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REGIONAL ECONOMIC INTEGRATION OF CENTRAL ASIA:

PROBLEMS AND PROSPECTS FOR THE KYRGYZ REPUBLIC

Tatikov Ruslan

Academic Adviser: Prof. Mine Yoichi

Graduate School of Global Studies

Doshisha University

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Acknowledgement

First and foremost, I would like to express my profound gratitude to my academic advisor,

Professor Mine Yoichi, for his guidance in every step of the way of my thesis writing and constant

support during my two years of study. Without his comments and advices I would not be able to

come up with this study and complete it.

My special thanks to Professor Agola Nathaniel, for his valuable suggestions and considerable

comments as well as for his willingness to find free time for discussion.

I would like to express my sincere gratitude to Professor Naito Masanori, Professor Nakanishi

Hisae, Professor Oyamada Eiji, Professor Ida Ryuichi and other professors who taught me during

two years, for their insight and fruitful lectures which enriched my knowledge about global issues.

My great thanks also go to the staff of Global Studies for their gracious assistance and support on

various matters.

I extend my gratitude to Japanese International Cooperation Agency (JICA) for providing a good

opportunity to study and live in a culturally rich environment and to explore the heart of Japan.

Thanks are extended to my wonderful classmates for their memorable and unforgettable student’s

life in Japan.

Finally, I am grateful for the support I received from my wife and children, for their direct and

indirect assistance throughout my education in Japan.

Tatikov Ruslan

Graduate School of Global Studies

July 01, 2014

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Abstract

Beginning from the middle of the twentieth century and up to this day more and more countries

seek for regional economic integration. In reality, it has become a global phenomenon. The Central

Asian countries a few times have attempted to create an integrated union since the independence

in 1991. The main goal of this integration was to establish economic or customs union like the

European Union model. Several times they have signed regional and bilateral agreements at the

levels of political leaders. However, instead of laying a foundation of regional economic

integration of Central Asia, they have signed a numerous bilateral agreements with other regional

countries. Ultimately, such policy has led to increasing complexity of trade turnover among the

countries of Central Asia. Therefore, the aim of this study is to examine the possible economic

effects of Kyrgyz Republic from possible participation in Central Asian integration as well as to

identify potential advantages and disadvantages, and possible challenges which might be faced by

Central Asian countries in the process of integration. This research finds out that Kyrgyzstan's

membership to a Central Asian Union will bring about trade diversion effect. It is assumed that

this effect in Kyrgyzstan can occur in short or mid-term perspective. However, from dynamic

effects the Kyrgyz market can achieve benefits in long-term perspective through the promotion of

garment industry and the increase of agriculture products. Another interesting finding of the

research is that regional economic integration of Central Asia can bring great benefits in terms of

the access to the world market, development of infrastructure in the region, rational use of energy

and water resources, and resistance to internal and external threats. Also, significant potential

challenges in the process of integration of Central Asia have been found out. There are the issues

of political regime, differences of economic development, aspiration of leaders regarding the

domination in the region, as well as the question of political will. As a conclusion the study comes

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up with some policy recommendations calling for faster regional economic integration of Central

Asian countries.

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION ................................................................................................... 7

I. Background ................................................................................................................................................ 7

II. Objective of the Study ............................................................................................................................... 9

III. Research Methodology ........................................................................................................................... 10

IV. Organization of the Study ...................................................................................................................... 10

CHAPTER 2: THEORETICAL ASPECTS AND HISTORICAL CONTEXTS OF THE STUDY .............................................................................................................................................. 12

I. Overview .................................................................................................................................................. 12

II. Definition of Regional Economic Integration ........................................................................................... 13

III. The Theory of Origins Regional Economic Integration .......................................................................... 14

IV. Forms of Regional Economic Integration ............................................................................................... 16 1. Preferential Trade Agreements ............................................................................................................................ 17 2. Free Trade Area ................................................................................................................................................... 18 3. Customs Union .................................................................................................................................................... 18 4. Common Market ................................................................................................................................................. 19 5. Economic Union .................................................................................................................................................. 20 6. Political Union .................................................................................................................................................... 21

V. Economic Benefits and Costs of Regional Integration .............................................................................. 21 1. Static Effects on Members of Regional Economic Integration ........................................................................... 22 2. Dynamic Effects on Members of Regional Economic Integration ...................................................................... 25

CHAPTER 3: INTERNATIONAL EXPERIENCE OF ECONOMIC INTEGRATION: EUROPEAN UNION AND SOCIALIST COUNTRIES. .......................................................... 27

I. Overview .................................................................................................................................................. 27

II. Economic Integration Processes of the European Union .......................................................................... 28 1. Origins and Development of European Integration ............................................................................................. 28

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2. Benefits and Drawbacks of Economic Integration of the EU .............................................................................. 33

III. Planned Economic Integration of Socialist Countries ............................................................................. 37 1. Historical Aspects of Integration of COMECON ................................................................................................ 37 2. Benefits and Drawbacks of Economic Integration in Socialist Countries. .......................................................... 41

CHAPTER 4: REGIONAL ECONOMIC INTEGRATION AS AN EFFECTIVE MECHANISM FOR ACHIEVING SOCIO-ECONOMIC DEVELOPMENT IN CENTRAL ASIA ............................................................................................................................. 44

I. Overview .................................................................................................................................................. 44

II. Contemporary Trends of Economic Development in Central Asia ........................................................... 46 1. Recent Social and Macroeconomic Indicators of Central Asian Countries ......................................................... 46 2. Recent Performances of Merchandise Trade in Central Asian Countries ........................................................... 49 3. Dynamics of Economic Integration Process in Central Asia .............................................................................. 62

III. Measuring the Potential Advantages and Disadvantages of Regional Economic Integration in Central Asia. ............................................................................................................................................................. 66

1. Evaluating Advantages and Disadvantages of REI in Central Asia through Trade............................................. 66 2. Potential Benefits of REI in Central Asia Regarding Non-Economic Issues ...................................................... 70 3. Possible Challenges for the Regional Economic Integration of Central Asian Countries ................................... 73

CHAPTER 5: ANALYSIS OF THE REGIONAL ECONOMIC INTEGRATION FROM THE PERSPECTIVE OF KYRGYZSTAN ................................................................................ 76

I. Overview .................................................................................................................................................. 76

II. Trade Policy of Kyrgyzstan toward the Central Asian countries .............................................................. 78

III. Possible Economic Effects of Kyrgyzstan’s participation in the Central Asian Integration Process......... 82

CHAPTER 6: CONCLUSIONS AND POLICY RECOMMENDATIONS ........................... 86

I. Conclusions .............................................................................................................................................. 86

II. Policy Recommendations ......................................................................................................................... 93

REFERENCES................................................................................................................................. 94

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Abbreviations and Acronyms

ADB – Asian Development Bank

ASEAN- Association of Southeast Asian Nations

COMECON/CMEA – The Council for Mutual Economic Assistance

CIS – Common Independent States

CACO – Central Asian Cooperation Organization

CAREC – Central Asia Regional Economic Cooperation

CU – Customs Union

CSTO – The Collective Security Treaty Organization

ECO – Economic Cooperation Organization

EURASEC – Eurasian Economic Community

EU – European Union

EEC – European Economic Community

ECSC – European Cool and Steel Community

EURATOM – European Atomic Energy Community

EFTA – European Free Trade Association

FDI – Foreign Direct Investment

GDP – Gross Domestic Product

GNI – Gross National Income

HDI – Human Development Index

IBEC – International Bank for Economic Cooperation

IIB – International Investment Bank

NAFTA – North American Free Trade Agreement

SCO – Shanghai Cooperation Organization

PPP – Purchasing Power Parity

SPECA – Special Program for the Economies of Central Asia

USSR – Union of Soviet Socialist Republics

UNDP – United Nations Development Program

WB – World Bank

WTO – World Trade Organization

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Chapter 1: Introduction

I. Background

Regional integration became a key concept in the 20th and 21st centuries in the process of world

development. There are general trends toward economic integration in developed and developing

countries. Despite the various levels of economic development, different forms of state and

economic models, most of the countries are seeking for some kinds of integration in a global or a

regional framework. In reality, globalization and integration are interrelated processes that will

determine the path of economic development in the world in the coming decades. However,

regional economic integration of developed countries - a way for cohesion and joining positive

forces of the world economy. In regards of regional integration in developing countries - is actually

the only opportunity to confront the negative effects of globalization and the global dominance of

the leading countries of the world. Thus, this is the only way to take a worthy place in the world

economy for the new independent states of Central Asia, whose economies were part of the

powerful economic complex of the USSR – the answer is regional economic integration.

According to Jovanović (1998, p.12) the importance of regional economic integration is well

recognized. It has affected most of the countries in the world and it has become a very significant

element in most economic policy decisions. In fact, most of the countries have attempted to get

integrated with each other. It should be acknowledged that the biggest achievements in integration

have been among the developed countries, in particular the European Union (EU), because this

integration is one of the most successful attempts of this kind in the world. A plenty of countries

in other areas of the world have tried to copy some of the integration achievements that have been

carried out in Europe. So, like the EU countries, the Central Asian republics could be integrated

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into the regional cooperation for achieving international competitiveness, sustain economic and

social growth, as well as advance human development and human security in the region. Besides,

Central Asian countries have the common history, culture, language as well as 70 years’ experience

of parts of the single regime under the Soviet Union.

Furthermore, it should be noted that for centuries Central Asia was a bridge of inter-regional trade

between Europe and East Asia, and North and South Asia, which was named the ''Silk Road'' in

the XIX century by Austrian geologist (UNDP, 2005, p.34). Unfortunately, during the Soviet era,

all trading routes to partner countries in East-West were closed down and all systems of trade and

transport were leading to Moscow. Eventually, Central Asia became isolated from the economic,

cultural and religious interaction with the rest of the world. But in 1991, after the collapse of the

Soviet Union and the subsequent independence of the five Central Asian republics: Kazakhstan,

Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan had been faced with social and economic

difficulties. In spite of these challenges, they have managed to create national identities and a new

basis of common market, to rebuild relationships in the field of trade and investment with the

outside world, and to improve regional cooperation for the future.

Moreover, today, the Central Asian region has been attracting the interest of all powerful countries

in the world. Firstly, this region abounds in rich deposits of oil and gas. Secondly, this region has

a strategic and geopolitical importance on the Eurasian continent. The most active and influential

players in Central Asia have been Russia, United States of America and China so far. But recently,

particular interest in the region of Central Asia is expressed by the European Union as well.

Because the sea trade links between the EU and China, the most important European trading

partner, is costly due to the background of the limited capacity of the main sea gate to Europe - the

Suez Canal, the Central Asian region is becoming a strategically important commercial land bridge

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between the EU and China. In addition, Central Asia is rich in oil and gas fields, which is also a

factor that attracts the interest of the EU.

Based on the above, eventually Central Asian countries can choose only from the two options for

formation their future in the new world. Firstly, to solve problems in own way relies only on their

own strength or while constantly risking being influenced by stronger neighbours; It is assumed a

not good option. Otherwise, secondly, to develop mutually beneficial integration ties with

neighbouring states, jointly strengthening their individual national economies. It is assumed to be

a beneficial option. For this purpose a Central Asian country will need to strengthen in such fields

as economic development (especially trade and investment) or natural resources (water and

energy) or national security (terrorism, arms, drug trafficking and Islamic militancy). However,

this study will focus mainly on economic issues particularly in the area of trade relationship.

II. Objective of the Study

The main objective of this study is to define and analyse the possible economic effects on the

part of the Kyrgyz Republic from its accession to the Central Asian integration. In detail, the

study will intends to answer the following research questions:

-What would be possible advantages and disadvantages of the integration of Central Asian

countries?

- What kinds of challenges exist in the process of integration of Central Asia?

- What are the trading relations between the Kyrgyz Republic and the other Central Asian

countries?

- What are the consequences to be faced by the Kyrgyz Republic from accession to the Central

Asian integration?

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This study can help to identify advantages and disadvantages for Central Asian countries, in

particular challenges and perspective for the Kyrgyz Republic in the process of regional economic

integration. Regional economic integration is meant for any form of concerted action taken by the

countries of a region aimed at a fuller utilization of their growth potential. In this sense, regional

economic integration is very important for enhancing and boosting economic growth for the newly

independent states of Central Asia, as well as the possibility and necessity of combining them

irrespective of the size and the present level of economic development.

In other words, this study shows us that regional economic integration has more advantage rather

than disadvantage in theoretical aspects, as well as in the light of the experience of European Union

which is very successful in this field.

III. Research Methodology

In order to answer these questions which were have been mentioned above, the research

methodology includes comprehensive analysis based on the existing literature in the West and our

country on this topic. In addition, this thesis builds on reports, surveys and articles that have

already been published by international organization, individual researchers as well as groups of

research institutes in order to consolidate the theoretical background on this issue. Moreover, the

data used in this thesis are taken initially from official government statistics of Central Asian

countries and other international databases.

IV. Organization of the Study

The study consists of six chapters. The next chapter - Chapter 2 – will discuss the theoretical

background and forms of regional economic integration as well as economic benefits and

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drawbacks of regional economic integration in order to understand how economic integration may

affect the state of welfare.

Chapter 3 will provide an overview of international experience of economic integration taking an

example of European countries, as a desirable framework of regional economic integration for

Central Asian countries. Since the European Union is one of the most successful economic

integration structure in the world, many countries seek to follow this example. Subsequently, this

chapter considers historical background of planned economic integration of socialist countries and

examines advantage and disadvantage of economic integration in that period time.

Chapter 4 will focus on Central Asian countries concerning such issues as essence and implications

of regional economic integration. Its analyses would be based on the latest macroeconomic trends

and performances of trade turnover of Central Asian countries. In addition, this chapter will discuss

the integration process of Central Asian countries which gained independence after the collapse of

Soviet Union. Also, this chapter will examine potential advantages and disadvantages, and possible

challenges which might face Central Asian countries in the process of integration.

Chapter 5 will analyse the perspective and challenges of the Kyrgyz Republic in regional economic

integration of the Central Asian countries. Moreover, the chapter will describe the Kyrgyz trade

relations and possible economic effects to be brought by its participation in the Central Asian

integration.

Ultimately, based upon the findings in Chapter 4 and Chapter 5, some policy recommendations for

the Kyrgyz Republic and other Central Asian countries will be suggested in Chapter 6.

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Chapter 2: Theoretical Aspects and Historical Contexts of the Study

I. Overview

In the process of globalization, regional economic integration has come to exist in all regions of

the world in both developed and developing countries. It must be noted that the term of “economic

integration” implies any regional economic integration or international economic integration.

However, if international economic integration proceeds in parallel with globalization, regional

economic integration may promote just purely regional economic blocks.

The issues of regional economic integration have been attracting many researchers all around the

world. Over the last 60 years, when European Union started to establish a regional alliance, there

has been a huge interest in understanding benefits of regional economic integration. A lot of

literature has been written regarding this theme. Nevertheless, regional economic integration still

remains a major topic, especially in developing countries. The fact is that there are lots of reasons

for creating a union, in political as well as economic and social terms. For instance, in political

terms: establishing more friendly relations between countries, guaranteeing economic and political

stability in the process of market reforms, ensuring regional security, and increasing its influence

in the global market; In economic terms: promoting trade among participants, opening an access

to national commercial products in foreign markets, improving the international competitiveness

of national economies, attracting foreign direct investment, securing an access for more cheaper

production of resources, boosting economic growth of members of the integration; In social terms:

poverty alleviation, migration and unemployment issues, mitigation of pollution environment,

human development and other motives.

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This chapter discusses merely the theoretical aspects of economic integration including definition

and forms of economic integration that have been expressed by economists and scholars in order

to provide common concepts of regional economic integration. Moreover, the chapter touches on

important issues such as gains and costs of regional economic integration which are major driving

forces of integration process in the world.

II. Definition of Regional Economic Integration

This section considers the definitions of economic integration brought forward by different

economists. To date, there is no common definition of regional economic integration since each

economist and scholar has one’s own view, looking at different aspects of integration.

However, in general, “integration” means bringing together all parts into a whole. At all times,

various economists and scholars have treated the term of economic integration in different ways.

Carbaugh (2004, p.540) points out that economic integration is a process of eliminating restrictions

on international trade, payments and factor mobility.

