STUDIES OF ECONOMIES IN TRANSFORMATION Trade in the New Independent States Edited by Constantine Michalopoulos and David G. Tarr 13 4~~~~~~~~~~~~~~~~~~~~~~ THE WORLD BANKJUNDP RECENT STUDIES OF ECONOMIES IN TRANSFORMATION No. 1 Country Department Ill, Europe and Central Asia Region, Food and Agricukurd Policy Reforms in the Fonve- USSR: An Ageda for the Transition No. 2 Michalopoulos and Tarr. Trade-and Payments Arrangements for Srtes of the Former JSSR No. 3 Country Department 111, Europe and Central Asia Region, Statistical Handbook: Staes of the Former USSR No. 4 Barr, Income Transfers and the Social Safety Net in Russia No. 5 Country Department Ill, Europe and Central Asia Region, Foreign Direct Intsimnent in the States of the Former USSR No. 6 Wallich, Fiscal Decenalizarion: Inrgovmemmental Relations in Russia No. 7 Michalopoulos, Trade Issues in the New rndepmient Stazes No. 8 The World Bank, Statistical Handbook 1993: States of the Fonner USSR No. 9 Holt, Transport Strateges for the Rsiasiin Federation No. 10 Fong, The Role of Women in Rebuilding the Russian Ecowomy No. il de Melo and Ofer! Private Semice Fims in a Trstional Economy: Findings of a Survey in St. Petersburg No. 12 Chu and Grais, Macroeconomic Consquences of Energy Supply Shocks in Ukraine STUDIES OF ECONOMIES IN TRANSFORMATION Trade in the New Independent States Edited by Constantine Michalopoulos and David G. Tarr 13 In asaon wih the United Nations Deeopma Prorme The World Bank Washington, D.C. Copyright C 1994 The Intemational Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in thc United States of America First printing December 1994 Papers in the Studies of 'Economies in Transformtion series present the results of policy analysis and research on the states of the former USSR. The papers have been prepared by World Bank staff and consulants and issued by the World Bank's Europe and Central Asia Deparment III. 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Washington, D.C 20433, U-S-A, or from Publications, The World BanLk, 66, ,avenue d'&ena, 75116 Paris, France ISSN: 01 14-997X Library of Congress Catalogig-in-Publication Data Trade in the new independent states I edited by Constantine Michalopoulos and David Tarr. p. cm - (Studies of economies in transformation paper no. 13) Includes bibliographical references. ISBN 0-8213-3077-2 1. Former Soviet republics-Cormmerce-C studies. 2. Former Soviet republcs-Commercial policy-Case studies. L Michalopoulos, Constantine. II. Tarr, David G. m. International Bank for Reconstruction and Development. IV. Series. -H3626.5.T7 1994 382'.0947-dc2O 94-35297 CIP. Contents Forewrd v Prefce vi Contibutrs ir 1. Smrary and Overview of Developments Since Independee I Citaine Mwhalopailos and David G. Tarr Appendix: Foreign Trade Statistics in the FormerSoviet Union 21 Misha Belkindas and Yui Dikanov 2. Rusiai Trade Polcy 29 VladimirKonova-ov Cormment on "Russian Trade Poicy" 52 Daniel Gros Comment on Chapter 2: The Origins of Russian Trade Policy 58 Sergei Gkeiev 3 Ukrame: A Trade and Excha System Stl Seekng Direction 65 Franvoise Le Gall Comment on 'Ukraine: A Trade and Exchange System Stll Seeking Direction" 82 Olkh Hawylyshyn 4. A Frms Eye Viw of ForeignTrade in Ukine 85 Greta Bauf Comment on Chapter 4: Market liberlizaon By Steallhl- Curse or Blessing in Disguise? 106 Daniel KaXm&m iV TRADE IN THE NEW INDEPENDENr STATEs 5. Estonia: A Shining Sbr from the Baltics 115 John Hansen and Pirita Sorsa Comment on Chapter 5: The Political-Economy of Macroeconomic and Foreign Trade Policy in Estonia 133 Ardo H. Hansson 6. Latvia: Trade Issus in Transition 141 Pirit Sorsa 7. Lithuania: Trade Issms in Transi6ton 157 Pirirta Sorsa IL Modova's Foreign Trade and Exdiag Regime 171 Jonathan Waiers 9. Kyrgyz Republic: External Trade for a Suai Country 187 Kathie Knumn 10. Uzbekitm-: Trade Reform in a Cotton Based Economy 199 M-whael Cannoaly and Silvina Vamkk 1L otlutioualPolsfor Export Devdopment 211 John Nash Conment on Chapter 11: Ihe Genesis and Demise of the Intesae Bank Project 229 Danid Gros. . 12 ITrade PerformanceandAccessto OECD Markes 237 Bardomijkwiuik 13. Poliy Reonmendations 255 Consmne AMicuoopoulos and David G. Tarr Name Index 274 Subject Inde 275 Foreword Lt fft yews of the World Bank's exisence, its economic and sectr work has provided the anaytical underpinnings for lending programs ad policy dialogue with boromwer countries. Trade policy is dte one area of reform in developing countries that has benefited greatly from analyses conducted in the con- ext of the Bans economic and sector wor These analyses formed the basis for trade liberalization undetan by devel- oping countries in the 1980s and early 1990s, supported by World Bank sructual and sectoral adjustment lending. Yet, ltle of this worrk has been published or disseminated widely. It is fitting dtat internafional trade issues would also be the focws of economic and sector work conducted by the World Bank in the economies in transition. In these countries trade policy is an integral part of price and enteprise reform and has an important bearing on freig exchange eamings and macro- economic stalhzation. This volume is based on economic and sector studies undtaien by World Bank staff and consultants in the context df trade policy reform supported by World Bank lending if eight new independent countries of the former Soviet Union. This work is augmented by a separate analysis of the issues of trade market access that affect these countries' export prospects in OECD markets. I um pleased that the work is being disseminated through this volume both because the findings are of inherent interest to a wide audience and beause they provide insight into the analytical basis of World Bank support for trade policy reform. Wilfied P. Thalwitz Vice President Europe and Central Asia Preface A:l fifEeen of the new independent states established in the economic space of the former Soviet Union have embadred on econoniic refonns, each at a different pace and on a different scale. All have experienced substantial declines in output and tade. Their heavy economic interdependence, its roots in the centralized state planning system of the Soviet Union, has intensified the linked contraction m output and trade. This vol- ume explores the factors that have contributed to these declines and identifies policies for restoring trade and output and pro- moting fuller integration with the world trading community. Understanding that trade is a crucial component of the eco- nomic transformation of these countries, the World Bank has been engaged in an extensive programn of research apd analysis of international trade and payments as part of its country eco- nomic and sector work- This volume reparts on important ele- ments of that program: eight country studies, work on inprov- ing trade statistics, analysis of the obstes to expanding exports to OECD markets, and several syntheses of these interelated issues prepared by the editors of this volume. The studies have been conducted by Wold Bank staff of the Europe and Central Asia Region in coUlaboration with staff from the Ilternational Economics Deparlment and outside con- sultants. Much of this work is unknown or unavailable outside te World Bank For this volume the principal authors of eali- ViII TRADE IN THE NEW INDEPENDENT STAnS or, comprehensive country economic studies under- addresses the institutional changes that the new taken by the Bank revised and updated their work independent states need to put in place to improve on trade and placed their analysis in the context of their prospects for integrating into the world trading the overall framework of each country's macroeco- community. Chapter 12 addresses the steps OEMD nomic, regulatory and enterprise adjustmenL This countries can take to improve access to world mar- volume collects these studies to facilitate their use kets for the new independent states. The final chap- by a growing community of scholars and policy- ter offers conclusions and recommendations about makers interested in the problems of economic tran- the courses of action governments could pursue to sition in general and trade and payments issues in increase trade and stimulate growth. particular. Bringing together the principal experi- There are six comments in the volume: two on ences in this area, and noting the commonalities and Russia, two on Ukraine, one on Estonia, and one on the differences, should broaden our understanding the Interstate Bank. The comments on the country of which policies have worked wel and which have chapters are based on earlier drafts of the papers noL and improve policymaking in the future. The that were presented at a conference in McLean, studies in this volume were prepared in the spring Virginia on June 15-16, 1994. The country chapters of 1994 and revised in early summer. In general, have since been revised. The comments were writ- they depict the trade and foreign exchange regime ten by authors who, with one exception, are not that prevailed as of end June 1994. Though the affiliated with the World Bank but who h-ave exten- analyses are relatively recent, the fast pace of transi- sive first-hand knowledge of the issues of trade and tion has meant that in some countries the policy payments reform in individual countries (see con- enviromnent has evolved significantly from that tributrs page). Typically, these comments comple- described in the studies. Publication of the volume ment the country studies by elaborating on the polit- is supported by the World Bank-LUNDP Trade ical economy of trade policy decisionmaldng. Expansion Program as well as by the Europe and We atfully acknowledge the help of Michael Central AsiaRegion and the International Economics Michaely and L Alan Winters, who reviewed all Department of thr World Bank. chapters fur the conference. We also thank Morris The first chapter brings togeher the findings of Morkre, staff of the International Monetary Fund for the country studies in an overview of trends in trade their comments at the conference, and Daniel Citrin and payments and examines the different policy for organizing the participation and comments of regimes that evolved in the eight countries and the the IMF. key factors responsible for the collapse of trade. An Many others have assisted in putting this vol- appendix to the chapter describes the statistical mae together. Jeff Hayden performed a variety of methodology for the data used throughout the vol- tasks extremely effectively, including desktop com- ume, Individual country clapters follow on Russia, position, initial design of the cover, production Ukraine, Estonia, Latvia, Lithuania, Moldova, coordination, editorial support and indexing. Misha Kyrghyz Republic, and Uzbecisn These countries Belkndas and his statistical team produced a con- account for more than 90 percent of the trade of ie sistent data set and checked the data in all the chap- former Soviet Union. tcrs. Meta de Coqueeaumont edited the volume and Following the country chapter on Ukraine, greatly improved its preentation. Leonila Oteyza and chapter 4 presents the results of an enterprise survey Minerva Patefna resourcefully coordinated the con- of Ukraine that ll-uminates the implications of trade ference. Minerva Patefla, Maria Luisa de la Puente, and payments policy at the microeconomic level. Jennifer Ngaine, and Shirlene Coward provided Chapter 11, which follows the country presentations, effective secretarial support and word procesing. Contributors Editors Constantine Michalopoulos Constantine Michalopoulos is Senior Advisor in the Russia and Central Asia Departinent of the World Bank and Adjunct Professor of Economics at American University. His previous assignments in the Bank since 1982 include Senior Economic Advisor to the Vice President for Economics and Researh and Director, Economic Policy Analysis and Coordination- Before joining the Bank, he was Chief Economist of USAID. He also taught at Clark University and Trinity College. Mr. Michalopoulos has published extensively on trade and finan- cial policy issues related to development In the last five years, his writings have focused on trade and payments issutes of economies in transition. He holds a Ph.D. in economics from Columbia University. David G. Tarr David G. Tarr is Principal Economist in the International Trade Division of the World Bank. His work on transition economies includes numerousjournal articles and World Bank missions to Estonia, Hungary, Latvia, Lithuania, Poland, Russia, and Ukraine. Prior to joining the Bank, he taught at Ohio State University and was Senior Economist at the US Federal Trade Commission. Mr. Tarr has authored several books and numerous articles in Economesrica, Review of Economic Srudies, Quarterly Joural of Economics, Journ of International Economics, International Economic Review, Review of Economics and Statistics and other journals. He holds a Ph.D. in economics from Brown University. X TRADE IN me NEW INDIPENDENT STA1ES Chapter Authors industrial development and a book on economic project evaluation. He holds a Ph.D. in economics G;reta Bull from the University of Colorado. Greta Bull is Director of the Kiev Regional Office of the Eurasia Foundation. In Ukraine, she has Bartlomiel Kaminaki worked as Director of the Kiev Office of Harvard Bartlomiej Kaminsld is a long-term consultant to University's Project on Economic Reform in the World Bank and Director of the Center for the Ukraine (PERU) and later as an associate at the Study of Post-Cornunist Societies at the University consulting firm Putnam, Hayes and Bartlett, Ltd. of Maryland. He is the author of several books The research for the paper included in this volume including The Collapse of St:4et Socialism was conducted under the auspices of the World (Princeton University Press 1991). For the last Bank's McNamara Fellows program. from three years his research has focused on trade-relat- September 1992 to July 1993. Ms. Bull holds a ed issues of transition economies. He holds a Ph.D. master's degree in public policy from the John F. from the University of Warsaw. Kennedy School of Government at Harvard University. - Vladimir Konovalov Vladimir Konovalov is Principal Economist for Eichaei Connolly Russia in the Russia and Central Asia Departnent Michael Connolly is Visiting Professor of of the World Bank. He joined the Bank in 1986 Economics and Acting Director, Program in and has eXtensive experience in issues of industrial Economic Policy Management at Columbia policy and trade reforn. Prior to joining the Bank University, on leave from the University of Miami. he held senior positions in the Australian Recent work and missions on trade reform in Govemant. Mr. Konovalov graduated from'the Mongolia, Peru, Uruguay, and Uzbekistan led to Australian Natiouial University. the writing of his joint article Silvina Vatnick on trade reform in a cotton-based economy. His recent Kathie L Krumm publications appear in Economica, Oxford Katdie L. Krumm is Principal Economist, Office of Economic Papers, and the Journal of Intermaional the Vice President, Europe and Central Asia Money and Finance. He co-edited The Effects of Region of the World Bank. She led the trade mis- Protectionism on a Small Country: the Case of sion to the Kyrgyz Republic and regulaly reviews Uruguay. Mr. Connoily holds a Ph.D. in econom- the trade and finance work on other countries of ics from the University of Chicago. the former Soviet Union for the Chief Economist. She also has worked in the Southern Africa and John Hansen Country Policy Departments of the Bank. Prior to John Hansen is Senior Economist for Estonia in joining the Bank she had wide experience in inter- the Baltics Operations Division of the World national trade and finance in Latin America, the Bank. In this capacity he has undertaken a number United States, and Africa. Ms. Krumm holds a of studies including one on external trade in the PhD_ in economics from Stanford TJniversity. Baltic States in collaboration with Piritta Sorsa and others. He first joined the World Bank in the Francoise Le Gall Industry and Trade Division and also served as the Francoise Le Gall was Senior Economist for macroeconomic tean leader for a major economic Ukraine at the Wodd Bank in 1992-94. The article mission to Romania when it rejoined the Bank in in this volume is based on her work during this 1990. Prior to his work on Estonia, he worked as a period. She has previously held positions in the macroeconomist in Guatemala, Sudan, and India. Asian and African Dpartmernts of the Intenational In addition to World Bank country studies on each Monetary Fund. She holds a Ph.D. from the of these countries, he has published articles on University of Michigan. CONThBUTORS Xi John Nash Other Contrbutors John Nash is Senior Economist in the Intemnutonal Trade Division of the World Bank and Codirector Misha Belkindas is Statistical Advisor in two of the World Bank/UNDP Trade Expansion departments of the World Bank that deal with the Program. He is currently undertalcdg missions and contries of the former Soviet Union. Prior to join- research on Georgia. He served as Assistant Professor of economnics at Texas A&M University Ping the BEcnk, he was Direeor of the Centrally Planned Economics Service at the WEFA Group. and as Assistant Director and Economic Advisor to - ~~~He has worked in economic forecadng and statis- the Chairman of the US Federal -Trade th Chairman of -be US Federal Trade tical issues, including trde statistics of the forrner Commission before joining the WVorld Bank in 1986. He holds a Ph.D. ineconomicsfromtie Soviet Union and Eastern Europe, for the past fif- 1986. He holds a Ph.D. in economics from the- teen years. He holds a Ph.D. in mathematical eco- University of Chicago. nomics from the Central Economics and Piritta Sorma Mathematics Institute of Moscow. Piritta Sorsa is Senior Economist in the International Trade Division of the World Bank. Yurl Dlkanov Yuri Dikhanov is a consultant in the Office of the She has published artcles on European integration, tradeand he enironent,and te Urguay Dimetor of Russia and Centrl Asia Departonent of trade and the environment, and the Uruguay teWorld Bank. H-is responsibilities include for- Round. She holds a Ph.D. in international econom- ics from the Graduate Institute of International eign trade, national accounts, and price statistics for countries of the former Soviet Union. His pre- Studies in Geneva. vious research includes work in index number the- Silvina Vatnick ory. He holds an M5. in applied mathematics and Silvina Vatnick is Senior Economist in the Russia mathematical economics from the Moscow and Central Asia Department of the World Bank, Institute of Physics and Technology. He is a PhD. with major responsibility on Uzbeldstan. She has candidate at the Institute of Economic Forecasting worked extensively on issues related to economic of the Russian Academy of Sciences. reform in the former Soviet Union since 1992. She has also worked on debt, trade, and capital flows Sgd Glazhv policy issues in Africa and Latin America and has Sergei Glaziev is a meber of the State Dumanof publishe variou articls on macoeconomc stabi the Federal Assembly of the Russian Federation published various articles on macrocconornic stabi-- lization, external debt, and capital flight Ms. and chairman of its Economic Policy Comittee Vatnick is a Ph.D-. candidate at Columbia Between October 1991 and October 1993 he was University. First Deputy Minister and subsequentdy Minister of Russia's Ministry of Foreign Economic Jonathan Walters Relations. He holds a Ph.D, from the Central Jonathan Walters has been Country Economist for Economics and Mathemaics Institute, Moscow. Moldova at the World Bank for the past two years and has led several policy-related missions to the Daniel Gras Daniel Gros is Senior Research Fellow at the country. He has also undertaken similar work in Armenia during that period. Previously he worked Center for European Policy Studies in Brussels and on macroeconomic issues in West Africa and trade Visiting Profrssor at the Johann-Wolfgang Goethe policy analysis in the customs unions of central Universitat Frankfurt am Main. Since July 1992 he Africa and southern Africa. Mr. Walters has an has been Head of the Group of Experts of the M.Sc. in economics from the University of London Ewopean Union's program for Technical Assistance and an MA. in philosophy, politics and economs for the Commonwealth of Independent States fromn Oxford University. -C(ACIS). In that capacity he has advised a number Xii TRADE IN THE NEW INDEPENDENT STAIeS of CIS govemments on intra-CIS trade and pay- Director (Ukamine) at the Intrnational Monetary ment affairs. He holds a Ph.D. in economics frmn Fund. He had previously been Professor of the University of Chicago. Economics at George Washington University before serving as- Deputy Minister of Finance of Ardo Hansson Ukraine. He has written extsively on trade policy Ardo Hansson is a Research Fellow at the issues and recently on Ukrinian reform problems. Stockholm Institute of East European Economics, He holds a Ph.D. from MIT. Economic Advisor to the government of Estonia, and Member of tbe Board of the Bank of Estonia. Danld Kaufmnnn His academic work focuses on the economic trans- Daniel Kaufmann is Chief of the World Bank formation in the Baltic States. His advisory work Mission in Kiev, Ukraine. He has previously been in Estonia has concentrated on monetary reform Principal Economist in the Europe and Central and macroeconomic policy. He hold a Ph.D. in Asia Departmt, a cor team member of the 1991 economics from Harvard University. World Development Report (The Challenge of Development), and Senior Economist in East Olbh Havryiyshyn Africa. He holds a Ph.D. in economics from Oleh Havrylyshyn is an Alternate Executive Harvard University. 1' Suminry and Overview of Developments Since Independence Constantine Michalopoulos and David G. Tarr T he break up of the former Soviet Union left trade in the fifteen new independent states in disaay. Between 1990 and 1993 the combined exports and imports of these countries with the rest of the wodd ("third country" trade) fefl by half, while trade among these counaies ('interstate" tade) declined even more. Though actual declines were less severe than the precip itous drops recorded in official statistics, there is little doubt *Trends in Trade that trade has contracted sharply. This sharp contraction has been caused in part by contractions in output, but the trade * The Trade-Macroeconomy decline has also caused the output decline, and the trade Lir* decline has been exacerbated by inappropriate policies. Thus. trade policy reforms are essential for macroeconomic recovery * Trade with the Rest of the of output in the immediate future as well as for efficient World: The Bias Against resoume allocation and growdt in the longer term. Exports This chapter summarizes the main developments and issues affecting the trade of the fifteen states fron 1992 to the * Conclusions first half of 1994. I begins with the trade data that establish the empirical basis of the subsequent discussion and then explains the interactions between the decline in output and the fall in trade. An exploration of the problems of trade with the rest of the world makes clear that, except in the case of a few coun- tries, mostly the Baltics, third-country trade had been restrained by limitations on exports and by the continued 2 TRADE IN THE NEW INDEPENDEN STAlES domninance of state trading organizations. Formal posed by intemational trade has been sharply dif- import barriers have been, until 1994, low or ferent Differences in initial conditions account for nonexistent, though undervalued exchange rates or some of the disparity, but differences in policies foreign exchange rationing have, in most cases, affecting trade have had the greater impact. shielded domestic producers from competition from imports. Trends in Trade Interstate trade among these countries has - Over the period 1990-93 recorded trade of the been plagued by all the problems of third country new independent states fell by more than 60 per- trade, but with even greater export controls and cenL Trade among these states bore the brunt of the state intervention, prompted in part by severe pay- decline. The lack of consistent and reliable data ments difficulties. Liberalization of energy prices makes estimating changes in the international trade has dealt the energy importes among these coun- of the new independent states more problematic tries a more severe terms of trade shock than that than usual, particularly for interstate trade. The fol- sustained by energy importers when oil prices lowing quantitative anysis is based on the most up- soared in 1973 and has generated a commensurate to-date information available from national and need for adjustmrent and financing. Partly in intemational sources, and its general conclusions response to these problems countries established a are confirmed by evidence from separate enterprise network of massive intergovernmental barter surveys (see chapter 4 and de Mdo and Ofer 1994; agreements that are fundamentally incompatible a detailed discussion of issues related to trade sta- with the evelopment of a market economy. tistics in the former Soviet Union is contained in The fifteen countries emerged in 1992 with the satistical appendix to this chapesr). the common heritage of the centrally planned Exports to the rest of the world fell from $105 economy and trade of the Soviet Union. Their billion in 1990 to $58 bilion in 1993. or46 percent experience in coping with the complex challenges Imports shrank even more, from $121 billion to Table 1.1 Tmde with the Rest of the World, 1990-93 (mrlrons of current U.S. dollias) 1990 1991 1992 1993 Exorts Iports EVorts Imports Exots Impots Expot Inports Amnenia 109 855 70 830 40 95 29 188 Azeaijan 723 1,413 487 1,24B 754 333 351 241 Bearus 3,438 5,256 1,661 1,957 1.061 755 737 777 Estonia 198 592 50 204 242 254 461 618 Georgia 515 1,543 30 480 161 269 222 460 Kazakhstan 1,777 3,250 1,183 2,546 1,489 961 1.529 1.269 KyrgyzRepubric 89 1,298 23 785 77 71 112 '112 Labia 304 1,642 125 478 429 423 460 339 Litwuania 679 1,543 345 475 557 342 696 486 Moldova 405 1,432 180 655 157 170 174 210 Rudsia 80,900 82.900 53,100 45.100 41.600 37,200 43,900 33,100 Taldestar 609 655 424 706 11i 132 263 374 Twiunenistan 195 523 146 618 1.145 543 1.155 749 Ukrine 13,390 15,907 8,500 11,300 6.000 5,500 6.300 4.700 Uzbekstan 1.390 2,217 1.257 2.048 869 929 1.466 1280 Former SoviettJnion 104,721 121,026 67,581 69,431 54,691 47,977 57.857 44,903 Notc The rest of the wodd refers to contries outside dte fonner Soviet Union Source: Nationa official statistics and CIS Goskonstat SUMMARY AND OVERVIEW OP DEVELoPMENTS SINCE INDEPENDENCE 3 $45 billion or 63 percent (table 1.1). Undoubtedly, 1990) at the official exchange rate and then at mar- part of the decline simply reflects the overvaluation ket exchange rates; and at implicit exchange rates of the official exchange rate for the ruble in 1990. that attempt to capture the rates used in interstate Moreover, it is quite likely that the actual decline in transactions, which frequently differed substantial- the volume of this trade was smaller than the ly from both market and official rates. All three recorded one. There is strong evidence of high lev- estimates suffer from shortcomings, (discussed in els of unrecorded 'illegal" exports, underinvoicing the statistical appendix), but despite significant and transshipments to the rest of the world-most- divergence among them, all three point to drastic ly transshipments of Russian goods through the declines in interstate trade of at least 65 percent Baltic states (see chapter 12). But the declines in over three years (table 12). exports were so large that unrecorded flows are There is little information on the composition unlikely to explain most of the drop. It is estimat- and direction of interstate state and how these have ed, for example, that oil exports to the rest of the changed. The information that is available suggests world fell from almost 100 million tons in 1990 to that trade between Russia and most of the other 66 million tons in 1992 before rebounding to 80 states has declined by less (64 percent) than trade million tons in 1993. Even after accounting for among the other states (71.5 percent). Two sets of unrecorded exports-it seems probable that real factors account for this developmenL Frst, Russian exports declined substantially. exports consist primarily of hard to replace energy Russia and Ukraine, the two lrgest countries, and raw material products. Second, although pay- experienced significant drops in ttade with the rest ments problems and financing difficulties have of the world. Russia's recorded exports, for exam- handicapped all interstate trade, these problems pie, fell from an estimated $80.9 billion in 1990 to were especially acute in non-Russian trade among $43.9 billion in 1993, imports frmm $829 billion to these countries. Imports from OECD countnes $33.1 billion. Ukrines exports plunged from an appear to have displaced some intetate trade as estimated $13 billion in 1990 to $6 billion in 1993. well. For example, dte supply of temperate-climate At the same time, though, several other coun- foodstuffs to Russia on credit, combined with sub- tries reported increases in third country exports, sidies for such foodstuffs in the domestic market. notably Estonia, Kyrgyz Republic, Latvia and has reportedly undercut traditional suppliers of Turknenistan. For Turkmenistan the changes prob- these products in the Russian market, such as ably reflect greater accuracy in the reporting of Moldova. energy exports previously attributed to Russia Estimates of total trade (interstate trade and rather than real increases in exports, and for Latvia trade with the rest of the world) using two alterna- and the Kyrgyz Republic reexports from Russia tive estimates for interstate trade clearly show a probably account for much of the increase. For significant decline in total trade, as well as a sharp Estonia, however, the increase seems to reflect the drop in the share of interstate trade that today may deliberate decision starting in 1992 to reorient its be as litte as one third of the total (tables 1.3 and trade toward Europe. 1.4). Some longer term decline in interstate trade Interstate trade declined more than trade with was expected, since previous trade patterns among the rest of the world; but it is difficult to develop these countries had not been based on comparative statistical estimates that accurately capture this cost or locational advantage. On balance, however, decline. This trade has been almost completely and recognizing that the actual drop is less than the denominated in rubles (Soviet and, since mid-1993, recorded one, significant declines in trade volumes Russian), which have been subject to very high are worrisome because they contribute to the dis- inflation. Three altemative estimates of the evolu- ruption of production and falling incomes. The tion of interstate trade were calculated for this contraction of output then can have further multi- study: in constant rubles; in US dollars, first (in plier effects on trade. 4 TRADE IN TH w NEW INDwENT STATES Table 1.2 Trade among the Countries of the Former Soviet Union, 1990-93 1990 1981 1992 1993 Epofts Imports Eipons Imports Eipopls Inorts Expots hwos MIllions 0 1990 RubIes Armenia 3,428 3,59B 1,835 2,407 1,294 B51 554 622 Azeebaljan 6,105 4.247 4,575 3,6B5 Z318 1.716 1,124 863 BeLas 17,224 14,841 12,415 11,152 9,659 8,488 7,349 6,895 Estonia 2,4S8 2.803 1,928 1,603 732 620 414 2B2 Georgia 5,724 4,949 2.723 2,532 662 951 617 835 Kazakhstan 8,443 14,314 7231 9,140 6,928 10.065 4,610 6,609 Kyrgyz Republic 2,445 3,179 2,605 2.248 1,193 1,261 595 709 Latvia 5,028 4.711 3,116 2,377 2,479 1,912 734 596 Lithuania 6,575 6,509 4,741 3,422 Z287 2,432 1,372 969 Moldova 5,853 4,992 2,991 -2962 1,58 1.815 1,373 1,389 Russia 74,710 67,254 58,837 42915 42,464 37,006 27.493 23280 Tldstan 2,377 3,359 1.621 2284 423 735 245 371 Turkmenistan Z469 2,923 Z,614 1,910 2,496 2192 1,425 1,910 Ukfaine 38.319 38.989 27,342 32970 17,722 26.152 10878 18,615 Uzbeldstan 8,169 11,864 6,642 7,371 2.989 3,639 2,874 3,213 Forner Sovet Union 189.337 188.472 141.216 128.978 95.204 99.834 61.657 67.158 MEans of current U.S. dlars at ofia and commlciu echae rates An-rnia 5,810 5,946 3,823 4,686 243 292 124 159 AzOrbaiJLC1 10,347 7.198 9,091 7,013 521 434 629 461 Belarus 29,193 25,154 23,151 203m 1,939 2128 3,092 3.348 Esonia 4,183 4,751 3,836 2,996 147 146 341 328 Georgia 9.702 8,385 5,594 4,806 144 224 295 433 Kazakhstan 14.310 24.261 14,285 1,949 - 2,141 2453 3,126 3,576 KyT9YZ Republic 4,144 5,388 5,163 4,293 236 344 282 378 Latvia B,522 7,985 5,920 4,365 451 472 587 649 Ularia 1,144 11032 9,268 6,251 506 624 929 1,111 Moldova 9,920 8,461 6,190 5.525 244 377 636 743 Russia 1256627 114,041 108,571 83,333 1O,954 9.246 15,752 10,546 Tajlistan 4,029 S5693 3,456 4,361 93 172 -118 198 Tudkenestan 4,185 4,954 6,314 3,684 616 410 1,731 876 Ukraine 64,947 66.083 49,598 61217 5.262 6.425 5,669 9.185 Uzbeldstan 13,846 20.108 13,761 14,100 628 827 2,085 2,225 Fonner Soviet Union 320.910 319.444 268,022 243,954 24,124 24,553 35,396 34.211 Milions of currentU.S dollars at inpfcexchange rates Armenia 3,509 5,477 1,862 3,766 1=335 1 1339 583 999 Azerbian 8,213 7,300 6,167 6,347 3,144 2972 1,555 1,S26 Bebirus 27.660 28.740 19.977 21.640 15.636 16.58 12,144 13,739 Estnia 3,289 5,257 2.574 3,013 983 1.173 568 543 Georgia 5,168 7,608 2.463 3,900 602 1,473 573 1.321 Kazakhstan 13,993 24.810 12.008 15,874 11,574 17:586 7.863 11,788 Kyrgyz Republic 3,250 6,120 3.470 3.628 1,599 2,048 814 1,175 Lahlia 6,516 8,302 4,046 4,197 3,239 3,396 978 1,082 Lithuania 7,213 12,062 5.211 6,365 2,529 4,551 1,548 1,852 Moldova 4,984 8,442 2,552 5.019 1,337 3,093 1203 2,417 Russia 146,183 95,802 115.355 61,227 83,753 53,113 55,355 34,109 Tajikistan 2760 5,375 1.886 3,662 495 1,186 292 611 Turkmenistan 4.603 4,042 4.883 2,646 4,691 3,055 2,734 2,717 Ukraine 60,348 71,841 43.147 60,872 28.133 48,73 17.628 35,294 Uzbelistan 11.327 18,818 9,228 11.715 4.177 5,818 4.100 5.243 Farner Soviet Union 309,016 309,016 234.851 213,869 163,227 165,944 107,942 114,417 Note: Total int3atxpons ofthe fommer Soviet Union may not qual inrs because county data we indepdendy estimated Source: 1990 and 1991. official statistics. 1992 and 1993, Word Bank stiffestinmates. See Appendi en fouign sradestics. SUMMARY AND OVuaVEW oF DEvELopxesm SINCE INm PDHN5 Table 1.3 Total Trade of Countries of the Former Soviet Union, 1990-93 (milions of current U.S. dollars) 1990 1991 1992 1993 EApos Imports Eofts imports Exports Imports Eorts Impwts At!oh andwamMearia!exhane ss Amenia 5.919 6.801 3,893 5.516 283 387 153 347 Azerbaifan 11.070 8.611 9.578 8,261 1t276 766 980 702 Belarus 32,631 30.410 24,812 22,332 3,000 2,583 3,829 4,125 Estonia 4,381 5,343 3,886 3,200 389 400 802 944 Gorgia 10,217 9.931 5.624 5,286 305 493 517 893 Kazakhstan 16,087 Z7,511 15,468 19,495 3.630 3.424 4.655 4,845 Kyrgyz Republic 4;233 6,686 5,186 5,078 313 414 394 490 Labia 8,826 9,627 6.045 4,843 880 B95 1,047 988 LilhuaIia 11,823 12,575 9.613 6,726 1.062 966 1,625 1,597 Moldova 10,325 9,893 6,370 6,181 400 547 81O 953 Russia 207,527 196,941 161,871 128,43S 52,554 46,446 59,652 43.646 Tajlstn 4.63B 6,348 3,880 5,067 204 304 381 571 Turlnenistan 4.380 5,477 6.460 4,302 1,761 953 28S7 1,652 Ukraine 78,337 81,990 58,098 72,517 11,262 I1192S 11,9S9 13,885 Utzbekstan 15,236 2,325 15,018 16,148 1,497 1.756 3,551 3,505 FannerSoviet Union 425,631 440,470 335,503 313,385 78,815 72,560 93253 79,114 At ipct exchange ratss Armenia 3,618 6,332 1.952 4.596 1,375 1.434 613 1,187 AzerWjan 8,936 8,713 6.554 7,595 3,898 3,305 1,906 1,767 Betarus 31,095 33,896 21,638 23,597 16,697 17,323 12,881 14,516 Estaria 3.487 5,849 2,624 3,217 1,225 1,427 1,029 1,161 Ger.gia 5,683 9,151 2,493 4,380 763 1,742 795 1,781 Kazakhstan 15,770 28,060 13,191 18,420 13,063 18.547 9,392 13,057 Kyrgy Republic 3.339 6,418 3.493 4,413 1,675 2.118 926 1,287 Lalva 6,820 9,944 4,171 4,675 3,668 3,819 1.438 1,421 Lithuania 7,892 13,625 5,556 6,840 3,086 4.893 2,244 2,338 Moldova 5,389 9,874 2,732 5,675 1,494 3,264 1.377 2,27 Ruissia 227.083 178,702 168,455 106,327 125,353 90,313 99,255 67,209 Tafikistan 3,369 6,030 2,310 4,368 606 1,318 556 985 Turkmenirn 4.798 4,555 5.029 3,264 5,836 3,598 3,890 3,466 Ukraine 73.738 87,748 51.647 72,172 34,133 54,073 23,928 39,994 Uzbeldstan 12,717 21,035 10.485 13,763 5,046 6.747 5,566 6,523 FonnerSoviet Unon 413,737 430,042 302,432 283,300 217,918 213,920 165,799 159,319 Sour= Tables 1.1 and 1.2 The geographic distribution of trade with the with OECD countries and China has held up fairly rest of the world has also changed substantially well. There seems to have been some reduction of since the breakdown of the USSR The geographic exports of energy and raw mateials to these mar- distnbution of Russia's trade over time, fir exam- kets in order to obtain foreign exchange, while ple, shows ihat the collapse of the trade arrange- imports have been sustained through OECD credits ments of the Council for Mutual Economic for foodstuffs and other products. As a result the Assistance (CMEA) and the shift by East European OECD countries are now the biggest trading part- countries to convertible currency trade at world ners of Russia (see table 1.5) and several other new market prices contributed to the dissolution of tra- independent states. ditional trade links with the Soviet Union (table 15).' Other trade has suffered as well.. Russia's The Trade-Macroeconomy. Link trade with India, for example, has fallen by more Several factors have contributed to the disar- than 50 percent in the last two years. Only trade rAy in trade relations in the new independent states 6 TTRADE W nTE NEW INDEPEr STATES Table 1 A Trade with the Rest of the Worid as Shares in Total Trade, 1990.93 (percent) 1990 1991 1992 1993 Expot bOr Ekpads Imports ExpOts Impos Evarts Impar At Official and commemia exchange rates Arfenia 1.8 12.6 1.8 15.0 14.1 24.6 192 542 Azerbaijan 6.5 16.4 5.1 15.1 59.1 43.4 358 34.3 Belarus 10.5 17.3 67 8.8 35.4 252 192 1838 Estoia 4.5 11.1 1.3 6.4 622 63.5 57.5 65.5 Georgia 5.0 15.5 0.5 9.1 528 54.5 43.0 51.5 Kazakhstan 11.0 11.8 7.6 13.1 41.0 28.1 32.8 262 Kyrgyz Republic 2.1 19A4 0A 155 245 17.0 28.4 22.9 Lahfia 3.4 17.1 2.1 9.9 48.8 472 43.9 34.3 Uthuania 5.7 12.3 3.6 7t1 52. 35.4 42.8 30.4 Moldova 3.9 145 2.8 10.6 39Q1 31-1 215 22.0 Russia 39.0 42.1 32.8 35.1 79.2 80.1 73.6 75.8 Tajlddstan 13.1 1O03 10-9 13.9 54.3 43.5 69.0 6554 Turknenistan 4.5 9.5 2.3 14.4 651) 57D0 40.0 46-1 Ukraine 17.1 19.4 1456 15.6 533 46.1 5Z6 33.9 Uzbekistan 9.1 989 4A 12.7 581 52.9 41.3 36.5 FofrerSoviet Union 24.6 27.5 20.1 222 59.4 66.1 62.0 56.8 AtipIiAtexchnrates Armenia 3.0 13.5 3.6 8.i 2.9 6.6 4.8 15.S Azerbaijan 8.1 162 7.3 16.4 19.3 10.1 1&4 13fi Belarus 11.1 15.5 7.7 83 6.4 4A 57 5.4 Estonia 5.7 10.1 1.9 63 19.8 17.8 44.8 532 Georgia 9.1 16.9 1.2 11.0 21.1 15.4 27.9 25.8 Kazakhstan 11.3 11.6 9.0t 1V.8 1A 52 16.3 93 Kyrgyz Repubric 2.7 2D2 0.7 '7.8 4.6 33 12.1 8.7 Lava 45 16.5 3.0 102 113 11.1 32.0 23.9 LAhuaria 8.6 11.3 62 6.9 18.1 7.0 31.0 20.8 Moldova 7.5 14.5 6.6 11.6 10.5 52 12.7 8.0 Russia 35.6 46.4 31.5 42.4 332 412 442 492 Tapkistan 18.1 1 09 18.4 162 183 10.0 47.4 38.0 Turkmenrstan L4.i 11.5 2.9 189 19.6 151 29. 21.6 Ukraine 182 181 16-5 15.7 17.6 102 263 11.8 Uzbekisan 10.9 10.5 12.0 14.9 172 13.8 263 19.6 Farmer Sovet Union 25.3 28.1 22.3 24.5 25.1 2Z4 34.9 282 Sow= Tabks l.l md 1.2 and the significant decline in output since 1990.2 of the Soviet Union; their location was determined Some problems were inherited problems from the with little regard for comparative or locational Soviet economy and planning system,3 some arc advantage Raw materials allocations within and part of the tmnsition from central planning, and between republics were implemented by Gosnab some arise from the policies countries have intro- and its local subsidiaries at the republic level, while duced to cope with these problems. the foreign trade plan, which determined exports In the Soviet era the central plan (determined and imports, was implemented by state foreign by Gosplan) cstablished mandatory production and trade organizations. The banking system was an delivery targets for enterprises. Trade among instrument of Gosplan and played a passive (basi- republics was domestic trade and, along with for- cally accounting) role in domestic and internantional eign trade, was directed as part of the centralized trade. Enterpnrses were guaranteed paymenL Their allocation of resources. The planning mechanism key concern was the delivery of inputs, which were often called for a few large facilines to supply all essential to their fulfillment of output targets. A SUNWARY AND OVERVeIw OF DEvELoPnirrs SiNcE INDaEPENDci 7 large share of total international trade was directed In addition, the central government's control over to CMEA countries and was conducted on the basis implementation of the plan at the rcpublic level had of massive bilateral barter agreements between diminish&d. In 1991, atransition year intemational govemments, which in effect extended the central trade suffred as a consequence of the USSREs dete- plan mechanism outside the Soviet Union. norating capacity to supply exporrables such as oil, Domestic prices were controlled and did not while the demise of the CMEA contributed to the reflect relative scarcities- A system of trade taxes decline of that portion of trade that could not effi- and subsidies-die so-called price equalization cieanly compete with imporLs from the West system-isolated domestic prices from world mar- (Michalopoulos and Tarr 1992) Rcpublican author- ket prices. The exchange rate of the ruble was fixed ities began to challenge Moscow openly over a and reflected a significant overvaluation. The price range of economic policies: They began to with- stuc that resulted involved large net subsidies hold taxes, to restmin exports to other republics, by energy and raw mateiial exporters Within the and, in the case of the Baltics, to initiate market ori- USSR enegy-exporting republics subsidized ener- ented economic reforms, including the liberaliza- gy importers (Tawr 1994), while the USSR as a tion of prices. whole tended to subsidize the rest of the CMEA Once the USSR broke up, the centalized bllo- (Marrese and Vanous 1983; Oblath and Tarr 1992). cation of resources by Gosplan and Gosnab ended, This system came under increasing strain in but new market-based mechanisms for allocating the late 1980s as enterprises were given dramati- resources were slow to emerge in most countries. cally increased autonomy, most notably the right to With production highly concentrated as it was in pay higher wages Economic decisionmaking was many industries, the failure to receive needed being decentralized before enterprises had been inputs from suppliers in the other new countries led privauized or had developed an effective corporate to output declines in downstream industries whose governance structure- Managers, increasingly failure to deliver inputs to enterprses in the next under the influence of labor, were paying higher stage of production often affected production levels wages and bartering enterprise output for consumer in yet another new independent state. These prob- goods4 lems were exacerbated by payments issues ta This diversion of enterprise output led to prob- arose immediately after independence (see below). lems with plan fulfillment and to declining output.5 Traditional exports to the rest of the world Of course, with less output there was less to trade- were concentrated in the raw material and natural Table 15 Geographic Distribution of Russia's Trade Outside the Former Soviet Union, 1990-93 (millions of U.S. dollars) 1990 1991 19S2 1993 Percentage Percenage - Percenrage Permentge Amount share Amount share Amount share Ant sham EXPORTS 80,900 100.0 53.100 100.0 41,600 100.0 43,900 100.0 OECD 30,282 37.4 37.195 70.0 25.376 61.0 26,607 60.6 Former CMEA ecoutues 34,818 43.0 12Z162 22.9 8,320 20.0 7,680 17.5 Rest of the wodd 1J600 19.S5 3,742 7.0 7,904 19.0 9,613 21.9 IMIPORTS 8S900 100.0 45,100 100.0 37,200 100.0 33.100 100.0 OECD 32,401 39.1 30,906 68.5 22.947 6117 18.310 55.3 FornerCMEAcountries 34,757 41.9 11,071 24.5 5,390 14.5 3,771 11.4 Restofthewoidd 15,743 19.0 3,123 6.9 8,862 23.8 11.019 333 Soure= Goskomsa of Russian Fcdeaion and tabks 1.1 and 1.2 8 TRADE IN THENEW INENDEWr STArTs resource goods that were more easily marketed in hansformation. The paths counties took in pursuit the West than industrial products. Some countries of such reforms diverged, and so did their overal had a greater capacity to cxport these goods than economic performance and patterns of trade. otes. For example Kazakhstan and Turkmenistan started off with significantly geater capabiies to Trade with the Rest of the Wodd: The Bias export energy and raw materials than, for example, Against Exports Belarus or Ukraine. But following independence, The new independent countics were quick to supply problems linked to the availaility of parts take control of commercial relationships for their and equipment constrained exports of several of major exportables and to esLablish their own lins these products. particularly oiL with correspondent banks in major financial cen- Despite very favorable exchange rates, nontra- tms The most stnlcing feature of trade policy in all ditional exports wme handicapped by the past ori- countries following independence was the presence entation of production toward sheltered markets, of extensive export controls to -keep goods at which, especially in the machinery sector, had sti- home" and the absence of explicit import restraints fled product innovation and resulted in low quality to protect domestic producers. Most countcies had products These products (cnown as "soft" goods) no import licenses or quotas, and import tariffs were very difficult to market in OECD markets, a were low. Export restraints, by contrast, were problem exacerbated by enterprises' lack of mar- numemus and emensive, including export licenses keting expertise and knowledge of customers' and quotas, export taxes limited licensing of information residing almos exclusively in the for- authorized exportrs, monopsony purchase on the eigp trade organizations in Moscow. domestic market of exportables by stat trading Meanwhile, the connued reliance on state organizations, and surrender of foreign exchange a tding inhibited the development of the infrastuc- below markct exchange rates. ture needed to conduct trade in a market economy. The consequences of export controls and The available methods of payments did not protect import protection are similar distorted resource traders from the risks of nonpayment by buyers or allocation and reduced efficiency (relative to an nonperfonnance by suppliers The legal and the open trading regime). Import protection explicitly administrative framework for enforcing trade-relat- taxes imports and implicily taxes exports; keeping ed financial and shipping contracts was inadequate, goods at home explicitly restains exports and and modem mechanisms of payment such as letters implicidy taxes imports. of credit were unavailable- Preshipment finance was unavailable because commercial banks avoid Export Policy extending loans except for very short maturities in Though startng from the same position, coun- periods of high inflation and uncertainty tries soon developed quite different export policies Postshipment finance was unavailable because (the trade regimes of the eight countries in this financially viable buyers pay in advance and study arnd mid-1994 are sumnarized in table 1.6). financing supplies to indebted clients is considered At the one extreme were the Balkics, most too risky. Finally, most countries had no capacity in notably Estonia, which substantially reduced export areas of quality control. standards, and marketing restraints and the role of N;;te trading organizations arrangements (see chapter 11). in intemational trade. By the beginning of 1994, In sum, the brcakup of central planning creat- with few exceptions, very litle of thcir exports to ed a shock that revubeated across the ffteen new the rest of the world were restained or flowed independent staes. The need was clear for major through state trading organizations. As early as the institutional and policy reforms to meet the many end of 1992, these countries had introduced new challenges of conducting internadonal trade while currencies, begun to stablize eir economies, and, undergoing fundamental economic and political in the case of Estonia, established a liberal regime SuMMAiY tyAtD OvERvmw oF Dsvnaors SiNcE INDEhvmElNC 9 for export and imprts. Specal interests were is desirable. So even though central planning had beginning to call for protection in 1994, as the new ceased, Russian ministries continued to perform currencies strengthened, but these protectionist 'niaterial balance" calculations through 1993 (rem- pressures wcre for the most part resited. iniscent of the planning process) to determine the At the other cxlme, in countries like residual above domestic "needsW that could be Georgia, Turkhenistan, Ukraine, and Uzbekism, exported export resaits were common and state organiza- With few exceptions export controls have been tions continued to control the bulk of foreign trade, administered in a nontransparent fashion, with especially key export As of mid-1994, these numerous ad hoc exceptions and frequent changes countries had not yet undertaken stabilization of direction. Thus the controls have intmduced efforts. uncertainties and reduced incentives to trade dis- In between were countries like the Kyrgyz couraging both traditional exports and the emer- Republic, Moldova, and Russia that have made gence of new exportables- The controls have also only intermittent stabilization efforts and have prompted significantlevels of unrecorded "illegal" retained a Sgnificant but declining role for the state exports and tanessbipments of raw materials and oil in the control of key conmnodity exports to the rest and led to substantial capital flight through the of the wodd, while iberaliming other trade policies. undeinvoicing of exports and overinvoicing of Countries that restrained exports did so for imports. As a consequence, exports taxation has various reasons. Export taxes produced govern- not geneated as much revenue as anticipated and ment revenue and offset the undervaluation of the cxport licensing has created strong incentives for currecy. Many governments resained exports to rent-seekingactvitiesandcorruption. TheBaltics, slow the adjustment to wodd market prices. whichle exports early and more thorough-. Certain "critical" imports, usually industrial and ly than the other counuties, seem to have had the agricultural inpus, foodstuffs, and pharnaceuti- best perfonnance so f5r. cals, were sold domestically at below world market Though export restraints have been progres- prices. In a system similar to the old price-equal- sively reduced since 1992, significant export con- ization scheme, state trading organizations would trols remained in foce in mid-1994 in countries pay domestic producers prices significantly below such as Moldova, Kazakhstan, and Russia and those prevailing in international markets and use dominated trade in Ukraine, Uzbekistan (see later the proceeds of the export sales to subsidize these chapters), Geogia, and Tajikisan Because the tar- importsfi It is estimated that at their peak in 1992, iff equivalents of the export restraints have been import subsidies in Russia amounted to 25 percent very higb, the costs of failing to adjust output and of GDP (see chapter 2); though by the spring of sales toward export markets in accordance with 1994 the subsidies had been almost completely comparative advantage have also been high? A eliminated. Other countries, such as Uzbekistan, preliminary estimate by Gros (see comment to seem to have retained such subsidies even into chapter 2) places the static costs of Russia's expon 1994. restraints in 1993 at roughly 20 to 25 percent of Finally, export controls are perhaps the last Russia's GDP-the dynamic costs would be even instrument of control for the line ministries that greater- oversee enterprises (see Glaziev's comment on Chapter 2). Control-oriented ministries use export Import Policies restraints to induce raw material producers to dcliv- Before 1994 most new states had imposed few er inputs to favored enterprises, thereby maintain- fornal import restrints. Instead, domestic goods ing some influence over enterprises. In this con- competing with imports received very high prolec- strained domestic supply framework, cxports are lion through undervalued exchange rates (see table viewed with suspicion and keeping goods at home 1.7 for a summary of the average monthly wage Table 1.6 Summary of Trade Regimes In Eight Countries of the Former Soviet Unlon, Mld 1994 Export restraints Import reatraints Counthy Taxes Licenses & quotasa laitfs Quotas & licenses State trading Foreign exchange Estonia Taxes for cultural items Tobacco, alcohol, some 0.5% for statistical pur- None None Convertible current only; 0.5% on other agriculture and forest poses account with a currency Items products, metals, broad- board mechanism sinco cast equipment, oll June 1992; no surrender shale, petroleum, and requirement since early I mineral all, 1994; virtual capital H account convertibility - Kyrgyz Subject to taxes at Llmiled number of Duties eliminated except None Extensive state procure. Floating exchange rate 30% maximum rate on goods as of June 1994 for 10% surcharge on ment at Interbank auctions, 10 goods (with one non-FSU Imports but payments problems exception) on interslate trade remain Lalvla Subject to export taxes None Average tariff of 10%; No licenses but specific None Convertble with wide of 1 to 100% on 383 low rates on Inputs duties on 130 products access to foreign tariff lines (at the six. (at six dlgit HS) exchange through corn- digit harmonized sys- mercial bureaus; no sur- tem, HS, level), with render requirement 90%o of them below 10%. Covers mostly agricultural products and metals and raw materials such as sands, wood, and leather Llttiuania Export taxes on less None except for tempo- Unwelghted average of About 10 products Abolished Convellble since 1992; than 16 products at 4.5 rary bans on red clover 3.2%, with a 0 to 30% currency board since digit level, ranging from seed, untreated oak, range; 76% have a zero April 1994; no surrender 0-50%, with 90% of and ash timber, tariff; Inputs have tow requirements them below 10% rates Moldova None Exports of cereals, 0 to 300%, most below None Continues for slate Convertible for current leather, and energy 30%; Inputs have low barter agreements wilh account transactions; products are banned rates; private barter sub- CIS states; extensive surrender requirement ject to 30% surcharge state procurement used to Interbank market Russla Specific laxes on ener- Uuotas on oll and oll 12°/ average tariff None Applies to both CIS and Convertible; access gy, natural resources, producis; limited Ilst of weighted by Imports; 0 third countries; state through interbank auc- and some Intermedi- companies authorized to 1t100% range; high tar- procurement used tions and commercial aries; selective exemp. export energy and raw iffs on arms, elecironics exchanges; no surren- tions materials an own and oleotrioal appil- der requirement account and on behalf ances, motor vehicles, of smaller exporters food, pipes, and machine tools; wide- spread exemptions, often by enterprise Ukralne None Most Important exporta- 0 to 50%, with most 0 to None Extensive use of state Poor access to foreign (June 1994) bles (104 gods) IO%10%; luxury goods sub- orders exchange markets; 50% 1eot to 60 to 350%; zero surrender requirement rate for noncompeting at nonmarket fates Imports (Russian ruble also sub- Nct to surrender requirements) Uzbekistan 10 to 50% on a wide Most important export None Rationed acces to for- Extensive use of state Very llmited access to range of consumer Items are licensed; state eign exchange for orders foreign exchange; 30% goods and many inter- controls result In a large, Imports surrender requirment at medlato goods Impllict tax on key official rate overvalued exports, especially cot- by 80% ton Ifi. a. Licenses for healih and safety are Ignored. Source: Summaries of country studies below and Interviews of World Bank economists. 12 TlRDE IN miH mNW I.msPENDErB STAWS converted at market exchange rates for the countries month in 1992, and only slightly higher in many of this study)-in part a consequence of the export countries in 1994 (see table 1.7). If the convertible restraints. Thus, in most sectors competition from currency earnings foregone as a result of restrain- abroad remained feeble. For example, a survey of ing exports to convertible currency areas had been 92 newly privatized firms (average size 1,518 available, the market price of foreign exchange workers) in two Russian oblasts in October 1993 would have risen and made imports less expensive. revealed almost no import competition.8 In addition, import subsidy programs siphoned Several factors influenced the exchange rate. off scarce foreign exchange for favored imports, First, financial demand for foreign exchange was that would not seriously threaten domestic suppli- very strong in almost all countries through most of ers.9 The large subsidies provided for industrial and 1993, which along with significant capital flight, agricultural inputs contributed to the delay in domes- depreciated the value of domestic currencies. tic adjustment and the restructuring of enterprises. Because of largc fiscal deficits, high rates of In some countries, including Ukraine, the gov- domestic inflation, and negative real interest rates, emment appropriated a significant share of the for- residents seeking a store of value other than eign exchange eamings, eitherthrough direct state domestic currenies-and unable to rely on domes- trading or through compulsory sales of foreign tic assets because of unclear property rights- exchange by exporters. The central allocation of chose to buy foreign exchange as an asset that foreign exchange is itself a nontariff barrier to would hold value, imports, because the rationing authorities typically Second, export restraints, by reducing the sup- protect import-competing industries through their ply of foreign exchange, also impaired the ability allocation - decisions and because less foreign to import. The cost of importing was extemely exchange is available forthe market further driving high as evidenced by real wages of only $10-$20 a up the exchange rate. As a consequence, the avail- Table 1.T Average Monthly Wage In U.S. Dollars, 1992-94 d 1992 1993 JL to Jun. Jtu. to fea Jan. to Jun. J,. to Decr 194g RUsSia 21 33 37 79 94 Ukraine 18 21 12 16 21 Moldova 12 17 13 20 21 Belarus 24 33 24 22 25 Kyrgyz 7 11 13e 18 20 Uzbeldstan job lDb 31 b 31 - Latvia 29c 29c 64 89 112 Lithuania 14 b 14 b 30 57 81 Estonia 12 d so 77 86 - a. Average monthly wage in domestic cuentries divided by market exchange nzes of domestic cuTrncy per US. dollar. b. Average forthe year in question. c. Avcge monthly wage forall of 1992, stae sector only. d. Janury 1992. e. An exchange rate fornibles to dollass was used priorto Apnl 1993; som to dolla ratewas used afterApril 1993. r. Averge monthly wage fordthe dind quarter (July-Sepiember) of 1993. g Data for 1994= averages of nonths as folows: Russia. Janury to May; Ukraine, January to Marh; Moldova, Jauary to April; Kyrgyz. May. Lia and Lithuania. January to Febray. Source: ForLithannia in 199Z, see LithuwL The Transitien m a Marker Econnty ' Wodd Bank (1993). For Estonia in early 1992, see Michalopoulos and Tarr(1992). Oerwise, inl World Bank Country Depamnt databases. SUMMARY AND OvERviEw oP Deveaowrm SINCE INDEPENDeNCH 13 ability of foreign exchange has been limited to ply side problems, these countries may find that exporting enterprises and to those thaL could get problems of market access seriously constrain their access Lhrough the often very h,n foreign exchange future export expansion.1l markets. Since neither import subsidies nor for- Following independence the new states faced eign exchange allocations were generally provided the external barriers that had been applied to the for goods that competed with domestic production, former Soviet Union. Barriers in the OECD coun- the programs reduced the amount of foreign tries were high and discriminatory eilher for politi- exchange available for competitive imports, or, in cal reasons or to counter the state trading practices market-determined environments, drove up the of the Soviet regime. Moreover, since these new price of foreign exchange. countries, like the Soviet Union before them, are Thus, regardless of the motivating philoso- not members of the GA, they are subject to indi- pl.y-traditional protectionism or the legacy of the vidual rules decided by each importing country. planning mentality restraining exports to keep Though the average OECD tariffs facing the goods at home-there is an equivalency: the trad- new independent states were only about 5 to 7 per- ables sector is taxed. Many of the new independent cent (see chapter 12), the tariff preferences the states continue to provide extensive protection to OECD countries extended to developing countries import-competing industries and to export and and to each other constituted a serious competitive import considerably less than they would have in disadvantage to exports from the former Soviet the absence of the restraints.l1 And most countries Union. The margin on individual items especially that have employed export controls further retard- manufactures and processed food, which account ed adjustment by providing additional support to for about 20 percent of total exports of the former enterprises in the form of explicit subsidies and Soviet Union, can be quite high. For examnple, ethyl directed bank credits at highly negative real inter- alcohol exports to the European Union ( EU) faced est rates. a tariff (73.8 percent) that was more than 30 per- This picture started to change in 1993. More centage points higher than the average duty for foreign exchange was becoming available through ethyl alcohol. There is considerable tariff escalation foreign exchange markets in Russia and elsewhere, as well, with effective tariffs ranging up to eight as markets were strengthened and new currencies times nominal tariffs for such items as vegetable were introduced. The appreciation of currencies in oils. real terms prodded more domestic enterprises to Nontariff barriers have also been an important seek protection from international competition. impediment to trade, especially in agriculture, Several countries including Latvia, Lithuania, and food products, leather, textiles, and ferrous metals Russia, responded to such pressures with new tariff (chapter 12). Antidumping actions have been a regimes in early 1994 or with plans for new higher particular problem for several countries. The new tariffs. independent states "inherited" antidumping actions started against the Soviet Union and were MaretAccess subject to many new ones in 1992 and 1993. Though the supply side problems outlined Belarus, Georgia, Kazakhstan, Russia, Tajikistan, above bear most of the responsibility for the decline and Ukraine have all been the object of some sort in trade in the last few years, it is also the case that of antidumping action on a variety of products most of these countries face potentially significant from aluminum to ferro-silicon and uraniumL The tariff and nontariff barriers in OECD markets. BU has alleged that since transport and energy Energy and raw materials, which account for a sig- prices are below world market levels. some see- nificant portion of total exports, encounter few tors are artificially competitive. problems of market access; but barriers on other And because the exports of these countries products are formidable. As they address their sup- tend to be relatively concentrated-for most of 14 TRADE INd TE NEW INDEPDENTEJ STATES them their top ten exports (at the tire? digit trade dependence on trade with the other republics in classification level) account for xrtore than three- 1990; for the others such trade ainounecd to more quarters of total exports-prolection of any of than go percent of the total. these industries in OECD markets can have a large The precipitous decline in interstate trade impact For examnple, Ukraine's concentration on between 1990 and 1993 was in part caEed by the steel exports means that fully 44 percent of its output declinr that reduced demand for all imports. manufacture exports to OECD markets face non- But because of the extensive interlinkages in pro- tariff baTriers or significant tariff discrimination. duction, the trade decline also worsened the output In the course of 1992, most OECD countries decline. started to grant most-favored-nation tretment and The introduction of market forces could also eligibility for the Generalized System of be expected to lead to so-me decline in the trade Preferences (GSP) to countries of the former. among these countries. Brada (1992) argues that Soviet Union, beginning with the Batics (chapter for the purpose, of analyzing trade flows, the former 12). All but four new independent states have Soviet Union can be viewed as similar to the applied and been granted observer status at the (NBA, except that a supranational power planned GAWr though none is yet a member. There is little both trade flows and the pattern of investment and evidence, however, that these steps significantly re- specialization. But the central planners' invest- duced trade barriers to these countries. GSP pro- ment preferences reflected comparative advantage grams -exclude many of fth major manufactures only in a very limited way either among the States exports of these countries.. MVoreover, nonttariff bar- or agains the rest of the world. Thus, several stud- riers seem to have increased rather tha decreased, ies have estimated that although the total external as evidenced by the growing numnber of antidump- trade of the CMEA countries was not excessive, ing actions. These remainng barriers, together with the intra-CMEA share of that trade clearly was 12- the prefernces extended to other countries, the and that share will decline substntialy when lack of membership in GAiTT and continued trat- placed on an equal footing .with other trade ment as "state trading" countries, mean that the (Biessen 1991; Brada and Mendez 1985; new independent states face perhaps the most Havrylyshyn and Pritchett 1991; Winters and Wang severe obstacles to market access of any other (1993) and Collins and Rodrik 1991). In particular; group of countries in the world today. The Raldces the collapsedo sales of machinery and related sec- are an exception: they have concluded a series of tors in Eastern Europe and fth former Soviet Union agreements with Finland, Norway, Sweden, and suggests that these sectors lack comparative advan- Switzerland providing for free trade treatmnent for tage. It is thus likely that a-large part of trade in Baltic products (except agriculture), and they have manufactures among the fifteen states was based concluded association agrements with the, EU. on dude diversion and, therefore, that the introduc- tion of market forces had some impa.ct in reducing Interstate Trade uneconomic trade.. At independence the pattern of trade among It does not appear; however; that the bulk of the the fifteen countries of the former Soviet Union' decline involved Such uneconomic trade. Rather,' was unusual by the standards of market economies five- othe factors seem to have had a greate impact in two notable resjrtcts: trade was highly concen- ' Payments problems, with econommc agents trated, with some, goods produced by a single or either unwilling or unable to use the banking very few producers, and trade amnong the countries system. to pay for goods and services from of the former Soviet Union absorbed an unusualy other countries. This problem was especially high proportion of total trade, even when cmared severe in 1992 duringthe period of the common with other regional trading blocs (see table 1.8). At ruble zone, but it continued after the introduc- 61 percent of total trade, Russia had the lowest tion of new-often inconvertible-murrenicics. SUMMARY AND OVfiVIEW OF DEvaonm3m SwimC INDEr'EIDENcB 15 Table 1.8 Total and Intmregional Foreign Trade * Export restraints at least as severe as those as a Percentage of GNP for Soviet Republics, that impede trade with third countries. Eastem Europe, and the EU *_ Pervasive state trading and monopsony pur- FOwgn trade a chases of exportables in many countries Shm of which prevented a market-based deterniina- -otal irif in re Va nal ltion of international trade while failing for a USSR (1990) variety of reasons to reestablish wade links. federaton l* An acatic framework of regiona trade pref- Ukrains 29.0 23.8 821 erences and discrimination. BelrLw 47.3 41.0 85.8 Uzbekistan 28.5 25.5 89.A Knzakhstan 23.5 20.8 88.7 Payments Problems Georgia 28.9 24.8 8S.9 Payments problems may well have been the Azerbarian 33.9 29.8 87.7 most serious impediment to interstate trade. The Uthuania 45.5 40.9 89.7 Moldova 330 28.9 872 dissolution of the Soviet Union brought with it the Labia 41A 367 88.6 dissolution of unified banking (under Gosbank) Republic 32.3 27. 85.7 and monetary systems. Fifteen independent central Tadjildstan 35.9 31.0 8635 banks quicidy emerged and exporters no longer Armnia 28.4 25.6 90 1 had the Gosbanic guarantee for interstate payments. Turknenistan 35.6 33.0 92.5 Estoia 32.9 30.2 916 More problematic, thE existence of fifteen indepen- dent central banks, in a common ruble zone gave Eastmr Eurone (CMEA) (19r8) Bigaria 30.1 5&1 3 4 nse to a severe free-rider problem in money cre- Czeoswovakia 23.0 10.9 472 ation and trade deficits. During the first six months Hungar 34.1 13.7 40.3 of 1992, Russia alone coduld crea cash rub[es, but Poland 19.6 8A 43.1 Romanua 17.6 3.7 21 the cental banks of all fifteen states could expand the aggregate money supply by creating credit in Belgum 742 44.5 rubles. In the absence of monetary coordination Derunadk 3Z7 13.7 41.7 among the cental banks, monetary restraint by one GoTnnany 29.8 14A 482 central bank could be exploited by othes Greece 26.8 133 49.A Spain 19.8 9.0 46.3 In addition to limiting the ability to control France 23.3 13. 55.6 inflation, this arrangement created problems in Ileky 59A 38.7 64.5 interstate trade. Although enterprises would be Netherards 5*A 342 62.g indifferent between selling domestically and Portugal 42.1 24.6 SBA exporting anywhere in the ruble zone for the same United Kngdom 26.0 10.7 412 price (risk adjusted) in rubles, the governments saw a. Total trade is measured as the averagc of ecpors and no value in exporting in the ruble zone. All they impors as percentage of GNP. inhtragion; trade refers to tde wid the USSP. th CMEA orte EU. gad for the exports were ruble cedits m their banking system, nmnething their central banks Source: USSR: Goskomstat for trade data in foreign trd could cr-_,; independently and they had too much prices, and unpublished World Bank estimates for GNP. Easter Europe: UNECE (1990) for trade data, and World of in any case. Govements, induding the Baltics, Bank Atlas for GNP. EU: PianiFeny and Sapir(1992). quicidy responded by imposing export licensing requirements on interstate trade. These export licenses were in place by January-February 1992, Massive terms of trade shifts against and major problems rapidly ensued in raw material importers of energy and raw materials, which supplies. have induced these countries to severely com- A network of correspondent accounts was press their imports. established in early 1992 among the central banks 16 TRADE IN THE NMW INDEPENDENT STA1ES of the fifteen states, and all payments orders were could not be used in trade. Denominating cleared through these accounts. But the system trade in rubles, however, was a problem became clogged: it took up to two to three months because of the ruble's instability, 13 and use to clear an interstate payments order. In an infla- of correspondent accounts was further con- tionary environment, the long delays implied huge strained by the general weaknesses of the costs for traders autempting to use the banking sys- commercial banking systenL temr. The payments situation deteriorated even fur- * Many of these countries were facing a seri- ther after July 1992. With rising relative prices for ous foreign exchange shortage and so were energy products, Russia's main export, Russia unwilling to use foreign exchange for the began to accumulate large surpluses on its bilateral denomination or setdement of interstate trade trade balances with most of the former republics. transactions. As a result barter continued to To avoid unlimited financing of its trade surpluses be the favored instrument of trade among while the free-rider problem continued and to stem most of the new states. the outflow of goods, Russia imposed credit limits on the centcal bank correspondent accounts in July Pnice Adjustnent and the Terms of Trade 1992 When a country exceeded its limit, the In al the new states price controls or export Central Bank of Russia could refuse to clear the sraints inially kept the domestic prices ofmany payments orders (the equivalent of checks) of products below world market levels. For example, enterprises in the debtor country Tbat mean t that even. after some price. lberization, world oil Russian exporters would not be paid for the goods prices in early-1992 were tbirty-two times greater they shipped to chat country, even if the importer than domestic prices in Russia (Michalopoulos and had funds in its commecial bank to cover the pay- TaT 1992, 17). Govermments also tried to control ments order. the prices of certain "essential" goods, which In effect, the system disfingtdished the different included some foodstuffs as well as important raw national rubles from those used by Russia and rein- mateias The rationale for the price control was to tmduced the incentive by non-Russian states to ease the adjustment of entcrprises and consumers export to Russia. But the system was still plagued to world prices. Since price controls were not the by huge uncerainties and long delays (about three same across all countries, restraints were placed on months) in a highly inflationary environment. By exports to prevent price-controlled commodities late 1993 all countries except Tajikstan had intro- from being exported to markets with higher prices, duced their own currencies, which eliminated the including other ruble zone countries. free-rider problem. Countries no longer had to fear But most prices in intemational and interstate tat direct trade between enterprises facilitated trade were lberalized. As a consequence, there thmugh the commercial banking system would were sgnificant adjustments in terms of trade, result in trade surpluses that had no value. As a especially between exporters and importers of result, Jhe requirement by the Central Bank of eneWr and raw materials. Estimates show that Russia for clearing through the central bank coffe- moving to world prices in interstate trade would spondent accounts was dropped, and a growing have implied a severe deterioration in the terms of network of correspondent accounts among- com- trade for energy and raw materi importing coun- mercial banks spread through some countries, tries like Moldova and the Baltics, with losses (Russia and Ukraine) providing reasonably fast ranging as high as 10 to 15 percent of GDP, while turnaround on payments. But while this network raw materii and energy exporters, such as Russia was facilitating some trade in 1993 and early L994, and Turkmenistan, would stand to gain (Tarr a host of new issues had emnerged- 1994).14 A terms of trade loss of this magnitude is The new currencies, with few exceptions substantially larger than that suffered by oil (again the Baltics), were not convertible and importers after the oil price shock of 1973. SUMARY ANo OvERviEw oF DEvELoPMENS SICE INPENDENcE 17 Energy importers attempted to mitigat the Tabia 1.9 Terms of Trade for IntersWte Trade problem thmugh special arfangements with export- among the Countries of the Former Soviet ing countries to supply oil and offier raw mateials -19919 at less than world prices (discussed below). Some countries (Belarus) managed to work out such World market arrangements during a transition period, but others 198 1992 1993 p:es (199- (the Balties) could not Russia has repeatedly indi- Armenia 107.2 85.0 75.1 68.3 cared that it was moving to world prices for all its Azetbajat 105.3 94.8 97.9 73.9 energy exports and has progressively moved in that Selaens 103 2 87.7 83.4 80.1 Estonia 107.5 87.7 83.0 652 direction. As of mid-1994 energy prices in the (eorgia 105-9 75.4 72.9 552 bilateral agreements were differentiated across Kazah 95.1 98.1 97.0 98.5 countries. Some agreements that included energy Ky1g.yz PespubE 104D0 87Z el15 8J.3 subsidies called for compensatory subsidies of Lahk 104.1 873 81A 75.7 Russis raw material imports (Uzbekisan); others Lihuania 105.1 80.7 742 652 (Belarus) apparently did not Moldova 101 65.4 65.0 46.6 Russia 97.4 113.6 120.1 137.6 Energy-importing countries sucth as ATmenia, a 1103 85. 7s5 753 Moldova, Lithuania, and Tajikistan, are estimated Turns 109.9 12t9 15EO 1347 to have experienced enormous declines in their Uke 96.0 94.1 8u8 862 interstate terms of trade of 25 to 3.5 percent from Uzbldstan 109.3 94.5 91.6 91.0 1991 to 1993 (table 1.9). RLussia and Tuknenistan Sow rr 1991-93. se App.idixf (r1990 seeTar (1994) were the obvin as gainers with improvements of 20 percent and 50 percent on their interste trade By abandon most of the machinery of the planned- 1993 the bulk of the movement to relative world economy. The others reestablished what they knew prices in interstate trade seems to have been best a network of massive intergovernmental accomplished, as indicated by a compaison with barter agreements analogous to the system of state projections of the terns of trade adjusment impli- trading under CMEA countries, with goods to be cations of moving eniely to world prices (at con- distributed through state ministries of material stant quantities based on 1990 prices) based on the resources, the successor to Gosnah.15 The agree- Tar (1994) estimates (table 1.9). ments were frequently implemented through Many countres bave not made the necessary national systems of state orders and controls of domestic adjustment to these price changes. Even interstat trade shipments. where substantial progress has been made (as in the Govenments saw these agreements as the Kyrgyz Republic) high energy import pnces mean answer to sevcra problems: the problem of con- that countries either have to sell largerquantitirs of trolling exports for key inputs, the problems with their exports or find other means of financing the payments and banking systems, and the terms of imports. They are finding it difficult to do either. tade problem (by permitting barter exchanges of Incomes are still faling and it is difficult to obtain products at prices beneficial to importers). Perhaps enough external financing for oil inports- As a most importt, these ageements gave policymak- consequence countries are running up rars in ers a sense of control over what appeared a chaotic interstate trade, inducing their trading partners to situation. Under the agreements, trade was divided, reduce the volume of trade even futher in most cases, into three categics or lists: obliga- tory, indicative, and enterse to enterpris.