimulate that very sector with significant government attention and subsidies.
Putin presented an economic vision very different from earlier statements. His new policy of import substitution aims at unlimited state intervention, industrial policy, and protectionism. This well-known model has failed all over the world. Putin is able to pursue this economically harmful advocacy only because of high oil prices and thanks to his predecessor, Boris Yeltsin, who created a critical mass of private enterprise and a market economy. To judge from his words, Putin has gone back to the Brezhnev tradition, which led to the Soviet economic collapse. The best we can hope for is that he did not actually mean what he said.
Russia's Prospects for WTO Accession
On November 10 Russia and the United States finally announced that they had reached agreement on a bilateral protocol on market access for Russia's accession to the WTO, and the United States declared itself satisfied that this was a good commercial deal. President Putin had evidently overruled Minister of Agriculture Gordeev, allowing reasonable rules for access to the Russian market for US chicken, pork, and beef. This happened at the very time when Putin publicly spoke for more protectionism.
The main work that remains is negotiation on the multilateral memorandum for Russia's accession. A general expectation is that these multilateral negotiations cannot be settled until late 2007. The West wants to make sure that Russia is really enforcing its new legislation in defense of intellectual property rights. Russia still insists on its right to introduce far higher domestic agricultural subsidies than the European Union and the United States are prepared to accept, which is a typical question left to the very end of the negotiations.
A new issue is the role of the enlarged state enterprises in the Russian economy after the last two years of substantial renationalization. This concerns particularly the three big state energy companies, Gazprom, Transneft, and Rosneft, and comes up against the European Energy Charter that Russia refuses to ratify.
The most serious conflict in Russia's negotiations with the European Union was Russia's domestic price of natural gas, which has all along been much lower than the Russian export prices, which vary greatly with country of destination, but this was settled on conditions favorable to Russia, when the European Union signed its bilateral protocol with Russia, a milestone that was reached in May 2004. Russia has complied with that agreement, but international gas prices have risen further. Producers of mineral fertilizers around the world are now complaining anew that the Russian domestic gas price is too low. At present, Russia's domestic wholesale price without tax is $40 per 1,000 cubic meters, while Gazprom's netback price from gas sales to Europe is about $150 per 1,000 cubic meters.2 Because of a rising shortage of gas in Russia, the Russian government itself discusses either to double the domestic price for industrial users or to partially deregulate the domestic price as early as 2007, while the current government policy is to let the gas price rise by 15 percent next year.
The remaining obstacle is the Russian embargos against the two WTO members Georgia and Moldova, prohibiting substantial imports of wine and fruits from these two countries, citing sanitary problems. After a recent arrest of four alleged Russian spies in Georgia, Russia blocked all transportation to Georgia apart from pipelines, all trade, and bank transfers, although Georgia soon released the four Russian military officers. Therefore, Georgia and Moldova are not prepared to sign any bilateral protocol on market access with Russia. Georgia had signed a bilateral protocol but has since revoked it. The real issue between these two countries and Russia is the status of the separatist territories, Transnistria in Moldova and Abkhazia and South Ossetia in Georgia. Russian-friendly leaders rule these territories, and Putin has repeatedly suggested that they should become independent. If Russia does not cease its embargos against Georgia and Moldova, these countries have little choice but to refuse to conclude bilateral protocols with Russia. These two countries could either mobilize other WTO members against Russia's accession or stop at precluding their relations with Russia to be covered by the WTO.
A last stumbling block for Russia is the US Jackson-Vanik amendment, which was attached to the US Trade Act of 1974. To give Russia normal trade relations, the US president must grant an annual “waiver,” certifying that the Soviet Union does not deny its Jewish citizens the right to emigrate in order for Russian exports to enter the US market at normal tariff rates. Naturally, Russia has no understanding for this. The judgment in the US Congress is that a bilateral protocol is not sufficient to convince the Congress to graduate Russia, as was the case with other WTO candidates. The multilateral negotiations will have to be settled as well. This will further infuriate the Kremlin.
Finally, the question is whether rising Russian threats to withdraw its WTO application are serious or not. On the one hand, Putin has been the stalwart behind Russia's approach to the WTO, and he recently overruled the agrarian lobby in the bilateral negotiations with the United States on the WTO. On the other hand, as Russian politics have become authoritarian and the oil prices have risen, Russia's commitment to integration with the world economy has weakened.
In all likelihood Ukraine will join the WTO before Russia, since Ukraine's new government has declared its firm intention to accede and realistically can do so by February 2007. It needs to settle two bilateral protocols out of 50, with Kyrgyzstan and Taiwan, which is perfectly doable. To fulfill its multilateral obligations, Ukraine needs to adopt about 20 legal amendments, which is well under way and can be done within a month or so. Ukraine's earlier accession to the WTO will be a further source of irritation to the Kremlin.
Recommendations for EU Policy on Russia's Accession to the WTO
The European Union has a clear interest in Russia joining the WTO and subscribing to the rules of the international trading system. Using the augmented version of the Rose gravity model, we estimate that Russian total two-way trade in manufactures could double from $187 billion (in 2005) to $352 billion. Slightly more than half of Russia's trade is with the European Union. Russia's accession to the WTO will be an important stimulus to the dynamism of the European economy.
Naturally, the European Union also needs to maintain certain principles in the multilateral negotiations that are likely to last most of 2007. The most important ones appear to be as follows:
1. Jesper Jensen, Thomas Rutherford, and David Tarr, 2004, Economy-Wide and Sector Effects of Russia's Accession to the WTO, Washington: World Bank.
2. When comparing gas prices in various countries, we must take note of high transportation costs and huge and varied taxes.
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