According to Balassa (1961, p.1), economic integration is a process and a state of affairs. Under

the process of integration, he assumes that the abolition of discriminatory measures will augment

economic output belonging to different states. As for the state of affairs, this implies the absence

of any form of discrimination of the national economy.

Robson (1998, p.1) argues that international economic integration, often termed as regionalism,

may be defined as the institutional consolidation of separate national economies into larger

economic blocs or communities. Integration in this sense first took off in the late 1950s when the

European Economic Community was set up under the Treaty of Rome of 1956.

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It should also be noted that international economic integration can be positive or negative. The

term of “negative integration” was coined by Tinbergen (1954) to signify the removal trade of

barriers between the participating states or the elimination of any restrictions in the process of

trade liberalisation. By using the term of "positive integration", he meant modification of existing

instruments and institutions and the creation of new one, for the purpose of enabling the market to

function effectively and also to promote other broader policy aims of the union.

Another economist, El-Agraa (1989, p.1), explains that international economic integration is

concerned about the removal of all discriminatory trade impediments between the participating

nations and with the establishment of certain elements of coordination between them. Either (1988,

p.524) views economic integration could involve a reduction in barriers to trade or to factor

mobility, or a unification of economic policies.

III. The Theory of Origins of Regional Economic Integration

This section reviews the theoretical aspects of regional economic integration in order to provide

common ideas that have been expressed by various economists. It should be noted that the theory

of regional economic integration is closely related with international trade and was primarily

presented by economists Adam Smith and David Ricardo in 18th and 19th century. In addition,

there were other economists who followed their original ideas on these issues. Therefore, the

common view on the theory of economic integration does not exist. According to Bulatov (1999,

p.613), a lot of directions have been considered in the theory of economic integration which differs

primarily in terms of different estimates mechanism of the integration. Let us consider some

aspects of the existing theoretical areas of international economic integration.

In their classics of economic theory, Smith and Ricardo supported the idea of free trade. The basis

of their views on foreign trade lay in the classical principle of the country benefitting from

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specialization in production and exchange of goods on the basis of the international division of

labour. This approach is the basis of the theory of international economic integration in different

directions.

The Swiss economist W. Röpke and the French M. Allais, who represented early neo-liberalism,

claimed that economic integration was to establish a single market space joined by a few countries

which would carry out the principle of free competition, regardless of the policies of states and

international laws.

Then, the American economists S. Rolf and W. Rostow believed that apart from the market

mechanism and state regulation, the establishment of multinational corporations was able to ensure

better integration of the international economy and its sustainable and balanced development.

A representative of structuralism, the Swedish economist G. Myrdal, criticized the idea of

complete liberalization of the movement of goods, capital and labour, arguing that the free

movement can lead to certain imbalances in development and distribution of production as well as

deepen income inequality. He considered the economic integration as a process of structural

changes in the economies of integration with development of large companies and entire industries.

Neo-Keynesian American economist R. Cooper stated that to get benefit from international

economic integration and simultaneously to maintain maximum freedom of each country, it is

necessary for participating members to agree on internal and external policies and to achieve an

optimal combination of the two possible options for development of economic integration: (1)

unification of the states with the subsequent loss of their sovereignty and mutual agreement of

economic policy; (2) integration with maximum preservation of national autonomy.

Theorists of dirigisme, J. Tinbergen, R. Sanvald, and I. Shtoler, deny that free market plays

important role in the process of integration, and deemed that the function of the international

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integrated structures will become possible on the basis of elaboration of one economic policy

among members of integration thereby eliminating artificial barriers and promoting coordination

and harmonization of a common policy.

IV. Forms of Regional Economic Integration

Commonly, the integration process begins with the liberalization of mutual trade, the removal of

restrictions on the movement of goods and services, capital and labour and then gradually leads to

economic integration of participating states. This process of integration is not spontaneous or fast.

Therefore, it is needed to go through various stages of regional economic arrangements. At each

stage, certain barriers are gradually eliminated and the preconditions for more efficient production

and foreign economic relations between the countries are to be created.

Consequently, for a better understanding of regional economic integration, it is suggested that the

characteristics of each stage of the integration should be considered, their precise definitions

should be given, and their basic mechanisms and features should be identified.

According to Balassa (1961, p.2), economic integration has several degrees, from its lowest to its

highest forms. There are a free trade area, a customs union, a common market, an economic union,

and a complete economic integration or so-called political union. But unlike Balassa, some

Western economists and scholars consider preferential trade agreements as the first stage of

regional economic integration. Due to the fact that this form of agreements is very important for

new independent states of Central Asian republics, the features of this stage of integration will be

considered in detail in subsequent chapters in order to understand and define the stage in which

they are placed now. The stages of economic integration are illustrated in Table 1.

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It should be noted that, currently, only the EU has passed through almost all of these stages of

integration. Most of other groups aiming at regional integration in the world are purely in the first

or in the second stages. Let’s consider in more detail the steps the regional integration requires.

Table 1: Stages of Economic Integration

Stage of economic integration

Reducing or eliminating trade barrier for goods and services

Establishing external tariff for non-members

Free movement of labor and capital

Coordinating only economic policy (single market, single currency)

Coordinating common (economic , social, foreign, security) policy

PTAs FTA Customs Union Common Market Economic Union Political Union

Source: adapted from Balassa (1961).

1. Preferential Trade Agreements

Preferential trade agreements (PTAs) are meant to form trade blocks which reduce tariffs and

guarantee preferential treatment among members usually only for some categories of products,

and in addition, encourage the levels of trade restrictions against third parties (Argüello, 2000, p.4).

Preferential trade agreements are perhaps the one of the weakest and yet the first stage of economic

integration. This is the first level, in which the countries go toward mutual rapprochement and

preferential trade agreements are carried out between them. It can be based on a bilateral relation

between two states or between existing integrated regions. Under these agreements, member

countries are supposed to provide each other more favourable trade regime than to third countries.

In other words, preferential trade agreements are a trade pact among states that purely reduce

external tariffs for definite commodities, rather than eliminate the tariffs.

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2. Free Trade Area

According to Balassa (1961, p.2), member countries of Free Trade Area (FTA) must eliminate

tariffs between them, and each country has the right to restrain its own tariffs against non-members.

El-Agraa (1989, p.1) points out that in FTA the member nations remove all trade barriers among

themselves but retain their liberty according to its own policy vis-à-vis the non-participants.

Several good examples of FTA include: the European Free Trade Association (1960), Latin

American Free Trade Area (1960), North American Free Trade Agreement (1994), and ASEAN

Free Trade Area (1992).

However, there are two basic features which distinguish between free trade area and customs union.

Firstly, the member countries have the right to carry out their own policy toward third countries.

Secondly, the trade area is conditioned by rules of origin. The main goal of these rules of origin is

to restrict trade diversion. Since the country with the lowest tariff can redirect its imports to other

members. As in the case of a customs union, the formation of free trade area may be accompanied

by trade creation or trade diversion, but their important difference lies in the way of their operation

with regard to the two alternative forms of integration (Robson, 1998, p.20).

However, FTA can be coordinated by a small secretariat which is located in the territory of one of

the member states, but often without it, generally, replaced by periodic meetings conducted on the

level of the heads of ministries or agencies.

3. Customs Union

One of the basic and stronger forms of economic integration is Customs Union (CU). According

to the definition given in the General Agreement on Tariffs and Trade, CUs must meet the

following requirements: (1) the elimination of all tariffs and other forms of trade restrictions

among the participating countries; (2) the establishment of the same level of tariffs and other

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regulations on the foreign trade with non-participating countries. However, creation of a customs

union involves the reduction of discrimination of products movements within the union, as well as

the equalization of tariffs in trade with non-member countries, as was described by Balassa (1961,

p.2). Nevertheless, in the process of creation of a CU, all participating countries give consent to

the abolition of trade tariffs and setting common customs and also regulate trade concerning third

governments. It is important to note that under a CU we consider purely about commodity trade.

Carbaugh (2008, p. 266) determines that a CU will take a shape when a group of countries concur

to eliminate tariffs and nontariff trade barriers among themselves and impose a common external

tariff on imports against non-member countries. For instance: Southern African Customs Union,

Customs Union of Belarus, Kazakhstan and Russia East African Community (EAC), etc.

In other words, the CU is only one of a number of possible types of agreement which eliminate or

reduce the tariff barriers between two or more political units while maintaining tariff barriers

against imports from outside regions. According to Viner (1961, p.5), a perfect CU must meet the

following conditions: (1) the complete elimination of tariffs between the member countries; (2)

the establishment of uniform tariff on imports toward outside the union; (3) proportional

distribution of customs revenue among the members in accordance with an agreed formula. Viner

examined the impact of a customs union on trade flows and distinguished between the trade-

creation and trade-diversion effects in a union. These distinction will be discussed in detail in the

next section.

4. Common Market

Balassa (1961, p.2) explained that common market would reach a higher position in economic

integration where not only trade restrictions but also restrictions on factor movements are

abolished. Carbaugh (2008, 538) defined common market as a group of integrated union that bring

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about: (1) free movement of commodities and services among participating countries; (2)

establishment of common external trade restrictions against non-participating countries; (3) the

free movement of factors of production across national borders within the economic bloc.

However, in simple terms, a common market is a sort of economic block which possesses all

function of customs union with common policies of trade regulation and including freedom of

movement of factor mobility. In the same way, El-Agraa (1989, p.1) argues that common market

is very similar to a CU which also allows for free factor mobility across national member frontiers,

i.e., capital, labour, and enterprise should be unhindered between the participating countries. The

good examples are East African Community and European Union which has already established

common market. Today, the people of European Union have common passports and may work

and invest without any restriction in any part of the member states.

5. Economic Union

The economic union is a sort of economic block with a deeper form of economic integration which

is consist of a single market with a common currency. In this term, El-Agraa (1989, p.2) describes

that economic union is featured by complete unification of monetary and fiscal policies. Balassa

(1961, p.2) argued that economic union involved the reduction of barriers on goods and factor

mobility in order to harmonize national economic policies and eliminate discrimination.

Nevertheless, in simple words, economic union is a full integration, which involves a single market,

single monetary and fiscal policy and introduction of single currency, as well as the establishment

of supranational regulations within the integration group. Economic union must meet the following

requirements: (1) the elimination of all trade restrictions and implementation of a unified foreign

trade policy; (2) free movement of goods and services, capital and labour; (3) thorough

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coordination of economic, financial and monetary policies. In this case, the best example is

Economic and Monetary Union of the European Union.

6. Political Union

Even so, political union or complete economic integration comprises not only economic policy as

well as issues beyond economic policy. In this sense, all monetary, social, fiscal, foreign and

military policy of the member states are coordinated by a central political system. El-Agraa (1989,

p.2) determines that in complete economic integration the participants become literally one nation,

and gives an example that the central authority not only controls monetary and fiscal policies but

is also responsible for a sovereign central parliament. According to Balassa (1961, p.2), total

economic integration presupposed the combination of monetary and credit, tax and budget, social

and economic policies, and furthermore, required the formation of a supra-national authority

whose functions would fasten the member countries. Perhaps, the best examples of complete

economic integration are the United States and the former Soviet Union (until 1991). Every state

has own governments, law and economic policies. Nonetheless, in case of the United States, each

state was placed under the control of the federal government which provided general state policy.

Movement of commodities, services, labour, and capital among states occurs freely without

barriers. In terms of trade, the nation established a common external policy. Unlike the US, Soviet

Union consisted of fifteen states, where government and economy were extremely centralized, and

all policy was coordinated by the central state system.

V. Economic Benefits and Costs of Regional Integration

This section identifies the economic benefits and costs of regional trading arrangements. There

are two types of gains and losses of accession into regional economic integration: static effect -

economic consequences that appear immediately after the establishment of the integration union

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as a direct result; and dynamic effect - economic consequences that appear in the later stages of

development of the integration union. For simplicity and clear understanding in this section, it is

proposed to focus on the benefits and costs of customs union which involve freedom of intra-

regional trade as well as setting a common external trade policy to the third party.

It should be noted that two scientists and economists made a great contribution to the study in

static and dynamic effects of custom union creation. “The Customs Union Issue” was written by

J. Viner which for the first time reflected upon the issues of static effects. As for the issues of

dynamic effects of customs union, B. Balassa devoted his work “The Theory of Economic

Integration”.

1. Static Effects on Members of Regional Economic Integration

The most important in the static effects are the effects of trade creation and trade diversion. Viner

was the first scholar who proved that the establishment of the Customs Union which would entail

not only the positive effect of integration but also the negative effect. In this sense, trade creating

effect has a positive effect (beneficial) whereas trade diverting effect has a negative effect

(harmful) on country's welfare. According to Balassa (1961, p.26), “trade creation represents a

movement toward the free trade position, since it entails a shift from high-cost to low-cost

sources of supply, while trade diversion – a shift of purchases from lower-cost to higher cost

producers – acts in the opposite direction”. El-Agraa (1989, p.19) expresses that trade creation

enables the people to consume not expensive internal products but cheaper imports from a

partner, whereas trade diversion enables the people to consume not cheaper initial imports from

the outside members but more expensive imports from a partner. Robson (1980, p. 12) stressed

that trade creation stimulate replacement from the consumption of higher price inner outputs in

- 23 -

favour of lower price outputs of the partner state. In this context, replacement has two aspects:

(1) the internal production of goods that are similar with those produced abroad is getting

unprofitable, due to high costs than in the case of import from partner states; and (2) enlarged

consumption of partner state substitutes for domestic goods that before satisfied the need at a

higher price. The two together comprise the trade creation effect of the union. Trade diversion

refers to a union stimulate replacement in the source of imports from external sources at lower

prices to partner sources at higher prices. In this context, replacement can also be regarded as

having two aspects: (1) the increase in the cost of the goods previously imported from abroad,

due to the shift from foreign to partner sources; and (2) a loss of consumers’ surplus resulting

from the substitution of partner goods at higher prices for foreign goods at lower prices of a

different description. Such shifts together constitute the trade diversion effect of a customs

union.

In other words, trade creation entails consumption shifts from a high-cost producer to the low-cost

producer. In accordance with the principle of comparative advantage, elimination of trade barriers

provides an opportunity for the development of greater specialization. In this context, it is easy to

import commodity at low prices rather than spend a large funds for the production. Consequently,

the formation and elimination of customs barriers increase imports, that is, efficient producers can

produce more inside the union. Eventually, consumers shift from domestic to foreign production

that would increase the volume of internal trade of member countries, and as a result lead to the

common growth of nation’s welfare.

Trade diversion entails consumption shifts from a lower cost producer outside the trading bloc a

higher cost one within it. In this term, trade diversion is regarded undesirable since production will

focus on the states of producers with higher prices and lower comparative advantage. Besides,

- 24 -

trade diversion may bring benefits to some members of the unions whose trade pattern a large

share of world trade. The terms of trade will not necessarily improve for each member; whether

they do or do not depends on the structures of trade and of demand and supply. Some advantage

from a customs union would also arise from savings from lower trade costs. In this case, members

would capture the natural rents from being able to export to other members at lower transport costs

for exports to the rest of the world. The best example for trade diversion is UK’s participation in

the European Economic Community (EEC). Because, before joining the EEC, the UK had free

trade arrangements with Australia where agriculture production was lower, but after UK became

a member of EEC, Australia had to import to European countries. However, the Australian

agriculture became less competitive because EEC had a protectionist policy in agricultural sector

from outside. As a result, the consumers of UK began to buy goods in higher-cost than cheaper-

cost producer from Australia. On the other hand, joining the EEC, the UK got benefit from new

free trade agreements in other sectors of the economy.

Furthermore, it should be noted that the theory of economic integration is also associated with the

works of Meade (1955) and Lipsey (1957). They evaluated the consequences of regional trade

agreement of trade creation and trade diversion thereby showing increase or decrease of welfare

as a result of their agreement on customs union. As a result, they argue that trade diversion may

entail welfare growth. Bhagwati (1970) also considered that regional economic integration can

impact positively on the welfare of region and even in trade diversion (Josic M and Josic H, 2013,

p. 2). Therefore, at all times, every economist has its own point of view on a variety of economic

models, definition and terminology that lead to heated discussions.