- State Trading Obligatry li trade comprised only a small Countnes reacted to these interstate trade number (sually five to fiften) of the most impor- problems in two ways. Estonia and, to a lesser tant products in trade, primarily energy, rw mato- extent the other Baltic states moved quickly to rials, and foodstuffs. This barter trade under the 18 TADE fIN THE NEW INDEPENDErT SwES obligatory lists was supposed to balance: prices inputs, especially energy, in exchange for an and quantities were negotiated in advance so that assured market for some of their soft manufactures trade would exactly balance if both countries met exports-which they fear are uncompetitive-they their obligations.t6 Prices were denominated in have been forced to export relatively hard goods U.S_ dollars and were supposed to approximate under the obligatory portion of the agreements. world market prices. In pratice, however, that did - Networks of these agreemeuts were concluded not occur. For example, the 1993 agreement in 1992, 1993 and 1994. The'later agreements con- between Uzbekistan and Russia established the tmined fewer items on the aobligatory lists" and basis for the exchange of cotton from Uzbekistan prices appeared to be closer to world market prices for oil from Russia; a similar agreement between than in 1992. Domestic procurement has been lib- Russia and Kazakhstan involved oil and wheaL eralized over time in some countries. The Kyrgyz The UzbekisLan agreement was supposed to be at Republic, Moldova, and Russia have moved away world prices, but in practice both commodities from sute orders to comapetitive procurenent by appear to have been set at less than world prices state agencies in the domestc markeL though the relative prices involved no subsidy. The The bilateral trade agreements failed to main- Kazakbstan agreement reportedly contained some tain the level of interstate trade. Deliveries were continued net subsidy by Russia, but the actual frequently less than half the contracted amountL prices paid by Kazakhstan probably resulted in a The price controls that motivated the bilateral terms of trade deterioration relative to Russia agreements also undermined themL Price controls (World Bank 1994b). on exports reduced incentives to export The ndictive lits represented an effort to Enterprises, lacking the needed inputs, often failed limit interstae exports in order to ensure adequa to supply the agreed quantities or found it unprof- supplies for domestic consumption and for export itable to export under these arrangements and to hard currency areas but with less government sought their own export arrangements instead. involvement than in obligatory trade. These lists Evading the agreements had become easier since specified the most important products in trade- the system of state orders had weakened. after those included in the obligatory list-between Moreover, analogous to the CMEA prt blems, there the two countries involved. The lists usually was ao agreement on how to settle imbalances in included a wide range of intcrmediate products and the agreed trade. consumer goods that were still under export licens- The distortionary impact of the obligatory ing or quotas. The agreements generally specified trade remained pervasive, even though by 1993 the maximum quota of a good that would be Russia had narrowed the list o? goods traded under licensed for exportto each country. The stae incurs state obligation to a few commodities (except in no obligation to supply the specified amount in the agreements with Ukraine). Countries such as indicative lists, but each government agrees to Uzbekistan and the Kyrgyz Republic tax their agri- license exports up to the specified amount, provid- culturl sector on their exports to Russia (offering ed that agreements are reached at the enterprise-to- low prices to their domestic producers) in order to enterprise level. Individual enterpises ar respon- subsidize the energy-using sectors that rely on sible for the terms of the sale, including price and imports of Russian energy. Russia, for its part. no financing arrangcments. longer has a system of state orders, but uses export All products that are not on the obligatory or restraints to keep the domestic energy prices low. indicative lists may be traded freely on an enter- Through mid-1994, Roskontract (the successor to prise-to-enterprise basis without export licenses. Gosnab in Russia) purchased eneWr cheaply on Although smaller countries like the Kyrgyz the Russian domestic market to meet its obligations Republic would have liked to perpetuate the old under the interstate agreements and then sold the arrangement of assured deliveries of key imported underpriced imported inputs, such as cotton fm SUMMARY AND OVEVIEW OF DEVEMENTS StSCE INcEm NDEiCE 19 central Asian states. at below world market prices more than the Kyrgyz Republic since these two in Russia. Such arrangements gratly extended the countrics maintain export controls on many major range of products that enterprises received at less exportables. Also, the agreements apparently have no than world prices. provions on ndes of ginorinortssipmentofgood& But the principal shortcoming of the state trad- Baltic Free Trade Area The Baltic Free Trade ing agreements is that they perpetuate the system Area agreement, which came into force on April 1, of managed trade and retard the introduction of 1994, lays down the principles of trade in industrial nmaket forces. As long as trade is conducted on the goods. Trade in agricultural products will be cov- basis of bilateral pacts, governments rather than ered in a separate agreement. Provisions cover markets determine the allocation of resources and customs cooperation and the rules of origin under the volume and terms of trade. which goods qualify for tariff-free status Estonia, Latvia and Lithuania agreed to liberaize trade and Regional Cooperaton in Trade and-Payments to create favorable conditions for competition. Governments have also tried to foster inter- While state assistance to enterprises and dwnping state trade through cooperative agreements. Many are considered out of line, emergency safeguard of these agreements reflect dth governments' desire measures-tariffs of no more than 25 percent for to demonstrate political and economic solidarity, no more than five years-can be taken if certain They are often short on concrete measures of coop- imports seriously threaten the domestic market eration beyond preferential tariff or export duty The interste Bank Ten countries of the for- treatnenL By and lage these preferenccs have not mer Soviet Union (all except the Baltics, been extended to the Baltic states. Until the sprng Azerbaijan and Georgia) have agreed to establish of 1994, the Baltics and some of the other smaHller an institutional mechanism for the multilateral countries (Moldova) ficed dicriminatory tariffand clearing and settlement of interstate payments in nontariff barriers in some major markets (Russia), Russian rubles (or hard currency). The agreement against which they applied discriminatory treat- provides for monthly settlement in rubles and for ment in tru Moreover, these Wfee trade agree- interim finance limited to one month's imports. ments," while providing tariff-free access to mar- Use of the bank would be voluntary, and transac- kets, have not typically ended the use of export tions could also be cleared through correspondent restraints, the most pervasive trade restraints these accounts. countries employ. Of the many efforts at regional 'The benefit of such an arrangement is less the coopeation four are the most notable: limited finance it would make available but rather Russia-Belarus Econonmc Union. The Russia- the opportunity to maintain trade flows despite Belarus economic Union was announced in early continued weaknesses in the commercial bank cor- 1994 and implemented in June 1994, but its impli- respondent accounts system and limited access to cations are still unclear. It involves Belzrus' rein- foreign exchange, especially for enterprises outside tegration in the new ruble zone and related mca- Russia. Though seven countries have ratified the sures of monetary and fiscal policy coordination bank's charter (Belarus, Kazakhstan, Moldova. and duty-free movement of goods. A customs Russia, Tajikistan. Uzbeistan, and Turkanenistan) union was implemented between the two countries and the first board meeting was held on December under the first phase ofthis agreementt7 8, 1993, (the governor of the Central Bank of KalzUan-KyrgyzRePubfic-UzelzinaFErwmic Russia was elected Chairmana, there has been litde CŽiopenzion Mm detllsoffilustle-party agreement, evidence of further progress. The bank's future announced after the introduction of new currencies appears uncertain (see comment by Gms). in 1993, are not well knowan It appears that all three countries would retain export controls for Conclusions some key tradable;-Kazakhstan and Uzbekistan Contraction in output and in the supply of 20 TRADE IN lHE NEW INDEPENDENT STAllS exportables, the imposition of export controls, and twofold in 1990 [UNECE 1991]. If this tade waee revalued the breakdown in the payments systemn appear to be at wodd prices, however, the former Soviet Union would have had a surplus [Oblath and Tawr 1992].) largely responsible for the contraction in interma- Soviet kade with India continued on ft basis of bulat- tional and interstate trade flows. Litle of the al ckaring. and Soviet inporm from Idia were main- tained at a high level until t Soviet Union failed im eet decline in interstate trade can be attributed to com-rn- mmitments for cude oil deliveries, at which tm na petition and adjustnent to intenational prices and also rcstricted its cxpots (Brada I992). Since the fanner comparative advantage since competition from Soviet Union was also suffcring a dclin in trade in its inwt vavnenta barter arangeents, and other counties industrialized countries has been wealk But while in the region male a relatively suessful unsition to con- the extnal enviroment and market access do not veffible cuTency tradc the fs suggest that a significant appear to have significanty affected exporLperor- cxplanation for the decn in Soviet imp from Esrn a a h si was nts deermoag capacity to supply exporables. mance so far, issues of access are likely to rise mn his was parly due to capacity problems in such industries importance as domestic market reforms proceed as oiL The Baltics, especially Estonia, stand out for -- Output is reported to have declined by 40 percent in adjusting most rapidly to the new environment and Russia bet%,en 1990 and 1994 (see chapter 2). but as is th introducing the most fir reaching changes in their case for trade, offiial data may exggerat the dcline (se appendix4 Official data on output and intertat trade are trade and payments regime. They also seem to bsd on etprise survys which ignr thenewly eumag- have made greater adjustnents fin reomenting their tngpd sector.Military OUtput hasd d prcipious ly. but this wil have less th a prportionc impat on twade away from the former Soviet Union and consumer welfare Moreover, with the removal of pnrc towards broader intemational markets. Of the other controls, the quoues for goods have largely been elmiunat- countries, Moldova, the Kyrgyz Republic. and cd, so that the enormous loss of leisre time spcet in the queues bas been recapturedL Consumer wdefr is lily to Russia have made the most progress in libalizing have falen by less than would be indicated by official a trade. Russia, and the other energy exporters have GDP also undergone significant adjustment and arm 3. See Ofer (1987) and William Easterly and Stnley shifting more of their production to the rest of the Ficr (1994) for a discussion of the ouput delinc in the world, where the risk of nonpayment is lower Sovicet Ut Though several initiatives for trade cooperation 4 Ta revenue frorcn wnprises, which hld been the main have been introduced, few have really gotten source of goverment revenue, declined, and the central underway, and it is too early to assess what their governme sarted facig mounting inflatory pressUrs (Mclinnon 1991a4. 5. Snldanha (1992) has effectily argued thatdodcentralized Notes economies wvidut owncs of capitaL such as a ladbo-man- 1. It can be argud that the decline in USSR trade with aged economies, distrt incentives to such a degree that CMEA counearisd tdwith Finland in 1991 wasatheesultof they would lkdy coBs witout corrdvc itervention, introducing convertible currency settlemenas. Cteay which inevitably occurs. Among other problems, these conversion of trade to a convertible currency basis con- types or finns display little innovation, pay ecemssies nthe in lge measu to the collapse of that portion of wages and avid hiring labor. Thus, transition econies tratc intuced by trade diversion- There is also evdnccr, must give high priority to privatization and corpomat gov- trad inuce bytrae dveriotThee i alo eidec. emnance issues. Also see Ward (1958) for a description of however, that the reduced Soviet supply of exports con-espAls by Watd of dechr aralized firof tributed strongly to the problem. pewrvese rponses by m es of decetralized firms - Brada (1992) has shown that, relatively speaking, trde amuong Czechoslovalia, Hungay. and Poland held up better than might have been cxpected in 1991 despite a 6. In Russia the state trading organization has limited similar shift to convertible currency payment in this tradt Monopsony power, but export restaints result in doacsic Moreover, the sharp decline in Soviet-Eastern European pnces that are below world price trade in 1991 only continued a trend of declining Soviet exports to its pamrer coutries in dth CMEA thathad begun 7. The cos of a trade restraint rise geometrically with the as eary as 1988. even though trade was based on the nts- level of thc restainL ferable mble over tha time.(ICe annual Soviet tade bal- ance with the aggregate of Easten European CMEA wars- Webster (1994) stat that whe almost nonexistent for- cned from a trade surplus of 60 million htraable rubles eign peaon was evidentin the factthat only 2pcetof in 1987 to a trade defcit of 4 billion trnsfrable rubks in managers said dattheirmnn compettrs were inpts, and 1989 [UNECE 1990] and further worsened more than none naiedioiratventuorescrforeign firmsas competitors. SUMMARY AND OvEaviEw OF DEvEWPMas SINcE INDENrENCE 21 9. some c such as whea in Russia, iipo subsidies 14. Based on 1990 prices. all FSU countries could be wer provided for a doroesically producd gomo; bt the expected mo gain on their trms-of-trade with ic rest of the subsidies were provided only to the cxt that domestic work This is for two reasons: Fs. as shown in studiis demand could wt be mnt by domCstic suppliers at a price such as Murrsse and Vanous (1983) and Oblath and Taw acceptable to the authorities (1992). the areate PSU would gain by moving to world prices in dwhr trade with tMe CMEA countries. Second. and 10. More generally. there is am equivilence between a tax somewhat rupiising aU 1S FSU counties wcre exporting on exports and a tax on impors in terms of mim impact o h bad goods ouside the FSU while importing softgoods, so imports. The intuition for this theorem of international all individial countries uld be expected to gain as well. economics (kimuwn as thie Lmer symmetry theorm) is that Because trade wi the res or the world was a vey small wh1c import trffs nstra im l dly' exp, ta-es sAr of tal tde, for those couties that wee importing resuin exports and foreign exchange earning Since a haa d goods and exporting soft goods within the FSU. the comty rqes faign xchange to import, country Ca- terms-of-tade gains with the rest of thc world were far not import if it does not export Although governments smalle than the losses sustaie.d in intastte trade See have not imposed signifiant ts on imports, the cxport Tarr(!994) fordeils. restraints limit imports and protect import-competing indousries as ifthwest tariffs on impors 15. . m of thesec_ s originally were planned and negod by minisies of th ecmnomy I1. The Batics have had duty and quota fre accss for (the sucocssor to Gosplan). which had responsi-biity for ere of manufcue (but not agriculdie) to the d c conoic m than ministries of cxrr- Nordic countries. They also have not been hit by quotas in nat economic reations which controlled e relatons their expors of texties to the European Umon. Fo detail h die of theword soc ChT 5-7 and Clapte 12 16. In the casm of lhi B2ltic. the original areents con- t27 Colins ad Rodri used historcal measures of tade tind no obligatory delveies and the indicatve lsts con- paters, whilc the oter stdies used grity models that tamed no naximm amount of delivies. These agree- is expt for the Collins and Rodrik study, prdcted axde vmcnts werabndoned aft 1992. was based on a regression of actual trade against such explanatory aables as distance incin of the home and 17- Although there are no tariffs between Russia and partner country. and participation in a region of trade prof- Belanrs Beas applies its value added tx to bothimpno ren= mand exprs, a bias aginst trad that is inconsie with a 13. In some cunties, fibr eample, Geia and Ukrine, thc Russian ruble was regaded as a relively stable ar- References recy and was subject to sureder requiments analogous to those imposed on bhad cuarncis in thesc countri.r aper 13 Appendix: Foreign Trade Stafftstcs in the Former Soviet Union Misha Beikindas and Yuui Dikhanov D iscussionson statistics alnays startwhich published an annual handbook on foreign trade statstics of the USSR- The data were present- reliability. Foreign trade stadstics in th Soviet ed according to the Soviet Foreign Trade Union would appear to be reliable because foreign Nomenclatu by product category, by destiation trade was a monopoly of the state A limited nun- of exports, and by country of origin for imports. ber of foreign trade organizations engaged in for- Exports of amaments and other politically seai- eign trade activities and reported their tansactions tive commodities were not shown separately to the Ministry of Foreign Economic Relations. although they appeaed in the trade totals.1 22 TRADE IN J HE NEW INDEEDeNr SrATES The ministry shared its data with Goskoomstat, which include information on trade with third which was in charge of estimating macroeconomic countries, are the starting point for the analysis in indicators. Exports and imports had to be included this volume. in the balance of gross social product and national income to prepare NMP accounts for the Soviet Recent Developments Union as a whole and for each republic. With the dissolution of the Soviet Union. the The valuaton of foreign wtade flows presented unified statistical system broke up and interrepubli- a bigger problem. Exports and impors were valued can trade became trade between sovereign coun- in foreign trade rubles, (called Valuta Rubles) and tries. Each national statistical office is charged with converting them into domestic rubles or foreign compiling data on the economic and social activity curency is dfficult because the conversion coefli- in the country. Because customs services-the cients are not reported? Establishing the matching recorders of trade statistics-are not yet fuly opera- domestic prices for certain traded products was dif- tional on the borders between the former republics. ficult because the domestic price had to be adjusted most goods cross these borders unrecode for differences in quality between products sold Statistical agencies in charge of collecting for- domestically and those that are expored. eign trade statstics rely on direct reportng from Separating data on foreign trade by republic enterprises- The rate of nonrepouse to ques- presented an even bigger problem. The establish- tionnamirs is high. Newly established pivate fims ments that sold the goods to the foreign trade org- are not subject to reporting in many countries. Data nization were not recorded for saiscal purposes on tade by small vendors can be collected only so it was difficult, if not impossible. to allocate through sample surveys, which these countries do export flows to a particular republic. The same was not use. The reported data also include a high mar- tue for imports. The foreign trade organization gin of error, because enterprises have strong incen- "sold" these goods to the Mnstry of Trade and the tives to underreport their foreign economic activi- Conunittee for Mateial Technical Supply, which ties. then distributed the goods by republic. Data have become even more unreliable since in1 the absence of direct estimates, input-out- most countries have introduced national currencies put tables were used to estimate intrrepublican or coupons in near hyperinflationay enviromnents. trade and foreign trade by republic in domestic Different exchange rates are being used to convert prices. The 125 sector input-output tables by datarecorded in national currencies into rubles and republic were compiled every five years. A census U.S. dollars, and foreign trade transactions are Of enterprses was conducted as part of the compi- recorded at different times. Furthermore, some lation to gather data on foreign and interrepublican countries collect and publish information only on trade in domestic prices. selected foreign tlade activities, such as trade cov- Mirror statistics on interrepublican trade flows ered by intergovemmental agreements or consumer were reviewed by the Goskomstat of the USSR and goods only. adjusted to achieve a zero balance. The last input- For these reasons, the exact value and volume output tables are for the year 1987. Comnpreesive of foreign trade flows in this period of uansition tade data for 1987 were initially published in 1988. will never be known. Nevetheless, the effort has For the first time these data esma interrepubli- been made to present trade estimates, using data for can trade flows in foreign trade rubles.3 Similar prereform years as benchmarks, employing other data were also published for 1988-90. economic indicators, -and making reasonable The last published set of comprehensive tmade asswuptions about possible developments in order data based on a consisent methodology for the fif- to prepare consistent estimates. The detailed teen countries of the former Soviet Union (ESU) source procedures, and approaches to preparing covers 1990. Those former Soviet Union data, tables in chapter 1 are described below. SUMMARY AND Owvmw OF DEvEOmas SINCE IrnOEPEDENCE 23 Foreign Trade Estimates used as the control total and were not adjust- Trade with the Rest of the World in Current ed.5 Data for the other countries, derived as U.S. Dollars (Table 1.1) described above, were further adjusted to For 1990 the official data set on international derive a "balanced set of interstate trde and interrepublican trade flows in domestic and flows. The matrix is presented below. world market prices was employed. This data set has been widely used at the World Bank (see, for 9D example, World Bank, 1993a) and the EIM. It is - h* Data on trade flows between Russia and referred to here as '1990 official data sef For the FoS states for [993 as reported by the 1991-93, data reported by national statisical Russian authorities were used with the totals offices, CIS Goskomstat, World Bank, and IMF aust4ed to include trade between Russia and staff estimates were_ue the Baltic states. * Data reported by the Russian Goskomstat Trade among Countries of the Former Soiet have been supplermented with infonnation for Union in Current Rubles (Tabe 12). 1993 reported by Xazakbstan. Kyrgyz The sources for this table are: Republic, Turkmnenistan, and Uzbekstan- 1991)pO * For the Baltic states estimates of annual "1990 official datasetw trade flows with the rest of the former Sovie Union were obtied from the national stats- 1991 tical authorities, or Bank or IMF staff esti- Data reported by national sistical offices and mates were used. published in Seditcal Hardbook: States of the * Whereinformationontradeflowsbetween Former USSR (World Bank 1993a). any two countries was not available for 1993 (usually the case for trade other than with 1992 Russia), intete trade totals were allocated Information (direct and mirror) on bilateral t c u t - - ~~~~~~~~~to each of the countne-s using dle gCDgraphi- trade was analyzed.4 The 1992 flow. matrix was cal distribution in 1992. Define the following reconstructed to recover uneporting in trade. notation: The difference between the data from directreport- ing and± those fmm the partner country was attrib- = th share of country j's total exports - - ~~~~~~that goes to country i; uted to underrporting of trade in each case. * A balanced trade flow matrix model was= the share of the total imports of country developed. Russia's exports and imports were i that originates from country j; Trade flow matrix for FSU counrdies ;_ _ _ E.pmte .um _._ _ _E_ _ Coca tVy - Tat Impt to Total - SXj=- M1 24 TRADE IN THE NEW INjDEDE SrATES Xiu = the exports of country i to country j; Azerbaijan and food for Moldova and Georgia were adjusted (see table A.A below). For Azerbaijan, the = the imports of country i originating adjustmcnt was done because prices increased less from countryj; for energy exports (mainly oil) than for imports X = total exports of countryj; (mainly natual gas). For Georgia and Moldova - agricultural exporters- the adjustment was made Mi = total imports of country i. because of significant differences in their exports' Note in the sbare notation we have a flow of foodprics andaverage foodprices in this interstate goods rmm the country of tde first subscript to the trade (in 1990. the base year, food prices were at country of the second subscripL We utilize the 439 percent of the world price in Georgia and 365 available share data from 1992 combined with the pacent in Moldova compared with an average of aggregate import and exportdata for 1993 to con- 242 peent for the former Soviet Union as a struct the wrade flow matix. We have that xij = c whole). This price discrpancy was due mainly to *X1 and Wlat. =i *the fact that these countries taded a basket of By definition. exports from country i toj, must goodsfrm, vegetables, wines and bradies-whose equal imports of country j from i. Therefore, for rlative prices were considerably higher than those any time period, we must have that ^; = u% for all of many other agricultual products (which have countries. Consequendy, we average the two esti- been and, in many cases, continue to be controlled). mates of trade flows among the fifteen NIS coun- tnes as fows: Total Foreign Trade (Tabe 13) Esiates of total exports and imports for (1) L1993)=mjj(1993) = lI2[uj(1992)Xj(1993)+ each country were derived by combining figures (199 )t,{1993) for intcrstate trade and trade with the rest of the -1(1992Th1j{1993fl world, using a common denonminatoL Since 1992, Equation 1 generates the fuil trade matix for 1993. the late has been reported in US. dollars and the former in domestic currency. To estimate total When the derived trade figures esmated trade, US. dollars were used as the common to achieve halanced tradc for the former denominatr Soviet Union did not deviate sustantially from oficially reported data, hE official data Interstate Trade in Current U.S. Dollars, by were used. OfflcW and Marke Ehange Rates (Table 12) One method to denominate trade of the former Trade inng Countr1e of the Forner Soviet Soviet Union in U.S. dollas is to use the officil or Unon in ConSat 1990 Rulm es (Table 1.2) market exchange rates. For the years in which the foTowing imfonmation was uves r official exchange rate was used (1990 and 1991 in our esmates) the ruble was ovrvalued relatvc to * Flows in current pnces. the dollar. The value and consequently the share of * Priceindexesoftriadelbtheyears 1991-93. .nes trd nttltaewl eatfcal miteztatl trade in total trade wnll be artificially The application of price indexes to the base lower if such an exchange rate is used. Since 1992, stuctr was carried out in thr steps: fir the when the market exchange rate is used, local cur- 1991-93 sectoral price changes in interstate trade rency is undervalued. The estimates were derived were assumed to be equal to Russian domestic sac using curentruble data and annal official or com- toral price changes (seoral WPl); second, energy mercial exchange raes: 1990, R 0591US$; 1991, prices were adjusted to include information on actu- R1.26UUSS; 1992, 1R1961US$; 1993. R938/USS. al transaction prices of Russian energy exports; and Converting tade in this way undervalues it in dol- third, export and import prices of energy for lar terms. Using market exchange-rate converted SUMMARY AND OvravEw OF DEVomwrs SINCE1 NDEENDENCmE 25 data artificially shrinks the share of interstate trade (see chapter 12). Some discrqmancies are due to dif- and creates the impression of substantial changes ferences in Eo.b. and ci.f. prices, valuation, and so in the geographical distribution of trade. This is ott. Hower, the differences are so high that they nothing more than a statistical phenomenon, as is cannot be explained by those factors alone. It is ilustrated in table 12. impossible to say, however, how much of the apparent underreporting is due to "illegal exports" Interstte Trade at Impiit Exchange Rates and how much because OEC agencies attibuted (abble 1.2) to Russia exports from otherstes. The second method atempts to captue the reality that trade among the states was valued at TemisofTrade ElfctsonsTradtAmowtheNIS other than intemational prices or, what amounts to The price indexes used for the tenrs-of-trade the same thing, at different implicit exchange rates. calculation were those (described above) used to To denominate interstate trade flows in U.S. dollars convert trade from currrent to constant rubles. at implicit exchange rates, interstate trade in 1990 Thus, the terms of trade estimates include all the at world market prices in 1990 U.S. dollars was data deficiencies described above. We chose 1990 taken from the "official data set".6 This is equiva- as the base year for estimation since it was the last lent to repricing interstate trade into intenational year for which a cornsive set of information trade prices in 1990 US dollars. was available. To derive intestate tade in constant 1990 dol- Basic data on expenditures are a set of official las for 1991-93, the gmwth rates of interstate trade statistics on trade flows to the rest of the world and in constant rubles (described above) were applied among the countries of dt former Soviet Union by to it Subsequently, the flows we converted into commodity (105 sectors) for each of the republics current U.S. dollars using The World Bank deflator for 1990 in domestic and world market prices for the world trade (1990=100, 1991=985, Cofficial data set"). For a discussion on te consis- 1992=100.4, 199396l). tency of dtissetofdata, seeTare(1994). The vectrs of price indexes estmated for fif- Russia's Trade with the Rest of the Worfd by teen sectors (for 1991190, 1992/90 and 1993190) Destnaton (rable 1.5) were apipHed to the base year trde structures ofthe Data presented in table 1.5 were :ported byrepublics. Tems of tade were defined as the ratio the CIS and Russian Goskomstats. For 1990 and of Lasper export and import price indexes. 1991, data originally reported in "valuta" rubles In order to present the formula for terms of were cDnverted into US. dollars using the trade, we first define the following notation: exchange rates cited above. For 1992 and 1993, the data were reported in U.S- dollars. An adjustment i c . e - ~~~~~~-Px. is country j's export prie of comnmodity has been made for 1993 totals to account for the J t fac- tha Gosorntat f Rusia istbute by es- group i tD other FSU states in year t (expressed fiact that Goskomstat of Ruzssia distributed by dS in Russian or Soviet rubles); tination only $27 billon of imports out of a total $ 33.1 bilion. The difference is reported to be the so- *Pmt is country js import price of commodity called "unorganized" trade, conducted by sm1all group i from other FSU states in year t companies and private individuals, and represents (expressed in Russian or Soviet rubles); Goskomstat's estimates. The difference has been distributed by destnation in the same proportion as AXt is the quantit v of country j's exports of com- the previous total. modity group i to the FSU states in year t; The data are interestng from the point of view of mirror statistics. For 1992 export from Russia is the quantity of country js imports of com- are lower than those reported by OECD countries modity group i from the FSU states in year t; 26 TRADE IN THE NEW INDEPDENT STATls jsxo is the value of commodity i exports as a For any FSU country j, equation (2) is an esti- share of country js total exports to the FSU mate of the change in the price of its FSU exports states in 1990, i.e., relative to the change in the price of its FSU imports, assuming fixed quantities. This formula is mO. x' the ratio of two Laspeyres price indexes. The evo- =; . x o ludon of the terms of trade over 1990-93 period is iSxo > pxi xi presented in the first three columns of Table 1.9. X i ° 0 Column 4 of Table 1.9 should be treated separately as a reference point. It relates to a special hypothet- ical case of how terms of trade of the FSU coun- psmo is the value of commodity i imporLs as a tries would change if in 1990 trade among the FSU share of country j's total imporLs from the FSU countries were carried out at world market prices. in 1990, i.e, This case was discussed extensively in Tarr (1994). 'Thus, one can compare the first three Columns to Column 4 in order to assess how far the transition > .Pm O .M; to the world market price structure has proceeded. 31 =0 = 1 0 For thfe Baltic states, the results should be - - -P.mD interpreted cautiously, because the price structure i-Es in trade between them and states of the former Soviet Union is different than the structure within The terms of trade for country j in year t are the CIS, and lies in effect between the former defined as the ratio of the pric index of aggregate Soviet Union and world price struces. Thus, the exports-Pxt to the price index of aggregate terms of trade for Baltic states in 1993 may lie impmts-Pmn. Thus, the percentage change in the closer to Column 4 of Table 1.9, i.e., the transition urms of trade is 100 times the ratio of the terms of to world market price strucure has been more pro- trade in two different periods. Since the larest found there. shocks inm t terMS of trad that occred in SU counties between 1990 and 1993 are due to price Table AL1 Setomil Price Indexes In FSU Trade changes oan trade among the FSU statesg in table 1.9 (1990=1 00) we have focused exclusively on the terms of trade among the FSU countries. fherefore our foreign SctO 1991 1992 1993 trade price indices are resticted to prices among P 1.7 54.31 765.81 the FSU countries. OQl and gas 2.48 95.00 1412.5 To estimate the change in the terms of trade on Coal 223 10t.00 821.86 its trade with other FSU states in year t relative to Other fuels 2.23 95.00 788.50 the base year, for any countryj we utlize the equa- NFoufe 2.10 66589 .3 2.03 tioc Cheicals 2.06 55A9 499.37 Machinary 2_17 39.91 375.12 Wood and paper 2.55 39.91 319.26 vjPXN - ConjtiUdlon maeral 2.47 42.11 446.40 Z , jSo Ught indusbty 3.06 29.80 211.61 TO TS - ies Y0P Food prducts 2.61 47.55 551.63 (2) = i -OTOT: Cher industry 23B 48.77 482.79 J xp i Agrcitiur 1.56 14.52 130.71 - i 0 Othrproducts 288 48.77 482.79 ies; -PMO Totl 2.37 47.41 48323 SUMMARY AND OVERVIEW oF DEVELOPMEWI SINCe INDEPENDENCe 27 Notes 3. For detailed explanation on the reasons for publication and methodology of estimations see Brown and Belkindas I. For 105 categories of commodities foreign trade (in 1993. domestic and foreign prices) was estimated in order to compilc the input-output tables for notional economy. but 4. Information previously used by the World Bank these statistics were kept secret until recently to avoid (Michalopoulos 1993: World Bank 1993a). has been revised exposing data on producdon and exports of military related using new informattion from the countries (CGoskomstat commodities. reports on foreign trade for various states). 2. The valuta ruble was used as a bridge between te .5 This approach seems feasible because the trade with domestic ruble and hard currency. The Soviet Dank linked Russia accounts for 70 to 75 percent of the trade of the the valuta ruble and hard currency. Links between the FSU states, thus largely determining their total interstate valuta and domestic rubles were established for more than Inide volumes. 3,000 products and differed for exports and imports. For 6. To be precise. 1990 trade was reported in foreign trade more detail see Brown and Bclkindas. "Who's Feeding rubles, which in turn were obtained from U.S.Dollars Whom? An Analysis of Soviet Intetreiblic Tradce' in The through multiplying by official exchange rate (R059/US$ Former Soviel Union in Transition, Volume 1, JEC. at the time). Thus. the reverse operation was done here in Congress of the United States 1993. order to obtain U.S. dollars from foreign trade rubles. Russin Trade Policy Vladimir Konovalov U Tntil 1991 Russa's trade regime provided an air lock between the domestic and world economies. Planners deter- mined resource allocation with scant regard for comparative advanitage. On the contary, they pursued self-reliance within the former Soviet Union. Goods were imported only if they could not be produced locally, and exports were the rsidual * Mareconomic Backgrod after domestic nee6s were satisfied. The air lock lain- tained by monopoly foreign trading organiza bich * Trade Developments enforced administratively set prices for ta -,- hese organizations took advantage of a dizzorb stic price * Trade Policy wih Counties structure in order to export raw materials tbs- asy to sell Outside the Former Soviet in hard cufency markets and used the revenues so subsidize Union imports of food and machinery. This strategr was completely at odds with the outward orientation pursued by the fastest grow- * Trade Rekons with Counties of the Formr ing countries over the past thirty years. Soviet Union An outside observer appearing on the scene in 1991 could make a strong case that reform of the incentives regime was * Concluding Remarks crucial to ensuring that production and consumption decisions reflected opportunity costs (were based on world markct prices), so that investment flowed toward activities that were in line with the countys comparative advantage. Achieving this required freeing exports and imports and putting in place a macroeconomic and reguatory environment that encouraged investment 30 TRDE N mE NEW INDEPEDENT STATES Viewed at any particular time over the past two controls stunted exports and reduced the capacity years, trade policy would appear to be in a state of to import. At the same time they introduced flux, with considerable uncertainty about overall massive distortions in resource use that retarded direction (World Bank 1993). However, looking economic developmenL Recently, some progress back it is apparent that progress has been consider- has been made in this area as well. As of mid-1994 able. The exchange rate is freely detemined by the all non-oil export quotas were abolished and elimi- market. Average tariffs are about 12 percent, nation of export quotas on oil was delayed until the despite enormous pressure for protection by indus- use of new mechanisms for access to oil pipelines trial lobbies. Import subsidies were cut from about is clarified 25 percentofGDP in 1992tovirtaally zero in early The progress in reforn was possible in part 1994. State trading through centralized procurement because of the protection the undervalued exchange continues, with dininished coverage, but trading rate afforded to import-competing industries. In the monopolies have been eliminated. Progress has also first eight months of 1994 the rat of inflation grad- been made in introducing a regul2tory framework ually declined, leading to an appreciation of the real typical of that in market economies. For example, a exchange rate. Competitive pressures fiom imports customs law modeled on dtat of the European increased, leading to cals for explicit protection. Union (EU) was adopted, along with implementing Tariffs and import policy have now become a cen- guidelines and procedures relating to customs tral policy variable. The pressure for protection has administration ta closely resemble those found in increased substantially in recent months and has to the EU.. some extent been accommodated by dte govern- Progress in liberalizing interstate trade and menL Tariffs were increased five percentage points eliminating export quotas and taxes has been or. average by a decree of mid-March 1994. much slower. Official bilateal agreements continued to of the increase reflecting substantialy higher pro- play a significant role in trade relations with other tection for dtree powerful industries: motor vebi- states of the former Soviet Union. Export controls cles, agriculture, and defense. But countervailing directed production (mainly resource based) to the forces wcre effective in raising opposition to the domestic market and limited price increases The proposed increase, and implementation of the high- Figure 2t1 Inftion, 1992-94 (CPI, month on month percentage change) 30 20 I 10 - - L -E - E 3 < at o z o -3 IL E -C E n a Z o U- E 2 - - < 1992 1993 1994 Sourcc World Bank calculations RussrnTwmDE Poicr 31 Figure 2.2 Real GDP Index, 1992-94 (1990 average =100) 100 90 80 60 70 < ] a ^ | Such exports are relatively price inelastic and do to . enco _) - N o not require much in the way of marketing or trade -10 co co co a a m a a afinance. Manufactured exports, however, have been severely disrupted, reinforcing declines in output * Merchandise E Merchandcse B Balance and profitability. The massive fall in imports is exports rnports linked both to the fall in demand for industrial Soure: World Bank cculdons 36 TRAD IN TH NEW INDEPEN STATES Table 2.5 Concentration Ratio of Exports (percentage of total exports) Commodies RusB UnitedSats Canada azil Korea brfa Top three so 18 25 21 17 28 Top five 59 25 35 30 25 35 Top ten 70 37 50 44 39 50 Notc 1992 for Russi 1987.18 for odr counries Source Roskomsat, UNCrAD Table 2.6 Product Structure of Trade with Rest of World, 1992 and First Three Quarter 1993 (USS million) Value Pecent Vaue Percnt 1992 1993 1992 199 1992 1993 1992 1993 Total 37,610 26.434 100.0 100.0 32=027 12.093 100.0 100.0 Foods and agricultural raw material 1.185 862 32 3.3 9,204 3.359 28.7 27.8 Timber unprocessed) 548 530 1.5 2.0 5 9 0.0 0.1 Mineral fuels and electric energy 21.349 15.133 56.8 57.3 541 18B 1.5 1.6 Crude oil 8,545 6.454 22.7 24.4 0 0 0.0 O.D Ofl products 4.171 2703 11.1 102 26T 142 0.8 12 Natural gas 7,479 5,289 19.9 2D.0 20 1 0.1 0.0 Ores. minerals and metlals #n primayrms) 3.902 2.240 1O4 85 461 375 1.4 3.1 Uncut ciamonds 1,361 428 3.6 1.6 0 0 0.0 00 Aluminum (unptocesed) 1.234 819 3.3 3.1 0 1 0.0 OD Manufactured goods 10,626 7,669 28.3 29.0 21,815 8,163 68.1 67.5 Iron. steel, other metal products 2.763 Z,827 7.4 10.5 1.168 585 3.7 4.8 Timber (processed) 550 415 1.5 1.6 41 9 0.1 0.1 Chemicals (Mostly ierblTzers) 2,529 1,824 6.7 6.9 2,302 831 72 6.9 Pharmaceubcals 16 9 0.0 0.0 942 199 2.9 1.5 Cellulose, paper and paper products 353 314 0.9 1 2 392 92 12 0.8 Text1esandclothimg 260 121 0.7 0.5 4,140 1.527 12.9 12.6 .Machinery 3,815 2071 10.1 7.8 12,128 4.565 37.9 37.8 Other 340 85 0.9 0.3 701 355 2.2 2.9 Note:The totals in this table understate actual trade (as shown in aggrgate in earlier tables)- Roskomstat can only provide a product brcakdown for the lower amnount shown hem and them isno basis on which to distrbute the vem2inder Source: RoskomstaL- inputs following the collapse in output and, more countly trade is critcal to Russia's attempts to halt recently, to steep increases in real import prices the slide in output and living standards. stemning from the elimination of import subsidies In the first half of 1994 both exports and and the imposition of various trade taxes (tariff, imports grew at about 10 percent over the same value added taxes, and excises). Expanding third- period in 1993. On the export side the change has Russowi TRADE PoucY 37 been the result of increasing physical volumes, as minum) account for about 59 percent of Russian the terms of trade have moved against Russia. exports-almost double the percentages of other Estimates of imports an: more uncertain since a sig- countnes. The top ten commoditics (the above plus nificant share is unrecorded (a product of so-called iron, fresh fish, nickel, fertilizers, and natural abra- shuttle traders inporting food and consumer sives) account for about 70 percent of Russian goods). Although the trade balance is likely to exports as compared to 37 percent in the United remain in surplus, Russia7s balance on the current States, 44 percent in Brazil, and 50 percent in India. account is likely to become negative. That prospect A firther breakdown of trade based on underines the importance of maintaining the Roskomstat data outlined in table 2.6 provides reform momentun-restrictions on imports and some indication of the product stucture in trade. exports will lessen the contribution of the trade scc- nese numbers understate total trade as shown in tor to economic recovery. While it is too early to the balance of payments, but they are ehe bestavail- project the capital account, it appears that disburse- able.) Almost 70 percent of Russia's exports are raw ments of new money will remain low, maybe at materials, and 97 percent of imports are mamifac- around the 1993 level of USS5 billion. But if stabi- tures and food product Exports of manufiatued ization is successful, capil light should level off, goods totaled at least US$7.7 billion in the fist easing the pressure on the capital accounL The three quarters in 1993. about the same as in the prc- overall balance, however, is lkly to deteriorate. vious year T'he three main manufacured exports Barter trade has always been a major part of were iron and steel products, nachinery, and chem- foreign trade by centally planned economies, but it icals (mainly fetilizers). Cars and related spare is now also undetaken by private enterprises in parts account for about half of machinery exports. Russia because of the very limited avaHability of Other important products include steam, boilers, tade finance. Major losses of resouces are associ- trucks, and grade Motor vehciles. defined bropd&y ated with barter-based trade, and enterprises' flexi- to include cars, trucks, tos, graders, and associ- bility in searching out new and expanding markets ated parts, account for more than tbree-quarts of is being significantly impaired by this practice. The total machiney exports. Ceranly the low level and problem is becoming increasingly severe. A signifi- range of manufacured exports suggest that there cant shift away from trade based on payments and are benefits to diversifying the export baser So does credits into barter trade occurred over the past two the fact that manufacturd goods account for more years (table 2-4). Between 1992 and 1993, the share than two-thirds of imports (with machinery and of barter in total trade with third countries increased transport equipment alone accounting for 34 per- from 41 percent to 48 percent for exports and from cent). Food and agricultural aw :maials (29 per- 25 percent to 31 percent for imports. Virtually all cent) are the next largest items in Russias inports. (registered) trade within the former Soviet Union is The relative share of these commodity groups has based on barter arrangements. increased in the past three years. ComrnodityStucture Trade Policy with Countries Outside the Russia's exports are based on a narrow range Former Soviet Union of products, as reflected in a high concentration Russia was very isolated when it embarked on ratio compared to that in many other countries reforn in late 1991- Since then the government has (table 25). The top three commodities (natural gas, done much to introduce the administrative frame- crude petroleum, and petroleum products) account work typical of market economies. A strategic for half of Russian exports, compared with 18 per- choice was made to use the European Union as a cent for the United States, 21 percent for Brazil, and model for the Russian Fedeation's trade policy 28 percent for India. The top five commodities (the fiamework. Since mid-1992, Russia has developed three listed above plus road motor vehicles and alu- a customs code and tariff schedule and imposed 38 TRADE mI l NW INE PNDENT STA-ES value-added taxes on imports. After initial attempts exports to quotas, discriminatory tariffs, and arbi- to regulate trade with ex-Soviet partners through trary antidumping or countervailing duty actions. bilateral agreements and quantitativc controls, the GAIT membership guarantees Russian exporters focus has now shifted to harmonizing trade policies nondiscriminatory tratment and access to GAITs applying to the former Soviet Union and third- dispute settlement rules. GATI membership will country trade. The manufacturing industry in Russia also help the government resist pressures for protec- was not protected by the usual barriers on imports tioa by making it costly to pursue certain types of because an undervalued exchange rate protected trade policies. domestic output, and because extensive export con- trmls kept raw material inputs cheap. Offsetting Centrallzerdirade these factors was a policy of large-scale import u- The state has gradually reduced its role in sidization, estimated to be some 17.5 percent of direct itrading- activities, albeit less rapidly than grss domestic product (GDP) in 1992 SThe govern- envisioned by the govermnent in 1993. This trade ment took great strides in eliminating these distor- is a remnat of the systen of cross-subsidization tions as it abolished both import subsidies (carly used under the former planning system- In brief, 1994) and export controls on non-oil products (July monopoly foreign trading organizations set prices 1994). The government has announced that export for traded goods. In effect, the foreign trading controls on oil and oil products will be eliminated in organizations took advantage of a distorted domes- January 1995.. tic price structure in order to export raw materials that were easily sold in hard currency markets Ins"tional Reform (they required little marketing). Revenues from Two federal laws form the legislative base for such transactions wer used to subsidize imports of Russia's import regime, the Law on the Customs food and machinry. Tariff and the Customs Code- The laws were devel- Something akin to this system was preserved oped in close consultation widt customs experts following the collapse of central planning. In third- fiom the European Union. Inport tariffs a stab- Table 237 Export Quotas for State Needs 1993, lished by decree. The Customs Code establishes fif- 1994 teen customs regimes, including provisions for (ashavebeeninitallapproved) export facilitation mechanisms, such as duty vd/WUe waivers and rebates, on imported inputs used in export production, bonded warehouses and outward rtem Unit 1993 7994 % processing trade, and free trade zones Customs Total bilonddL 15.4 9 58 classification is based on the Harmonized Electrical energy billion. Kvh 4.7 2.5 53 Commodity Description and Coding System Oi and gas mlnn tons 20 25 125 (Harmonized System), which was adopted in condensate January 199;Z Diesel fuel Om tons 45 38 84 Russia is in 1he proess of acceding to the Fuel oil ths. tons 6,000 6,345 105 Gasoline ths. tons 275 275 100 GAT Russia became an observer to the GAiT in Jet fuel ths tons 30 30 100 1990, requested accession in June 1993. and pr:- Marine fuel ths tons 1.080 1,000 92 sented the GATT Secretariat with a memorandum Aluminnn thstons 100 350 350 describing its trade policies in February 1994. The Copperrefined ths.tons 50 e 120 memorandum will be the basis for intereted GA1T Nikel ths tons 40 50 125 contracting parties to pose questions concerning Ceclulose ms, tons 10 990 476 Russian trade-related policies. GAIT membership - nca m doL 1.300 990 76 assistance wIll bring many benefits. It will become more diffi- Average 114 cult for Russia's trading parts to subject Russian Sour=e Mfinisay of Foreg Economic Rclations RussmAN TRADEPouCY 39 country trade export quotas are set aside for state vided at subsidized prices. In mid-July 1992, the needs so that the government purchasing agent, transparency of the system was improved by the Roscontract, buys exportable goods on the domes- replacement of multiple exdcange rates with a uni- tic market at less than world prices.; Centralized form rate (detemnined by the interbank auction) and trade accounted for about 40 percent of third-coun- direct budgetary subsidies, calculated as import try exports in 1993 and is expected to account for coefficients. In effect, the subsidy coeficients main- 20 percent in 1994. The aprofits" made on this pro- taied multiple exchange rates on the imnport side. curement were initially used to finance centralized The import subsidies were a major fiscal bur- imports, which were in tum initially massively sub- den and were estimated to account for almost 25 sidized. Subsidies have been eliminated (see below), percent of GDP in early 1992. Subsidy coefficients and the profit from centralized exports are used to varied firom 61 percent on food products to 90 per- service exteral debt and provide revenue for the cent on food proce-sing equipment Some 55 per- central budget Centralized trade has been a major cent of subsidies went to industry, and 45 percent to distortion in the tading system and an impediment food products (and their inputs). Import subsidies to firther reform. In particular Ihe profits fom cen- were financed through taxation of exports and talimzed trade have induced certain inteests to lobby extemal borrowing- As discussed earlier, rapid against price liberalization. Also, centralized trade depreciation of the ruble and the unwillingness of is not subject to import and export taxes, which the authorities to pass on the resulting cot increases results in considerable variability in incentives. toi end users determined the extent of the subsidies. The total value of centalized exports approved Over time, however, the import subsidies became for 1994 is some $9 billion, about two-thirds of the unsupportable and they were first reduced and then approved level for 1993, while the number of prod- abolished on January 1, 1994-a major change in ucts subject to centaized exports has dropped from the incentives regime (figure 25). thirty-three in 1993 to fouteen in 1994 (table 2 7T. Licensing. Imports of goods into Russia are Energy and fuels dominate. The most notable relatively free of quotas and licensing. Licensing is changes in 1994 have been the eliminadon of coal, used largely to protect public hcalth (industi ferdlers, and timber from the list and the addition waste and certain chemicals) and licenses are of natural guas Volumes on remaining goods have administered by the Ministries of Agriculture and generally increased as the number of goods includ- the Environment and apply to only some 3 percent ed has dropped. Quotas are sometimes modified of imports. The customs authorities require quality dunng the course of the year, since centralized trade certification for almost half of total inports (rep- is an easy way for the authorities to obtain more utable foreign certificates are accepted). The proce- budgetary revenue- dures are not intended to protect local industry by delaying imports. Import Policies Tarzffs and Excise Duties. The main interven- Import Subsides. Import subsidies used to tions on the import side are various taxes (customs account for a large share of government expendi- duties and excise). During the early part of 1992 Ltre. A caTryover from the price-equalization mech- most imports were tax exempt, except for a minor anism that was part of socialist trade, import subsi- administrative surcharge of 0.15 percent The basic dies were used to isolate domestic users fron differ- duty structure was introduced in July 1992, with a ences between domestic and world prices. Until base rate of 5 percent (with relatively few excep- mid-1992 import subsidies were a component of a tions, such as beverages at a higher rate of 25 per- system of multiple exchange rates aimed at provid- cent). The tariff schedule comprised four columns ing for basic import needs for final consumption depending on the source of imports: least devel- (mostly food) and for ensuring that intermediate oped countries (zero rate); developing countries inputs for selected sectors and enterprises were pro- (half the basic rate); most-favored-nation (MFN) 40 TRADE IN THE NEW INDEPENWr STATES Figure 2.5 Trend in Import Subsidies, 1992-94 (perent of GDP) 25 20 \ 10 A 15 10 10 20 3Q 40 1Q 2Q 30 40 10 1992 1 1993 1 1994 Sou World Bankcalculaons countres (basic rate); and non-MFN countries decree of March 1994), a response to considerable (twice the basic rate). The customs duties applied protectionist pressures and fiscal concerns. They to about three-uas of Russia's impots and resulted in substantial increases for some products were about 4 percent on average (import weight- and greater product differentiation. Particularly ed). affected by the recent increases are cars (from 25 The tanff schedule has been changed substmn- percent to 40-46 percent), integrated boards and tially three times since mid-1992, and thbes fir- chips and some electronic goods (firom 5 to 60 per- quent changes have led to confiLsion and uncertain- cent), weapons (fiom 15 to 100 percent), and sev- ty among importers. The net result of the changes end types of machine tools (from 5 to 25 percent). has been a significant increase in the variability of The main basic rates of the new customs tariffs are d:t7-y rates, which now range between 0 and 100 zero percent for pharmaceuticals; 1 percent for oil percent The Law on Customs Tariffs stipulates a products; I to 10 percent for plastics, chemicals, ceiling tariff duty of 100 percent of the customs and noncoton yarns and fabrics; 5 to 10 percent for value of a good. The average inport-weighted duty agricultural products (although some rates are rate increased to about 11 percent in late 1992, much higher, such as 20 percent for sugar, 30 per- declined about 8 percent in mid-1993, and then cent for cigarettes, and 100 percent for spirits); 10 increased to 12 percent in mid-1994. The granting percent for fertilizers; 10 to 20 percent for footwear of exemptions at both the product and enterprise and clothing; 20 to 25 percent for wool and raw level added to the variations in the import structure. cotton and zem to 20 percent for machines and A step in the right direction was talen with the new equipment (although some items are as high as 60. Law on Customs Tariff of January E, 1994, which percent). abolished enterprise-specific exemptions. Excise duties ranging between 10 and 400 per- The most recent changes in the customs tariff cent are levied on certain products (luxury goods, were implemented on July 1, 1994, (following a tobacco, cars, and alcohol)- Although declaed rates RUsSIAN TRADE PoucY 41 for some goods are higher for imports than for through auctions. Exports produced by joint ven- domestic goods (alcohol, cigarettes. cars), actual mres and commodities produced under subcontract rates for most products are higher for domestic agreements were not subject to quotas. goods because the base used for tax collection is The magnitude of export quotas can only be less favorable for domestic goods.3 Most imports deduced ex post from the official trade statistics. are also subject to a 20 percent VAT.4 The March Distribution of quotas was undertaken administra- 1994 decree on tariffs noted earlier stipulates that tively, and although they were not published, histor- excise taxes (both rates and the base on which they ical performance was one of the more important cn- are collected) will be harmonized for foreign and teria determining quota distribution. Given the domestically produced goods- enormous profits to be made, it is not surprising that quotas were subject to intense rent-seeking efforts Export Policies Profits were greatest where the price differences Export quotas. From 1992 to mid 1994 export were largest (and the quotas most restrictive). Some restrictions were the single most important interven- quotas-and their foreign exchange carnings-in tion in the trade regime. Although the goverment export regions were assigned to local authorities (in recently announced the futurc elimination of these part, as a form of economic transfer intended to restrictions, their effect on relative prices and tradc lessen demands forgreater local or regional autono- patterns lingers. Exports from Russia were subject my). A small portion of the quota was sold on the to a range of quantitative and licensing controls commodity exchange. While this amount allowed including quotas, licenses, export registration, and for some flexibility for distributing a share of the special export controls on military technology. quotas to new entrants into expordng, thc effect was Export quotas applied to most energy and other raw limited by the small volumes. materials, which accounted for about 70 percent of Export controls have led to enormous efficien- total exports. The quotas and licensing requiements cy losses. As mentioned earlier, in Januay 1993 the were intended to ensure that goods remained avail- domestic price of exports implied an exchange rate able in domestic matlets. Limiting the amount of of 171 rubles to the dollar, when the market exchange domestic production that could be exported. Such rate was 555 rubles per dollar (see table 2.l)-an controls kept the domestic prices of these goods implicit export tax of more than 200 percenL Low lower han they oterwi would have been, reduc- domestic prices of energy maintained though export ing the profitability of industries with export poten- taxes encouraged domestic consumption, discouraged tial and boosting the profitability of industries that production, and reduced exports. The lack of invest- relied on artificially cheap inputs. No constraints ment in oil production is clearly related to the low applied to exports of manufacmred goods, and all domestic prices maintained by export controls. And, exports are exempt from VAT and excise taxes.S by reducing forxeign exchange earnings, the controls The quotas were based on assessments of have also lessened the capacity of the economy to material balances (the difference between projected pay for imports. Moreover, such tight controls led domestic consumption and production) undertaken to a significant appreciation of the exchange rate. by the Ministry of Economy. In effect, the quotas A decree of May 23, 1994, eliminated quotas perpetuated the practice under the centralized and licensing on all non-oil exports and services as regime of exporting only goods that were in excess of JtIly 1 1994, except those subject to international of domestic needs. In periods of price liberalization, obligations. Controls on oil are expected to be elim- export volumes were increased. The Ministry of inated in January 1995 (the delay is due to difficul- Foreign Economic Relations handled the distribu- ties in designing and implementing new mecha- tion of most export quotas as follows: 50 to 55 per- nisms of access to the oil pipelines). The elimina- cent to Roscontract, 30 percent to enterpre, 10 to tion of export restrictions will have wide-ranging 12 percent to regions, and 3 to 5 percent for sale ramifications for the economy: 42 TRADE IN THE NEW INDEPErDENr STATES Table 2.8 Export Taxes as of End 1993 Share in Expot Tax Rare Value overall price LtenVWn 11J Quni (US$ nubil) e(ot (U) $4Jnt ECU/unit Sult Fishaandproducts(tmt) 431.0 525.0 1.7 1,218.1 0 D Iron ores (tnt) 5.377.9 125.8 A 23.4 0 0 Coal (int) 16,208.1 530.6 1.7 32.7 0 0 Crude oil (tint) 67,713.5 7,115.0 22.7 1051 30.0 33.9 Petroleum products (tmnt) 29,514.2 2,824.4 9.0 95 Y nma n.a Gasollne n.a n.a n.8 n.a 40.0 45.2 Gasoil n.a n.a na n.a 30.0 33.9 On fuel (mazu) na n.a nn na S.D 9.0 Natural gas (milrion m3) 73,881.0 5,705.3 182 77.2 18.0 20.3 Ammonia (tmt) 2,342.1 184.8 .6 78.9 2.0 2.3 Methanol (trnt) 704.0 57.0 .2 81.0 3.0 3A. Synthetic rubber (tnt) 121.0 106.0 .3 876.0 65.0 73.5 Nitgenowus fertilizes (pnt) 3,742.9 270.5 .9 72.3 5.0 5.7 Phosphorc ferfllizers (tnt) 114.7 13.5 0 117.7 4.0 4.5 Potassium fertilizers (tnmt) 2.1222 140.8 A 66.3 3.0 3. Logs and timber (flsin 9,060.6 540.9 1.7 59.7 8.0 9.0 Processed limber (thsm3) 2,528.5 371.9 12 147.1 7.0 7.9 Plywood (thousand in3) 236.0 74.5 .2 315.7 0 .0 Cellulose (tint) 594.2 1482 .5 249A 15.0 17.0 Paper (tmt 352.9 85A .3 24MO 15%,: 36.3 Cotton fabrics (thousand m) 97,314.0 40.4 .1 .42 0 0 Pig irOn (tml 1,710.1 174.5 .6 102.0 0 0 Ferroalloys (tDn) 213.1 123.1 A 577.7 16.0 18.1 Alurninum (tint 1,107.1 961.9 3.1 R686. 70.0 79.1 Machinery and equipment na 2,295.6 73 n.a 15% a n.9 Total na 22,415.1 71A na n.a n-a Overall expors n. 31,409.8 n.a n.a n a n. a. Military cquipmcnt and aviation twchics. Souxce World Bank cstimacs. Higher energy prices on the domestic mar- tribute to economic recovery and growth. ket. Resource-based industries will be In effect, the previous export restrictions encouraged to expand production and redi- represented a substantial tax on import rect sales to export markets. In the short activities through lowering of the run the potential to expand exports may be exchange rate. A higher exchange rate will constrained by transport capacity, but this improve the prospects for much needed obstacle should be overcome in the medi- restructuring of the industrial sector by um term. Consumers will be encouraged reducing the cost of capital equipment to economize on the use of energy and raw imports. However, it will lead to increased materials, thereby increasing efficiency. external competition for domestic mar- Industrial enterprises, particularly the most kets; energy-intensive activities (such as fertil- G Creater transparency anrd less rent-seek- izers and chemicals), will be forced to . accelerate restructuring. ing acntivtes. The system of export restric- accelerateresgtructuing oftheexchangetlions was a major source of rent seeking, Further strengthening of the exchange as producers and middlemen tried to bribe rate through higher export proceeds. The officials to obtain quotas or to evade cus- resultant increase in imports will con- toms controls. The rent-seekdng activity RUSSIN TRADE POUCY 43 was on such a scale that it undennined export taxes as of end 1993 is shown in table 2.8.) respect for administration. Most taxable goods were subject to levies quoted in An unclear, but potentially large fiscal ECUs per ton. The ad valorem equivalent tax rates impact. The budget will benefit from ranged from I to 80 percenL Oil and gas, which increased excise tax revenues in the short accounted for about 40 percent of total exports, run. However, that gain wvill be offset by a were subject to rates of 34 percent and 20 percenL loss in revenues from centralized exports Two important factors have altered the effects as th diffrenc betwen dmesti and of the fonnal export tax structure. One was the sur- as the difference between domestic and world prices narrows. Thlere may also be a charge applied on all barter trade and on some rble loss in revenue if profit taxes from bea and joint-venture trade; the other is evasion and industrial sector fall. Moreover, the exemptions. The stated purpose of the surcharge authorities will be under enormous pres- was to penalize exporters who avoided the (implic- sure to increase subsidies to certain sec- it) foreign exchange surrender taxes. The surcharge tors. These pressures should be resisted had grown progressively higher, rising from 15 per- since the purpose -Ca realignment in rela- cent in early 1992 to 50 percent in early 1994. The tive prices is to forct a restructuring of the surcharge on barter trade was eliminated in early economy and a much needed improve- 1994 as part of. a package of currency reforms ment in dhe efficiency of energy use. (notably that exporters were no longer required to surrender export earnings to the Central Bank of By shrinking the gap between domestic and Russia). Exemptions granted to oil exports and to export prices and taking away Roscontracts privi- all deliveries of goods for state needs were largely leged quota position, the elimination of export quo- responsible for collection rates during 1993 as low Las will severely reduce the potential for the author- as 22 percent. In addition exporting regions with- ities to profit from distorted relative prices and held export taxes, partly because they needed the thereby hasten the elimination of centralized trade. revenues to provide local services. Under the recent In the short run domestic prices will probably package of reforms export taxes will become the remain below world prices because of export taxes, main instrument influencing relative prices in suppressed domestic demand ([alling output and Russia. Export taxes are an area in which the gov- ability to pay by industrial enterprises), and tans- ermnent could move more boldly in reform because port and pipeline constraints to exporting. As trans- there is ample scope to cut tax rates, a move that port constraints are eased, export taxes will become could be introduced in parallel with an overhaul of the main.wedge between domestic and world energy taxes in general. The government has prices. The authorities have recently announced that decreed that export taxes will be eliminated at the centralized trade for non-oil products will bec climi- end of 1995. nated in 1995. The position with respect to oil prod- Strategic exports. Some important categories ucts is not yet clear, but given the elimination of of goods (mainly raw materials) may be exported quotas the authorities will need to switch to other only by registered e'porters (a form or nontariff fonns of revenue- restriclion). About 200 foreign trading organiza- Erxpnrt ares. Export taxes are also applied to tions and larger enterprises art entitled to export the ccrtain ratural resourecs and semiprocessed con- listed goods. All other exporters of these goods modities, to keep prices low on the domestic market must work through registered exporters. The stated and to raise revenue. Export taxes were introduced objectives of this practice arc lo exercise control in January 1992 and have been changed numerous over the hard currency activities of exporters and times since then in response to changes in the revenue collection and to "protect" small exporters exchange rates -and in the relationship between who arc supposed not to know how to transact in domestic and world prices. (The structure of the international markets. The latter exporters are sup- 44 TRmE IN THE NEW NDEPENDENT STAirS posed to be responsible for the selling of Russian political considerations, guided the geographic dis- raw materials too cheaply on the world market tribution of enterprises, not economic efFiciency. To Such behavior has been motivated more by the enforce economic dependence, there were often large diffrrence between domestic and world prices only a few single-source suppliers spread among for many of these products than by ignorance. The several of the former republics. These artificial tradt- large profits to be made in exports have attracted ing patterns are now drstically changing and the many small exporters who can still earn healthy former Soviet Union countries are all turming to the profits by selling at what appear to be relatively low outside world prices in world terms. There is nojustification for using exporter reg- Payments Problems isters to control the number of exporters once quo- Problems with the monetary and payments sys- tas are lifted. Domestic prices will move toward tem helped bring about the collapse of interstate world levels, and export activity will tend to settle trade. During the first half of 1992 only Russia down as profit margins are reduced to normal lev- could print rubles, but all te centrl banks in the els. Controlling the numbers of exporters will inhib- ruble zone could expand the money supply by cre- it evolving market structes and fostergreater con- ating credit in rubles. In the absence of monetary centration of industry. Exporters should be regis- coordininoTS tbis quicldy gave rise to a free rider tered only to help ensure the collection of export problem, because monetary restraint by some cen- taxes in the short term; all intersted parties should trl banks could be exploited by others that were be registered as a formality. Once export taxes are able to expand their money supply independently. lifted, the export register should also be scrapped, Ibis anrangement fueled inflation, impeded efforts to stabilize the ruble, and posed difficulties for trade Trade Relations with Countries of the and payments. Former Soviet Union Russia accumlated a significant trade surplus The disintegration of the former Soviet Union with other countries during 1992, a consequence of has contributed to a severe decline in trade and is an traditional structural relationships within the Soviet important remason for the subsequent collapse in out- Union and the relatively larger upward adjustment put. Previously the various countries were tightly in the price of oil, Russia;s main exporL To stem bound together as trade within the former Soviet the outflow of goods and to contrlI the amount of Union absorbed an unusually high proportion of credit extended to the other countries, Russia estab- total trade, even when compared with other regional tisbed a network of correspondent accounts for the trading blocs. Only Russia had a significandy dif- central banks of the countries to monitor all bilater- ferent trading pattern, not only because it was the al transactions. Credit limits were imposed on these best endowed, but also because Moscow was the accounts after July 1992. When a country exceeded seat of the ministries that controUed trade. The its limit, the Russian central bank would refuse to breakup of the former Soviet Union seriously dis- clear payments orders (such as checks) of enterpris- rupted interstate trade. The Soviet economy had es in the debtor country, meaning that Russian been largely closed to the West, and the former exporters would not be paid for the goods they republics had little alternative but to trade with each shipped to that country_ This move accelerated the other or with other command economies in the east- introduction of independent currencies throughout er bloc or with socialist economies such as Cuba the region. Matters were exacerbated by the dramat- and Viet Nam. The highly militarized Soviet econo- ic decline in the efficiency of the banking system my required cooperation in arms production and once Gosbank, the central bank of the former Soviet also contributed to a large proportion of interstate Union, was dissolved. It began to take two to three trade. Finally, in the Soviet Union's "hub and months to clear payments orders-a risky business spoke" economy, which was run from Moscow, in an environment of high inflation. RussiAN TRDE PoLIcY 45. The former republics were not able to adjust rubles. Enterprises that wish to import from Russia quickly to the shifting terms of trade and began to must first acquire Russian rubles. For these coun- run up large debts with Russia despite the credit tries, Russian rubles must be obtained through limits. By late 1993 net trade debt to Russia exporting to Russia or by obtaining credit from amounted to 1,500 billion rubles (Russian enter- Russia (or the country can use assets acquired prises' arrears amounted to 1,500 billion rubles, through trade or credit with other countries or while other countries owed Russia 3,000 billion donors to purchase Russian rubles). Thus, there is rubles), most of it for shipments of Russian fuel no need to force all trade transactions through the and energy. In mid-1993 the Russian government correspondent accounts of the central bank of stopped issuing technical credits (these had been Russia. Over time, the importance of the central granted on a case by case basis, without any bank correspondence accounts declined and com- specific limits or terms of repayment). All the mercial banks were allowed to deal direcdy with negative balances on correspondent accounts in the one another. Central Bank of Russia were transformed into Various initiatives were put forward to government-to-govemment debL Repayment peri- improve the payments system. One, the proposal to ods and intemst charged (typically LIBOR plus 2 establish an Interstate bankt seemed well on its way percent) were detemiined for both accumulated in 1992, but then progress stalled (see comment by debts and new credit lines. Most countries lacked Gros to Chapter I1). The Interstate Bank was never the resources to repay the debt, so the terms and created in part because no individual country had a conditions of repayment became a contentious large enough incentive to push for it, least of all political issue. One solution that was pursued was Russia, which was running a surplus with all the asset-debt swaps. The first, with Ukraine, gave other countries. Russia shares in the Lisichansk oil refinery as Private commercial banks have met some of partial repayment of the TUkainian debL the need, becoming much more active in settling payments across countries of the former Soviet RecentDevelopmerns in Payments Mechanism Union. They have done this through a network of Gradually a number of countries in the former corespondent accounts and through Western banks, Soviet Union began to introduce their own curren- largely in Euope. As a result, active exchange mar- cies. The introduction of new currencies consider- kets have developed among the various countries. ably changed die incentive structure that led to Commercial banks are able to process tranactions credit limits being imposed through the centra bank through their corrspondent accounts in a matter of corrspondent accounts. En particular, central banks days, compared with two to three months on trans- with independent cmrencies cannot create noncash actuons through Cental Bank of Russia clearing Table 2.9 Russian Regulatory Regime for Trade with Other Countries of the Former Soviet Union Trade Exort rcenfing Stat Exptrtensing Stafe (epords and quotas obfigab;ons Exports Ipwods and quoas obligatons andimport) Type of bade Obrfgatory rst goods No Yes No No No Yes . No lndcati list goods No No Yes No No No Yes All otlr goods Noa No Yes No No No Yes a. An excepdon is tla goods not on the indicaive lists, butwhich axe subject to licensing to ibird coutries, axe also subject to licensing in intescae tae. Source: Worid Bank 46 TRADE IN THE NEW INDEPENDENr STATES mechanisms. In addiLion, traders have circumvent- which resulted in sipnificant price differences for a ed payments problems by moving cash across bor- number of products. Many prices, notably for ener- ders (reportedly in large suitcases) or by resorting to gy, were still well below the world leveL Without barter arrangements. All these channels involve export restmints, these products would be exported large transaction costs, howevcr, and even today the to world markets or to other countrics where prices commercial banking system is not efficient enough were higher. to support a full] recovery of interstate trade. On the import side, there were few formal Consequently, the lackl of an effective payments restraints on imports from other countries ofthe for- system remains a bottleneck that will be overcome mer Soviet Union, but competition from abroad was only as the commercial bankdng system develops. weak in most sectors because an undervalued ruble provided very high implicit protection against hard Trade Regime currency imports. In addition extensive foreign The most significant trade barrier has been the exchange subsidies are available but only on non- widespread use of export licenses and quotas. import competing products.The regulatory environ- Although most of these restrictions on non-oil prod- ment between Russia and other countries of the for- ucts were recently eliminated, they have heavily mer Soviet Union is outlined in table 29. influenced the evolution of trading patterns in the Stae trading through bilateral arrangements. countries of the former Soviet Union. These con- In an effort to deal with trade problems between the trols were imposed in reaction to two develop- countries of the former Soviet Union, countries ments. resorted to many of the features that charactenized One was the lack of monetary coordination trade under central planning. By March 1992 an within the ruble zone, which meant that each coin- extensive network of bilateral trade agreements had try had a strong incentive to import goods and pay been signed that divided trade into "obligatory" and for them in rubles, which their central banks could "indicative" trade. Trade not under the agreements create independently. Countries responded by was to be enterprise-to-enterprise based. imposing quantitative limits on exports. The other Obligatory list trade was conducted on the impetus for export controls was the wide variation basis of intergovernmental barter agreements cov- in the pace of price liberalization among countries, ering the most important products traded between Table 2.10 Fulfillment of Intergovemmental Agreements between Russia and Other Countries of the Former Soviet Union, 1993 SlAtedty coract ActuaVly Wd PemtgeaofMfnwt Eps mz kywads Cis States Tota Import Eq rt Tot import Eport Tol impat Export Byconiact Fulfiled Azerbarjan 955 454 501 65 25 40 7 6 8 47 15 Anmenja 446 208 238 60 12 48 13 6 20 30 36 Belarus 3,692 1,841 1,851 2,184 1,092 1,092 59 59 59 10 0 Kazakhstan Z195 1,103 1,092 560 212 368 26 19 34 -11 156 KyrgyzRepublie 266 133 133 129 64 65 49 48 49 - 1 Moldova 526 252 274 165 93 93 35 37 34 22 0 Talikistan 206 103 103 17 - 17 8 - 17 0 - Uzbeldstan 2,630 1220 1,410 1,471 735 736 56 60 52 190 1 Ukraine 7,670 4,319 3,351 2,458 1,229 1,229 32 28 37 -968 0 Turkmenistan 14 7 7 12 a 6 87 87 87 0 0 TotalaVerage 18,599 9.640 8,959 7,163 3,468 3,695 39 36 41 -681 227 -not availabk Note: Table encludes nuaal gas shipments Sourc: lusdir of Marke Dtcasting RussJAN TRADE PouaCY 47 the countries-such as energy products and raw long as trade was conducted on the basis of bilateral naterials-much as had occurred under the foaner pacts, it was governments rather than markets that CMEA These commitments obligate the country to determined the allocation of resources. fulfill the contract, and maximum allowable prices Obligatory list trade became less important are specified for many products. Although an effort over time as Russia diverted raw materials to more was made to roughly balance this portion of the lucrative third country markets, and tne number of trade by assigning prices and adjusting volumes, products covered by obligatory lists fell over timc Russia accumulated large interstate trade surpluses As of early 1994 they applied to only 30 products. as prices were raligned. For indicative list trade Moreover, the foundations of the system were countries agreed to provide export licenses for all undermined by the recent decree abolishing export enterprise-to-enterprise negotiated contracts up to quotas and licensing (except on oil products) This the quota amounts specified. The trade took place wili align domestic and world prices on the Russian only if the enterprises agreed on the terms of the market, lessening any margin for cross-subsidized sales, including price and credit conditions. trade through government-to-government agree- Indicative lists covered some 1,000 to 1,500 prod- ments. Policymakers should move boldly to elimi- ucts, including a wide range of machinery and agri- nate the remaining controls on interstate tade, and cultural and consumer products. no new obligatory agreements should be signed All remaining products were to be freely trad- once the current contracts expire at the end of 1994. ed at the enterprise-to-enterprise leveL Moreover, products could be traded in multiple ways; in partic- Supply Response ular, oil was taded in all three categories. However, During 1992-1993, the focus of the govern- the majority of trade in value terms was in the first ments main policy changes was in the area ofprice two categories. reform- This resulted in large changes in the incen- These bilateral agreements did not resolve the tive structure hicing Russian fims and consumers myriad trade and payment problems. It was unclear as domestic prices began to converge to world lev- how and how frequendy trade imbalances should be els. It is still too eady to detcrmine what effects settled-convertible currency, rubles, and addition- price reform has had on the strucmte of Russian al shipments of goods have all been proposed as a industry. Until late 1993 it appeard that the impact means ofpayment. Govemments were not very suc- of price liberalization on industry structure and cessful in fulfilling their obligatory trade agree- employment was quite limited, even though mea- ments, largely because the continuation of price sured industral output has dropped dramatically. controls reduced incentives to export (table 2.10). On an aggegate level, industrial output fell by 16 As shown in the table, these agreements were to percent during 1993 after having fallen by IS per- cover the bulk of Russia's total trade with former cent in i992. Output declined further in the first Soviet Union countries. In the event, the average quaer of 1994. The largest declines in output dur- fulfillment ratio was only 39 percent and actual ing 1993 were registered in the machine building, trade under the agreement was valued at only metal working, and petrochemical branches. with US$3.7 billion (out of total trade of US$272 bil- reductions of more than 40 percenL The dismal out- lion). Actual fulfillment of contracts varied consid- put performance reflects the inefficiency and erably by country from 7 percent (with Azerbaijan) uncompetitiveness of much of Russian industry. to 87 percent (with Turlamenistan). At the same Russia inherited a highly concentrated and capital time, the system of state orders had either broken intensive industry, much of which was geared down or become less effective. As a result, enter- toward the production of military hardware. About prises that either did not find it profitable or that half of all enterprises were engaged in heavy indus- lacked te necessary inputs, often did not supply the try,6 accounting for over three-uarters of total agreed-upon quantities. More fundamentally, as industria employment 48 TRADE N THE NEW INEPrEar STATES There has been some adjustment by Russian Their technology, plant, and equipment are largely finns, but on the whole much less restructuring and obsolete. Since planning was done in terms of phys- resource reallocation has occurred than is needed. ical inputs and output, there has been ittle regard Many enterprises have altered their output muix forfinancial reporting and control. Central z,lanning This has been the case in particular for firms also eliminated the need for sales and marketing engaged in defense-related production. Arms pro- departments and strategic product developmenL curement by the govemment fell by about one-third These functions are crucil for successfully operat- in 1992, and fell further in 1993. While the output ing in a market environment. Moreover, many of of the defense industry has fallen substantially as the larger enterprises have traditionally provided the result of procrement cutbacks, the proportion their employees and *heir famnies with a wide array of total output produced by firms in the military- of social services, including housing, health care, industial complex has fallen even more due to education, transportation, and culural, recreational, diversification away from military production. The and sports facilities. Employees are often locked share of defense-related output is estimated to into this community-enterprise system in the sense account for only one quarter of total production of that the firm provides all these social services as such enterprises. But much more is required. Many well as employment. For that same reason local of the enterprises in this sector, as well as many authorities try to maintain the staus quo as long as other parts of manufcting, need to undergo very possible, to avoid having to take on these social significant retooling, restructuring, downsizing, or functions, which they lack lte resources to finance. closure. Despite the significant fall in industria out- Both central and local governments provided put in the last few years, the Russian economy is dikected credits to enterprises, wbich allowed themt still over-industrialized. For the economy to move to continue to operate production facilities and toward a more appmpriate structure and for eco- maintain their social services and further delayed nomic growth to occur, futher drastic reductions in restructuring. Firms also provided substantial both output and employment shares of the industri credit to each otiher, whether voluntarily or by sector will be inevitable. Moreover, changes in the accumulating arrears. Until mid-1992 payment sectoral structure of industry will also be required. flows went through branches of the State Bank, Russian industry remains ovedy speciaized m pro- which acted as remitting and collecting agents for ducer goods, especially machinery and equipment, seller and usually lent funds to debtors- After mid- while the consumer goods industry is severely 1992 the combination of price liberalization, underdeveloped. macroeconomic instability, and greater enterprise The weak supply response to the changes in the autonomy led to a breakdown of the bank-guaran- incentives regime that occurred during 1992-93 is teed payments system. In the absence of effective largely related to the legacy of central planning, bankruptcy procedures, firms responded by grant- which closed Russian enterprises off from interna- ing each other credit Interenterprise arrears tional competition. Bureaucratic control of prices became huge. The growth of interenterprise credit and domestic resource flows resulted in a vertically and continued directed credits from govermment integrated and highly concentrated production significantly reducd the pressure on firms to take stucture. Domestic competition was severely con- the drastic actions that the change in econonuc strained. Enterprises were expected to increase their environment demanded. production capacity, output, and employment; there During 1993 and especially in 1994 budget was little emphasis on productivity and efficiency. constraints became firmer as the govermnent p0, information on the budgetary cost of the import subsidies or the potential export tax revenues. The No specific assumption about B needs to be cost of the import subsidies is given as 25 percent made at this point However, the discussion will be of GDP. Ihis implies Pw Qr(T-1) = 0.25 Y, where limited to the case greater than one, which imnp ies P,, is the wodd marketprice. which is here assmned thabthe elasdcity of demand is assumed to be below to be given because Russia is a small economy in one. tenns of trade flows (Russian exports and impors As an aside I want to note that it should be pos- arm about as large as those of Belgimn). The domes- sible to get a rough approximation of the short-rn tic price is given by T times tbe word price P = Pw elasticity of demand frm the available trade data. T. Substituting in the demand curve (which implies Experience has shown that- as the import subsidy thatA T = Pw T) leads to: was reduced, consumption of inports fell substan- tially. The elasticity should thus be quite high (5) A Q` /Y = 025 r/I(T-i)] = 0.25 (1+tyt Thestartingpointforall welfare calculations is the consumer surplus (CS), which is given by: The welfare loss (as a proportion of national income) can then be written as: (2) CS=AIJQ-dq=AQ1BI(1l-B)-QP (6) Welfitre loss I Y 0.25 f [[1(1-B)] [T/Cf-1)] The loss of wdfare from atariff is equal to the IT-o-B' -1] - 1i loss of consumer surplus (the difference between the consumer surplus under free trade and with the To solve the equation one needs to have an tarif) plus the tariff rcvenue. Denoting the quantity etimt of T-and of S. consumed under free trade by QOp and the quantity For the case of the import subsidies, aT below consumed with the trade restriction (tariff or sub- 0.5 (corepoding to an import subsidy of over 100 sidy) by QT. and using the demand equation, the percent sisould be appropriate since the value of loss of consumer-surplus can be written as: imports (at world maret prices) was more than 50 (23) LossofCS-CSyr-CST=AlQ1O3t']i(1)-A tpercent of GDP in early 1992 (and the cost was -T - - - about 25 prcent of GDP). With T = 05 inserted in -Q Qrl - - - the etuation, th bcketed terms on the right side 14 1£ of equadon 6 collapse to: -[8/(l-B)j [24X-)108 -1] + 1. [BI(I-S)l A [Q;-r -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ COMMENT ON 1RUSSIAN TRADE Poucy" 57 The following table shows the value of this expres- Gylrason, ThorvaIdnr. 