A few weeks ago, speaking at a press conference, Prime Minister Bidzina Ivanishvili floated the idea of Georgia joining the Eurasian Union. Although he later backtracked on his statements, the cat was out of the bag.
Predictably, the United National Movement slammed the Prime Minister, accusing him of betraying Georgia’s aspirations to integrate into Euro-Atlantic structures.
True or not, as a trade economist I cannot comment with authority on whether joining the Eurasian Union will turn Georgia into a Russian satellite. I can, however, comment on the economic and trade aspects of joining the Eurasian Union. Or rather, the Customs Union of Belarus, Kazakhstan and Russia, and soon Armenia – which is one of the few existing integration projects of what currently is only a proposed Eurasian Union.
A customs union has two important implications. First, it stipulates free trade among its members. Second, it stipulates a common external tariff towards the rest of the world. It is the latter that differentiates customs unions from free trade agreements, such as the proposed Deep and Comprehensive Free Trade Agreement with the European Union, or the existing free trade agreement with Turkey.
So, should Georgia follow Armenia and join the Customs Union? The answer is a clear no. In fact Georgian policymakers would be well-advised to not even let this appear as if it is a real policy option. Here are five reasons why:
The customs union is in direct conflict with Georgia’s obligations to the World Trade Organization (WTO). Currently, Georgia has an average bound tariff of only 7.4 percent, far below the common external tariff of the Customs Union of Belarus, Kazakhstan, and Russia. As a WTO member, Georgia cannot increase its tariff above the bound tariff rates. Any such tariff increase is likely to lead to complaints by other WTO members.
Georgia’s average applied tariff is just 1.5 percent, even lower than its average bound tariff. Joining the customs will drastically increase import tariffs and thus the price of imports from outside the Customs Union. Given that most of Georgia’s imports are currently not sourced from Belarus, Kazakhstan, or Russia, this implies drastic price increases.
Joining the Customs Union is also incompatible with joining the European Union. It is not even compatible with the proposed Deep and Comprehensive Free Trade Agreement (DCFTA). Georgia cannot have it all. It’s either the DCFTA and the European Union or the Customs Union of Belarus, Kazakhstan and Russia.
Georgia should be afraid of what economists call trade diversion. While trade agreements often create trade by reducing trade barriers, they almost as often also divert trade. In Georgia’s case, increased exports and imports to and from Belarus, Kazakhstan, and Russia likely come at the expense of reduced exports and imports to and from other countries. Think of it this way: instead of importing from Turkey, the European Union or other countries, Georgia will, in many cases, import more expensive (or lower quality) Russian, Kazakh, or Belarussian products for the one and only reason that these imports are cheaper once tariff rates are taken into account. Good for Russian, Kazakh, or Belarussian producers, but likely to be bad for Georgia. Unfortunately, as Kazakhstan’s experience with the Customs Union shows, this is not just a theoretical possibility (see: http://freepolicybriefs.org/2012/11/05/the-eurasian-customs-union-among-russia-belarus-and-kazakhstan-can-it-succeed-where-its-predecessor-failed).
Given that membership to the European Union is incompatible with membership to the Customs Union of Belarus, Kazakhstan and Russia, any serious thought given by politicians and political parties on joining the Eurasian Union introduces uncertainty about Georgia’s future trade policy. Uncertainty Georgia can ill afford as current and future trade policy is an important aspect in many investment decisions. The effect of trade policy uncertainty can be huge. A case in point is Portugal’s accession to the European Union in the 1980s. With the accession eliminating all trade policy uncertainty, this elimination of trade policy uncertainty has estimated to be responsible for more than 80 percent of Portugal’s export growth to the European Union. A large effect indeed.
Michael Fuenfzig is a Tbilisi-based trade economist and an assistant professor in the ISET MA program. A German national, he received his MA in economics from the University of Bonn and his PhD in economics from the University of Pennsylvania.