- 25 -

2. Dynamic Effects on the Members of Regional Economic Integration

Regional integration agreements can lead not once to increase welfare because of static efficiency

profits, but also steady and stable improvement of people’s welfare. However, in spite of that

dynamic effect are less analysed in economic literature compared to static effects, despite the fact

that the former may have greater influence on country's welfare. Likewise, dynamic effects can

emerge through various field of economic activity. Balassa (1961, p.118) marked that among the

important elements of dynamic effects may include: economies of scale, external economies,

market structures (increased competition), technological change (technological innovation) and

investment (improved investment).

Economies of scale are the most important among other factors that have been traditionally

identified as the dynamic effects of economic integration. Increasing the size of the market may

allow domestic firms to get appropriate effects on the economies of scale, so-called internal

economies. This factor is particularly important for small countries that are interested in expanding

the size of the market. Economies of scale are made possible by larger regional markets. In fact,

internal economies of both a static and a dynamic character contribute to the economies of scale.

“Gains from scale economies internal to the firm would come through lower costs and increased

productivity, if companies previously working at below minimum efficiency can now expand

product and move down their cost cures (in static models) and their learning curves (in dynamic

models)”, (De la Torre A and Kelly R.M., 1992, p. 5). Hence, increased production levels due to

better exploitation of economies scale is made possible by increased size of the market.

Along with the internal economies, a larger scale of production can lead to favourable external

economies. In this terms, the expansion of trade in a Customs Union and more complex forms of

economic integration often entails improving the productive and non-productive infrastructure of

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participating countries. This causes even greater effects for long-term benefits of integration, in

particular, reducing costs related to the export-import operations. However, Balassa (1961, p.118)

underlined “the concept of external economies comprises all forms of intra-industry and inter-

industry relationships that contribute to cost reductions”. In this context, external economies of

scale increase the efficiency of an entire industry or economy. The external factors are beyond the

control of a particular company, and comprise positive externalities that decrease the costs of

production of firms.

Significant dynamic gains may also stem from increased competition by regional free trade market.

Increased competition among the members of the union can bring great benefits such as

encouragement of business growth, improved production methods and reduced prices, promoting

the growth of product quality, rationalization of industry, economic restructuring as well as

modernization through the adoption of superior technologies. Competition can lead the

disappearence of monopoly and oligopoly position in the market. The iIncrease in competition

among corporations allow the people to consume higher quality and cheaper goods. Accession to

the Customs Union, in particular to their more developed and complex forms, can contribute to

rapid spread of advanced technology, improve technological innovations and progress through

development of research programmes.

According to Balassa (1961, p.119), integration always influences on investment activity, since

new investment will be necessary to use the potential economies of scale in production as well as

changes that will occur in the allocation of investment funds. Actually, wider and secure market

can improve the investment climate, thereby increase the flow of foreign investment into the region.

As a result, increasing investment may promote economic growth owing to the influx of capital

and increased tax revenues for the members of union. Moreover, the attractiveness of investment

- 27 -

in the region would increase investors in the member as well as non-member countries. In addition,

investment is one of a mechanism for the development of infrastructure and other projects which

directly impact upon the improvement of welfare in the region.

Chapter 3: International Experience of Economic Integration: the European Union and the

Socialist Countries.

I. Overview

Integrated groups in the global economy, especially among developing countries, periodically

appear and disappear, and it happens by various reasons. Stalemates may occur due to inefficient

agreement, lack of political willingness, economic differentiation, and impossibility to achieving

the common goals. Unfortunately, these problems are found in almost every union.

However, in general terms, economic integration is more favorable rather than harmful. There are

a lot of integrated groups in the world which have achieved significant changes in welfare: for

example, North American Free Trade Agreement1 (NAFTA), Association of Southeast Asian

Nations 2 (ASEAN), African Union 3 (AU), MERCOSUR 4 and many others. But, these all

organization cannot achieve the same progress like the European Union (EU). Thereby, the one of

the successful and the most advanced form of regional economic integration is the EU. Actually,

1 Agreement signed by Canada, Mexico, and the United States 2 Including 10 states (Brunei, Cambodia, Thailand, Indonesia, Malaysia, Singapore, Vietnam, Philippines, Laos and Myanmar) 3 Consisting of 54 African states 4 Economic and political agreement among Argentina, Brazil, Paraguay, Uruguay, and Venezuela

- 28 -

the EU illustrated the good example of regional economic integration which led to some

improvement of welfare of the citizens in participating countries. Thus, this pattern pushed many

developed and developing countries to attempt at similar benefits in their own regions.

This section will consider a brief historical background of emergence and development of

European integration, as well as economic benefits and costs from this integration, inasmuch as

the experience of regional economic integration of the EU may have some bearings with the

successful way of the integration process in Central Asia. Moreover, this section will also discuss

the process of socialist economic integration thereby showing historical achievements and

drawbacks of integration. There are undoubtedly different instruments and processes of integration

between the European Union (free market) and the Council for Mutual Economic Assistance

(controlling market). In other words, in centrally planned economies most enterprises were public.

The economies were organized on the basis of comprehensive development plans and as well as

all production, investment and prices were under the control of government.

II. Economic Integration Processes of European Union

1. Origins and Development of European Integration

The European Union has the 28 member states with approximately 505 million consumers and

nominal GDP estimated about €12.9 trillion5, or $16.7 trillion, is the biggest economic unit in the

world, even bigger than the U.S.6, and is the most advanced and perfect integrated group in the

world. The European Union was not established overnight by the Maastricht Treaty. It was the

5 Source: Eurostat European Statistics Office, http://epp.eurostat.ec.europa.eu/ 6 The GDP of the United States was estimated about $16.2 trillion in 2012. source: World Bank, International Monetary Fund, the United Nations

- 29 -

result of gradual and step by step running through every stage of integration. If we look at the way,

the EU passed through almost all forms of integration beginning from a free trade area to an

economic and monetary union, and eventually, this economic integration endeavors now towards

a political union. In all stages of development of the European integration, we have witnessed

differing degrees and depths of economic cooperation among the member states (the transition

from lower to higher forms of integration), as well as an expansion of members (increasing the

number of community members). The creation of the economic and monetary union in Europe can

be divided into the following four stages:

The first (1957-1968) stage has launched the creation of a free trade area with the abolition of

customs duties, quotas and other restrictions on trade between the participating countries. In this

respect, the history of establishment of the European Union began in 1951 with the foundation of

the European Coal and Steel Community (ECSC), which consisted of six countries7. The purpose

of this community was to combine steel and coal resources within it, and on the other hand, to

prevent another war in Europe. Development of the single market between the participating

countries was the main objective of establishing the European Economic Community (now the

EU). The most important step toward integration was to establish the European Economic

Community (EEC) and the European Atomic Energy Community (EURATOM) which was signed

in 1957 among the six countries. Among these three communities, the most important and fruitful

was the EEC (also known as the Common Market) which had the aim of (1) abolishing gradually

all trade barriers among member’s states; (2) setting up a common external tariff against third

countries; (3) eliminating restrictions on the free movement of capital, people and services; (4)

conducting a common policy on agriculture and transport; (5) standardizing tax systems; (6)

7 There were West Germany, France, Netherlands, Belgium and Luxemburg

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developing principles to harmonize economic policies and other issues. However, according to

Jovanovic (1997, p. 11), the United Kingdom (UK) at the first stage of negotiations refused to

participate, since the Treaty of Rome was assumed to be a creation of a common policy in some

sectors that would lead to a formation of supranational bodies therefore be unacceptable on the

ground of national sovereignty. In 1956, the UK stated that the country preferred creating a free

trade area only. Afterwards in 1960, the European Free Trade Association (EFTA) was established,

being composed of seven states of European countries: United Kingdom, Austria, Denmark,

Norway, Portugal, Sweden and Switzerland. Thus, Western Europe began to develop two types of

integration, reflecting different interests and different ideas about integration models. In 1962,

European Economic Community adopted the Common Agricultural Policy, which brought gains

to the farmers of the participating countries (Petith, 1976, p.132). Nevertheless, in 1967, the three

communities8 combined to form the European Community, in order to enhance the economic

relations among the six countries.

The second (1968-1986) stage began from the creation of the common customs tariff and switch-

over to a common commercial policy towards third countries. In 1970s and 1980s, the membership

of the European Community expanded, joining Denmark, Ireland and the UK in 1973, Greece in

1981 and Portugal and Spain in 1986. That was the first of the process of enlargement which

became a major policy area of the Union. In 1977, the EC eliminated customs duties, among nine

members (Baldwin, Haaparanta & J. Kiander, 1995, pp.2-3). Thus, in 1979, European Monetary

System and other funds were created in order to support undeveloped states. Besides, in the same

year, its first direct elections of the European Parliament was held.

8 European Coal and Steel Community, European Economic Community, European Atomic Energy Community

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The third (1986-1992) stage set in 1986, by signing the Single European Act among members of

the European Community, which implied the creation of a single internal market and elimination

of the remaining barriers to movement of goods and factors of production.

The fourth (1992-2002) stage started from the creation of the Economic and Monetary Union

providing the single currency- the euro, and monetary policy of the EU. In this sense, the big step

to the deepened integration was taken by signing the Maastricht Treaty in 1992 which changed the

European Community into the newly named European Union. The treaty prompted member states

to create euro, as the European currency and formation the tree pillars of the union: economic and

social policy, foreign and defense policy, justice and internal affairs. Moreover, Pedersen (1994,

p.131) remarked that the EU Treaty required that a state seeking membership of the Union must

satisfy certain basic conditions: European identity, and democratic status and respect for human

rights. In 1995, Sweden, Finland and Austria joined in the European Union. This was the fourth

occasion of geographic extension of the European Union. In 2004, ten9 countries from Central and

Eastern Europe joined and then Bulgaria and Romania in 2007. The latest expansion occurred with

the participation of Croatia in 2013.

It should be noted that currently, some country are the full members of the Union but others are

not, and the different status can be understood in terms of two geographic areas: the Schengen area

(formed 1995) and the Euro area (the euro was introduced as the common currency from 1999).

Thus, UK signed the Schengen agreement, but still does not consider it necessary to join the euro

zone. Denmark and Sweden after conducted referendums also decided to keep the national

currency. Norway, Iceland and Switzerland are not members of the European Union, though

included in the Schengen zone.

9 There are Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia

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Moreover, it is important to pay attention to some institutions which play main role in development

of integration process in European Union. Actually, Hansen (2001, p.8) noted six main institutions

involved in management of the European Union: (1) The European Parliament is an assembly of

732 deputies which elected for five years directly by the peoples of the member states. The main

role of the European Parliament is the approval of the EU budget. Besides, they approve new

members into the Union and consider trade agreements with the third countries; (2) The Council

(usually called the Council of Ministers) representing the government of the member states. At

least twice a year they carry out sessions at the level of Heads of State and Government, as well

as meet regularly at the levels of various ministers (foreign affairs, economy, finance, agriculture,

etc.). The European Council summits make strategic decisions regarding integration such as the

Single European Act or the Maastricht Treaty; (3) The Commission – the supreme executive body

of the European Union which have the right to initiate legislation, which consists of 28 members,

one from each member state, and in charge of certain issues (agriculture, energy, etc.); (4) The

Court of Justice - the highest judicial organ of the European Union authorities ensuring compliance

with the laws. The Court regulates disagreements between the member states, institutions, citizens

of the European Union and others. (5) The Court of Auditors – an institution established in 1975

which is responsible for auditing the accounts of EU budget and its institutions. They are appointed

by the Council from each member state; (6) The European Central Bank - established in 1998 from

the banks of eleven10 states the European Union of the euro area. Greece became the twelfth

country euro zone which adopted the euro in 2001. The main functions of the bank are

development and implementation of monetary policy of the euro area, maintenance and

10 There are Germany, Spain, France, Ireland, Italy, Austria, Portugal, Finland, Belgium, Netherlands, Luxembourg

- 33 -

management of official exchange reserves of the euro area, issue of money - euro, establishing the

basic interest rates and others actions.

2. Benefits and Drawbacks of Economic Integration of EU

In order to know the benefits and drawbacks accruing from the membership in the integrated

European Union must be approached individually according to the countries. Cost effectiveness

of the European Union varies from state to state because of differences in economic development.

Actually, the benefit of the European Union membership overbalances the cost. The study will

consider the example of Latvia, because this state was part of the Soviet Union for as long as 30

years. In the period of the USSR, Latvia focused upon the electrical and mechanical industries, in

particular for the needs of the Soviet army. After the disintegration of the USSR, Latvia was faced

with socio-economic problems, as had happened with other former Soviet member states.

Now Latvia is regarded as developed country which formally became a member of the European

Union in 2004. In 2007, Latvia joined the Schengen area and simultaneously eliminated all

restrictions of border controls against other European Union members. The Latvia has achieved a

good progress in GDP growth from 2004 until 2008. Unfortunately, the world economic crises

imposed a burden for Latvia (2008-2010) and the country started to recover from 201111. It should

be noted that once after its accession in 2004 up to 2006, Latvia received the European structural

funds - about €625 million and €710 million from the Cohesion Fund. In the “new” period, Latvia

has been allocated €5.6 billion of the European funding12. It proved to be a great impetus to the

development of economy of Latvia. Latvia’s benefits and drawbacks from integration is supposed

11 Source: The World Bank data 12 Source: EU bulletin - Information and news, No 25, February 2010

- 34 -

to be based on the dynamic effects, that is, through a foreign actor that is Foreign Direct Investment

(FDI), since FDI is a driving engine of economic growth. Figure 2 show that after the accession of

Latvia to the market of the EU, the FDI increased steadily until 2008 and after the brief reduction

in 2009 (then recovered from the world economic crisis) gradually recovered to achieve the high

level in 2011.

Figure 2: FDI in Latvia from 2004 to 2011 (Billion EUR)

Source: Investment and Development Agency of Latvia, based on the data of the Bank of Latvia, 2012

The new market, favorable climate of investment, stable economy and strong monetary policy of

Latvia have attracted a lot of foreign investors within the Union and beyond. Besides, the

advantage of drawing the FDI to Latvia lies in its geographic location and well-developed

infrastructure between the EU and the Commonwealth of Independent States13 (CIS). Virtually,

most of the FDI inflow in Latvia has come from the EU countries (See Figure 3). In 2011, the

biggest FDI came from Sweden, followed by the Netherlands.

13 The CIS is a regional organization whose participating countries are former Soviet Republics, founded during the collapse of the Soviet Union.

- 35 -

Figure 3: FDI in Latvia by Country of Origin at the End of 2011

Source: Investment and Development Agency of Latvia, based on the data of the Bank of Latvia, 2012

Each of the two countries illustrates evidently essential share: the Swedish FDI mainly put in

financial services (59%) and in the real estate sectors (24%). About 76% of the Netherlands FDI

focused on the real estate, on trade services, transport, and storage. It should be noted that the

investment from the EU members covered roughly 70% of the total FDI inflow in 201114.

FDI covers all sectors of economy in Latvia (See Figure 4). The biggest share of the FDI inflow

accounts in the real estate operations (24%) and financial intermediation (23%). This is obvious,

as these sectors are highly profitable. Also, the wholesale / retail trade (13%) and manufacturing

(12%) are the important sections attracting the FDI.

Figure 4: FDI by Sector, 2011

14 This information is available on the website of the Investment and Development Agency of Latvia

- 36 -

Source: Investment and Development Agency of Latvia, based on the data of the Bank of Latvia, 2012

Nevertheless, there are certain drawbacks in Latvia's integration in the EU. According to the

newspaper, Business Day, more than 50% of the banking sector was controlled by four

Scandinavian banks in 201115. 49% of two huge communication industry in Latvia were possessed

by Swedish companies. Moreover, Swedish companies own a substantial share in the area of social

media and control 60-65% of television advertising market16. Two of the three leading internet

portals (TVNET and a apollo.lv) belong to the Norwegian and Finnish companies. Absolutely over

50% of retail sales in Latvia are operated by two vast supermarket chains, one of which belongs

to the Swedes. Over 70% of the fuel retail market - petrol stations - belongs to three companies;

two are possessed by Canadian and Finnish companies (Einar, 2013). This example shows one of

major disadvantages of economic integration of developing and developed countries. In this regard,

Latvian people are losing control of the most part of the essential economic sector in their own

country. Such kinds of examples are palpable in Latvia.