1994. Structural Adjustment, sion for selected values of 13 and the welfare loss as Efficiency, and Econominc Gmwth. CEPR Discussion Paper 911. Center for European Policy Studies, a proportion of GDP under the assumption that the Brussels. budgetary cost of the subsidies was 25 percent of Koen, Vincent. and Eric Mceyemans. 1994. Exchange Rate GDP: Determinants in Russia i992-93. International Moneary Fund. Washington. D.C. Welfiue cost as B W(l-S)[2-(1-Sf) -1] +l pet of GDP Notes This work is based, in pan, on my work for the European 2 0.2 43 Expertise Service (SES-AGIR), financed by the TACIS 1.00001 03 73 progranme of the EU. I wish to thank Gerird Duchene for 0.5 0.5 125 correcting a mistake in the first draft and David Tar for useful comments These three values could be interpreted as a 1. At least if one compares 1992 or 1993 to 1991 or 1990. low elasticity case (B = 2 implies an elasticity of demand equal to one-halt, a medium elasticity (B 2. One other minor comment is that it is not clear which purcdasing power parity the author is using All the author 1) and a high elasticity (B = 0.5 implies an elasticity says is that the measure is subject to considerable uncer- of demand equal to two). tainty. He might usefully have referred to Koen and An interesting special case is B = 0.5, which Meyermns (1994) for a detailed presentation of different purchasing power parity exchange rates, including one causes the right side of equation 6 to collapse to based on the priceof a bamburger in Moscow. 0.25*(T-1). In this case the welfare loss is linear in 3., The welFare loss (loss of consumer surplus) from energy T, which is in apparent contradiction to the usual export taxes that lower the domestic price is equal to one convexity of the welfare loss. However, this result half times the proportional difference in price times the is due to holding tariff revenue constant Equation 6 proporbonal change in quantity times the value of initial consumption. As mentioned above, Konovalov finds that just says that for B = 0-5 the welfare loss is linear in the world market price for energy goods was more than the tax rate that yields 25 perent of GDP. three times the domestic price. This suggests an export tar- iff of 200 percent Even conceding that part of the price dif- As discussed ifl the text~ the real loss of welfare fcrence, say 25 percent is due to transport costs, the implic- was probably much higher since the Russian gov- it tariff is 150 percent This implies that the loss of welfare emnent collected little revenue. The trangles cal- f41 each unit of consLunption is equal to 05 * 1.5 * 0.73 = culted here clearly understate the true welfere loss- es of Russian trade policy. 4. This is based on Gros and Jones (1991) who show that for the world market value of overall energy consumption was about S240 billion in the former Soviet Union. This References would imply a welfare loss equivalent to about 5130 bil- Christensen, Denedicte VbN& 1994. The Rwszin FedenrdaOn lion- Russia accounted for toout two-thirds of overall ener- in Transition: External Developments. Occasional gy consumption inthe former Soviet Union. Paper 111. International Monetary Fund, Washington, 5. If the observed decline in pmduction results from a deci- D.C. sion by producers to keep the oil in the gmund to sell it Gros, Daniel and Eric Jones. 1991. Price Reform and later at a higher prie, the welfae loss for Russia might be Energy Markers in the Soviea Union and Central limited. For an exhaustible resource like oil, it does not Europe. CEPS Working Document 57. Center for matter how much is pumped out in each period, but that European Policy Studies, Brussels. whatever is extacted is used efficiently. Comment on Chapter 2 The Origins of Russin Trade Policy Sergei Glaiev The Russian Federation's economic relations with the rest of the world during the early 1990s were shaped by an array of macroeco- nomic problems: falling output of energy and otier raw materials, declining industrial output, and rapidly ris- resouies, wbich was a treat because of the huge ing inflation. These and other destabilizing p betwe tenal and extal pncs forces hurt the performance of Russian The new rgme was more complicated and exporters and importers. In addition, the less stabk than the ordwdox central planing sys- federaton faced the rupture of existing um The system of mltiple exchange rates result- economic ties with ptdncers, regions, and ed in distortions to those of te previous regime. witl the gap between market and afficial former Soviet republics. Under central planning freign trade was con- . m . . . ducted on the sanm basis as internal production and boosting iznorn of subsidied goods. aThis regime began to collapse in 1991, when the countries of the former Soviet Union declared quasi-physical indicators, was determined by fte ddfricc btweenmtem prouctio andcon- thd soveretgnty and staltd their struggle with dumptiffrence begimee balanter nal production anSoviet central authonties for their economic rights. andsuonmp -onT regme baacednternallanoducti Foreign tade was central to the dnve for indepen- and consmtonl according to central plan;, exports dencepica authorities started issuing licens- and imports were regulated through direct statec es to their domestic companies, allowing them to organizades, which we isued throughforeigntrade exploit price differences and to conduct vey prof- orgaruzations~~~~ baeinitenlrtarmns ble export operations. In exchange for the licens- The dismantling of central planning stutoed es compames were expected to deliver consumer with the adoption of theLaw on State Enterprises m fodomest consumptioAfter the failure 1987, which hlbeSizcd the state wctor, State enter- Inot 198, wichlibralzedtheStae 5ctO Stte fl of the military coup d'etat in August 1991 the pnses were allowed to trade on their own and werc given sponsibility fort wide range of other acv- process accelerated, and in November 1991 both - ~~~~~~~~~central and republican authorities lost control of the ities, including rech and development and man- trd and foreign revenues lunging the agement of labor, productivity, and profitability. Multiple exchange rates and licenses for foreign s into chaos. Tbhe new Russian govermment began to liberal- trade operations were intrduced to smooth the transition and to avoid the spontaeous outflow of n l pe feooi ciiy u tutrl CoMMENr TUE OmoGs or- RussIAM TRADE PoucY 59 obstacles, especially the huge gap between internal restrictions at the expense of consumers. and external prices, hampered its efforts. After Experience the world over has shown that import more than seven decades of isolation from world restrictions are easy to introduce but difficult to markets and international competition, the govern- remove, as entrenched interests would lobby hard to meat feared that rapid liberalization of foreign trade retain them. Import restrictions can also impair the would lead to drastic changes in relative prices that competitiveness of the national economy. would undermine the competitiveness of domestic This knowledge sparked interest in a second companies, which would be unable to adjust to sky- option restricting exports of energy and raw mate- rocketing prices of energy and raw materials. The rials. This option offered some protection from for- cost of these shocks, the government believed, eign competition without giving rise to powerful would have severely outweighed the benefits that rent-seeking groups that would lobby against could be realized from foreign trade. removing the restrictions. Export restrictions benefit The disruption in interstate tade was another downstream users at the expense of export-oriented obstacle to reform. Trade with the other former producers, urdice import restrictions, which benefit republics accounted for more than half of Russia's producers of import-competing products. Consumers foreign trade. This trade was conducted in internal are generally too disorganized to effectively defend rices because of the concern that exposure to mar- export restictions while exporkts tend to press for ket prices would destroy the long-term ties between their removaL. cnterprises in the former Soviet republics. The cal- Export restrictions have natural limits; they lapse of CMEA trade was seen as a cautionary should not exceed the rent revenues caused by example of the threat of liberalization either natural or structural advantages. Kept under The authorities also worried that rapid liberal- these limits, export restrictions do not block exports inztion would lead to capital outflows and excessive (which continue to be profitable), while keeping the foreign competition in the internal markeL For all prices of energy and raw materials comparatively these reasons, total liberalization of foreign trade low. In that way, export restrictions, promote the was viewed as too rsky. Some restrictions and spe- competitiveness of manufacturing industries and cific regulatons would be needed to ease the transi- benefit the state budget at the same time. If the tion. Tariff and non-tariffmeasures could be used to restrictions surpass these nabunl limits, vested- dampen price shocks. Currency controls would be interest groups will protest and send a strong signal needed to avoid huge capital outflows. Export cred- to lower the restrictions-n automatic adjustment its and guarantees to finance export of sophsidcated mechanism that keeps export barriers from rising goods would be provided. A mechanism for main- too high. taining import levels and generating currency reserves for the govemment had to be established. The Export Regime After choosing export restrictions over import Controls on Exports or Imports? restrictions, the authorities had to decide whether to The government had to choose between export use export tariffs or quotas. In theory the two types or import restrictions or a mixture of both to protect of restrictions would have the same economic domestic output and consumption. Macroeconomic impacL Tariffs were better, however, because they instabilty and the lack of internal competition were resulted in fewermarket distortions and administra- arguments against the use of import restrctions. tion costs. The export tariff could also partly substi- The chaotic rise of prices after price controls were tmte for an import tariff, since the main threat to relaxed made the calculation of rational import tar- competitiveness was a rise in energy and raw mate- iff impossible. Policymakers also worried that rial prices, that could have bankrupted the mainfac- import restrictions would play into the hands of turing industry. The introduction of the export tariff vested intrests, who would take advantage of such created favorable conditions for the gradual adapta- 60 TRADE IN 1HE NEW INDEPENDENT STATES tion of the national economy to world prices, per- as to generate federal budget revenues. The quotas niiLting tariff barriers to be lowered gradualy as went to enterprises chat promised to tum the larger well. export revenues over to the budget after covering Foreign trade was regulated through three the cost of the purchase and delivery of the goods. mechanisms: an export tariff for protection of the The lagest share of the quotas was distnbuted home market against too rapid an exposure to world by the line ministries. Regional administrations dis- prices and foreign competition, the limited use of tributed quotas for some specific goods, such as export controls for strategic raw matcrials, and a timber. A small portion of the quotas were sold compulsory surrender requirement for half of all through auctions. The plan was to gradualy expand foreign exchange proceeds. the share of quotas sold through auctions and to The export tariff applied only to 150 commodi- phase out the quotas by early 1993, except on pri- ty items, including certain Taw materials. fuel, fer- mary energy resources. rous and nonferrous metals, chemicals, timber prod- Removing export quotas, however, proved ucts, foodstuff, aviation engineering products, and more dificult than anticipated. The industrial nun- military equipment Ad valorem duties, calculated istries and the Ministry of Economy pushed to con- on the customs value of the dutiable goods, applied tinue quantitative controls and administrtive con- to most covered exports. The highest rates were trol over the allocation of quotas in order to induce levied on iodine (30 percent) and propylene (40 per- enterprises, to supply resources to the domestic cent). Specific duties, calculated on the unit weight market to meet the requirements of the ministries- or quantity of the dutiable goods, were also applied for instance, to deliver fuel to agricultral enterpris- to some goods. The highest specific duties were es and to cities that were insolvent. WVith liberaliz- levied on silver ore (64.000 ECU per ton) interme- tion of the state sector in 1987, liberlization of diate goods and germanium (33,600 ECU per ton) internal trade in 1991, and liberization in 1992, and certain rare metals (21,000 ECU per ton). the power to distnbute export quotas became the Specific duties on most goods were below 100 ECU major instrument of control over enterpnises. per ton. Auctions, which removed the discretionary ele- The government planned to gradualy decrease ment from quota allocation, never became an the export tariff rates as manufacturing enterprises important instrument of quota distriution. Quotas adjusted to the higher prices for raw materials and sold at auctions were based on current supply and energy. The initil plan was to lower the average demand conditions in the corresponding commodity tariff fiom 25 percent in the beginning of 1992 to exchanges. In 1993 about ten auctions took place, zero at the end of 1995. Between 1992 and 1994, generating 9.5 bilion rubles in revenue for the state. the government reduced the export tariff several More than 500 companies participated. For most of times, lowering it to an average of one-third its them the auctions offered their only chance to original leveL exporL The companies that purchased quotas at Quotas were retained on some energy and raw auctions were generally more successful and effi- material exports even after the introduction of cient than their privileged competitors, who export tariffs, largely because of concerns about the obtained the quotas free of charge. effectiveness of the export tariff. The export restrictions were designed not only Quotas are set by the Ministry of Economy on to regulate internal prices and influence firm behav- the basis of supply and demand forecasts The quo- ior but to generate revenues for the government tas are distnrbuted among producers by line min- Expor tariffs and state exports accounted for about istries and, for some commodities, by regional 28 percent of budget revenue. Additional revenues authorities under the direction of the Ministry of came from the forced sale to the government of 50 Economy. In 1992 a new category of export quotas percent of energy and raw materials export rev- was introduced for distribution tbrough tenders, so enues at the 40 percent of the market exchange rate. COMMENTARY: THE Oaitias OF RussiAN TRADE Poucy 61 That requirement was abolished in the middle of reducing the competitiveness of domestic industry. 1992. In response. import restictions grew in importance. To control capital flight and force the repatria- The first import tariff was inrduced in mid-1992, tion of export revenues fiom the sale of strategically mainly for fiscal purpose. It was a moderate 5 per- important materials, export registration was intro- cent tariff on all goods. Later, as the ruble appreci- duced for those commodities. The list included ated, tariffs were increased and differentiatd. The crude oil and processed oil products, gas, electric tariff was raised to 15 percent on final goods and 25 power, celulose, nonferrous metals, certain mineral percent on luxury goods. Tariffs on energy and raw fertiizers, grain, soya and sunflower seed, fish and materials remained the same or were reduced. New crusceans, caviar, and spirits. In addition ores for tariff rates arc calculated within the framework of the production of ferrous metals, wood. raremetals. existing tariff legislation, with a maximum tariff of rough and sawn coniferous lumber, and wooden 100 percent of the customs value of the goods. The slippers were also classified as strategically impor- average weighted tariff rose from 5 to 7 percent to taut items afterJanuary 1,1994. 13 to 15 percenL Licenses are issued only to enterprises regis- Initially, a value-added tax (VAI) was levied tred at the Ministry of Foreign Economic on domestic production but not on imports. To Relations. To qualify, firms must be selected by a reduce the distortions created by this differential special committee of the Ministry. Export quotas taxation, the relevant laws were amended to include are also required. The foreign currency proceeds of inports after February 1, 1993. The VAT is now set the sale of strategically important raw material at 20 percent for foreign and domestic goods. The exports must be deposited in assigned bank VAT on imports is calculated on the customs value accounts. of the goods plus any import and excise duties. Thus Russia had established a dual export regime in 1992. Exports of energy and raw maten- Trade wit the Counis of the Former Soviet als were regated thomugh tariff and nontaif fmeth- Union ods. They were subject to curency controls and, in One of the most difficult aspects of foreign the first half of 1992, had to sell 40 percent of their trade liberaliztion for Russia has been liberalizing export earnings at an exchange rate that was equiva- trade with other countries of the Commonwealth of lent to an additional 20 percent export tax. Exports Independent States (CIS). At first, trade was con- of all otcher goods (except danguous products such ducted in internal prices, which meant that Russian as weapons or dmgs) were free of rcstrictions. exports were undervalued and imports were over- Tnese export measures were designed to reduce the valued. The total amount of subsidies Russia grant- risk of foreign trade liberalizaion, avoid the bank- ed to the CIS countries through price distortions ruptcy of manufacturing industries, and maintain reached about USS10 billion, or 6.5 percent of the competitiveness of final goods The export bar- GNP. Maintaining trade with the CIS countries was riers were gradually lowered as enteprises adjusted vital to the stabilization of the Russian economy, to the higher relative prices of energy and raw because of the strong links between Russian compa- materals and to the appreciation of the ruble. nies and consumers and producers in ocher Soviet republics that bad been forged over decades. The Import Regime Inmediately switching foreign trade with CIS Import policy was fi more liberaL in large part countries to world prices would have caused huge because a greatly undervalued ruble increased the adjustment costs. price of imported consumer goods and protected Another problem was administrative. So many local producers against foreign competition. Russian companies had partners in the CIS coun- Between 1992 and 1993 the ruble began to appreci- tries chat processing export requests would have ate, rising to about ten times its original value and been impossible without severely interrupting trade. 62 TRADE IN TE NEW INDEPENDEwr STArEs A transitional mechanism was required. The mcch- tern for setting and allocating quotas and issuing anism worked out by the Ministry of Trade and licenses. Resources was simple and it was a boon to those who controlled it The ministry positioned itself as Shifts in the Structure of Trade an intermediary that would arrange bilateral trade Trade volume decreased in 1992-93, despite between Russia and other CIS countries through the liberalization. Several factors accounted for the specal intergovernmental agreements. The volume drop in Russia's ovemrll tade: of mutually supplied goods was calculated in world *Continuing disrption of the trafitional pnces to kep trade balanced. The agreements x economic links among enterprises within the quantity of goods that each country was obliged RLssia and between them and their foreigc to deliver. In practice the ministry got the right to d counteparts. buy a certain amount of goods at domestic prices and to exchange for a certain amount of goods that * Elimination of previously state-financed Russia needed. The goods were then sold, as speci export activities (particularly in machinery fied in the ageement, in the interal market at and equipment). domestic prices. This large-scale barter trade was - * ~~~~~~~Dismanding of the centndlzcd distn-bution inappropriate to the new economic situation, and of hard curecy reserves to pay for the Ainistry of Foreign Economic Relations criti- imports and settlements on intertate bank cized it sharply. But the government decided to go credits. ahead, and the Ministry of Trade and Resourc got the right to trade and to contol the trade within CIS * Li-berlization of export and import opera- simultaneously tions for all economic entities. This dual system of foreign trade with different * Continuing changes m Russia's trade rg- regimes for foreign trade within die CIS and the cst uaLions (imtroduction of value-added taxes of the world could not work efficiently. Huge reex- . e on imported goods, new ports of Russian raw materals through transactions with CIS countres sted immediately. No reliable information about the trade balance between Russia * Delays in signing of interstate foreign and CIS countries is available because of registra- trade agreements for 1993. tion methods used by the local divisions of the The sitation has been aggravated by delines Ministry of Trade and Resources. in the auction of myjor export items and an absence To normalize trade relations with CIS coun- of efective controls over customs, taxes, and tries, negotiations wyen started on free tade ee financing of foreign trade deals. Poor control over ments, and-by mid-1992 such agreements were credit creation and monetary policy has also exacer- signed with almost al CIS countnes. In the fall of bated t 1992 the Ministry of Trade and Resources was The shocks from intenal macroeconomic transfonned into the state commercial organization, .ances outweighed the positive influence of Roscontract, and lost its regulatory power over for- . t The fir signs of a pos- eign trade. Not until January 1, 1993 was a unified i r procedure established for export licensing and the -tigoqoafoeprsadiot.o wcre not supported by export promotion measures, s f f s o owing and the gains disappeared again untl the end of the international practice, a single government body, y of sophisticated goods need govem- the Ministry of Foreign Economic Relations, was ment assisace and promotion (export credits and assigned authority for issuing inport and export t informatn services, political support) licenses. The licensing regime is based on sched- to realize their competitive advatage in export ules of goods subject to license and a uniform sys- rkets. New instruments of trade fiance are CoMMENTARY: THF ORIGN oF RusswI TIUDE Pat 63 urgently needed The system of Russias transportur trade with the Asia-Pacific region (Republic of tion infrastructure needs attention as well. Korea, Hong Kong, Singapore, Taiwan (China), Several actions are needed to rai the quality Philippines, and Thailand). of Russian products to meet international standards. The first positive shifts in 1993 were the A system of certification and control over export- result largely of the adaptation of sonme enterpris- oriented production is needed that will be accepted es to the new conditions introduced by foreign by foreign customers Information services for for- trade libeization. The disintegration of inpo- eign trade operations need to be developed, to make tant technological links in the producion of information available on prices in varous markets sophisticated products has increased the prices of on potential foreign partners, and the like. Some Russian products and resulted in a loss of compet- positive changes have already taken place. Foreign itiveness on both intemaional and home markets. trade has become more efficient and diverse The crucial task now is to develop an effecivre. Russian foreign trade has diverfied geographical- unified industial and foreign trade policy, that ly. Trade wvith the United States, CGemany, Canada, will strengthen the scientific and industrial sec- the United Kingdom, France, Spain, Sweden and tocs, spur the export of highly processed goods, Finand is improving noticeably. Exports to China and define a new competitive organizational have increased considerably in recent years. as has structure for indutial productionL Ukraine: A Trade and Exchange System Still Seeking Direction Franfoise Le GaUl Tb0 trade and exchange system in Ukraine is still steeped in the oconnc patterns ibite *om the fomier Savet Union. It has been seathing for a middlc road somewhere between the "blind" capitaism of the West and the 'muinmniledr command * The Economy Today economy of the socialist east Its story is one of too little reform, not too mudh, of a system built on static planning * Output and Prices mechaims and administraive controls at a time of great eco- nomic change and of policies that have seriously hampered eco- * External Trade oiomic recovery. Reform of the trade and exchange -regime would boost economic performance, but it is only a part of an * Trade Regime overl program of stabition and reform. This chapter covers the wade and exchange regime of * Export Regime Ukraine through June 1994. In late October 1994, the govern- ment expressed the intntion to implement a far-reaching eco- * Import Regime nomic program reform that includes an overhaul of the trade and exchange system along the lines recommended in this * Bilateral Agreements chapte. * Exchange and Payments The Economy Today System A review of recent economic developments, pardcuarly of underlying macroeconomic and strunal problems and exter- * Reform Issues nal- shocks to the economy, shows how much the collapse of tade has contributed to the economic decline of Ukraine. Economic conditions, already difficult at the time of indepen- dence in August 1991, worsened dramatically dteafter, dam- 66 TlRAD IN mhE NEW INDEPENDENr SrATl5 aged by both govennment policy-especially the to a lesser extent, Turkmenism These enery sup- absence of a coherent macroeconomic stabilization plies have been cut off intermittently as Ukraine has and structual reform program-and extemal allowed payments aresas to mount. The declining shocks, such as the collapse of trade with the former fortunes of one industy or enterprise often have a Soviet Union. The result has been a large and con- ripple effect throughout the economy because of the tinuous drop in output, high and variable inflation, rigid specialization inherited from sociist days. and a serious deterioration in the balance of pay- Shocks on the demand side have had an impact ments. as well. Specalized markets have dwindled, most The economic environment has provided few notably military equipment, which accounted for as incentives for economic agents to respond efflicient- much as 10 perent of GDP in 1990 and no doubt a ly to market signals (mcluding changes in the exter- substantial share of exports to the former Soviet nal terms of trade) and to business opportunities at Union. Recenty, new signs of waning demand have home or abroad. High inflation has eroded confi- emegd, aconsequence of alargefall in eal wages- dce in the future, making people and firms reluc- they sbrank by balf between December 1992 and tant to save and invest. Decisions about resource December 1993-and the stringent credit polcy of allocation have been made more difficult by wide late 1993 and early 1994. swings in relative prices, which distort the informa- nflaion reachcd almost 5,000 percent in 1993 tion content of prices. Notwithstanding a recent (up from 1,210 percnt in 1992), and vaied consid- tightening of bank credit, most state enterprises erably from month to monthL It spikled in January, continue to operate under soft budget constraints. June, September, and December as the govement Ratier than adjust. entepises have tended to accu- adjusted fte administered pnces of energy, food. mulate payments arrears under the expectation that and tranWort and communications to reflect domestic as will bemonezedby te centralbank increasing costs. While the undelying rate of inSla- (or that ceditor such as energ suppliers will be com- tion steadied in the first half of the yar, by October pensated by the govenment) and that extnal amrars and November pnces were rising 50 percent a (notably to Russia) will be consolidaed into st deb. monkl The hyper inflation-like increases came on the heels of a massive expansion in credit during Output and Prices the summer months With demad flagging badly in Real GDP contracted by roughly 15 percent in the first quarter of 1994, inflation fell markedly, 1993, bringing the cumulative fall in output since reaching 5.7 percent in March. 1989 to 40 percentl This trend accelerated in the These price developments have not been ade- first months of 1994 as industrial production quately capured by Ukraine's three principal declined by almost 35 perent dunng January-July exchange rates the official rate, the rate established compared with the same period in the previous at the foreign exchange auctions of the National year. Particularly hard hit have been metallurgy, Bank of Ukraine (which are subject to administra- machine building, and construction materials, all tive itstrictions of varying intensity), and the pard- energy-intensive and facing shrinking markets for lel market rate in Kiev. AUl tbree rates d; give some their products. indication of domestic inflationary pressmes. The The disintegration of long-estabLished supply parallel market exchange rate increased from an and customer links, both within Ukraine and with avcrage of 3,002 karbovanets (kxb) to the U.S. dol- other countres of the former Soviet Union, has hurt lar in Apnl 1993 to lab 32,871 in December 1993 many industries. Frequent disruptions in the supply and krb 47,731 in May 1994 (table 3.1). On a real ..of energy and raw materals have led to growing basis, however, the parallel markt exchange rate shortages. With domestic production meeting only appreciated by 64 percent between April and about half the country's energy needs, Ukraine December 1993 and by another 19 percent in the relies heavily on imports mainly from Russia and, first five months of 1994. The evolution of be aurc- UKRANE ATRADEAND EX GE Ss Sn SEEKING DmBCnON 67 Table 3.1 Dynamics of Karbovanets Exchange Rates, 1993-94 Nomit exhange ro Monthly dage Redxchaneia nt (Kt&VSS) (prcent) (April 1993-100) RaIo a -PI o.tCIlo Date Offia Actfon Mafeta Offical Auction Madnt aCnge Offcial Acton Mar madeetrate 1993 Jan 727 878 na. 14.6 na. n.a 732 65.9 n.a. n.M. na Feb 973 1,284 na. 33.9 462 n.a. 28.8 51.0 67.3 nL.m n.Ea Mar 1.616 1.899 n.e 66.1 47.9 nna. 22.1 65.7 772 na. n.a Apr 3.002 3,002 3,002 85.7 58.1 n.a 23.6 100. 100.0 100.0 100.0 May 2999 2999 2,939 -01 -0.1 -21 27.6 7683 78.3 767 102.0 Jun 3.656 3,658 3,38B 21.9 22.0 15.3 71.7 55.6 55.6 51.5 107.9 Jul 4.589 4.589 3.858 25.5 25.5 13.9 37.6 50.7 50.7 42.6 118.9 Aug 5.970 14,007 6,935 30.1 2052 79.8 21.7 542 127.2 .0 85.1 Sep 5,970 16,4S0 11,615 0.0 175 67.5 80.3 30.1 82.9 58.5 51.4 Oct 5.970 22.833 19.407 0.0 38.7 67.1 66.1 18.1 692 58.8 30.8 Nov 6,194 31,150 265303 3.8 36.4 35.5 45.3 12.9 65.0 54.9 23.5 Dec 12,608 25.317 32,871 103.6 -18.7 25.0 908 13.8 27.7 35.9 3B.4 1994 Jan 13,000 25,0W 37,911 3.1 -1.3 15.3 19.2 11.9 22.9 34.8 343 Feb 13,000 31,422 37.416 0.0 25.7 -1.3 12.6 10.6 25.6 30.5 34.7 Mar 14,000- 41,139 39,253 7.7 30.9 4.9 5.7 10.8 31.7 30.3 35.7 Apr 14.000 42,000 44,242 0.0 2.1 12.7 6.0 102 30.5 32. 31.6 May 15.100 42,0W 47,731 7.9 0.0 7.9 20.0 92 25.5 . 289 31.6 SounrWorld Bankcak ons a. Kicv parld zmadzkct tion rate and the official rate tells ie same str, but The state budget deficit, which had been as in even starker tems (figure 3.1). Another indicator wide as 18 percent of GDP in 1992, fell to 3.5 per- of developments in the real exchange rae, the month- cent of GDP (cash basis) in 1993. One-shot mea- Iy wage in the state sector in U.S. dollas, fluctuated sures accounted formuch of the reduction. Revenue tbroughout the period April 1993-March 1994, but increases came almost entirely from the taxation of around arising trend. Convertd at the parallel mar- inflationary gains, which contnbuted to the serious ket exchange rate, this monthly wage increased decapitalizationof entprises. Spending cuts were from an average of $12 in the second quarter of largely ad hoc, leaving some items untouched (price 1993 to $21 in the first quarter of 1994 (table 3.2). subsidies) and slashing others down to bare bones Loose financial policies are to a large extent (investment). Dii addition, taking expenditure arrears responsible for the high infladon. Monetary policy (mainly on salaries) into account put the deficit at 7 has generally played the passive role assigned to it percent of GDP on a commitment basis. under the Soviet system. Total bank credit rose 19 Progress on structural reforms has been slow, percent a month during January-May 1993, a some- proceeding in fits and starts. In 1992 and 1993, the what slower pace than in 1992, but then rose to 40 govemment moved to liberalize a number of prices percent a month between May and September. Most (nonessential consumer goods), but reimposed a of the increase represented govenmment support to wide range of controls thereaftr, from administed state enterprises (and collectives), especially in coal prices on a few key items (energy goods and munic- and agricultue, indicating that monetary policy was ipal services) to limits on retail profit margins and being used to circumvent budgetay constraints. This margins on some individual commodities and option became more difficult to exercise at the end requirments for advance notification and approval of 1993. as the central bank imposed strict limits on of prices on goods produced by "monopolies", and credit (they were relaxed somewhat by April 1994). local authorization for selected price adjustments. 68 TRADE 1IN THE NEW INDEPENDE STATES Table 3.2 Changes In the Average Wage (state sector) (in karbovanets and U.S. dollars, 1993-94) Nomfnal wage Real wage Noh*mn wage (karbovanets) (karhownets) WUSS) Date Amount Change ) Axot Change ) Offic Auction Ma ata 1993 Jan 15,175 -24.4 115.0 -56.4 20.9 17.3 na. Feb 19,240 26.8 1132 -1.6 19.8 15.0 n.. Mar 23,070 19.9 1112 -t.B 14.3 12.1 na. Apr 25,653 112 10D.0 -10.1 8.5 8.5 8.5 May 30,420 18.6 92.9 -71 10.1 10.1 10.4 Jun 58,266 91.5 103.7 11.6 15.9 15.9 172 Jul 72,000 23.6 93.1 -10.2 15.7 15.7 18.7 Aug 80,736 12.1 85.8 -7-9 13.5 5.8 11.6 Sep 196,600 143.5 115.9 35.1 32.9 119 16.9 Oct 240,188 22.2 S52 -2.4 40.2 10.5 12A Nov 307.200 27.9 75.0 -12.0 49.6 9. 11.7 Dec 793.000 158.1 1015 35.3 62.9 31.3 24.1 1994 Jan 763,396 -37 82.0 -192 58.7 30.5 20.1 Feb 760,099 -0.4 72.5 -11.6 58.5 24.2 20.3 Mar 845,990 113 783 5.3 60.4 20.6 21.6 Source World Bank calculations a- Kiv paaclf rnarlk n.a. Noc applicable The state order system (discussed later) has Resistance to fundamental dhange in economic remained important for major products (600 groups policymaking has come from several quarters. of commodities in 1993. accounting for about half Analysts of the political economy of Ukraine have of turnover in these goods), attenuating the impact pointed to the officials and politicians who favor of price signals. Large monopolies continue to "gradualism" and "state guidance" over the. dominate the distribution system and other sectors unchecked laws of the market, and to state enter- Some municipalities have begun to privatize small prise workes, fearful of losing their jobs. Some enterprises and retail outlets, but the impact ofthese have also noted the emergence of a class of rent- local initiatives has been slight. In early 1994 the seekers, who depend on an econom., caught some- central government announced its intention to where between state planning and the marketplace accelerate the privadzation of medium-scale and (see comment by 0. Havrylyslyn). Among them are large enterprises as well dietors of state enterprises and agicultmal coflec- As for the private sector, businesses are being tives, heads of trade groups, and managers of new constantly buffeted by changing rules and discre- private commercial entities formed as spinoffs from tionary decision-making. Cumbersome registration state enterprises. For exrmple, if under conditions and licensing procedures and a shortage of commer- of relatively easy access to bank credit and of con- cial real estate impede the entry of new businesses trols that keep domestic prices below maret levels, into markets. These problems of economic restruc- economic agents can obtain the financing to buy tuiing are compounded by the lack of factor mobili- raw mateials and a license to expor the opportuni- ty. In sum, little of the economy (mcluding the agri- ties for quick returns are plentiful. Moeover, these cultural sector) is in private hands at this stage. profits, whose size is obscured through underin- Ob t -Jan b < o fb b b oaooo 88 -Jan i Jan 1 9 Feb Feb- Mar ~~~~~~~~~~~Mar Apr AprI May . May | I Jun Jun C Jul C, Jul -L ; Aug 1 Aug | Se I Spl Oct. #S I Oct- '\ Nov ' /Nov- Deo Dee1' ( %|. Feb ' I Feb S Mar M LMar t Apr L - Apr | May m-ny. . 0 a0 70 TRuE rn 3T NEW INDEPENDENr SrATES voicing of exports, are often kept abroad because of substantial worsening in the terms of trade, and a inflation and restrictive forign exccha -e regula- modest shift in trade away from the former Soviet dons. Total capital fLight was estimated at roughly republics toward the rest of the world (table 3.3). At $3 billion in 1992-93. the niicro level, these trends are not always as clear- cut. The decline in trade volumes, 'hatever the Extemal Trade magnitude, may in part be accountedA for by prod- The shifting pattern of Ukraine's external trade ucts for which demand has slowed, an adjustment reflects such disparate influences as the brealkup of that is critical to thc transition process (see chapter dte Soviet Union; lax macreconomic policies that 4). Also, some share of external trade has been have supported soft budget constraints and high channeled to the domestic markeeL Notwithstanding inflation; myriad price controls thatsidestep the root the decline in trade, there appears to have been an causes of inflation and prop up a skewed structure increase in foreign economic activities by smaller, of relative prices; and a complex and restrictive trade privately owned companies. and exchange regime. Because these shifts in trade The level of trade fell significantly during parterns have come about somewhat haphazardly 1990-93. both with the former Soviet Union and rather than through structred changes, specifying with the rest of the world. Export and import vol- these tends in quantitative terms is a risky busi- umnes with the forner Soviet Union suffred follow- ness; for that reason, the numbers must be viewed ing the disintegrtion of the central planning system as rough estimates (see appendix to chapter 1). and the contraction in demand, exports dropping by In the picture of Ukraine's trade that can be 71 percent and impors by 52 percent Thie collapse pieced together from the data, three developments of the markt for military equipment hunt exports, stand out a sharp contrcion in trade volumes, a while the collapse of the interrepublic payments Table 3.3 Trends in Ukraine's External Trade, 1990-93 (milions of current U.S. dollars and percent) 1990 1991 1992 1993 Valure Tota exports 78,337 58,098 11,262 11,969 Forner Soviet Union a 64,947 49.598 5,2B2 5.669 Rest of World b 13,390 8.500 6.000 6,300 Total imports 81,990 72.517 11,925 13.885 Forner Soviet Union 66,053 61,217 6,425 9.185 Rest of World 15,907 11,300 5,500 4,700 Trade baance -3.653 -14.418 -663 -1.915 Former Soviet Union -1,136 -11,618 -1,163 -3,515 Rest of Wodd -2,517 -2,800 S00 1,600 Pesawnkge distbut-on Tal exports 100 100 100 100 Former Soviet Union 82.9 85.4 46.7 47.4 Rest of World 17.1 14.6 53.3 526 TOt imports 100 100 100 100 Former Soviet Union 80.6 84A 53.9 66.1 Restof Wodd 19.4 15.6 46.1 33.9 a. Figes for uade with th famner Soviet Union are dedved from country data and Wodd Bank staff cstimates reported in oatil curencies using official Or cmaxchangelratlfor 1990 and 1991 and ann aveage maket exchange rie ror 1992 and 1993. b. Rest of the World refers to countries outside the fomer Soviet UnionX figures are based on country data reponed in US. dollars UKRAisn A TuDE AND EXCHANGE SYvimi Sn. SInI- NCw DaRrcno 71 scheme impeded all trade. In trade with the rst of Eastern Europe (Bulgaria, the Czech Republic, and the world, export volumes fell by 51 percent and Slovakia), but it has also found new markets for its import volumes by 69 percenL The production and exports-mostly raw materials-in Asia (Cbina). supply of exports were affected by the breakdown Changes in relative prices and a collapse in in central planning, the absence of market institu- investment demand throughout the former Soviet tions to support external trade, and continued weak- Union appear to have influenced the composition ness in trade with Eastern Europe following the col- of Ukraine's trade. Machine-building and con- lapse of the CMEA. Inports fell as incomes aidd smmer goods have shnmnk as a share of exports to output shrank and foreign exchange was in the former Soviet Union while ferrous metals extemely short supply In contrast to the general have expanded. There are indications that raw slide in trade, there has been a tremendous expan- materials and metals also have inmreased as a pm- sion in barter which may have accounted for more portion of exports to the rest of thc world. Trends than half of total exports by early 1994. on the import side are more difficult to gauge. Oil As the prices of energy imports (mosdy from and gas products dominate imports from the for- Russia) moved toward world levels2, Ukraine's mer Soviet Union, but account for very little of tenms of trade with the former Soviet Union deterio- the imports from the rest of the world. Beyond rated. Despite a large drop in energy import vol- that the picture is murky. Little information is unies, the share of gas and oil imports in current available on whether the bulIk of imports from the prices shot up from 75 percent of total imports in rest of the world consists of consumer goods or 1990 to 29 percent in 1993, or from 10 percent to equipment and spare part& about43 percent of imports from the former Soviet Union. Though substantial, the contraction in the Trada Regime volume of energy imports was smaller than that in Trade policy has been cast within the vestiges real GDP, and in both 1992 and 1993 the energy of central planning, with its emphasis on supply of intensity of the Ukainian economy increased, a goods that exist to this day in Ukraine. A key fea- reflection of the lack of structural adjustment in tme of this approach is administrative control of y. domestic prices (and the consequent isclation from The direction and composition of trade also world prices) which is considered necessary to pro- underwent a number of changes. In 1991 interre- tect living standards by ensuring that basic goods public trade accounted for more than four-fifths of and services are available at low prices and to sup- total trade; by 1992 one half of all trade was with port state enterprises by providing inputs at low countries outside the former Soviet Union. To some prices. And because the resulting domestic prices degree, this shift was an illusion, a reflection of the are often lower than world prices, producers have a valuation effect of the sharp real depreciation of the strong incentive to sell abroad3 The authorities, ruble against hard currencies. (The ruble was the concerned that domestic shortages will become domestic currency until Ukraine pulled out of the more severe, have focused trade policy on measures ruble zone in November 1992.) In 1993 the former to neutralize the pressures aring from the dispaty Soviet Union's share in total trade climbed to in domestic and world prices. From this perspec- almost 60 pernL tive, exports are essentally a means of financing Russia is Ukraine's single most important trade the minimum required level of imports. partner in the former Soviet Union, a legacy of its Though there have been many changes to the position as the principal market for Ukraine's trade regime in the past three years (boxes 3.1 and exports to the fonner Soviet Union and a reflection 3.2), the system remains highly intricate and limit- of the growing importance of energy in Ukraine's ing, characteristics that often work in favor of the imports. According to partial data, Ukraine contin- new class of rent-seekers. At times, the changes ucs to trade heavily with its former partners in have been lime more than tinkering and at others, 72 TwnE i ma Naw bireurr STATs Box 3.1 Status of Foreign Trade and Exchange Regime, June 1994 Export tax None. Quotas Cover 104 goods or about 30 pmerent of total export value; obtained through stats orders, state contracts, or at quota aur- tons. Licenses For goods under quta. Import mestakrts TamiSs Inial stndard rates of zero to 50 percent. with most in the 0 to 10 pemnt range. Some Food and alcohol products, tobacws, furs and leather, and jewelry ase subject to rates ranging froin 60 to 350 percent imports of manubfcured goods not produced locally ae exempt Ucense Restricted to a few goods an safety and enrWronmental grounds. State bual Major partner counties Fomer S at Urmon (mainly Russia). BLdgada. Czech Rapublic. Slovalda, Hungary. Romania Turkey. Ian. Mongolia. M4 rcwYndffes btded undaragmenmu wU countisa ofe formeSo Union Exports Ferrous and nonferrous mtals. chenical poducts, maffcine- bulding products (or example. combnes,r motors, pumps. cables. loconoives), fibers and texble treads, meat and dairy products. sugar, vegable oD, salt Imports Petleum and natural products, wood prducts, rolled ferous metlas, cherki prducts. Forein -ww AegiMe Surender reqLmments 40 pemnt of foreign exchange earnhgs to be surrendered to te govemmentatthe offidal mte (b 1 6,500 per U.S. doar and kib 8f. per nule as of June B. 1994) and allocatd by te Terxder Commit (at te ofidcal exchange mte ior pdodty impots); 1 0 percent of eamings to be surendered to the Natonal Bank of Ukraine at an adnisered rate of kib 25.000 per U.S. dolar for the buing up of offkial reserves. remairehg 5D percent may be kept In foreign eixchange accounts or sold at weekly auctons measures tilting toward trade liberalizaton have al and indusal inputs) and thosethat a not (man- been taken together with measu representing ufactues). In the former case, a strict system of greater control. For example, while detailed quotas controls, anchored by licenses, and variously con- were being specified for exports, legislation adopted sisting of quotas, a specia regime, and expor taxes, in late 1992-ely 1993 initiated the move to a has sought primaily to maintain domestic supplies, framework that would view the world outside though some quotas have been inposed in response Ukraine as a single entity; in principle at least, a to EU restictions on products from Ukraine (select- number of trade regulations apply uniformly to the ed threads, yanms, and fabrics). A presidential former Soviet Union and the rest of the worlid. decree of May 5, 1994, has substantially narrowed the sope of export controls. In the later -case, for- Export Regime mahities are much less onerous, with no license Export regulations distingish between goods being required. However, for al goods, the foreign that are considered vital to the economy (agricltur- exchange regime presents the main obstacle to- .~~- UKRAiNE A TRADE AND ExcHANGE SysrEm Snlu SEriNG DltRECnoN 73 exporting. Exporters are required to surrender half (foreign) buyer, the government can bring pressure to of their export earnings at a fLxed exchange rate that bear on the pmcess; it has close links with large state is much lower than the market rate. enterprses, and in the final analysis, the price is Quotas. The system of export quotas applies to approved by the Ministry of Foreign Economic major agricultural commodities, raw materials, and Relations (see section on licenses). The exports are intermediate goods. The quotas are determined as paid for through normnal banking and interstate clear- part of the material balances drawn up by the ing channels. As with state contract, the government Ministry of Economy together with the branch min- offers-though it cannot always deliver-a variety istries, in this exercise, the overall volume of of incentives to the producing enterprise, including exports (and imports) is derived from estimates of preFenred access to critical inputs, tax breaks, subsi- output and consumption of priority goods. Export dized credits, and customs privileges quotas, which are used principally to fulfill bilateral Firms can also purchase export quotas at auc- trade arrangements (discussed later), are then allo- tions organized by the Ministry of Foreign cated up to the level established in this way. In con- Economic Relations since April 1993. While this cert with theMinistry of Economy, the branch min- mechanism provides an opportunity for increasing istries allocate the quotas to tie enterprises-gener- the share of new entrants in exporting, its effect has ally those under their control-that sign state con- been limited by the small volume of quotas up for tracts and state orders; a very limited share of the auction. According to the directives that first set up quotas is available through auctions. the auctions, lists of commodities and amounts to The list of products subject to quotas has be auctioned were published in the mass media changed on several occasions, getting shorter each twenty days before the auction. The asking price time. Under legislation adopted on December 17, (in U.S. dollars) started at the. level of the export 1993, the quota list covered 240 goods equivalent to tax and was gradually reduced until the lot was almost two-thirds of total export value. The decree sold or the state's reserve price (reportedly, half the of May 5, 1994, removed more than one hundred export tax) was reached. Quota payments were in products from the list, which now covers about one- karbovanets at the central bank exchange rate ot third of total export value, the day. After administrative costs of the auction Under the system of state contracts introduced were covered, any remaining revenues were chan- in 1993, an enteprise agrees to deiver to the state a neled to the budgets of the local administrations in commodity for export meeting set specifications the areas where the quota purchasers resided. and quantities. The government, for its part, under- Quotas could be resold freely, with any profits takes to allocate critical inputs to the entaprise going to the enterprise. New directives of Febuary through its centralized allocation system.4 The gov- 7, 1994, changed the quota allocation system to ermnent guarantees p.yment for the final prodi'et- cover only unused regional and enterprise quotas and finances the purchase (at the domestic price) rather than a set amount and barred firns from sell- through the state budget The export earmings are ing quotas. That changed again in the decree of channeled to the foreign cmuency account of the May 5. 1994, which specified that a set share of the Ministry of Finance at the State Export-Import total quota was to be earmarked for sale at the auc- Bark of lkraine. This system is increasingly being tions; a new mechanism for determining the auc- used for exports to countries outside the former tion price (given that export taxes have been abol- Soviet Union and has become the sole source of ished) was not elaborated. hard currency in the budgeL "Special Regine " A special regime was intro- Under a state order, an entrpise is directed to duced in December 1992 for expcrts of strategic supply a commodity to an enterprise outside Ukraine products. One year latet, the list wvas pared down to within .the context of bilateral agreenments. Although coal, am.monia, ethylene, benzoL methanol, mineral price is negotiated directly beween the seiler and the fertilizers, and ferrous metals. Exports of these 74 TRADE IN THE NEW INDE ENDsfr STATE Box 32 Staes In the Evolution of the Foreign Trade and Exchange Regime, 1992-94 Expons Expott taxes January 11, 1993 Export taxes set at 5 pecent (for manufactured goods) to 30 percent May 20.1993 Permission given to export goods under quota by paying an export tax, usually 30 percenL December 26. 1993 Al export taxes eriminated. Quotas March 22.1993 Comprehensive quotas covering 390 products published. December 26,1993 Quota coverage reduced to 285 goods, or about 60 percent of export value. but quotas become binding as export taxes a- abolished. May 5,1994 Scope of quotas narrowed to 104 goods. or30 percent of export value- Specil reghkne December26, 1992 Exports of stratgic goods placd under special regime requiring approval of Cabinet of Ministers. December 26. 1993 List of strategic goods shortened; export restrictd to five authorid aorganzatons in each sector. May 5.1994 Special regime abolished and replacad by quarrly aucdons of quotas. Ucenses January 1993 Lkenses applied to all exports except manuatrers. May 5.1994 Licenses required only for goods exported underquota; one-year limiton general tsenses removed. itparts Tarffs January11. 1993 Taff structure adoptd, with sltndard rates of between zero to 50 pewrcet mosny in the zero to 10 percent range. June 23,1993 Selected goods xemnpted frm importtariffs May3, 1993 Tadffs raised on certain goods (60 to 100 percntforfood producs, 200 to 35D percent foralcolol, 200 pnert fortobaccos, 150 percentforfurs and leather). Quotas December26, 1993 Quotas introduced on meat mi%, and dairy prducts, foodgWins, fats. sugar. machinery and equipment and ferrus metls to go into efect on March 1. 1 994. March 4.1994 Moratofium imposed on quotas. May3,1994 QuoCas formally eliminated. Foreign exdane reke- Surender reqtirernents Septemberb22. 1992 Surrender requirement reduced from 100 percent to 50 percent, and compensat- ed at central bank auticon exchange rate. August 12.1993 OffIal exchange rate fixed by Cabinet of Ministers and National Bank of Ukaine introduced and appled to 50 percent compulsory surrender requinet adjusted at intervals sbrting at lab 5,970 per US doarin August 1993 and reaching krb 16,500 in Jue 1994. January 1, 1 994 Surrender requirement mocriled. with 40 percentof foreign exhange earnings to be surrndered to govermnent at official rate and 10 percent to the National Bank of Ukraine at an administered rate (lab 25,000 per U.S. dolaor); remaining 50 per- cent to be kept in fbreign exchange accounts or sold exclusively tD the central bank at the adrrdnistered rate. February 25,1994 50 percent of foreign exchange not surrendered r ay be said at auctn Foreign exchange markets September 2Z, 992 Weekly auctions of U.S. dollars by National Bank of Ukraine inited; administra- live restrictions apply. March 16.199M Weekly U.S. dollar auction expanded fron 6 to 40 barns. April 16, 1993 Weekly aucdiors of Deutsche marks and Russian rubles establised July 21. 1993 Uaaine Inteebank Curncy Exchage auctions replace centrel bank auctions. Novemberg, 1993 Ukaine Interbank Currency Exchange closed. Febnuay 25,1994 Central bank autons of US. dollars. Deutsche marie. and Russian rubles resume; Ukraine Intebank Currency exchange reopen for auctndo Belrus ruble and Kazakh tenge. UKAINE A TADE ANm ExcHmGE SysnEm STLL SEEDNG DIRECnON 75 commodities required the approval of the Cabinet Export rares. New export taxes ranging from 5 of Ministers upon the recommendation of an inter- to 30 percent went into effect in January 1993. The ministerial commission. In 1993, enterprises wish- rates were in principle set so as to capture half of ing to export strategic goods were subject to elabo- the difference between domestic and world prices. rate screening covering everything from date of Because domestic price controls, combined with die establishment and ownership of the enterprise, to real depreciation of the karbovanets, had left many current economic acdvities, fiancial records for the prices well below their world market level, the ratcs previous two years, and the balance sheet approved were expected to allow anple profits. A few of the by the State Tax Inspectorate. In 1994, the regula- tax rates (selected fertilizers, ferrous metals, tires) tions were initially amended so as to strengthen were reduced in May 1993, reportedly because of control over export prices and hard currency eam- complaints by some exporters that the raIes were ings Thus only five organizations in each sector- too high. selected by the branch ministries from a list of In the past, these expor taxes though a serious twenty organizations kept by the Cabinet of burden on exporters, injected some flexibility into Ministers-had the right to export underthe special the quota system. Instead of seeking to obtain an regime; most of them were state foreign Trade orga- export quota, enterprises and traders could export nizations. Subsequently, the decree of May 5, 1994, goods subject to the quota regime by paying an abolished the special regime, replacing it with a export tax, usually assessed at 30 percent In 1994, system of quarterly auctions of quotas. The quotas -ll export taxes were eliminated, but the quota sys- are to be sold at auctions in which any organizaon tem was maintained. As a result, the quotas have may participate. At the same time, however, enter- become binding on exports. prises cleared to export strategic goods could no longer choose to pay a 30 percent tax that feed Import Regime them from the quota imits (see discussion of export Imports come under a simpler regime than taxes, below). exports, perhaps because domestic industries Licenses. Licenses are used to control export receive considerable protection from a highly quantities and prices. Until recently, they spelled out depreciated exchange rate and chronic shortages of the lowest acceptable price for the export goods foreign exchange. In January 1993, an import tariff established by the Ministry of Foreign Economic stucture with a relatively narrow and modest set of Relations, taking into consideration world prices. rates was adopted. There were no nontariff barriers Now, they incorporate the actual contract price, except for the requirement that products meet safety though it is still subject to government approvaL All and environmental standards. This system came exports except manufaures used to require licens- under some strain at the end of the year. when es, but as of May 1994, licenses are required only quantitative restictions were briefly put on the for exports of commodities under a quota Requests books, but overall, it has retained a fair part of the for licenses must be handled within thirty days of original outlines. More damaging, perhaps, are cur- application to the Ministry of Foreign Economic rent foreign exchange arrangements that cross-sub- Relations. A general license is issued for exports sidize key imports (enerry, agricultural inputs). under state contracts and state orders and may also This mechanism shields smte enterprises and agri- be issued to firms by an independent decision of the cultual units from market-based prices, thereby Cabinet of Ministers. Otherwise, single licenses contributing to the misallocation of resources in the only are awarded for specific tansactions. Licenses economy. may be denied if the required documents are not The import tariff does not draw a distinction properly presented orregisterl te goods would be overall between the rest of the world and the former exported at a price below that established by the mi- Soviet Union. In the initial legislation, m'at goods - istry. or the quota on the good has been exhausted. cary taiff of zero to 10 percent A small number 76 TRADE N mE NEW INDEPEJDBlE STAIS of goods are subject to tariffs of 15, 20, or 30 per- months later, the decree of May 3 formally elimi- cent (for example, the 30 percent tarff applies to nated import quotas In addition, imnport licenses for certain fabrics and textiles), and the tariffs on some goods subject to quota and for a variety of other alcohol and tobacco products are 50 percent. products were abolished. Licenses were retained Preferential tariffs (normally zero) are extended to only for a few goods, to meet safety and environ- goods from least developed countries as classified mental concerns by the Generalied System of Preferences and from countries that enter into a -customs agreement" or Bilateral Agreements create a -special zone" with Ukraine. Concessional A network of bilater agreements has been put rates (often 2 or 5 percent) apply to goods from in place in an effort to rebuild trade iinks with the countries with which Ukraine has negodated most other states of the former Soviet Union and Eastern favored nation trading status-the new states of the Europe and to ensue a supply of critical inputs to former Soviet Union and twenty nine countries domestic producers. It also dovetals with the sys- located prinarily in Western Europe and North tem of export controls, in paricular quotas, that is America, as well as developing countries that do used to fulfill Ukraine's obligations under the not qualify for preferental mtes. Goods imported in agreements. operations fulfilled under stale contract or state In 1993 and 1994, Ukraine signed bilateral order are exempted, as are a variety of raw niatri- agreements with the fourteen other states of the for- als and intermediate goods (many of them are iely mer Soviet Union; it has simil arranigements with to be under some form of state control). Tariff several countries in Eastern Europe (including exemptons for imported inputs incrase the effecave Bulgaria, the Czech Republic, Hungary, Romania, rte of protection for fal goods, and thu tend to and Slovakia) and the developing world (India, induce a shift to these goods; they also have a nega- Iran, Mongolia). These arrangements account for the tive effect on fiscal revenue. bulk of Ukraine's tade The agreement with Russia The decree of May 3, 1994, eliminatd tariffs is the most importantf The 1993 agreement with on a large number of manufactures that are not pro- Russia is typical of such agreements except that it duced domesfically. At the same tume, import duties covers more products than the othes The bilaesal were increased on a variety of consumer goods and arangements include three categories or lists: foodstuffs.5 Tariffs on some food products were obligatory, indicative, and enterpiso-entprise. raised from 10 or 20 percent to rates between 60 The obligatory list is a descendant of the percent (sunflower seed oil) and 10) percent (boiled planned interepablic flows and transfers of the sausage), and those on alcohol and spirits from 20 Soviet Union-many of the same agencies and staff or 50 percent to 200 percent (beer and wines) and are involved. The obligatory list, or intergovern- 350 percent (vodka); duties on tobacco were raised mental bart, specifies the most critical commodi- by 4to 200 percent. As a result of these changes the ies in trade between Ukraine and Russia. Exports tariff stmcture has no doubt become more widely from Ukraine, covering 140 product categories. dispersed, reflecting the special interst of certin come mainly from machine-building and metal industries and enterises. working, the chemical and petochemical industries, Inport quotas were iwroduced on paper, but non-farrous metalurgy, and agriculture. Inports are not in practice. A December 1993 resolution of the more concer.trated, consisting of 75 product cate- Cabinet of Ministes placed quotas on an aray of gories, mainly petroleum and gas products and goods (meat, milk and dairy products, foodgrains, chemical goods. Each country is obligated to fulfil fats, sugar, machiery and eqtupment, and ferrous this part of the agreement Ukraine does so through metals and parts thereof), an arrangement that took a variety of arangements (basically an,ything that effect on March 1, 1994. Three days later, a mora- works), mainly state orders and staWe contracts. torium was issued on import quotas, and two Oboligatory list trade is supposed to balance; he two UxRAmE A TRADE AND ExcHAx SYsraEM sTh SswNG DOzREN 77 countries negotiate prices and volumes in advance egories. Bit most ofthe trade in value terms between with the objective of balancing trade-in other Ukraine and Russia is in the first two categodes words, a sort of mini-clearing system. Prices are In addition to bilateral agreements, Ukraine has denominated in U.S. dollars and are supposed to signed free trade agreements with Belarus (1992) approximate world prices. In practice, some prices and Rnssia (June 1993). Under the agreement with are negotiated; for example, energy products Russia, goods are to trade at world prices, free of imported from Russia and sunflower oil exported t export and import taxes. Trade in key commodities, Russia have been priced below world levels, such as energy and petrochemicals, machine-build- Recently, the imporepnces of energy products have- ing products, and sugar, is excluded, covered in a been rising rapidly, and oil prices were close to separate waiver. The agreement also specifies that world levels by the beginning of 1994. It is quite wade can be halted if there is a severe domestic possible that the prices of Ukraine's export goods shortage of a good or a severe balance of payments have increased more slowly. deficiL The free trade agreement does not apply to Indeed, tde estimates in table 1.9 suggest that the system of bflatal trade, so probably covers by 1993 Ukraine's terms of trad vis a vis otber only 10 to 15 percent of the flows between Ukraine countries in the former Soviet Union bad deteriorat- and Russia. (Some Ukrana officials estimate that ed by 112 percenL This compares to a hypothtical it applies to less than 5 pclentL) deterioration of 13.8 percent tht would have been Though these bilatal arangements were cxpeced if 1990 trade was conducted at world developed to alleviate trade and payment difficul- prices. This would support the conclusion that by ties among the new independent states, they have 1994 the bulk of thc terms of trade adjustment had fallen considerably short of their goaL Trade taets occurred, that wade was basically at world prices ar frequently u1nmet, pardy because price contrls and net subsidization by the major trading partner, reduce export incenives and pardy because the sys- Russia, had ended. On the other hand, evidence tem of state orders is weakening and firms lack crit- regarding the prices on which obligatory list trade ical inputs. A more general problem is the uncer- between Russia and Ukraine was to take place in tainty about how to setde trade imbalances. 1993, suggests that, at least on that portion of the In May 1993 Ukraine and Russia signed an trade, some Russian subsidies continued. As e :,sult agreement coverng 1.05 trillion rubles (R) of debt of the terms of trade shift, in 1994 Ukrine .;accum- incured by Ukraine to Russia during 1992 and the lated large arreas on its trde with Russia, and first quarter of 1993; this debt was converted into a Russia consequently reduced deliveries of oil. US$25 bilion state debL6 Russia extended an addi- The indicative list covers more commodities: tional cdit ofR 250 billion in 1993 to pay for gas 229 groups of exports and 40 groups of imports. imports; this debt was trnsformed into a state debt These commodities also reflect the latte of trade of US$203 million. Throughout 1993, Russia inter- that prevailed in the Soviet Union The indicative mittendy cut off gas supplies to Ukrane because of list specifies the maximum amount or quota that debt arears. B2t, with the trade deficit mounting, wil be licensed for export to each country; there is these are at best stop-gap measres. Ther has been no state obligation to supply the amounts liste Each some discsion that Ukraine might lease some oil government undertakes to lice exports up to the and gas facilities to clear its debts to Russia. quota amounts provided hat agreements are reached at the enterprse-t-eteprise leveL Exchange and Payments Systm Individual enteprses ae responsible for the terms Ukraine's external trade bas been seriously of the sale, including price and credit arrangements. impared by a complex set of exchange egulations Al remaining products may be freely traded and a breakdown in the payments system with the betwee enterpnses Products can be traded in more former Soviet Union. The pinitive foreign than one list; for instance, oilis traded in all three cat- exchange surrender requirement which tax exports. 