Sequencing in Customs Union Formation: Theory and Application

to Eurasian Economic UnionGerald Pech

based on joint work with Aidos Alimbekov and Eldar Madumarov

Sequencing as a Problem

• Why do economic unions not form in one go?• Historical coincidence? – Eastern Europe• Evolving nature of union?• Increasing attractiveness over time

– could bring in a “strategic” motive behind the sequencing

A “Strategic” Explanation of Sequencing

• Aghion-Antras-Helpman, J Internat Econ (2007): “equilibrium sequencing”

• An “agenda setter/formateur” can form union at once or start with a core union

• Assume that forming the core union has a “negative externality” on an accession candidate

• It should be willing to join under conditions more favourable to the formateur

• Prediction: The country which is most negatively affected joins last

Kyrgyzstan’s delayed entry

• Signatory of the 1995 agreement – but not of the Dushanbe agreement 2007

• WTO member since 1998• April 2010: Bakiyev steps down• Atambaev wins election on promise of close

ties with Russia• Kyrgyzstan joins in 2015

Effect of Customs Union on Kyrgyzstan

• Re-import business and textile industry historically benefitted from low tariff regime

• Kyrgyzstan expected to be a net-loser from joining customs union

• But Kyrgyzstan also suffers negative external effects from core customs union

• Main industries equally hit by exclusion from integrating market

How to Explain Sequencing in Eurasian Customs Union

• So by joining Kyrgyzstan loses compared to status quo ante

• But once core customs union has formed joining is the least bad option

• So is the strategic sequencing model the best explanation of what happened with Kyrgyzstan’s entry?

A Historical Precedent: The Zollverein

• The German Customs Union (Zollverein) was founded in 1833 between independent German states

• Development that started at Prussia’s initiative in 1816

• And finally resulted in German nationhood

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The Zollverein: Hesse-Cassel

• In 1828, Hesse-Darmstadt joined Zollverein• Negative externalities on Hesse-Cassel

– through higher border-tariffs of neighbouring Darmstadt

– resulting in civil unrest– and fear of further loss of transit traffic

• Recalcitrant duke resigned in 1831, successor signed ratification documents

The Zollverein

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An Aside: Why Was Prussia Interested in Integration?

• Prussia did not benefit that much from trading with the smaller states

• But it a gained better bargaining position when negotiating over trade with big players such as England and France

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What is missing from the story

• As Alimbekov/Madumarov/Pech (2015) show, the AAH story either needs – myopic accession candidates– an exogenous constraint on bargaining institutions

which the agenda setter can choose from – bargaining frictions: it takes time to bargain

• Kyrgyzstan’s WTO membership makes negotiations more complicated

• Problems in negotiating with Bakiyev gvt’– better modelled as “political uncertainty?”

Richer Explanations

Some more facts

• Kyrgyzstan receives Russian infrastructure support

… some more facts

• New border facilities at Kazakh-Kyrgyz border– Making core customs union more credible and

costly?• Russia promises Kyrgyzstan help in securing its

outer border – suggests that desire to “incentivize” Kyrgyzstan to

invest into border controls could have played a role

An Imperfect Commitment Model of Accession

• Assume accession is irreversible• and accession candidate cannot credibly

promise to implement policies which are necessary to make union successful

• Like investing in border security• Sequencing solves the incentive problem:

Make accession conditional on investment

Supporting Materials

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Winners and Losers

• Economic welfare of a country is sum of– Consumer surplus– Tariff revenue– Profits of home producers– We assume that foreign firms have market power!

• As a proxy for impact of CU we use– change in current account balance – change consumer surplus of non numeraire good

• Political benefits and costs!www.geraldpech.net 18

Eurasian Customs Union

• 1995: First agreement signed between Belarus, Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan.– Uzbekistan not interested at the moment– Tajikistan only has land border with Kyrgyzstan

• 2007: Dushanbe agreement on customs union signed between BY, KZ and RU

• 2010: Official launch of CU with external tariff at (high) Russian rates– for some goods July 2010, for others July 2011

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Tariff Protection

simple average 2009

weighted average 2009

Kazakhstan 6.78% 5.52%

Belarus 8.00% 2.3%

Russia 8.09% 5.9%

EU 10.6% 7.37%

from: Jandasov/Sabyrova 2009

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Standard and non standard channels

Source: Vashakmadze, E., Kaminski, B., Mironova, Y., (2011).

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Standard and non standard channels

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• • where is the average value of the export index for country i

in the pre- and the post customs union period (t=1,2), CU is a dummy variable for customs union which takes the value 1 for the subsample starting in 2010, CDi is the country fixed effect and Ii is a dummy which is 1 if the country is a latecomer in the customs union (i.e. Tajikistan (TAD), Kyrgyzstan (KY) or Armenia(ARM)) and 0 if the country as of now is not expected to join the customs union (i.e. Ukraine, Azerbaijan, Moldova).

0 1 72,..,6it s i is

EXP CU CD CU I

Dependent Variable: Method: Least Squares Date: 05/03/15 Time: 17:39 Sample: 1 12 Included observations: 12 =b0+ b1*CU+ b2*TAD+ b3*KY+ b4*ARM+ b5*MOL+ b6*AZ+ b7*(KY+TAD+ARM)*CU

Coefficient Std. Error t-Statistic Prob.

b0 238.1018 96.99498 2.454785 0.0701b1 289.1980 96.99498 2.981577 0.0407b2 -166.0115 137.1716 -1.210246 0.2928b3 0.672807 137.1716 0.004905 0.9963b4 49.87698 137.1716 0.363610 0.7346b5 -179.2669 118.7941 -1.509056 0.2058b6 383.8645 118.7941 3.231343 0.0319b7 -235.6465 137.1716 -1.717896 0.1609

R-squared 0.921567 Mean dependent var 338.6452Adjusted R-squared 0.784308 S.D. dependent var 255.7868S.E. of regression 118.7941 Akaike info criterion 12.62738Sum squared resid 56448.15 Schwarz criterion 12.95065Log likelihood -67.76429 Hannan-Quinn criter. 12.50770F-statistic 6.714100 Durbin-Watson stat 2.690579Prob(F-statistic) 0.042389

itEXP

itEXP