15 There are Swedbank, SEB, Nordea and DnBNord 16 There are Lattelecom and mobile operator LMT

- 37 -

The next issues are related to unemployment. From the beginning of economic crisis in Latvia, the

unemployment increased from 7.4% in 2008 until 18.7% in 201017. According to a report by Einar

Graudins, during the past ten and fifteen years Latvia has lost about 400 thousand people. It should

be noted that the population of Latvia is around 2.1 million. This is the best example of negative

effects of the freedom of movement of labor, capital and goods within the EU, where people find

profitable jobs and better places for living.

To summarize the drawbacks of the integration, Latvia is integrated into all institutions and

policies of the European Union. As a result of the integration of Latvia in the EU, foreigners now

control the telecommunications market, bank system, natural resources, real estates and lands

thereby losing sovereignty on the one hand, but the country attracts the FDI which brings about

economic growth on the other hand.

III. Planned Economic Integration of the Socialist Countries

1. Historical Aspects of Integration of COMECON

The Council for Mutual Economic Assistance (CMEA, better known in the West as COMECON),

is an economic grouping formed in 1949 by the former Soviet Union and the socialist countries of

Eastern Europe. This bloc comprised very large and several smaller countries and was expected to

give less favourable members good opportunities to develop own economies. There were six

nations which formed the COMECON, namely USSR, Romania, Bulgaria, Czechoslovakia, the

East Germany, Hungary, Poland, and Albania that joined as the sixth member in February 1949

but left in 1961. In the 1960s and the 1970s the membership of the COMECON expanded, joined

17 Source: World Bank

- 38 -

by Mongolia in 1962, Cuba in 1972, and Vietnam in 1978. Furthermore, other socialist states such

as China and the North Korea have had observer status. Since 1964, Yugoslavia was an associate

member as if it were a full member. COMECON actively cooperated on the basis of special

agreements with Finland (since 1973), Iraq (1975), Mexico (1976) (El-Agraa, 1989, p.116). It

should be noted that the Council was established with the purpose of accelerating economic

development, rational division of labour among member countries as well as the growth of

scientific and technical cooperation among the socialist countries. However, the precise reasons

for COMECON's foundation are quite complicated; in some Western literature it is written that its

primarily goal was to link the East European states economically closer to the Soviet Union and

as well as to respond to the Marshall Plan18 which was introduced in 1947 to the Western Europe

by the U.S (Kaser, 1967, p.9). Obviously, in that period, COMECON was considered to be a form

of socialist alternative to the European Economic Community.

Moreover, socialist inter-state bloc may be called as the “Plan Coordination” form of integration

which featured "fixed price" and "controlled market" and not related with the “free market”

principle of the European Community embodied in the six stages of economic integration as

mentioned above.

COMECON’s activities can be divided into several stages. The first stage was from the time of its

founding until 1954, when activities was restricted merely to registering bilateral trade agreements

between member countries and concluding agreements for the promotion of scientific and

technological cooperation. Although COMECON intra-bloc trade developed rapidly until 1953,

this was mainly motivated by political reasons rather than the Council’s considerations. Despite

its intention, this integration during 4 years was simple and weekly organized. However, a new

18 The United States America’s initiative to aid Europe to help rebuild European economies after the end of World War II and prevent the spread of Soviet Communism.

- 39 -

phase of COMECON began after the death of Stalin in 1953, when the new USSR leadership

Nikita Khrushchev strengthened the organization to be an active unit. From 1955, its Council

meetings started to take place more often, being assigned with basic tasks of coordinated planning,

production specialization, and regional trade (Brine, 1992, xii).

The second stage (from 1956 to the 1962) witnessed a fast growth of COMECON activities,

especially after the adoption of the Charter of COMECON in 1959. “During this period several

innovations were made, mainly in the later 1950s, such as the first joint investment and joint

enterprise agreements. Progress was slow, but Soviet interest in strengthening the Council

continued, stimulated in part by the formation of the rival groupings of the European Economic

Community and the European Free Trade Association in the West” (Robson, 1998, p.132).

Nevertheless, it should be noted in these periods COMECON succeeded in solving significant

problems faced by the member countries, especially in terms of fuel, raw materials, machinery and

equipment. For example, in 1958, the largest construction projects in the world, called Druzhba

(Friendship), was carried out. This was a huge oil pipeline for transportation and distribution of oil

from Soviet Union to the Eastern Europe19. Also, the Central Dispatching Board was established

in 1962 in order to connect the electric power systems among members.

The third stage (from 1963 until the late 1970s) was related to foundation some institutions. In

1964 all operations among members began to be carried out by the International Bank for

Economic Cooperation (IBEC), which was established in 1963 in order to promote the

development of foreign trade, enhance the cooperation among the members and the

implementation of multilateral settlements. This was achieved by the introduction of the so-called

transferable rouble, in which all trades and projects were conducted within the members that used

19 Now the oil transported from Russia to Ukraine, Belarus, Poland, Hungary, Slovakia, the Czech Republic and Germany.

- 40 -

that currency. According to Zwass (1989, p.60), the IBEC created 300 million transferable roubles

(after the accession of Cuba and Vietnam increased 305 million transferable roubles), while shares

of each countries was in accordance with their share in intra COMECON exports (See Table 2).

Table 2: Share in IBEC Capital

Countries In millions of transferable roubles In % Soviet Union 116 39

East Germany 55 18 Czechoslovakia 45 15 Poland 27 9 Hungary 21 7 Bulgaria 17 6 Romania 16 5 Mongolia 3 1

Moreover, in 1970, the second international credit institution of COMECON, the International

Investment Bank (IIB) was formed. The objective of this institution was to provide long-term and

medium-term low interest loans for joint investment projects to further development of socialist

economic integration. Unlike the IBEC, the share of the member countries was set on the basis of

their share in the COMECON National Product (See Table 3), (Zwass, 1989, p.62).

Table 3: Share of Member Countries in IIB Basic Capital

Countries in millions of transferable roubles Soviet Union 399.3

East Germany 176.1 Czechoslovakia 129.9 Poland 121.4 Hungary 83.7 Bulgaria 85.9 Romania 52.6 Mongolia 4.5 Cuba 15.7 Vietnam 3.0

- 41 -

Then, in 1971, the COMECON accepted the Comprehensive Program which had a purpose to

extend and improve cooperation. For the implementation of this Programme, the COMECON

members signed a series of important multilateral agreements. For instance, this document covered

the Five Year Plan (1976-80) for Multilateral Integration Measures. This was intended to integrate

several sectors of the economy, including mechanical engineering, petrochemicals, agriculture and

transport. Totally, the plan covered about thirty key projects, to the amount of 9.0 million

transferable roubles (Robson, 1998, p.137).

The fourth stage is concerned about the crisis and disintegration of the COMECON (from 1980s

until 1991). During the 1980s, COMECON members was not able to achieve economic growth in

particular in their Five Year Plan (1981-85), since these states faced numerous problems such as

debt crisis in some East European states and the hike of oil prices. Shortly after Mikhail Gorbachev

became the General Secretary of the Communist Party of the Soviet Union in 1985, COMECON

adopted the Comprehensive Programme for scientific and technical progress to the year 2000

(Zwass, 1989, p.156). However, in 1991, the collapse of Soviet Union led to a quick loss of interest

to this organization, since the USSR would no longer supply fuel and raw materials in the old

terms. Eventually, East European states began to redirect their exports and imports toward Western

Europe. COMECON was formally dissolved in June 1991.

2. Benefits and Drawbacks of Economic Integration in Socialist Countries.

The issues of economic benefits from planned economic integration, namely COMECON, were

consistently debated by various economists. Actually, it is impossible to estimate quantitatively

the effects of COMECON on intra-regional trade in COMECON, because the trade barriers

- 42 -

between the socialist countries had very complex forms, which included the modalities of central

planning decisions. According to Zwass (1989, p.3), COMECON is a unique phenomenon, quite

different from all other unions in that the countries were brought together into a bloc for political

reasons in this case. The advantages and disadvantages of the activities of COMECON are not

determined yet even today. Robson (1980, p.135) argued that the effects of trade creation and trade

diversion to the COMECON states were very difficult to estimate. Supply was thought to be equal

to demand. The concepts lose their relevance even in market economies when the structure of

production is changing substantially under the impetus of forced industrialization. In such situation,

what occurs should be “development creation” and “development diversion”, though these are

much more difficult to quantify. However, despite limits, we try to denote some benefits and

drawbacks of socialist countries in economic integration.

Cooperation and specialization in industrial production, agriculture, science and technology,

transport and the environment was one of COMECON’s key goals as mentioned above. This idea

has arisen from “international socialist division of labor” and the belief in the advantages of

economies of scale, unification of resources, reduction of duplication and creation of a larger

market. Obviously, COMECON achieved some success in joint planning and joint investment in

large-scale projects, such as the “Soyuz” natural gas pipeline, the “Mir” electric power grid and

others. In this term, numerous mutual institutions were established under COMECON activities,

in particular for industrial production or research and development (Brine, 1992, xii). Nevertheless,

lots remained on paper and could not reach completion for various reasons. Moreover, the main

trade agreements among COMECON members were bilateral, despite their efforts of enlarging

multilateral trade. The drawbacks of bilateral trade included a tendency to reduce the volume of

trade thereby forcing participants to accept goods of lower quality than could be obtained on the

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world market. Hewett (1977) used adjusted input-output tables for all COMECON countries to

indicate gains and losses from 1960 until 1970. A result of counties analysis showed that Soviet

Union concentrated on trading with the more developed COMECON countries, particularly

Czechoslovakia and the East Germany, and less with Poland and Hungary. Only the trade with

Rumania and Bulgaria were gainful for the USSR. This pattern of gains and losses was associated

with the import by the USSR of relatively costly machinery from the more advanced member

countries and the exportation in return of relatively cheap food, non-agricultural raw materials and

fuels to less developed member countries. Honestly, Soviet Union attempted to dominate

economically and politically, for that period was the so-called Cold War period, in which two

powerful nations, the United States and Soviet Union was fighting (not physically) for influence

in the world. The COMECON population accounted for 450 million in ten countries. The levels

of economy were different from state to state. The Soviet Union was the strongest and richest in

terms of military power, political influence and economic resources. The USSR played important

role in trade development within COMECON, as the main supplier of fuel and raw materials to

other members. Actually, the Soviet Union supplied cheap primary products and fossil fuels to

other member states, and eventually finished goods could be returned to the Soviet Union.

COMECON members became dependent on the USSR as a market for their agricultural produce

and manufactured goods. The price in intra-COMECON trade was fixed for five-year periods and

essentially different from competitive prices on the world market. Despite its shortcomings, the

Soviet Union was able to achieve domination of the Eastern half of Europe.

Moreover, other COMECON members like Cuba, Mongolia, and Vietnam got benefit, because, in

COMECON, economically developed states provided funds to the undeveloped members. Thus in

1987, these countries received economic aid: for instance, Cuba - US$4 billion, Vietnam - US$2

- 44 -

billion (half in the form of military aid), and Mongolia - US$1 billion. Additionally, these three

countries were getting aid at lower interest rates. At the same time, the other COMECON members

also reaped numerous benefits from Mongolia, Cuba and Vietnam. For instance, Cuba imported

sugar and nickel, Vietnam - naval and air bases, Mongolia - copper and equipment for the

construction of aircraft, automobiles, machine tools, gas turbines, and electronics (Curtis, 1992).

Chapter 4: Regional Economic Integration as an Effective Mechanism for Achieving Socio-

Economic Development in Central Asia

I. Overview

Historically, Central Asia is a core region. For a long time, the region was the principal trade

corridor between Europe and East Asia, and between North and South Asia. In the second half of

the 19 century, the development of sea transport which was cheaper and safer led to a disintegration

of traditional trade routes which eventually rendered the glory of the region to an oblivion. After

the colonial competition between Tsarist Russia and Great Britain, the so-called "Great Game",

the strategic region of Central Asia was conquered by Russian Empire at the end of 19th century.

With the emergence of the Soviet Union with a command economy, Central Asia was integrated

as Turkestan Autonomous Soviet Socialist Republic in 1918, and then transformed in 1924 into

several Soviet Socialist Republics (SSR): Uzbek SSR, Turkmen SSR, Tajik SSR and Kara-Kirgiz

Autonomous Republic, covering today’s Kazakhstan and Kyrgyzstan. The Kazakh SSR and

Kirghiz SSR received their status as Soviet republics only in 1936. Out of fifteen states of the

Soviet Union, these five Republics were main agricultural producers exporting commodities like

wool, cotton, silk, tobacco, grain and meat. Moreover, Central Asian Republics possessed various

natural resources that supplied the USSR with fossil fuels (oil, gas, coal), rare-earth, precious

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metals (gold) and non-ferrous metals (aluminum, copper, zinc, nickel, lead and etc.). In this regards,

the leading producer of copper, lead and zinc was Kazakh SSR, which formed the basis metallurgy

in Soviet Union. Kirghiz SSR and Tajik SSR almost monopolized the extraction of metal antimony.

Turkmen SSR was the major producer of strontium, while in Uzbek SSR produced the gold

(Slepchenko, n.d, p.2).

The disintegration of the Soviet Union has been considered a real opportunity for Central Asia to

revive regional unity and regain historic trade routes with rest of the world thereby getting out of

the social and economic isolation. Nevertheless, after receiving independence, the Central Asian

republics faced various problems especially in socio-economic and political spheres. In addition,

transition from a centrally planned to a market-based economy was a painful process for the new

independent states. Despite this, the Central Asian countries were able to overcome these

challenges and to find their own niche in the world politics.

This chapter analyses potential benefits and drawbacks of regional economic integration in Central

Asian countries as well as possible drawbacks in regional economic integration. Furthermore, the

recent socio-economic performance and dynamics of the development of economic integration

process in Central Asia will be discussed in this chapter. The Central Asian countries were a part

of Soviet Union, and after the sudden collapse of the USSR, this region were to lose all relationship

with the rest of the world. In this sense, as the first stage, Central Asian countries attempted to

unite as one alliance, because these countries had common history, culture, language, and in

addition, they share 70 years’ history of a single regime under the Soviet Union. Some researchers

think that regional economic integration in the former states of USSR has been largely successful,

whereas others consider the consequences as unsuccessful. But almost all researchers agree that

regional economic integration in Central Asia is the way to achieve socio-economic development

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and transform these countries into a big player in the world arena. For instance, Martin Spechler

noted that the lack of regional economic cooperation in Central Asia is "pathology" (Libman, 2012,

p.53).

II. Contemporary Trends of Economic Development in Central Asia

1. Recent Social and Macroeconomic Indicators of Central Asian Countries

The dissolution of the USSR led Central Asian countries to the economic depression, increasing

unemployment, poverty and starvation. Ultimately, each Central Asian country chose its own path

of development that affected the socio-economic and political transformation of these countries.

On the grounds of their conducting different socio-economic and political reforms, human

development index of these countries show a marked divergence (See Table 4).

Table 4: The Human Development Index in Central Asia (2012)

HDI rank20

HDI GDP index

Life expectancy index

Education index

Kazakhstan 69 0.754 0.686 0.747 0.839 Kyrgyzstan 125 0.622 0.443 0.758 0.721 Tajikistan 125 0.622 0.451 0.754 0.710 Turkmenistan 102 0.698 0.643 0.712 0.743 Uzbekistan 114 0.654 0.512 0.766 0.716

Source: UNDP 2012

All Central Asian countries rank almost at the same level in terms of education index. So far, the

leaders of these countries are paying more attention to the sphere of education. Kazakhstan is a

leading performer in Central Asian republics with regard HDI and GDP indices. Turkmenistan in

these indicators is in a better position than other Central Asian countries in spite of their propensity

toward a closed economy. Kyrgyzstan and Tajikistan are lagging behind in the Central Asian

20 The HDI was examined from 186 countries

- 47 -

countries and even among the Commonwealth of Independent States. However, one should

recognize that the Central Asian countries are achieving good results for the short period.

As is well known, Central Asian countries generally possess rich natural resources but have big

differences in terms of their surface area, population, political formation, income and natural

resources, and manufacturing capabilities to strengthen their national economies and their presence

in the global market (See Table 5).