78 TRAwD IN Tll NW IND1 'DENT STATE and cross-subsidize imports, represent the major late more foreign exchange to pay for imports of hurdle to stronger export performance. oil, gas, and lumber. Under regulations issued on August 12, 1993, 50 percent of hard currency and Foreign Exchange Surrender Requirements ruble earnings7 had to be converted and deposited Though restrictive overall, the administative in the Prominvestbank (the government's agent control of the foreign exchange system has at vari- bank) at a fixed exchange rate set by the Cabinet of ous times been loosened ortightenecd With the intr- Ministers (krb 5,970 to the U.S. dollar)fi In addition, duction of the foreign exchange decree of February the Ukraine interbank currency exchange, which had 5, 1992. high taxes on exportrs and the full surren- replaced the central bank auctions, was closed in der of foreign exchange were imposed. Some November. Under new directives in January 1994, months later-against a backdrop of great strain in 40 percent of forcign exchange eamings wcre to be the financial policies of the ccrntries of the former surrendered to the govermnent at the official rate SovieL Union evident in Russia's decision in June to (krb 12,610 to the U.S. dollar as of December 2, bar foreign entities from obtaining foreign exchange 1993)9 and 10 percent to the, centrl bank at an on the Moscow Interbank Currency Exchange and "administered rate (lIb 25,000 to the U.S. dollar as in Ukaine's withdrawal in November from the of December 29, 1993). Firms could keep the ruble zone-the National Bank of Ukraine began its remaining 50 percent of their export earnings in for- own weredy auctions of U.S. dollars in September. eign exchange accounts or sell them exclusively to The central bank established official exchange rates the central bank at the admiistered rate. At the end for the karbovanets against the Russian ruble and of February 1994 controls were once again relaxed. the U.S. dolar. exchange rtes for the bandung sys- The central bank foreign exchange auctions were tem were determined separately on the interbank resuned, and rmained foreign exchange earnings markeL Although these rates were all market based may be sold at the auctions- The National Bank of in principle, there were important divergences in Ukraine remains the only seller at the auctions, practice between the official and banking rates, and however, and buyers may bid only on the basis of even greater spreads between these rates and the pre-selected import contracts. The Ukraine inter- paralel markec rates. Enterpnses responded to this bank currency exchange also reopened its doors; system of high taxes, multiple exchange rates, and but only for auctions of the Blarus ruble and the negative real interest ratt by keeping their export Kazakh tenge. earnings abroad or engagng in barterade. The foreign exchange arrangements have a In response to these developments, a new for- direct bearing on the import regime. The Tender eigr exchange decree in March 1993 substantially Committee, a group of twelve government repre- liberaized the exchange system. Firms still had to sentatives establshed in November 1993, meets repatrate all their foreign exchange earnings to weeldy to allocate the foreign exchange surren- domestic commercial bank accounts, but they only dered to the govermnent to imports of key com- had to surrender half the proceeds (less any modities; these generally: cover energy supples amounts needed to service foreign loans or repatri- (imported by the State Oil and Gas Committee), ate profits) to the interbank auction within five days lumber, and agricultural inputs, iLe. imports that of repatriation. The foreign exchange surrendered do not compete with domestic production. In was blocked at an acCoUnt in the firm's commercial effect, the committee decides which imports to banc and sold within five days at te interbank auc- subsidize by providing foreign exchange at the tion, and the karbovantsi thus generad were tans- of fcial exchange rate_ ferred to the enterprise. Later in the year, the government again changd Iterstate Paymerns ystem course, and over a period of several months it intro- For the most pat, the intese payments sys- duced administatve controls designed to accumu- tem has been in disarray since the breaktip of the UxcRAE A TtAnE AND ExcHANGE SysTE SmL SEmcI3o DNtEcnoN 79 Soviet Union. During 1992 interstate trade was set- Overview of the Trade and Exchange System tled in rubles. All payments were channeled The costs of the government's economic through carrespondent accounts at cental banks. policies are high even when measured against the Delays of up to two to three months in clearing pay- government's own objective of reducing adjust- ments ordes and Ukraine's withdrawal from the ment costs during the tanmsition. The combination ruble zone made a new fonn of settlement unpera- of unrestrained financial policies and limited tin. Strting in November 1992. payments were stuctural refonns have fueled high rates of infla- cleared through corTeondent accounts at commer- tion without preventing a massive decline in out- cial banks; after January 1993, the correspondent put or eradicating unemployment (which is sin- account at the Central Bank of Russia was used ply hidden). Trade and exchange restrictions only for importing key commodities, such as oil and have failed to ensure price stability4 provide ade- gas,under interovmentalagreements. quate supplies of goods to industnes and con- Since the end of 1992, lkrainian commercial sumers, or stabilize the exchange rate on a sus- banks have been able to maitain conewpondent tainable basis. These policies have kept the econ- accounts in rubles (and in karbovantsi since omy largely divorced from the interational price February 1993) in Russian commercial banks, structe and ill-prepared to adjust production in and Russian commercial banks have been response to changes in relative prices, such as allowed to open corespondent accounts in karbo- higher oil and gas prices. And by isolating the vantsi in Ukrainian commercial banks. A economy from technological pmgress abroad, Ukraihian enterprise wishing to buy Russian these policies havre hurt the country's competi- goods (say, at a price of 1 million rubles) can go tiveness- All this has made it more difficult to to a Ukainian bank to get rubles The bank wilI expand exports and undertake efficient import negotiate the karbovanets price of 1 miion rubles substitution. The consequence has been large with a Russianibank or attempt to buy the rubles trade deficits and economic imbalances. at the foreipg exchange auction of the National Almost three years after independence, the Bank of Ukraine. If the price is acceptable, the external regime reflects many of te old premises of Ukrainian importer initiates a payment order that the Soviet era, despite innumerable amendments allows the Russian exporter to be paid in rubles intended to modify the traditional system. The gov- through the Ukrainian bank's correspondent emment has abolished the regisaon requirement accout with the Russian bank for taders, given enterprises a more direct role in These channels offer greater flexibility and foregn trade, reduced the number of xports subject speed in trade activities !ban previous arrange- to quotas, allowed price incentives to exert a greater ments. A few of the larger banks in Ukraine and influence on trade patems, and begun to apply uni- Russia mainai multple corrsondent accounts form regulations to trade wit e hard currency ara for this purpose and claim to be able to process and countries of th formei Soviet Union. Despite transactions in the days. However, the underlying the numerous changes-which, by their very num- markets remain weak, and there a reprts of long ber and frequency, generate uncrtainty among delays in obtaining rubies in- Ukrae. he Russian taaders and theirforeign partners-th trade regime ruble is classfied as a "first currencf and is subject retains its reliance on administrative controls. to the same surrender rules (at a rate of krb 7 per Several featums of the extenl regime stand ruble) as convertble currencies under the foreign ouL Frst, the trade ielations exist in larg part to exchange system Reflecting the strong demand for bolser domestic price controls. On the ewport side, rubles, the auction excange rate dereciated from quotas artificially d output to domestic madkets, an average of krb 1.6 per ruble in January 1993 to keeping domestic prices down in the short run and krb 17.6 in December 1993 and krb 20.5 at the end supporting industries that rely on cheap inputs of ofApri 1994. agicultual goods, raw eis,and intenediater 80 TRADE IN THE NEW IDEPENDENT SrATES goods. On the import side, tariffs protect inefficient industries. Hence, thc authorities' fear that liberaliz- domestic producers by keeping prices high enough ing prices and giving more reedom to enterprises for them to survive. Second, govemments rather will aggravate monopoly exploitation may be over- than markets determine a significant portion of drawn if trade reform is carried out at the same trade flows through quantitative restrictions, state time. Other gains would come from the transfer of contracts, state orders, and bilateral agreements. marketing know-how, improved information on These interventions prop up the traditional system product lines, and innovation. of trade and reduce the cffectiveness of market To succeed, trade eform must be accompanied forces. Third those mechanisms also benefit cor- by measures to bring about structural adjustment panies (mostly state enterprises) with close links to and stabilize the economy. Just two sets of policy the goverrnment and its administration, at the measues are emphasized here, price liberalation expense of small-scale and private sector activities and macreconomic stabilization. The former and at an additional cost in resources devoted to would bring incentives in line with a more efficient unproductive rent-seeking activities associated with allocation of resources. It would also eliminate the trade controls (lobbying, smuggling, and evading need for adminstrative controls over trade, which tariffs). Fourth, the array of quantitative controls are designed to keep goods flowing to the domestic discriminates against exports. marke Th later would serve to break inflationary Cunrent foreign exchange arrageents hurt all expectations and stabilize the exchange rate at a exports (ncluding manufactured goods and those more reaiistc level, which would the provide undertaken by the private sector), limit transactions ccarer price signals to producers, reduce pressures that are settled in hard curency and rubles, encourage for export controls and taxes, and facilitate imports- baTrtrade, and spur capital flight. The use of mul- In other words, without strict financial policies tiple exchange rates whereby exporters receive less designed to reduce the budget deficit and limit cred- than the market exchange rate on the 50 percent of it expansion on a sustainable basis, efforts at hiberal- foreign exchange that they arc obliged to surrender izing the trade and the foreign exchange regime is a form of taxation. High inflation and delays in would be ineffective, overtaken by an inflationary settlement add to the burden. As a result, much less spiral that would erode Ukraine's competitiveness foreign exchange is available at auctions now than i thLe interational marketplace and encourage cap- in late spring 1993, furher constrining imports and ita flight and the dolladzation of the economy. putting downward pressure on the exchange rate, Trade ngulations should be simple and neutral in their impact, ie. they should avoid benefits that Reformn Issues yield different incentives to different producers and Economic conditions in Ukraine are gave in trade Straightforward nrles that are easy to under- no small part because of the trade and exchange stand have the addtional advantage of opening up system The governent needs to move quicldy and to public view the vested interests opposed to trade decisively to turn conditions around. Measures to reform, which could restrict their maneuvering foster openness in trade could also address some room, and of enabling reformers to oversee and key concxr s of the authonties. liberaizig cxports monitor refonns more easily- would provide incentives to enterprises to maintain The objectives and strategy outlined above production and employment at higher levels than suggest the following policy measures as the core of they otherwise would be. The adhitional foreign emenal reform over the short to medium term exchangj earmings would expand the capacity of the economy to import, easing domestic shortages. Foign Exchange Regime Opening the economy to imports could contribute * Esblish an imebmnk cumtcy market open to generadng competitive pressures that woud crb to all registered banks, with no restrctions the market power of highly monopolized domestic on bidding. UIWNE: A TAE AND ExcHANGE SYSTEU STLL SEEKN DiETON 81 * Unify aie exchange rate at the market rare. procure the export goods and distribute the Regarding the overall public finances import goods through market mechanisms. (including off-budget operations), is move In additon, there are issues that will have to be would cause expenditues to because e addressed over a somewhat longer period of time. government would have to buy foreign These relate to the growdt of trade finance and the exchange at the market rate, but it would me of tle financial system in suppoing tade, the also lead to an increase in revenues because lin between foreign investment and export pro- the government would eliminate subsidies motion, the role of the Government in export infor- on imports and sell its foreign exchange at mation and marketing, acs to Western markets, the market rate. As a general principle, the membrship in GAIT. and, in general, the develop- authorities should avoid efforts to mobilize ment of manufacted exports.'0 financial resources through measures that distort trade, relying instead on expanding Notes dne zsorce base by linitng tax exemptions 1. Thlese figures overstate t dmp in output snce they do and reinforcing tax administration. not cover the rapidy expanding lunofficia eonany. Eliminate tbe allocation offoreign exdcange 2. Calculations of the terms of tadt art sensitive to the choice of bas year, and they are sriously compronised by through the Tender Committee. tl poor wi g of Ukrainan eVcpon prices and tc inoom- pecov f tradeancidons. As aresu esmates of Eporsi the detiato ind terms of tade with Mhe Io n Soviet Union in 1991-93 vary widely, rangig from about 10 per- * Abolish all quotas and licenses for exports cnto in 40 pwmtl in line with domestic pnice li zation. 3. Uklnd ofics hot staed tha a gDod many daonstc * Improve the mechaism for limitn exports ycus waee ac=aly higherhan wdd pncesbycad 1993. to quot-constained mars, such as te EU. 4. Accrding to a decree of Januy 22, 1993. twenty-trne Instad ofexport taxes, the government could grus of commodites ar centrally alloed. Entpses must purchase all odr ps neded to met ste obFb- auction quota rigs, which is equivalent to dons dtrogh commercia indiaris Ietting competiion determne diexport te S. The new duties am rprtdly payable in bovani at th official rate (about oneatird af die parall mark rate as Imports of My. 1994) while the imported goods are to be sold at * Abolish any remaining li s -domestic prices calculated at Jie exchange rate on the paalS let m aker, thereby reducing he im paof the duty. * Provide for any domestic protection in a & Principal is to be repaid quartiy and in equa amounu transparent manner (and on a limied basis) over he six years 1994-1999. Int paymnt, also quar- through a uniform and low tariff dudy. are at LIBOR (or six-month U.S. doUar deposis) plus - tone pertage point on the US. dolar equivlnt of the debt lbe pelq rt on debt service es is LIBOR plus OtherMeawres two percentage points Debt sere may be dicharged in In a second stage, the following complemen- c ontedae of orpmbes equity in reacl prevty. - ~~~~~~~~~~~~~mg ona dw daw of pament or as c qq ina reial p ropety. tayr measmes can becde to tke reform agenda: - t. - t 7. A 100 pacent suwender requiement on ruble eanings * Elimin t state order system, and reduce was imposed in August but was relaxed in practice in the number ofgoods understate couacts tD3 a short list of commodities ess al fr thA nuer of enterprs wee exempted frm the sut- government's own - s. - der req_;met akddig to th distorions in export paten -For xampe, the Government grand an exemption to the * In tasctions with the countries of the - ". tob y andcd .~~~~~~~9 Tb mw nca D, t1=a ue 94 former Soviet Union, promot enterPrise-tol- 9 sb 16.00onJune8. 1994.. enterpise twn1 Eimit the coveae of bUt- 10. In June 1994, Ukaine signed a Partnership and - eral agreemts to a few utidal o - Coopeaion Agreement with t EUI, which sets out general ielin for future COopDon, indug te pospect of a : - tic andwAtbinfth textofthesecagreements, - llf-eetralde urea. Comment on "Ukraine: A Trade and Exchange System Still Seeking Directon" Otek Havrylyshyn Le Gall's fine paper provides an early yet comprehensive look at Ukraine's extenal trade tendencies since independence. It is essentially correct in the judgment that trade policies are the result of a search for a third way between capitalism and a The discuion of energy prices and terms of command economy. Indeed, trade policies trade seems to present a paradox. Energy pnces axe a good example of the crucial tenden- rose about five times faster than oder prices, yet cY in Ukraine's politcal and economic energy imports fell less than GDP and enea inen- thinking to define a third way a opriate sty (necessay) increased. Le Gall aributs this to Ukraine's "unique" siuation. ,, st. . to a "lack of structural adjustmentY' Perhaps a dif- dent of Ukrainian issues today must ferent way of puttmg it is that the government's become fa.ffiu with this tendency, and a wiligness to increase effective subsidies to ener becomplae familiarit this tendencarty, y,ers (bY credit emissions) may have more than good place to gain tis famliarity is in a fottemofraesck recent eition'ofPoliffca Thoug4whc compensaed for the terms of trade shock. recent edition of Political Though, which mTere is an interestng political economy devotes special attention to the "third insight in the comment about how the tariff suc- way."' tme has become more reflective of tbe interest of Let me make a few detailed comments and specific industries and enerpse Eariier, Le Gall suggestions before noting some crtcal, over- noted that export protection is more prevalent than looked iss I hink that the discussion of the ups import protecdon. as is typical of the early ransi- and downs of the tade regimfe, the heart of the tion phrse. ibis pattern has been recognized by paper, would have benefited from an accompany- many writers on the subject, and some of them have ing schematic presentation to complement the predicted thatas tings sette down, more tradition- tex-something in te iit of the "regulation al import-pm will ge. L Gall's index" t Kaufman (this volume) a Of arlc about import tariff trends in Ukraine makes course, t wil not be possible to achieve the quan- a similar poinLt tification needed for an effective exchange rawe Le Gall desibes the process of intergovern- type of masure, but tere should be some effort to mental barter between Ukraine and Russa. What give a flavor of the de-gree of restrictiveness and terms result at the end of ffie day from such barter is protectiveness of the system, and to highght any crncial in deteiing t effective tems of trade. specific tdCI But the ocess is far fom transpr COMMOENT ON "UKCRA A TkADE AND EXCHANOE SYrat SuLL SEwnGo DnRECnone 83 Consequently, it is difficult to be certain about the entice potential beneficiaries to lobby vigorously to terms of trade or the effective price of energy and maintain the trade regime that yields such benefits. so it is difficult to judge claims that Russia no Put simply, this means strong lobbying pressures to longer subsidizes Ukraine or, as some Ukrainians keep the wedges between world prices and domes- claim, that Ukraine could be subsidizing Russia by tic prices large, and to retain the system of licensing being forced to accept "prices" for its bartered that permits these wedges to be exploited. There is, exports that are much further below world prices of course, no need for Le Gall to write a second than are the prices for energy imports.2 I would not paper on the political economy of Ukraine's trade bave expected the paper to sort out the contents of regime, but this phenomenon ought to at least be this black barter box, but then I read the tantaizing recognized in the paper, especially in the few phrase "World Bank cluations suggest!" If such attempts made to explain policies. calculations are reliable enough to be mentioned, Indeed, one such explanation that Le Gall notes they ought to be explicitly shown in the paper (with is the need to protect the living standards of the appropriate qualifications on range of error, of popuation through low prices. Ihis brings me back course). This is too importnt an issue to not use full circle to my fist comment on "the third way."I every piece of available evidence, suggest that the debate on the '"tird way" is a con- Let me tun finaUy to a more substantive criti- venient intellectual facade that allows for the devis- cal comment the paper does not once mention or ing of policies that benefit rent-seekers. The fact even hint at how trade policies may be influenced that rent-seeking elites in many countries around by the interests of rent seekers, how the accompa- the wodd have, throughout history, engaged in con- nying capital flight (which is surely fed, in the structing such facades of "protecting the popula- main, by such rents) affects the accuracy of trade tione only goes to show that Ukraine is not even statistics. This seems an obvious topic for the dis- unique in its "third way." In fact, Ukraine is not cussion for two reasons: it follows natumlly from even unique among the formerly centrally planned the rich economic litet on wade regimes, and it economies. For most of them today, it may be less is clearly a major characteristic of all post-Soviet instructive to ask "how to reforn" than to ask "why societies, to an extent that may exceed its manifes- are reforms delayed." rations in other developing countries. Some quick The is a beguilingly simple answer: powelaf arithmetic hints at the (possibly) enormous magni- economic elites do not want to reform, because the tude. The middle range of casual estimates of in-between world after planning and on the way to cumulative capital flight from Ulaaine for 1991-93 market capitalism is ideal for them. As central com- puts it at $8-10 bilion, or 12 to 15 percent of GDP. mand disappeared, there was a new autonomy for Casual estimates for Russia of $25-30 billion give the old Soviet "ptriarchs" (directors of enterpnses, slightly lower but similar GDP ratios of 10 to 12 state-fars, local leaders). At first thcir communist percent Compare these numbers with casual esti- background discredited them, and the expected mates for Mexico in the mid-l98Os of about $20 reform measures-privatization, opening up of for- billion, equivalent. again, to about 12 to 15 percent eign markets for competition, slashed subsidies- of GDP; for Argentinatde numbers may be as high threatened their elite status. In countrics where as 40 percent of GDP. reform measures were quickly undertaken, mem- But in a short three years, Russian and bers of the elite who were not pushed aside were Ukrainia rent-seekrs have achieved in ably forced to begin to behave roughly blke competitive more han thei Latn American counterparts did in capitalists. In counties that delayed-reform, these as short a period. Even if these are wildly over-e- old elites -along with some newcomer-had time mated and the annual capital-flight values turn out to transform themselves into a new, monopolist- to be on dte same order of magnitude as in Latin capitalist elite reliant on state financial support and America, that is still a big enough Eldorado to privileges - - Q . . .~~~~~~~~~~~~~~~~~~~~~~~1 84 TRADE IN THE NEW INDEPEDENT STAMES The in-between economic arrangement is work, to sort out the efficient capitalists from the straightforward. The state provides budgetary sub- inept; in a competitive environment, it often takes sidies and cheap bank credits allegedly to keep the only one generation to go ftom riches to rags But economy going and people on the job. This anrange- it's a big if and a questionable one, because allow- ment leads to inflation and provides the directorate ing competition would mean wholeheartedly pursu- with continuing patiarchal influence and the funds ing the thrd change, liberlization. While the ren- to engage in side operations (through "commercial"- tier-patriarch elites might eventually consider the spinoffs fram the state factory), such as pudasing first two steps to be in their interest, it is a stretch of cheap titanium, magnesium, or petroleum; obtain- the imaginaton to believe they would ever consider ing licenses from their old-boy colleagues at the in their interest a liberaization that closes the lucra- Ministry of Foeign Economic Relations; and sell- tive price wedges and that results in competition in ing these commodities abroad at a tidy profit The trade that removes their monopolistic privileges. result is mnaterials shortages, corruption, capital There are two ways to cut this Gordian knot. flight, new affluence fora few, and popular discon- One is to establish an economy that is privatized, tent Popular discontent is partidally quieted as pat.- but monopolized, and bigbly regulated by goven- archs fulfill theirneoful obligation, ensuimg that nent Were that to happen, we would be likely to workers havejobs and some privieges (bealth care .;ee-as we have many times in LaIn America and vacations, somc consumer goods) and are paid Africa since the 1960s-not a single succsful sta- enough to srvive as before. Discontent neverthe- bilizadtion effort, but radter a series of failed efforts, less finds a outlet in wodrers' behavior "you pre- becau th necessary liberalization ofmadcetactiv- tend even less han min Soviet times to be paying us, ity is not in fact undtake As in Argentina, the and we pretend even less to be working." The crisis may become so doep that eventually societal result: even more absenteeism, even less producliv- consensus for full reflnm and ltibaltion can be ity, even less production. More worrsome for the expected. The second, and better way, is through future is that new investent in production capacity bold political leadesip that rcognzes the nature is not taking place, since commeial tade opera- of the dilemma and-despite personal political risk tions are far more profitable. -acts quicldy to implement ibazation measures La therc a chance that the elites will come to that remove the economic icentives and oppomtni- real that they are kiling the goose that lays the ties formonopolistic lobby-group actdvitica golden eggs and become proponents of reform? A We should work toward and hope for, the bet- slim chae but only fo parilrefor, which may tsrscenario, but we shoud be pepred fort first not be enough. Consider the thee major changes the grm reality of a long freez of the transition that are needed financial stabilization, privatiza- process in cormtries that missed the carly opporu- tion, and market liberalization. At some poiit, the nity to move forward qmcldy and, thereby, gave a eliteswllcuzeg thatsivcapcreditand "new-old" elite the chance to hijack reform and subsidies cause inflation, which in the long run mold it to their own interests. hurts even die new capitalists by eating away at the - production poeni of the economy. Some effors Notes at fiscal and credit restraint are tbem lklely. Very 1. Political Thought (Poitychna DuWka 2. 1994), is a soon-in some cues already-the new capitalists biingua publicaton of the itt of Worid Eonmy will se that privatizon of even larg-scale state [IoIWdoiw Reo, Iyiv. enterprises is in their interests because it can, of 2. The econoat logic behindtis amet is th Rusia, course, be ogizeW so that they becom the major a mopoly spir Of crtcal aU ha, of cou the stroaga position. shareholdes. Fair or unfair, this would be good for the economy if tre competitio we allowed to 4 A Firm's Eye View of Foreign Trade in Ukraine Greta Bull A enterprise-based perspetive is useful in understanding the factors influencing the foreign trading regime in Ukrine during a period of rapid change. This chapter presents such a perspective using the results of an extensive enterprise survey conducted in Ukaine in early 1993, intrviews with the sur- Iha i DsVt eyed enterprises, and observations by the author on institu- * Changes in Distribufion:| - Patterns tonal development The main conclusions of the analysis are: * The Mafia and Government * The sta distnbudon system is not fulfilling its intend- Licenses ed functions of ensuring the delivery of key strategic goods, such as fuel and other raw matrials on a com- * Paerms of Trade and lhe petitive basis; nor is it leeping prices stable through Increasing Iniportance of. adminstave price setting; or preventing mafia Unrecorded Transactions involvement in the distnrbution of basic goods. which tends to price vulnerable groups out of the markt As a * Expanding UnoFffcial Trade inraigytkgondsibin result, fhms are mcreasmgly takig on disnbution functions themselves, either direcdy, by investing in * Obstacles'to Trade distibution entities, or by contacting with prvate *I Profile of a Successful - intennediares. So many pdvate entepreneurs are now Producer involved that a large enough number of entrants would be ready to take over to ensre adequate compedtion * Conclusions and were the system to be officially pivaizd." Recommendations *While there is no disputing a serious drop in trading volumes, the size of the fall has been overestimated 86 TRADE IN THU NEW INDEPDENET SrATEs because official government statistics are selection process). Because the characteristics and unlikely to capture smuggling, personal behavior of the two groups varied significantly, imports, imports of goods of little interest they are analyzed separately. to the Ukrainian government (particularly The average producing enterprise in the sample consumer goods) or the activity of private employed 580 people and had been in business. for a traders, who have entered the market in the little more than fourteen years. By far the largest past thre years. There are good indications enterprise in the sample was a holding company in that private firms and black marketeers Kharkov-its primary activity was identified as have increased their trade activity, which production-that employed 100,000 people.1 The suggests. that the collapse in trade has average trading enterprise employed 68 people and indeed been overstated. had been in business for almost three years. E Enterprises considered the breakdown of Producers were more likeiy to be state owned the banking system as by far the most sed- than were traders and were also more likely to be ous obstacle to wade. Yet, this perceived leased or collectively owned7 two common ways of obstacle was really a symptom of larger "privatizing" state property in Ukamine (table 4.1). problems that reflected the growing diver- Traders, on the other hand, were rarely state-owned gence between Ukraine's market and that and had greater concentrations of privat ownership of te ruble zone. Although purely mechan- than did producers. ical problems played a part, other siguifi- The=sample yielded tirty purely state-owned cant underlying factors were distorted enterprises, twenty-five of them producers and five prices, high inflation, and interenterprise taders (table 4.2). These enterprises ae referred to arreas. Other frequently cited obstacles to as state enterprises under the narrow definition. trade included the inconvertibility of the Seventeen more enterprises (eight producers and karbovanets and the instability of the legal nine tKaders) with mixed ownership forms clssfied system. themselves as state enterprises by juridical status. * Enterprises responded differently to the Since the sample of state enterprises was so small changing trade environmenL Those that particularly for trading companies, a broader cate- adapted best were more likely than not to gory of state enterprises was determnined on the be traders, to be smalL to pmduce or trade basis of the juridical status of firms. Fimns with the in consumer and other "light" goods, to be juridical staus of "state enterprise" or "other. were less dependent on interrepublican trade, to classified as state-owned since they were likely to receive less direct government support, to share characteristics typical of state forms of own- make greater use of direct sales and inde- ership such as greater age, larger numbers of pendent distribution networks, to have more extnsive contacts with oversea mar- Table 4.1 Ownership Structure of Enterprises in the Sample Populaton, February-May 1993 kets, and to have shifted from shrinldng (percent of enterprises) Soviet markets to oter mnarket areas. Ownership Producers Trades Enterprise Profiles ~ s a 5 The survey, conducted in four cities from mid- 1 weyowned aI 3 1 00% pnivaty ownd463 February to May 1993, covered 341 enterprises: 78 100% Colleive ownership 10 4 in Kharkov, 114 in Kiev, 75 in L'vov, and 74 in lot% Owned by other enterpdses 2 5 Okdess Slighty more than half (178) the enterpris- 100% Leased 8 I es were identified as primarily "taders" and the Mixed ownership (indudes remainder (163 enterprises) as primarily "produc- foreign owners) 18 24 ers" (see appendix for survey methodology and Xoo prcent of owneip shresbongdtots A FIRM's EYE View oF FoumEIN TbDE IN UKAINe 87 Table 4.2 Distribution of Firms by Ownership Type as of February-May 1993 Nafnfo Narrow Broad Brd Producer Trader slate private state nonsta Number of flrns 163 178 30 187 6S 2748 Ageof lrnm(ears) 14 3 40 2 33 2 Number of employees 580 68 1,940 47 1,348 77 Percentages Stateowned 17 4 100 0 -46 1 Prlvatelyowned 53 69 0 100 11 74 Leased 9 2 0 0 23 1 Colleclive 13 5 0 0 16 7 Other 8 20 0 0 4 17 Total Io - 100 1iao I - 1o 1W a. Two finns in the smple rfused to idcat eir sw . Sam= Authoes survey employees, and high levels of "state,' "collective," Stateowned producers were more likely to and leased" ownership. Entrprises with dte juridi- report trade with Russia than were non-state produc- cal status of "joint stock," "cooperative'" "joint ven- ers; they also reported more extensive contacts with ture," limited liability," "small enterprise" "part- partners in other countries of the former Soviet nership," and "sole ownership" were grouped as Union than did the other groups (table 43). nonstate enterprises because they were more likely Trade with Russia, Belarus, and the Baltics was to be structured as small, privately owned enterpris- consistently reported as occurring regularly, while es. These broader categories are generally used in trade with Central Asia and the Caucasus was seen comparng state and nonstate enterprises, as increasingly unreliable. Although past trading In many instances, there was little distinction patterns clearly influence current paterns, it seems between the behavior of producer and state-owned that enterprises are reoienting themselves toward enterprises or between that of traders and nonstate markets on the basis of proximity, relative wealth, enterprises. In generaL then, this report does not and political stability. distinguish between these groups except when there are significant differences between thenL Figure 4.1 Percentage of Enterpri_s Reportng Internalional Trade by Major City Major Trading Partners All survey participants had engaged in trade 1 outside of Ukraine at some point in the last three 0.9 years, eiter within the former Soviet Union,3 0.8 abroad, or in both market areas. Trade within the 0.7 . 1 ' 0.6 ~ A * boundaries of the fonner Soviet Union was, not sur- 0.5 prisingly, more common, with 92 percent of the 0O4 sample reporting such ade in the past tbree years 0.3 * * - and 62 percen reporting tade with the '"ar abroad." 02 i jI l AU enterprises in the survey reported high lev- 0.1 * . . I els of interrepublican trade over the past thee 0 years.4 As expected, enterprises in Kharkov were far . 5 less likely to have overseas trading contacts than 3 enteprises in any other city (only 35 percent report- ed); Odessa enterprises reported just the opposite U FormerSoviet m RestofWorld (figure 4.1).5 Unon 88 TRADE IN nTE NEW INDEPENDENT STATUS Table 4.3 Primary Trading Partners, 1990-93 (percent) Producers Traders Trade Parher Average State NonrSiate State NAnsSte Russia 8g 100 ag 89 87 Belarus and Moldova 50 91 48 53 40 cau a 22 65 17 21 13 -aJUcStites 42 80 39 *53 32 CentralAsiab . 28 76 29 16 16 a. Gera Arma, and Azebaijan b. K1.aldMwn Kyrgyz Republicb Tadjidstma, Tu nistn nnd Uzbedstan Source Ahorsesurvey Tabe 4A Goods TraWd and Produced (percentage repwfing) Traders reportng tfde In: % Producem rport productn oat Consumergoods 82 Consumer goods 68 Saerlcesitefleclun property 46 Servieslhtlectual property 39 Industria/alf-lnished goods 36 lndusIaYhaIf-finlshed goods 23 riculture 29 Aglicultr a 6 Equipment 24 Equipment 23 Chemicalsraw materials 23 Chemlcalslraw matfas 5 Fuels 19 Fuels 2 Woodipaperproducts 9 Wood/paper products 16 BuDding materials 19 Balding materiabs 14 a. The low propotion ofagriculturul activity eflects te urban bias ofthe simpke most fod prcessing plants are located in rual Soure: Autoes survcy Outside fte former USSR, the most commonly cent). Although taders no doubt purchased some of reported trading partners we Eurpen ex-mom- these goods as production inputs for thei own par- bers of the Council for Mutual Economic Assistance ent enterprise, trds are moving them in such lap (CMEA)fi The top five tading pamtners wit the rest quantities as to strongly suggest that traders play a of the world fortde sample as a whole were G 7many? significant role at the wholesale level as middlemen Poland, the United Stes, Bulgaria, and the Czech and for produces. Traders' involvement with chemicals Slovak Republcs. Other top tading parters were and other raw mateials, equipment, and fuels also Hungary, Austria, Italy, Israel, and China. Overseas tends to support this view. trading partners were located as far away as Although it may seem surprsing in a country Austalia and in as diverse places as Argentina, 'known for its lack of consumer goods, nearly 70 per- Gibraltar, Singapore, and Zimbabwe. cent of producers reported manulctuing consmer goods. It may be that in recet years producton enter- Goods Produced and Traded -pses have shifte at least small panu of tbeir plant to For traders, the two most commonly traded the production of conser goods, malking it more items were consumer goods (82 percent of traders lrikyytbatproducersw lddreportn&ingftm, reported sales) and services and inteectuld property no matter how smal a share of total prducton. (46 percent), both of which are loosely regulated (Prdwucs were not asked to describe reative proper- "goods" that do not require high levels of capital tions oftot plntdevoted to ewh item tey produced) investment or long-term cost recovery, making them attractive to small, relatively young trading compa- Changes In Distribution trn nies (table 4.4). The next most commonly traded Some analysts havr argued that the state distri- good was industrial and half-finished goods (36 per- bution system should be kept in place in a truncated A FIRR's Es Vmw oF FoRasn TUsm iN URAINE 89 form until a private distribution system evolves to At the wholesale level, sales and purchases take its place in ordor to: need to be considered separately. On the sales side, Help ensure the delivery of key strategic survey intenrews suggest that the state system is not goods, such as fuel and other Taw maten- functioning competlitvely. Producers are avoiding als, to provide continuity dining a difficult the state distribution system when they can either by transition. selling diecty to end users (pesumably because they get a better price than by selling through an inter- * Help keep prices stable under the system mediary) or by selling though private rather than of adminisiaive price setting. state intermediaries (table 4.5). Enterprises reported * Keep the mafia out of the distribution of selling 80 percent of their goods in Ulkraine and 73 basic goods, to prevent pricing vulnerable percent of their goods to other countries of the for- groups out the market mer USSR directy to end users, either dtrough retai oudets or to other production enterprises. Producers Our interviews indicate that the state system is made a surprisingly high percentage (11 percent) of not fulfilling these basic functions, particularly at sales in Ukraine directly to consumers through their the retail level. In both retail and wholesale trade, own shops and kiosks, which suggests growing firms are increxasingly taking on distribution func- i inretaitade.Te reman- dions themselves, either by investing in new distrib- ing goods were sold through intermediaries. both state ution entities or by contracing with private inter- and privately owned. Entrprses used stat interme mediaries. So many private entrepreneurs are diaries for percent of sales in Uaie and 5 per- involved in distribution now that if the mtem woe cent of sales in other countnies of the former Soviet officially "privatized," there would be enough Union and nonstate intmediaries for ll perent entrants ready to take over the state's role and ade- sales in Ukraine and 19 percent sales in other coun- quate competition to prevent the exercise of monop- ties of the former Soviet Union. oly power by any single piivate company. On the purchases side, the State Committee for Materal Resources (SCMR) has privileged access Pnvate Altematives to State Distbution to raw maerils through the system of state orders The anecdotal evidence makes it overwhelm- and stte conts, iuhasing raw materials (mnclud- ingly clear that the private sector is capable of ful- ing energy imports from Russia) at below-market filling deliveries at the retail leveL while the state prices and distibudng them to favored producers at sector does not appear to be performing as welL The similarly low rats Despite the priileged position abundance of goods at the local farms madus, pri- of the state distribution system, an alternative vate shops, kiosks, and the bazaar at the Republican ditribution system has emerged, even in the pro- Stadium in Kiev 8 and the nearly emptY shelves in curement of "strategic goods." Although govern- state shops speak eloquently of the private sector's ment-allocated supplies of cheap raw mateials are performance advantage. 'rice stability," implement- undoWbey attractive to quaying entepses. new ed through star acquisition of goods at below-mar- enrants to the procrement market could compete ket pnces and limitations on price markups. has led with government suppliers in the reatively large to shortages and rationing in the state shops. W-ith market of firms with no access to te cheap raw goods either unavailable or rationed through queu- namras and firms unable to meet their full needs ing, the low prices ame meaningless. And since state with the limited supplies provided by this system. shops are turning increasingly to imported goods Traders appear to be heavily involved in supplied by private entrepreneurs they are passing wholede trading Thirty six percent of traders on "commercial" (non-ontolled) prices to their report trade in industrial and half-finisbod goods, 24 customers, regardless of the government's atempts percent n equipment trade, 23 percent in chemicals at price control. and otber raw materials, and 19 percent in fuels. 90 RADE IN Tim NE INDEENEN STATs Table 4.5 DIstrIbutIon of Enterprise Sales (percent) In other countdes of te In lUkane fowner Soviet Unor, Average Producers Traders Average Pvders Traders Company-owned store 15 11 18 3 6 0 End user, state 37 46 29 41 52 31 End user, nonstat 29 26 31 32 22 41 Subtomi. direct saes 8t 83 78 76 80 72 Internedl6ry, sate 9 10 a8 5 5 6 Intanmediazy, nonstate 11 8 14 19 15 22 Subtotal. lndirectsales 20 18 22 24 20 28 Note: Percentas may not Lo 100 becaus of rounding Somu: Audrs suIvey As is the case with sales, poducers increasingly were massive privahization of the distribution and diversified teir prhasing activities in order to find procurement system to take place. Indeed, survey secure lines of supply as the state distribution system respondents ranked the mafia as one of the weakest weakened. Fully 85 percent of producers inter- obstacles to trade both within and outside the for- viewed reported reguly engaging in "trade/com- mer Soviet Union. Although the mafia is likely to merce" in addition to the production described as be more of a tra at the retail level domestically. their main activity, most likely because trading was respondents felt that it was a threat that could be becomng essental for ensurng production inputs. handled- A number of survey respondents even Asked for the main remason for declining production, remarked that they preferred dealing with the pri- 23 percent of enterprises that experienced such vate mafia over dealing with the 'government" declines blamed rgular deliveries." mafia (bureaucrats responsible for issuing licenses Many enterpises are establishing private affili- of various sorts), noting that one generally got axs to address key infrastructural needs formerly something for one's payment to the private mafia handled by the sate. More tn three out of four sur- (protection, retail space, and the like), while pay- veyed firms had at least one investment in another ments to the govemnment mafia simply removed an company in ULkaine or in another country of the obstacle to productive activity. former Soviet Union, suggesting that entprises are The government's role as guarantor of strategic taking stakes in other finns to help ensure the deliv- goods creates an environment ripe for corruption. ery of inputs (table 4t6). Several producers also The license conveys an economic rent that provides repord foning their own ting companies-sepa- an incentive to "lobby" government officials. It was rate from the firm but with a subsmntial ownership widely belieed among respondents that the "gate- share-to sell the enterprise's goods and help pro- keepers' for export licenses are generally able to cur inputs for production and consumer goods for provide camfortably for themselves financially The the entpise's employees. The large investments by alternative to navigating the complicated and producers and tders in reta space (both kiosks and expensive foreign trade bureaucracy is smuggling shops) and in tading companies are further evidence There was evidence in the survey data that some of a shift away from the state distrbution system. respondents had resorted to smuggling. The Mafia and Government Ucenses Patlems af Trade and ie Increasing hprtane That so many entrprises are providing their d Unrecorded Transaos own distribution services and trading independently According to recent estimates (table 1-2 in this suggests that the mafia would have difficulty cap- volume). Ukrainian exports (imports) to the other tuning enough of the market to pose a serious dre newly independent states in 1993 may have becn as A FiRE's EYE VIEw oF FoRsamN TRDE IN UnWNS 91 low as 28 (48) percent of their value in 1990 (see countries of the former USSR, and the rest of the table 1.2 above, based on constant rubles); and world). Producers were asked for trade shares at the Ukrainian exports (imports) outside of the former time of the survey and three years previously; Soviet Union in 1993 only 47 (30) percent of their traders were only asked about current trading pat- value in 1990 (table 1.1). Although the results of this tems since most of them did not exist three years survey generally echo ihese declines, the survey also ago. Next, enterprises were asked to describe confimed dtat official daa are likely to overestimate changes in trade activity as measured by changes in the decline. First, the enterprise surveys used to the number of sales and purchase transactions in the estimne intenrepublican trade are unlikely to include past three years within three market areas (Ukamine, the private traders that have entered the market in other ex-Soviet republics including Russia, and the tie past three years. The survey results reported here rest of the world). To accommodate enterprises suggest that these are precisely the firms that are unwilling to discuss absolute levels of sales or pur- experiencing growth under new market conditions. chases, changes in transactions were defined in rela- Second, statistics based on customs declarations, tive terms: increased by more that 50 percent, less which are used to estimate overseas trade, are unlike- th 50 percent, or remained the same; deciased ly to include smuggled goods, personal imports, and by more than 50 percent, less than 50 percent, or imports of goods that have traditionally been of lit- fell to zero. Although straight value and volume tle interest to the Ukrinian government (particular- measures would have been preferable to such in- ly consumer goods). Trading companies, the most rect indicators, high rates of inflation, confusion likely to experience increased trade activity in for- about which cuLrency units to use,9 and the wide eign markets, trade overwhelningly in consumer variety of goods produced by any single cntepris goods and frequently use personal - imports as a made providing more concrete data prohibitively means af getting around customs regulations. 'ere costly. were also strong indications in the survey data of Trade Shores. Trade patterns among the sur- increases in black maket trade for the entire sample veyed firms shifed considerably over the fist tbree population. years of the decade, exhibitng a strong trend away from markets of the former Soviet Union and Trade Realignments toward domestic and hard currency markets (figure Changes in the direction of trade were deter- 42). Producer sales to Russia are estimated to have mined on the basis of two sets of questions. Frst, dropped from 25 percent of total sales in 1990 to 15 enterprises were asked to describe the share of the percent of total sales in 1993, while purchases fell monetary value of total sales and purchases devot- from 33 percent to 22 percent10 Trade with other ed to four market areas (Ukraine, Russia, other countries of the former USSR besides Russia, Table 4.6 Investments In Secondary FRrms (percent) Pmducesm Traders Oterouwnes of the Ofhercounis of the /amnew farmer Sot nuion lAabe fornr Sovet Union Trading companies 20 B 32 1 7 Retal outlets/kiosks 38 4 46 5 Service enterprses 12 5 14 3 Commercial banks 29 4 20 I Producton enterprises 44 1 23 B Transport 5 2 6 2 Jointventumes 26 - 0 2 0 SouceAuhs survey 92 TRADE IN HE NEW INDEPENDENT STATES Figure 4.2 Percentage of Producers' Trade by Interstate trade as a proportion of total trade Market Area, 1990 and 1993 flows has not been as important to traders as to pro- ducers, accounting for only 10 percent of total sales, compared with 20 percent for producers (figure 4.3). Purchases were more common from other 0I9 countries of the former Soviet Union, representing 0o 1X j I C m 16 percent of the total, but this was still far below 0.7 -r.:tl the 28 percent share for producersSeveral factors os - ' s help explain the relative unimportance to tradrs of 05_ markets in the former Soviet Union. Most traders 0.4 _ _ _ _ - began to operate at a time when trade with other 0.3 counties of the former Soviet Union had become 0Qt _ _ _ _logistically difficullL Also, traders found it difficult 0.1 0 _ _ _~ _ 1993 to enter these markets because of the traditional 1990 1ss3 1s50 1993 dominance of the markeLts by lamge state entities. s ~~~~prwchases such 2s the SCMR, which bad various unfair advan- *Uft I R31ssa l90"r ;Rest o .esh otr worls tages (privileged access to local raw materials, to of the export licenses, to foreign exchange, payment order processing through the central bank's cormspondent accounts in 1992, and monopoly control of trade although never accounting for a significant propor- arranged tbrough intergovermmental agreements). don of Ukraine's trde, also appears to have shrnk The lawr margins avaiable to traders in overseas considerably. particularly on the sales side, from 9 Figure 4.3 Proportion of Trdes Sales and percent to 5 pecent Puczses In Each Market Area, February-May Foflowing its introduction into cash circulation 1993 in early 1992, the Ukrainian karbovanets dropped steadily in ra value relative to the ruble.1t I Growing price differentials between Ukraine and 90 trading partners still in the ruble zone explain much 80 of the drop in the share of purchases from former 70 Soviet markets. Lower prices in Ukraine relative to prices in other countries of the former Soviet Union induced producers to tun to domestic suppliers for 50 inputs. For the sample population the proportion of 40 purchases sourced domestically rose from 54 per- so ceat of the total in 1990 to 63 percent in 1993.12 Over time, trade with Russia and other coun- tries of the former Soviet Union began to fall under 10 0 li . the same controls as other foreign trade, including 0 I 7_. the system of quotas and licensing and mandatory o ' forign excchange conversion sdcemes. Quotas and g cg 0 licensing depssed sales of low-priced Ukainian exports to Russia, while the extension of foreign ° X exchange surrender rquiments (at below-market chnge aes) to rubles fiuherinmited the legal sup- * Satls | Purchases ply of rubles available to purchase Russian imports. A R's EraYE VIEW OF FoRtIuN TRAM IN UIKANE 93 markets relative to former USSR markets also influ- number of enterprises-even among producers- enced trade shares. reported increased activity in these markets, a trend Traders operate chiefly on the domestic mar- thal runs counter to expectations, given the large ket, although they also play an important role in drops in trade with the rest of the world reported in importing goods from the far abroad (see figure official estimates. This aggregate outcome is easily 4.3). The high proportion of purchases within explained by the sizable drops in trade by lae state Ukraine suggests that traders are helping to keep enterprises wit their correspondingly large import goods moving domesticaly as centralized supply and export volumes, losses only partially offset by lines fall apart. There is no reason to believe that the increased trade of many small enterprises with traders could not play a similarly important role in correspondingly small trade volumes.- This argu- extemal markets if allowed to compete with the ment is supported by producer transaction data state trading monopoly on air terms. weighted by enterprise size (table 4.8). But even Trade actvity. Corresponding to the sizable among larger enterprises, many reported increases fall in the proportion of trade with the former Soviet in trade activity, particularly on the import side. Union, enterprises experienced large drops in the Overwhelmingly, traders of all sizes reported number of sales and purchase transactions in these substantial increases in foreign trade activity, rein- market areas (table 4.7). Roughly 60 percent of pro- forcing the claim that traders are becoming increas- ducers and traders mported decrased trade activity ingly active as middlemen in overseas markets with other countries of the former Soviet Union, (table 4.9). and 30 percent of traders reported that their trade Traders were able to increase their activities activity with other countries of the former Soviet abroad because of a general loosening of restric- Union fell to zero. Not surprisingly, decreased trade tions on participating in external trade. Although activity with other countries of the former Soviet the systm of quotas and licensing is restrictive and Union was accompanied by increased activity in tends to favor players with connections, everyone domestic markeu now has the right to participate in foreign trade- Changes in trade acivity in European and other not just the handful of large state enterprises markets ar particularly interesting. A surprising resticted to buying and selling goods through lr Table 4.7 Reported Changes In Number ot Transactions in Each Market Area (percent) Prod-cem Traders Change hi Transcos Imports Epods irtMPs Eorts Trade acvity wilth te ferSoieat Union Up 25 28 27 22 Same 16 9 11 18 Down 45 47 33 27 Down to Zero E 16 30 33 Trade acitMfyir* te far abroad Up 49 37 52 51 Same 11 12 22 23 Down 22 26 19 18i Down to Zero 18 25 7 a Trade adtviy- domstc Up 64 71 72 79 Same 16 8 12 a Down 19 21 16 13 Down to Zero 1 1 0 0 Not:: Pcnagp ma nal 100 because of ounding. 94 TRADE q TH nlw INDEPENDENr STATES Table 4.8 Changes In Producers' Overseas Trade Activity Weighted by Size of Enterprise (percent) /mpoft s Ntaerofeffopbyes Lptame Down4?e Upwsam Downore Fewerthan 250(sosfirms) 66 34 60 40 More than 250 (21 flrms) 48 52 27 73 Average 60 40 49 51 Table 43 Changes In Reported Trade Activity with the Rest of the World (percent) Producers Traders Chawe In ltrnactins IMPot Eports Imports Expors Up/same 60 49 74 74 Down to zero 40 51 26 26 state trading agencies a few years ago. By choosing was reasonably easy to evade customs officials in to trade in consumer goods and services and intel- the early days. When problems arose, it was usuaUy leca] property. which were umegulated, traders possible to "resolve" customs disputes with finan- could bypass government controls, providing fur- cial incentives to the right person?13 ther scope for trade expansion overseas. From the data in this survey, it is difficult to The emphasis on consumcr goods makes it distinguish which transactions were not recorded at likely that these transactions are unrecorded, since alL which were partialy recorded, and which were the Ulkrainian government has paid little attention to physically recorded at the border, but financed cre- consumer goods preferring to focus instead on large atively. Not all of the types of transactions dis- industral goods. Still other imports go unrecorded cussed here could consistendy be associated with because of a reliance by trading companies on per- smuggling, but it is likely that many of them occa- sonal imports. Trading companies regularly send sionally wem Each of these means of unofficial people abroad on cheap shopping junkets to buy trade would have contibuted to underrporting and goods to take advantage of personal exemptions on undervaluing of nade transactions, helping explain import duties (Bul 1994). (Ukraine's allowance for the inconsistency between official statistics and duty-free personal imports is SIO,OO. trends observed for many traders. Enterprises were extremely relucttnt to admit Expanding Unofficial Trade to unofficial trade,14 but two indicators provide The restrictive policy environment in Ukraine some idea of its magnitude: the means of payment at the time of this study would be expected to for purchases abroad or for sales in other countries induce smuggling and creative trade financing of the former Soviet Union (table 4.10) and the schemes. Q2!otas, licensing, mandatory conversion source of hard currency obtained by enterprises of half of foreign exchange eanings, a collapse in (table 4.11). Types of payments likely to elude offi- the payments system and effective price increases cial statistics-such as barter, cash payments, and for Russian goods made trading difficult business payments to offshore accounts-were frequently for anyone trying to play by the rules. At the time of reported by survey respondents for both interstate this study, Ukraine was just beginning to open cus- trade and trade with the rest of the world. (Payment toms posts with ocher countries of the former Soviet documents are part of the transaction doc.u:ata- Union and commaent by interviewees suggest that it tion required at the border.) Deals settled in cash or A ARM'S EBl! VIIW 01: IFOIJUN TRAInI IN UKRINEs 95 through payments to offshore accounts were likely eligible to establish an account in that country. to be illegal, particularly after off-shore accounts Traders, who generally had less access to official for enterprises were restricted in the spring of 1993. transfer systems in the second half of 1992, report- Barter deals were officially tracked by the ed paying for 23 percent of their purchases through Ukrainian government, but there were a number of such proxy accounts. Producers used this method for reasons why many of them might not have been 17 percent of payments to other republics (table 4.12). recorded. High taxes on barter trade in the, period The second indicator of unofficial trade activi- before the study were a strong incentive for keeping ty was the source of hard currency obtained by the deals quiet Also, until January 1993, enterprises enterprises. A surprising number of respondents were required to obtain special licenses to engage in volunteered the information-the question was not barter trade. Like other licenses, these were difficult asked directly-that they had obtained hard curren- to come by and many people bypassed them. cy on the black market. That suggests that the use of Finaly, many barter deals were not directly a illegally obtained hard currency is even more wide- goods-for-goods transaction but involved more than spread than estimated in this study. two partners; Ukrainians consider these deals to be Fims did notresort to unofficial trade solely as "clearing" arrangements and wculdd not have a means of expanding trade, although enterprises recorded them as bartr.15 that fiequently used cash or proxy payments were The proportion of transactions paid for through more likely to experience increases in trade than bank transfers, though remaining high, was less enterprise that did not But many firms, particular- than the 100 percent it would have been before the ly production enterpnses, were drivcn to barter by breakup of the Soviet Union. Even within the bank- the inefficient monetary and payments system. ing system, enterprises found creative, unofficial Thus enterprises that relied heavily on barter were ways of maling payments. For example, although it consistently more likely to experience a diminution was illegal for a Ukrainian firm to open a ruble in trade activity in both market areas, with one account in Russia, a number of firms had them, interesting exception: some taders used barter as a some having opened before they were disalowed, tool for increasing their activity in other countries some noL Producers reported making 6 percent of of the former USSR. Traders that increased their their payments to other countries of the former trade with countries of the former Soviet Union Soviet Union through these accounts and traders 4 reported paying for 37 percent of their purchases percenL Enterprises without bank accounts in the with barter exchanges, compared with 27 percent ruble zone often sent and received payments for the total sample. Thus for certain traders that through a parner's account in another republic-an specialize in trade with other countries of the for- account used jointly with a relative or tusted friend mer USSR, barter may be a tool for getting around Table 4.10 Means of Payment for External Trade Transactions (percentage of sales or purchases) Ezq,os to farmerSoviet Unin Imporb fmm the rest of he wvd Producers Traders Prducers Traders Bank Transfer 70 65 Hard Curency - Transfer 62 52 Cash (karbovantsUrubles) 8 8 Hard currency - cash 7 13 Barter 21 27 Barter 23 24 Hard Currency 1 1 Othera 7 11 Note: Percages way not teoal 100 becus of rounding a. Mostly karbovauer purchases for foreign goods. A nuber of foreign compaies have begun sdling goods in Uknc forkaub- vantsL taking a short-tem loss in the hope of long-tem profits. Source Authores survey 96 TRADe IN n1e NEW INDEPeNDEWr SrTAES Table 4.11 Sources of Hard Currency Obtained 3.9. Traders and producers were unanimous in their by Enterprlss a top three choices, although traders tended to assign slightly higher scores in all three areas than did pro- Souse Pfoduces Traders ducers.16 For trade outside the former Soviet Earned fmm sagis 76 s6 Union, the greatest obstacles to exports were incon- Purchased on aucdons 16 17 vertible currency (4.4), legal system instability Purchased fm commerdlu 24 31 (4.2), and high taxes (3.7; figure 4.5). banks In Ukraine Purchased from other 17 22 firms hIn UkrWine PurchUlased fr.m commercial7412The Banidng and Payments System Purchased from commnercial 4 12 banks in former Soviet Union The overwhelming agreement among respon- Black market 13 15 dents that the collapse in the payments system in the a. Rubles arc no incdded as - second half of 1992 was responsible for shrining Sour Authrs swrcy trade with otber countries of the former Soviet Union raises the question of whether the collapse of inter- Table 4.12 Sources of Payments Recived for state transfers was a root cause or a symptom of a External Sales In the Former Soviet Union larger problem. Anecdotal evidence accumulated over the couse of th survey suggests that the logis- Producers Trades tical inability to transfer payments to Russia and Commercal banks in Ukrane 58 56 otherrepublics was perceived as the principal factor Commercal Banks in 6 4 dimnishing trade flows with the former Soviet farmer Soviet Urdon Union at the end of 1992 and beginning of 1993, Affiiwaed rgantzaIns In 17 23 but that toward the end of the survey period respon- famer Soviet Union NaKlonal Bait of Ukrine 9 a dents wcre beginning to believe that cost was over- Other 10 18 taking logistics as an obstacle: Russia was simply getting too expensive.17 The demise of the united Sow=udtes sun banking system itself reflects the underlying cause payme-nts difficulties and li-ensing requirements. of the problem: the divergence of two once-united Since these firms specialize in finding goods thar markets that now had substantiaUy different eco- Smce~~~~~~~~~~~nn poshscmpicte bytm Russias growingoos ha others want to buy, they would have the necessary noric policies-complicated by Russia's growing information and a .izfficiently regular flow of dif- unwilligness to subsidize its exports to Ukraine The ranldng of the inconvertibility of the currency ferent tyes of goods to nibe bare worJL As spe- xn of amnssse sa aeiett cialists.in locating goods, traders with good infor- second to the payments system as an impediment to - . . ~~~~~~~~exports to the former Soviet Union suggest that mation and contacts in other countries of the former Soviet Union could work on behalf of otber enter- enteprise managers were already becoming aware prises in this market area. of the difference between the purely mechanical payments problem and the underlying economic Obstacles to Trade causes of the collapse. Survey respondents were asked to rn vanous As the divergence in economic conditions factors according to the severity of the impediment between the two markets grew wider (because they presented to trade on a scale of one to five (the Russia pursued price reform more aggressively than higher the numbcr, the greater the obstacle). For the Ukraine and had a tighter monetary policy), the sample as a whole, the collapse of the payments bankiDng system could no longer sustain a currency system was by far the largest perceived obstacle to system in which the ruble-karbovanets exchange export in interstate makets with a rating of 4.7 rate for bank tansfers remained 1:1 while the cash (Figure 4.4.). Inconvertibility of curency a43, ate was 1:1.5 (November 1992), and growing cae next, followed by legal system instability at rapidly.18 Once Ukraine exited the ruble zone alto- A FIRM's EYE VEW oP FoREIaN TRADH N UnAm 97 Figure 4.4 Raulngs of Obstacles to Export In Interstate Trade (scale of I to 5; the higher the nunber, the greater the obstade) 4.5 4 3.5 3 25 2 1.5 05 - yr hcnvels Lgal gh Ln NI N Tansprt cyatn curraucy Wstn kionTn Figure 4.5 Ratings of Obstacles to Export in Trade with Rest of World (scae of 1 to 5; the higher the numnber, the greater the obstacle) 4.5- 4 3.5 S 2 1.5 0.5 hcauiMe't11e Legal gho tame Lkens NOMd Trwwspcvt currency Irstabft ktonlm gether in November 1992, the ruble became a (siaa- time, the ruble was placed under the compusory tively strong) foreign -hcurrency.t9 Since the conversion scheme, furte rsicting the supply of Ukrainian government could no longer create non- ruble forein exchange available legary to cash ruble credits rubles were valued according to Ukrainian enterprises. Ukrainians were then forced theft scarcity price causing the prices of Russian to buy rubles at market prices or find creative goods to skyrocket overnight for Ukrainians and "unofficial" ways to finance their trade with Russia diminishing the price differential between Russia and other countries of the ruble zone, just as they imports and those fr-om the West. In April 1993 thec had begun to do in overseas markcets. Ukrainian government placed intersUtat trade under The reason for the frustration of enterprise the same quota and licensing regime as other for- directors is clear from an examination.of the dam- eign trade in order to prevent Russians from buying age caused by a combination of purely mechanical up relatively cheap Ukrainian goods. At the same banking problems, runaway inflation and interenter- 98 TRADE IN nle NEW INDEPeNDeNr STrAES prise arrears. During the second half of 1992, sur- in tle buildup of interenterprise arrears in the sec- veyed enterprises experienced an average delay of ond half of 1992. 72 days before transfer payments from other Legal System Instability, Taxes, and Other republics reached their accounis and were released Common Complaints for use. Since the Ukrainian transfer system was The legal turmoil that followed the collapse of simpy an outgrowth of the old centralized Soviet the Soviet Union made it inevitablc that firms systan, problems emerged for payments within would citc legal system instability as an impedi- - Ukraine as well, where the average wait to receive ment to greater exports. In 1992 alone, the domestic payments was seventeen days. High infla- Ulrainian tax code changed three times. Export tion aggravated the situation by inducing commer- licensing has changed radically four times sinE c cial banks to hold money as long as possible, so that July of 1991, with substantial legal adjustments occur- they could lend it out as short-tern loans. More ringbetweenthemajorupheavalForeignexchange than one enterprise described protracted struggles rules have changed continually as well. This insta- simplyo o getsalready-translred money out oftheir bility, exacerbated by the absence of a reliable ownous, because y were more likely than mechanism for publicizing changes in the law, forced businesses tc waste resources trying to keep traders to use the bank transfers system (and to use up wit te law and fequenty led to unanticipated itin lager volumes), exprienced greaterdelays: an business losses, particularly when businesses were avenge of nineteen ldays for domestic payments forced by legal changes to recalculate their taxes. and eighty-two days for producers' interstate pay- Both producers and traders ranked high taxes nents compared with fourteen days (domes.tic) and fourth as an impedikment to interrepublican trade at sixty-four days (interstate) for traders. On average, 3.2 and third for trade abroad at 3.7. There was no producers reported not having received 7.8 pay- significant difference in assigned ratings between ments-payments that should have been sent to prcC_cers and traders or between state and nonsate their accounts at some time since the beginning of enterprises, nor was there any significant difference 1992. but had not yet arived at the time of the inter- between the two populations in reported taxation view (early 1993). Traders reported 1.4 payments rates (the average was tpercent) or in the lineli- still outstanding hDod of receiving tax breaks. OnlY 28 percent of State-owned enterprises were much more lie- hdenterpises reported receivig tax breasl of any Iy to lose through the payments system than were kind (usually as a startup enteprse, ajoint venture, nonstate enterprises: 24 days for domestic payments - or for production of a good considered Important to for state enterprises compared with fourteen days the Ukrainian economy). for wonstate enterprises, 82 days for inrerrepublican Though the Licensing system has changed sig- payments compared with 68 days. State enterprises nificantly since the time covered by the survey, one were far more likely to have payments outstanding finding probably remains relevant Traders consis- than were nonstate enterprises: sixteen payments tently viewed obtaining a license as a more serious compared with one for nonstate enteprises. By the problem than did producers, giving it a 3.6 rating as time enterprises realized that there wasta an obstacle to interstate transactions compared with problem with payments, the average state enterprise 2.8 for producers and a 3.6 score for overseas sales, would have had far more payments in the system compared with 3.0 for producers.20 Similar differ- than the average nonstate enterprise. Furthermore, conwy gussig tht tey wuld ltiatel be ences emerged between nonstate and state enter- correctly guessing that they would ultimately be baied out state enterprises continued to make prnses, although less pronounced. Traders were also defiveries to Russia, even afte it becameclewhat more lilkly to be turned down for a one-time deliveries to Russia, even after it became clear t.at license for a specific good: 22 percent of traders Russian enterprises were not making payments. reported being turned down, compared with 15 per- This expectation was undoubtedly a principal factor cent of producers. A FIRM'S Ev View OP FOREIGN TRADE IN UKRuM 99 Surprisingly, the mafia consistently received Figure 4.6 Ownership Form of "Successful" and very low scores as an obstacle to export, despitc ts "Unsuccessful" Producers pervasiveness in retail trade. A likely explanation is Percent that the mafia is so ubiquitous (and the term so 60 loosely defined and overused) and the people in ULkrine have become so accustomcd to dealing 50 with the "inafia"' that it has become a regular part of the business routine and is therefore viewed as a 40 cost of doing business rather than an obstacle to trade. 30 Profile of a Successful Producer 20 il Although it seems clear that traders arc thriving . under the new economic conditions in Ukraine, the i 1111 fate of producers is less clear. Traders sprang up as * liii- a result of the economic changes, whereas produc- i . ers were more likely to be older and had to adaptto X s i changing conditions. That the old state "dinosaurs" g e . £ EL E a are struggling to survive is now widely accepted as e S ° fact, yet it is not true that all producers are failing. en From a policy point of view, therefore, it is instruc- tive to examine the types of strategies that allowed Successiul Unsuccessful certain producers to grow, and the characteristics out of the sample for the analysis of strategies of that kept others struggling to survive. successful enterprises. To distinguish "successful" enterprises from Nearly half (48 percent) of producing enterpris- -unsuccessful" ones, producers were asked to es re-ported increases in the volume of production describe how the volume of their production had over the past three years, including 30 percent which changed over the past three years (increased or expenenced increases greater than 50 percent Only decreased by more or less than 50 percent, 38 percent reported decreases in production, includ- unchanged or dropped to zero.)21 In Ukcraine's dis- ing 16 percent reporting decreases greater than 50 torted economic environment, a designation of percenL Unsuccessful enterprises were far more "successfl"' in no way implies that an enterprise is likely than successful enterprises to be large, state- profitable, it simply means that it is surviving and in owned enterprises (table 4.13), with ownership con- a position to expand production. To avoid picking centrated in forms typical of state firms, such as col- up the natual growth effects of new enterprises, lective ownership and leasing, in addition to straight enterprises under three years of age were screened state ownership (figure 4.6). The average unsuccess- Table 4.13 Changes in Production Volume in the Past Three Years for State and Nonstate Enterprises (percent) Broad defilWon Narrow definitn Change in producaon Sample average State Nonslate State Nonstate Up 48 32 67 32 67 Samek 15 16 13 a 17 Down 38 51 19 60 17 Number of enterprises 74 43 31 25 18 100 TRADE IN TE NEw INDEPENDEwN STAIES fat enterprise had 1,977 employees, compared with with 73 percent for unsuccessful enterprises. a relatively lean 709 for the successful enterprses. Furthermore, 54 percent of successful enterprises Unsuccessful enterprises struggled to maintain reported at least one investment in a retail oucet in production levels despite a greater likelihood of finan- Ukraine, compared with 43 percent of unsuccessful cial assistance from the govemment. Unsuccessful enterprises suggesting that successful producers are enterprises were far more likely than successful increasingly managing their own retail trade as enterprises to have received credits in the past year well Successful enterprises were also more likely (82 percent, compaed with 59 percent of succesful than unsuccessful enterprises to invest in trading enterprises) and to have worked under state orders companies in Ukraine and other countries of the (82 percent, compared with 71 percent). Although it former Soviet Union and in other producing enter- is clearly the government's intention that these sup- prises, suggesting a more developed independent ports should cushioa the losses of large state enter- network of supply and distribution. pnises, it seems equally clear that these "crutches" The types of goods produced probably also are not necessarily helping to encourage production, influenced the shift in sales to domestic markets. but are simply keeping people employed. Enterpnises producing large industrial goods ta A primary reason for inareasing production were part of integrated all-union production among successful enterprises appears to be their processes would have had a hard time selling geater skill at making up for losses in interses these goods in Ukraine, much less in foreign mar- sales through new sales to domestic and, to a lesser kets. The production of "heavy" goods was more ext, foreign markcets. Both successful and unsuc- commonly associated with unsuccessful enter- cessful enterprises expeenced a simlar substantial prises than successful ones, while "light" goods contraction in sales te other markets in the former were more comnonly manufacturd by success- Soviet Union of about 65 prcten But while 88 per- ful enterprises.?2 (No more detail is possible cent of successfdul enterprises reported increased bout the role played by types of goods in the suc- sales in Ukraine, only 50 percent of unsuccessful cess of the enterpnrse because the proportion of enerpises did. These shft to domestic mars do total plant deicated to te production of each not necessarily mean that enterprises will be suc- type of good was not known.) Two production cessful in the long run-there are stil too many dis- areas in which differences were significant were tortions in the domestic market to make any predic- "industrial and half-finished goods," which were tions about the ability of enterprises to stay afloat in manufactured by 20 percent of successful enter- the absence of government interventions-but they prises and 32 percent of unsuccessful ones, and do indicate that these enterprises are responding to "services and intellectua property,' which were the price signals they observe. More successfu enter- produced by 37 percent of successful enterprises prises (33 percent) than unsuccessfu enterprises (25 and 25 percent of unsuccessful ones. percent) reported increases in foreign sales as well. Although successful and unsuccessful enter- Furthermore, successful enterprise were more like- pizes had an almost identical distnrbution of sales ly to have foreign sales to begin with (57 percent) in each market area, unsuccessful enterprises than were unsuccessful enterprises (50 percent). were likely to be more dependent on imports from The shift to domestic markets by successful other countries of the former Soviet Union, rely- producers seemns to have been aided by a shift with- ing on them for 45 percent of their inputs, (comn- in Ukraine toward direct salt - :o end users-other pared with 29 percent for successful enterprises). production enterprises or retail shops and kiosks The heavy reliance on inputs from other countries Successful enterprises sold only 10 percent of their of the former Soviet Union may explain the heav- production through state intermediaries, compared ier shift to barter settlement for inurepublican with 20 percent of unsuccessful enterprises, and 85 transactions among unsuccesful enterises than percent rported direct sales to end users, compared successful enterprises A FIRM'S EYE View oF FoRIGN TRAe iN UKRAINE 101 The use of barter in interstate transactions was total sample. Furthermore, enterprises in Kharkov more commonly associated with unsuccessful enter- were less likely to receive tax breaks than enterpris- prises (27 percent of their interrepublican transac- es in any other city: 14 percent reported receiving tions) than successful ones (15 percent). Onc he tax breaks, compared with a sample aveage of 28 barriers of separate currencies and state quotas on percent. Additionally, 73 percent of Kharkov enter- ewports were erected between Ukraine and Russia, prises reported that customs procedures with other the only outlet for enterprises with no access to countries of the fomer Soviet Union resulted in loss- rubles would have been direct exchange or cash on es, whie the sample average was only 65 percenL delivery. With direct support from the state allocat- ed more sparingly (even to priority enterprises), Conclusions and Recommendations entaprises dependent on fuel and other raw materi- The private sector is alive and well in Ukraine, al inputs from Russia (once heavily subsidized) although driven underground by the hostile legal would have been able to buy only as much in fuel and macroeconomic environment. The Ukrainian inputs as they could sell in output in Russia, placing government should do eveything it can to bring the new imits on their production capacity. Sinilar private sector out of the shadows and turn it into an trends were observed in foreign trade: umsuccessfiu engine far economic growth Ther is much to gain entrprs were more likely to report frequent use from encouraging small-scale entrepreneurship and of barter in foreign trade (49 percent of overseas little to lose. An obvious place to begin to improve purchases) than were successul enterpmses (27 per- the environment for entrepreneus is trade-both cent). More than half of unsuccessful enterprises domestic and external-an area in which private (51 percent) blamed the malfunctioning payments enterprises are thriving and that many view as the system for their declining production, 23 percent only way to make money in Ukraine today. If the blamed irregular deliveries, and 14percentpolitical government allowed traders to make money and instability. offered incentives to keep it in the country and Producers in Kharkov illustrate many of the invest it, substantial private sources of capital points made about unsuccessful firms. Because of would develop quicldy in the trade secor and could the city's location near the Russian border and an form the basis of a new, privately-owned and- industrial profile of large, state-owned enterprises financed sector of the economy. tightly integrated into the Soviet system, enterpris- Ukraine would be vasdy better off without the es in Kharkov exhibit many of the characteistics of state distribution systemr Enterprises have clearly unsuccessful enterprises and were far more likely to expressed a vote of no confidence in the system, experience declining production than enterprises in shunning it except for fulfilling state orders and any other city in the samplc 60 percent of Kharkov contracts. All vestiges of the planned distribution producers reported decreases in production (includ- system need to be eliminated, including state orders ing 26 percent reporting decreases of more than 50 and conta, quotas and licenses m foreign tade, percent), compared with 38 percent for the sample the State Committee for Mateial Resources, and average (-with 16 percent reporting decreses of interstate agreements. The true economic threat of more than 50 percent). the mafia, while widely publicized, is overstated. If Both customs and taxes were consistently rated the economy were opened to widespread competi- as greater obstacles to trade in Kharkov an in the tion, the mafia would not be able to gain a monop- rest of the sample. For interstate markets, taxes oly over distibution. The mafia is larey a creation received a rating of 3.8 from IKarkov enterprises of the distorted communist economy: where private and 32 for the total sanWle; for overseas trade, the commerce was illegal, it simply went underground. ratings were 4.4 for Kharkov and 3.7 for the sample The government should stop bailing out old avrage. Tbe aveage reported tax rate was 55 per- state enterprises, a practice it can im afford. Wh-le cent in Kharkov, compared with 44 percent for the shutting the dinosaurs down overnight would be 102 TRADE IN THE NEW INDEPENDENr STAIns undesirable socially and politically, the support they from the list were interviewed briefly by telephone are receiving now is not doing them any good-not to deternine whether the firm fit the criteria even the successful enterprises which might be able required for inclusion in the survey: to survive in a market economy if given the proper * Located in Kiev, L'vov, Kharkov, or assistance in the short term. More likely the state Odessa- For logistical simplicity, only four enterprises that are succeeding are doing so because sites were selected, chosen for their size, they are changing their behavior. Behavior changes varying economic profiles, historical trade do not come about by continued state support, but relationships, and locations near difkent rather by the absence of iL borders of Ukraine. The mandatory foreign exchange surrender * Directrade relaons withfirms outside of laws serve only to chase dollars out of the country i U-nznc ar some thne in the past duee and should be eliminated If Ukraine must use mandatory foreign exchange surrender as a hard years f the firm bought or sold goods only through local intermediaries, it was currency tax, then the surrender should be at a mar-. onothconir toc haversuficient wai ket exchange rate, not at administrative levels set by nconswer theve questions and the National Bank of Ukraine- That will encourage enc tocausem the sampe. wams excluded from the sample. enterprises capable of selling their goods abroad to do so and will make it more likely that they bring In businessfor more dwta si months. the earnings from thes sales back into Ukraine. Willingness to meet witi an interviewer Finally, the foundations for any radical change for roughly thsiy minutes. A director, a in economic policy need to be clearly articulated at vice director, chief economist, or chief the national level-with authority clearly divided accountant of the firm, knowledgeable between local and national authorities-so that about its extnal economic actvies, had local authorities are made accountable for any dif- to agree to answer interview questions. ferent regional impact of their policy choices. The target number of responses was forty traders Appendix: Survey Methodology and forty producers for each city, except for Kiev, The survey was conducted from nid-February where 60 taders and 60 producers were to be inter- to the end of May 1993 in Kiev, L'vov, Kharkov, vat and Odessa. The duration of the sw'ey was limited to as short a period as possible to minimize the innnep effecs ofconsantl chaginglegilatin onTwo intenrview questionnaires were prepared, effets of consthange ing legislation onever one for prducing enterprises and another for results. Wben changes in legislation nevertheless affected survey results, respondents were asked to tade, mtermedians and other service providers3 describe the situation affecting them in the last half Although the questionnaires were similar, certain sections varied in order to reflect differences in of 1992. Two separate but similar questionnaires business prctices between producers and interme- were prepared, one for producing enterprises and diaries. Russian-language questionnaires were used another for traders and service providers, rflecting in Kiev, Kbarkov, and Odessa A Ukrainian version differences in business practices between the two of each was prepared for use in L'vov. grotTs. During each meeting, Ukrainian interviewers Sam7tpl S;election -had to decide (based on responses to section I of Respondents were randomly selected from lists the questionnaire) whether to use the trader or pr- of firms registered as participants in foreign trade ducer questionnair The following rough set of for 1992 with the Ministry of Eoreign Economic guidelines helped them decide: Relations and its regional affilines. Firms selected * If the enterprise identified its main activity A Rn's EYE ViEw OF FoREIN TRADE IN URNEA 103 as "Tradef Commcrce," the enterprise was expected in Kiev, the producer sample was com- given the trdo questionnaire- prised of largely small pdvate enterprises. If the enterprise identified its main activiy In L'vov, some interviewer bias became obvi- ous as soon as sufficient nunbers of results began aues Poductionnaire, icopedthpruer to come in-but too late to remedy-and was even- qtnely confirmed by the interviewer. To save time, * Enterpises that identified their main actvi- the interviewer identified the large industrial enter- y as `*Serwvice" '-'onsuing," sranport," priss with which she was familiar as lkely produc- or "Other" were to be identified as produc- ers, instead of randomly calling enterprises on the ern if they depended on a continuous out- list, resulting in a high concentmion of enormous side source of supply for physical inputs to state-owned enterprises among the producer sam- provide their service and as tradeslsservice ple. Traders were selected randomly from the list providers if they could easily switch sup- because the interviewer had no prior knowledge of pliers or do without a particular good and vanous trading firms, so the trader data appearto be stilmction. relatively sound. In Kiev, sources of potential bias ar less clear. Inteeniew Press There is no confirmed evidence of interviewer Local Ukrainians were hired at each site to selection bias in IeGv, where the selection and conduct interviews.24 Interviewers were requied to interview process was by far the most controlled. have no contact widt any government-related orga- And because there was more than one interviewer nization in order to mainta full confidentiality of in Kiev, any bias is likely to be somewhat dissipat- nterprise rsponses and to elicit a more candid ed. One possible source of bias, however, was the interview. Students were frequently employed as itrviwces decision whether afirm was aproduc- intrviewers 25 Interviewers we: required to gress er or a trader. Toward the end of the survey, one of that the results of the survey would be strictly confi- tie Kiev interviewers was having difficulty finding dential, released only in aggreate forn. enough quaified producers to interview to meet the Interviews lasting 30 minutes to 2-m/2 hours quota. Traders might have been identified as pro- were conducted with the director, vice dirtor, ducers rexpediency's sak, thus skewing the daa chief economist, or chief accountant of a fim The toward private ownership in the producing sector. questions wer delivered oraEly, although respon- Or, it may well be that in Kiev, the capital city and dents were offered a copy of the questionnaire so significantly larger than other cties in the sample, that they could follow along with the interviewer's the small-scale sector of the economy is simply questions. This tewcnique proved eWecially useful more dewloped than in other regions and that there in questions with a stong visual content, such as was no bias in the sample. those asking respondents to rank obstacles to export on a five-point scale. Notes This study is drawn on a longer work produced under die Potential Sources of Bias in Data Collecton World Bank's McNamara Fellowship program, entited Foreign Trade in Ubkrin A Microaecooc Arlysis- I The profiles for producers in Kiev and in m indebed toa number of people for their assistance or L'vov were radically different than expected and the course of this project Flrz for guidance in the substan- varied widely from those of the producer sample as tive parts of the paper, I would like to thank Daniel Kaufmann and David Tarr of the World Bank and a whole. In L'vov where a grat deal of private Lwrence DeMilner of the IMF for their invaluable input owncrship and forczipn investmnent was expect, dmtugbout the year. I would also lik to hnk Francoise Le GalLI Natalie Jaresco and Elizabeth Ames for maidng it the sample was made up almost enirely of large througb an exaustig fu st of tbe paper and pwviding stat enteprises, with almost no foreign investmen.L comments I am patdcuarly indebted to Andrei Hancharuk Instead of the great variety of enterprise types from the Ukrainian Ministry of Foreign Economic 104 TRADE i NHE NEW INDE DENT STArT Relaions and Trade for playing the ole of mentor dtough- industrial and half-finisbed goods (39.7%). equipment out the year and walking me through the maze of the C363%). and consuicrgoods (27.7%). Ukrainian bureaucrcy. The World Bank mission in Kiev and the McNamara Fellows program in Washington pro- 11. Average wags in dollar terms at market exchange rates vided valuable logistical support, as did a number of people increased fomm about $10 to S100 a month in Russia from at the Ministry of Foreign Economic Relations and Trade February 1992 to Febmuy 1994. while not exceeding S51 and the Ministry of Sttstics Fnally. I am deeply idebted aimonth in Ukraine (see chapter 1. table 1.7). to Anna Gordin and Natasba Nilova, without whose hard work and patience none of tNis would have been possible. 12. For overses markets canges in p on wer not and to James Hill and Brenda Juntunca, who lent consider- si>icatenwgh to draw ally conclusions. able moral support throutghouL 13. Ukraine stated implementing customs control proce- dares at borders with other republics of the former USSR 1. This value was dropped in averging since it was so on 1 Apri1 1993. By this time, according to officials at the much lager than the oodtes State Customs Commite Ukaine had opened a total of 271 borde control posts, including 57 with Russi and 27 2. Collective ownerhp means that ownership shares arec widL Belars nemMew widh Statc Custms Conuniuee. 31 held by cmployces of the company. Juridical owneshp wit B ta o m t mueas that other idical puisone (enterpnses or organi- May 19934 zations) hold shaes 14. Meaning that the transaction itself was illegal or that 3. These terms are commonly used in Ukrainc since the the mews of payment was illega or only semi-legal pro- breaukp of the Soviet Union. sed Ukmim the viding a incentive for the entrprcneur to keep the deal 'near abroad" s to counties that were once pat of the Soviet Union; the term (dal'nii zarnbezh). "far abroad" 15. This survey probably understates th reliance on barter -ees to the rcst of the word, including Eastern Europe rade. Although the interviewers took great pains to describe what was meant by a bartcr arrangement. 4. Th was some ndc t ion of interviewer bas in h Ukrainians ihad a difficult time identifying indirc pay- L'vov sampkc which may have li s ha lre of inter- metwihgosabrt.Anragmntnwicaf- stare tradr and decreased the stre of wade with the rest of mcntor win e goods as b t An acangeent in wRsih a fac- ct world for L'vov producers For a -e dctfld s send Ukraine sinu goods to a factry in Rusia, which -sin, please refer to the Append, Survy Mediodolog. in p tur sends gnto fa in Ruuranwsm R which in tbzn sends goods wto thewry in UlYkmi was no gene- 5. L'vov, as the unofficial capital of westun Ukaine, is ally coasiderd barer but rathr as a straight cash transac- geneay secn as a gateway into Ukaine from Eastern tion or as a "clearing" tansactioiL When they could be Euope- A part of the USSR only since the Second Wodd identified, such trwnsacons wer counted as barter. War. it is generaly viewed as having higher levels of entre- 1 Eggier scos wer as typical for wostate enteprs prnuri activity and foeign inrvement than cities doscr in compaison wi stal enrpise in both mkak aras to Russa. Kicv, as tWe capital of Ukraie. was expected to have a wide variety of different types of ownerip and 17. By the end of Septemnber 1992, Ukraine's debt to videspread conacts with foreign pn both in interre- Russia was so immense that the Russian govcrment sin- publican and overseas markets Khakov, which Ls situated ply forbade any further delivery of Russian goods to only 40 miks from the Russian border, is a city known for Ukraine This move forcn the Ukrinans to introduce the beavy indusay-induding many enterprs in tbe milli- karbovanets into full circulation, including for bank tary-industrial complex-and subsequently for its vcry dqosts and tranes which had prviously been valued at clos integration intD tli Soviet (especially Russian) mar- an implicit ratc of 1:1 to the ruble, although the cash keL Odessa, the largest prt city in the former USSR. is exchange rae was 1:15. Between November 12 and 16, widely regaded as an enepruril and cosmopolitan 1992 the National Bank of Ukraine orderd al commercial city. with a partcuLly strong niafiL banks to convert bank deposis w karbovauri at a rate of 6. The CMEA was the trading bloc of dte former Soviet one to one. CitiDzens were given a set period of time in Union, and included the countries of Eastrm Europe as vwhich to exchange their cash rubles for karbovantsi. wellUos a nudber of socialtst countries in Afrioe. Lan altough very few people in fact did so. as the ruble was Amelas and ASuic wort 1.5 times more than the karbovantsi by this dime. From March 1993 or', intetate transfers were to be madc 7. Eat and West Gemany combined. thrugh wcespondnt accounts hdd by Ulkainian banks in commercial banks in other countries of the former Soviet & See Bul (1994). Appcndix B, for a further discusion of Union, at an echdange rate to be detenined trougb inter- the bar. bank auctions for hard currency and rubles. The exception 9. Survey respondcnts would have had to disdoVingi not to tbis rue was payments for imnta concs, only beywesn condncy units lharbovadtsi or rublesh. but whidcwould contiue to b cleared though acounts in the only between currency uninots(karbvantusior rubIes) butt Natondal Bank of Ukrainc- To lend greater credence to its also betwee the cash and noricash values for the unit they ddcto omitiigecag ae,tegvrmn selectd dedication to maintiig ecmange ran bc govamuent began on March 14. 1993 to require that all cnterprises 10. From other countries of the fonrer USSR, producers eaning bad curency place them in accounts in banks with typically bought chemicals and raw materials (4.2%), crem reationships with Ukranian banks and that A FmM's EE VIEW OF FOREIGN TRADE in UnAmE 105 50 percent of these earnings be subject to conversion to International Monetary Fund. 1993. Ukraine - Rzcent karbovantsi at the official rate of the National Bank of Ecoomie Devlopmet. Washington, D.C Ukrainc. The hard currency generated in this trnsaction would then provide liquidity for the National Bank auc- The World Bankl 1993. Ukraine: Country Economic tions, which would in tun determine dbe maret exchange Memorandun. Report No. 10029-UA, Washington. race for hard currencies. Unregistecred off-shore hanks D.C accounts were caiminaizd by a decree of the same time period. Rubles were placed in tde mandatory convcrsion Webster. Leila. 1992. Privare Secioer fan4zfauing in regime. and the fistm ruble auctioos began taking place on a Poland- A Survey of Firms. World Bank, Industry weekly basis on 21 April 1993. Dcevlopment Division Washingon. D.C. 18. By May 1994 the diffrential had reached 1-26 and was still growing.SOUICeS for Uk.inian Laws 19- Fo -oedmie pio fdebeadw f Newspapers: Uryadovi;e Kur'yer. Golos Ukraini 19. For a mor detailed descrip.tion of the brnakown of shc K;rsrvsje Vdenioo, ufrainiv Business News, Interfax. banldng sy see (Bull). Bullei QfNoJrMave Marcial on Questans ofRe Puiati 20. Both results ze significant It a 95% confidence IvedL of Foreign -conomic Acirities of Ukrine, Mintry of For intepublican trde. M = 3-19 and (095) = 3.04 c Foreign Economic Relatons and Trade of Urine, Kiev, x c 334 and for overseas tmde M = 3.3 and 0(0.95) 1993 3.15rdoe). its party with the Gernan mark, and inflatin c. She of abor foretrci ving nmployment bieneif between mid-1992 and mid-1993 drpped to 85 SOxw=WoddBar t(1992). percent Foreign rerves of the Bank of Estouia dated with the trasition proces, stict fiscal pol- more than trebled following the currency reform, cies and the early introduction of a modern tax sys- and in early 1994, equaled more than three months tem helped the country avoid current budgetary of imports. With trade increasingly shiffing to deficit These meas als cred good prospects Westem markets ah 1992, Estoia felt less of an for budgetary savings sardng in 1994 that willhelp impact from the collapse in trade with the former Fstonia resume its progam of public investmeat Soviet Union. Annual interest rates on loans which was virualy halted dunng the two years dropped from over 50 percent at the time of mone- immedely afrerEsonia regamned is imdependence. ary reform to aromd 20 pern in early 1994 Real Impact of rejorms. Estonia's early introduction lending rates have generally remained positive with of price reforms improved its terms of trade in 1991 respect to anticipated rates of inflation, which have relative tD its trading partners in the former Soviet been falling steadily. Union and had apositive impact on enterprise prof- Although GDP fell more than 30 percent its and perfonnance. The boost in profitability may between 1989 and 1994, official unemployment have delayed adjustment during the follownng (worers receiving unemployment benefits) years, however, because the fnancial cushion that remained at around 0.1 percent of the labor force accumulated during the period of aposkive tems of until early 1992, sing to 2 to 3 percent duing trade effect made it possible to hoard labor and 1993. Hidden unemployment is considerably larer, avoid cestructuring longer than would otrwise however, since workers have beea on unpaid leave have been the case (Table 5.1). The movement in or short work weeks. Including those workers relative prices helped the government budget-sub- brings real unemployment up to 8 to 10 percent of. sidies were rceduced, and inflation incr d t rev- the labor force in 1994. The private sector is enue base. Price liberalizaion also eliminated the absorbing substantial amounts of labor, and open monetary overhang. Inflation soared from 19 per- unemployment has been reduced by the large net cent in 1990 to over 200 percent in 1991, as real migration out of Estonia-especiaully to Russia. wages declined by nearly 40 percent (Beween independence and 1994, Estonia's popu- The real shock took place in 1992. As other lation dropped from 1.6 million to 1.5 mIlion.) countries of the former Soviet Union2 started to The first signs of a tunaround began to appear free prices and decentralize trade, Estoniaes flows during 1993. GDP growth resumed in the second 120 T1WE IN llEw bwEewENr StAlIS quartr of 1993, and prelminay estimates indicate menL The housing situaion remains difficult and an overl decline for the year of only about 3 per- uncerain, and other non-wage benefits provided by cent3 Trade, especially with Westen Eure, con- enterprises in the Soviet tradition reduce people's tinues to grow rapidly, responding to Estonia's willingncss to move Prvatization of the housing essentially free trade policies and the favorable stock and state enterprises, along with the tansfer market access conditions that European coutries of responsibility for most social services fm have granted. The rapidly growing private sector enterpises to government agencies, is addressing now accounts for 80 to 90 percent of retail trade and these problems- Severance pay is high, aveaging a rising share of manufacturing output GDP may two to four montbs of wages, but companies appear well show substantial growth in 1994. to be avoiding severance costs by pitting workers Complenay refomrm Progress m sttucural on special unpaid leave. reforms, such as privatization, labor mobility, and Problems in the financial sector and the reluc- financial intermediation, has been slower than in lnce of banks to lend in the current high-risk cavi- stabilizaion- Strctural refbrms are needed to mmr entar also impeding adjusmtm and economic improve the responsiveness of production and growth- Risks are high because of the uncertain investment to market forcs. When structural futme of many enterprses and the widespread lack refam moves too slowly-often to keep unemploy- of collateral until land ights are bete established. ment from iing too high-recovery slows as well, The resultant high nomial interest raes discourage which can reverse some of tie benefits hm stabi- borrowing since potential borrowers rghty antici- lization. Aware of these undesirable consequenc, pate future declines in both inflation and inteest the Eoian goverment bas acceleated strual rates Non-performing ruble credit and the fezing reform since early 1993. of the assets and receivables of Estonian banks in The need for enterprse resucing and pri- Russia have eroded the financial condition of many tization became more urgent wit stabiization and banks and state enterpises. The value of these the tightening of monetary and fiscal policies. claims is further reduced by the high rate of ruble Enforcement of bankruptcy laws also created pres- inflation and the small likelihood of settlement. sure to reduce inter-enterprise and tax arrears and to All of these interwined problems point to the prvaie failing public enterprises 4 Privation need to proceed raidly with privatization, enter- had been slowed by restitution issues, limits on the pnse liquidation, and related reforms in property sale of land, conflicting views of state and local rights. Incraed capialization of banks could help authorities, and problems of valuation. Privatization reduce the risks Although the banking system is gathered speed durng 1993 however, followmg highly liquid, most of its liquidity comes from nstitutional and procedral improvements A single short-tam deposits. The lack of long-term funds entity, the Estoniman Privatzation Agency, became exposes the banks to high risks in cases of delayed responsible for all enterprse prvatization By early lon repayments. WIthout adequate capital and 1994 more than gO perent of small enteprises had long-term resrves, a bank could be forced to close been privafized, mostly in trade and services, and because of temporary liquidity problems. (As noted only an estimated 300 lage enterprises rmained to above, the central bank in Estonia is prohibited be privatized.5The head of the privaizaion agency from lending to commercial banks in aU but the caUed for more bankruptcy proceedings for state most exceptional rescue cases.) An emerging inter- companies that cannot readiy be sold tbrough con- bank market is easing some of tese liquidity man- ventional channels. agement problems, but a moem adequate capial base - Closely linked to priraization is labor mobil- would allow banks to prdently take on somc ity. Formal constraints to labor mobiity do not highe risks That in tun could make significany exist, but structural rigidities, mostly inherited from more credit available to enterprses for long-term the Soviet years, continue to reduce labor move- working capital and investms. Esmaai A SHIG STAR FRoM mmE BALne 121 Trade Flows The bulk of this trade in 1992 and 1993 wa Estonia has been the most successful among with Estonia's Nordic neighbors. Fnland became the counties of the former Soviet in reorienting its Estonia's largest trading pxa, taing a fiflh of international trade to the West That reoreneation Estonia's exports and supplying more than a third was facilitated by a patten of trade during the of its imports in 1993. Trade with Sweden also Sovietperiod datmore cloely matched its co increased substtialy, probably reflecting geo- ative advantage than was the case for many other graphic proximity and the impact of Estonia's fee republics. Also, the share of Soviet-oriented heavy trade agreements wih the Nordic EFIA couMtri machinery total exportswas smaller for Estonia Trade wnth the European Union has been less than for the two other Baltic countris.6 important but growing a process ly to be acod- Lewe and direction. As part of the USSR, eratedby the Fre Trade Ageement signcd with the Estonia depended on intrnal tade for 95 percent of EtUin July 1994. its exports, one of the highest dependency ratios in Of the ex-Soviet republics, Russia's share in the union (rable 52). By 1992 and 1993 wel over Estoia's exports remained important, but fell half of Estonia's exports (measured at official sharply from 60 pert in the lte 1980s to 20 per- cxchange rates) was to the West, the highest share cent Belarus and Ukranm, once important trading among the former Soviet states7 The reorientation partners, now account for only a small share of of imports has been even more substantial, with Estas exports. Baltic trade accoud for 12 per- some two-thirds of imports originating in the West cent of Estonia's expots but only 6 percent of in 1993, mostly in Finland. After a sharp drop in impors. This trade can be expecd to increase with 1992. Estonia's tade started to rcover in 1993.8 the establisment of the Baltic Fr Trade Aea in Total exports doubled in dollar terms. The most April 1994, and with insing specialaon in de dynamic component has been trade with the West thee counties. Table 52 Extenal Trade, 1990-93 n millions of current dollars and percent) 199 1991 1992 1993 Vale Tol eorts 4,38 3,886 389 802 FonmerSovietUniana 4.183 3.836 147 341 Restofwodd b 198 50 242 461 Tota inpods 5.343 3.2D0 400 944 Former Soviet Union 4.751 2996 146 326 Restof wodd 592 204 254 618 Tot balnce -962 686 -11 -142 Former Soviet Union -568 840 1 15 Restof wodd -394 -54 -12 -157 Percnage Diston Totl expos 100 100 100 100 Fomer Soviet Union 955 98.7 37.8 425 Restotwoid 4.5 1.3 62.2 57.5 Totblm port 100 100 100 100 FormerSoviet Union 88.9 93.6 36.5 34.5 Restofworld 11.1 6A 63.5 55.5 a. Figures fruawhtbefonSovit nion a ed rodawuntyad Wodd Banksmff sdme rI p nldhada cur- mocks using ocial or mmerlcangr far 1990 and 1991 and anu avengc etange tes for 1992 and 1993. bI Ihe rest of t wadd ras to canids outsidc fanEr Sviet Uni figmes ar based an cannty daa repaod in U.S. dolls 122 TRADE iN TIE NEw INDEPe rr SrAmES Commodity composition of trade. The com- prices in many pats of the former Soviet Union has modity composition of Estonia's trade with the for- stimilated this tade, as have export restrictions in mer Soviet Union has not changed much over the many countries. The Estonian govemment has used past 50 years. Estonia has exported processed food, border controls, licensing of petroleum importers, texiles, and capital-intensive engineering products export taxes and a state monopoly on metals to in return for energy and raw materials. Since rcstrict this tadck but the measures have had limited Estonia regained its independence in 1991. the vol- impact because smuggling is difficult to control and ume of dtis trade has declined significandy, but the the financal incentives are enormous. Much of the patterns have not changed appreciably-in part problem will disappear as price hlbeiion pro- because Estonia's production structre under the ceeds in Russia, a process that had alrady begun by Soviet regime was less distorted with respect to its early 1994. Even after domestic and wodid prices underlying comparative advantage than was the converge, transit trade in these goods is likely to case for most of the republics. Food and engineer- continue since many countries in the former Soviet ing prducts Continue to dominmae exports to Russia Union am major suppliers ofsuch products, and the and other newly independent stas. In trade with Baltic ports are well-suited for handling these goods the West, mosdy with Europe, Estonia exports pnn- and shipping dtem an to European and other desi- cipaly resource-intensive goods, such as wood and nations. food, and labor-intensive manufactus, such as tex- Trade in scrvices is a major source of foreign tiles, clothing, and furniture About a third of exchange earnings for Estonia, contributing US$ imports from the West have traditionally been capi- 335 mIlion gross and U5S 77 million net in 1993. tal goods and 15 percent energy products. In 1993 Services that year were equal to 41 percent of mer- inports of capital goods wer up 150 pernt, chandis exports. Tamsittrade, tourism, and ship- reflecting a significant increase in new investment ping are Estonia's major sources of service export actiity, much of it financed by fonign direct earnirngs reflecting its favorable gateway position investmenL between East and West, its long-established role in The bulk of Estonas exports to the Baltics go trade and shipping services, and its many cultwal to Latrvia. I 1992 electricity made up two-thirds of and historic attractions which, together with low those exports, the rest being chemicals, textiles, and prices, make Estonia an attractivC destination for machinery. As Estonia sold its electricity in 1993 tourism. Estonias liberal trade policies, increasing for less than one-tenth the price prevailing in econonic stability, favorable investment climate, Western countries, futre exports to Latvia are and emerging role as a financial center in the egion liely to benefit from substntial gains in terms of indicate that services will continue to be an impor- trade. The modest trade with Lithuania consists pri- tant source of export eanings. marily of consumer goods-cotton, paper, and clothing w=e traded (often by barter) for energy Trade Policy and some consumer goods. In 1993 processed food As a small, open economy, Estonia has long became an important export item to both Baltic relied heavily on trade. Openness provides many neighbors- advantages for a smooth and rapid transition to a Because of its geographic location, Estonia has market cownomy. It provides a raional set of mar- long been heavily involved in East-West trade. This keetemined prices for resource allocation, intro- trade picked up again during 1992 It indudes regu- duces competition even to local monopolies, and lar re-eorts front t former Soviet Union that are alows countries to speciaize according to their shipped to the West through Estonian ports, and comparative advantage Opennss has also allowed re-exports of nonferrous metals and petroleum, Estonia to exploit its advantageous position close to much of it of questionable origin.9 The large differ- high-income Eumopcan markets and between East ences between world prices of raw materials and and WesL EsToiAw A SaNING STAR PRom THEBAm 123 Exvort polictes. Estonia lberalized its export rates. If the PPP rate can be laken to reprment the policies early. Nearly all export restrictions had equilibrium rate at the time of monetary reform, been removed by 1992.10 With its more rapid liber- inflation has eliminated most of the original under- alization of prices, Estonia had less need than many valuation and the protection which that undervalua- of its neighbors in transition for export controls to tion provided.14 protct food secirity or to ensure the domestic Issues in mrde policy. Estonia's liberal trade availabilty of goods These liberal export policies regime, and its converttble and orginally underva- allowed exports to expand and enabled the country ued exchange rate have been instruental in adjust- to earn the foreign exchange to buy needed imports. ment and reorientation of its exports. The underval- The remaning export and import licenses are ued exchange rate created incentives for exports to based largely on social, security, or health grounds. hard currency areas and shielded domestic produc- Some restrictions protect strategic supplies or ers from intemational competition, providing uni encomage domestic value-added (as in art glass form incentives for produccrs and allowing viable making).1 the only remaining trading monopoly is activities to survive. Exchange rate protection in metals exports an attempt by the gvovmcnt to avoided the lobbying dint comes with, tinff protec- control this lurative trade, to get a share of the tdon and let the maket ratber than the govement profits, and to reduce related illegal activities, pick the wimners Although export restrictions are very limited, it is The policy of no protection also established an imortantto cnsure that pcdures for securing any environment of openness and transparency, with requred licenses are sunple and transparent so that clear maket-based signals forproduces Easy access Licenses are not used as trade restrictions. to forign impus and foreign exchange arwoddprices Import polces Estonia bas no quantitative encouraged export development This policy flame- import restictions and very few importtaxes. 2The work was more effectv than a system of duty-draw- last of the often high import tarf on Western trade backs would have been, especially because inexperi- inhrited from the Soviet systm were abolished in enced administators tend to reduce the attractve- February 1992 (IMP 1993). Import licenses are in ness of such schemes:trough pressing ddays and force mosdy for health and security reasons. To othermeans The transparency of economic policies reducc evasion of the fuel excise tax, the govem- and th,e duty-free cnvironment were also favorable ment imposed a license requirement on all to the development of subcontracting activities that importers of fuel prducts in January l994.13 With take advantage of Estona's highly skilled but low- these exceptions, any cnterprise or individual may cost labor. Subconacting is often a fist step to import virtaly any good. exporting and foreign investment in countries like Until recently, domestic industry has been Estonia, where conditions are less favorable to for- impliitly protected by the undervalued exchange eign investment ta in industrial nations. rate. Estimating an equilibrium exchange rate is dif- Estonia's trade performance clearly demon- ficult under the conditions prevailing in a transition steates the sccess of these policies. Estonia's trade economy, but the slowing and occasional reversal performance in 1993, the first year for which trade of international resees accumulation indicate that values are relatively reliable, surpasses that of all dte an equilibrium real rate is developing. Further sug- other ex-Soviet republics. In 1993 Estonia had per gesting tdat the kroon is no longer significantly capita expots to die West ofUS$297, compaed with undervalued is the threefold rise in domestic prices US$181 for Lavia and US$90 forLithuani Estonia since the exchange rate has been pegged. Tbe esti- has also amacted the highest level of foreig invest- mated purcbasing power panty (PPP) raze was four ment per capita of the Baltic states (see below). kroons to the dollar at the time of monetary reform Estonia substntially inceased its exports of textiles in June 1992, or about-one third of the prevailing and clothing to Finland and Sweden, and conquerd market exchange rate at deutscbemark-dollar cross- new markets in the EU. especially in Gemany. 124 TRADE IN -am NEW INDDENDEMT STATES The main challenge now is to avoid backslid- Or protect domestic producers, particularly if the ing in response to protectionist pressures. which are hcalth controls do not apply to domestic production. particularly strong now in agriculture Industry is likely to begin clamoring for protection as hard Recommendations budget constraints, rising input costs, and te loss of Controls on exports should be used sparingly traditional markets force more firms to restr becuse of their high economic cosL They are just or close. Government rev_nue shortges, rising fled only for clearly defined health or security rea- unemployment, and the appreciating real exchange sons or when domestic price controls that keep rate may also create presures to impose barriers to prices artificilly low cannot be relaxed immedi- trade ately for social reasons)16 Export controls might Since mid-1992 agriculture has been pressur- also be justified if Estonian exports in target mar- ing for taiffprotection and for producdon subsidies kets were to become subject to quotas, which would and concessional credit to help counter the rapid create a need to ration aess by domestic produc- rise in prices of imported inputs)15 Parliament ers and exporters to these markets. So far this has passed a producer-price-support law in August not happened. 1993 to guarantee agicuiltural incomes. The law Export restrictions tend to lower the prices for could result in annal support payments of domestic uses, reduce presue for domestic price EEK 12 biion about 20 pernt of estimated bud- adjustments, discourage potentially viable export getary expenditumes in 1993. The law provided a development, and protect local industries that use safety valve, however, requiing the subsidies only the goods as inputs Export restictions also affect if the budget coud handle tde added burden. imports by reducing forign exchange eamnings. Because the low imnport pces in agriculture Taxes are generally preferred to licenses bcaus often reflect export subsidies in Western countries thcy are morn tansparnt, less apt to stimulate lob- or the slower pace of price hiberalization in other bying, a good mechaism to transfer t rents from x-Soviet republics. across-the-board protection producers to the government- Where price incen- would be overkill, leading almost mevitably to tives are strong, bans on exports are difficult to domestic inefficiencies and resource misalocaion. enforce. Estnia's failure to control exports of non- Any move to incrase protection involves substan- ferrous metals thmugh export restrictions is a good tial risks. Tariffs are dificult to remove once estab- example. lished. Scelctive, temporary protection can be used Protection from impor will do almost nothing to address unfair trade practces orsudden surges in to solve the problems of Estonies agriculal sec- imports (both coutervailing dufies and safeguards tor. The problems stem from poor quality, uneco- are permitted under the GATI), but these mecha- nomic scales of production, and distorted input nisms involve-considerable danger as well, and the prices. Improving internal cfficiency and downsiz- merits of each case should be carefnUly assessed. ing the sector in line with market demand are They should be introduced only after a public needed. Tariff protection or subsidies would only inquiry at which producers and consumers make retard or impede adjustment to world prices. their interests heard, and should include a sunset Similarly, protection will not solve the prob- clause, involing automatic expiration after a fixed lems of Estonian industry, which come from out- period, say a year. dated technology and inefficient scales of produc- The recent icrea in export and import con- tion geared to the large Soviet market Distorted trols on health grounds for agricultual and forest prices under central planning had led to the use of products should be reviewed to enswe that the con- input-wasting technologies that have become tols will be limited to those required to achieve the unprofitable as input prices climb to world levels health objectives sought Some risk exist that die Erecting protective barriers would retard adjustment licenses may be used to control domestic supplies by allowing producers to contnue using inelficient ESroNwU A SHmuG SrAinoM nmm BAncs 125 methods imstead of exposing them to modem tech- yielding to these pressures could be high and the nologies and efficiency-increasmg competition) and gains smalL By weakeig incentives to adjust, pro- to continue producing poor quality products unable tection would delay transition and slow economic to compete in Western markets. Estonia needs an growth Although protection might reduce unem- action plan for industrial transformation that meets ployment in the short run, the delay in recovery four objectives: would mean protacted demands for unemploymcent insurance and1 other social safety net spending, * Moves rapidly on restituion and pnvatia- ic ng the fiscal burde over the longer run. ion, with car ties to property. Protcto would also forte domestic producers and * Provides adequate corporte governance consumers to pay more for products they need, and ownership control forentrprises pead- reducing real consumption as well as the resomus ing privatization (the difficulty of providing available for investnent m fiture growdL good corporat governance for public enterprises leaves rapid privatiztion as the Trade Policies vwt the Former Swet Union only viable approach). Enia has followed a policy of non-discrmi- nation in its trade with the countries of the fomrer * Develops restructuring or lrqmidationt plans Sovict Union and a complete shift from sate trade for those enterprises that cannot be sold- to enterprise-crse trade within a framewor * Restructures the banking sector and of general trade agreements. Trade with the ex- improves banking skills so that investents Soviet republics is suJect to the same rules as trade can be propedy evaluated and adequate with countries in the WesL Indicative lists have not finance made avaiable. b used since early 1992.17 Since 1993 exports to non-convertible curncy areas are no longer sub- Thc revenue arguments forprotection ae weak ject to the value-added tx. These measues con- as welL Several factors work against the use of tributed to some recovery in trade with the former trade ta for raising revenue. Esronia has entered Soviet Union in 1993. After a large drop in 1992, into free trade agreements with a number of its most the value of eports to the region in 1993 (measured important trading partne (four EFrA countries, at official exchange rates) rose to two and a half the Baltics and, most recently the EU) that cover a times their value in 1992. major share of imports. Since these imports would In early 1992 Estonia had bilateral agreements have to be exempted, the scope for revenue colec- m place with Azerbaijan, Kyrgy Repubic. Russa, tion is severely limited, and tariffs would divert and Uzbekisan The main benefit of these agree- even more trade toward the fe trade partners, fur- ments for Estonia was that they facilitated awcss to ther reducing the potential revenue yield. Using Russian exports of vital goods such as fuel, an trade taxes to raise revenue makes sense only in advantage that diminished in importnce as most of low-income countries that lack the administrative the agreed trade failed to rake place and Estonia capacities to collect broader-based taxes, which is developed alernadve sources of supply in the West not the case in Estonia-even if its tax administa- A September 1992 general trade agreement tive capabilities are not yet up to European stan- with Russia was never implemented. Russia failed dards. Rather than focusing on import duties, to ratify the agrement, mostly for political reasons, Estonia should make some minor adjustments in but also because of disagreements on rues of origin broad-based income and value-added taxes, which and the handling of re-exports of strategic Russan could boost revenue substantially without introduc- goods. Russia wanted the government of Estonia to ing lage economic distortions police a ban on such goods. Failue to do so would Pressr for potection will increase as unem- resuk in cuts in stategic exports to Estonia such as ployment rises duing the transition, but te costs of gas and oiL The min advantage of a trade ageamnt 126 TRADE IN THE NEw INDENDr STATES to Russia would be to restore most favored nation in foreign trade and repatriate foreign exchange treatment, under which Russia's import duties on earnings. This reduced capital flight and improved Estonian exports would drop to about half their cur- incentives for domestic investment by establishing rent levels. Both Russia and Estonia continue to pro- positive real returns for domestic assets. Since the vide duty-free treatment for each other in outward currency reform, access to forign exchange is no processing activities, such as Estonian processing of longer a barrier to trade, foreign exchange is frely Russian raw materials for re-export to Russia. available to all importers at market exchange races. Estonia shoud ty to conclude a trade agreement Until the currency reforni, enterprises were with Russia that will grant it most-favored-nation required to surrender foreign exchange at the over- status and reduce the policy-derived uncertainty in valued official exchange rate and pay a separate tax trade with Russia. That would help Estonia main- on their foreign currency profits. A surender tain some trade with its old partners durng the tran- requirement was reintroduced with convertibility, sition process, trade that wfll be paticularly impor- but at market exchange rates, a requirement abol- tant for industries that cannot quickly restructure ished in early 1994. In a period of hypeinflation, a their production to compete in Western markets. surrender requirement at below-market rates Estoniais lely to be a cmpetitive supplier of food imposes a heavy cost on enteprises and makes and textles to the many countries of the former access to foreign inputs more difficult Surender at Soviet Union even beyond the transition, another market rates can stil carry a cost if the margin strong argument for placing trade relations with between buying and sellng rates of foreign Russia and other newly independent countnies on a exchange in commercial banks is high. sounder basis. Payments problems with countries of the for- A temporary preferential agreement with the mer Soviet Union still remain, stemming rom the countries of the former Soviet Union is sometimes credit situation in Estonia and the instability of the proposed to help maintain trade flows with the Russian ruble, even though many of the physical area. Such an agreement is unlikely to be in payments problems-lengthy clearng procedues, Estonia's interst, however, particularly since physical transfer of document-have been solved. Estonia might bave to sacifice its hlberal policies Introducing independent currencies created some to reach compromises with more protectionist part- initial problems in clearing payments because the ners. More efficacious would be to address the central banks were not accustomed to dealing many non-tariff barriers that still impede trade in direcdy in foreign exchange for trasactions within the region, such as payments problems and cur- the former Soviet Union. Introducing the kroon rency inconvertibility, made payments easier once banks and traders Trade among the Baltic countries is now facili- became accustomed to the change since the kroon tated by the Baltic Free Trade Agrement, which was stable, convertble, and widely available as came into force on April 1, 1994. By removing pay- both currency and credit-everyting tie ruble was ments bottlenecks and other non-border constraints not All ruble correspondent accounts were closed to trade, the agreement should improve the market after the kroon was introduced, and new corespon- access of Estonian products in neighboring coun- dent accounts were opened between the Estonian tries and set them on an equal footing with Westem and Russian central banks. In late 1992 Estonian fiee trade partners. commercial banks were allowed to open their own correspondent accounts with countepars in Russia, Foreign Exchange and Payments an amngen ent that improved the payments situa- Establishing a convertible currency was an tion substantially. Private commercial banks have important improvement in the incentives for foreign started to make payments arrangements with fteir trade because increased public confidence in the counterpars in other republics. No hard documents convertible kroon encouraged companies to engage are needed for transactions, and some banks in ESToNw A SHNuING STAR FROM THE BALncs 127 Estonia are now linked into the System for Estonia. Most important are its location, resource Worldwide Interbank Fnancial Telecommunication base, industrial stucturem and skilled labor force. In (SWIFI). Payments transactions are complemented addition, successful macroeconomic stabilization is by open auctions in Tallinn that allow residual bal- creating a iavorable environment for private sector ances to be converted into the desired currency development and forign investment when required. However, demand for rubles in Structal issues in nade adjustmnt. Estonia's Estonia tends to be low, maling the market volafile. share of heavy industries (whose adjustment to Trade finance is still difficult to get and expen- world prices or Western standards is most difficult) sive, at least in nominal terms. Banks consider trade was relatively small compared with the other Baltic finance to be high risk, and since the banldng crisis countries-l7 percent compared to 30 percent. in 1992193, they have favored security over high Estonia also had a relatively small share of all- yields Many entrprises are in such severe financial union enterprises-40 of a total of 300 large indus- straits that they have no money in the bank to cover trial enterprises, whose heavy reliance on subsi- payments orders. Until property rights are estab- dized inputs from the region, such as energy, made lished and privaization is firther advanced, the lack them especially vulnerable to the terms of trade of collateral wil limit access to credit Some coun- shock and trade diruption. Switching types and tries or areas witiuin countries have no correspon- sources of inputs is often technologically more dif- dent banks, making access even more difficult for ficult for these firns, while their previous monoP- certain enerprises. oly status and state ownership make it hard to Weak pdentil superrision in thepast allowed adjustment wo competition. some banks to sit on payments orders untilfunds are The structre of the energy sector in Estonia received rather than notifying the payee of the fimd also made adjustment easier. The domestic avail- shortage. The clearing situation improved substan- ability of oil sbalej which is buned directy to gen- tiaIy during 1993, in large part because of the heavy erate electricity, reduced the country's dependence penalties the central bank imposed on banks that on oil imports-oil shale meets about half the coun- delayed payments. Since the end of 1993 payments try's energy needs-and lessened the terms of trade within Estonia and to the West have generaly been shock Port infrastructure alrady in place was able executed without delay. Payments with the new to handle supplies from sources outside the former independent states improved substantialy in 1994, Soviet Union, fiuther facilitating a shift in energy at least for enterprises that are able to use tbe private inpuis. correspondent accounts. However, many Estonian Adjustment is generally easier in labor- and enterprises have started to request prepayment or natural resource-intensive industries. The high skill payment in hard currency for trade transactions level of the Estonian labor force, which facilitates invoiving rubles, since high ruble inflation made the adoption of new techniques, is also easing trade delayingpayments auractive to Russian enterprises. reorientation. Years of schooling in Estonia are Nevertheless, Estonian companies are sometimes close to those in industrial countries and among the forced to accept rubles in payment becase markets highest in Central and Eastrn Europe The combi- are linited for many products, and trade with Russia nation of high skills, low wages, and an open trade is the only way in the short term to keep some com- regime has created favorable conditions for subcon- panies going. Because of these problems, barter still tracting, which has promoted exports and adjust- accounts for a significant share of total trade. ment through the trander of technology and know-how. One Estonian firm that started with sub- Microeconomic and Trade Adjustment contracing has since increased both its ovrall lev- In addition to macroeconomic influences, els of output and its percentage of value added, Estonia's trade adjustment was aided by several gradually becoming a successful indepndent structural and microeconomic factors particular to exporter of garments in its own name. Tbe company 128 TRDE IN mm1 NEW INDEPE4DENT STATIS has even started to train its own subcontractors in Table 5.3 Structure of Baltic Exports to the Latvia and elsewhere in Estonia. Estonia is the only West, 192 Baltic country with substantial labor-intensive friKtatr Eswaona LetL Uhuma exports to the West; Latvia and Lithuania export more resource-intensive goods, which may be the Exports (Indigenous) 219 175 223 result, in pet, of their traditionally less transparent and more protectionist trade regimes. Exports per capia (USS) 137 65 60 The more standardized nature of products in ReS-xports (USS mflton) 154 372 418 resource-based industries makes trade reorientation Oil 20 290 247 easier. These goods rely on local raw materials and Metals 134 82 172 therefore suffer least from trade disruption with the TotW Exports to to West 33 547 641 former Soviet Union. Minor changes in packaging (US$ millon) or quality are often enough to meet Western stan- e of Idusty (peroen) dards. As pert of the Soviet Union. Estonia was Labor-Intenive 34 19 17 already exporting large quantities of fish to the RSDurontesnsive 29 31 29 Capital-inienstve 20 28 31 West and therefore had some familiarity with ober 17 19 23 Western standards. However, significant invest- Memorandum Item ments are often required in food product industnes Offdidly reported exports to meet Western health standards. to te West (USS mfllon) 242 429 557 Excluding metals and petroleum for likely re- export, labor-intensive products (mainly clothg Na: Da= r eported by OECB counre Labor-intve= and firniture) accounted for one-dird of exports to SITC 65, HZ 84. and a5: resource-iuzasive = S1TC 9. 24,63; capita-intensve = srrC 5. OECD countries in 1992 (Table 5.3). Nearly 7 = =STC 2= SrarC 28. 33.67.6L another third consisted of resource-based goods Saw=C COMTRADE. such as wood and food. The largest losses in over- all trade volumes were in heavy industry and in energy-intensive industries such as chemicals and c declne in output between 1990 and 1992 were cngineering, which were the most dependent on the loss of Soviet markets, difficulties in getting Soviet markets. Data for 1993 shows a continuation inputs, and the sharp increase in the costs of of the trend of Western expts based on labor- and inputs-especially fuel and fertilizer, ;oods that source-based goods. were highly subsidized under the Soviet regime A -Statistics on industral output for 1992 confirm drught in 1992 also hurt output. that no radical change had taken place then, though Foreign prvestmene Foreign participation has there is some indicadon of a switch to labor- and Se i in helping Estonia icouient its resource-based activities. Heavy industry declined ewqnts. By mid-1993 nearly 4,000 enterprises with from 24 percent of the total in 1990 to 21 percent fomp captal wcre opeting i Eaonhi account in 1992, while light industry increased its share ing for nearly 10 percent of registered enterprises.18 from 26 percent to 29 percent Clothing is the only Finland leads in number of ventures, Sweden in industrial subsector that did not suffer a major tems of capital. The early and gradual involvement decline in OUtpUt in 1992, largely a consequence of of foreign partners since the late 1980s exposed its rapid re-orientation to the West (especially Estonian enterprises to Western business practices. through subcontracting arrangements) as demand These initial contacts with foreign clients or suppli- in ex-Soviet markets fell and terms of trade there era often provided the first outlets for re-oriented worsened trade. Some companies used their former clients' Import competition hit agriculture the hardest. distribution networks or hired managers from for- However, the main causes for the sector's 40 per- mer foreign suppliers as consultants in market ESrONIA: A SHnno STm FROM TE BALhncs 129 development. Foreign investors are also likely to be almost everything "by the book." Estonia has important in the privatization process. already implemented most of the standard recom- Foreign investment in Estonia has been the mendations relevant to its circumstances, and has highest among the Baltic countries, a sign of the con- done so in the midst of the daunting complexities hidence in Estonia that has developed abroad because that accompany the transition from a centrally of its stable economic enviromnent, sructural reform nlanned to a market-based economy. and free trade policies. In 1993 Estonia attracted Consolidating gains. The main task facing US$69 per capita in foreign investment comparrA Estonia's leaders today is to protect and preserve with US$18 in Latvia and US$11 in Lithuania. what has already been accomplished- Resisting Foreign investment in Estonia doubled between pressureS to introduce additional tariffs and other 1992 and 1993.19 The bulk of foreign direct invest- protective barriers is an important challenge. Since me-t h Estonia comes from the West and s related the pressures today come largely fom the agricnl- to trade, whereas the majority of foreign investors ura sector, high priority should be given to finding in Latvia and Lithuania are from the other ex-Soviet solutions to the problems of this sector that will countries and focus on their own domestic markets. ensure the well being of the rural population with- Privae sector. Getting pivate sector activity to out recourse to tariff protection. Protectionist pres- grow quickly is important in the transition for sures from the indusal setor are not yet as strong, absorbing labor and bringing out a supply response but demands for protection may weU rise as more of to the new incentives. lnformation on the emerging the large state enterprises are privafized and begin private sector in Estonia is patchy, and much of the shedding substantial amounts of labor. sectors activity is not captured by oflicial statistics. For both agriculmre and industry, the best way Its role in adjustment already appears to have been to protect the living standards of those now worlkng quite important, however. Estonin authorities esti- in these sectors is to maxie the overall growth of mate that by the end of 1992, the sector accounted the economy and to facilitate the movement of for about 20 percent of total output (IMF 1993). By labor into the good jobs that are developing in lead- early 1994 over 80 percent of retail sales were made ing sectors. Growth and labor mobility would be by private entprses. In December 1992 about one seriously imperiled if protectionist measures that quarter of the 50,000 enterprises registered with the seek to preserve uncompetitive jobs are allowed to national enterprise registerstis belonged to the pub- prevail. lic sector. In agriculture, privaization has resulted An agenda for action. The peoplc of Estonia, in the emergence of 10.000 new farms (EIU 1993). especialy those whosejobs will bedisplaced r The private sector is likely to expand further as pri- economy shifts production to sectors in vbhic vatization of state enterprises gathers momentum country can be internationaly competitive, need tk Private sector growth is a response to the lib- understand why protection is not the answer. Public eral incentive framework and helps explain the low information and education campaigns can make an unemployment levels despite lhe large declines in important contnbution. But more is needed. If the output and employment in the formal sector since government is to successfully resist protectionist independence. Between 1991 and 1992 employment pressures, it must not only follow sound economic declined by nearly 30,000 in industry and by 15,000 policies, but must also be perceived by the public to in agriculture, yet by mid-1993 only about 22,000 be actively engaged in ensuring a better life for all people had registered as unemployed. No statistics Estonians in the futue. Simply resisting protection- are yet avaiable on private sector employment ist forces will not be enough. To preserve the remarkable progress already made in establishing a Policy Conclusions sound economic environment based on competition Recommending improvements in external and free trade, the government will need to launch trade policies is difficult in a country that has done an active, high-visibility program to facilitate the 130 TRADE ix NTE xNw INDDm4DENT SrATES movement of workers to new and better jobs. The tion to labor mobility. The Soviet ecducation system current economic policy environment, if maintained, turned out graduates with highly specialized skills, will virtually ensure that these jobs will be created. but without adequate flexibility to adapt to new The task is to help workers move to thejobs. types of work. To make it easier for people to leave To preserve incentives to change jobs, the gov- jobs in declining industries and to find new, more emnent will need to stand firm in refusing to pre- productive jobs, adult workers need training in serve jobs by bailing out inefficient frmns that are basic skills such as searching for jobs in a market going bankrupt. It should also keep unemployment economy, using a computer, and even, for some benefits close to levels needed to naintain mini- workers in old Soviet enterprises, speaking mum living standards to avoid creating perverse Estonian. Such training can be provided at low oDst incentives to accepting new employmenL The gov- and can have a large direct impact on changing the ernment s1hould also resist efforts to accelerate structure of employment, while demonstraing the develcpment in specific areas of the country government's concern and thus building credibility through public subsidies-a policy that rarely for its market-onented appoach. achieves its obectives. Education for childrn will be even more The government could take several actions to important in the longer term. Experience around the facilitate the creation of new jobs and the move- world snows that labor mobility and livinZ stan- meat of workers to such jobs. dards are highest where general education at the pri- Market access. The government should seek to mazy and secondary levels is strongest Since poor, unprove access to markes in the former Soviet Union hard-hit areas can rarely afford to finance high- as well as in the West A country the size of Estonia quality education with their own resources, interre- can achieve internationally competidvescales of pro- gional transfers by the central governmnt will be duction only by expanding its markets externally. requied. A comprehensive sae for restructur- Initiatives currenty under way to improve Estonia's ing and financing education for life in a market permanent access to the European Union markets economy should be developed. will play an important role in maintaining the Housing. The government needs to formuate a growth of Estonia's exports to western markets- comprehensive policy package relating to housing though it will be chaIlenging to find ways to limit development Many Soviet-ea industries and col- the degree to which Estonia must introduce tariff lective farms were located in particular areas for barriers in order to participate in this customs union. political rather than economic reasons. As a result, Adjustment polices and infr Cture. Aside today there are large concentrations of people in from preserving the progress already made in estab- locatons where new employment opportunities wil lising an investment-friendly, competitive envirn- be hara to find. The movement of labor from rural ment, the most important contributions the govern- to more urbanized areas. or from large state farms ment can make to growth and employment are to to smaller family-run cmmerial farms, means that accelerate privatization, especially in large-scale part of an already inadequate housing stock will enterprises, land, and housing; improve the security have to be abandoned or used less intensively by and marketability of property rights; and improve the smaler group of families who remain. basic physical infrastructure to support private sec- Although some workers can commute from tor economic activity. Such developments will help rural to urban areas in many parts of Estonia, other establish the conditions needed to encourage the workers will not be able to take new jobs in distant sound, market-based lending against collateral that towns if they cannot find a place to live. Since is needed to sustain the transition process. many of the workers who move to new jobs will Education. Ensuring the nght kind of educaion have very limited financial resources, affordable and training m hard-lut areas, especially for people rental housing is vital. Detailing the elements of a under fifty years old, would make a major contnibu- pclicy package for housing reform in Estonia lies ESrONIA: A SNIur-r; STAR FROM 1m BDLncs 131 beyond the scope of this book but implementing the Bank of Estonia. Estimates fiom the latter source. based such a poliy could go a long way to prescrving on indicators such as electricity consumption which capture sucha poICY couldtgoha long way to preserving de new private sectr more adequately than official GDP Estonia's remarkable free trade environmenL statistics, indicaLte that the ravery .ay have even stand Socid safety net Every country needs a system in late 1992. of social services, including social infiastructure, 4. Inter-entcrprise affears wcre estimated at about 20 pcr- that reaches even the poorest areas. These ser- cent of GDP in mid-1992. Thcse stabilized by year-cnd, but vics-sucashealhcnic, schools.emplom tax arrears increased to EEK 520 maillion by end-1992. Net credits to foreign enteprises in the former Soviet Union services, police, and infrastructure, including clean were estimated by the IMF at EEK 400 million by end- water and sewage disposal-have a direct positive 1992 (IMF 1993). much of which may be very difficult to impact on people and build confidence that the gov- recover. ernment is concerned with helping them trough the 5. In 1991 Estonia reported a total of about 2.700 state entprises of which 2.234 wer controlled by vrious min- transition process- Furthermore, the provision of istries. and 421 were controlled by local governments- such services often involves direct employment There were also about 1,773 cooperatives (World Bank opportunities at the local level and, by making eal 1992) income transesrs in ldnd rather than cash, avoids the 6. In 1990 capital gcods constitued 28 percent of Estoia' problems associatcd with welfare payments. s c£ports, compared with 37 percent for Latvia and 43 per- probles assciatedwith elfiur 'Ilitits.cent, for Lithuania (World Bank 1992). A social safety net to protect those least able to adjust to global competition is important for rea 7. The margin of enror in dte values is lare because of the substantial adjustmncts in prices and cxchange rates in sons of equity and for reinforcing the crdibility the past few years- For example. market exchange rates and sustainability of the govemment's policies. indicate GDP per capita of USS 3,493 in 1991 and USS 959 in 1992, even though real GDP declined by only about 30 Protectionists should not be able to point to groups pj..L of people living in squalor because their jobs were &- The decline in trade fim 199l and 1992 shown in Table wiped out by competition from goods produced S.2 may be otated. Expon to the fanner Soviet Umnon more efficiently somewhere else. Whie the gov- in 1991 have been convcrted from rubles to dollars at emment's emphasis should be on fahilitating the exchange razes that significandy ovecrst the equivalent dollar value of the ruble. Using Western price-based ddea- movement of labor into new, more productive jobs, tos would bring the decline from 90 pect to 50 percent significant resources will need to be allocated to between 1991 and 1992. provide means-tested transfers so that all Estians 9. The trade in metals was valued at USS 45 milion in can live decently through the transition process. 1992 and USS 90 million in 1993. some 10 to 11 percent of En sun, Estonias stelhir economic policies am officially recorded exports. Import sistcs of OECD tad- ing partners indicate that another USS90 millon worth of fostering rapid growth in external trade, especially mins was cxported from Estonia, bringing the real total to with the WesL Now it needs to give increased allen- over USS 135 million. In addition. petroleum re-export tion to the domestic policies required to assure that ac'nted for aotheUS$20 millon in 1992. its trade policies can be sustained. 10. The number of export goods subject to licenses was reduced from 201 in 1991 to 38 in eary 1992, and to negli- giblc levels in 1994- Notes I1. Licenses are required for exports and imports of metasC This chapter draws upon work on Estonia's trade policics on security grounds; tobacco products, alcohol, and phar- by A. Himlnan, and benefitted from coannents by Michael maccuticals on social and bealth grounds; and weapons and Michaely, L. Alan Winters, David Tarr, and Costas explosives on security grounds. Recently added to the list Michatopoulas. of goods requiring a special permit for trade were a number of agricultural and forestry products and pesticides (health 1. All further references to Efstoni's independence refer to grounds); precious metals (securty); dangerous waste the restoration of independence in August 1991. not to (social and health); and broadcasting equipment (security). Estoniaes Independence from Czarist Russia in 1918. Export licenses are required for silica and quartz sands, fire 2. Although this chapter refcrs to Estonia as a former clay, gravel, petroleum and mineral oils, praffin wax, and Soviet republic, this status was defacto, not dejure- oil shlue to protect straegic supplies. Distilled mineral tars have quantitative export restrictions. Export taxes remain in 3. Preliminary estimates range from the -7.8 percent of the force only for ciutural items. Estonian Statistical Office to the slight positive increase of 132 TRADE IN mmI NEW INsE T STATES 12. Apar from a 0.5 percent statistical tx on imports and risen shply, and egg cxports to Russia were again prof- cxports, the tariffs are effcively excise taxes on luxury itablc. items, such as fur (16%) and cars, bicycles and boats (101,). the same raes as the excise mus charged donme- 16. The GATT rules allow for temporay expott restrions cally produced goods to prevnt or relive critical shor.ages of foodus or othr Csscntial products. or dtose necessy to die applicatin of 13. These arc charged on a specific basis to control tax eva- smtdards, in the context of consevaion of exhustible nat- sion through under-invoicing of import costs. Alhbough ual resour cs, if such msures am mRde effecfive in con- geneally inferior to ad valorem duties specific duties seem junction with restictions on domestic producto appropriate in the prescnt cnvironment of reltively stable world oil pcsand signlificant difficulty conrlling] IllU 17. Obligatory lists define gveneto-o vcnut sales lvoicingu at fixed quantitics and prices. Indiafive lsts set out a list of goods to be cxdcnged, but leave the negotiation of 14 Estimaes of the initial undervaluation based on pur- pncesto the enterprises. chasing powe parity vary between 15 and 70 pacent based 1. g ines t from the West stated in the late on stdies conducted in early 1992. beforc countries began 19B. F.nd the foreig investment regime has gradually to leave the rblc zone. Average monthly wagcs were more wrc m hcbrL la 19r9sun owncrship bad foegan than US$ 100 by mid-1994 (up from about IIS 40 at the rctsmmioiis were amowed Uns wfe ign esnrs fobm- time of currncy reform). Estonian products are still com- proved Undllac for for- pctitive in world markets at this wage rate. but aside from eigu investment policy prvided fis incentives for for- db margin provided by inasingproductiviLy or oal a investors lowcr profit taxes for a number of years, undavaluation of the kln s"c to have been largdy off- depeding on the size of the invesntmnt). Since tben, for- sutey ioElation by itht-1994. eign and domestic investors have received smilar ince- sivs. Salc of land to figiEgcrs was rcacy nlrafizb . 15. Domestic producers fist complained about a burttr and both profits and cpial can fnrdy be repatiated in fbr- substitute that they claimed was being imported at bighly eign cmrency. The Ministry of Finance prnodes sdectv ubsdizcd prices fm Fialan.A A closer look showed the investment guarant and seves as an information cr low cost was eplined by the product being part bu and for potntia investo To improve access to information part margarine. Soon a similar local prduct appeared in on its relatory framework. Estonia has recently opened a stores at competitive prices Other complaints related to speca office to provide foreign investrs with comprehen- very cheap agricuItural products (especially eggs and cre- sive gudance on investing inEstia. als) coning fom Rnssi. These compla resulted in the imposition of a 70 pcent duty on wheat floor frm Russia 19. This figue coves only debt and equity invsment in in August 1993. The duty was abolished in Decembcr pWcal plait and ClqiiLL Fiancial investmcnt incltd- 1993. pardy because of complns fm consumers, bak- mig foreign deposits brought the ovea:l total up to USS 160 es, and pasta makers. By eadry 1994 Russs prices had mlihn for 1993. Comment on Chapter S The Political-Economy of Macroeconomic and Foreign Trade Policy in Estonia Ardo H. Hansson The chapter by John Hansen and Piritta Sorsa on Estonia's foreign trade policies and performance gives a comprehensive overview of recent developments in that country. A reader unfamiliar with the Estonian case will find much useful infor- have made it the most open economy in the Baltic- maton. Seasoned veterans can gain new Nordic region. Even the composiion of ESronia's insights mto the changes that have taken tal appear to be healthy, with investmnct goods place. Estonian poli cers can find making up a lage share of imports, and exports sound advice for future actions. The paper being close to Estonia's likely comparative advan- is especially useful i bri nage, including the boomng tansit trade in Russian is especialy usefiil in brngngg together a rwmtras wealth of statistical mformaton. ra mateacow MZy approach in this comment is to note the In this comme, I will expand on the work few cases where I disagree with the position of done by Hansen and Sorsa, to delve more into t Hansen and Sorsa, while providing supplementary political-economy of-Enies macroeconomc and remarks in the vast majority of areas where we do foreign trade policy. In particula, I ask why Estonia chose to follow a near-textbook model of financial conservatism (budgetary balance, a strict curecy Common Influences on Baltic Economic board-type monetary rle, a fixed exclange rate to Policies the German mark, and a functioning bankruptcy It is useful before considering factors specifc law) and economic liberalism (simple, broadly- to o t re tO F a9 tO revew soe mfuence on Eston s based taxes with a flat personal income tax, nearly economic policies that are common tO all threc acr teboard free ade, including in agicutre, Baltic States, if not to most economies in trsition. concertd pursut of free trade agreements with E se Ever since the start of senous debate on the Western neighbors, early abandonment of indica- political and economic futue of Estonia in 1987, tive and obligatory lists, ful currency convertibility. the overriding concer of Estonians has been to and a near absence of subsidies). escape the discredlted Soviet past and to "rtur to Estonia's remarkable successes malk under- EuraoW (see van Arkadie and Karisson 1992; standing its expenence all the more important Hansson 1993). Such concerns may have been Hansen and Sorsa describe Estonia's rapid foreign stronger in tei Baltic States than in Eastern Eumpe trade reorientation away from former Soviet mar- or the Commonwealth of Independent States (CIS). kets, and the rapidly growing wrade volumes that 134 TRDE IN 1EE NEW INDEPENDNT STATE The countries of Eastem Europe were less tied to cally weak2 For this meason, I would disagree with the Soviet market, already had forml independence HInsen and Sorsa that ibere has becn great pressure and national currencies, and generally had better for tariffs on industrial goods. The main pressure macroeconomic performance than did the Baltics. from industry has so far come for waivers on pay- The non-Russian CIS states suffecred from the same ing the VAT on imports at the border, but even this ills as the Baltics, but usually had a less clear desire pressure has not been very strong and is nothing to escape the Soviet system like the pressue from the agraian lobby. As a result, Baltic residents initially had a near- The evolution of foreign trade regimes may religious devotion to concepts such as currency also have been indluenced by the legacy of convertibility and trade reoientation, though the repressed inflation. During 1990-91, gowing nomi- understanding of how to achieve these goals was il demand under fixed prces led to chronic short- weak, even among local economists. 