Table 5: Regional Indicators (2012)

Population (millions)

Population density (per sq km)

Surface Area (thousand sq km)

GNI21, PPP22 (billion $)

GNI, PPP, per capita ($)

Kazakhstan 16,8 6 2,725 197 11,78 Kyrgyzstan 5,6 29 200 12 2,23 Tajikistan 8,0 56 143 17 2,18 Turkmenistan 5,1 11 488 46 9,07 Uzbekistan 29,7 69 447 109 3,67

Source: World Bank (2012) Kazakhstan has a big advantage in surface area not only among Central Asia but even in the world

(ranked 9th), and its territory lays vast oil reserves. Moreover, the population density is the lowest

and GNI per capita is the highest of the Central Asian countries because Kazakhstan is one of the

major supplier of oil products in the world market. Uzbekistan's inhabitants account for 45% of

the total population of the Central Asia countries that is approximately thirty million. This country

also has significant reserves of oil and gas. But in regard to income, the Uzbek figure is lower than

Turkmenistan and Kazakhstan. Actually, Turkmenistan has a good income in spite of the smaller

size of population. This is related with the large energy resources, in particular gas. While

Kyrgyzstan and Tajikistan are the lowest in terms of GNI per capita and surface area, since they

are located in mountainous areas and do not have substantial natural resources.

21 GNI- Gross National Income, 22 PPP - Purchasing Power Parity

- 48 -

In terms of the stages of economic development, Central Asian countries are unequal. Amongst

Central Asian countries, Kazakhstan has achieved tremendous success in economic development.

In 2012, the GDP of Kazakhstan accounted for $203 billion and FDI approximately $15 billion

whereas the GDP of Kyrgyzstan and Tajikistan only about $7 billion (See Table 6).

Table 6: Selected Macroeconomic Indicators (2012)

GDP (billion US$)

GDP annual growth

(%)

GDP per

capita (US$)

Inflation (%)

External debt/ GDP

(% of)

Net FDI

/GDP (% of)

Net FDI (millions

US$)

Kazakhstan 203 5.0 12 116 5.1 67.3 7.4 15 117

Kyrgyzstan 6.5 -0.9 1 160 2.7 93 5.7 372

Tajikistan 6.9 7.5 871 5.8 52.3 2.8 198

Turkmenistan 35 11.1 6 798 *5.3 1.4 9.0 3 159

Uzbekistan 51 8.2 1 717 *7.2 17.3 2.1 1 094

Source: World Bank (2013) and *Asian Development Bank (2013)

Unfortunately, the position of Kyrgyzstan is an exception in terms of GDP growth rate; the country

was not able to reach a positive result. However, the inflation of Kyrgyzstan is the lowest among

Central Asian countries. While the GDP growth rates of Turkmenistan (about 11%) and

Uzbekistan (about 8%) are in better position, Uzbekistan is conspicuous with a very high level of

inflation. Their levels of FDI are lower than in Kazakhstan but higher than in Kyrgyzstan and

Tajikistan. It should be noted that most of large foreign investment was successfully attracted

mainly to oil and gas projects, because Kazakhstan, Turkmenistan and Uzbekistan have large

reserves of fossil fuels and metals. These countries have a number of modernized industries. As

for Kyrgyzstan and Tajikistan, such strategic reserves do not exist, although they export some

amount of aluminum, gold and electricity. The economic importance of these two countries lies in

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the fact that they occupy the upper reaches of the main rivers of Central Asia - the Amu Darya and

Syr Darya. Due to the location of these rivers and tributaries, from the waterworks they can

produce electricity and regulate the flow thereby ensuring the irrigation of agricultural land in the

region. Their disadvantage is the lack of development of the industry.

2. Recent Performances of Merchandise Trade in Central Asian Countries

In the process of globalization, the trade plays a key role in the development of national economies.

Actually, the expansion of trade is considered beneficial as it facilitates the economic growth. After

independence, the trade policy regimes of Central Asian countries were the same, though they now

have differences in terms of trade policy and the resultant achievement of trade levels (See Table

7).

Table 7: Total Merchandise Exports and Imports, million $ dollars, 2002-2012

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 % of GDP (2012)

Exports Kazakhstan 9 670 12 927 20 096 27 849 38 250 47 755 71 183 43 196 59 830 87 603 92 286 45 Kyrgyzstan 485 582 719 674 891 1 321 1 856 1 673 1 756 2 242 1 894 29 Tajikistan 737 797 915 909 1 399 1 468 1 409 1 010 1 195 1 257 1 359 19 Turkmenistan 2 862 3 465 3 854 4 944 7 155 8 932 11 945 9 323 9 679 16 751 19 987 57 Uzbekistan 2 988 3 725 4 853 5 409 6 390 8 991 11 493 11 771 13 023 15 021 14 258 28 Imports Kazakhstan 6 584 8 409 12 781 17 352 23 677 32 756 37 889 28 409 30 839 37 056 44 939 22 Kyrgyzstan 587 717 941 1 189 1 931 2 789 4 072 3 040 3 223 4 261 5 374 83 Tajikistan 721 881 1 375 1 330 1 725 2 547 3 273 2 570 2 658 3 206 3 778 54 Turkmenistan 1 832 2 579 3 148 2 947 2 558 4 442 5 707 8 992 8 204 11 361 14 138 40 Uzbekistan 2 712 2 964 3 816 4 091 4 782 6 728 9 704 9 438 9 176 11 038 12 028 23

Sources: Asian Development Bank During the 11 years from 2002 to 2012, the commodity turnover of Central Asia has substantially

increased as a result of high prices of primary products in the world markets, which Central Asian

republics possess.

- 50 -

Kazakhstan

Kazakhstan’s external trade turnover grew rapidly in the period from 2002 to 2008 (See Figure 5).

Nonetheless, the global financial crisis and the fall of prices of primary goods had an impact on

Kazakhstan’s trade turnover negatively in 2009 which led to a sharp decline of exports to 39% and

imports to 25% compared to 2008. However, in 2010, with the restoration of price of oil, the value

of the exports of Kazakhstan began to grow and reached $92.3 billion or 45% to GDP in 2012.

Meanwhile, simultaneously, imports had also increased and amounted to $44.9 billion or 22% to

GDP of Kazakhstan in 2012.

Figure 5: Total Imports, Exports, Trade turnover and Balance

Source: Asian Development Bank

In 2012, five product groups dominated in export of Kazakhstan: energy products, iron and steel,

chemical and food products, machines and equipment (See Figure 6a). Energy products account

for 70% of the total exports of commodities, which include mainly oil products and natural gas.

However, this structure have not changed after the independence of the country. Therefore the

economy of Kazakhstan still significantly depends on the world oil prices.

- 51 -

Figure 6: Exports of Kazakhstan, 2012

Source: Agency of Statistics of the RK Source: UN COMPTRADE

The main consumers of these commodities are the EU and China, and their portions of exports of

Kazakhstan are larger than those from other countries. The EU has become the top trading partner,

which accounts for 50% share of its total exports in 2012 (See Figure 6b). Kazakhstan’s exports

to the EU are dominated by oil and gas, silver, refined copper, chromium, titanium, uranium, and

ferroalloys. The main share of the export after EU belongs to China (18%) and then followed by

Russia (7%). Exports of Kazakhstan to China consist of oil and gas, refined copper and copper

alloys, uranium and zinc. Kazakhstan exported metals, chemical products, agriculture, etc., to

Russia.

Imports of Kazakhstan amount to almost $ 45.0 billion in 2012. Most imported product groups to

Kazakhstan are machines and equipment (41%), chemical products (13%), iron and steel (12%),

energy products (11%) and other commodities (See Figure 7a). These are the main commodities

of imported prepared goods, since the level of development of manufacture is low in Kazakhstan.

The main supplier of goods to the market of Kazakhstan in 2012 is Russia, whose share is 38% of

total imports (See Figure 7b).

Figure 7: Imports of Kazakhstan, 2012

- 52 -

Source: Agency of Statistics of the RK Source: UN COMPTRADE

Exports from Russia to Kazakhstan are dominated by oil despite the fact that Kazakhstan is an

exporter of oil products. According to Mogilevskii (2012, p.17) “it is cheaper to supply Russian

oil to some Kazakh refineries and to sell crude oil from new deposits in Western Kazakhstan to

Europe”. Likewise the main key trade partners were China and the EU which have the same

fraction, 17%, of imports of Kazakhstan in 2012. China and the EU mainly provide Kazakhstan

with machines and equipment, as well as chemical and industrial products.

It should be noted that Central Asian countries have a share of 3% of total exports and 3% of total

imports of Kazakhstan. And moreover, Uzbekistan was the key partner of Kazakhstan in 2012.

Kyrgyzstan

Kyrgyzstan’s trade turnover has substantially increased from 2002 to 2012, approximately in seven

times (See Figure 8). Only in 2008 the global crisis led the economy of Kyrgyzstan to recession

that caused a decline of trade turnover in 2009. Actually, Kyrgyzstan is a major importer and its

trade deficit could be observed from the time of independence. The trade balance of Kyrgyzstan

was in a negative balance at the end of 2012 and accounted for $3.5 billion, or increased by 60

percent in comparison to 2008. The main reason for this worsening trade balance is a decreasing

volume of exports of gold and a growing volume of imports of machines and equipment.

- 53 -

.

Figure 8: Total Imports, Exports, Trade Turnover and Balance

Source: Asian Development Bank

Gold is a major commodity of exports of Kyrgyzstan which accounts for 30% of total exports in

2012 (See Figure 9a). Other important export products are mineral products (13%), food products

(12), textile (11%), machines and equipment (11%) and other products which are shipped to

different countries. The main buyers of Kyrgyz products in 2012 are Switzerland, Kazakhstan,

Russia and Uzbekistan (See Figure 9b). Switzerland is a sole consumer of gold which occupied

29% of the country's total exports. Total exports of Kyrgyzstan’s goods to Kazakhstan amount for

21% which comprised electricity, chemical products, fruits and vegetables, prepared foods, ores

and precious metals. Kyrgyzstan’s export to Russia is highly dominated by garments and clothing

accessories, cotton, fruits and vegetables, and rolled glass. The main exported goods to Uzbekistan

are transportation goods, parts and accessories of vehicles, metal and rubber products, electricity

and incandescent lamps.

Figure 9: Exports of Kyrgyzstan, 2012

- 54 -

Source: National Statistical Committee of the KR Source: Ministry of Economy of the KR

In 2012, major imports of Kyrgyzstan are machines and equipment (26%), energy products (23%),

food products (18%) and other important goods (See Figure 10a). The main supplier of goods to

the market of Kyrgyzstan in 2012 is Russia (33%) which provides most energy resource (oil

products), machines and equipment and base metals (See Figure 10b). Kyrgyzstan’s imports from

China (23%) are mostly clothes, textile products, machines and equipment, metals and food

products. Kyrgyzstan’s imports from Kazakhstan (10%) are mainly gas and coal, wheat, chemical

products and base metals. In case of EU (10%) the major commodities are automobiles, machines

and equipment.

Figure 10: Imports of Kyrgyzstan, 2012

Source: National Statistical Committee of the KR Source: Ministry of Economy of the KR

- 55 -

The Central Asian countries have a share of 33.27% of total exports and 11% of total imports of

Kyrgyzstan. Almost all Central Asian countries (except Turkmenistan) are key partners of

Kyrgyzstan in 2012.

Tajikistan

Tajikistan, like Kyrgyzstan, is a deficit country, and the trade balance is negative and has reached

at about $ 2.4 million at the end of 2012 (See Figure 11). Hence, the trade deficit is larger in Central

Asian countries, especially because the country lacks essential energy resources and industrial

production. However, the trade turnover from 2002 to 2012 gradually increased, approximately in

two times, and amounts to $ 5.1 billion in 2012.

Figure 11: Total Imports, Exports, Trade Turnover and Balance

Source: Asian Development Bank

In 2012, the exports of Tajikistan amounts to over $1.3 billion, and the main products are base

metals which account for 41% of the total exports of commodities, which include mostly raw

aluminum products (See Figure 12 a and b).

- 56 -

Figure 12: Exports of Tajikistan, 2012

Source: Agency on Statistics of the RT

The large portion of exports of this commodity attributes to Turkey, then China and Russia.

Moreover, the significant share of exports is occupied by mineral products (22%), and the key

consumer of electricity is Afghanistan. Regarding textile products (19%), the major buyers of

cotton fiber are Turkey, Iran and Pakistan. Hence, the main key trade partners in 2012 are Turkey

whose shares is 36% from total export, then Afghanistan –14%, and China - 13%.

Figure 13: Imports of Tajikistan, 2012

Source: Agency on Statistics of the RT

Imports of Tajikistan have reached $3.7 billion in 2012. Most imported products to Tajikistan are

machines and transport equipment (27%), mineral (20%) and vegetable (15%) products as well as

- 57 -

chemical products (13%) (See Figure 13a). The main supplier of goods to the market of Tajikistan

in 2012 is Russia, whose share is 38% of the total imports (See Figure 13b). Then follow China -

16% and Kazakhstan - 13% which supply machines and equipment, prepared foods, clothes, wheat,

mineral products and other goods to the market of Tajikistan.

The volume of the exports of Tajikistan to Central Asian countries accounted for 8%, and the

volume of imports from those countries accounted for 24%. Meanwhile, Kazakhstan is the key

partner of Tajikistan.

Turkmenistan

The foreign trade turnover of Turkmenistan shows a stable and rapidly growing trend, in particular

the sharp rise in 2010 (See Figure 14). While the foreign trade turnover of Turkmenistan amounts

to almost $4.7 billion, it has reached $34.1 billion in 2012, indicating the expansion in seven times.

As a matter of fact, Turkmenistan has the largest gas reserves in the region, which ranks the fourth

in the world. Therefore, the trade balance of Turkmenistan is similar to that of Kazakhstan,

recording a trade surplus in 2002 - 2012.

Figure 14: Total Imports, Exports, Trade Turnover and Balance

Source: Asian Development Bank

- 58 -

In 2010, four products dominated the export of Turkmenistan: natural gas (53%), petroleum

products (20%), crude oil (11%) and cotton fiber (5%) (See Figure 15a).

Figure 15: Exports of Turkmenistan, 2010

Source: State Committee of Turkmenistan on Statistics

Geographic distributions of these commodities cover Iran (33%), Russia (25%), China (10%) and

other countries (See Figure 15b). According to the estimation of Jumaev (2012, p.7), the exports

of natural gas from Turkmenistan is directed to China - 40%, Iran and Russia -30% in 2011-2012.

In 2010, the large shares of commodities in imports of Turkmenistan are machines and equipment

(38%), base metals (20%), food products (7%), chemical products (7%) and other goods (See

Figure 16a).

Figure 16: Imports of Turkmenistan, 2010

Source: State Committee of Turkmenistan on Statistics

- 59 -

The main share of suppliers of these products are Turkey, EU, China, Russia, the United Arabic

Emirates, Iran and other countries (See Figure 16b). However, a majority from these commodities

are finished goods which are used for investment projects in particular for the construction of a

new gas pipelines.

It should be noted that Central Asian countries have a share of 2.25% of the total exports and

3.11% of the total imports of Turkmenistan, and moreover, Uzbekistan is the key partner in 2010.

Actually, Turkmenistan’s external trade turnover with Central Asian countries is insignificant.

Uzbekistan

The volume of foreign trade turnover of Uzbekistan has demonstrated a steady growth trend even

during the global crisis (See Figure 17). During 2002-2012, the foreign trade turnover of

Uzbekistan increased from $5.7 billion to $26.2 billion, or rose approximately in five times. The

trade balance of Turkmenistan, like Kazakhstan and Turkmenistan, has been positive from 2002

to 2012. However, in 2012, the trade balance of Uzbekistan dropped by 5% compared to 2011,

and this is related to the decrease of exports and the increase of imports.

Figure 17: Total Imports, Exports, Trade Turnover and Balance

- 60 -

Source: Asian Development Bank

During 2002-2012, the exports of Uzbekistan reached the highest point in 2011, which amounted

to $15 billion. The main commodities are energy products, food products, metals, cotton fiber and

other goods (See Figure 18a). Energy products accounted for 18% of the total exports of

Uzbekistan, which include natural gas and a less amount of oil products. Furthermore, the most

important export commodities of Uzbekistan are cotton fibber and vegetables and fruits, which

are shipped to different countries.

Figure 18: Exports of Uzbekistan, 2011

Source: State Committee of the RU on Statistics

- 61 -

The main importers of these commodities in 2011 are Russia (29%), Kazakhstan (11%) and China

(9%), and their portion of exports is larger than other countries (See Figure 18b). Uzbekistan

exported natural gas, automobiles, fruits and vegetables to Russia. China imported mostly cotton

fiber, uranium and others from Uzbekistan. Uzbekistan’s export to Kazakhstan (10%) is dominated

by natural gas, vegetables and fruits.