1 Among the ages. In an attempt to staunch the outlow of goods public, the belief that thes goals could be achieved in the absence of normal stabilization policies, the was far weaker than the hope that they could be. Baltics, followed by most of the other Soviet That hope created a readiness to support any project republics, imposed direct export controls to "protect that seemed to offer a chance of isolation from the internal markeCw After balance was restored by Soviet instability or of greater integration with the price liberalization and monetary reform, it might WYesL These included monetay reform and the free not have been easy to move from a mindset that tade agreements with the EFTA countries, encouxaged imports and resticted exports to the Such sentiments helped to avoid much of the opposite view charcterstic of more balanced detailed bargaining over tariff rates that so often economies. That could have slowed the dismantling hampers trade negotiations. The social demand for of export barriers (which was not the case in a large "window to the West" overrode narrow see- Estonia) or the erection of import resaints (which toral concerns. Normal politics was largely sos- was the case). It remains unclear, however, why pended. This is one reason for the relative weaness these factors would have played a smaller role in of the industdal lobby in the Baltic States, particu- the other Baltic States or the CIS, a pattern that lady in Estonia Because this group sought largely casts some doubt on their quantitave importance in to maintain the status quo, its demands found pub- Estonia. lic animosity rather than supporL Such sentiments may have also increased support for free trade as a Factors Speiffic to Estonia way to crb the market power of local industries In If diffcrences in monetary and trade policy are the CIS, by contrast, weaker support for reorienta- greater among the Baltics than between the Baltics tion resulted in greater power for the industrial and other economies in transition, it may be that lobby and less support for liberal policies. factors specific to Estonia are more important in Extensive democratization hai an influence as explaining Estonia's policy differences. I divide well The first semi-free parliamentary elections these into three categories: objective factors, were held in 1990. Estonia held fully democratic macroeconomic policy choices, and accidents of elections in September 1992, followed by the other history. Baltic States. Over tm, amorphous "movements" and popular fronts began to give way to parties fit- Objective Factors ang the left-right specm of Western democracies. The first objective factor, also identified by This process, though still far from complete, fiurher Hansen and Sorsa, is Estonia's geographical loca- undercut the power of lobbies, which work outside tion Estonia is in this sense better placed to reorient the democratic process. Since national politics its trade than are the other Baltic States and some reformed more rapidly than did industrial associa- Eastern European and CIS countries. Helsinki is tions or labor unions, these groups became politi- only 80 kilometers. from Taflinn. With average CommEr. THE PoLmcAL-EcoNoMy OF MACROECoNIoC AND FOREON TRADE PouCa IN EsTrowA 135 wages in Finland and Sweden some fifteen to Macroeconomic Policy Choices twenty times greater than in Estonia, there were Hansen and Sorsa correctly emphasize the -ny areas in which a new division of labor would links between Estonia's macroeconomic policies cut business costs. Cultural and linguistic ties with and its foreign trade performance. The importance Finland (similar languages. the influence of Finnish of such factors is supported by the transition expe- TV) and, though less so, with Sweden, further rience more generally.Tight financial policies com- strengthened the basis for trade ties. The other bined with an initially undervalued fixed exchange Baltic States had less direct access to Scandinavia, rate appears to be a recipe for trade expansion and while among the Eastern European countries, reorientation, as well as for keeping unemployment Slovalcia, Romania, and Bulgaria may also have relatively low. A recent study with Jeffrey Sachs been less favorably locatecd for reorientation. (Hansson and Sachs 1994) exploring the link Another objective factor could be historical between the choice of macroeconomic policies and and cultral differences. As a nonspecialist on these economic performance among the Baltic States cor- themes, I am hesitant to elaborate on this topic other roborates the findings of Hansen and Sorsa in the than to remark that the recent experience of foreign trade area economies in transition leaves little doubt of their The key elements explaining Estonia's sharper relevance. For instance. any adequate explanation and more rapid reorentation in the context of grow- of why the Czech Republic has had more success ing overall trade volumes are clear. The currcncy han, say, Russia or Romania. must include such board system produced a cmdible economywide factors. In Estona's case, these could include a iel- hardening of budget constraints. The Bank of Estonia atively long period of democracy between tbe world was prohibited by law from financing commercial wars, the knowledge that Estonia had prospered banks, except in a banking cr'sis. A similar prohibi- during that period with little access to the Soviet tion on central bank financing of the government market, and the impact of Fmnish TV in easing almost mandated fiscal balanae. reducing the scope adaption to a market economy. These issucs for stae support for troubled firms. The resulting deserve more study. demand bamer forced firms to seek new customes. Third, as nicely argued by Hansen and Sorsa, Remaining doubts about the hardness of budget Estonia's better performance than the other Baltic constraints were removed by the harsh resolution of States could be linked to a more favorable initial the banking crisis in January 1993 (Hansson economic structure. Estonia was less industrialized 1994c). A government that is prepared to close than the other Baltic States, and the structre of its down the three major banks with little or no rescue industry appears better matched to its natural of depositors is likely to be unsympathetic to pleas resource and skill endowments. Estonia also had a for help from nonfinancial enterprses. more favorble energy balance, having produced In addition, the initially undervalued initial one-half of its own energy needs (this has since exchange rate (the average monthly wage in June risen to over 60 percent). Latvia appears to have 1992 was $35) reduced domestic demand for had the worst initial conditions, having been both imports and made export sales attactive. With the highly industrialized and heavily dependent on kroon pegged to the Deutschemark and fluctuafing energy imports. Lithuania was similarly energy greatly relative to the ruble, and with payments with import-dependent, but may have had a more favor- the West functioning better than those with the able industrial stucture than did Latvia. ruble zone, enterprises had further incentives to find A final objective reason for different policies is new Western markets. And, as noted by Hansen and the much smaller agricultural lobby in Estonia, Sorsa, the initial undervaluation also gave some resulting in an environment more amenable to lib- exchange rate protection which may have damp- eral policies. For whatever reason, the growth of ened pressures for tariffs relative to those under a new peasant farms was far slower in Estonia. morm appreciatc.d exchange rate.3 136 TtADE Di mm NEW bNDEPENN STAll Among the Baltic States, lithuania bas had the that Estonia's policy choices and success were least success in tade expansion and reorientation. almost preordained. Careful examination shows that According to figures from the Lithuanian these choices were often the result of luck or acci- Department of Statistics, 80 percent of trade in dents of history. Many choices depended less on 1993 was with dte former Soviet Union. Lithuania economic fundamentals or a prio social demands also took the longest to implement tight policies. than on the preferences and wil of a few decision- Until eary 1993 its currency moved more like the malkr More often than not, pubic supportfor spe- ruble than the Deusechemark which may have cific policies (the curncy board, zcro tariff) made it less risky for Lithuanian fims to trade with developed only after the fact. the ruble zone. A later period of rapid appreciation One fortuituous development was the rapid agais the dollar created exchange rate risk in al construction of new links with the West. including directions. The introduction of an Estonian-type oil import terminals, and telecommunications links, currency board in April 1994 is a natural experi- and ferry, ship and air connections with Helsinki ment on the importance of such factors. H their role and Stockholm. These physical links laid th basis is in fact great, trade reorientation and expansion for trade and investment, particularly with the should now take ofE Nordic countries. Estonia's tourism boom (2.9 mil- Lavia's trade performance falls in the middle. lion visitors are expected from Fnland alone in LaTvia has long implemented tight macrconomic 1994) has far surpassed that of the other Baltic policies, but it has either pursued a floating States Estonia has achieved energy independence exchange rate or folowed the SDR without a clear from Russia in all fuels but natural gas. This net- commitment to maintain the raz The residual work and its influence, which depended on the exchange rate risk nught explain some of the dffer- actions and decisions of a relatvely small group of ences with Estonia. individuals could well have tured out difrently, A related theme is the impact of monetary as the experience of Latvia and Lithuania shows. independence on the ease of payments with the They remain strongly tied to Russia for liquid ruble zone. I do not share the concerns of Hansen fuels. Attempts to establsh a regular Riga- and Sorsa regarding the disruptiveness of the Stockholm ferry connection have faltered, and breakup. Replacing one currency with sever delays at the Polish-Lithuanian road border and should in principle have complicated interrepubli- weaker telecommuniation links have furher lim- can payments. In practice, payments wee already ited the access of Latvia and Lithuania to Western pm-lyzd by the inconvertibility of different repub- Europe. bcan rubles (as a result of the differential growth in Another example is the failed attempt by the supplies of noncash rubles, which strained their leftst former pime nmister Edgar Savisaar to exchangeability at parity). The replacement of this declare an "economic state of emergency" during systen withi one in which the Russian ruble-kroon the economic crsis of January 1992 (a time of mas- rate was market determined eventually restored sive shortages and hoarding). The attempt failed by convertibility and impioved the speed of payments the smallest of margins. Parliament had initially The ruble nmket in Estonia started out small and approved this plan, but the public outcry following highly illiquid. As better correspondent links were the realization that the legislation had passed only put in place with Russian banks, and as some banks because of anti-reformist (largey ethnic Russian) began to specialize in trading rubles, liquidity support, gave some initial supporters cold feet The improved over ime, decree needed to implement the "state of emer- gency" failed to win the support of pariament, and Accidents of Hihoiy Savisaar was fored to resign. Had the plan been Most explanations of Estonia's performance implemented, Estonia would have started down a woud stop here, but that could leave the impression very different, illiberal path. ODmmQ crN THE PuncA-Eco moMly oF MACROEcoNoMIc AND FOmEGN TRADE PoLIcY IN EsTNIA 137 The rapid pace of monetary reform (Estonia accident ofhistry. It depended on the political win was the first to break from the ruble zone) and the and savvy of a few people, the most important choice of a currency board and other strict policies being Bank of Estonia govcrnor Slim Kallas. also depended on chance and the activities of a few Putting such a policy in place was possible only key individuals- In May 1992, when the reform was under the unique politics prevailing in the case of in its final stages o' preparation, Prime MinisterTnit such "national projects." Public demand for a con- Vaihi (who was also chairman of the Monetary vertible national currency was intense, with strong Reform Committee) unilaterally and unexpectedly pressur to 'do something" by June 1992. In these proposed the early introduction of the one-kroon circ tances, the first cohent plan that promised (with a nominal value of 500 or 1000 rubles), to cir- to achieve tis goal would find support It happened cuate in parallel with the ruble until the actual cur- to be the currency board proposal of the central rency refomL ViE viewed this plan as a way to bank4 Counterarguments by opponents were next ease the severe cash shortage afflicting the ruble to irreTevant under these conditions. Had another Lone and to clear lare anears on wage and pension concrete program been presented earlier, the course payments. of events would bave been very different Had this proposal succeeded, it would have Another accident of history was the party in meant fircing a large budget deficit by issuing power prior to the major decisions. One interpreta- new money, the antithesis of the strict financial tion of the results of recent elections in transition principles that later won support Its implementa- economies is that voters wish primarily to punish tion would have delayed the curremy reform until incumbents for the hardships of tansition. In at least late summer (the tightly orchestred three- Estnia, the most votes in September 1992 went to day switchover could not have been conducted dur- the Isamaa party, which supported liberl foreign mg the summer holidays, when many Estomans are bade policies and strict financial policies. It had away from home) and would have brought a farther been in opposition to the Savisaar government and burst of inflation. Suppressing this proposal had been only loosely linked with the later VAS required enormous effort by those committed to government It benefited from being a relative "out- strict policies. side,? The elections consigned both previous prime Similrly, the choice of an undervalued fixed ministers to opposition.5 exchange rate had litme support among government In Lithuania, the politically right-wing but eco- advisers and academic economists Motivated by nomically not very liberal Sajudis govemment was considerations of purchasing power parity, kcy punished by voters, who supported the ex-conona- advisers pressed for a strong revaluation (of upto nist Democratic Labor Party (LDDP). In the eight times!), arguing that only such a large revalu- Latvian eections of June 1993, the ruling Popular ation would generate the levels of dollar income Front failed to make it into the new parliament, needed to purchasegoods atthe "world prices" that although many of its former members returned would supposedly prevail under the kroon. under new party affiliations, and the new govern- Understanding of the need for undervaluation was ment was as centrist as the previous one. limited. Academic economists tended to favor a The final accidents of history concem the indi- floating over a fixed rate. The fact that ministers viduals who became the ke"' decisionnakers. It was who outwardly supported the currency board con- only by chance that lsamaa, which led the new tinued to lobby die central bank for "credits' after coalition, had a leader (Mart Laar) with clear, radi- the monetary reform indicates that many politicians cal views on general policy priorities, rather than a probably never understood exactly what they had pragmatist with few consistent positions. That the supported. Social Democratic Party within the coalition was The choice of a fixed, undervalued exchange led by liberals was also not inevitable. The leader- ratc and a currency board rule was thus largely an ship of a few people allowed the government to 138 TRADEN Nm wE NEW lwwvEr STATES resist the illiberal proposals of some branch min- with great financial needs but few easily collectible juries, especiaUy agriculere Finally, Siim Kallas's taxes. Estonia opted for nearly full free trade selection to head the central bank in late 1991 was None of this means that the interational finan- hardly based on his radical views which would so cial institutions has been unimportanL The IMF influence the course of events. Had a few of the played a crucial role in stssing the need to raise people at the top been different. so would have the tax rates at the time of currency reform to close the outcomes.6 emerging budgetary gap. Its officials also spurrd the authorities to restructure the banks in late 1992 Some Weaker Influences and provided the technical assistance to carry this Two factors that would be expected to play a ouL In most areas, the views of the government, role in shaping the general thrust of Estonia's centa bank and intemational financial institutions maCroeconomic and trade policies were not in fact have fully coincided. Perhaps because the require- of primary importance: pressure from the interna- ments of the financial institutions have not become tional financial institutions and public opinion- In a constant source of friction, Estonia's relations many economies in transition, there is a conflict with them are excelenL between the international financial institutions The second fior that has been less important always urging stricter financial policies and more than might be expected is the impact of immediate liberal economic policies, and the governments public opinion. The government pumsued its chosen seeking a loosening of finanrcial policies and slower path at the expense of political popularity. The liberalization. In these cases, pressures from the clearest case ofbucldng short-term political expedi- financial institutions act as a binding constraint on ency is in agricultural policy. A government seen to the authorities. be 'nationalisf could be expected to cater to the In Estonia. when disagreements arose, it was demands of ethnic Estonians, who dominate the usually because Estonia preferd more radical poli- countryside. Many Estonian city dwellers also cies than did the financial institutions. In the spring claim a readiness to support the farm sector, possi- of 1992, the International Monetary Fund initially bly because Estonia's agrarian history remams a urged Estonia to postpone monetary reform until its strong force in the national psyche. Nonetheless, the technical capabilities were more advanced government has staunchly opposed costly agricul- (Hansson and Sachs 1992). Estonia opted instead tural support programs. for a rapid monetary reform, since postponement was politicaUy impossible and economically unde- Trends that Remain Unclear sirable (the ruble collapsed soon after the introduc- Some motivations for Estonia's chosen policies tion of the kroon). Also, the IMF had initially sag- reuain unclear. I am less optimistic than Hansen gested a classical central banking model-much and Sorsa regarding the administatve capacity of like those later chosen by Latvia and Lithuania- the ftate. As in aU economies in transition, that allowed for the issuing of domestic credits. Estonia's state apparatus is intellectually iDI-pre- Estonia opted for the more restrictive currency pared for the market economy, and sometimes board. demoralized or comrpt. The naural response is a During the banking crisis that erupted in hefty dose of liberalism (Aslund 1992; Hansson November 1992 (Hsson 1994c), the IMP recoin- 1994b), which leaves minimal room for corruption mended a less harsh policy package than the one and allows the state to focus on the core set of tasks Estonia adopted (which saw one major bank close that only it can provide (national defense, internal with n, bailout of depositors and two others merged security, a stable currency). Estonia's very liberal with a partial rescue). Finally, several international stance has been pardy motivated by this under- financial institutions have recommended imposing standing. Proposals by the Ministry of Agriculture uniform tariffs to raise revenues for a govemment to iitroduce untansparent import quotas have been COMMENT TaE POLxnCAL-EcONOMY OF MActOECONOMIC AND FODUe:n TARAIl: J4IC IN ErroNa 139 rejected. Because of its liberal trade regime, Esconia agreement among the Baltic States took effect on may have the least problematic situation at border April 1, 1994, and negotiations for a free trade crossings aunong the Baltic Stat It remais agreementwith the EU are reaching the final stages. unclear, however, why these considerations have These pacts will cover all ofEstonia's najor tading played a greater role in Estonia than in other partners except Russia, and they can hardly be economies in transition, changed. All three Baltic states have a strong commit- Negotiations with Russia are more tricky ment to fiscal balance. In 1993, the fiscal position (Hansson 1994a) They have focused on a most- of the central governments ranged from a surplus of favoxed-nation agreement which has been initialed 0.6 percent of GDP in Estonia to a deficit of I per- but not yet signed. Hansen and Sorsa argue that cent in Lithuania. Planned budgets for 1994 were Estonia should make all efforts to get such a treaty also near balance. In comparison, leading reformers Yet, while this clearly seems a sensible short-run such as Hungary and Poland have had deficits of 4 strategy, it may not be the best long-nm strategy. to 8 percent of GDP. This commitment remains to Russia has at tmes taken a threatenig tone toward be explained. Estonia. Given its muddled politics, Russia is likely to puUE stop-go economic policies for some time. Future Trends and Issues These constitute a source of great uncertainty for In the fumre, Estnia is likely to maintain a rel- Estonia (Hansson 1994a}. Continued shifts in atively hlberal position, even if govermments Russia's real exchange rate will influence the prof- change. Support for such a stance has grown with itabilihy of activities dependent on Russia. Russa time. The taonomic activities that have arisen in has also been chaotic in its tariff policies, first response to such policies (including shopping imposing huge increases, then removing them, with tourism from Finland to take advantage of the an mcetain promise to reinstate them again in the resulting low prices of consumer goods) have cre- futre. ated new vested interests in sustaining such a Ideally, Estonian fims would take this uncer- regime. tainty into account and take new steps to reorient At the same time, the greater importance of toward the West I they are slow m doing so, there accidents of hirtory over clear a priori social may be an argument for spurring reorientaton by demands in creating a liberal trade regime means keeping trade with Russia unattractive. If political that this regime is sustained partly by inertia, and security cames a premium, the need to wean can be pushed in other directions without regular Estonian enterpises from the Russian market is all new impulses to keep it on the same path. While the greater. This at least raises the possibility that high-ranking ex-communists have little chance of Estonia should not make great efforts to reach a regaining power, pragmatic politicians lacking a most-favored-nation agreemenL With only 18 per- clear vision are popuar and could domiinate a future cent of its trade still with Russia, the short-run costs government. They could slowly erode today's ultra- of further reducing this share should not be too liberal regimne As Hansen and Sorsa note, real high. The main cost of such a sateg would be in appreciation of the kroon and rising joblessness strained Baltic unity, since Latvia and Lithuania could also boost pressures for protectionism. Public remain more dependent on the Rusian markt and support for current policies is notyet so strong as to thus less able in the short-run to absorb the loss of a preclude such an evolution, which would take away share of this market Estonia's uniqueness. The chances of reversal are reduced by the Noles many fiee trade agreements with major trading part- The author is Research Fellow, Sockholm Itte of Eat nes. These have long been in effect with Fmiland, European Econonmcs. Stockholm School of Economics; Economic Adviser, Government of Estonia; and Mcmber Norway, Sweden, and Switzerland. A free trade of the BoarLd, Bank of Estonia In 1992, he served as advi- 140 DE U NEW IN EPENDENT STAlES sor to tse Pre Minister of Estonia on monetary reform References and was an Alternate Member of the Monetary Reform AsluSd Andes. 1992. The Role of the State in the Commite The opinions expressed re his own, and not tnd, Anders. Stoclitholm c sinn of East those of the Government of Esontor the Bankof Estonia. E|B b 7 Worin Papc 4t. He would like to thank John H ansen and David Tarr for WorkingPaper41. commnents an an embler vasi Hansson, Ardo. 1993. Traforming and Economy whie 1. For instance. many economists spoke of the need to BuDdINg a Na= 7h Case of Es&oa. Stockbholm 'suengthen the economyn as a prequisite for achieving a Instut of East Eur n Ecnomics Wo*ing Papa stable curenacy, a sequence tat makes lttle sense 2. The impotence of the l:bor onions is shown by the con- 1994a. 'Coming in fin the Colt The Impact of saucy of the mnmum wage during the nineteen months of POlical Developmants in Russia on the Economic the curren goverment. whe5i the averagc nominal wage Tfansfonmation of the Baltic Stes." in Nordiom more than doubled. The abiity of the unios to orgnize (Z2)635. any effective strike action is also doubtful. The near absoece of new grass-oo unions to replace the old comr- 1994b. Interational Trade and Economic muni ones is a puzzle Tsonus clan hr Efaal. dPreard for te European Forum for Democy and Solidarty conference on 3. Herc, it is still necessary to cxplain why the other Baltic MThe role of internationd trade in the transition States and CIS sttes, which stated from a simlarly under- P ,c" PRage.am Ry. valued rate, were less able to resist pressures to impose tar- if- s i994c. Rej ung the Bkg Sym it EIrantL Prepared for the London School of 4. The best indication of the strength of pressus for rapid - of Est-West Studies conferenc currency reform is that the thlree crcal laws that would on tBanking refom in FPSU and Eastern Europe: fom the basis of the post reform monetary system were Lmtm ntm Central EuopC Budaest. Ruay intoducd in parliament on May 9. 1992, and passed near- ly umously only elven days lar. Hmoa. ArT and Jcffre D. Sack. 1992. -owwing the Estonian Kroo in Trmsidon 3.()1-3. 5. A futer chane event is the exact composition of the pvC The faa tia Estonies new coalition sartd Hansson. Ardo and Jeffry D. Sachs. 1994. Monerary with a parliamentary majority of one vot means ta minor . hfsfland CriMeSrabMlnion: A Compaisan differences in election outcomes ould bave brught a vey of Experiences in the Batics. Prepared for the differeat government to power. University of Chicago Law School conference on etral Banks in Btes Europe and the Newly 6. In Central Europe, we can similady contrast the more tdSts".p radical libera programs associacd wiUh Vaclav Klaus in the Czch Republic and Leszek Balcrwicz in Poland to van Arkadic. Brian. and Mats Karlsson. 1992. An the peneay less libel;- paths dhosen by the mome pg Ecic SurW eyof he Boac S.rae London: Piner mndC'regiUMns in Hungary and Slovalia. PubLsher 6 Latva: Trade Issues in Transition Pirit Sorsa L-aM. a smal (2.7 million people) resource-poor economy about the size of eland, bas a centuries old tradition in tde as a gaewway btween East and WesL Its ice-fre ports on theBaltic Sea and its location at the mouth of an inbland river system made it a cental tading post in dte middle-ags when Rigas the cap- U Macreconomic Situafton ital was an important lamsa city. Much of Latia's economic and Structural Reforms actvity during its brief perod of idependence between the two world wars depended on tade, a pattern continued during its * Trade following five decades as part of the Soviet Union, although witn a highly disoed allocation of resources. Latvia's proximty to lare, high-income Eumpean markets Tdcnes tansport costs for Latvian goods and gives it an advn- the Former Soviet Union tage as a transit center between Eastern and Western Europe Since r-esablihing independence in 1991, Latvia has starmd * Issues in Trade Policy to ieorient the direcon and stmcture of its trade to match its natmral comparative advantage as an intermediary in Europe * Payment Issues - and as producer of skill-intensive products and services. A filst indication of Latvia's advanugeous location is the substantial * Policy Conclusions re-export trade that has passed through its borders since inde- pendence. Geographic location and related historical tes to is neighbors also facilitated the creation of commercial and other links to the West Technological and financial assistance from Latvia's rich Nordic neighbors has also been importanL Latvia has negoiated Liberal fir-trade agreements with most counties 142 TRmz IN THE NEW INDEPENDUNT STAins of the European Free-trade Association (EFTA), Soviet Union; and frequent changes in the trade that have opened important trading possibilities for regime, which may have promoted lobbying for Latvia in the neighboring high-income countries, protection and delayed adjustment. Oiler distor- though Latvia has been slow to take advantage of tions result from the lack of a clear and transparent these agreements. Links to Western Europe will be drawback program for exports, while price and further reinforced in 1995, when a free trade agree- export controls in partner countries have enabled ment with thc European Union goes into effecL the rise of highly lucrative re-exports, which togeth- er with service exports, probably contributed to the Macroeconomic Situation and Structural appreciation of the real exchange rate and attracted Reforms resources from other activities. Successful trade refonfn requires a stable eco- noniic environment and price incentives that reflect Iniffal Reforms relative resource scarcities. On the stabilization Iatvia introduced price reforms in early 1991, side, Latvia has succeeded in bringing inflation and by the end of 1992 less than 8 percent of goods down from an annual rate of 958 percent in 1992 to and services in the consumer pnce iodex remained a projected 35 percent in 1994. Preliminary infor- under price controls, mostly energy and public util- mation for 1994 indicate that the economic decline ities such as municipal services. The first elements may be bottoming out, and the economy was of modern tax system were introduced in 1991, expected to rebound in the second half of 1994. widening the tax base.1 The faster liberalization of Progress with structural reforms has been prices in Latvia than in the rest of the former Soviet slower. Latvia's economic transition stamfed in late Union initially brought terms of trade gains, 1980, with increased economic autonomy within improved company profitability, inceased govern- the Soviet Union. Price, trade, and tax reforms pre- ment revenues, and held output contraction at less ceded stabilization mostly for political and technical than 10 percent in 1991, allowing unemployment reasos, but the real momentum for reform was not rates to remain at a low 0.5 percent of the labor reached until political independence in September force, (table 6.1). 1991 and Iatvia's detachment from the ruble zone The macroeconomic situation worsened rapid- in mid-1992. ly in 1992. As other countries of the forner Soviet The introduction of convertible currency in Union started to liberalize prices, Latvia's terns of 1992, coupled with tight monetaly and fiscal poli- trade deteriorated rapidly, with toual teMs of trade cies stabilized the economy, reduced economic losses (comparing 1990 prices to world prices) esli- uncertainty, and improved the business climate. An mated at between 13 to 24 percent, or about 8 per- initial undervaluation of the currency helped export development and provided temporary protection Table 6.1 Selected Economic Indicators, 1990- against imports, but by the end of 1992 the currency 93 (percent) was appreciating rapidly, reducing te competitive- h t t 1992 1993 ness of Latvia's exports. Many of Laivia's trade -- policies have probably slowed adjustment and trade GDP 4.5 4.3 -33.5 -10 reorentation. Among these are export taxes on Inflation 10.5 262 958 35 goods in which Latiia may have a natural compara- Fiscal buano/ce/DP 2 6A -1.5 0 tive advantage, such as wood and wood products; Unemployment a highly dispersed levels of protecion on imports of (%tof lbrforc) - 0.5 2.2 5.8 many agriculural and otber poducts, with negative Real wages 5.3 1623 15.7 0.5 effects on efficiency and modernization; discrimi- natory taxes on exports in nonconvertible curren- a. Reisieed unemploymnt ates. - Not available cies, dampening trade with counties of the former Sourc= Lavian authoritis and World Bank saff esiates LAMVIA: TRADii IssuEs iN TRsnmoN 143 cent of GDP (Tarr 1994). Higher input prics and credit was the main policy inslrument used. excessive credit creation in ihe ruble zone acceler- Stabilization was also facilitated by limits on wage ated inflation, and prices increased tenfold in 1992. incrases in state enterprises, which kept budgets in Stocks were rapidly depleted, and most companies' balance and helped contain wage inflation. financial situation worsened with the deterioration The introduction of the convertible currency in terms of tade. Unemployment passed 3 percent was important not only to stabilization but also to in early 1993. Trade with the other new indepen- trade expansion, by providing appropriate incen- dent states collapsed, and GDP shrank by 34 per- tivcz to exporters and importers and foreign cent in 1992. exchange for imports by reversing capital flight The currency reform delinked Latvia's currency Stabilizaton from the ruble area and helped contain inflation, In July I99, the govemment launched a stabi- which averaged less than 2 percent a month in the lization program supported by the IMF. Latvia's third quarter of 1993 and 1 to 2 percent in mid- maintenance of fiscal balance, by reducing pres- 1994. The current account of the balance of pay- sures for monetary financing of government ments registerd a suplus equivalent to about 6 per- deficits, facilitated stabilization. Latvia's decision to cent of GDP in 1993. In early 1994 Latvia finalized adopt a flexible exchange rate regime allowed the a second standby arrangement and two systemic authorities more leeway in using monetary policy reform facility drawings from the BIF for a 15- for maroeconomic management of the economy month period. than in Estonia for exanple, where monetary disci- Enterprise adjustment moved more slowly. pline was imposed by law.? Latvia's policy, howev- During 1992 enterprises used both interenterprise er carefiuly arrived at, may pose greater challenges arrears and tax arrears to the government to delay for the susminability of the stabilization program resructuring. They also increased their stocks of ffan would a less flexible policy. final goods, reduced investment, raised prices, and In May 1992 Latvia introduced a temporary cut back worling hours. In 1992, the largest losses currency, the Lavian ruble, to ease cash shortges in industrial output in Latvia were in energy and and permit an independent monetary policy while capital-intensive machine-building, steel works, and the economy stabilized sufficiently to allow for the food and light industry, all of which were the most introduction of a permanent currency. By March dependent on trade with the former Soviet Union. 1993 monthly inflation had fallen to single-digit Industries that increased production included labor- levels and Latvia introduced its permanent curren- intensive activities such as textiles, shoes, fumriture, cy, the It. The lat, backed by pre-war gold reserves linen, and confectionery, and resource-intensive and foreign cumrency, was slightly undervalued to sectors, such as fishing and forestry. allow for inflatiuary adjustrents. The undervalua- Conditions became more difficult in 1993, as tion-measured by wages in dollar terms3-per- the government got tougher on firms with tax sisted until confidence in the new cmrency ares, confiscating inventories and introducing muerged. By September 1993 the currency had insolvency proceedings. Manufacturing output appedated relative to the dollar by about 50 per- plunged to 60 percent of ics 1992 level. Te small- cent, implying nominal wages on the order of $60- est declines were in industries that had increased 75 a month The Iat continued to appreciate, reah- exports to the West, such as wood and funitur ing a monthly wage equivalent of $110 by early The largest declines were in clothing, paper, metal 1994. In February 1994 the central bank started to working, radio equipment, and construction materi- use SDR as an informal reference to the value of the als, which were dependent on markets in the former currency. Soviet Union. As enterprises felt the squeeze, they Cmrency reform was accompanied by very began to lay off employees. Official unemployment tight monetary policy and tight fiscal policies. right rose to about 6 percent of labor force by the end of 144 TRADE IN THE NEW INDEEDENT STATES 1993, but underemployment is likely to be much exports of metals and oil) most exports to the West larger, as many workers have been on unpaid leave from Latvia were resource-intensive products (31 or on short work weeks. Unemployment was low percent), mainly wood, followed by capital-inten- relative to the contraction in output for several rea- sive products (28 percent) consisting mainly of sans, including a decline in real wages and, proba- chemicals (table 5.3 in chapter 5). bly, greater absorption of workers by the private Other problems remain as well. Latvia has sctor, a fact poorly captured by official data.4 made the least progress in large privatization among the Baltic countries. With the exception of agricul- Structurat Reform ture, in which privatization of farms has resulted in The implementation of structural reform mnca- some 50,000 units, most progress has been in small sures has lagged behind macroeconomic stabiliza- privatization. About 70 percent of small businesses tion pc;licies. In particular, adjustment in Latvia has were privatized by mid-1993, mostly in services been influenced by the slow pace of systemic and trade (EIU 1993). Largr-scale privatizations reforms with an impact on the supply response, have suffered frm cumbersome institutional proce- such as privatization, private sector incentives, dures and lack of clear guidelines. By the end of development of property rights. factor mobility, and 1993 only 19 of the 1,200 lare enterprises and 82 financial intermediadon, of the 1,082 agricultural enterprises under the Trade reorientation and adjustment to world Agriculture Ministy had been privatized. market conditions are also made more difficult by Until recendy, privaztions were the responsi- the large share of heavy industry in Lia's econ- bility of the relevant sectoral ministry, resulting in my (30 percent) compared with 17 percent in confusion about such basic questions as who is Estonia. Differences in quality and standards in authorized to carry out privazizations, what forms Wesatrn makets mean that trade reorientation is are permitted, and how information is to be reported likely to require new capital investments. In addi- and collected.5 To speed up the process, the goven- tion, many of the industies are large (an average of ment bas centralized all privatization in one agency, 8,000 employees in the engineering industry, for the Privatization Agency of the Ministry of example), and had no exre to competition. One Economy. Greater use of vouchers and leasing hundred and forty of Latvia's 400 industrial enter- arrangernents has been approved recently, which pnses were all-unon enterprie-the sole pmducer may facilitate t sale of smaller units. of a pnoduct in the Soviet Union-and othes were Constraints on labor mobility may also be near monopolies. Understandably, many ofItvias slowing adjustment to a new set of market-based most important exports to the former Soviet Union incentives. The unavailability of housing because of in 1993 were from Lhese monopoly industries, slow privatization of the housing stock has kept Much of this industry was also very energy inten- people from moving to new jobs. The large uon- sive, vulnerable to the energy price adjustments cash benefits provided by many state enterprises accompanying the collapse of old trading airange- have also reduced incentives to move, while gov- meats with the breakup of the Soviet Union. For emnient mandaed severance pay amounting to sev- many of these industies, open trade may be the emal months' salary makes enteprises reluctant to only source of competition and incentive for adjust- lay off redundant workrs. ment for several years to come. Difficult access to credit until mid-1994 may Reorientation of trade will be easier in raw also have slowed the supply response to reforms materials production because these products are and afected trade financing. Interest rates on more homogenecus. And in labor-intensive indus- deposits and credit remained negative in r terms tnes, the high skill levels in Latvia make retraining during 1992 despitethe tight credit situation.Banks easier and facilitate a reorientation to Westem stan- were reluctant to lend long term in the hyperinla- dards and quality. In 1992 (outside the likely re- tionary environment and without collatral. And LATrVIA TRADE IssuEs IN TRANsmON 145 savings remained low, in part beause until placed the value of this trade at $30040 million in September 1992 foreign currency deposits offered 1992. (See chapter 5 on Estonia). Much of this trade better returns than domestic currency deposits. And is likely to cease once prices in Russia and other interest rates responded very slowly to lower infla- countries of the former Soviet Union adjust to tion because of inadequate capital and poor bank world levels or these countries relax their expart management. Nominal interest rates exceeded 150 controls and declining levels were already apparent percent ayearin 1993 when inflation averaged 110 in mid-1993. pertcnt. a reflection of credit scarcity, severe uncer- tainty, and the nonperforming portfolios of domes- Level and Direction tic banks. In early 1994 real interest rates started to Latvia has made a good start in diversifying its fall substantially, reflecting an improved credit sit- exports away from excessive dependence on the uation and gradualy changing expectations on former Soviet Union, but dependence on the former inflation. Soviet Union still seems strong in imports. As part of the Soviet Union, more fian 95 percent of Trade arvia's exports and nearly 90 percent ofits imports Since independence Larvia. like Estonia, has were within the USSR. By 1992 and 1993, about continued to serve as an impornt cente of East- half of its exports were going to countries outside West transit trade, tansshippiag substanti quanti- the former Soviet Union, but nearly two-thids of its ties of trade of the former Soviet Union. Latvia has imports stiHl originaLed in the former SDviet Union an oil pipeline and a port speciazing in oil ship- (table 6-2)Y This is in sharp conrdast to Estonia, ments. Since the start of the transition, re-exports of which was importig most of its goods from outside peroleum and raw materials such as metals have the former Soviet Union by 1993. Miis may reflect iceased, most of it illegaL6 OECD estimates the fctthatuil the end of 1993 Iatvia had export Table 62 Direcon and Level of Latvas Trade, 1900-93 min migions of current dollas and percent) 1990 1991 1992 1993 Valt Toal expots 8,826 6.045 880 1,047 FormerSoviet Union a 8,522 5.920 451 587 Rest of wodd b 304 125 429 460 Toal import 9.6Z7 4,843 895 988 Former Soviet Union 7,985 4,365 472 649 Restof wodd 1,642 478 423 339 Total balanoe -801 1.2D2 -15 59 FormerSoviet Union 537 1,555 -22 -62 Restof wodd -1338 -353 6 121 Pere DMbbulian Tolalexports tOO 100 100 100 Former Soviet Union 96.6 97.9 512 56.1 Rest of world 3A 2.1 48.8 43.9 Totalimnport 100 100 100 100 FornerSovietUnion 82.9 90.1 52.8 65.7 Rest of world 17.1 - 472 34.3 a. Figues fortradewith th fnner Soviet Union are derved from coutry dataandWodd Bankstaffemates potedin nationl cur- rences using official orcoannnial change rate for 1990 and 1991 and sanal aveage market excge rates for 1992 and 1993 b. herest of the wodd refs to ountrics outside dbe fe Sovicet Union; figures a based on cowty dataoed in U. dol 146 TADE IN n NEW INDEPENDE?r STATIS taxes that affected several potential export items to easier in such resource-based goods because quality the West, such as wood (see below). By reducing is more uniform and less important to sales than in exports in hard currency, the export taxes reduced the case of machinery and equipment. Many of the amount of foreign exchange available for these products reflect Lvias resource base and its imports. The apparent reliance on imports from the natural comparalive advantages. Trade in services is former Soviet Union may also reflect technological of considerable imponance for Lavvia. Receipts dependence on the East in production or the role of from the tansport sector amounted to about 15 per- re-exports both in import and export stazistics. cent of GDP ([MF 1993). A main scrvices exporter After collapsing in 1992, Latvia's trade levels was the Latvian Shipping Company, which operates stabilized in 1993. In 1992 both exports and a fleet of over 100 ships. Touism and other port imports, especially with the former Soviet Union enterprises accounted for other se.vices carnings. fell to a fraction of their previous level measured at Latvia has been less successful in exploiting its the official exchange rate.8 The following year skilled labor potential in exports to the WesL In trade with the former Soviet Union rmcovered some- 1992 labor-intensive products such as clothing, tex- what, especially for imports, while trade with the tiles, and fumiture constituted only 19 percent of West grew very slowly in dolar terms. Total bvia's exports to the West, compared with 34 per- Larvian exports in 1993 rose only 17 percent (in cent for Estonia. That trend continued in 1993. nominal dollars terms). Exports to the West Subcontracting activities and related foreign invest- incrased less than expors to the East and imports meat have not taken root in Latvia as they have in from the former Soviet Union recovered. In 1993 Estonia, perhaps because of Latvia's much less re-export trade also started to decrase and trade tanarent trade polcies. flows were affected by large value changes follow- ing price adjustments to world levels for Russia's Trade Policy raded goods. The redl apprecation of the lat by the Trade is parficularly important for a small end of 1993 may also have affected export incen- country like Latvia, which depends on trade for tives, while re-establishment of some trade links much of its economic activity. Latvia's trade poli- with former Soviet trading partners after the initial cies during transition have featued a gradual reduc- collapse in 1992 may have helped exports to the tion in export restrictions, a tightening of import East in 1993. restictions, and a policy-induced bias against trade Russia was still Larvia's inain trading partner with the countries of the former Soviet Union. in 1993 (30 percent exports and 36 percent or more Exchange rate policies have also influenced incen- of imports.)9 The European Union (EU) was its tives for foreign trde. largest partner in the West (25 percent of exports and 17 percent of imports). Intra-Baltic trade has EXPOrt Policies remained a small share of the total, with exports at Latvia inherited he anti-export bias of the about 6 to 10 percent during 1990-93 and imports Soviet system, which restricted exports in order to increasing slighdy from 14 to 17 percent, probably supply local markets under the distorted price struc- reflecting shifting terms of trade with Estonia and ture. The first step in reform was to abolish state Lithania (EIU 1993; State Committee for Statistics trade in 1992. The only state monopoly left is in 1994). nonferrous metls, an attempt to control the iUegal Exports to the rest of the former Soviet Union transit trade. All exporters to the former Soviet were composed largely of machinery products, fol- Union required licenses to comply with the agreed lowing patterns established durng central planning, product lists negotited in bilatera eats (mdica- while exports to the West were mainly resource- tive lists). based goods, such as wood, metals, mineral fuels, In mid-1992 all export quotas and licenses leather, and vegetables. A reorientation of trade is were abolished and replaced by a more transparent LATW TRADE LssuEs mN TRAsMoN 147 Box 6.1 Key Features of the Trade Regime in March 1994 Insmaunent Descrip on Pewentage of tadff Amsa apon resraints Taxes CoPr ertble currency Range of 1-1009; 90% of atas beow 100% 8% (eather, wood) Nonconvertible currency Range of 1-200%; 84% of dutes below 10% 8% (eaherwood) Quotas None Licerses Metals tade goverrnent monopoly Imponrrtfs l Tarifs Unweighted average 10%. 38%below5% Range of 0-50% 60% - 15% 1%>30% 2% specfic rates Licenses Metals subject to government monopoly Quots None State bacti Abolished in 1992 Ewharage rate * Converbble currency since 1992 under flexible exchange rate regime informally inked to SDR since February 1994. * Real apprecialion measured in monrt US dollar wages hom S1G-16 in 1992 to $SIO in may 1994. * ND surender rquirements. a. Atthe sixigit harmonized syst cassiicaion system of export taxes. The taxes were intended to added to taxable exports, including mostly agrcul- compensate for the undervaluation of the real tural products and some raw materials. The bias exchange rate, since the prices of most of the goods against exports in nonconvcrtible currencies was subject to export taxes had been liberalized The reduced with the drop in tax rates and number of export tax rates were highly dispersed (ranging goods subject to taxes. The reduction in specific from 2 to 300 percent) and higher on exports to taxes (from over 3ariff Hles to about 20), which nonconveriible cmrency areas and on barter trade.1I tend to hide the level of potection, also improved Excluding specific rates, two-hirds of the taxes on the transparency of the system. Many of the remain- exports in convertible currencies were below 10 ing export taxes have an industrial policy tilt They percent compared with one-tenth of taxes on are levied on raw materials,which reduces the price exports in nonconvertible currencies. The higher of inputs to domestic industries processing these taxes OD nonconvertible currencies and barter were inputs. reportedly designed to encourage exports to the In addition to export taxes, export expansion West may have been hampered by the absence of a tans- At the end of 1993, the export tax rates were parent duty drawback scheme. (See chapter 11). lowered substantially, reducing their dispersion and Thbough a second-best option, duty drawbacks are restrictiveness.1I Duties were eliinated for many needed in the presence of protection on rw matei- final goods, though a number of new items were als and other inputs to help Latvian producers com- 148 TRADE ; TE NEW [N I ENDENr STAll pete in world markets. Although many inputs have Agriculture prepares a monthly list of domestic been exempted from import tariffs, administrative prices for various commodities to serve as basis for costs and uncertainty about receiving the exemption customs valuation and duties (IMF 1993). The inex- are high because producers have to apply for duty perience of Latvia's customs department in deter- exemptions (see below). Laivia is currently prepar- mining the value of goods is given as the reason for ing a simple. fast, and tansparent sYstem. the rise of specific duties and minimum prices. This use of domestic prices-if they exceed world prices Import PoaiWes -instead of international ones can, however, give During the early years of independence domes- additional protection to domestic producers. tic industry was protected against imports by the The Tariff Commission, headed by the undervalued exchange rate. The import regime M4inister of Foreign Trade and composed of repre- itself was relatively open: all state controls on sentatives from other ministries and producer and imports were eliminated and everyone was free to trade organizations, set and reviewed import and engage in foreign trade. Demands for import pro- export policies until the end of 1993. Unlike the tection emerged as the real exchange rate appreciat- case in many countries, which permit changes in ed- duties to be made only by parliament to guarantee The first import duties were introduced in permanency and tansparency, in Latvia the Tariff September 199Z The aim was a uniform rate of Commission had the authority to change rates upon protection at 15 pecent applied to all imports a simple request by any physical or legal parson. mainly to raise fiscal revenues. Uniformity is The Commision modified rates severl imes, cre- important because it gives the same protection to all ating za incentive to lobby for protection. Mast of activities and avoids ct picking of winners by the the changes to duties have no clear economic justi- government that differentiated rates implies fication. Though the overal level of protection was moder- A new law covering import dutics entered into ate and mostly tariff-based, the uniformity objective force in March L994 Despite some improvements was not reached and the structure of protection in the dispersion of rames, the new law seems to became highly dispersed, ranging from zero to 100 percent First, differentiation according to source FRgure 6.1 Structure of the Tariffs In Latvia In March 1994 was introduced, with a higher 20 percent duty on goods from counties without trade agrements with Perntoftota L.atvia, (most of the former Soviet Union, Japan. and 60 many developing countries) In 1992 these coun- tries accounted for at least half of Latvia's imports 50 Exemptions, especialy for inputs, fiuther reduced uniformity. A number of products were subject to 40 specific and seasonal rates. The transparency of the systcm was reduced by 30 several elements of the tariff policies, including exemptions and the use of specific rates, especially in agriculture. Following petition by importing 20 intrests, exemptiDons were applied at the dicretion of the relevant ministry. Specific rates hide the actu- 10 d al level of protection received by both producers and consumers. Furthermore, the customs depart- 0 _ . ment uses a system of "minimum prices" for the o _ N X tl0 valuation of agricultural imports. The Ministry of Duty rate (%) LATV?A TRADE IssUES IN TRANSMON 149 Figure 6.2 Sectoral Distribution of Nominal Tariffs In Latvia in March rrscelaneous nuf. 'instrunwnts~ transport qul Averdge esectrial nachinery rnTut products constrcion nut shoes paper| wood lealher chenic Is rre2als _ agricuEure o 2 -4 6 8 10 12 14 16 Unwuighted Average dut (y) by secbr havc slightly inceased the overall level of protec- price of the taxed products. Many labor-intensive tio in Latvia. The unweighted average of the duties industries are likely to have a comparative advan- was about 10 percent (not including specific rates). tage in trade with the West, so the higher-than- The number of goods subject to high duties average pmttion they received may reduce incen- iicreased12 The uniformity objective was still not tives for trade reorientation - in these industries. achieved: 60 percent of duties were set at 15 per- Protection weakens incentives to improve produc- cent, while 38 percent were at 5 percent or less (fig- tivity and quality and makes production for the ure 6.1). Most of the lower rates apply to inputs, local market or for markets in the former Soviet which can resukin high rates of effective protection Union more attractive. (of valuadded). The main improvement is that The new tariff structre maintained the dis- ministries may no longer exempt specific users crimination by trading partner. The unweighted fiom paying custons duties on inputs, which should avemge duty for imports from trading partne with reduce the dispersion of rates and effective protec- which Latvia had no trade agreements was 13.4 per- tion to domestic value added. cent, (10 percent for those widt agreements). Free- The highest nominal protection rates (13-to 15 trade agreements with most of the EFTA countries percent) were in labor-intensive industries such as and with the other Baltic countries, which granted shoes, leather, textiles, wood and paper (figure 62). duty-free entry to industil goods, futher intensi- The lowest rates were in capital-intensive machin- fled the discriminatory pattern. cry production. which exports to markets in the for- Transparency and consistency remained clu- mer Soviet Union. The effective rates of protection, sive. A large number of products werc still subject especialy in the labor-intensive industries, are esti- to specific duties (about 130 product lies at the six- mated to rmnge from 100 to 150 percent depending digit harmonized system classification). These rates, on value added because inputs were in most cases though appearing to be low, may easily be in the xempt firom tariffs. Some industries rceived addi- range of 50 to 100 percent The Tariff Commission tional protection from export taxes (leather, metals, continues to administer changes to duties, but a new wood) on inputs, which tend to lower the domestic customs law has made tariff changes subject to 150 TRAveIN TMHr.auW INOEEND STATES Parliamentary approval. The law also established ment involvement in this trade has gradually been the basis for temporary protection measures, such as reduced. The intoduction of convertible currencies anti-dumping or countervailing duties under GAIT in Latvia and some other countries has reduced the praetice. barriers to trade created by unstable nonconvertible Following intensive lobbying by farmm against currencies, while improved commercial bank net- cheap imnports tariffs on a number of agricultural works between republics have improved payment goods were increased in June 1994 Protection is mechanisms (see below). Problems with market unlikely to solve the problems of Latvian agricul- access in Russia and the bias created by Latvia's ture, however, which are related to low productivity own trade policies also impede trade with countries and inefficient farin size. Protection will also of the former Soviel Union. Trade among the increase the cost of food to consumers, with poten- Baltics has been facilitated by a free trade agree- tially adverse consequences for low-income groups. menton industrial goods since 1993. In late 1991, as the centralized system of con- Exchange Rate Polrices trol in the former Soviet Union was being disman- The undervaluation of the exchange rate in ded, Latvia and other former republics started to early 1992 provided temporary protection against negotiate bilateral trade agreements to maintain competition from imports, while making exports trade flows, mainly through obligatory lists negoti- relatively more atuacive than domestic sales. The ated between governments, and indicative lists low average wage in dollars, at about $10-16 in negotiated between enterprises within an agreed early 1992-low even after allowing for productiv- framework set by the governmenL Difficulties in ity or skill differentials with other countries- fulfilling the agrements soon reduced their impor- reflected this undervaluation. Asset demand for for- tance. Quantities delivered fell below targets as tm- eign exchange was stmong, fueled by high inflation, ditional supply networks were dismantled and uncertanty about the value of ruble assets, and neg- countries, especially Russia, accumulated substan- ative real interest for ruble deposits, which tended til arrears in this trade. The negotiated fixed prices to depreciate the exchange rate. gave little incentive for Russian enterprises to flfill The exchange rate began to apprecate substan- the conats when more lucrative trading opportu- tially following stabilization and introduction of a mides were available at world prices, especialy for convertible curency. By mid-1992 average wages many energy and raw material products that Latvia in dollars had risen to $35. By January 1993 they had long been importing from Russia and otie. were at $50 (IMF 1993), and in early 1994 at $ 10, Furthermore, the substantial ruble inflation in 1992 a nearly tenfold increase in two years. The real made the accumulation of arreas by Russian exchange rate appreciated as stabilization and high importers from Latvia attractive. As long as Latvian domestic interest rates reduced asset demand for exports to Russia were denominated in rubles at foreign exchange and resulted in substantial inflows fixed contract prices, delaying payments to Latvian of foreign currency- Foreign exchange fiom the ille- enterprises provided substantial rents for Russian gal transit activities, foreign exchange earnings importers. from service activities, and capital inflows from In 1993 there was no trade agreement between other countries to Latvia's "offshoreT banks may Latvia and Russia because Russia did not ramtify the also have contributed to the appreciation. 1992 agreement with Latvia until April 1994, most- ly for political reasons.13 The agreement did not Trade with Countries of the Former Soviet include an obligatoxy list because Russia and Latvia Union could not agree on implicit prices. With no ratified Latvia's trade with the other new independent agreenent in 1993, Latvia's exports to Russia were states is slowly starting to rake place through regu- penalized by a doubling of Russian import duties in lar trade channels between enterprises as govern- early 1994, while Russian exporters had difficulty LArVIA TRADE [SSunE IN TRON 151 Box 6.2 Chronology of Main Trade-Related Reforms, 1991-94 Domestic Extemal 1991-1992 Most pices liberalized 1992-93 GSP teabmt in main industrial countis 1991 Tax rfborn 1992-93 Free-uade agrements with most EFrA coun- 1992-93 Introduction of comeribe currency ties (Fiand, Norway, Sweden, and Swum*d 1992 State tading abolshd 1992-93 Abandometof indicatve Es Mid1992 Export quotas a rces replaced by 1992-94 General trade agreements with a number of ex- sporttx Savietrepublics September 1992 Introduction of import duie 1993 Ballic ree-trde agreement End 1993 Reduction in export restints 1994 MFN bade agreenretwlh Russ March 1994 Reform of nport regime is" Application to join GATr June 1994 Increase in agncuural dudes 1994 Agmemntwitlh the EU on a for-yevarnut to afree-Irade agmeement getting licenses for exports to Latvia. Latvia soon Trade widL the odxer Baltic countries was on a applied disciminatory import duties of its own on different footing, folowing implementaton of a Russian exports to Latvia. Fnally in April 1994, fieetrde ageement in 1993. That agremnt gavc Russia and Latvia agreed to gant each other most- the Baltic countries the same free-ndde staus as favored nation treatment, eliminating the discimi- most of the EFTA countries had with Latvia. The natory duties on both sides of the bourder trade creation potential of the agree-nent may be After the failure of the government-negotiated limited, however, by the smaHl size of the Baltic trade agements, trade among the coimtries of the markeL Trade diversion-the replacemet of mare former Soviet Union shifted to enterprise-to-enter- efficient third-country inports by imports from pr- prise barter or hard currency anrangements, which tected partners -is unlikely to be a serious problem kept some level of trade alive in the region in 1993. as long as Latvia mainis only a modert levd of So did the various outward and inward processing protection. schemes, which allowed enteprises to bypass bor- der taxes. Under these arrangements, products Issues in Trade Poicy imported from Russia to Latvia, for example, for Latvia's trade policies raise a number of con- further transformation were exempt from border cemns for the efficient allocation of resources and a duties, and exports of the final product to Russia successful transition to a market economy. On the were exempt firom Latvian export taxes, VAT, and export side, Latvia should remove all rmaining Russian import duties. Because the system did not restictions (see chapter 13) and introduce a duty require strict application of input coefficients for drawback scheme- Now that prices have been fuly duty-free treatment, it probably permitted Latvian libazed, there is no econonic reason for export producers to import duty-free more raw materials taxes. The high taxes on exports in effect for most than needed for the final products, unlike a strict of 1993 no doubt contributed to the slow growth in duty drawback system)4 Though rversing some of exports during that year- Because most of the the antiexport bias of the export taxes, this arnge- remaining export taxes are on raw materials (wood, ment had high administrative costs and the process- leather, sands for gls making) not subject to price ing provisions were bureaucratically convoluted controls, the taxes protect the domestic production and subgect to discretionary approvaL A transparent of these inputs, weakening incentives for rsmuctur- duty drawback system for aU exports would be ing the economy. Taxng raw materials may also more efficient impede the export of resorce-basod goods in which 152 TRADE IN THE NEW INDPENDENT SrTAm Latvia may have a naturl comparative advantage, true luvel of protection for producers and cor- A tax on exports also interferes with imports by sumers, because of the difficulty of computing ad reducing foreign exchange receipts and depreciating vatorem equivalents, and a minimnum price system the exchange rate. And high taxes encourage smug- is not the way to solve problens widL customs valu- gling. ation or to prevent fraud. UJsing domestic prices The discriminatory structure of export taxes (minimum prices) as a basis for customs valuation should also be abolished. Higher taxation of exports may increase the protection from imports since in nonconvertible currencies is unlikely to encour- inefficient production would raise dormestic prices. age a reorientation of trade to the West since prod- If valuation is a problem, prices are available in ucts sold to the forner Soviet bloc countries could international exchanges for relatively uniform agri- not often be sold in the WesL Levying taxes on final cultural goods, while international experts in cus- goods may make them unmarketable, rendering tows valuation can establish values for more differ- adjustment more difficult If the objective of the entated products- export taxes was to reduce incentives to trade in Thid, Lawi needs to establish an institutional nonconvertible currencies, uniform taxes would framework for trade policy that is simple, transpar- have been more effective: Latvia's exports to the ent, and based on clear criteria Tariffs should be West grew slower than its exports to the former established according to specified guidelines and Soviet Union in 1993, a year when trade bias changed only by Parliament on theecommendation against countries of the former Soviet Union was of a central organ such as the customs department high. Trade is best promoted by a transparent and or the cabinet Where there is discretionary power liberal trade policy framework-witness Estonia's to change tariffs, the process is open to corrupton success in reorienting its trade using neutral trade and lobbying for protection. And ftquent changes policies. in duties reduce the credibility-of policies and the The lewel of protection of imports is moderate, stability of incentives, reducing investment and but the dispersion of taes, lack of transparency, and dircting it to sectors in which Larvia may not have inconsistency of the regime create problems of a longeerm compaative advantage. allocative efficiency. Latvia should move to a mod- Temporary tariffs should be imposed only in est uniform ra& of about 10 percent or less, phased clearly defined circstnces, foRowing clearly in over five years. Though some temporary protec- defined guidelines. The GATr allows counties to tion may be justified during transiion to help enter- impose temporary duties as safeguards against sud- prises adjust to new relative prices, it should be pro- den surges of import or to counter dumped or sub- vided on a uniform basis. The rate should be low, to sidized imports. The procedure should be public avoid any build up of pressures to ecempt inputs and transparenL and capital goods from the duties. Also, a high rate Fourth. Iatvia should eliminate import dis- of protection would incrase the trade diversion crimination by trade partnerbeyond MEN duties. If cost of Latvia's free-trade agreements, as its free- the aimn is to negotiate concessions, charging higher trade partners can take advantage of high rates of duties on imports from counries with which Latvia protection against third countries by exporting has no trade agreements is unlikely to confer much expensive or outdated products to Lawvia. A low bargaining power. Discrimination against Russia rate of protection would promote transit and entre- was removed through conclusion of a trade agree- pot activities and would also increase fiscal rev- ment in eariy 1994, but it remains for other coun- enues by reducing incentives for tax evasion. tries such as Japan, a number of countries of the for- Second, to improve the transparency of its mer Soviet Union, and many developing countries. import regime, Latia should eliminate specific tar- The higher duties charged counties with which iffs and the system of minimum import prices on Latvia has no agreement only increases the trade agricultual goods. Specific rates tend to hide the diverting effect of fre trade agreements. LATVA: TRADE IssuEs mN TRwmmoN 153 Latvia is at a stage in its transition when having Payment Issues a transparent and nondiscriminatory farnework for Convertibility of the lat and liberal access to protection is critically importanL The tariff and foreign exchange15 have eased foreign trade trans- import scheme needs to be changed now. before actions and reduced exchange rate risks for Latvian production adjusts to distorted incentive stuctures. traders. By early 1993 Latvia's trade parters in the Change will be much more difficult later, once fonner Soviet Union were increasingly willing to stong vested interests have been created. Already accept payments in Ltvian rubles (and later in las)- agricultural interests have successfully lobbied for However, the instability of many of the new curren- special import protection on several products, spe- cies and the nonconvertibility of sorne currencies in cial tax rates, and a clearing of arrears. the former Soviet Union continue to impose high Overwhelmingly, international experience demon- costs for trade in these currencies. Because of the strates that openness boosts growth and prosperity. high risk of holding some of these curencies, banks Latvia need look no farther than Estonia, whose charge very high commissions on these transac- transparent policy framework and successl adjust- tions For example, in 1993 the Russian ruble had a mient in trade shows how important openness can be 47 percent commission in Latvia and the Ukrainian to successful transformation from a command to a karbovancts 300 percent, while the US doUar had market economy. only a 6 percent commissiun. Increased competition In addition to pressures for protection from between Latvian banks will only partially solve this special interst groups, fiscal revenue concems may problem, which pardy reflects the respective con- also influence discussions about the approprate tries' ecnomic conditions. level of import tariffs. Doing away with exemptions Problems in making payments for trade can and reducing incentives for smuggling would substantiallyincrease tiansaction costs. lnitilly, the improve revenue collection. But existing free-trad largest payment obstacles wer related to difficul- agreements between Latvia and a number of its ties in clearing centl bank correspondence accounts trading partners, accounting for nearly a fourth of between republics, payment delays in the banking Ianvia's imports (11 percent from EFTA, 17 per- system, difficulty and high cost of getting trade cent from other Baltics), also reduce fiscal revenues financing, and nonpayment by trading partnes for import duties. Increases in duties would only Bankc-related payment difficulties are grdually divert more wade to these sources. This has an eff-- being resolved by improved links between commer- ciency cost, since Latvia would shift imports from cial banks abroad and the shift to convertible cur- more efficient outside sources to less efficient part- rencies in foreign trade. One of the main inpedi- ncr countries. So oiler revenue sources should be meats to wtade, especially with ex-Soviet bloc coun- sought instead, tries, is the problem of macing payments through The transparency of Latvia's trade policies will the banking system. In early 1993, it still took on be improved by joining the GATT Latvia has been average three to four weeks to have payments cred- an observer in GATT since 1993 and applied for ited, and the cost of the transactions was increased membership in 1994. Accession to GATT would by the high foreign exchange risks. require Latvia to remove dscrination by trading Slow clearing arrangements between central parmer except for GAiT consistent free trade banks and the nonconvertibility of country-specific agreements and would be likely to touch on such balances from exports to the different states of thc issues as the state of private sector refrmis in Latvia former Soviet Union also impeded trade. Central (progress in establishing a market economy is bank cleating accounts fiequently closed and required), justfication of current interventions in reopened as countries introduced currency reforms trade policy, and the binding of import duties at and ergnized the clearing system. some maximum level, although applied rates can be The payment problems made barter the main lower. vehicle for trade with countries of the.former Soviet 154 TRADE WN THE NEW INDEPENDEtrr STAIES Union. Barter was often a first step away from the fited from coniUents by Monsour Farsad, M. Michaely, system of state orders and toward enterprise-level Morris Morkre, D. Tarr. and L Alan Winter wadeo In conditions of high market instability, barter 1 Sevcral distortions in Latvia's tax policies affected trade transactions probably play a key role in maintaining and Slocazional efficiency. Most important was a value- aldded tax (VAT) that penalized non-had currcncy exports cntical trade flows. Therefore, impediments to ese (mostly to fomer Soviet Union) with a 12 percent VAT tranctions such as the higher taxes on nonconvert- when expors to hard currency areas were exempL (IMF ible currency trade are counterproductive, at least 1993). until effective payment mechansms are established 2- This flexibility allowed Latvia to adjust to external and economic stability is restored. shocks by adjusting the exchange rzte with accommodating monetary policy. but it also made Lamia more vulnerble to speculative behavior, which could hurt the economy. By Policy Conclusions contrast in Estonia any changes in foreign exchange posi- Latvia has come a long way in a short time don w directy tnsDitted tO domesic money supply and thcb to inflation or domcstic demand- from a centraly planned to a market-based econo- my. Convertbility of the currency and monetary 3. EstabUlishing tie cormrect or equiiftrium real exchange rane can be a formidable tas. Wages in dollar terms can be and fiscal discipline have stabilized the macroe one proxy of the overall cost levels in a country. Wages in nomic fiamework, providing the level of confidence countries of the fomer Soviet Union are available mostly necessary for a successf supply response to tade for the state sector. which may not reflect costs in the poly f . Ssetergig pnvatc secr and ignores the potentially lrge poicy reforms. Susuining these pohias willtake nonwage-benefitypical of planned conomies strong commitments, e cially during a privatiza- 4 The empleyment staics also suggcst that the decline ticn phase that is likely to incrase unemploymenL in ouput may have been overstated by the production sa- In the medium tem, progress will depend on stoic- tistics. Bctween 1990 and mid-1993 the number of tral reforms, especially minva sectorcentives, employed in the economy dropped 10 pecet whik. output fell by 50 percent. Energy statistics support a similar con- prperty rights, and financial intermediation, to per- lusio. Exact statistics on energy consumption i general mit a sustainabk supply response to the market- wrin industry are not avilable, but electicity consumption based inrAmtives for production. in the economy in 1991 and 1992 fel by only slightly ovcr 20 percenL Further reforms ii trade policies are needed so that trade expansion can fuel economic growt. 5. Privatization has also been delayed by several isues linked to restituionL Because land may not yet be sold in Exports should benefit from removing te remain- lattvia. pending termination of restitution procedures in ing export constraints and discrimination against most cases is leased for one to five years. Citizenship trade with countries of the finer Soviet Union ad requiemnents fior resthution have yet to he resolved as welL fiom establishing a simple and transparent duty 6 The substantial diffe between local and OECD sta- drawback scheme. The creation of a sustinable tistics for thesc products suggests that much of the re- extport isillegal. basis for growth in trade and foreign investment requires more attention to thr hansparency and oon- 7. Official satistics list petrolum as Latvia's main export (20 percent), although Latvia produces no petroleum. sistency of import polices. Most important is to which is likely to bias Latvi's trade statistics. It would establish a unifonn level of pmtection based on ad contribute to an overestimate of the share of Western valorem tariffs, grer stability in the tariff srcx p in tobl and to an overesimat of imports from the former Soviet Union. Accordingly. trade reorientation tme, and institutional airangements that leave less would have been less successful and dependence on scope for discretionary actions. A transparent struc- im overstated. tore of inoentives and open trade policies WIU allow 8 Trade data for 1992, and especialy far 1991, are subject Latvia to take full advantage of its favorable geo- to large margins of err when based on official exchange graphic location and to realize its ddcl potential in rates (1.8 rubles per dolar) Using the rate of 5 rubles per graphic docno ad o ealz ss rae otntalm olldar (the rate used by ti IRF forEstonia in 1991) shows skill-intensive goods and servics. nade contraction about 46 pe;cnt, which convsponds bet- trto the esmated contraction in output Notes 9. The Latvian tade data reports imports of many energy This chapter has rdied on notes on latvia's trade policies products without a specific source, butmost of these can be by 4 Michaey, A. Hillman, and C. Muller and has bene- asswned to originate in Russia. LATvIA: TirtAt IS it II IN T ANSnION 155 10. Taxes on exports in convertible currencies covered 270 Latvian entcrprise received duty-free inputs for domcstic of 5,020 six-digit harmonized systenm (HS) lines of which production as well. 76 percent were at or below 10 percent, 14 percent betwneen II and 20 percent, and 10 percent between 35 and 30 per- 15. Sinc indepcndenzc thc foreign exchange market has cent. Taxes on exports in nonconvatiblc currencis cuv- been based on laissez faire policy and access to foreign ered 422 six-digit HS lines, of which only 10 pacnt wa exchange has 'tot been a major barrier to tmdt As of mid- caed 422 belowi HS lines, 62perofentich onl 11and20 peret w1992 the market has been organized around the commercial at or below 10 percent, 62 percent bew 1n I an bak2idpiat oeinecanedalr.Whl h cent, and 28 percent between 35 and 300 pecent. Somne banks and privnte foragn exchange dealers. While the but not aL, of the duties were eliminated on exports to free- instiunonal stwture allows foreign exchange trnsactions trade partncrs in the Nordic countries: leather (200 per- through an interbank system, mast transactions have been cent), ferrous scrap and wastc (300 percent). and manry carried out by private agents. Major Latvian commercial wood products (100 percent) remained under duties banks operate in all converible currencies and have corre- spondene aaccounts in at least five to ten banks. 11. However, for exports in convertiblc currencies the nunber of six-digit HS lines subject to duties increased Re ence from 270 to about 383. Duties rangcd from I to 100 per- cent, 90 percent of them at or below 10 percent In exports Economist Intelligence UniL 1993. Baltic Republics: in nconvertible currencies, the number of tariff Lines sub- &ro* La14 LiwInIia CoWzty Prfile. London. ject to taxes declined from 422 to 406. Duties ranged fiom 2 to 200 pcnxnt. 84 percent of them at or below 10 percent International Monetary Fund (1MF). 