In 2011, the imports of Uzbekistan have amounted to $11billion and main imported products of

Uzbekistan are machines and equipment (41%), chemical and food products (13%), energy

products and metals (8%), and other important goods (See Figure 19a).

Figure 19: Imports of Uzbekistan, 2011

Source: State Committee of the RU on Statistics

The main suppliers of these goods to the market of Uzbekistan in 2011 are Russia (22%), South

Korea (14%), China (12%), the EU (12%), Kazakhstan (10%) and other countries (See Figure 19b).

The volume of the exports of Uzbekistan to the Central Asian countries accounted for 13%, and

the volume of imports accounted for 14%. Besides, in 2011, Kazakhstan and Turkmenistan have

a larger share of trade turnover with Uzbekistan.

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Nonetheless, the largest trading partner is Russia and then follows China. The EU is gradually

becoming the major trading partner of the Central Asian countries. Now, major trading partners

are Afghanistan and Iran. Likewise, over the past few years, the intra-regional trade has increased.

3. Dynamics of Economic Integration Process in Central Asia

After the collapse of the Soviet Union, the Central Asian countries started to build up new political

and economic relationship with the rest of the world. Along with the development of new foreign

economic relations, the Central Asian countries began to create regional economic integration. The

aim of regional integration is to strengthen the economic independence. Figure 20 illustrates the

regional organizations to which the Central Asian countries belong.

Figure 20: Regional Organizations in Central Asia

Source: Figure has been redesigned by the author based on UNDP (2005, p.47)

In 1992, the newly independent Central Asian countries joined the Economic Cooperation

Organization (ECO) with an intention of promoting trade between regions; the member states were

Iran, Pakistan, Turkey, Afghanistan and Azerbaijan. According to an UNDP report (2005, p.56),

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the trade expanded within the region but not as expected, since the scope of preferential tariffs for

suitable products was limited.

The Commonwealth of Independent States (CIS) was established in 1991, but the Central Asian

countries (except Turkmenistan) became the member of organization only in 1993. Turkmenistan

has been an unofficial associate member because it has not ratified the charter. The purpose of this

regional organization was to form a common economic area that is to promote free movement of

goods, services, capitals and labor. Unfortunately, the CIS has not been able to implement a

regional free economic trade policy substantially. Nevertheless, the free trade agreement was

signed by CIS prime ministers in 2011. Rakhimov (2010, p. 97) points out that meetings have

been conducted regularly to solve socio-economic, political and military issues. Over 2000

agreements in various aspects of relationships with CIS have been signed, though most of them

remain only on paper.

Shanghai Cooperation Organization (SCO) was founded as the “Shanghai Five” group in 1996 by

China, Russia, Kazakhstan, Kyrgyzstan and Tajikistan, and later joined by Uzbekistan. SCO’s

mission is a little different from those of other organizations in terms of security and economy

which primarily “focused on extremism, separatism and terrorism”. Shanghai Organization

discusses about the strategy of security and the ways to maintain political stability in Central Asia.

Gradually, these problems became not so much relevant for most of the countries, and the

organization began to focus on economic issues. Now, a significant share of investment to Central

Asia is dominated by China and then followed by Russia. Hence, China became as the main

investor in the field of infrastructure development and the construction of oil and gas pipelines in

Central Asia.

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The process of regional economic integration among the Central Asian countries began in 1994

with the formation of the Central Asian Economic Union which was signed among Kazakhstan,

Kyrgyzstan and Uzbekistan. The goal of this Union was to create a common market, that is, a free

movement of goods, services and capital. In addition, this Union involves the coordination of

monetary, fiscal and customs policies, and has decided to create a political body called the Inter-

State Council (ISC). It is composed of the presidents and prime ministers of the participating

countries. Moreover, the Union has founded a permanent working body - the Executive Committee

of the Interstate Council with the functions of coordination, advice, forecast analysis and

information. Thus, the regional economic integration of three states has received political

development, which is supposed to promote the coordination of internal and external policy

(Saidazimova, 2000, pp. 68-75). Later, in 1998, after being joined by Tajikistan, the leaders of the

States decided to rename the Union as the Central Asian Economic Community. However, some

Russian observers assessed this event as the emergence of a united Turkestan and claimed that this

union’s hidden agenda was to curtail the growing influence of Moscow in the region

(Novoprudskiy, 1994). In 2004 when Russia became a member of this Community, the

organization had already been named as the Central Asian Cooperation Organization (CACO).

The previous functions had become weak and the idea of a common market remained unrealized.

In October 2005, at the meeting in Saint Petersburg, the leaders of the CACO member countries

resolved to combine the organization with the Eurasian Economic Community.

Eurasian Economic Community (also called as EURASEC) is an international organization that

focuses upon multilateral economic cooperation and attempts at establishing customs union among

its member states. In the way of the creation of common external tariffs, EURASEC has faced

numerous barriers. In the course of events, Kazakhstan and Kyrgyzstan did not want to accept the

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high tariffs set by Russia. Russia also did not want to follow the line of the lowest tariffs of

Kyrgyzstan who was a member of the WTO. However, in October 2007, the government of Russia,

Belarus and Kazakhstan agreed to activate the new Customs Union (CU) which came into effect

with the implementation of a common external tariff in January 2010. Kyrgyzstan, Tajikistan, and

Uzbekistan agreed in principle to join the new CU, but no definite moves in that direction have

been taken since then (except for Kyrgyzstan).

There are two programs which are focusing on regional integration of Central Asian countries.

Central Asia Regional Economic Cooperation (CAREC) 23 is an informal organization that

operates on the level of ministers which mainly concentrates on the development of trade and

infrastructure (transport and energy). The second program is Special Program for the Economies

of Central Asia (SPECA)24 in which all five countries join together. SPECA is similar to CAREC,

but basically provides advice and is responsible for promoting and monitoring the UN conventions

in the field of gender policy, water resources, statistics, etc. (Linn & Pidufala, 2008, p.8).

It is important also to note that most of the Central Asian countries have bilateral free trade

agreements within the region and beyond. However, the agreements between the countries of

Central Asia can been categorized as endeavors in the first and the second stage of regional

economic integration, namely, the preferential and free trade agreements. The depth of the scope

of agreements depends on countries’ circumstances.

23 CAREC’s members are: Afghanistan, Azerbaijan, People’s Republic of China (PRC), Kazakhstan, Kyrgyz Republic, Mongolia, Tajikistan and Uzbekistan; as well as the following multilateral institutions: EBRD, IMF, Islamic Development Bank, Asian Development Bank (ADB), UNDP, and the World Bank. 24 The countries of SPECA are Afghanistan, Azerbaijan, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan and Uzbekistan. The United Nations Economic Commission for Europe (UNECE) and the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) jointly provide overall support to the Programme.

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III. Measuring the Potential Advantages and Disadvantages of Regional Economic

Integration in Central Asia.

1. Evaluating Advantages and Disadvantages of REI in Central Asia through Trade

Growth in trade can increase the welfare of countries, stimulate investment, and advance poverty

reduction in the region. But sometimes trade may affect negatively the socio-economic progress

when the country is not based on market principles and economically isolated from the rest of

world. In the context of positive effects, trade can facilitate to boost GDP of the country, enhance

competition, attract FDI and also ensure an access to the world market especially for the people of

Central Asia who depend on trade and do not have direct outlet to the ports and markets. The trade

among the Central Asian republics and between the republics and neighbors constantly faces

serious hindrance and restrictions – poor road, quite high toll fare and delay of crossing the borders

and other several factors. Thus, the first advantages of the formation of a Central Asian Union is

that the region will be able to build infrastructure in this region thereby ensuring free and reliable

transit across borders.

There is no doubt that regional economic integration in Central Asia will bring greater benefits

than drawbacks. According to an UNDP report, the Central Asian countries may generate double

economic growth rates, people will be better off during the coming 10 years if the trade costs

decline and water and energy resources are used more rationally (UNDP, 2005, p. 1). One of the

clear benefits of regional economic integration of Central Asia is illustrated in the study of Ram

Upendra Das (2012). He puts a main focus on trade integration and analyzes the trade structure of

Central Asian countries using econometric models. His study has explored the potentials of intra-

countries trade growth in Central Asia by taking two approaches: (1) Aggregates Framework

which includes Cosine index of trade complementarities and trade gravity model; and (2)

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Disaggregates Framework which covers Revealed Comparative Advantage Index and Intra-

Industry Trade. According to the results, the greatest potentials for beneficial trade relationships

in the sphere of export among Central Asian countries are those of Kyrgyzstan-Kazakhstan,

Kyrgyzstan-Tajikistan, Turkmenistan-Kyrgyzstan, Kazakhstan- Uzbekistan. Furthermore, the

future prospects of intra-regional trade was also projected and evaluated in chosen years of 2020,

2025, and 2030; in those years, high potentials are expected in those of Kazakhstan-Uzbekistan,

Tajikistan-Turkmenistan, Turkmenistan-Kyrgyzstan, Uzbekistan-Kazakhstan and Tajikistan-

Kyrgyzstan. It should be noted that these findings presuppose establishment of a free trade area

among Central Asian countries. In this regards, welfare gains of the Central Asian countries is

supposed to amount to 0.35 percent of their GDP. In addition, the volume of the region’s exports

is expected to increase by more than 1,000 percent. Another interesting conclusion of the research

is that free trade agreements between the South Asian and Central Asian blocks will lead to a great

expansion of the volume of trade that will be about US $ 91 billion by 2030. Comparing the trade

volume merely among Central Asian countries, this will be only US $ 63 billion by the same year

(Ram Upendra Das, 2012, pp.1-3). This result of advantages from regional economic integration

in Central Asia is based on purely mathematical and statistical simulation. Now we will try to

demonstrate benefits and drawbacks of economic integration of Central Asia theoretically in the

light of static and dynamic effects.

To establish any free trade area among the Central Asian countries will have certain effects on

trade creation for Kazakhstan, Uzbekistan and Turkmenistan, whereas trade diversion will occur

moderately in Tajikistan and deeply in Kyrgyzstan. This is based on the facts that Kyrgyzstan deals

with re-export of cheap commodities and raw materials from China. Kyrgyzstan is the first country

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that has become a WTO member not only among the Central Asian republics but also among the

CIS countries (See Table 8).

Table 8: Accession of Central Asian countries to the WTO

Applied Working parties Member Kazakhstan January 1996 10 meetings (1997- 2008) Kyrgyzstan February 1996 December 1998 Tajikistan May 2001 March 2013 Turkmenistan Not applied Uzbekistan December 1994 3 meetings (2002, 2004, 2005) Russia June 1993 August 2012

Source: WTO Website, www.wto.org

The accession of Kazakhstan to the WTO proceeds more quickly than the case of Uzbekistan. The

admission is expected soon, possibly in 2013. The admission process of Uzbekistan has progressed

in advance but less than Kazakhstan. Although Tajikistan had applied so late then other Central

Asian countries, it has already become a member of the WTO in March 2013. Turkmenistan had

not been interested in a WTO membership due to its unwillingness to abolish their conditioned

tariffs. But from the last year, Turkmenistan also began to negotiate for the accession to the WTO.

Yet, WTO can bring about significant advantages for the Central Asian countries. Accession would

make them prepared for a common regional trade policy among the Central Asian countries and

would help to attract FDI. Otherwise, in the emerging Central Asian Union, Tajikistan and

Kyrgyzstan have to focus only on the domestic market which is more expensive than in the case

of China or other countries. For instance, most of new and used cars are imported from the EU,

Japan and the US to the market of Central Asia (except Uzbekistan which produces four types of

cars (Lacetti, Damas, Matiz, Nexia). While after integration, all countries may be willing to buy

Uzbekistan’s cars because of its cheaper prices. In Uzbekistan’s automobile sector may enjoy the

benefit of trade creation.

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Ideally, the creation of customs union can get benefits for each of the Central Asian countries by

way of economies of scale. The Central Asian countries face relatively small size of the market

and the strong dependence of exports on a limited range of commodities. In this regard, the creation

of customs union, Central Asian manufacturers will focus on over 60 million consumers rather

than merely those in one state. For example, Uzbekistan’s automobile industry, Kyrgyzstan’s glass,

cement and slate industry, Turkmenistan’s carpet industry and other.

Moreover, according to a study of Irnazarov and Salmanov (2012, p. 6) in interviews, they noted

that foreign companies would like to see the entire Central Asian region as a single space, because

they consider this region as a profitable place with large trade opportunities.

The growth of trade enables them to enjoy comparative advantages which allow local people to

access to improved consumer goods, enhance technological innovations and use resources more

effectively. Central Asian countries need to continue the economic reforms in order to create a

developed market economy. Especially Kazakhstan, Turkmenistan and Uzbekistan needs to

diversify their economies, because their economy still depends on oil and gas thereby a decline of

the prices of fossil fuels will affected the welfare of the country negatively.

Central Asian countries would gain double benefits of attracting FDI and creating a good business

climate if they get integrated into one union. Nowadays, there are various obstacles to do business

and finance in the Central Asian countries. This is mainly due to political regimes, economic

instability, weak laws, long procedures of business registration, corruption in political and

economic structures and limited information about those countries in the outside world. In this

regard, among the four countries, Kazakhstan has achieved an impressive progress in the field of

reform as well as development in the financial sector. The government of Kyrgyzstan has also

facilitated to promote the reforms in financial sectors. Tajikistan is moving forward in the

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development of financial systems gradually. As for Turkmenistan and Uzbekistan, the financial

sector is largely dominated by state-owned banks and in most cases controlled by the government.

In terms of FDI, there exists much attention of foreign investors to the local economies. However,

the main and essential restraining factor of smooth flow of investment into the countries is the lack

of effective policy and of legal framework which makes the investors uncertain about the future

projects and their outcomes. The governments of Central Asia shall understand that there is a

strong need to take the wide range of measures to make such cooperation effective for the

prosperity of the region’s economy.

The creation of an integration union also has some disadvantages. For instance, the adoption of a

common customs tariff without exemptions and transitional period can lead to an increase of

import prices on a number of sectors in such fields as the production of food, chemical, wood

industry, metal products and some other industries. Moreover, a higher level of integration may

lead to a loss of sovereignty in the face of a mighty supranational body. In this regards, the Central

Asian countries may encounter these challenges in the future. Moreover, integration of the Central

Asian countries may have some impact on the trade relations negatively with regard to non-

member states. It implies some price increase and shortages of some goods. However, it will

depend on the establishment of the external tariff by Central Asian countries for non-members.

Actually, in order to truly evaluate physical drawbacks of the Central Asian integration in detail,

it is necessary to consider sector by sector using econometric models, which is outside the scope

of my study.

2. Potential Benefits of REI in Central Asia Regarding Non-Economic Issues

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Substantial benefits from the integration of Central Asia may realize if an effective common policy

is formed in terms of the water and energy management and the establishment of appropriate

regional infrastructures. This problem began to exist at least at the time of the breakdown of the

Soviet Union and will come to the center of attention in the coming years. Eventually, this problem

will impact negatively upon the intra-regional relationship and may even lead to the conflict

between Central Asian countries. Therefore, Tajikistan and Kyrgyzstan, which control the

headwaters of two major rivers in Central Asia - the Amu Darya and Syr Darya - have many

disagreements with the downstream countries: Kazakhstan, Turkmenistan and Uzbekistan, as

agriculture of these latter countries depends on freshwater. However, the water is very important

for Kyrgyzstan and Tajikistan too, due to the fact that the generation of water energy provides over

90% of the domestic market. It is important to note that after the breakup of the Soviet Union, the

Central Asian countries inherited the interlinked infrastructure which makes those countries

dependent on each other. Single Central Asian Power System is an interconnected block of energy

system. This block covers the southern part of Kazakhstan, energy system of Uzbekistan,

Tajikistan, Kyrgyzstan and Turkmenistan. During the Soviet times, the development of

hydropower and irrigated agriculture was interlinked in a single system. The system allowed

countries to balance seasonal fluctuations in demand for electricity and irrigation water. For

example, in winter, Kyrgyzstan and Tajikistan accumulated water in the reservoirs and did not use

power in full capacity. Kazakhstan, Turkmenistan and Uzbekistan supplied coal and natural gas to

neighbors. In summer, Kyrgyzstan and Tajikistan provide water to Uzbekistan and Kazakhstan for

irrigation agriculture, and supplies neighbors with electric energy. Nowadays, the situation has

changed and the Central Asian countries collided with each other in face of the problems of the

management of water and energy resources.