1993. Larvia. lMF Economlic Review 6. Washin,gton, DC. 12. Chocolate (50 percent or higher speific rate), bread and pastry and some food preparations (30 pecent or high van Aradic. B. and M. KarLssogL 1992. Economic Surveys er specific ratc), insecticides and si alchetmicals (30 per- of the Bali States. New York University Prss: New cent), and parlor games and casino equipment (30 percent) YoL were added to the list of higherdntie 13. Disgreement also peristed over the treatment of re- Taor. David, 1994. -The Terms of Trade Effects of Moving xpaorts Russia wanted no re-exports of goods covered by to World Prices on Countries of the Former Soviet bilEral agreements. and it threatned to stop deliveries of UniotL"lJowl of Comparatie Economica 18:1-24. gas, if it found nt ractals were being re-exported. World Bank. 1994. Statistical Handbook 1993: SWr of 14. For example. textiles could be imported duty-ree from the Former USSR. Studies in Economies in Russia to Latvia against exports of clothing to Russia for Trnsformation & Word BatL Wasington, DC. the sm value but which inco_pemted only 40 percent of the imported inputs (exact barer basis). Strct application World Bank, 1993. Latvia The Transirion to a Market of a duty drawback would have aElowed duty-frme import Economy. Washing DC. for only 40 percent of the raw materials used. Thus the 7 Lithuania: Trade Issues in Transition Pira Sorsa With 3.7 mitlion people, Lithuania is the largest of the Baltic republics Its inmcome per capita, dtough slightly below that of Estonia and Latvia, is among the highet of the couties of the former Soviet Union. More agrarin than Estonia and Latvia, Lithuania is geographically and histoicaly closer to EThe Macroeconomic Centra EuropeI Foreign trade has played an important role in Situation and its economy, thugh smaller than in the two other Baltic states. Complementary Reforms During the interwar period Lithuania bcame an expoter of agricultura products to industialized Eurpe- During the * Trade Flows Soviet years, imports and exports accountbd for 50 to 60 per- cent of GDP. Since independence Litania bas stared to reoo * Trade Policy ent its trade from near-total dependence on the former Soviet Union to the Wes Lithuania has considerable potential in * Payments Issues products and services that can use its highly skilled labor-fotr. * The Role of RestrUCturing The MacroeconomIc Situaton and Compbmntwry and Investment hi Trade Reforms Adjustment Success with stablization and macroeforms in Litnia * Policy Conc1us'bns has influenced trade performance by affecting stability of the economic climatc and incentives to enpage it foreign trade. As in Estonia and Latvia, in Lithuania stabilization was preceded by reform of prices, taxes, and wages. Lithuania was also one of the fust counties to initiate privaization in 1991, although progress has been only more moderate in recent years. Stabilization was delayed first because Lithuania remained in 158 TRADE WN THE NEw INDEPENDENT STATES the ruble zone until late 1992 and later because of significantly since independence, reducing the mon- technical difficulties in introducing its own curren- etary overhang, although with a slight delay com- cy. Currency reform played a key role in stabiliza- pared to Estonia and Latvia because wages in tion. but political interference in monetary and fis- Lithuania renained indexed to prices slightly cal policies in the early part of 1993 slowed slightly longer. the reform momentum. The replacement in April 1994 of the flexible exchange rate policy with a Stabilizaton currency board regime for managing the economy Lithuania is well on its way to a stable econo- is further stabilizing monetary aggregates and the my, a consequence largcly of curency r_form cou- exchange rate. pled with relatively tight fiscal and monetary poli- aes. Convertibility has been important in creating Initial Reforms incentives for foreign trade and reducing uncerlain- Lithuania started price reform in February ty in foreign transactions. Stabilization started in 1991 just slighdy behind its Baltic neighbors, but May 1992 with the introduction of a temporary cur- wel in advance of Russia and other ex-Soviet rency. The central bank issued coupons (talonas) to republics. By November 1992 only about 15 per- address the shortage of cash rubles. In October cent of prices in value terms in the consumer basket 1992 the talonas became the official Lithuanian cur- remained controlledc2 This earlier start in price ib- rency under an exchange regime of a umfied float- eralization than in other countries of the former ing exchange rate and cmuent account convertibili- Soviet Union initially brought terms-of-trade gains ty. In June 1993 once inflaton had been reduced to to Lithuania and the other Baltic countries relative an acceptable level, the permanent national curn- to the rest of the former Soviet Union and helped cy, the lita, was introduced. hold output decline to about 15 percent for 1991 Until 1994 stabilization efforts suffered from (table 7.1). the politicalization of monetary policy, leading to The elements of a modern tax system were cycles of altemating tightening and loosening. introduced gradually srting in 1990.3 Ihey includ- Lithuania, using exchange rate policies similar to ed a profit tax (29 percent), a general excise tax (18 Latvia's was slightly less successful in controlling percent), specfic excise taxes on alcohoL tobacco, monetary cxpansion and bringing down inflation. and petroleun products (varying rates between 10 The central bank was unable to resist domestic pres- and 71 percent), personal income taxes, payroll tax sures in early 1993 to slow the appreciation of the (31 percent) to cover social security payments. lita by selling litas. That increased the money sup- Early tax reform helped to enlarge the revenue base ply and maintained inflationary pressures. As a when output declined. Real wages have declined result, inflation declined more slowly in Lithuania than in the other Baltic countries: average annual Table 7.1 Selected Econmnic Indicators, 1990- inflation was 1,021 percent in 1992 and 410 percent 93 (percent) - in 1993. falling to a monthly rate of 3 to 5 percent indicarr 1990 1991 1992 1993 in mid-1994, close to the -levels in Latvia and Change in GDP -6.9 -15 -36 -16 Estonia. The decline of inflation was associated Inrlation 1621 225 1,021 410 with a strengthening and tightening of monetary Fwal balance policy, which culminated in the introduction of a (percent of GDP) -2.6 5.2 0.6 -5.S currency board ;n April 1994 and the fixing of the Unemployment - 0.3 0.6 1.6 lita to the U.S. doll at a rae of 4 to 1. This mecha- Real wages - -20 -12 45 nism is designed to isolate monetary policy from political or other interference, and thus improve -notad credibility of macropolicies The currency board Sourc= World Bnnk (1993). W(1993) arrangement also totally eliminates the use of mon- LJHUANAC TkDE ISuS IN TRANsmoN 159 etary policy as an economic management tool since untary leave, is likely to be larger) the rate was the amount of inoney in circulation is strictly linked lower than in the other Baltic republics, perhaps to foreign currency and gold reserves. Monetary reflecting Lithuania's greater tolerance for arrers, financing of government deficits is impossible with a practice stopped sooner in Estonia. Other factors this anangement. That means that adjustmnent to probably contrbuted as well, such as the terms of extemal shocks will direcdy affect domestic trade gains in 1991, government decrees forbidding demand. If Lithuania runs a deficit in its current or limiting layoffs in 1992, and high payroll taxes, account, domestic demand will have to contract as which may have driven employment to the infonnal a result of the tighter monetary situation. sector. Until 1993 prdent fiscal policies kept budgets in surplus or in balance, greatly easing the task of Complementary Structural Refonns stabifization. The fist deficit appeared in 1993, and Structural reform, despite a quick start on pri- fiscal pressures continued to rise in 1994 because of vatization, has moved more slowly than stabiliza- revenue shortfalls and hacreased spending on social tion. Slow structual reform may slow supply programs to ease the transtion. response to new relative prices and incentives to Trade and other adjustment have been delayed export and imporL The restructuring of privadzed to some extent by negative real interest rates and companies has been delayed by the failure to clamp enterpnse arrears Interest rates remained negative down on arrars and by the high degree of manager in real terns through 1992 and early 1993, but then and employee share ownership. Greater flexibility turned positive. Interenterprise arrears-in effect, in factor mares has been hampered by regulations zero-interst financing-night have contributed to restricting labor movement and mandating generous negative real interest rates by offeing an altenative severance payments. RestructLring of the bankdng to credit financing. During 1993 the stock of inter- system has moved slowly as welL enterprise arrears rose to almost the level of total Lithuania started privatization in early 1991, deposits in the banking system. Most of the arrears with an innovative voucher scheme for Lithuanian were of domestic origin, although arrears through- citizens. The vouchers could be used to buy hous- out the forner Soviet Union contributed to their ing, small enterprises, or shares in larger mterpris- growth. By early 1994 Lithuania had yet to mount a es. Management of the privatization program was major effort to collect the arrears. In the absence of given to a centalized agency, thereby avoiding the a strong debt collection agency enterprises continue problems of piecemeal privatization that Latvia to rely on arrears, although the level stabilized in experienced. Restitution has not presented much of early 1994. Only two bankruptcics took place in a problem (except for land) because it applies only 1993 (IMF 1993). to residents. Housing became the first target of the Output contraction started slightly later in program, and in early 1994 about 95 perent of the Lithuania than in Estonia and Latvia and was felt housing stock had been transferred to private own- mostly in the second half of 1992 (-36 percent). ership. Almost all small entcrprises and about 60 Severe shortages of energy imports from Russia percent of larger industrial enterprises have been accelerated the decline. There have been some signs sold to investors. In agriculture almost all agribusi- in 1994 that the decline is bottoming ouL There are ness and land is private. also reasons to believe dtat output may have Labor mobility is improving. Until early 1993 declined by less than the official statistics show. people required official permission to move to cer- Unemployment has been low, and the emerging pri- tain cites, and the employer or employee had to pay vate sector is not covered in the statistics. Despite a special tax as welL Restrictions on the production the output contraction official unemployment has profile and on layoffs in privatized enterprises also remained low. At 1.6 percent in 1993 (though true reduced mobility and affected trade and other unemployment, including workers on unpaid invol- adjustment. Severance payments are as much as six I CLlO n1} U'nl nin; xKv INtflqrnrifmtr SrAln!s mtontlr' salary in state enterprises and eighteen Lithuania's imports were still coming from the for- months in private enterprises, discouraging the mer Soviet Union in 1993, the sharc of exports to shedding of excess labor. The difficult housing situ- the West (measured at official exchange rates) was ation furter discourages changing jobs. above 40 percent in 1993, up from 6 percent in The restructuring of the banldng sector has pro- 1990 (table 7.2). Slowing the process of reorienta- ceeded slowly, though private commercial banking lion were a slower pace of stabilization, a trade pol- is growing and the role of state banks is shrinking. icy fiamework in need or greater reform, uncerLain- Credit atansactions still carry high risks, making ty arising frotm the low pace of struncal and other banks reluctant to lend. Trade finance is costly and reforms, and other structural and natual constraints difficult to obtain for laick of coUateral and high per- particular to Lithuania ceived risks. Restructring and stabilization of the After a severe slump in 1992 Lithuania's financial sector requies further trengthening of pi- exports and imports increased in l993.4 In 1993 vate commercial banks Cesially in credit assess- exports to the West continued to grow, and exports meat and banking supervson skills) and resolving to the former Soviet Union recovered even more, the portfolio problems of the three large state banks- climbing 84 percent in nominal dollar terms. Imports increased by more than 60 percent, again Trade Flows with the former Soviet ULion accounting for most Lithuania has been slower in reorienting its of the incrase. Some of the increases, especially trade than Estonia, but has done better than many imports from the former Soviet Union, may reflect other new independent states. When Lithuania terms of tade changes. The undervalued exchange reestablished independence in 1991 more than 90 rate in 1992 and 1993 boostd incentives for pen:ent of its trade was with other countries of the exports outside the former Soviet Union. The former Soviet Union. Though 70 percent of reduction in antiexport bias achieved in 1993 (see Table 7.2 Extlernal Trade 1990-93 (milions of cunent U.S. dolars and percent) 1990 1991 1982 1993 Value Toal Expots 11,823 9,613 1,062 1,625 Fomer Soviet Union a 11,144 9,268 505 929 Rest of world b 679 345 557 696 total nports 12575 6,726 966 1,597 ForrnrSDvietUnion 11.032 6,251 624 1,111 Rest of world 1,53 475 342 486 Tade bealnc -752 2,887 96 28 FofmerSovietUnion 112 3,017 -119 -182 Restofword d864 -130 215 210 Pe.rcetae disbbuion Total exports 100 100 100 100 FormerSoviet Union 94.3 96A 47.5 57.2 Rest of world 5.7 3.6 52.5 42.8 Tota limports 100 100 100 100 FormerSoviet Union 87.7 92.9 64.6 69.6 Rest of world 12.3 7.1 35A 30.4 a. Fres for rade with hc fanner Soviet Union are derived from cunty data and World Bank staff estimates reported in naDtional currencie using officdal or cmmerial excange rates for 1990 amd 1991 and annul ave market xchnge mtes for 1992 and 1993. b. lhe zrst of the world wfer.s to counties outside the fanner Soviet Union; figures ate bad on county data reported in U.S. dodllar. LmruAmnA: TRADE ISSUES IN TRANErnoN 161 below), probably contributed as well, as did the been important to Lithuania, as it has to the other introduction of a convertible currency, which sub- Baltic countriesft The OECD reported $418 million stantially changed the incentives for foreign trade. in oil and metal imports from Lithuania in 1992 R-expots of raw materials from the fomer Soviet (table 53 in chapter 5), whereas Lituanian national Union (see below) may also account for some of the statistics show only $4 million in oil and metal increase in expet to the West. exports to the OECD in 1992. This trade reflected Lithuania's main trading partners are Russia the low prices of raw materials in Russia compared and the European Union (EU). In 1993 the EU to world prices, a price incentive that is disappear- absorbed 53 percent of Lithuania's exports to the ing as Russian domestic prices adjust to world 1ev- West, some 21 percent of it going to Germany. els. The level of this trade in 1992 and 1993 was so Neighboring Poland accounted for 21 percent of large, however, that it must have had an impact on exports. Despite free trade agreements in effect the real exchange rate and on econornic activity in since 1992 the Nordic countries' share in exports lithuania. With its location at the land and sea was relatively small, at 9 percent. In 1993 Russia crossiuads between East and West, Lithuania is still provided four-fifths of imports from te former likely to continue to maintain a comparative advan- Soviet Union. Lithuania!s dependence on Russia. tage as a tansit center. especialy for energy imports, was related to the lack of infrastrucue for importing oil and gas from Trade Policy other sources and the shortage of foreign currency To meet the needs of a market economy until 1993. Ukraine and Belarus were also impor- Lithuani has been gadually reducing export rant ade paruts Intra-Baltic trade accounted for restrictions introducing modest though volatile and only about 5 to 7 percent of import and exports, nontranspaent, levels of import protection; and most of it with Latvia. shifting to enterprise-to-enterprise trade within the In 1992 the composition of trade with the for- fonner Soviet Union, with a common set of incen- mer Soviet Union continued to folow patterns ties (boxes 7.1 and 7.2) established under central planning, which did not always conespond to Lithuania's naturl compara- Export Polies tive advantage. (No more recent pmduct data are Lithuania has substantially reduced the inherit- available). Lithuania exports machinery, food, and ed antiexport bias of the Soviet trade regine. After light industry products such as texfiles and imports a transition period of export restrictions, including energy and raw materials forits transforming indus- quotas and bans in 1991 when prices had not yet tries. Most intra-Baltic trade was in energy. adjusted to wald levels, the transparency of export To the rest of the world Lithuania continued to restictions was improved in 1992, when Lithuania export mostly food and other resourbasedgoods began to replace licenses and bans with export such as timber, in which trade reorientation to the taxes. Most license requirements were lifted in West tends to be easier. Other important exports in October 1992, except for reasons of food security 1992 were chemicals and petroleunm Lithuania is and the fear of supply shortages for goods whose not yet exploiting its high-skill, low-wage potential prices bad not yet been liberalized.6 Export bans for labor-intensive export activities, which is where were removed on sugar, butter, vegetable oil, its comparative advantage seems to be. The share of remaining in effect only on nonferrous metals and such labor-intensive items as textiles and clothing products conventionaly prolubited in international in Lithuania's exports to the West in 1992 was the trade (arms, narcotics, cultural items), although smallest of the Baltic countries at 17 percent (table some other products were taxed at prohibitive rates 5.3 in chapter 5). (500 percent). Until mid-1993 some exports were Transit trade, much of it of questionable legali- subject to the gener excise tax at different rates ty and unreported in lithuanian statistics, has also than was domestic production (see below)Y During 162 TRDE n mm NEw INDmEPNDENT STAiEs Box 7.1 Summary of the Trade Regime In May 1994 Instrument Descripian perr,nlage of tff es a Epirtresainkts Taxes Range zero to SO percent 6%(animal products. 90 perment of duties less tan leather, wood, metals) 10 percnt Quotas None Ucenses None Bans Red clover seed. unteated oak, ash- freeminber unti May 1995 Tariffs Unweighted average 32 percent High rates on local Range zewo to 30 % (except alcohol); product, low rates on Somre specific rates; inputs Seasonal dubes; 75% of dutes= 0 Quotas Glss bottles, feed and breeding arni- mals, p for sausages. cereals and mixed fodder, raw ntrials for sugar processig urtbotted alcohol tBchical alohol. inputs to alcohol State hadlg None ErhenW rnte * Convertible currency since 199 awr- rency board since 1994 * Real apprecaton measured in monfty wages in USD ftrrn 8 to 13 In 1992to USD 75 by end of 1991 No surrender requirements a. At the six-digit harmonized system clasicaton 1992 and early 1993 the remaining antiexport bias Some restictons covered products still under price may have worsened the collapse of trade, although control or in severely short supply domestically this influence was countered by the undervaluation which could not be adequately addressed by of the real exchange rate, which increased the imports due to delays in foreign funding. attractiveness of exporting to hard-currency coun- Further reforms took place in February and tries. May 1994. Export taxes and the number of products In June 1993 export taxes were reduced consid- subject to the taxes were reduced, export quotas erably. although other export restictions were were eliminated, and bans were lifted on all but two increased slightly. The appreciation of the real iterms0 Remaining export taxes, mosdy on metals, exchange rate in 1993 helped reduce the need for but also raw materials and intermediate products, export restictions Most export duties on final cover 8 percent of product lines (at the six-digit goods were eliminated and remaining duties were level in the harmonized system) at rates of 5 and 50 lowered to 5 to 50 percent) However, some export percent Since the prices of most of these goods had bans remained, and the number of prducts subject been liberalized, the restrictions were probably to quantitative export restraints was increased9 intended to protect domestic processing industries. LmIUANiA TRADE IsuEs IN TRm=oN 163 Import Policies overall level of protection (an unweighted average By January 1992 Lithuania had abolished of 3.2 percent), the dispersion of rates is still high. essentially all import restrictions.0 I A depreciating The higher duties apply mostly to goods also pro- and undervalued exchange rate provided some pro- duced in Lithuania,t2 while many raw materials tection against imports, while the lower general have zero duties (figure 7.2) The highest average consumption tax on imports (10 percent) than on unweighted nominal protection rate (about 20 per- domestic production (18 pere:nt) subsidized cent) was applied to such labor- and resource-based imports slighdy, industries as leather, shoes, textiles, wood, and Lithuania's import policies became gradually paper. Effective protection to value added in these more protectionist in 1993, as the rapid appreciation industries is even higher as a result of exprt taxes of the real exchange rate generated pressures to on some inputs used by these industries (skins, restrict imports. Lithuania's stated objective was a logs), which tend to lower their price below world transparent tariff structure with uniform, moderate market levels. Under the temporary transformation tariffs of about 20 to 30 perocnt The duties were scheme, producers may be allowed to import duty intended to provide fiscal revenue, and to protect free more inputs than needed in the production of domestic enterprises during the transition. mnport exports, furher increasing the dispersion of protec- duties were introduced in mid-1993 and increased tion (for a discussion of the temporary transforma- slightly in the fall of 1993, mostly on agricultural tion scheme, see chapter 6 on Latvia). goods. In February and May 1994 some of the high- The transparency of the import regime was est rates were lowered, though duties on a number compromised by non-tariff barriers introduced in of products were increased. By mid-1994 pressure 1993 and 1994. Import quotas have been placed on to increase agricultural tariffs further was intense. a small but increasing number of products.13 In The import tariff structure in place in mid-1994 1993 special import rights were given to selected alls short of the government's stated objectives. enterprises to import alcohol, which were replaced There are 10 different levels of duties from 0 to 100 by a quota in 1994. Specific duties are applied to pcent, with most of them between 0 and 30 per- some products (cars, some agricultural products. cent (figure 7.1). While this implies a moderate alcohol), which obscures the amount of protection Figure 7.1 Distrbution of Tariffs they receivm Many of these restrictions appear to Percent of xta reflect successful lobbying for protection rather than any economic or social justification. 80 Confidence in the stability of the importregime 70 has been eroded by frequent changes: the import regime was changed ten times between July 1993 60 and May l994.1' Duties have been raised and reduced, and the number of products subject to other restrictions has changed. The easy procedum 40 - for introducing changes, and the proven success of producers in lobbying for protection creates incen- 30 tives for others to lobby. The procedure for chang- ing tariffs is particularly vulnerable to lobbying 20 - efforts: the cabinet issues a change through a simple 10 decree, following a request fom a ministry. 0 o -~ gExchange Rate Policies 0 to ~O u2 CD to C _ _ N N A bIn the early years of the transition, the under- Duty rates valuation of the currency provided substantial pro- 164 TRADE IN TtE 1EW INDEh oDENT STA1ES Figure 7.2 DistributIon of Import ProtecUton In Lithuania miscelaneous annuf. nstrurents transport equipment eectial nmchinery metal products constructi nIat shoes, paper-_ wood leather plstic's- chmcals agricuture 0 5 10 15 20 25 Unweighted average import dulies (%) tection against imports. The temporary currency, er barrier to tade. Licensed banks may trade *iely the talonas, depreciated sharply in 1992 andin eady in foreign exchange. There are no restrions on cur- 1993. One indicator of this undervaluation is that rency holdings or on accounts in foreign cunencies. wages in dollar terms remained at about $S13 a month in the state sector in 1991 and 1992. This Trade with Countrs of the FormerSoviet level was lower than in Latvia and Estonia and Union probably reflected Lithuania's stronger antiexport Trade with the countries of the former Soviet bias (although the undervaluation, bg increasing- Union has shifted from state trade to enteprise-to- export incentives, neutralized some of the antiex- enterprise trade. Following independence the gov- port bias of the regime). ermnent accorded high priorizy to bilateral dce With tie introduction of the liia in June 1993, agrements.15 which initially may have ded the cmuirecy staed to appreciate in real terms. In enterprise adjustment to market incentives since late 1993 tle monthly average wage in the state sc- they prolonged govemment involvement in produc- torhad risen to $75, up from $31 inMay 1993. This tion decisions. The country's high dependence on real appeciation win gradually increase the antiex- energy imports from the former Soviet Union and a port bias of export taxes and increase pressures for shortage of convertible cmrencies contnibuted to import protection-a process that has already this reliance on bilateral agreements. Tbe efforts to begun. mmainain govenment-to-govermt trade (even for indicative list trade) with the former Soviet Union Payments Issues may also reflect an attemwt by Lithuana to moder- Once Lithuania's curnrncy bcane convertible, ate its terms-of-trade shock in this tride. To encour- thc incentives for trade and to repatriate capital also age enterprises to participat they were offered improved. When the currency was not convertible, preferential access to low-priced raw materials. transaction costs.to firms were high and they had amtactive output prices, and tie promise of hvor- litdc incentive to repatriate foreign exchange earn- able tratmentfor export license. Entewprises signed ings. Full access to foreign exchange lowers anoth- a contract with the government to deliver a specific LrrHUANIA: TRADE ISSUEs IN TSmmoN 165 amount of a product for export leaving only a sma Union. But the inconvertibility of many of these share of output to be sold freely by the enterprise. countries' currencies has meant that enterprises Although the undervaluation of the real exchange have been stuck with die claims on the other coun- rate provided substantial incentives to shift exports tries' currency, unless another company that needed to hard currency markets, many enterpises involved the currency has been found to buy the claim. in trade with the former Soviet Union were unable Markets for trading rubles or other currencies of the to take advantage of this opportunity, whether countries of the former Soviet Union have not yet because of a lack of trade contacts or because their fuly developed in Lithuania (IMP 1993), mainly products did not meet Western standards. because of weak demand for rubles. Frequent clos- The agreements failed to maintain trade flows ing of central bank clearing accounts and difficul- wit the former Soviet Union, and were soon aban- ties in setling remaining balances also impeded doned. Most of the negotiated trade never material- trade with countries of the former Soviet Union.16 ized because of difficulties in fulflling orders and Barter became important in the early stages of the accumulation of amears by Russian enterprises transition because of payment delays through the Increasingly, trade began to take place between banking system m a highly inflationary environ- enterprises and government involvement dwindled, ment and the thin markets for rubles and other For 1993 the government negotiated only a fine- inconvertible currencies. Barter allowed enterprises work agreement for trade with Russia, its main pur- to circumvent the high transaction coss of mone- pose to guarantee most favored nation teatment tary exchange. Because enterpnse Lnks were not The agreement was never implemented because of always direct under central planning, a trilateral a dispute with Russia over re-exports. barter developed. A Baltic enterprise selling to Trade in general and that with the former Russia entered into a second arrangement with Soviet Union was also affected by payments prob- anotherBaltic enterprise buying the goods provided lems. Lithuania's payments problems are similar to by the Russian enterprise. Barter, though ineffi- those experienced by othr Baltic countries. Making cient, helped maintain minimum tmde flows in the payments through the banking system has been a absence of fully convertible currencies until banks stmbling block. To facilitate payments Lithuanian could be relied on for making payments. Recently, banks were allowed to open correspondence the importance of barter has declined as the pay- accounts in other countries of the former Soviet ments system has improved. - Box 7.2 Chronology of Main Trade-Related Policy Changes, 1991-94 Domestic UEd 199 199092 Motst prs libedr.Bd May 1994 AModerate import rictions trduced and changed a mamber of times 1991 Tax refonr 1994 Inboduction of a cumrny board wih a fixed 1991 State trading gradually replaced by epo exchanw rts licnses, quots, taxes, and bans 1992-93 Intoduction of a converfible currency under Exteral flexible exchange ates 1992-93 GSP reatment in main industrial counties 1992 Export surrender requiremnts at below market 1992-93 Free trade agreement with four EFTA countries rates abolished Finland, Norway. Sweden, Switzerland) 1992 EBnnafon of separate profittaxation on hard 1992-93 Abandonrent of indic:aive ist currency exports below market rates 1992-93 General trade agreements with most couoties 1992 Export restrictons reduced and most tioenses of the former Soviet Union replaced by taxes 1993 Baltic Free Trade Agreement 1992 Export bias in excise taxes removed 1994 Applicaion to join GATT June 1993 Further liberalization of export ricions 1994 Free tade agreemernt with the EU over a six- 1993 All surrender requirements abolished ear adjustment period 166 TRAnE IN lB NEW vNDEPNENT STATES The Role of Restructuring and Investment energy needs. In 1992 oil constituted nearly two- in Trade Adjustment thirds of Lithuania's imports. Changes in its avail- Lithuania has shifted its trade to the West more ability have had a iarge impact on industrial activi- slowly than Estonia has (know though, that trade ty. In 1992 Russia cut off oil supplies and failed to statistics are subject to large nmrgins of error). supply the amounts agreed in the initial (indicative) Many factors underlie this developmenL Lithuania trade agreements.17 Lithuania could not easily tam was slower to stabilize its economy than Estonia. to the West to make up the shortil because its and the prolonged uncertainty affected investment ports were not equipped to receive oil imports by and production decisions. The lag in introducing sa. cumency reform and convertibility may have affect- The sucture ofLithuania's industry also made ed trade performance by slowing the supply adjustment and trade reorientation more difficulL response and the reallocation of resources. Lithuania has the highest share of heavy, Soviet-a- Lithuania's trade regime never fillly eradicated its ented mdustry in total output among the Baltics antiexport bias, reducing incentives for exporting, (over 30 percent). Their energy intensity is high. .bile frequent changes in policy aeated uncetain- and quality differentials vwth the West are !arge, ty, aenouraged lobbying, and reduced incenuves to making adjustment to new relative prices and stan- invest in actvities in which Lithuania has a compar- dards partictulary difficult Machinery accounted ative advantage. Regulations affbeting labor mobii- for about 33 percent of industrial employment and ty and company operations reduced the potential other heavy industries such as chemicals, energy, benefits of privazation, further delaying resrucuw- and buihding matrials accounted for another 18 ing and a supply response. Lithuania was also slow- percenL A large share of production was for miti- er than the other Baltic countries to give up state tary purposes (especially electronics and telecom- trade. Since most of the govcrnment's bilateral munications), tied to the former Soviet Union. trade agreements were not fulfilleL total trade was Some 40 percent of Lithuania's 600 industrial stae affected. The fa-lure to sustain this trade also con- enterpnses were all union enterprises. The large tributed to production declines since expected ener- size of these industrial complexes-an average of gy inputs were not avaiable. 843 employees compared with 160 in the EU-and Lithuania could have reoriented its trade more inefficiencies that developed as a result of a lack of quicldy had it taken better advantage of the reative- competition during the Soviet em increased the ly favorable market access it enjoyed in its Western costs of adjusmet to world standards. Even in the markets. Lithuania has had free trade agreements light industries such as food processing, many units covering industria goods with most EFTA coun- were organized into associations with a monopolis- tries since 1992/93 and has received preferential tic position in the domestic markeeL GSP treatnent in the EU and the United States (see The contraction in industrial output took place chapter 12). Its tradc with the EFrA countries, slightly Later in Lithuania than in the other Baltic probably reflecting short-term supply constraints, countries, in part because of hoarding of raw mate- was smaller than trade with the EU, but trade with rials and a continuation of bart arranganemes. both groups could expand considerably over the Many enterprises received indirect tax relief, subsi- medium tern. Lithuania's highly skilled, low wage dies, or other help from the goverment or cheap labor force and geographic proximity should favor credits from banks. Not a single enterprise closed development of skill intensive exports to Western before mid-1992 Europe. In 1992 industrial output plunged 50 percent. The demand and terms-of-trade shocks, among the Stuctural Issues most severe in the former Soviet Union, were felt Of the Baltic countries Lithuania has been the mostly in the second half of the year. The total most dependent on the formner Soviet Union for its tenms-of-trade deterioration in 1990 prices com- LrrnuAmt: TRADE IssuEs IN TRANSrON 167 pared to world prices was estimatcd at 25 to 35 per- below Estonia, and slightly below Latvia. This is cent, or 13 percent of GDP (Trm 1994). In 1992 likely to reflect the much more uncertain policy and trade collapsed (table 7.2). Arras to the govern- economic environment in Lithuania (and Latia). ment and to other enterprises started to accumulate. Foreign investment seems to have had only a Agricultural output shrank 30 percent however, small impact on trade reorientation in Lithuania, official estimates of output and trade decline do not though it might have helped maintain trade with the capture the huge unrecorded capital outflows and formcr Soviet Union. Most foreign investors in unofficial imports. GDP continued to decline in Lithuania are from countries of the former Soviet 1993, but the resumption of some trade and external Union. In 1992 one-third of joint ventures were assistance helped maintain activity. with Russians, established to ensure the continua- tion of supplier relationships or to facilitate the re- Foreign Investnent export of Russian goods. But 60 percent of capital Lithuania has attracted less foreign participa- investments were from outside the former Soviet tdon than Estonia. Although the only formal restric- Union, including 305 German joint ventures IMP tions on foreign ownership are in sectors such as 1993), though the amounts invested have been defense, public utilities and energy, transport and smalL Such investments may bring important skills communication, alcohol, and tobacco, in practice and know-how, however, that can facilitate trade there arc additional constraints that limit foreign with the WesL Most investmnents have been in the investment sales to foreigners. Only a limited list of services sector (hotels, restaunts), trade, and com- enterprises is eligible for hard currency privaizm- munications. There are a fewjoint ventures in man- tion, foreigners cannot own land, and the mortgage ufacturing, mainly in textiles and funiture (IMP law is inadequate. Also bureaucratic impediments 1993). and discretionary authority (the state privatization committee must authorize sales to foreigners) limit Policy Conclusions the interest of foreign investors in Lithuania. After a slow start, Lthuania is making progrss Between 1987 and 1992 over 2,000 new projects in consolidating the gains from stabilization of its with foreign involvement were registered, about economy. Stabilization is crucial to susuinable four-fifts of them joint ventures and the others for- trade reorientation and a vigorous supply response eign-owned firms. The lagest increase was in 1992, to new market incentives. Further supply response when over half the projects were registered. Most of is likely to depend on maintaining maaconomic the recent ventures are not yet under way (IMF stability, establishing incentives for private sector 1993). activity, and making progress in privatizing and Balance of payments statistics show fairly low restructuring the state enterprises and improvirng levels of foreign direct investment in Lithuania property rights. Getting the incentive framework $10 million in 1992 and S40 nillion in 1993 (table right is especially important, since privatitzaion will 7.3). In per capita terms that puts Lithuania far not lead to restructuring unless constraints to pri- vate initiative and factor movements are removed. Table 7.3 Foreign Investment in the Balties Issues in Trade Policy. (U.S. dollars) Lithuania's trade policies raise a number of Cowty 13 (miron) Per capita issues for aDocative efficiency and successful tran- sition to a market economy. While much of the EsLorna 11o 69 explicit antiexport bias of export policies has been uu,huanlia. 401t1t remloved, the export restrictions that remain have no clear economic justification, now that prices have Swwcb Wb itd Baik been liberalized. Import tariffs may have mtroduced 168 TRADA IN T1E NEW INDEPENDEN STAINS some antiexport bias. While the level of protection deprives its enterprises of the benefits of more open is moderate, the import regime lacks transparency competition from trade. The hope that protection and consistency. Lithuania needs to cstablish a sta- will give producers time to adjust the quality of ble and consistent system of incentives for trade, their products to world standards is contrary to now, before the new structure of production takes experience the world over- Enterprises frequently shape. use protection not to accelerate restructuring, but to Lithuania should consider eliminating most of avoid it That perpetuates inefficient production, its remaining export taxes and bans. The taxes hin- especially where markets are highly concentrated, der trade expansion in products in which Lithuania as in Lithuania today. may have a comparative advantage. The main A low and uniform duty of 10 percent or less impact of the taxes is to provide uneven protection applied to aU inports would establish a more uni- to domestic industres relative to pmducers of raw form level of protection in Lithuania. Rates higher materials. The taxes may even result in negative than that arm likely to create substantial pressures to value added, especially in leather industries, where exempt inputs and capital goods from the duties. export taxes of 50 percent have been levied on And because a large share of Lithuania's trade is inputs. Only for some agricultural products whose with free trade partners, a high duty on imports prices cannot yet be liberalized may export taxes be from third countries could easily lead to costly trade justified temporarily, and then only if they are diversion. linked to the speed of price liberalization (see chap- A uniform tariff would also achieve the rev- ter 13). enue objective better than does the curent distorted Lithuaniian export performance would also be structure. The government's 10 pcent revenue tar- improved by the introduction of a duty drawback get for trade taxes could be achieved with less eco- system to reimburse exporters for duties on import- nomic distortion through a more uniform tax with a ed inputs, improving their intemrational competi- broader base. According to estimates, dining the tivenes; The system would also ensure equal treat- last quarter for 1993 customs revenue amounted to ment for all eport The current transformation only about 2 to 3 percent of total govermment rev- regime is not transparent since itdepends on specif- enues, far short of the projected 10 percenL ic agreements, permits administrative discretion, Lithuania should also eliminate specific duties and rebates duties in excess of the amount of inputs and quantitatve resrictions on imports to improve used for export production. (Other potential export the trasparncy of the regime. Although quantita- pronotion measures are covered in chapter 11). tive restraints now affect very few tariff lines, the On the import side the main concerns are too increase in coverage in 1994 is worrisome. If quan- much dispersion in rates and the lack of transparen- tity restraints are maintained, quota rights should be cy and consistency. Frequent changes in duties and allocated by auction to ensure that they go to the other incentives create uncertainty, which discour- highest bidder and so the most efficient producer. ages investnents and restructuring and encourages Improving the consistency of import policies producers to lobby forprotection. and the stability of incentives calls for a more stable The dispersion of tariff rates, by favoring one institutional arrangement Changes in permanent activity against another, tends to promote or extend tariffs or other trade policies should follow clear the life of otherwise uncompetitive activities. It also guidelines and require approval by the Executive means that the government rather than the market is and the Parliament to ensure that changes in duties picling the winners and losers. A uniform duty receive strict scrutiny. Temporary protection, such woudd let the market establish the viability of indus- as safeguarding against sudden surges in imports, ties. By setting higher rates on existng activities, could be managed by a customs department under the government discourages investments in new stict guidelines and criteria, subject to time limits activities. And by protecting its industry, Lithuania and public scrutiny. Joining thce GATI7, to which LrnlunuA: TRAD IssuEs iN TRNsmoN 169 Lithuania applied for membership in 1994. should 6. Food and energy product some raw materials, textile. ensurmtand stable policies. In e metal and woor' products remained subject to licensc. ensure more transparent and stablc poficies.In the*although prices Lor wood and nmay raw materials were lib- interim, Lithuania should try to conclude at least a eralized by the end of 1992. general trade agreement with Russia to stop the d 5is- 7 Epmu in Lithuana wer abjet to other restraints as criminaion it faces in Russian markets. wel that might have nfluenced early export performance, In stnmary, more transparency and consisten- bhat had been eliminaxed by 1994. Until the first quarter of 1992 convertible currncy exports were subject to a surfen- cy m trade policies would also accelerate der requiment of 20 percent of hard currcncy revenues Lithuania's economic transition. Lithuania has Ihis amounted to an export tax of about 20 percent This removed many restraints on exports and should was abolished in April 1992. when a new surrender requirement at a market ratc was introduced for some cnter- now remove the remaining export taxes and bans prises until 1993. Profits from exports in convertible cur- which are unnecessary now that prices have been rencies were ctaxed separtly until 1993. Th exchange ratc liberalized. Protection should be uniform and based used for computing the tax was below market raes, which in January 1992 amounted to anoffier 20 percent tax on for- on taris alone. A 10 percent uniform duty would eign cenc prfit avoid presrs for excemptions on in,puts and limit travoide diverssumsfexempion s on itradts adLimito & Thesc included mostly agricultural raw materials. such trade diversion in free trade markets. Lithuania as livestockt feathers, sugarbects. Ieather, timber, and met- should also distinguish between permanent and als. temporary proteton and rview the istitutional 9. Export prohibitions remained fo live swine, red clover alanugement for changing trade policies. More sta- seeds, gamins. flour, other grain and grain products, bread bility and consistency in trade policy will help and bread products. cakes, and pestcides. During the sec- establish a frameworkc that wiU call forth an efi- ond half of 1993 export quotas wcre introduced for estabish fraeworkthatwilicall orthan efi- ioLasse used in exchange for sugarbeet seeds and agricul- cient supply response to market incentives. tural machinery, and technical spirits, meat products for sausages, gain, and fodder. 10. Red clover seed and untead oak and ash-free timber until May 1995. Notes The chapter benefited from comments by A. HIknanI. Il. A statistical duty of 0.01% applied to all trade. Mtichaely. C Mihalopoulos, N Morkre, C. Mueller, D. 12. After alohol the highest rates are on glass bottles (30 Ta=. L Alan Wintms and U. 7Zachu. percent) and sugar (70 percent tempomry duty). The 25 1. Traditionally, Litunia has been mare agraian than the pc rate applies mostly to domestically produced goods two other Baltic countries, although the industrial sector (carpets, cenent, matches, some household machinery. fur- grew rapidly under Sovietrule. nihtur, several agriculturl products); 20 percent to a num- ber of agriculturl products, corks, electronics, chocolae 2. This included energy products, municipal and infrastruc- 15 percent to textik producs. fish. meat products; 10 per- ture services, some breads. some producer support prces in cent to leather, wood, paper, stone and plaste; 5 percent to agricultre (pork, heef, chicken, milk, cggs, vegetables), a number of agriculural products. The highest duties. 40 to and about 1 00 items. subicct to monopolistic conditions. 100 prcent, are on alcoholic beverages. A number of fruits and vegetables and flowers are subject to seasonal duties of 3. The antiexport bias in the tax system was removed in 10 to 15 percent 1993. Previously, a large number of excmptions reduced the tax base and distorted prices. Excise taxes bad been 13. Bottles of transparent glass (in addition to a 30 percent levied in a way that distorted trade. The general excise tax duty), feed animals, pork for sausages and other foodstuffs, was levied on exports at rates ranging fiom 10 to 86 per- raw materials for sugar-producing industries, cercals, and cent (IMF 1993), constituting a tax on exports (equivalent mixed fedder. to the difference from the 18 pcrcent domestic rate). Imports fhced a lower (10 percent) general excise tax than 14. The first changes came only a month after the fit cus- domestic production, which amounted to a subsidy. toms law was passed. in response to the agricultural lobby's complaints about cheap imports. Duties on meat 4. Changes in the volume of trade are atremly difficult to and poultry were doubled to 30 percent and those on live- estimate because of valuation problems in an enviromnent stock raised from 5 to 30 percent Duties on crop and ani- of high inflation and distorted exchange rates. mal products were also raised. The ease with which one 5. The trade is ikely to be ilegal from both Lithuanias; and sector managed to increase protection is lkely to send the Russia's point of view. In Russia the trade circumvents wrong signals to producers. In September 1993 duties on export taxm and in Lithuania iE bypasses the gDvernent more agnctultural products were raised: potatoes cereals, monopoly Ot me Ls tandei h man, confctionery. Further changcs werc introduced 170 TMADE IN TM NEW INDEPENDENT STAE in 1994. with increases in seasonal duties for fowas and References foranumnberofothb agricuulal poducts. Economist Intelligence Unit. 1993. Baltic Republics: 15. Thcsc generally included obligatory lists of state-to- A mnub Lagv. Lidruania: Comnay Profik. LondOA state trade and indicative lists setting a framework for International Monetary Fund. 1993. Lithuania. IMF enterprise-to-enterprise trade with licenses and quotas. Economic Review 7. Intrational Monetary Fund. Payments were to be settled through bilateral clearing of Washngo1 IFD.C. rubles in correspondent accounts in the two central banks. Products in state trading were at fixed prices in dollar terms Tarr, David G. 1994. 'The Terms of Trade Effects of and quantities, with the dollar prices converted to rubles at Moving to World Prices on Countries of the Former product-specific exchange rates (below world market Sovict Union," in louma of Companasive Econocs. prices). 18:1-U4. 16. In 1990 and 1991 clearing accounts between cental van Arkadic. Bri-; nnd Man K;ason 1992. An Ebn banks in rubles of each year were closed separately. In S wadvey Bn Mats K on. 1992. Presso 1992 separate accounts were opened for each rcpublic. The Ncw States. New York UivetyP account with Russia was again closed in mid 1992 for New Yodk reforms in Russia's payments systmL Another closure took World Bank. 1993- Lithuanic the Tmnition to a Ma*et picc upon the intrduction of the talons in Octobcr 1992 Eoony- Wasbinmon. D.C and one morc closure in June 1993 upon the introduction of the lita. World Bank. 1994. Stadrical Handbook 1993: Star vif 17. Already in 1991 supplied crude oil by Russia was at TutfoenF ionrseriesNoR. StWoid BankmWashin 70% of agreed arunts In 1992 oil mports wc at 35 * D.C of their level year before, while in gas the volume of D.C. import was 45% below tbc lcve of 1991. 8 Moldova's Foreign Trade and Exchange Regime Jonahan Walters Moldova, like other republics of the Soviet Union, never participated direcdy in trade with the world outside the USSR or had any influence over the regulations applied to its extenal * Structure of Foreign Trade trade and payments.I Within the USSR, Moldova was a highly open economy, exploiting its broad comparative advantages as * Thie F;reiqn Trade a supplier of agricultural and agroprocessed products. as werl as Regime producing consumer durables and hi-tech defense systems. Almost all nonagricultural industrial inputs (nomably primary * The Exchange and energy resources) and most consumer goods were imported Payments System from the rest of the USSR. But the division of Moldova's pro- duction betwecn domestic consumption and export to the rest of * Completing the the USSR or beyond, as well as all price setting, was decided in Uberalization Moscow according to central planning requirements. Independence in 1991 was accompanied by severe disloca- tion in the trade and payments system within the former USSR * Uberalization of the and, for Moldova, an almost complete lack of access to foreign Foreign Trade and exchange. Unrestrained expansion of money and credit within Exchange Regime in the ruble area accelerated the disintegration of the trade and Perspective payments system, leaving Moldova isolated. GDP was cut in half between 1990 and 1993, while prices soared more than 400-fold. The initial response was the same dtroughout the area of the former Soviet Union. Moldova and the other countries of the former Soviet Union erected banriers to export to keep 172 TRDs iN TE NEW INDEPENDENT STATES domestic markets supplied with cssential goods. tural reforms, supported by the RMF and the World These export controls took their place within a Bank, designed to acclerate the transition to a mar- framework of proliferating bilateral state trading ket economy. Key features of the stabilization pro- agreements and an extensive system of state pur- grm were substantial tightening of monetary and chases (known formerly as "state orders") iniple- credit conditions, partularly strict limits on credits mented primarily by state trading monopolies. to the government and the banking system; tight fis- Moldova removed most direct controls over domes- cal policy, through strengthened revenue measures, tic prices when Russia liberalized its prices in a broadening of the tax base, and phased elimina- January 1992, replacing them with legal limits on tion of consumer subsidies; sad introduction of a profit margins. The interlocldng systems of export new currency (the leu), with a floating exchange control, state purchases, and indirect price controls rte. A struchital adjustment program put in place at were intended to protect supplies to the domestic the same time encompassed more liberal trade and market and keep prices down. pricing policies, privatization in industry and agri- Imports were less encumbered by controls, but culure, and the repl.acement of generalized subsi- they were highly constrained by several factors. dies of consuraer goods with more targeted com- Rapidly rising prices within the former Soviet pensatian of vui icrable groups. Union, as prices rose toward world levels, substan- By April 1994 the stabilization measures tianly increased the cost of critical Moldovan appeared to have takn hold. Inflation had fallen to imports, particularly for primary energy products. 5 percent a month, the fiscal deficit was on track to (Moldova imports 99 percent of its energy needs, stay within the 1994 target of less than 4 percent of largely fom Russia and odter former Soviet Union GNP, and the monthly refinancing rate of the cen- countries). Russia was sharply reducing its implicit tral bank was highly positive in real terms. Progress and explicit financing of the biiateml payments was also being made in structura reforms. deficits of the other new independent states as its own economy came under increasing pressure to Structure of Foreign Trade moderate nmnaway fiscal and monetary expansion.2 Moldova's extemal trade is undergoing rapid More generally, the breakdown of the payments ttansformation. Before 1991 nearly aD trade (most systm, the extrme scarcity of hard currency, and exports and 86 to 89 percent of imports) took place the prevailing exchange rate also lzd to a contrac- with other Soviet Republics (tables 8.1 and 82). By tion of imports protecting the Moldovan market 1992 and 1993 imports and exports outside the for- In 1993, however, the autarkic orientation of mer Soviet Union had risen to between 22 and 39 the authorities was modified considerably. There percent This changing pattern reflects not only an was a growing realization in Moldova that an econ- increase in trade outside the region but also a con- omy with a production structure highly oriented tinning fall in the level of trade within the region- toward external trade was not going to be turned the Ministry of Economy estimates a declne of up around by the demand and supply forces generated to 50 percent in real terms in 1993. Moldova's main in its small domestic market alone. It was also trade partners in the former Soviet Union are becoming clear chat the terms of trade shcks fiom Russia, Ukraine, and Belarus; important trade part- higher energy import prices and the decline in ners outside the former Soviet Union include Russian transfers and credits were likely to be per- Romania, Bulgaria, Germany, and Turkey (table manent_3 Adjustment to external conditions was 83). Countries of the European Union (EU) thus of paramount importance. Such adjustment accounted for 6 percnt of exten trade in 1993. required maaoeconomic stabilization and an inde- I the period preceding independence (1987- pendent monetary and exchange rate policy. 91), Moldova had a moderately negave balance of In late 1993 the Moldovan authorities initiated trade with countris outside the Soviet Union and a progam of macroeonomic stabiizaion and struc- roughly balanced tade inside thb. USSR The rapid MoLDDVA's FoRwGN TRADE AND ExcHANI E REtow 173 Table 8.1 External Trade In Current U.& Dollars, 190-93 (In million of dollars and in percent) 1990 1991 1992 19 Value Total exports lO,325 6,370 400 810 Former Soviet Union 9,920 6,190 244 636 Restofworld 405 180 157 174 TotW imports 9,893 6,181 547 953 Former Soviet Union 8.461 5Z5 377 743 Restofwould 1,432 656 170 210 Trade balance 432 188 -147 -143 FarmerSovitUnion 1,459 665 -133 -107 Restof world -1.027 -476 -13 36 Percentage dlbufn Totnl exports 100 100 100 100 Formner Soviet Union 96.1 97.2 60.9 785 Rest of world 3.9 2.8 39.1 215 Totdal imports 100 100 100 100 Former Soviet Union 855 89.4 66.9 78.0 Restofworld 14S 10.6 31.1 22.0 a. Figu for ad willt the fmer Sviet Unio ae dcived firm county daa and World Bank staff estmated rpoted in natonal urencies using official or co_nemcial echg rate fur 190 and 1991 and annual average imkct chwge rates for 1992 and 1993. b. Thr zest of dewodd dfrsto couties outside t fnerSotvi tlJi figsarbasd on coatryduarcpedin US. doliaus. Table 8.2 External Trade In Rubles, 1990-June 1993 (millions of rubles) 1980 1997 1992 June 1993 Exports 6,176.7 8,140.8 63,880.0 146,850.6 Fonner Soviet Union 5,853.3 7,809.0 47,841.7 83,548.9 Agriculture and food industry 3,048 3,595 23,909 Rest of wold 32S.4 331.8 16,038.3 63,301.7 mports 6,461.4 8,443.8 94,849.6 184,5Z8 Former Soviet Union 4,991.6 7,237.3 74,127.3 118,825.8 Oil, gas, and coal 544 1,364 40,145 80,689 Rest of world 1,469.8 1,2065. 20,722.3 66,127.0 Trade barance -2847 -303.0 -30969.6 -38,1022 Forrner Soiet Union 861.7 571.7 -26.285.6 -35,76.9 Rest of world -1,146A -874.7 -4,684.0 -2,825.3 Trate with omer Sowat Uon as percentage of total bode Exports 94376 95.92 74.89 56.9 Imports 7725 85.71 78.15 64.25 Trade balance -W0t8 -198.68 84.88 92.58 Sourcc: Nadonal Bank of Molda increase in eneWr prices after independence pro- dteir 1991 level, but they have grown to represent duced a lre deficit in volume tenDs in trade with dmost half of total iMpotS (table 8.4). countries of the former Soviet Union, despite the The most significant imports in 1992 (the last lower volume of energy imports. In 1993 energy year for which there are complete data) were raw impcuts in volume terms were about 60 percent of materials, energy, and other mineral products (table 174 TRADE im THE NEW INDEENDENT SrATEs Table 8&3 Moldova's Main Trade Partners, 1992 Without reliable data on trade volume, esti- (millions of rubles) mates of the terms of trade loss suffered by Trade pastier Exports Impofls Balmce Moldova can be only approximate. A very rough estimate can be obtained by calculating the loss due FniWSon7 -t to inceased energy prices, for which there are bet- Union 47,541.7 74,127.3 -26,255.6 Azerbrijan 1,259.5 1,149.5 110.0 ter data, and assuming that other import and export Belarus 2,775.0 9,571.0 -6,795.0 prices have gone up in line with average domestic Russia 25.015.7 42,876.3 -17,860.6 inflation. That puts the estimated terms of trade loss Turkuneistan 1,696.4 1,725.6 -29.2 Ukraine 12,466.3 14,351.0 -1,884.7 for Moldova at more than 20 percent of total GDP Uzbeoan 958.3 1,522.3 -564.0 over 1991 and 1992. Other 3,6695 2,931.6 737.9 The Foreign Trade Regime Restof wod 16.038 20,722 4,684 Moldova's trade regime has changed substan- Budgaria 2,387 2289 99 tially in the years since independence, toward Canada 491 31 459 increasing liberlization (box 8.1). Germnmy 721 2,813 -2.092 Italy 142 1t419 -t em Podand 754 377 378 The Eiport Regime Romania 6,107 6,855 -748 As of early 1993 Moldova's system of export Swierland 1.373 27 1.346 controls was extensive and complex. All exports TuSkey 3,39 34 3.105 equid licenses. General licenses (valid for one OhSA 924 2,570 - ,745 year) were issued for exports in fulfillment of bilat- cal state agreements, while specific licenses for Soure SteDqwpunet of Stics Moldova each consigmnent were required for all olher exports. All prices had to be validated by the Table 8.4 Volume of Energy Imports from Ministry of Foreign Economic Relations, a measure Countries of the Former Soviet Usion, 1991-93 designed to prevent undennvoicing. Export quotas were imposed on 155 categories of goods, including Prduct 1991 1992 1993 some to hard currency markets. Exports for barter Coal 4,196 2.060 ,9856 were permitted ondy if the exporter could establish Natural gas (mulon mU) 3.873 1.972 1,82 that the counterpart imports were used in produc- Heating ol 1,651 1,952.5 1,000 tion of the exporL Barter for trading rather than pro- Diesel fuel 990 699.8 400 duction purposes was thereby prohibited. Export Benzene 725 364.5 200 Otler energy fuel 220 85 70 taes were applied to about 50 categores of goods, Energy price index 100 6,143 86,769 most of them raw materials that were re-exports Consurnerpficeindex 100 889 3,955 from Russia and other countries of the former Soviet Union (Moldova produces few raw materials Soo=s State Dvpamt of Stawd%cs~ Moldova o t w) of its oWn). 8.5). There is also a diversified list of other import These controls were plrogressively lifted during items. still reflecting the close integation of the 1993 and early 1994. As of mid-1994, export economies of the former Soviet Union. The main licenses were required for ceeals, leather, and ener- export products are food stffi and other agricul- gy products, which are also subject to a quota,4 and tural products, closely followed by machinery, or tbeen categories of goods for health, environ- equipment, appliances, and textiles. Today, howev- mental, and cultural rcasons, including industrial er, ivloldova is facing tougher competition in the waste, medical supplies, weapons, drugs, precious more liberalized markets of the former Soviet metals, and nuclear materials. Licenses for textile Union. exports to the EU are imposed according to EU MOLDOVA'S FOREIGN TRADE AND ExcHWNciE REGEnM 175 Box 61 Chronology of External Tmde Policy Changes, 1991-94 199142 December Price liberalized and value added tax intoduced 1994 Febuary Antlmonopoly law inboduced January Fomrign exchange surrender switched to Inter- December Foreign exchange surender rerenen bank market rather han t cenbal bank number reduced to 35 pent of goads subject to et'port licenses and quotas reduced, excise taxes leied on all non-CIS and 1993 some CIS Imports Apri GeneralIzed export licensing requirement abo- March Import tariffs raised isted Apri Export licensing and quotas eimited (sxcop? August Number of goods subject to export lbenses and for rmited number of goods). minimum prics for quotas reduced exports tempomaly suspended, prahibilon an September Expot taxes abolshed barter lifted for aS counties and introduced for October Permissible tading margi ncreased iurd curncy counties November Import tarff reduced May Pic conls and subsidies breadand mulk November Natonal currency intoduced and th Chidnau removed Inlebank Foreign Currncy Exchange estab- June Impottariffs raised (folowing increases in lshed December93 and March 94) December Inport ariffs raised requiirments.5 ports of radioactve wastes and rates are on inputs, the highest on beveages and barter exports to countnies with convertible cumen- tobacco products. Rates are doubled for imports cies are prohlbited. All other products are free of from countries to which Moldova has not extnded export resnli censes, quotas, prohibitions, Most Favored Nation (MEN) status-10 Barter taxes 6-except pnce validatiolL7 inports are subject to a 30 percet surcharge on the base tariff ratc. Inports from CIS countres, devel- The Import Regime oping countries (as classified by the United Until late 1993, most imports from outside the Nations). and countries with which Moldova has former Soviet Union were subject to imp-rt tariffs free trade agreements are exempt from tarfi.l I and taxes dating from before independence.g Rates Import licnses are rquired only for the same catc- varied from 5 to 1,300 percenL These taxes and tar- gories of goods requiring export licenses for health, iffs were levied on the ruble value calcuated using environnmental, and cultural reasons- the fixed Tvaluua ruble" rate of 1.8 rubles to the U.S. dollar. By late 1993 the ruble had depreciated to Plres such an extcnt thatthe highest import duty rate was The liberaization of extemal trade and pay- equivalent to only about 2 percent when recalculat- ments has been accompanied by progressive liber- ed at the prevailing exchange rate The Moldovan alization of price which is reduig the differential market nonetheless remained lagly proectd fom between domestic and world pces. In particular, competition from imports from outside the former domestic enc-gy product prices have been allowed Soviet Union as a result of the prvailing ruble-dol- to pass through the full price increases of imported lar exchange rate and the extreme scarcity of for- energy products as those prices nse toward world eign exclumge. levels (although energy prices remn contmlled).12 A new import tariff was introduced in Direct price controls on food staples were progres- November 1993, and rates were amended in sively removed during 1993-94, and tt.e la.-' con- December 1993, March 994, and again in June trols, which by then applied only to certaii bread 1994.9 The tariff structue includes eleven rates and milk products, were aboliished in May 1994.13 aging from zero to 300 percent, with most goods Most controls oz wholesale and retail markups subject to rates of less than 30 percent. The lowest remicn but their levels have been increased, and 176 TRADE IN TME NE.W INDIMENirNw Simni exports and luxuries have been exempted. Profits of removal of quotas on exports to the rest of the for- monopolies above a specified norm are subject to mer Soviet Union and the establishment of a for- an excess-profits tax in an attempt to hold down ciga exchange market in Moldova have allowed their prices.14 Monopolies are also required to altematives to state trading to begin to develop. A report their prices to the Ministry of Finance; the notable development in this regard was the cmer- purpose of this requirement is unclear, but it may gence in 1993 of a. substantial private market for give rise to informal price controls. gasoline. Nonetheless, state purchases for central- ized barter continue to exert a very significant influ- The State's Role in External Trade ence on the Moldovan economy. Moldova has abolished its once comprehensive state order system, but the stare still purchases sub- Trade Agreements stantial quantities of certain goods, largely under Since the breakup of the USSR, Moldova has centalized barter exchange within the franework concluded trade agreements on an annual basis with of interstate agreements with other countries of the the other countries of the foxmer Soviet Union that forner Soviet Union. Most of the centralized have consisted primarily of lists of goods to be imports planned for 1994 are energy products (coal, exchanged.18 Trade takes place almost entirely on maoisL and gas), but some grain and medical sup- the basis of barter. Over time, thcse agreements plies are included.15 These goods are supplied to have been relaxed somewhat, from obligatory lists Moldovan producers, households, and the govern- to mostly indicative lists. Direct trade between menL enterprises appears to be increasmg, but the role of The system works as follows. The Ministry of state procurement agencies remains substantial. Economy identifies- the -needs of the state" and Bilateral trade imbalances are supposed to stay informs the state procurement agents within the limits establisbed by negonation of inter- (Moldcontract, State Fuel Agency). These agents state credits, but arrars are frequent'9 For then call for the specified goods fom producers Moldova the primary purpose of these agreements identified by the Ministries of Agriculture and is to achieve security of energy supplies Industry.16 Prices are negotiated between producers On April 8, 1994, the Moldovan Parliament and the state procurement agencies. I the procure- ratified the CIS Treaty and Economic Union ment agencies fail to call for the goods within the Agreement and on April 15, CIS leaders reached specified quarter, the producers are free to market agreement on a fee trade area. The free trade area the goods on their own. In principle, producers sup- is intended to be a precursor to a customs union. plying state needs receive preferential treatment in Moldova also has a free trade agreement with the allocation of credit, fuel, and other inputs, but it Romania, its principal trading partner outside the is not clear to what extent this preferential treatment former Soviet Union. occurs.17 Moldova has negotiated trade and economic Though there are no precise data on the propor- cooperation agreements with a number of countries tion of state purchases for centralized barter in (see footnotes 13 and 25) and is in the process of Moldova's wade with the rest of the former Soviet negotiating such agreements with sevraal othersYD Union, the Ministry of Economy believes tha; it has The principal provision of most of these agreements been falling rapidly. One official projects a decline appears to be the mutua accordance of bN stamts. from 80 percent of imports from the former Soviet Moldova is also negotiating ac ession to the GATr. Union in 1993 to only 20to 25percentin 1994. The fulfillment rate of planned state purchases for cen- The Exchange and Payments System talized barter in 1993 was only 60 percent. Until November 29, 1993 Moldova was a de These teds are consistent with othercanges jure member of the ruble area. On that date, in trade and payments regimes. In particular, the Moldova introduced its national currency, the leu, MoLDovA's FOREIG TRADE AND ExcHANGE REGUE 177 which henceforth was the only legal tender in the that time) replacing them with coupons at par. On countryY21322 The conversion took place at a rate of August 9, 1993, the National Bank began quoting I leu to 1000 rubles, and did not include any signif- an official exchange rare for the noncash Moldovan icant confiscatory element,3 De facto, however, ruble against other currencies, including the Moldova departed from the ruble area in stages. Russian ruble (the initial rate was 13 Moldovan When the USSR broke up, the interrepublican rubles to the Russian ruble).26 Or. November 16, payments system broke down. Transfers between 1993, the Chisinau Interbank Foreign Currency the banking system in Moldova and the rest of the Exchange was inaugurated. former Soviet Union became increasingly difficulL The Cbisinau Exchange was founded by seven There was thus a premium on Moldovan access to conunercial banks as aclosedjoint-stock fund, with ruble deposits in the Russian banking system, as theNationalBanckofMoldovaplaying asuperviso- opposed to those in Moldovan banks. In effect, a ry rolc. Eightecn of the country's twenty one com- Moldovan noncash nruble" had been cated. mercial banks are licensed to participate in the mar- In paralleL a shortage of cash rubles emerged ket. U.S. dollars, Russian rubles, Romanian lei, and throughout the former Soviet Union, and the deutschemasd are traded at the auctions, held thre Central Bank of Russia favored Russia over the times a weelk27 In the initial weeks of operations, other new states in the allocation of scarce cash the National Bank was the only seller, but now sev- rubles In June 1992, Moldova introduced its own eral other banks are also active on both sides of the coupon (at par with the nble), which was legal ten- madret der only in Moldova and circulated alongside the Participating banks accumulate demands for ruble. The Central Bank of Russia imposed restric- foreign exchange on behalf of their clients and tions on the level of debit balances Moldovan enti- themselves Foreign exchange may be purchased ties could accumulate in the Russian banldng sys- for clients only for crrent account transactions and tem consolidating all baniang tansactons between must be used within thrty days of acquisition. Moldova and Russia into a correspondent account Banks are permitted to maintain an open position in in the central bank, subject to an upperdebit limiL24 foreign exchange, subject to an upper lbuit (assets Thus, by mid-1992, an embryonic national cumen- minus liabilities cannot exceed 10 percent of the cy, in both cash and noncash forms, had been creat- bank's total net assets for any given foreign cuen- ed in Moldovaf5 cy and 30 percent for all forign curncies). Only Introduction of a de jure national currency in banks with a general license can transact in foreign Moldova was delayed for largely political reasons. exchange directly with nonresidents; banks with a There was concern that Russia would grant prefer- local license must deal through the correspondent ecces in the prices of energy products only to mem- accounts of the National Bank of Moldova28 bers of the ruble aea, athough this concern lessened The supply of foreign exchange on the as the prices Moldova paid for Russian energy mse Ciuin Exchange comes mainly from exports and rapidly toward world levels. There was also con- from foreign credits, most vT them channeled cern over the possible reaction of the Transnistrian through the National Bank of Moldova. Exporters authorities to fonmal departure from the ruble area. are obliged to repatriate 100 percent of the proceeds On July 24, 1993, the Central Bank of Russia for deposit in Moldovan banks witbin ninety days withdrew from circulation all pre-1993 "Sovief' of the goods leaving Moldova. Moldovan residents rubles and replaced them with new Russian rubles. may open accunts !n foreign banks (outside- the The new rubles %were made available only to coun- former Soviet Union) if they have a long history of tries that elected to join a"new' ruble area The fol- foreign transactions and a demonstated need for lowing day, the National Bank of Moldova began rapid payments; about ten such aurizations have withdrawing from chclation all rubles in denomi- been given. At least 35 percent of the repatriated nations greater than 100 (equivalent to US$ 0.10 at proceeds of exports sold outside the fome Soviet 178 TRADE IN THE NEW INDEWNDENr SrTAs Union must be sold on the Chisinau Exchange with efficient sectors Competition wilt also stimulate fifteen days of receipL (Before January 13, 1994, innovation and the acquisition of more efficient the surrender was made to the National Bank of production techniques. However, further measures Moldova.) The remnaining 65 percent can be held on are needed to realize the full benefits of libeaiiza- deposit in interest-bearing accounts (at unregulated tion. ates), but an enterprise or individual can hold only one hard currency account for each foreign curren- More Liberarization of Exports cy. Transfers between foreign exchange accounts Thc remaining restrictions on cereals, leather, have to be authorized by the National Bank. In and ener should be removed. The restriction on addition, hard currency accounts can be cashed only cereals is designed to provide food security and to for expenses associated with business trips. keep down the domestic prices of animal feed There are some 200 exchange houses, both However with import liberalintion and e greater bank and nonbank, authorized to deal in csh for- availability of foreign exchange, such food security eign exchange The exchange houses set their own concerns can be accommodated by trade; cereals exchange rates, but the spread between buying and can be exported in times of surplus because they sefling rates cannot exceed 10 percent. Every for- can be fely imported in times of deficit On the eign exchange purchase is supposed to be for cur- animal feed issue, the solution is not to keep prices rent account puroses and individually documented artificially low but to restucure the livestock for scutiny by the National Bank of Moldova The industry so that it is competitive at world prices. in nonbank exchange houses can access the Chisinau June 1993 the grain procurement price was set at its Exchnge auctions only indirectly through a bant. presumptive world level, though no Moldovan There is also a sheet market in Chisinau, in which grin is taded on world markets, so it is not clear activity seems to be modesL29 The supply of for- that the price was set at an appropnate leveL Pper eign exchange to the exchange houses and street pricing represents a further reason to hlbealize grain market appears to come largely from savings, exports. tourism, and small-scale exports. Similar arguments apply to the ban on leather Since the introduction of the leu there has been exports, which results in implicit subsidies to indus- little intervention by the National Bank in the for- tries at use leather, such as leathe processing and eign exchange market (it had sole ss than $20 mnil- footwear. The ban on energy exports should be lift- lion net of purchases on the Chisinau Exchange as ed as well, except insofar as Moldova is bound by of the end of April 1994). W-ithin the first few agreements with CIS countries on reexports (agree- weeks of the startup of the Chisinau Exchange, ments that are rooted in the continuing subsidiza- exchange rates in the three markets-Chisinau tion of energy and other products in those coun- Exchange, exchange houses, and street-began to ties). exhibit a high degree of convergence, suggesting The prohibition of barter exports to countries that the markets are broadly competitive?0 with convertible currencies intended to reduce capi- tal flight through export sales disguLised as barter to Completing the Uberaliation evade rpatriation requirements, should be Moldova has done much to open its trade and removed. Such prohibitions are unliely to be effec- exchange regime since late 1993. Although it is too tive so long as the underlying incentives for (macro- early to assess the effects of this liberalization, it economic instability and an unfavorable investment has paved the way for Moldova's integration into climate) continue to exisL Similarly, the vaidation the world economy. Exposing Moldovan producers of export prices by the Ministry of Economy proba- to competition in domestic and export markets will bly does little more than add to the costs of alEow resources to shift to those sectors in which exportes through administrative delays, while con- Moldova has a comparativc advantage from less tributing to aclimate ofbusiness uncertainty by sig- MOLDOVA'S FOREIGN TRADE AmN EXCAGE REGIME 179 naling to producers that export controls could easily taCS fec trade area will influence Moldovas tar- be reintroduced. The use of minimum reference iffs on imports from non-CIS countries. If Moldova prices should be pennanently abolished (the prac- places a significantly higher tariff on a given prod- dce was temporarily suspended on April 29, 1994). uct than do other member countries, that product is To realize its gmwth potential, Moldova should likely to be smuggled into Moldova through those seek to negotiate improved access to as wide a other countries. In an area with such long frontiers range of markets as possible The most effective and weak customs administrations rules of origin means of pursuing this objective would be through will have only a limited effect in preventing such GATT membership, closer association with the smuggling Higher tariffs will also do more to divert European Union, and removal of any residual trade fom non-US to CIS countries than it will to obstacles to free trade arrangements with the CIS promote Moldovan production. The upper rates of and Romania. The furiter reduction of barriers to Moldova's tariff structure are already significantly the entry of Moldovan products into export markets higher than the norm for other as countries. wil be of critical importance to economic growth Moldova could achieve greater uniformity of tariff rates by applying MFN rates to all countries of Low and Uniform Tariffs origin (except those where free trade agreements Experience worldwide demonstrates that apply)-a move that will in any case be requird for import tariffs should be low and uniform if the accession to the GAIT. Because of Moldova's fls- stimulation of domestic production is to be accom- cal constraints, it is not in a position to offer rats panied by increased productive efficiency. High lower than N to developing countries. The 30 rates protect inefficient producers, and a wide range percent surcharge on barter imports is unliely to of rates distorts produces' decisions. Inefficient deter barter significantly and should be removed. producers cannot compete in competitive export Duty exemptions for foreign investors and small mares High tariff raes tend to cause appreciation businesses are probably only a weak investment of the exchange rate through their depressing effect incentive at best and wil be difficult to administer. on imports, which reduces the profitability of Their use should be minimized. exporting31 In addition, high triffs often lead to high rates of evasion nther than to revenue gains. Reformning Value Added and Excise Taxes Experience in East Asia and elsewhere suggests that In their current application, both the VAT and any tariff protection given to producers should be excise taxes discourage exports and domestic pr- temporary and that producers should know in duction. For trade with CIS countries both taxes are advance that it wil be temporay. levied on an origin basis: domestic production- The government is committed to reducing tar- whether for export or for domestic consumption- iff res that are above 20 percent All ates higher is taxed and imports axe not (except for excise taxes than 20 percent are expected to be cut to 20 percent on imports of gasoline tuies, cars, and diesel fuel). by November 1995, two years after introduction of The system appears to reflect the view that CIS the first tariff decree. A progressive reduction is trade is not really intermational trade, as well as a recommended, starting immediately by reducing the desire to avoid td. price-raising effect of taxing highest rates to 50 percent or less?2 Though low imports, although Russia, a major CIS partner, is tariff on inputs should eventually be harmonized imposing its VAT on a destination basis. Applying widt triffs on final goods to reduce the dispersion these on a destnation basis has several advantages. of effective protection, that should await the mati- It avoids the bias against exports and domestdc pro- ration of the customs administaion and the intro- duction in favor of imports created by applying the duction of a duty drawback systm for exporters tax on an origin basis. This measure could have a Moldova's membership in the CIS has impor- positive efiect on revenues by reducing Moldova's tantimplications for its taiffpolicy. Membersip in trade deficit with the rest of the former Soviet 180 TRADE N Tm NEW INDEPENDENT STATES Union. For these reasons, the government should case for gasoline), price controls should be consider applying these taxes on a desdnation basis removed. Monopoly price control and regulation (after consultation with other CIS members), which should be reviewed. In a small country like would mean that imports would be taxed and Moldova, liberalization of external trade can go a exports woud noL33 For some goods the price-ais- long way in promoting competition in radables, ing effect of taxing imports would be partly offset obviating the need for direct controls on monopo- by diversion of trade to non-IS imports. lies. Price reporting by monopolies could be For tade with non-CIS countries, the tax removed immediately, except for clearly defind regime is already on a destination basis, but delays statistical purposes. in crediting exporters with VAT paid on inputs could be an impediment to exporrts34 A VAT A Smaller Role for State Purchases refund system should be considered. Reform of the system of state trading is of dt highest priority. The continued involvement of the Prce Reformn nd Compeiion Policy state in external trade retards the transition to a mar- Remaining price controls still constitute a ket economy by placing bariem between domestic wedge between domestic and world prices and producers and world prices. Payments by the sta should be prgrssively removed. Margin controls to domestic suppliers are often delayed, without inhibit investment in the trading sector and may adequate compensaion, depressing the effective result in shortages; they should be lifted Energy price paid to prducers well below world levels. prices charged by sta-owned utilities should con- Producers are deprived of the stimuus of competi- tinue to reflect increased costs, and cross-susdies tion and of the pmfits that signal optimal resource should be removed as a more effectively trgeted allocation. social safety net is put in place. For enegy products As a first step, stat procurement shoud be put in which private trade is pnritted (as is already the on a competitive basis, with suppliers invited to bid Box 82 Access for Moldovan Exports to OECD Markes Exports fromn he USSR faced the highest tarff bariers in OECD mats and were subject to nontarff banti- ers beyoid thse imposed on mostOECD tadig pafflrs. For eample, in 1990. inporttaiffs for Soviet goods In the United States. the Eopean Uion and Japan were 70 tD 90 perocent higher overall than te average il on all i.mpt in those markets. This differental is even gmetrwhen FSU goods - compared t hose from aras that were teatd prefemrnally, such as EFTA and developing counries uder the Lome Conventi Sice te breakup of t USSR access has been eased somewhat paiculadry by t Untd Sts but sub- stanbal baiws ran Access has iprovedmore for Eastam Eurmpean cwnt an for counties o tlhe for- mnerSoviet Union and more frthe Bal couoiesth forhe rst of the former Soiet Urion. a dfferenlieton tat is stongest in the EU nma the d s geographically to Moldova. Moldovals exports ar dustered in product groups for which OECD nmart have awauly high lwis of prtcton: agrcultural and agrprocessed products, cothn and foowr, and otr Ight goods. In 1990, 82 percent of Modr. .'s exports witin the Soviet Urion and 85 percnt o; its extemal exports would have been skt- jectto trade bariers in the EU nmkt-higher than the 73-75 perent average hat woudd have appried for the Soviet Union overal The extnt of nontadbarrers, which have ptcuarly stoka effes, was conider- ably higher than average for Moldova. Acession to the GATr in orderto rceive MFN tratrantfirm el members, ard negotiatin of fse or prefr- entW tade agrements with te EU and othr OECD members are dearly of high prlory to Moldoa The post- Uruguay Round reducon In ade barriers should provide ftherbenefit, altugh it vl tke some time to - implement Howevr, th emphasis on reduction of nontrff barers In te Urguay Round should be df paricu- lar brbenetto Molkk'a. SowKrce mi and Yeas (1993) MOLWoVA'S FOREIGN TRADE AND ExcHANGE REwGIE 181 on state contracts In addition, the state should One measure that would strengthen confidence encourage competition by seeking out seveal pro- in the operation of the market would be to remove curement agents for each commnodity, inclu&ng pri- the requirement to surender 35 percent of hard cur- vate trading companimes. T introduction of compe- rency proceeds. The surrender requirement suggests tition will result in fiscal savings in some cases and to economic agents that there is a tax implicit in the improved profits for produccrs in others; overal it market rate or, worse yet, that market determination will bring prices in line with supply and demand. of the exchange rate could be suspended at any Competitive procurent will have less impact time. The surrender requiement might therefore be on prices where markets are dominated by a single significantly deterring exports and ought to be buyer and altmratives to supplying the state are removed immediately. limited. Although some enterpnses and farms in Of perhaps geater importanc than i mproving Moldova are exporting independently, and some the functioning of the foreign exchange marIkt is competition among traders exists, many makes are increasing its scope. Currently, a large share of domtinaed by monopsonies. Wher these exist, any imports is being financed by foreign ca:dits, while stautory monopsony rghts should be removed, only a small portion of the proceeds of those credits Assistance in marketing should be provided to pr- is being allocated by a markeL In futre credit ducers who require it, either direty or through negotiations. the government should strive to xport promotion agencies. increase the portion that can be allocated by the Similarly, competition should be encouraged, marke Creditdisbursments in currency should be on the import side, particuarly for grains and agro- channeled tbrough the Chisinau Exchange, and chemicls, which are dominated by lare, state goods that are supplied diety should be auc- cnterpises, by allowing fee entry into those mar- tionedt kets and by pivatzation. State trading agencies Some imports financed by foreign credits have should be encouraged to resort to tlie foreign been subsidized, eithcr direcdy or, more often, exchange market rather than to barter for imports. through payments arrangements by purcbasers to In addition, taders and producers involved in cen- the government budget on cmrdit terms and condi- taled tAding through state purchases should be dons that were not market determined. And even placed on an equal footing with their competitors; when market interest rates have been imposed on they should receive no preferences in the allocation such credit, repayment bas often been over long of credit or inputs. peiods and poody enforced. These explicit and implicit import subsidies should be eiminated; they Further Liberlizafaon of Foreign Exchange misallocate foreign exchange and undermine fiscal The leu was intrduced smoothly into the discipline. Moldovan economy. The new cumncy is accepted by the population, and its introduction did not dis- Liberalization of the Foreign Trade and rupt external tade relations (as happened in some Exchange Regime in Perspectve other counties). In lare part this success was due Moldova!s ferile soil and low labor costs give to thc nmoeconomic stabilization policies that the country considerable export potntial; its small accompanied the curency inroduction. domestc maket impLes that recovery and growth in paranl, the Chisinau lnterbank Forcign will depend strongly on export performance. Curremncy Exchange and the exchang houses have Sustined economic growth wfll require substantial developed a well-functioning, competifi-e foreign capital investment With domestic savngs likely to exchangemadt, an unpoxtat achievement A c- remain low for the next few yeas, significant for- pettey determined excbr,Tc rate and the market sign i"Jlows will be needed., In the early years of allocadon of foreign exchge will conue grat- recovry, the nflowsca be expetd to be domi- b to the rstuctidng of theMoldovan economy. nated by loans, partculaly from official sources. 