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According to scientific estimates, Central Asia has a great energy potential. A majority of

investment projects in Kyrgyzstan and Tajikistan are directed toward building hydropower.

Despite this, Kyrgyzstan and Tajikistan depend on oil and gas. About over 90% of oil is imported

from Russia. It will be very much sensible to solve these issues among the Central Asian countries

in the process of regional integration. As the region produces substantial energy, mineral and

agriculture resources, the entire population in the region may thrive without importing the natural

resources from the rest of the world. Availability of natural resources in Central Asia makes this

region attractive for powerful countries such as the EU, the US, Russia, and China. Therefore their

economic and political influence in the region increased significantly over the past two decades.

All these factors encourage the Central Asian countries to unite with each other in order to

efficiently use water and energy resources in this region.

Another important advantage accruing from regional integration is that they can fight against drug

trafficking and terrorism jointly. Firstly, Central Asia borders on the world’s main center of opium

production – Afghanistan. After the independence in 1991, Central Asia has become one of the

main drug trafficking routes for the Western and Eastern European markets where opium has

traditionally been consumed. According to the United Nations Office on Drug and Crime, the first

route crosses the Iran (often via Pakistan), Turkey, Greece and Bulgaria and come to the Western

European market with the annual market volume reaching about $20 billion. The second route

passes through Tajikistan and Kyrgyzstan (or Uzbekistan or Turkmenistan) to Kazakhstan and the

Russian Federation with the annual market volume approaching approximately $13 billion

(Chalwa, 2010).

Secondly, in the Central Asian region, there is operations of international terrorist organizations

or their divisions, radical Islamic fundamentalist extremist groups, which raises concerns not only

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the countries in the region but also in the entire world community. Territorial proximity to

Afghanistan is a destabilizing factor. The problem of Islamist terrorism in Central Asia can be

considered through the prism of the Islamic Movement of Uzbekistan, so-called Hizbut-Tahrir,

which represents a real threat like Al-Qaeda (Brletich, 2008). For example, terrorist attacks have

happened in Uzbekistan in 1999 and 2004. Besides, the most essential armed conflict occurred in

Tajikistan (Tajik civil war 1992-1197).

The situations of terrorism and crime in Central Asia may destabilize internal political and

economic systems which may have serious implications for ordinary people. One of the paths to

stabilize the region is therefore to promote regional integration and cooperation between the

Central Asian countries. These are another reason why regional integration is needed in the Central

Asian region.

3. Possible Challenges for the Regional Economic Integration of Central Asian Countries

Some essential challenges should be addressed effectively in pursuit of regional economic

integration of Central Asian countries. Let's highlight the main significant potential challenges of

regional integration in Central Asia: (1) political regime; (2) differences of economic development;

(3) aspiration of leaders in the domination of the region; and (4) political will;

(1) This obstacle is concerned with countries other than Kyrgyzstan since almost all Central Asian

countries are authoritarian except for Kyrgyzstan. All four leaders ruled the country for over 23

years and have a presidential form of government. Unlike other Central Asian countries,

Kyrgyzstan after the People’s Revolution in 2010 has adopted a new Constitution which followed

a national referendum. As a result, Kyrgyzstan transformed from a Presidential republic into a

democratic parliamentary republic.

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(2) Differences of economic development have been discussed above based on the factual data.

However, it should be noted other factors too weigh much. For instance, these countries diverge

in terms of ideas of economic development and attitudes to openness to the outside world.

Kazakhstan, one of the first Central Asian countries affected by the crisis, started to join the

international economy decisively. On the other hand, Uzbekistan and Turkmenistan have not been

affected so much because their economies are more isolated from the external world. Countries in

the region show different degrees of development, different levels of economic development and

economic models. Actually, economic development is a distinctively important factor, even

though the economies of the countries like Kazakhstan, Turkmenistan and Uzbekistan depends on

oil and gas. This advantage has given them opportunities to develop their economy in high level.

But we should not forget that Kyrgyzstan and Tajikistan possess vital resources like water. One of

the main tasks of this region must be to improve the management of water and energy resources.

Otherwise, in 10 to15 years from now, whether they want it or not, the countries in the region will

have to address the water problem. This can be done only in the interaction of Central Asia under

effective cooperation and integration.

(3) Ambitions of the two leaders have led to a controversial situation. This problem has existed

since the first step of integration was taken in 1994. The president of Kazakhstan is considering

his region as a place of strategic location between Asia and Europe, possessing a large territory

and sharing the common borders with Russia. The leader of Uzbekistan is conscious that its

population is the largest in the region and the country is located in the heart of the region bordering

all Central Asian countries. The leader of Turkmenistan seems to take a neutral position. However,

it is important to note that the regional integration of European Union started only after the World

War II with the initiatives taken by the two leaders of France and Germany. The two leaders of

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European Union had strong will, clear views of long-term integration. They defined some

successful factors of integration: economic recovery and peace in the region based on democracy

and free market. Despite different degrees of economic development, the EU member countries

were able to reach agreements and has become the most successful integration alliance.

(4) Political will is a very important factor of successful regional integration. Without political will,

the idea of integration cannot become realized. This means that all ruling elites in the countries of

Central Asia must communicate with each other about the prospect of development of the region

as a whole. Political will should be accompanied by mutual respect equality. It should be noted

that almost all Central Asian countries (Turkmenistan’s diplomatic credo is neutrality), particularly

the giant exporters of fossil fuels, Kazakhstan and Uzbekistan, have strong desire to establish a

free trade area or a Central Asian alliance. For instance, at the CACO summit in 2004, the leader

of Uzbekistan suggested the creation of Central Asian Common Market in three stages: (a)

establish a free trade area; (b) a customs union after five years; and (c) ultimately a common market

after seven years. Unfortunately, the plan could not be realized because the CACO has become a

part of the EEC (UNDP, 2005, p.59). In December 2012, the president of Kazakhstan announced

that intra-regional integration is the best way to solve social, economic, water and energy problems,

as well as to build up security of the region. This was stated in the message of the President to the

people of Kazakhstan entitled "Strategy - 2050 - a new policy of state ".

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Chapter 5: Analysis of the Regional Economic Integration from the Perspective of

Kyrgyzstan

I. Overview

Kyrgyzstan is located in the central part of the Eurasian continent which borders three Central

Asian countries: Kazakhstan, Uzbekistan, and Tajikistan, as well as China in the eastern part of

the country. Its total surface area is 198,500 square kilometers. Kyrgyzstan is a landlocked country

with multiple ethnic groups, and its population is more than 5.5 million in 2012. The main

population group of the country is Kyrgyz (72%), followed by Uzbeks (14%), Russians (7%) and

people of other nationalities: Kazakhs, Ukrainians, Koreans, Dungans, Uighurs, Tajiks, etc.

Kyrgyz economy is dominated by the agriculture sector and heavily depends on the gold export

and the transfer of remittances from Kyrgyz migrant workers especially in Russia. Gold is the main

export commodity of Kyrgyzstan, which roughly accounts for 40% of GDP. Furthermore,

Kyrgyzstan has the considerable subsoil and the potentiality of hydropower. However, its

economic potentials remain largely unexploited. Recently, the government of Kyrgyzstan has

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attempted to develop hydropower potentials by attracting foreign investments, but these projects

has not completely been implemented yet.

The political system of Kyrgyzstan is different from those of other Central Asian countries. Unlike

their neighbors, Kyrgyzstan transformed from a top-down presidential system to a democratic

parliamentary system of government after the new constitution was adopted after the revolution in

2010.

Kyrgyzstan originally became a part of the Russian empire in 1876, and then the Kyrgyz Soviet

Socialist Republic in 1936, which heavily impacted upon the people’s ways of thinking through

communism and the command economy of the Soviet Union. After the collapse of the Soviet

Union and the subsequent independence in 1991, Kyrgyzstan has made a significant progress in

transition from the centrally-planned toward the market-oriented economy. In addition, the

liberalization of economy at that time brought about a great opportunity in terms of

democratization of Kyrgyz people’s life and development open foreign policy with the rest of the

world.

Kyrgyzstan has to evaluate a number of possible consequences of the creation of a regional

economic integration among the Central Asian countries. These effects may be positive and

negative and may be political and economic issues. However, this chapter will analyze economic

issues, in perspective of foreign trade policy of Kyrgyzstan toward Central Asian countries and

possible economic effects of Kyrgyzstan’s possible participation in the process of Central Asian

integration.

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II. Trade Policy of Kyrgyzstan toward Central Asian countries

The creation of bilateral or regional free trade agreements have become an integral part of the trade

policy of Kyrgyzstan since 1991. All free trade agreements signed with countries in the region

have been based on long-standing trade and economic relations in the region. Kyrgyzstan signed

bilateral free trade agreements with nine countries and one preferential trade agreement with

Turkmenistan (See Table 9).

Table 9: Trade Agreements with Central Asia and other countries

N Partner Agreements Date 1 Russia Free trade agreement October 8, 1992 2 Kazakhstan Free trade agreement June 22, 1995 3 Uzbekistan Free trade agreement December 24, 1996 4 Azerbaijan Free trade agreement January 12, 2004 5 Armenia Free trade agreement July 4, 1994 6 Moldova Free trade agreement May 26, 1995 7 Ukraine Free trade agreement May 26, 1995 8 Belarus Free trade agreement March 30, 1999 9 Tajikistan Free trade agreement January 19, 2000 10 Turkmenistan Preferential trade agreement March 29, 2006

Source: Ministry of Economy of the Kyrgyz Republic

Hence, Kyrgyzstan has free trade agreements with almost all Central Asian countries, except

Turkmenistan. According to these agreements, imports of goods from partner countries are duty-

free, if the products originate from these countries. On the other hand, export duties applied to

these countries depend on partners. Furthermore, these trade agreements are limited according to

goods. Uzbekistan’s taxes are levied on Kyrgyzstan's imported products. All in all, these

agreements have not been fully realized due to various reasons related to numerous obstacles that

remain in trade – high tariffs, delay of crossing the borders and other factors.

Kyrgyzstan’s foreign trade with the Central Asian countries has been unstable during the years of

2008-2012 (See Figure 21).

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Figure 21: Foreign Trade with Central Asian Countries (in millions $), 2008-2012

Source: National Statistical Committee of the KR and author’s calculations

The main reason for erratic trade turnover of Kyrgyzstan with Central Asian countries is

unfavorable climatic conditions in 2009 which impacted on the exports of agricultural products.

In addition, internal political and ethnic crisis in 2010 led to the closure of borders by neighbors

of Central Asia and as a result sharp decline of merchandise trade within the region; the key

partners of Kyrgyzstan in the region of Central Asia are Kazakhstan and Uzbekistan (See Figure

22a, b).

Kyrgyzstan and Kazakhstan has close relations during all history of their development. Moreover,

these countries have joined together in many regional groups such as the CIS, SCO, CSTO25, ECO

and EURASEC. Kazakhstan has remained as a top trading partner of Kyrgyzstan for exports and

imports of goods and services. Although Kyrgyzstan’s exports to Kazakhstan were unsteady

25 The Collective Security Treaty Organization (CSTO) - established under the framework of the CIS - serves as a mutual defense alliance among Russia, Belarus, Armenia, Kazakhstan, Kyrgyzstan and Tajikistan.

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during the five years, merchandise exports have expanded from $184 million in 2008 to $395

million in 2012 (See Figure 22a).

Figure 22: Exports and Imports of Kyrgyzstan with Central Asian Countries (in millions $), 2008-2012

Source: National Statistical Committee of the KR

Meanwhile, during the same period, Kyrgyzstan’s import from Kazakhstan has been stable and

increased almost two times (See Figure 22b). The share of foreign trade of Kazakhstan in the total

trade turnover of Kyrgyzstan accounted for 15.1% in 2012. Kazakhstan is a supplier of grains and

flours, coal, and gasoline to the market of Kyrgyzstan, while Kazakhstan is a consumer of building

materials, agricultural products, electricity, precious metals and some industrial products. Under

free trade arrangements, Kyrgyzstan can obtain great benefits from the imports of petroleum

products from Kazakhstan. About 96% of oil products is exported from Russia to the Kyrgyz

market.

Kyrgyzstan and Uzbekistan are members of such organizations like CIS, SCO as well as ECO.

Actually, Uzbekistan has adopted a closed economy policy with the rest of the world, though both

countries keep a good relationship in mutual trade. However, the exports and imports of

Kyrgyzstan with Uzbekistan are unstable. These oscillations are basically related to Uzbekistan’s

demand for the electricity of Kyrgyzstan, and Uzbekistan’s exports of natural gas to the Kyrgyz

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market. That is why the volume is greatly reduced from $232 million in 2008 to $190 million in

2012 and imports are declining year by year from $160 million in 2008 to $68 million in 2012

(See Figure 22 a and b). The Uzbekistan’s share in the foreign trade of Kyrgyzstan in 2012 was

3.6%, mainly consisting of gas, oil products (jet fuel), electric lamps, limestone, base metals, rice,

special vehicles, etc. The main foreign trade policy of Kyrgyzstan toward Uzbekistan is concerned

about energy sectors, inasmuch as Kyrgyzstan's economy is dependent on the imports from

Uzbekistan that is the primary supplier of natural gas, while Uzbekistan’s market is in need of

electricity and water from Kyrgyzstan.

The level of economic interdependence of Kyrgyzstan with Tajikistan has been deepened on the

basis of cooperation in the CIS free trade area, namely, EURASEC, ECO, CSTO and SCO.

Tajikistan is a country where merchandise trade with Kyrgyzstan is not significant in comparison

with other neighboring countries. During five years, the exports of Kyrgyzstan to Tajikistan has

risen from $27 million in 2008 to $40 million in 2012 but imports has remained at the same level

$4 million (See Figure 22a, b). Tajikistan is a country where trade balance in regard to Kyrgyzstan

is favorable. Actually, these two countries can achieve higher stage of economic development in

the field of cooperation in the water and energy sectors. It will be huge opportunities to export

electricity to third countries. The main trading products between Kyrgyzstan and Turkmenistan

are clothes, footgear, machinery and equipment, vehicles and energy products.

Turkmenistan is a country which considers the integration process with skepticism. Therefore,

Turkmenistan has not been involved in most of the integrated unions. Only organization that gives

an opportunity of cooperation between Kyrgyzstan and Turkmenistan is ECO. However, the

volume of trade turnover of Kyrgyzstan with Turkmenistan is tiny. During the five year period,

the exports of Kyrgyzstan to Turkmenistan remained almost at the same level: $4 million in 2008

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and $5 million in 2012, and the imports has stayed almost invisible. Possibly, it is related to the

geographical location, the poor quality of agreement, and the high trade tariffs and so on. The main

trading products between Kyrgyzstan and Turkmenistan are food products, plastics, machinery

and equipment, vehicles and other products. In fact, Kyrgyzstan's prospect of the expansion of

trade with Turkmenistan is not very promising and might be restricted to the field of natural gas

for coming years.

III. Possible Economic Effects of Kyrgyzstan’s Participation in the Central Asian

Integration Process

The participation of Kyrgyzstan in economic integration with the Central Asian countries would

provide essential economic benefits to the whole region. Some of the countries can get benefits in

the mid-term perspective and some of them in the long-term. In this regard, this section will make

a comprehensive analysis of possible static and dynamic effects of Kyrgyzstan from its

participation in the Central Asian integration.

Primarily, it is important to note that the promotion of re-exports of Kyrgyzstan is one way of trade

policy that brings more income for the population. As mentioned in chapter 4, Kyrgyzstan was the

first country among the CIS that became a member of the WTO. Now, Kyrgyzstan is a core country

in Central Asia that engages in re-exports of Chinese commodities to other Central Asian countries.

According to the World Bank (2008), it is estimated that about 75% of imports of Kyrgyzstan are

re-exported to the Central Asian countries and Russia. Also, Mogilevskii (2012, pp.20-31)

estimated that re-exports accounted to over 13% of GDP of Kyrgyzstan in 2010, and around 70

and 120 thousands of people are directly employed in the two largest markets in Kyrgyzstan:

Dordoi and Karasuu. However, if we take into account the people who work for the textile industry

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and trade, often informally, especially in such fields as food, household services, exchange bureaus,

urban and intercity transportation, this number could double.

For the moment, Kyrgyzstan has become a leader of re-export of goods to Russia and other Central

Asian countries. However, in terms of Kyrgyzstan's participation in customs union of Central

Asian countries can lead to a loss of customs duties, an increase of unemployment and de-

escalation of Chinese cheaper goods. In other words, Kyrgyzstan's membership in a Central Asian

Union may be characterized by trade diversion effects. It implies, as a result of this integration,

the tariff for third countries may increase and hence consumers will be forced to buy more

expensive and sometimes less quality products from manufacturers of member countries rather

than goods from all WTO members. Secondly, the economy of Kyrgyzstan which depends on

import duties can significantly contribute to the decline of the state budget revenues. It is assumed

that this may occur in the short or the mid-term perspective.

Moreover, Kyrgyzstan faces with other big problems which are related with WTO commitments.

According to the rule of WTO, Kyrgyzstan must compensate to other trading partners (to WTO

members) for less favorable trade policy, in case of the adoption by the Central Asian Union of a

more protectionist policy than the existing tariff system of the country. It should be noted that

neither Kazakhstan nor Uzbekistan nor Turkmenistan are WTO members. In order to prevent

considerable negative effects to the economy of Kyrgyzstan, it is desirable that the rest of the

Central Asian countries should become members of WTO and at the same time accept the same

external tariffs for third countries. Otherwise, the outcome can be a significant damage for the state

budget of Kyrgyzstan. Thus, static effects of the participation of Kyrgyzstan in customs union with

Central Asian countries may be affected by trade diversion.

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However, the Kyrgyz market can achieve certain benefits of dynamic effects in the long-term

perspective by comparative advantages and economies of scale. An large integrated market

surrounding Kyrgyzstan will allow the country to achieve a competitive level of costs due to

economies of scale, which is important particularly for Kyrgyzstan whose economy is

characterized by its small domestic market. Besides, the elimination of trade barriers and the

emergence of integrated markets in Central Asia will enable Kyrgyzstan to increase the level of

competition between producers which may impact on price competitiveness and quality of goods

for consumers in this region. Eventually, Kyrgyzstan can increase productivity and improve

efficiency in main industries.

Actually, the second largest sector of Kyrgyz economy after gold is textile and clothes. Given the

garment industry of Kyrgyzstan is rapidly developing and its products are actively exported to the

countries of Central Asia and Russia, it is considered that this sector might be a driving force of

Kyrgyz economy in the long-term perspective. Kyrgyzstan possesses cheap labor with high quality,

electricity and water resources, and this will give a golden opportunity to freely export Kyrgyz

goods to the world market. Furthermore, Kyrgyzstan may obtain advantage from a free access to

fuel, seed, fertilizer, and machinery which are imported from Kazakhstan. Thus, Kyrgyzstan's

participation in regional economic integration in the Central Asian countries may bring great

benefits by providing duty free access to the market of Central Asia by Kyrgyz commodities and

assuring the provision of energy and other vital inputs.

It is important emphasized that one of the advantage of the effects on economies of scale for

Kyrgyzstan and other Central Asian countries is that the region will be able to attract more FDI. It

will facilitate economic growth of this region and draws new technology (innovation), financial

capital, management skills and access to the world market. In reality, existing FDI in the region is

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focused on the projects which related to natural resources, for instance oil and gas in Kazakhstan

and Turkmenistan, and gold in Kyrgyzstan. However, the FDI in other financial, industrial and

hydropower sectors of economy of Central Asian countries remains in a low level. Ultimately, the

regional economic integration of Kyrgyzstan with other Central Asian countries can promote the

development of all sectors of the economy by attracting more FDI.

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Chapter 6: Conclusions and Policy Recommendations

I. Conclusions

There is no doubt that regional economic integration has become one of the best tools to respond

to modern global and regional challenges. The issue of regional economic integration has attracted

great interest in the world, while the Central Asian countries are realizing its importance seeking

to find out their own ways of promoting regional integration, for regional economic integration is

one of the routes to contribute to the growth and development of economies in the region of Central

Asia. Through the descriptive and comprehensive analysis, the issue of regional economic

integration between Kyrgyz Republic and other Central Asian countries has been discussed in this

study.

The theories of economic integration overviewed in the second chapter has delineated certain

common ideas about the definitions and the forms of regional economic integration, which have

been expressed by a number of economists and researchers. According to the preceding study, it

is possible to say that regional economic integration can create conditions for free trade within an

integrated area, thereby bring great benefits for member countries. Indeed, free trade agreement is

favourable for free movement of goods and services among countries without obstacles imposed

by their own and neighbouring governments. In the absence of barriers, free trade can lead to an

increase of welfare for everyone. However, there is no guarantee that every consumer will be better

off, due to the effect of free trade on income distribution. Taking measures to redistribute income

might be necessary to compensate for the loss of income of some consumers due to the market

competition.

As a matter of fact, in the process of development of large-scale manufacturing industry, the

increasing scale of production, and deeper specialization in the industry, it has become impossible

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to produce the whole range of products within one country, as each country is endowed with

different resources. In this regards, the first thing that should be discussed is the differences of

production conditions. For instance, one country possesses something that the other does not, but

without that the latter country cannot develop modern industry. This also applies to certain

commodities for personal consumption. The second is the costs of production. The cost of

production is different from country to country. For instance, a cost per unit of the car production

in Japan is lower than in the auto industry of the USA. This can be the cause of various conflicts.

South Korean and Taiwanese electronics are cheaper than those produced in Japan first of all due

to the cheap labour in the former. Such examples exist a lot in the world. It is better to buy things

produced in other countries than produce all at home. Adam Smith’s “Absolute Advantage Theory”

emphasized that countries would prefer development of free international trade since each of them

has absolute advantage regardless of their status as exporters or importers. He also believed that

the benefits of specialization would be obtained in the end, shared by all countries and all social

classes, because this arrangements lead to the accumulation of capital for economic growth and

the increased demand for labour thereby creating jobs.

David Ricardo's comparative advantage theory extends Smith's view and proves that, even if one

of the two countries has an absolute advantage in both commodities, trade is good for both

countries. Ricardo illustrates this argument with a simple example: It is possible to make grape

wine in England, but the cost could be excessive. It is more profitable to produce cloth in England

cloth and exchange it for wine from Portugal. Therefore, countries should specialize in products

in which they benefit. Ultimately, it should be admitted that regional economic integration is

necessary for:

increasing national competitiveness

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using "economies of scale" that allows a country and a region to expand the size of the

market and reduce transaction costs, encourage the inflow of FDI;

responding to the global challenges;

contributing to the modernization and structural reforms in the economy;

giving domestic producers better access to financial, labour, material resources as well as

to the newest technologies;

giving them an access to high quality and cheap price of goods for domestic consumers;

strengthening good-neighbour relations between countries in all fields;

strengthening the position of the countries involved in the global market;

The experience of regional economic integration of the EU, especially the emergence and

development of European integration as well as its benefits and drawbacks, has already been

examined in chapter 3. Also, the economic integration of the Soviet Union has been discussed.

Lessons from this experience are very much important for the Central Asian countries that were

part of the USSR. However, the European Community and COMECON are different organizations,

in spite of their efforts to achieve the same purpose. The USSR dominated COMECON politically

and economically, and this domination did not exist in the European Community. Furthermore,

the EC was based on the common market, while COMECON on the common plan. In addition,

COMECON was not a supranational organization, but their members were not able to make

decisions independently. Despite such shortcomings, the share of the COMECON member

countries accounted for one third of the world industrial production and the economic potentials

of these countries increased to some extent. Thus, in history, COMECON remains a unique

integration system with a command economy.

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Eventually, the study came to a conclusion that the EU’s experience has been demonstrated that

political will for integration, and the cohesion of members can bring about almost the highest form

of successful integration in the world. The main factors of the success of the EU is the historical

reconciliation between France and Germany, as well as sustained political efforts of political

leaders. It is important to note that the European integration was not easy and prompt, and in reality,

this path took more than 55 years with challenges and gradual reconciliation among members.

Today, the EU is a good example for all regional organizations and in addition a dream shared by

many state leaders. The EU has made a great step in creating an integrated European continent and

has become economically superpower organization in the world. In fact, the European states

created a peace and stability among themselves as well as provide effective protection from

external threats. Finally, the EU experience illustrates the importance of developing regional

economic integration. In this sense, the Central Asian countries can learn much from their

experiences and emulate the best practices in order to create its own successful integration.

The fourth chapter has shown that the formation of regional economic integration in Central Asia

is not without challenges and own costs. These challenges as well as potential advantages and

disadvantages of the Central Asian integration was fully discussed in that chapter. Based on the

comprehensive analysis, the study finds that the new five independent states of Central Asia which

used to be a part of the powerful USSR shared a similar economic model and structure in the early

1990s. However, by the twenty first century, their achievements in economic development were

remarkable. The necessity of economic integration in the region is largely based on deep

interdependence and mutual complementarity of the economies of the region. Regional integration

based on complementary among Central Asian countries can bring more benefits than drawbacks.

Since Kazakhstan, Turkmenistan, Uzbekistan has hydrocarbon feedstock, while Tajikistan and

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Kyrgyzstan has electricity and water resource. With extensive hydrocarbon and hydropower

energy, this region can become engines of growth of the world and these resources must be used

more efficiently and more fairly distributed than today. But these issues should begin from a

creation free trade area among Central Asian countries. Free movement of goods among Central

Asian countries and between the region and the outside world will curtail the cost of transportation

and open up an outlet to the world market on the one hand, and this may promote the revival of

the ancient Silk Road, on the other hand. In such a condition, Central Asia will endeavor to produce

more competitive goods toward other countries of the world. Cross-border economic relations,

trade, investment and infrastructure are the key factors for creating competitiveness on the regional

market. Openness and liberalization is the only one way to diversify the economy presently

characterized by overdependence on a limited number of commodities. An appropriate trade policy

in Central Asia can again turn it into an important part of the world trade.

It is emphasized without fail that any project which require regional coordination cannot be

implemented as long as the leaders of region are not convinced of the importance of such projects.

Kazakhstan and other countries of Central Asia are well aware of that in the process of

globalization, recognizing that it is impossible for them alone to cope with new challenges and

threats as well as solve their economic problems. That is why the president of Kazakhstan proposed

the idea of creation a Central Asian Union. Virtually, most experts have expressed that the initial

idea of creating a common market among Central Asian countries was realistic. However, the lack

of will and aspiration on the side of the leadership in the region is leading to some disintegration

of regional economy. According to Rakhimov’s (2006, pp. 64–65), an interview and sociological

survey among more than 50 experts from Central Asian countries, Russia, and the UK

demonstrated that the main problems for regional cooperation among Central Asian countries are:

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(1) the different national interests and economic development (50%); (2) the rivalry between

Uzbekistan and Kazakhstan for leadership (35%); (3) the fear of sub-national structures (30%).

Thus, it should be noted that the main potential challenges of integration which Central Asian

countries might face are concerned about political will, political regime, differences of economic

development and aspirations of leaders who want to dominate the region.

Chapter 5 has analysed overall perspectives and challenges for the Kyrgyz Republic that would

occur from its participation in the Central Asian integration, which include static and dynamic

effects of regional economic integration in the process of unification. Actually, Kyrgyzstan is a

young and newly independent state. After getting independence in 1991, Kyrgyzstan took a course

of developing its own foreign trade policy, and as a result, it has become one of the first member

of WTO in the CIS in 1998 and signed numerous bilateral agreements with Central Asian and

other countries. However, the level of integration of Kyrgyzstan with other Central Asian countries

is still on the stage of preferential trade agreements, though they have already signed free trade

agreements which are to be implemented in the framework of CIS organization. Currently,

Kyrgyzstan has fairly low and uniform external tariffs in the Central Asian countries.

Actually, the Kyrgyz trade turnover with other Central Asian countries is fluctuating. It is the result

of various factors: demand and supply of goods from neighbouring countries, global crises,

unfavourable climatic condition and other reasons. Since the independence of Kyrgyzstan, its main

partners in foreign trade have been Kazakhstan and Uzbekistan. In 2012, the share of foreign trade

of Kazakhstan in the total trade turnover of Kyrgyzstan accounted for 15.1%, while Uzbekistan

for 3.6%. In regard to Tajikistan and Turkmenistan, the merchandise trade and trade relationship

are not significant.

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Other important findings of this study is that the participation of Kyrgyzstan in the integration of

the Central Asian countries may be negative in terms of static effects, but positive in terms of

dynamic effects. On the negative side, Kyrgyzstan may suffer trade diversion to some extent. It

implies that applying high external tariffs by Central Asian Union would heavily impact upon

foreign trade of Kyrgyzstan and hence on the state budget revenues, since Kyrgyzstan is a net

importer which heavily depends on imports duties. Moreover, this cause could lead to

unemployment of Kyrgyz people who are involved in the concerned sectors. On the positive side,

Kyrgyz would have benefits of regional economic integration with Central Asian countries that

arise from economies of scale and increased competitiveness due to the expansion of its market.

Economies of scale can stimulate competitiveness of Kyrgyz products and attract FDI to all Central

Asian countries, not only to Kyrgyzstan. It is expected that all countries will achieve economic

growth as a result of integration in the long term perspective. However, in reality, the direction

may change, if a Central Asian union will adopt a single a tariff system, taking into account the

views of all parties in the region.

Summarizing the results of this study, it should be noted that the prospect of the creation of a single

customs union in Central Asia is quite real, but for this requires presidents’ strong will based on

an understanding of clear benefits for the future that can be achieved from this integration or

cooperation venture. Regional economic integration in Central Asia can contribute to solving

challenges in such area as: (1) trade and investment, (2) finance and business, (3) transport and

communications (4) migration and unemployment (5) energy and water resources, (6)

environmental and security, which today are matter of concern for all Central Asian countries.

Thus, the task of the region is to take maximum advantage of the opportunities offered by regional

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integration, and to ensure an economically, socially, politically, ecologically sustainable

development as well as the security for all people who live in the Central Asian region.

II. Policy Recommendations

Based on the findings of this study, the following policies are recommended:

Establish a real free trade area among Central Asian countries. The study has found that intra-

regional trade relationship in Central Asia is poorly developed. However, there are also findings

that the Central Asian countries have a huge potential for trade integration in a variety of sectors,

because free trade area as a first stage of integration can stimulate the integration of the regional

countries. In other words, a free trade area can create closer relationship among the leaders of

Central Asia and this impetus is expected to develop the next step of regional economic integration.

Thus, now it is very important to carry out the liberalization of tariffs, rules of origins of production,

and to establish appropriate measures to facilitate trade within the region.

Secure the access to WTO other three Central Asian countries. The Kyrgyz Republic should

actively promote the accession of these countries to WTO. Otherwise, it will face with difficulties

in integrating with other Central Asian countries. In this regards, Kyrgyz Republic will be able to

use the process of accession of Kazakhstan, Uzbekistan and Turkmenistan to the WTO as a means

to promote its trade and economic interests through participation in multilateral trade negotiations

with these countries in the framework of the WTO. Moreover, joint efforts of other three Central

Asian countries may bring great opportunities shared by all states in securing access of national

products to the world markets.

Design viable programs for regional development in Central Asia. As illustrated in the study,

there are obstacles in border-crossing economic interactions among countries such as high tariffs,

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delay of cargo, poor infrastructure that would push up costs of goods and other factors. This leads

to the suggestion that the authorities of the Central Asian countries should design programs for

regional development.

Create a research institute by governments of Central Asia. Establishment of a Central Asian

institute will bring great opportunities to promote the study in the region on local as well as

international levels. Moreover, this recommendation assumes that such an institute will support

and encourage individual and group of research projects, holding seminars and conferences,

publishing a scientific journal and books which will concentrate mainly on Central Asian countries.

Organize a business forum with participation of all stakeholders in Central Asia. The

business forum should be aimed at promoting economic cooperation among the countries of

Central Asia. The Forum will allow business stakeholders to present investment opportunities for

Central Asian countries to implement joint projects, to discuss the problems of their realization

and other relevant issues.

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