182 TRAiE mm nEW INDeb ENerEr STATEs Table 8.5 Trade by Product and DestinatIon, 1992 (milions of rubles) Eipaos Impons Trade Balance Frmer Fannr FOw Soviet Restof Soiet Restof Soviet Restvf Padc Ttal Union Wodd TOt Un Word Ovarai Unin Wor Lvestok and pmducts 3241.90 3,097.40 144.50 379.30 360.20 19.10 2,852.60 2,73720 125.40 Vegetable prducts 5,930.60 4,581.10 1,349.50 10,497.70 4,470.30 6,027.40 (4,567.10) 110.80 (4,677.90) Oilsandfar s 1,273.30 1255.10 17.20 82.90 80.70 2.20 1.190.40 1,175.40 15.00 Foodstuff, akchd, and beverages 15,344.10 14,597.70 446.40 2,06790 855.30 1,212.10 13,27620 14,041.90 (765.70) Mb'naralprdut 945.00 59.60 885.40 41.665.00 41,654.80 10.20 (40,720.00) (41,595.20) 87520 Chemical products 1,908.70 452.70 1,456.0D 4,053.90 3,45440 599.50 (2,145.20) (3,001.70) 856.50 Plstics, rubber, and products 661.50 615.70 45.80 2,114.70 1,964.40 15D30 (1,45320) (1,348.70) (104.50) Leather, fur, and producls 583.20 474.70 108.50 394.40 174.10 22030 188.80 300.60 (111.80) Wood aid products 121.90 17.00 104.90 1,578.20 1,349.80 22840 (1,45630) (1 ,33.80) (123.50) Paper. cardboa and prducts 1,145.70 535.60 610.10 22M50 1,997.20 20530 (1,056.80) (1,461.60) 404.80 Txies and prducts 5,941.60 4,413.90 1,527.70 9,765.80 6,08250 3,68330 (3,82420) (1,668.60) (2,15560) Foowear. hats umbrellas,ofer 1,144.50 567.70 576.80 54.20 186.60 362.60 595.30 381.10 21420 Prmducts of stone, cer glass 58320 550.50 32.70 1,139.80 632.10 507.70 (556.60) (31.60) (475.00) Prciou metal, g, and jewelry 812.90 809.00 3.90 350.60 335.30 15.30 462.30 473.70 (11.40) Metals and products 6,635.80 309.60 6,32620 5,74&40 5,137.70 610.70 887.40 (482810) 5,715.50 Machinery wad eqUipmet 6,39630 5.42920 967.10 3,500.40 1,392.30 2,108.10 2,895.90 4,036.90 (1,141.00) Ectic equpnd and appliances 7251.60 6,144.30 1,107.30 3,834.70 1,719.90 2,114.80 3,416.90 4,424.40 (1,007.50) Vehicles 2570.90 2,35920 201.70 3,801.80 1,665.00 2,136.80 (1,2S.90) 70420 (1,935.10) Cameras. watces medcine, musical instruments 235.10 207.40 27.70 300.20 270.60 29.60 (65.10) (6320) (1.0) VaYous poducts 1,072.30 986.60 85.70 785.70 322.30 463.40 286.60 664.30 (377.70) Art poducts, antiques 2.30 220 0.10 16.90 1630 0.60 (14.60) (14.10) (050) Sennoes of materia chaacter 77.60 64.50 13.10 19.60 5.00 14.60 58.00 59.50 (1.50) Toli 63,880.00 47,841.70 16,038.30 94,849.60 74,127.30 20,722.30 (30,969.60) (26,285.60) (4,684.00) To receive these loans, Moldova will need to fostered for instisttional development in the finan- demonstae its creditworthiness through prosects cial sectoa Measures to promote competition and to of strong growth in hard cunrency earnings. increase confidence in the banking sector, and posi- External credits will progressively be replaced by live real interest rates, will be necessary to atract foreign direct investment. Investos will be amact- deposits and the repaltiation of foreign exchange. ed primarily by Moldova's potential as an export Producers will be farmore responsive to profit base, particualy for regional markets. signals if the dominant form of ownership in Liberaizaion may be a necessary condition for Moldova shifts from public to privat The privati- export expansion, but it will not be sufficient zation program wil n3d to be accelerated, and Complm enty policy reforms and investments measures taken to facilitate the sup of new busi- wil be needed to induce producers to respond to nesses, with Moldovan and foreign investmenLt price and profitability signals. Macroeconomic sta- More carefully targeted social protection prgram bility will remain wzcial35 In the absence of such a and policies that promote the free movement of *comprehensive approach, even the partial liberal- workers will be neessary to faciliate the shift of ization tt has occmred so fhris unlely to be sis- resources to more producfive sectors. So will tanable. removal of subsidies to producer Credit allocation onl the basis of profitability To help Moldovan products remain competi- wil have to become dte nom. Bankruptcy and col- live in traditiona markets and become compettive lateral laws wil need to be enforced, and conditions in new makets will reqinr substantial invesment MoLDOVA's FREImN TRADE ANw ExcHNGs tEna 183 in new technology, including investments in 4. This quota is currently set at zero for al three products. upgrading quality and packaging. investment in thereby effectively prohibiting exports of those products (as has be the cae for some time). transport will also be needed, hotb in infrastructure and in cawiying capacity. These in frmts wilu e 5. Licenses are still specific to consignments (except for exports in fulfIllment of stare seeds or intestate agree- forthcoming only in a business climate friendly to mants) but have to be issued within 10 days of the applica- investment don for a licens Following the abolition of the Ministry of Foreign Economic Relations in April 1994, licenses are Institttions that facilitate trade are also neces- isszed by the Ministry of Economy. sary. More efficient payments mechanisms are beingdesined,for mplemntaton i 199. to 6. Exjntls to CIS countries are subject to Moldovan VAT being designed, for implementation in 1995, to andcxcisttaes(aL thesamecrzAesasfordomnesicsales). overome the substantial delays in settlements. ThIE effecivenss o newmechnism in oldoa is 7. Validation is carried out by the Customs Deprtent in effectiveness of nesr mechanisms i Moldova IS accordance with minimun refernce prices established by closely tied to CIS-wide developments ir. the pay- the Ministry of Economy. Infonnation used to establish meuts systert Financing instruments adaptedtothe ithese reference prices appears to come mainly fom the exportng enterprises themsves. Expors priced blow the needs of intemational trade wil also be neede. The rfernc lels are reprted to the Department of Prices of Customs Department has been receiving training the Ministry of Financ and technical assistance on strearilpnirgopCeUS & Import rffs dated back to 1981 while impor cases and cutting delays in trade clearance-particularly wee intmduced in 1991. Tax rates were generally consid- important for expanding perishable agricultural erbly higher than trffs. exports. An export promotion agency is being 9. Tbe _endments sulted fm representations; by pro- established to provide advice on market opporuni- duccrs to reduce tariffs on inputs and machinrcy, as wdl as to incre hase m on some finat goods. In addion, the triff ties and trade procedures and to publiciz for ates on some luxwry oods wcre reduced sine xcise xes Moldovan products through trade fairs and other on non-FSU imts of those gods were being introduced. media. Enteprise surveys have exposed cotsider- Po. EN status has been accorded to (and by) Austria. able confusion about trade regulations. An export Canada, China Czech Republic, EU, Finland. Hungay. promotion agency could play an invaluable role in India, Larvia, Novay, Switzerland. Slovalia. Tukey. making such information accessible to producers Ukraine~ and t United States_ and potential investors. 11. A few other catgores of goods are exemptd, includ- ing inberited property, social and hunanitarian goods, san- pies, advrising materials, goods under coopeation age- ments. investments in and inpuls far joint venures with Notes foreign partners and for small businesses. and imports financed by the sc budget or by eaternal credits to the 1. In die persroiks a era, Moldova did develop very limited government direct trade rdations with the rest of the world. 12. There are also cmss-subsidies within the stucure of 2. Polical facrs affected the distibution of thcse reduc- utility prices from prduces to bouseholds, as wel as tar- tions among the otber ex-Soviet republics, however. The getd subsidies and trasf to pensioners for coal and gas terms and conditions of Russian finamcing for Moldova sWlies. seem to have been strongly influenced by Moldova's resal to ratify the trey sablising the Commonwealth 13. Direct controls remain on public transport tariffs, of Independent Swtes and by the lack of ageement over chba for conmntal serc and rents. thc sDms of TransnEtria and over the pmmsenoef Tbe 14tb *Rstatus of Tmansnistrma and over the presence of the 1At 14. Monopolies are defined by law as enterprses that Russian Army in that region. for mo than 35 peret of sales in the domestic 3. Tair (1993) has estimated that the tems of trade shock mark A listofsuck enisesis secified byjoitdec- from the move to world prices wil be greatest for Moldova sions of the Ministers of Econo and of Finance. Te Int- of all ountries of the former Soviet Union. Similarly. esta such decision da4s from Janary 204 1994 but is based Odowsld (1993), in a comparison of prices in the former on 1992 market data. The Decition provides, however, that Soviet Union and worldpces, fnds that goods tat consti- a listing based on 1993 data sboud be drawn up by June tote a larg proportion of Moldovaes exports, such as food- 1994. Giwvn thc marked ince i opeess to imports of stuff odher agricultral goods, and consmer goods. were tde Moldovan economy since [992. this updaing is mpr- overpriced in the Soviet Union, while enagy products t were highly uderpr iccd." is.5 For detals of planned centralized exports and impors see Goverment Decision 71, "On volumes and disuion 184 TRaE 3N Ten NEW INDEENDENT STAmT mechanisms for supplies to mee state needs in 1994" 26. Priorto this dale, there had been no official recognition Feruary 11. 1994. that the Moldovan currency was no longer equivalent to the Russian ruble. The official exchange rate quoted by the 16. Centralized exports planned for 1994 are meat prod- National Bank of Moldova since late 1992 had been that ucts, edible oil, sugar, tobacco product wines, canned established by the Moscow Interbank Foreign Currency fruits and vegetbles, washing machines, c:pefs. pumps Exchange at the session of the Friday prior to the datc of andfunitue. quotationL From late 1992 on only one official rate was 17. The degree to which cei is directed by the gover- quoted: prior to that there were different "investnent' and ment has declined sharply with the introduction of redi- ommaC2 ratc. nancing auctions by the National Bank. Howcver, directed 27. At each session, there are up to 10 participants in the fuel supplies remain of some sinfimanc. US dollar auction, and fewer in the auctions of rubles, 18. As of Apnl 1994, agreements for 1994 had been con- Rmaian ld and deutscemarl Tbe auction prccss is cluded with aU counties of the former Soviet Union except simple and open. For a given currency the chairpeson calls Armenia. Belarus, Estonia. GCorgia. and Uzbdcstan. For out exdange mtes in small rising incremnents. Participants the last four oDunties agreements were reported to be in (inluding the NBM) delare their desired demand or sup- the fsal suges of presagmion. ply wt crch ratr r fi t rate at which demand and supply are equal. Acual tading takes plwce at this market-clearing 19. As of Apnl 1994, Moldova was in substantial arrears w rate, which is quoted as the official rate by the National Rlssia for natural ,gs and fild, although it was not clear if Bank of Molt.va unti the next session. This is the only this figure, net of arrears by Russia to Moldova, exceeded rate at which -h NBM conducs or accounts transactions. the oustandi balance on the interstate credit of 5D billion Banks' pmdssib c buying and selling rates are the official rubles agreed in 1993. Ukncie and Turkmenistan were in r plus and rinis I percent for hard curencies or 2 per- net aneas to Moklova. cent frother currcncies. 20. Australia, Bangladesh, Bulgia Cbina, Cyprus EpL 28. Thc local license operates as a "learneres permit" Fance. Greece, Iran, lIae, Japan. Korea Saudi Arabia, (intended for one year) while banks acquire experience. Slovenia, South Africa, Sweden, Syria, Thailand, and the The criterina for the granting of a general license relate United Arab Emites. inly to the availability of ta'ined pesonnel and an ade- quate accountancy system. This licensing system applies 21. However, in Tansaistria the eu was not admitted as mainly to transactions outside the former Soviet Union: for legal ender, although smal amounts entered into cira- transactions with other countries in the former Soviet ionL Instead, the pre-993 Soviet ruble continued as legal Union, most Moldovan banks now bave direct conespon- means of excange, lat overstacmed with a sticker depict- dent account relatonsbips in those counwtries. ing Field Marhl Suvorov (a nineteenth-centuy Russian Field Mrshal mrsonsible for conquering Ronaniank 29 This maret scms to ecist for those who Wish to make ing Bessrabia). In addition, the new Russian ruble was cir- small, rapid transactions or who wish to avoid official culating widely in Trsansstria since this was the medium sUnIiIy. In the weeks after the witdawal of the pre-1993 of payment of the 14th Russian Army based in rwaspoL ruble and after the inuoduction of the Iet this market saw There also appars tD have becn some dolaization of the consderable activiy in rubles. Most of these rubles were Trasnistrian economy. presuably destined forTranisnistria. 22. However, hotebills and aparument rents can be paid in 30. There is, however, a wedge between the Chisinau freign cxchange by those who are not permanent residents Exchangc rate and the exchange house raes becuse when of Moldova- exchnge houses buy freign exchange at banks they pay the bank's makup over the Cbisinat Exchange ratc plus a 23. Cash mounts in excess of 70.000 rubles had to be 4 percent commission for cashing the foreign exchange. placd in blocked accounts but only for a fcw days and the Ths places a wedge beween the CIFCE. accounts were remuneraed at a market-based interst rat 31. Experience in ffie succesflly transforming economes 24. The CBR imposed such restricions on all FSU cmn- of Eastern Europe shows that producers in formerly cen- tries to stm the surge in money creation, and to ration the trly planned economics can survive low import tariffs; access of the newly-indepedent states to that money cre- import liberalization appears to provide an impulse to ation. In effect the conditions of supply of rubles became grater compedtveness of producers in both domestic and specific to each member co y af wha was still nominal- export markets. Poland, Hungary, and the former ly a mnetay unionL See pp 56-57 of Russia Joining the Czechoslovakia, which experienced impressive export World Economy, World Bank, October 1993 for an grwth in the early 1990s, had aveage import tarff of LS account of these dvelpmt to 20 prcent. 23. HoweCr, severe restrictions on the convertibility of 32. The revenue implications of this measure cannot be this currency existed. Not only were there limitations on computed now becaue the datare absent rapidly improv- conversion into other FSU currencies (as described above), ing data collection systms sbould make uh calculatg but Moldovan reasideuts faed a severe shortage of forign posbl soon. Revenue could be proected by imposing an curency in Moldova and had no legal access to foreign excise tax on the products in question that would apply cuoency markts in the restof FSU. equally to imports and domestic production. Since no MoLDovA's PORaEIN TRADE AND ExCOIAC Rus ISe S import duties are imposed on goods from Moldova's main Kaninski, Bartiomicj. 1993. How due Marker Transition truing partes reducing the high tariff mtes is not likely Affeted Expon Pe4fonnne in the Ceal Europeo to have a large effect on revenue. Econoines. Policy Research Working Paper t179. World Bank1, Washington, D.C 34. Expors ar effci vely zero-rated even wben the VAT on inputs was paid in another country ratlF'r than in Mihalopoulb Constainc 1993. TruSt lsutsein he New Moldova. However, those VAT paymcnts are not refunded Independenrt States. Studies of Economics in but arc credited against hc enterprses next VAT payment Transfomnaion 7- World Bank Washington. D.C. for an enterprise exporting most of its production to non- CIS countries, that imposes a long delay in receiving the Michalopoulos, Constantin and David Tarr. 1992. Tead crediL and Paynts Arrmsgemns for Ses qf dtc Former USSL Studics of Economies in Trasition 2.World 35. The experience of Czechoslovakia, Hungary. and BanL Washingum D.C. Poland compared with that of Bulgaria and Romania is instiUUve. In the fist group of counuiet ihe seady Orlowskip undirect Tranfrs in Trade among FU suit of macrocconomic stabilization and the consequent w. duitrets. PT rens and Pold Rponses iS decline in domestic aggregate demand, pmmoted finns to Rc P7sbl PCdcs Kid Worknag Paper 5S6. KieL take advantage of the tade and change libealizaon aler to seek eXport markts Bulgaria and Romania, which wcre T;u DaM. 1993. How Moring to World PriAas due less effective in their pursuit of stabilizaion and hlberabz- Tr of Trade Ho IS Countries of she FSU. Policy don,did notexperienceanexportboom(Kaininski1993). Research Working Paper 1074. World Bank. Washington. D.C. Refeelnces International Monetary Fund. 1993- Economic Review: Wodd BankL 1993. Rusuia Joining the World Ecnaony. Molova. Washingtm. D.C. Washingtn. D.C. Kaminski. Barlomiej. and Alexander Yeat 1993. OECD World Bank. 1994. Moldova: Moving to a Marker Trai Barriers Faced by ite Succssor States of te E an Washington. D.C Soviet Union. Policy Researcb Worldng Paper 1175. Wordd Dank, Washing D.C. 9 Kyrgyz Republic: External Trade for a SmaU Country Kathie KRumm The extensive and often arbitrary division of abor in the highly integmted economy of the Soviet Union left Kyrgz enterpri with little autonomy and lite information about the identityo f their eventual customers. When the Sovict Union broke up, the problems the Kyrgyz Republic faced as one of the I The Macroeconomkic newly indepndent states were compounded by a sizable tade Situation and defict with both the forner Soviet Union and the rest of the Complementary Reforms world and by a substantial deteioration in the tems of ade. In addition, the Kyrgyz Republic lost official transfers from the * EvolutSonofTrade Sonet Union on the ordr of 10 percent of GDP The d Trde Policy ext rnal tade adjustment for tie Kyrgyz Republc is daunting - Tae cThe trade regime needs to accommodate the tempowary dif- ficulties of the transition while leading the economy toward Paymegnts Exchangecandade patterns consistent widL te country's longer-team goals. Payments Key objecdves for the transition and the medium term are to * Microeconomio and Trade eam fopeign exchange through export growth to allow imports Adjustment to recover, and to stimulate efficient production through multi- ple trade channels and adjustment of productive capacty. * Policy Recommendations In cxport the strawgy is to more fully exploit the markets that aady are being tapped and to diversify markets where that seems appropiate. Ataining projected export growth requements for the coming three yems will require a 15 per- cent a year expanson in exports outside the former Soviet Union and maintaining the level of exports within the region. 188 TIUDE IN IHE NE INDvwENDErmSTwr EAI The composition of imports and exports with tbose Througbout 1993 the economy continued to markets will change, however, since much of the adjust to sevcre exten shocks, including the tems previous tradig patern was mefficient of trade shock, a shrinkdng volume of exenal trade The Kyrgyz economy is relatively small, but a and loss of union transfe Real GDP decined con- diverse set of neighboring markets should allow tinually-by 5 percent in 1991, 19 percent in 1992, expanded production to be based on comparative and 16 percent in 1993. Unemployment has not advantage and tade integration with other inceased at a level commensuate with the decline economies. Policynakers are coming underprese in outpu Open unemployment reached 1.5 percent to use the trade policy to protect specific industries of the labor force in 1993; including workers on firm the need to adjusL But agriculture and minimg unpaid leave the undelying rate could have been as sectors, in particular, should be advocates of low much as 10 percent at years end. protection. Competitive exporters of processed and Although the government succeeded in redu- manufactred goods could be expected to gmw ing its budget deficit frmm 16.6 prcent of GDP in alongside an agricultural andmining base. The recent 1992 to unde 9 percent in 1993, it did so by severe- establishment of a system fbrdeading withe Ilargst ly cutting all expenditure ctgorie ratr than by loss-making entupises sbould help to make policy improving its rvenue effort In fact tax revenues ts on openness to tmade credible. fell pecipiously from 14 percent of GDP in 1992 In early 1994 the Kyrgyz govenmnt sharply to 8 percent in 1993, largdy due to lack of enfore- acclerated the pace of trade reform and removed ment, multiple exemptions, and a prolifeamtion of most formal baies to trade. This is a pagmaric bater activity and unreorted transactions. The tax approach for a landlocked republic surrounded by effort declied further m eary 1994. With the diffi countres that also are experincing rapid economic cult fiscal situation, srong measures are plnned to change But to achieve the coutry's objectives for ensure that the vlue added tax and the income tax trade, implicit barriers to trade will need to be cary the major burden for raising revenues, com- atackd as vigorously. pm by other reasonably transparet and effi- cient taxes. Only in this way can presues be resist- The Macroeconomic Situation and edtoimposrexcesiveadetaxes,wbichwilljeop- Complementary Reforms ard ex ngrowt and trade efficiency, as wel as The government of Kyrz yRepublic has take excessie taxation ofemerging busess activities- couageo steps on the road o amarkteconomy.- Despite stbilization efforts, iflation remained In May 1993 the Kyrgyz Republic left the ruble high, reacbing 1300 percent in 1993 (700 to D50 zone, the fist of the new indepeent states to do so percet on a wholesale price index bass). Only pat after the Baltics. It intmoduced its own national cur- of the increase can be explained by monetary devel- rency, the som, and adopted a stbilizatonprogram opments such as ffie price incrcases following the supported by an IMF stand-by arrangement and shift to the som in May. Monetary control began to access to the Systemic Transfrmation Facility. The bite by mid-1993, but the financial problems of ail- pmogram targetd radical changes in monetary and ing entcrprises interfered with stabilization. financial policies in order to move the economy Falteing enterprises infected other enterpises, toward a market-based allocation of resources. banks, and the central baen largely through a Some progress was made, intspesed with penods buildup of arrears, which introduced a channel for of faltering. The country adopted a program in mid- implicit cross-subsidiza1ion within the economy. 1994 under the BMBFs Enhanced Structural Most detrmental was the implcit subsidzaton of Adjustment Facility to support further stabilization the enterprise sector by the agricultural sector. As efforts for 1994-97. A reasonably stable macroeco- entrprise arrms to the domestic energy complex nomic environment is important for facilitating motnmd, the generation of domestic currency from external trade- bartr energy imports came to a halt, cutting off KYRGYZREZIDC ExTNALTRADE oRA Sxam. Couwmy 189 payments to farmers for cmps for the complemen- average monthly wage esdmated at US$20 as of twr bar r exports (see discussion of state trading mid-1994 (table 9.1). ftrugh bilateral agreements). Farmers required additional credit for seonal agrincu.ial paymentsL Evolution of Trade Monetary control was relaxed beween August According to ofEcial emates both export and and October 1993, with the major source of expan- import volumes dropped by about a third in 1992 sion being the cetral bank. Inflation soared above and continued to fal in 1993, to half their 1991 lev- 30 pect in Septmbe. Real iarates were at cls (table 9.3)7 These figures probably ovest- bighly negativc annual rates dunng the second half mate the trade decline. however. and unrecorded of 1993. After October the National Bank of trade outide the sate tAding system has expanded Kyrgyz Rpublic ained some control over crdit rapdly Nonetheless, by all accounm tere has been expansion, keeping the monetary reins tight though significant deteioration in the terms of trade csti- the fit que of 994 and bringig monthly infla- mated at 20 percent since 1991 (based on 1990 tion down to 7 percent i March 1994. However. in weights, table 9.3) or estmated at 15 percent in the absence of payments discline and contol over 1992 and a firther 30 percnt in 1993, for an acce- interterprise airas such seve monetary tight- mulated deterioration of 40 percent since 1991 enmg was required that there was substntial (bsed on L993 weights). The tade deficit reaced demonetization. Most trade transctons are report- 12 percent of GDP in 1993, compared with 11 per- eSly being conducted on barter tems. cent in 1992. The deficit was financed primarily by The som was introduced at 4 som to the U.S. intmaitional donors. Also, the National Bank was dollar and 200 ruble to the som Official exchange granted technical craedit from Russia, and dtere was rates were deterined in the forign xchage ac- asma inflowof foreign direcetmt inL 1993 tion market under the auspices of the central bank. The share of trade with the former Soviet Soon after its intmducdon, the som was widely Union &l sharply in 1992 and further in 1993. accepted as the medium of exchange, and for a few especially for export thgh remainig large, weeks it wevn appreciated against both the dollar about 72 percent oftotal epot in 1993 (table 9.2). and the uble.Iin July 1993 the som stred to depre- Les changge has occured in trde in traditional date, but tess rapidly than inflationary develop- exporM such as wool. tobacco, minerals, and engi- ments This resulted in a substantial real apprecia- neering products, which accouned for a tbird of tion against the dollar by the end of 1993, but con- expolts in 1993 (nearly half of exports to the former sistent with an even sharper apprecation of the Soviet Union) as the hadin 1992. There has been a ruble againtthe dollar; a real depreiation against magia shift m composition, with fast growth in the ruble (figure 9.1). The real exchange ate stabi- minor agdicultual products such as honey and a lized and depreciated slightly in early 1994. collapse in some indusial products such as agicul- Competitiveness has not been undemied despite total machinery Driven bY the ge increase in the real appreciation agat the dollar, with an energy prices, the change is even greater for Table 9.1 Exchange Rate, Inftion, and Real Wages, May 1993-May 1994 Average exhng rate CPIMonthy dzexofarlwage Averae wage Date (cdun rafte NBKaucti) pearentge hang199e12100)in hi USdbars May.1993 3.9 21.4 65.0 13.8 Dee 1993 8.o 15.7 53.0 22.3 May 1994 12.3 3.5 48.0 20.1 Sr Kyrz auati and stRff caASIdc=s 190 TRAAE In mm NEW INDE ENT STAllS Table 92 Extenal Trade, 1990-93 (millions of current U S. dollars and percent) m9O 1892 199 Totl Expots 4233 5.186 313 394 FarmerSovietUnion a 4.144 5.163 236 252 Restotwodd -89 23 77 112 Total Inpots 6.686 5.078 41S 490 FormerSovietUnion 5A388 4,293 344 378 Restofwarld d1,29 785 71 112 Trade Bviancse -2,453 108 -102 -96 Farm Soviet Urion -1.244 870 -108 -96 Rest of wolId -1.29 -762 6 - Pecntage tt Total Exports 100 100 100 100 FomerSovietUdion 97.9 99.6 754 71.6 Restofworld 2.1 0.4 24.6 28.4 Tolal Imports 100 100 - 100 100 FormerSovietUWon 80.6 84,5 82.9 77t1 Resofworld 19t4 15.5 17-1 22.9 a. Fiurs forn de wa the ftm&Sodvi Union aD denved finm couty datad WoMddfBkstffetiate repeatd in iand cLtueas usgofficiarcommecis exclangerts for 1990 and 1991 and anual save edhmnntes for 1992 ad 1993. k testof wodd rf to cunis outsid efanerSovietUz figuesasedUmcont ydaameporedin US. doars Flgwe 9.1 Evoluton of the Real Exchange Rae May 1993-April 1904 (May 1993=100) 250 U.S doltr 200 150 / - ~~~~~ RPusdan Ruble '100 - sao 50 o-i co . I1 II It I I C') ) C') e 0 0m C 0a flc t imports, where the share of tadidomi energy The reorientation of trade is more apparent in imports from the former Soviet Union increased market outside the former Soviet UnionL By 1993 from 9 percent of the total value of imports in 1991 exports outside t region h bireased to 28 per- to about a-third of total in 1993 nearly baif of total cent up from less than 1 percent in 1991? Trade imports from the former Soviet Union increased with countries as dipate as China, KYRGYzRuac ThnmuAfTl F=ORASMALLCOUNtRY 191 Table 9.3 External Trade Volume, Terms of tions including export licensing and taxes, dual Trade and Composlton by Commodity GrOups, exchange rtces, and an absence of supportive infa- at DometC PrIce, 199043 s umand financid services (table 9.4). 1991 1992 1993 State Tradfing through BflatralAgreerents Vdwn 1deett991=1WO In 1993 and 1994. blatal agreements were Total exrs 100 6 46 reached with Russia and Uzbekistan; additional Total iport- 100 69 52 agrements were reached with Azerbaijan and Terms of Trade Tadjilist in 1994. The bar terms for oblgatoy (prce Of exports reawfID list purchases are now defied in doIlls at prc huports) 1990 wsi4s 10W 84 79 closer to world price Kyrgz Republic also 1993weipits 100 85 61 entered mto indicative list agreements with dtse Expods 100 100 - and oth comtries defining the levels of eots Madhinery & mnet wo 31 41 - "quota") on whch th orgnaig country agrees (wool products) 29 24 _- notto mpose coDs prices US demd Nonferrus n-iefly bdewen enteises mecuyg andgord. 1m mmiber of commodities covered by the MmLy. an d gold 8 I11 - Food prduction (incluing two types of agrement has been filling steadily sUgarantao) 20 7 - finm 118 in L92 o 70 in 1993 im the case of Other 13 17 - expected delvey from Ruia For obligaty lst hiwaougs 100 100 - arrangements th number is relatvely small for Oilland ga 9 28 - Mahinerymwor s 1 9 24 - example, eight commodities from Russia in bgjhtadustry 22 7 - cange for five commodities from Kyrgyz Food pwduction 16 6 - Oshsr w 34 35 - Republic in 1994 and five commodities from Uzeckisun in exchange for seventen i NWbe:assiEdacwdigtGfEi; S ~ from the Kyrgyz Repblic. Thc volum of trde SczcStaff caLodis plannedunderteclearaagemntwihRussia Korea, Turey am! the United Kingdom. Mor for 1994 declind as well, apparently influenced by thec shrfl in perforace under the 1993 agrcee exports include hides, wfth investor interest in -inks. Trade,~ ment wbich reached only about 55 percent of leathw iZr,tstry ksuchradewith Rsians vei dl lut planned levels. Oveall however, the centazed timsit or rexras such as Russian vecst but als-Krgz ns= nd xhstid o n chract of trade is changing only gradually. Thc ivalue of trade under obligatory or clearing agree- IS qmcldy bcrig fth Kyrgyz Reublies lwges ments negodated for 1993 was equivalent to about ftadmigpamter a third of exports andaflfth of imports In addition, Trade Policy pirement and distibution of commodities under Early in tie transiri thc _ the agreements ar dominated by the st-owned Falyin he unsion.the ovcments tde ading companies, under dic-coordination of ffi policy was shaped by the demands of shot-rn presues, particlady by the need to ensure energy M of Trade. The days of using bilateral agreements as a and aw amr suplis foug ckfin arang- cnde for trade subsidies from neigbboring coun- mens a desire to satisfy local needs by resticting exports,andresistancetoareorientaton of uc- ties are neary over Recent agrmnts have tion and tading paerns. e result was ad. pol- encoagd th use of wodprices in U dollars icy regime inadequate to the danting s at as the implicit mechanism far balancing flows of and heavy with ditorons such as state trding ods uder h obligatoy list th large ve through bilateral agreements, direct trade c- increases in enrgy and grain pies only pady off- 192 TR=DE IN mE NEW I NDENrSTAlES Table OA Chronology of Extemal Trade Policy tobacco and mor than 100 percent bigher for wooL Cngs, 1993494 The trade subsid:y embedded in the Rusia agree- Date ReguaEflws meat helped stabilize wool prices for Kyrgyz Republic ata time of coUapsing wodd prices. In tic case of gas, the arrangements were more complex .aruay Pk Ieraizaron, ucnudng ulnination of The implicit price paid by Kyrgyz Republic for IUSf9It witrob .Uzbekistan natural gas under the 1993 agreement Muarc LibeIzatoin of agriculral marketig. was 40 percent less than estmated world pnces, a wt repbaemnent of stat order system withseatemen p ases pricing arrangement linlod to Uzbekistan's depen- April Export licenses. prohtbitions, taxes for dence on irrigation watr flowing from Kyrgyz counti ousde as Republic- To time the flows to meet Uzbekistan's Octobr Export knses forCS counrs needs, the Kyrgyz Republic genemtes less hydro- March Introduction of export duis for expots o electicity thm it otherwise would have, and these Russia shortials are made up by other energy inflows May Introduction of the som and foreign mdgs auclin including gas Under the L994 a _cmns bowev- June Intoducton of tadig margins and pke eir, the implicit prices paid by Russia for Kyrgyz contruls onnwiopolle tobacco and woDl expor fdll to close to world lev- August LIfting of trading margins for imported els, and thc impElit price paid by the Kyrgy Republic for Uzbek gas rose to near world leves. November Reduction in number of goods 5UbJt ta implying a further deteroration in terms of trade by Uatradigmagin (to tn) 1995-96. 1994 The benefits of these agreements limited Febuay Wkie ae tor exchange aucon andre erdefctsceaesubs -ynl Elon of wadtial harm over the medium tern. lie clearing bread amaagrcgi subeizee in dust at the expense of Apri Renova of r price Cd on ea r- agcllurandminin thoughthedomesticpricing pike olirthanatal monopoles and payment system This analysis assumes that it June ElEminaton of export lncensg aid taxes would be appropra for the government to realize from all bate fited nwnber of goods the gan from any trad subsidies frmm neighboring June Repeal of legislation on saordeIS and countries implicit in pnces diffcrent from wold domestic supply contcts and replace- ment with voluntary purchases for sa levels. Though domestic prices for oil ae adjusted needs qumterly to reflect mtational pnces. severl (pri- marily industrial) enterpises have not paid tbhir Soc Wodd Bank (1"9d adwmsnidtmmwnr bills and are running arrears Price data for 1993 imdicate that other inputs, such as aluminum, cop- per. and metal products are also selling at below set by higher relative prices for sme key Kyrgyz world levels. Agicultual producers meanwhile, exports, this shift has rsWlted m a20 percent deted- are required to sell to the state at domestic prices oration in the terms of trade (even higher using hat ae below word prices. Payment delays to pro- nmore recent trade weights). In 1993 favorable ducers constite another burden on agriclture; the exceptions in pricing appear to have been limited to six-month payment delay in 1992193 implied a tax wool an tobacco cxports under the agremnt with on producers of about 50 percent. These implicit Russia and natual gas imports under the Uzbek taxes on output ar parly offset by input subsidies, agreement (table 9-5). The implicit prices paid by such as below world prices for fertilizer, though Russia under the 1993 agreement wer about 35 problcms of availability are reducing the value of percent higher dm the estimted world price for the subsidy. Continuing tD place such a heavy rev- KnRGtz RErusuc ExmNAL TRAD FOR A SMALL COUNr 193 Table 95 Price Comparlsons for 1993 Clearing Arrangments between the Kyrgyz Republc and Russia and Uzbekistan (U.S. dolas) Ralicof deafng prke to worfd Discon of Traddannd*y Ctearhw Pits Wofrid Prie a price (7) Expods to U_zbcWan Al*ony t.4 1,530 96.7 Me:rcuyb 4,350 3,000 145.0: Exports to Rhesi Anmny 1,749 1,3O 1143 Levsuiy b 4.350 3.000 145.0 Cotanfiltr 1,134 1t300 872 Naui wool 4.,so 2,000 225.0 RawTobacco 3,000 2,160 138.9 lnyrshn~ Lfrb Natura gas 48 80 60.0 Auomobie gasol 200 195 102.6 Diesel fu 160 162 98.8 Heavyfuel c (mazu 80 65 123.1 Relined copper 2200 1,922 1145 P"awahr1m ,220 1922 114.5 No - aLPrico reor rcuic nete Unarjoedf fr napor su css-July pdr fr several saucs finwlurogWcdd Bank data, me racF Eat.. the MuifgJatm. sdthelraL Wce b. Avaepro=pdace=rpi ny-Je 1993.csmndk fromWod Bak(1994.) enue burden on the taditional agricultural sector, finance for seasonal cop procum enL Such crisis which is already under stress, cannot be succssfu management will not allay farmers' fears about As for the export-oriented mining sector, more fute compensation. And the buden for subsidiz- tansparent taxation methds should and can be -lg enterprises amrs was also borne by other (p used- Taxes should be kept moderate, however, to sumably productive) uses of credit who were cut avoid discouraging the foreign investment so criti- off so that the government oDuld maintain its over- cal to developing the mining potential of the all credit controL All these distortions mean that Kyrgyz Republicr incenfives to optimize import consumpion and pro- Most of the gain from (the rapidly declining) duction of traditional exports have not been tins- trade subsidies *om neighboring countres and the mitted to the economy, perhaps the most cntical implicit taxation of traditional exports is going not reason for reforming clearng armgements. to the government but to enterprises consuming oil These state interventions, because of the but not paying for it and to gas consumer Te sys- restctions needed to enforce the bilaeral agree- tem, which was supposed to provide the state with ments, had reperussions on other trade as well. financial resources from the sale of barter imports Export licensing and taxes were particularly oner- such as oil to finance purchases of barter exports ous. In 1993 producers of the fourmajor agicultur- such as agricultural commodities, has been dismpt- al commodities-wool. tobacco, cotton, and wheat ed by mounting arsu The govenment and the -were obligated to sel 80 percent of production to National Bank of Kyrgyz Republi had to use extra- the state. Halting efforts to liberalize agrculur ordinary measures in 1993 to secur short-term trade had been under way since 1991, but the sys- 194 TRAm m ma NEW Iinm wEr SAEs tern remained highly controled and inconsistent - Restrctons on Direct Trade and unsustainable. Producton fel in both agricul- The greatest damage among resticive trade lure and processing industries. Though the non- policies cane from export restictions, which pre- clearng indicative list might have facilitated trade sented a formidable obstacle to exports while pro- at a time of restrictive expor licensing by trade tecting inefficient enterprises. In 1993 over half of partners in the former Soviet Union, thc benefits exports were subject to licensing and neady a third will be short lived. And they came at the cost of to export taxes continuing support for a broader state contract Pis- The Kyrgyr Republic began taxng many of its tem that inhibited the emergence of private ente- exports to Russia in March 1993 in retaliation for preneurship, dynamic tade pattrns, and new mar- Russia's levying of eWort taxes. The tax rates ket contacts favoring efficient activities, ranged from 10 to 150 percent exports to Russia, In early 1994 the government starred to dis- with a 10 to 50 percent surchage for barterxpo mantle the state trading system asocited with Taxes did not apply to exports of other wuntries of bilatera agreements. A February 1994 decree the former Soviet Union though they did apply to explicitdy abolished state orders and replaced them expors outside the foum Soviet Union, genecraly with a procurement system based on contractal at lower rat than for exports to Russia. Unofficial arrangements and financed through budget alloca- charges imposed by vanous adminis ng officials dons. By-laws related to obligatory domestic supply and furtier restctions and administatve interven- contracts were allowed to expire The number of dons by local authorities increased te efective rae commodities covered was reduced for 1994, and the of export xaion. Thes txes aid very little rev- proportion of the projected harvest covered by state enue for the government budget-about 2 percent needs felL The government indiated its intentions of the value of exports in the fist fivc months of to e_limint bilateral agreements as soon as feasi- 1993, for example-cuse of numerous exemp- ble, perhaps as early as 1995. dions and incentives to export illegally For the However, operational changes to implement Kyrgyz Republic the only commodites for which it the new state procurement policy were still being is a major world producer are in the inral sector, put m plac by mid-1994. and considerabie ambigu- namely, mercury and possibly antimony, account- ky remais among producers and traders about ig for 20 percent and 15 percent, respectively, of whether supplying state needs is compulsory. total world consumption. This would not be suffi- Unless institutional and financial mechanisms are ciently oligopolistic to justify a significant export put in place to satisfy state needs, particularly for tax. In the second half of 1993 the government cntical imported energy commodities and major revised the export tax schedule several times, agricultuanl crops, the govenament vwll continue to including the intrduction of a 10 percent surcharge be tempted to reort to ad hoc control measures. on -expor, while continuing country-specific tax Also, large state trading institutions continue to exemptions in the context of bilateral agreements. dominate the market, leaving defacto monopolies, Early 1994 the government reduced the maximmn and impeding the growth of more efficient private export tax rate to 30 percent (with one exception) market-oriented tnading networks. and eliminated export licenses except for a small Prvate sector trade is emergmg but public sec- number of hazardous materials and items of cultura tor marketing agents will continue to play a role- importance. albeit a declining one-until the private sector has There were few direct barriers to imports expanded stfflcicntly to take over all trade. Recent because the govcz:mnent sought to avoid resticting experience indicates the importance of adequate the supply of raw materials and commodities from public sector financing and border pncing to emer- any source. Imports from countries outside the CIS gence of a private sector able to fufill that role in a were subject to low customs duties of 5 to 15 per- way consistent with market orientation, cent of their value at world prices; no customs KYRCYZ RaPunuc ExTERNAL TRAnE FOR A SMAW COUNmY 195 duties are levied on imports from within the CIS. negligible. Participation in the auctions was initially Exporters do not receive rebates for duties paid on limited to commercial banks, but access to the auc- imported inputs, but in early 1994 the government tion has been broadened to include all exchange eliminated import duties. Excise taxes were bureaus. Them is also another market in which both imposed on a few imports, mainly tobacco, alco- commercial banks and exchange bureans partici- bolic beverages, and luxury commodities, at nearly pate. In July 1993 the som started to deprctiate in the same rates as those imposed on goods produced nominal terms, tilling from its introductory rate of domestically (10 to 30 percent), reversing a policy 4 som to the U.S. dollar to 12 som to the dotlar and of dscrimination in favor of imports. The value fom 200 rmbles to the som to 150-160 ruble by added tax (VAT) continues to be imposed on an on- March 1994. This represented a real appreciation of gin basis It needs to be converted to a destination about 50 percent against the US. doHlar and a real base, which would be in line with recent develop- depreciation against the ruble. The sharp decline in ments in Russia. real incomes and financial savings and the tight money supply could have contributed to the som's Other Trade Relatons real apprecation against the dollar The Kyrgyz Republic intends to apply for Oder problems confront the exchange regime observer sus at the GA1T, seekiag evenualy to for currencies of the countries of the fmer Soviet become a member and to gain access to the existing Union. There, improving the payments system for multilatral trade framework It is also being intetate trade is critical, both to increase the avail- approached by other bilateral and regional trading ability of other currencies and to reduce pressures partners to enter into agreements that provide a on the som from the ruble. The reliance on decen- framework for trade. Ihe Kyrgyz Republic is a tralized correspondent bank accounts has not membcr of the CIS and of the Economic resolved those difficulties. Ruble trade is hampered Cooperation Organization, which seeks to further by highly segmented markets and the absence of a economic ties betwecn Muslim countries portfolio of cumrcies including rubles held by the (zAfghanistan, Iran, Pakistan, Turkey and five Ex- large financl institutions. Cash ruble trade is fur- Soviet republics). In carly 1994 the Kyrgyz ther hampered by the lack of a framework for vol- Republic entered into a free-trade agreement with tmm transactions. Thcse pmblems were exacebated Kazaklcstan and Uzbekistan, but export controls for by the introduction of the Kazakh tenge in key commodities remain in those partner countries. November 1993 and by the designation of the The government is developing free trade agree- Uzbek som as the sole currency in Uzbedistan in ments while continuing the process of economic January 1994. A significant portion of interstate reform, including uniateral and multiteral lower- trade appears to continue to be settled on a barter ing of trade barriers. Becaue of its small size, the basis. Kyrgyz Republic's ability to extrac concessions in exchange for lowering its own barriers is minimal. Microeconomic and Trade Adjustment Some reorientation of trade has taken place, Foreign Exchange and Payments particularly in mariets outside the former Soviet Under a floating exchange rate regime, the Union. A driving force behind the new export push official value of the som against the doHlar is deter- is the need to find alternative sources of imports, mined by the free interplay of supply and demand both of consumer items such as electronics and in weekly auctions held by the National Bank of clothing and of oil and industrial inputs. Much of KyrgyzRepublic. Thi weekly auction is the princi- this trade remains on barter tens, primarily pal source of dollars for the banking system, with because of continuing payments problems and so its the dollrs supplied mainly from bilateral and mul- size is unknown. (in interpreting historical trade tilateral loans. The official supply from exporters is data, it is important to account for some large pro- 196 TRADE NHE EW INDEPENDR STATES cessing activities located in the Kyrgyz Republie, import, but more attention £o world pricing would which have now ceased operation - for example, be more appropriate. For smaller crops such as the processing of sugar which was imported from fruits, vegetables, and honey thcre is evidence that Cuba, a negative value-added activity), the removal of trade barriers has fcilitated wtade. The process of industrial restructurng has just begun. Several industries, at least pardy becuse of Policy Reommendatons eir noncompettiveness in trade, halted production To move tie economy toward a market-orient- in 1993. placing many employees on leave-without- ed base, with mot trnsactions carried out direcdy pay status Among the large industries affected by firms the government began to progessively were machine-buildingproducts, whose exports had dismande most forma control in early 1994, been part of an integrated Soviet production chain; removing the web of explicit restrictive aade poli- textiles, which included import-competing itemw, cies that prvailed in 1993. Thsrs reforms have yet and building products, wbich had been exported. to yield the expetd rts, in part because implic- Many of the competing imports are financed on a it baicis to private sectorexpanson remain mi both barter basis through exports to new markets. the domestic economy and extemal nde To com- On the positive side, the solid mining potential plt thepmcess te tgemnment would need to: of the Kyrgyz Republic has begun to be t urthe cu the rle of the state bye with new investment in gold mining and increased - - n~~~~~~~~~~~reIig up the dominant state wadfing cxpors of antimony and mercury to markets outside into commerciay orented and the former Soviet Union. In manufacturin& srme the -~~~~~~~opttv unt aneu d bynot re icting da producers have found markct niches, including o s p e . = t~~~~~~~~~~~~~~ading sphces of such pnivatizd entities. leather producers and a fiw high-tech military- industial enterpses. Some new trade relations are * Elimina blateal clearing arrangements. developing to supply critcal industrial inputs now If key neighboring trading partners insist blocked within thc interrepublican sysem, such as on such clearing arrangements, the focus dyes for textles. Joint ventures frequendy play a should be on setting up transparent bid- mk in the real side adjustments. Recent export-on- ding d procrent arrangeets ented ventures mclude leatier, gold, and cigarette Resist any futher buildup in arars on manufacturing. Privatation, once based on sales to domestic oil sales. manager-worker collectves, now stress voucher pnivatization and strategic investors, including for- * Join GATT. Avoid participating in free p t su- trade zones where there will be pressue eigners-trs, Einepo . In agriculture there is litte evidence of a shift to raise tariffs in the c in production or marketing patterns for major com- modities, despite serious pzoblems. The strong mar- To ensure an exchange and payments regime sp ket potential for tobacco and sheep products, for P ° of ex example, has yet to be realized because of the con- *Stnve to maintain a unified exchange rate straints imposed by marketing policies reinforced and fiul convertibility of the sm fr trade by oligopsonistic marketing structures. Producers were required to sel most of their output to the state, which traded pnmarfly in traitional markets * Investigate the possibaity of establishing a in the former Soviet Union. The movement away venue for non-dollar trading by interested from the state order system and the eventual demo- parties with the facilitation of an impartial nopolization of marketing should facilitate t tap- intermediary. ping of new markets. Grai production increased in response to pricing policies that reduced food KYRGYz REUnuc ExrENAL TRADi FOR A SMALL COUNIY 197 In agricuture die private sector will shortly be in a *EUqy and compecion pod:cy. Crating an position to replace the state in agricultual trade enabling environment for traders 2nd without leaving a transitional marketing voidL To increasing competition by reducing iimped- unblock the system and pess ahead with the shift iments are essential to resource realloca- tdon to meet the changing structure of Give an explicit commnitmeit to private prices. The freedom of firms to enter and sector paticipants in agricultural trade and leave on industry plays a crucial role in processing that their contribution Ls resource allocation, incuding for export viewed favorably by govermenuL Bewam p h t m of measures by local authorities to restrict productiont Perhaps tae most higl bar- such participadon. ~~~~riers to entry for twis are the high prof- cts tax rate and limits on trading margins. - In areas where large state enterprises con- In November 1993 margin controls were tinue to have a predominant role in price- lifted except for food products such as setting (for example. where processing dairy and grain products, for wbich differ- remains highly concentrated), link prices entialmargnsareaUowedforremoteareas. closely to border prices- Accelate pay- The list of commodities for which the ments. to producers for commodihtes dcliv- Antimonopoly aad Pricing Commission ered to state awgets, preferably through sets prices has been reduced to a handfu immediate cash payments, since delays are of natural monopolies. There remain as important as low prices in disrupting instances, however, in which oblast production and marketing. authorities have imposed their own price control mechanisms. a Implement a procureent system (mclud- ing dxe major agriculturxa commodities) by Taxation. To meet the fiscal pressures of offering a competitive price to create a the transition, any solid source of govern- voluntz.-r and secure basis for deliveries ment revenue has to be exploited. The under bilaal clearng arrangements. VAT and the income tax will need to carry the major share of the revenue burden, but As important as the direc fa just dicssed their base needs to be broadened. The sys- are a number of other factors that are impeding tem needs to be implemented in a reason- trade. Macroeconomic and trade reform will not ably transparent and efficient manner, to yield their full benefits unless several other con- resisL pressures to impose excessive trade straints to the operating activities producing and taxes that will jeopardize export growth trading enterprses are liffti and trade efficiency or overburden emerg- ing businss activities. * Property rights. Property rights must be clearly defined and enforceable under law * Transport. commwcation, and business if mutually agreed commodity trade and services. The Kyrgyz Republic has a fairly private capital investments are going to well developed system of roads, railways, occur. The Kyrgyz Republic is undertak- and air links, and its freight system copes ing an ambitious program to privatize a quite well with large buk shipments. The large share of state-owned enterprises. In system is poorly suited to smaller ship- January 1994 Parliament passed a new ments and quick-response trade move- concept note for privatization that should ments, however, which are critical to the inprove the quality of the privatization emergence of a new structure of produc- program by focusing more on competitive tion and trade. Transport policy needs to measures. be adjusted toward greater reliance on 198 TRADE IN THE NEw INDEPIDENT STATES roads, smaller transport companies (wit Economics): Ani Kocbkobaeva (Wald Bak, BDisb; implications for transport asset divest- Dani Rodbi (ColumBna Uk).ivty) nd Pbdro Roipz tur), and dependable telecommunications. There is substantial knowledge about mar- 1. The macroeconomic update draws on World Bank kets in the former Soviet Union, though it 1994a. needs to be continually updated in a fast 2. Calculations of the eums of trade ar susitivc to the evolving market situation. Also, much of choice of base ye, and they are seriously compromised by dwt krnowledge is beld by the staff of da Ithe poor trackig of cxport pnces in Kyrgyz Republic and the Micomnplet coverage of tansacons. As a result, csld old state trading companies and the trade mats orcri deterioradon in die tems of with te fr- ministry, and those market-making ser- mer Soviet Union in 1991-93 vary widely, waging from about 10 percent to morc than 40 pcVenL vices need to be spun off and barriers to entry rmove& - 3. A sgnicant -but impossible to quanify-p of the inrase. however. is due to valmuion adjustmets. In combination with the completion of trade reforms, thcse polices would move the Kyrgyz References Republic a long way toward meeting its short-tenm Woreld Bank. 1994a Kyrgyt Republi Ecwonomic Repart trade objectives and its medium-term economic W=aagnD.C. vision. World Bank 1994b. Ryrgyz Republic Externa Trade NOts Porcy. Washibgon, DC. World Bailt t994e. Kyrgyz Republict Mining Sacior This chapter draws fm a Wodd Bank (1994b) report on Review. Washington, D.C. he Kyrgz Republic's cndtron trade policy, ppad by a term led by Kathic Krumm (prncipal authort Tom Daves Wodd B:nt 1994d Kyrgyz Republp Priumaran.d (World Bank, Tashkent); Alex Duncan (Oxford EnterpriseSear Adjwstmar Credit Wasbington, University); Chris Jones (Center for International D.C. 10 Uzbekistan: Trade Reform in a Cotton Based Economy Michael Connolly and Silvin Vatnick For the first two years after independence the government of Uzbelki was very cautious in its approach to economic reform. lberlized prices only partially, imposed a number of new taxes, eliminated import tariffi temporarily? privatized * The Milacroeconomic only small shops and residential housing, and enacted prelimi- Framework for Trade: nary banking, property, and foreign investment legislation. At Policy and Trends the same time, the government maintained firm control over most trade activities including trade flows under the state order * Trade Policy system, export licensing, bilateral trade and clearing arrange- ments, and access to hard currency. WLthin this policy frame- * The Resource Transfer work, Uzbedistw's trade has suffered a major decline in real Caused by Implicit terms since 1990- Payments difficulties and recession in the Taxation: The Cotton countries of the fo-mer Soviet Union reduced interstat trade in Sector 1993 to 30 percent of its 1990 level, while trade with the rest of * The Payments Framework the world amounted to 76 percent of its 1990 level. for Trade In late 1993, as the economic situation deteriorated and Uzbekistan withdrew from the ruble zone, the government * Recommendations for began to consider more comprehensive economic refomL A Trade Policy in the Presidential Decree of January 22,1994, called for wide-rang- Transition ing economiic reforms from accelerating privadzation and enter- prise reforn programs and encouraging private sector business activities to reducing reliance on state orders and liberalizing foreign exchange controls. While this decree represents a sig- nificant shift in the government's expressed policy toward the 200 TRADE IN THE NEW INDEPENDlNT STATES pace and extent of refonrs, in fact, little has been stronger commodity prices in 0992 and 1993 led to done so far to put these policies into pracficc. modest improvements in the external environment Uzbekistan now faces a major challenge and for trade. opportunity to rejoin the world community on a Disruptions in import availability have hurt multilateral basis that does not discriminate in trade producdon. In 1993 manufacturing output fell more treatment between the former Soviet Union and the than 15 percent The largest drops in production rest of the world. In doing so, the country can set occurred in the heavy industrial sectors most close- the foundation for economic recovery and long term ly linked to other countries of the former Soviet growth through trade expansion. Union. As a result, tade and payments flows have been disrupted. Agricultural production remained The Macroeconomic Framework for Trade: relatively stable whilc energy production rose by Policy and Trends about 6 percent, led by an expansion of domestic Between 1991 and 1993 Uzbekistan's output nagral gas production. (at 1990 prices) declined by 13 percent (table 10.1). Uzbelistan experienced a smaller economic con- Prices, Wages, and Employment raction than other countries of the former Soviet Inflation accelerated in 1993 as measured by Union largely because Uzbekistan was better able the GDP implicit price deflator. laion rates aver- to diversify its exports beyond former Soviet Union aged about 915 percent (compared to almost 700 markcets. The govemnment kept the centralized sys- percent in 1992): about 1,200 percmt in wholesale ten almost intact, shielding the economy from mar- prices, and 850 percent in retail prices (compared ket forces for the fist two years after independence. with 530 percent in 1992). Prices rose steeply in the Adjustmnent has been postponed, especially in the second half of the year. when demand was fueled indust and cotton sectors, where activities wer by a significant growth in domestic credit- still under control in mid-1994. Agriculture epro- Increased subsidies on a range of goods partidly sents an important part of GDP (33 percent), so offset retail prioe increases. economy-wide adjustment. when reforms deepen, Since enterprises and collectives have not yet may be less severe than elsewhe. iLaorcover there been significantly restructured or privatized, was no significant deteroration in the taers of trade employment levels have been maintained by signif- following the collapse of the Union. In fact, icant downward adjustment of real wages. The Table 10.1 Macroeconomic Indicators, 1989I3S Rtm f989 1990 1991 1992 1993 Rube sperdla(pemdaverag) Offidal exchange mats - - 1.67 1,280.0 Mwket exchange rate - - - 220.00 1,821.0 Annual pomnte dcange Real GDP 45 4.3 -0.9 -9.5 -2.5 GDP deflator (averago) 0.8 4.0 98 700 915.0 Retal price (aerage) 0.7 4.0 105 530 850 Wholesale pries (average) 2.1 7.3 147 1,400 1,200.0 Monthly wages (average) 6.5 11.1 246 550 1,000.0 Rea wages 43 3.5 -39 -42 -22.0 Unemployment - - - 0.5 Pcent of GDP Totl bank credit 52.5 - 41t6 47 97 107.0 Centra govnment budget dicdt 0.6 0.9 4.5 10 3.0 Souse: Goskoinprozsat. IMF and Bank staffestinmts. UzBELnsT*C TRA1DE REFoRM IN A Conr BASED ECONOMY 201 Table 102 External Trde 1990-93 (milrions of curent U.S. dollars and percent) 1990 1991 1992 7993 Value Total exports 15,236 15.018 1,497 3,551 Fomr Soviet Union a 13,846 13,761 628 2055 Restofwortdb 1,390 127 869 1,469 Total imports 22,325 16.148 1,756 3,505 FormerSovietUrion 20,110 14,100 8Z7 225 Rest of world 2217 2,048 929 1,280 Trade balance -1,13D -258 46 FnaerSoviet Union -6,263 33 -198- -140 Restof Wld 4827 -791 60 186 PWdtttg buibn Total exports 100 100 100 100 FormerSovistUnion 90.9 91.6 41.9 587 Rest of world 9 1 8.4 581 41.3 Totl imports 100 100 100 100 Fonner Soiet Union 90.1 87.3 47.1 63.5 Restof wold 89 12.7 529 365 a.1ligures fir razi wilh dhl fanrSoiUnienm a derived frm emutry dazanmd Wodd Bank staffetnalesrcpde im ntionil cur- aCns using offici orcouanercinl gp ratcs rhr 1990 md 1991 and nnual aage made= ciung mat for 199n aed 1993. h_ Trct agtF word mfes to counries utside die finrSovict Uniofgmus arn based on country damrqxned in US. doll aveap ral wage deterioraed by almost45 patent percent); agrictiltural iput subsidies; energy price in 1992 and by an estmated 22 percent in 1993, as subsidies for industrial and household consuers; did pensios and family allowances. Labormobility and creditsubsidies from the central bank at below- is still very limitedL market interest rates. Many of te subdies, partic- uly on graienergy products, and agricultural FisCa Developmenlts inputs, are provided by subsidizing impors In 1993 the government managed to limit the deficit in thenarrowly defined -ruble bude to 25 Money and Credit percent of GDP. primarily through impoved tax After fafling to reach an agreement with Russia collections and by shifting expenditures to extra- on a new ruble zone in 1993. the government budgetary funds. The consolidated budget which decided to introduce a temporary new currey. accounts for net lending, extrabudgetary fimds, and Curency coupons (sum coupons) were introduced other foreign currency tansactions shows a sub- onNovenber 15,1993. On July 1,1994, afull-fledged stantially higher deficit, of about 15 percent of new currency, the sum was intrdced. GDP. Domestic credit to enterpises expanded sub- Subsidies constitute a large share of spending. stantially in 1993, thrugh both direct goverMnment In 1993, total budgetary spending on subsidies credit and the banking system. The central bank amounted to about 31 perent of GDP, almost a refinanced credits to agculture and industry and thiu of it (9 percent) ,.Ig to consumer subsidies. also prvided funds to the Ministry of Finance for The four mam categores of subsidies arc consumer the Turnov Fund (revolving credit to enteprises). subsidies, of which direct budgetary food subsidies Lending and deposit rawes remamed highly negative are the most important (60 percent), followed by res- in real tems, transfoming credits into grants sub- idential gas, heating and public transotation (2G jecting deposits to very high implicit taxation. 202 TRADE IN THE NEW I4DEfNDEr STAon Pattems of Trade Table 10A Uzbeldsan: Hard CurrencyTrade by Measured in constant rubles, Uzbekistan's Commodity exports to the former Soviet Union fell by almost (JS$ milions) 19 percent in 1991, 35 percent in 1992, and 20 per- 1992 1993 cent in 1993. Since demand for imports from the Total oxpors 869 1,466 former Soviet Union fell more than exports did, COttn fibre 673 568 however, Uzbekistan's trade balance with the Metl products 58 34 region improved in real terms (table 103). ineraldenfilzer - 39 35 Cotton is the major export and dominates for- Olher 99 282 eign trade transactions. In 1993, as in 1992, cotton Tot knports 929 1.280 fiber accounted for about half of Uzbeldstan's Wheat 573 339 export rade with the former Soviet Union, most of tM&apoultY 46 21 Sugar 44 83 it through deliveries under bilatera trade agree- Oil seeds - 37 ments CITable 103)- Natural gas accounted for 23 Tea, coffee & spics 10 64 percent, a fourfold incacase in volume over 1992 TxtOs & footwear 34 42 Machinety & equipment - 83 and electric power for 12 percent a doubling of the oam 223 6t1 previous year's volume. In 1993 cotton also repre - SW= B3nWad WB Lk esb=s seied almost half of total exports to countres out- side the former Soviet Union CTable 10.4)?2 Most cotton exports are handled through state orders and production quota plus any over-quota output, but state trading companies. The state sets pmduction any international sales must go trugh state tradig quotas and purchases 75 percent of the quota at a companes fixed price (approximately 15 percent of the world Wheat and food accounted for the lagest share price). The state then sells the cotton domestically (42 percent) of Uzbekistan's ha cur impors for about 20 percent of the world price and intr- in 1993, foilowed by mainey and equipment (12 tionaly at world prices (which are also used in cal- percemt), and textiles and clothing (6 percent) in culaing clearing and barter arrngments). Cotton uade outside the former Soviet Union (table 10.4). producers may sell the remaining 25 percent of the A $60 miHlion deficit in 1992 was followed in 1993 by a surplus of $186 milion. Lower grain imports Tabde by CommodiU t from hard currency areas in 1993 accounted for biTiions of rubles) most of the tumaromund, offsetting increased impo of other food items and sharply higher imports of 1992 1993 capital goods (table 103). Uzbeistan's overal cur- Total exports to the formr rent account deficit increased to about $380 million Soviet Urion i23n1 1,159 in 1993, up from to $230 miliont In 1992 a deficit Cotton Ibre 49.1 600 Natu gas 39 262 in the balance of iaade with the counteris of the for- EeCtiCy 0.1 142 mer Soviet Union more than offset the surplus in Oil products 16.3 59 the balance of non-FSU trade when expressed in Other 53.2 59 tms of US doHar equivlents. Total imports from Xe tfrmer Uzbekistar's mam nmport firom the countries of Soviet Union 161.9 1,489 the former Soviet Union is oil, the bulk of which Sugar & meas 4.6 38 was gasoline and diesel fuel amounting to almost Natural gas 7.6 118 30 percent of total imports from the region in 1993 Oil products 270 423 (Table 10.3). Oil volume in 1993 was 30 percent OMter 76.4 12 larger an in 1992. Natu gas imports, part of a Source GeskompregnezsitWodt woRm st;l s substantial transit tade from Tuenista throgh UzBsIcwrAwc TRADE REFORM IN A CoN BAsw EcoKohy 203 the existing pipeline system, comprised 8 percent of also removed the 35 percent tax on foreign total imports in 1993. lmports of metal products exchange proceeds, the 15 percent surrender accounted for 9 percent of the totL down sharply, requiemnt at the official exchange rate and a 15 because of the disruption in exteal payments sys- percent foreign exchange tax replacing them on tem, which also cut heavily into imports of other April 15,1994, with a 30 percent surrender requime- manufarcd goods. ment at the market exchange rate for all export pro- ceeds. This surrenderrequirement does not apply to Trade Policy exports that do not yield hard currency receipts and Formal tad restraints, other than licensng of thus rmais diminatory against hard currency expors, are few and limited. Trade is nevertheless exports. severely regulated through plicit controls imple- Trade tnactions are also affected by domes- mented through state trading anangements. The tic taxes lik the value added tax (VAT) and excise governent is attempting to intoduce uniform taxes, which are levied on the value added of resold weameut of trade regardless of destination. Export imports but not on cxports. The VAT (20 pewnt in taxes are now the same for exports to the former July 1994) is the country's prmary revenue source. Soviet Union and to the rest of the world, and the Excise taxes are applied on a varety of domestical- number ofgoods subject to export liceuses has been ly produced goods including alcoholic beverages, reduced frm 74 to 26 as of March 1, 1994. Inport cigarettes, andjewelry, but not on imports. tariffs have been liftd on morts from all somces, untfil July 1, 1995. In early 1994. the government Imprlc Trade Taxes Intenwi regulaory barriers Until early 1994 Table 105 List of Rtems Subject to Export the government was slow to relinquish control of Liensing (as of March 1994) tfhc economy and inteational transactions To -maintain that control, the govenmnent established a t Electric enerw complex system of intea regulations tat discour- 2. Settee on tasorting elect0 eneg age and distorts trade. For instance, most exports 4. ca-gas ot key commodities to outside the former Soviet 5. Diesel fuel Union countries are stricdy controUed through b al fuel export registration and licensing requirements and 7. 00 for technical uses S. Natural gas t monopoly on trading rights for cerain p 9. Services on tansporting naturl gas lines held by state foreign trade organizations. All 10. UVgdHide gas exports are also indirecdy controlled through the t21. Coas condensatestate order system, which essentially reserves a 13. Rolling of ferrous mets large porion of domestic pmduction for the dispos- 14 Steel tubes al of the statec 15t Copper and copper podUcts The state order system is an impediment to the 16- Alumrinum 17. Chemical libers nondistortionary expansion of trade. Trade is taxed 18 Mineral fertTlers implicitly when the domestic prioe of goods mpo- 19. Wooden maerials ed and exported by state trading companies in 20. Cotton fiber Uzbekistan differs from the world price. It is possi- 21. Si fabrics 22. Tobacco ble to compute the implicit tax as the additional 23- Sugar 'wedge" between the domestic and world prices, 24. Meat and meat produ(s taking into account transportation and other tariff 25. Wheat fctom 26.Zinc Export licensing is clearly necessary to sourcc Mnis6tiy orForcipuEcouoniic Relhtions enforce the implicit export tax since a competitive, 204 TRADER IN IM NW bNDOOENTDW STAMTS Box 10.1 TaxatIon of Exports and Imports in the Rudle and Foreign Currency Area (as of August 993) R6bleZon Foeign CunwcyZan ExportTaxes * 10 percent on exports a (also * 35 percent on hard-currency levied an barter tade, but exenp- earnings, except for sate orders. tons for st enrpses, ceal- chable cnmitutons up tD 1 per- ized cotton exports, and other cent equity and porftfio invest- eiens). ment. and purchases of foreign excharng anthe urrency rmadketb *Ban on baztertrade from July 16. 1993 (excpt for lismd products, * Bader tade conducted after July mostly petrmleum buldig mated- 16. 1993. wi be taxed in foreign als, and xnber). excange atte 35 percent rte. * Ban an barterrade fom July 16, 1993 (except for listed products. musty petroleum, bulding mated- aandlumr.) Customs Dutes zero *h ws aboiedJly8,1993. * pot 2 to 40 percet * ps al o3 percentadninistra- be duge Value Added Tax Baslc rate of 25 percent c (not Basic rateof 25 percente (not lWied on exports but on the value lvied on exports butontvalu- added bf rsl inports), added of resold inwods). Souac Wadf Bank Mission, Govermcnt of UzhekstiL Clhclaid;tion ccgds in Box 0.1 do not eacly corspond to Govnentc:godes.) a. Forted fhmaE Ss Unio acmpt on cotn fib wbhi has a30% me exept for fM exapted by aiborsaxed at tie rae of 40,000 rbhson,andcxporedby odhero zoimswbichistaxedathmcof 150.000biiton. Odhereceptios incud nansaI ga: 20%,* cdtns commod 20%. as wdl a tax on expos of agcuku goods: tomr 2,000 to 40.000 ib1s per to which wades by prducL b. 1n ect sinnJ=anuary i, 1993 but colced olysinceJin6.1993. Rctivcin pdcpto iany 1.1993- c. Treamnt differs for final and imnndiare goods. unlicensed exporter would be willing to pay a are treated as excise tax reveaue in Uzbekistan's slighdy higher domestic price for the good and fiscal accounts and constiu the second highest export it at a slightly lower price, making a profit source of tax revenue. Product lines-accounting ncarly equal to the rate of the implicit export tax. for the majority of foreign trade-must be handled The system is intended to keep more raw materas through state foreign trade organizations with- and intermediate inputs within the country at a in the Ministry of Foreign Economic Relations lower prce than would be the case with fiee tade (MFER).3 in those goods Indeed, the profits to government Expon regsraion and licensing. Until the agencies from the export of cotton and other inputs beginning of 1994, when treatment was unified, UzanuKsmi TADEhREFoRm i A Corrom BAs EDowoy 205 trade with the rest of the world had been more The Resource Transfer Caused by Implict heavily reguated and controlled ta trade with the Taxation: The Caton Sector countries ofthe former Soviet Union. Hard cumn- The massive resource transfers in the conon cy trade was regulated and controlled through reg- industry provide a dramatic Mlusation of die istraion and licensing requirements. All contracts impact of explicit and implictt mazes on the econo- had to be registered at the Ministry of Foreign my and trade. All cotton tade is subject to cxport Economic Relations. The signed concrat then had licensing. And dteuarters of cotton production to be submitted with oter documentation, such as is subject to the state order system For 1992 the a certificate of regisnaion as a legal enteprise and. implicit tax an cotton famcrs that is trnferred to for some products, healdt or other certificates, in a the government is estimated at about $1 biGon. reiew process that typically took about five to ten The S1 billion transfcr from domestc fimecrs days. Only six product catr requied a to tbe govenment consis of two parts. One part is import license vesus seventy-three export cate- the income foregone in selling 85 percent (1992 gomes. However, mpor were fiurher constramed stae order) of the planed producton to the stec by foreign exchange access restriction License purchasing agency at the controlled price rather approval takes approxiatealy one week Large than at the world pric. The otherpar is theo mplic- state enterpiscs are ligible for general export it tax on export sae ofthe fire qu and te over- licenses that pennit annual exports up to a set quota product which has to be sold through state amotnL trading organizations. A poron of the transfer to Because a large pporidon of rade is still con- the govecrment is used to subdize domestic sales ducted under bilaea agreements, export licenses of cotton fiber, which is sold internally at a pric are used to ensure that the government can meet its sligsy less than balf the world price. Tese sales to commitments. They are also used to control the consumers at below-wodd pices const a con- exports of raw materials that are important to sumer subsidy equal to the value ofthe coton con- domestic production and to restrict the resale sumed domestically less the value at domestic abroad of products priced below world levels prics, resenting appoimately $120 mon. domestically because of price controls or heavy On the other side of the ledger is the tanfder subsidies. Though the pcse economic effect of back to farmers thrgh the heavy subsidization of licenses depend on dte -c - in which y agicultul inputs, includig water and inported are applied, they are clearly highly distortive and mputs. An earlier estimate of agriculbanl subsidies pose a serious barrier to tade expansion. They dis- calated that cotton farmers received a subsidy of comage the production of exports and reduce for- approximately $670 million in 1992 (World Bank eign exchange earnings by breaking the liik 1993). The net transfer out of agriculture-the between domestic and world prices. Licenses also implicit tax on farmers-was therefore approxi- encourage mt-seeking behavior, which wastes mately $370 milon. resources. The welfare cost of the implicit taxation of oDt- Conwner subsides on imported goods. As ton is high. The gonment establishes annual pro- part of the government's subsidy progran, stat duction targets (quotas) for cotton farmes wading companies purchase goods abroad and sell Seventy-five percent of the quota amount must be them domestically at lower prces, obviously inc- sold to a state purhasing agency at a controlle ring a loss in the process. And becase dtere is price of approximately 12 prent of the world pic excess demand for dte impored goods at the subsi- fob TashkenL A 5 percent export tax is imposed on dized price, the state order stm rations the quan- any exports of the free-quota over-quota produc- ity imported for sale in he domesdc market This tion. artificial depressing of domestic prices discourages UzbCekistans market for cotton fiber can be domestic production of those goods. depicted graphically (figure 10.1). DW and Dd are . III I i13 -~~~~~~~~~~~~~~~~Es------------ ------ -4 .. . . -u 5I. V .11 .g~~~~ flinfla..UflW*OUSUA ....... Ab~ IIA L!J UzBEEnsrAN: TADE REFORu IN A CorroN BAsS) ECONOMY 207 Box 10.2 Chronology of Main Trade Reforms, is represented by a horizotal line at price Pc up to 1994 quantity .85% The second, higher price, Pf is the price for the fee quota amount, or distance Qq - is" .85Qq and the excess over the quota, distance Januawy21 Signicant reduction i te nunberof Qr-4 items subject to expodt ficensing tD The total quantity of cotton fier supplied, QTI 26 iems (ccvering, however, the majo*ty of e value of exiort)- is determined by the intersection of the domestic supply curve with price Pjz Domestic farmers Fabluary SS% tax on fbolegn e:echange pw- FDmsi amr t:eeds VW had been inrduced in mcease sales unti the marginal cost is equal to the May1993 was removed. A1S%sur- highest price. The quantity of conon fiber con- er rapnwd at he foWi samed domestically is determined by the intersec- exchange ax wee temporaly ine- tion of the domestic demand curve with thfe con- dLcedu trolled domestic price for textiles, P* Finally, total Febnay Import duti abolished _temoraly exports equal distance QT -Qt It is relatively easy using figure 10.1 to Api' 11 The 35% hard currency tac on for- descibe the consumption and production effects of eign UCe hr tennskd b Uzbekan's policies on the cotton sector. By Preskiental Dece but a 30% cur- reny surneder roq*ernt reducing the price received by famers at tmargin ed in its paca. Gifen that oial tPf the pe c foreign exchange auctiom undenal- . P ues fongn mhgge by 8 te of emuon fiber to fall from Q- to QJ. The quantity U npdt forign xchange tax has farmers would supply at price Pw is Qr Domestic been reduced tD 2%) textile mills are charged a pnrce below the worid April A 30% surrender reqirement at te price The quantity consumed locay rises from Qj afficW rat was inrduced. Weekl hfrcign exaste aoducn W to Qd_The cunm of these two effects (the reduction uplwmnted to detrm the officdal in aspply zrd increase in local consumption) is the rat By June 1994, te implict for- reduction i Uzbelstas exports. The correspond eign exchange tax was therforem reduced to approximately 24% ing decline in export earnings is the sum of areas because tihe offs! exchange rate P, 9)adPQQ)(oeta h fiin reained undarvalud by PabodQd) and P|MtQ') ote that the efficien- 809% cy or deadweight losses to the country consist of the lume 24 Uzbetfttan obWm observer status small triangles above the demand cuve. abc, and wilh the GATr under the supply curve, h10). The two transfers are shown by arma PwbcPd, which is the consumption subsidy to domeslic textile mills. The second is the the world and domestic demand for cotton fiber. -r gKabuneE nbvby andfrom below by For simplcity, it is assumed that Uzbekistan is bn jjom and distanc fr which it unable to affect the world price of cotton fiber, so drstepterfom farmers to the government. the wodd demand curve is drawn perfectly dasic at Te heavy b iatio of iputs also needs to wr The domestic dmand is also assmed to be be taken into account to get the full picture of elastic. Over 55 percent oftextile mi products are r t a welfare effects These subsi- exported and these exteral consume are likely to dies create an incentive to waste resources by have~ ~~~~~~~~de creay acns toev alenato suppe However,b have ready access to alternative supplies. However, obscuring the true resource cost of cotton produc- D dis not perEctly elastic. Dojistnot rfzmers elas twoiprccs dwhich foon tton. The total cost ofthe resources used in produc- Domestic famersoface two prices, which form ing additional units of cotton is reflected in curve a r ng step UzTe fars p e. ruis th S'- If frmers opeated along this. curve production trolled pieat which Uzbek; farms werc required to wol ea on ~weetecreitret h would be at p.omt k, where te irve a peri stb sell 85 percent of der 1992 quota outpu O ld woldpibisui s warld pna: ~Now if fanners receive a per tsu 208 TRIDE IN THE NEw INDEPENDENr STATS1 sidy of s. t thethe supply cuve S jshifts down by urenCy and Russxan rubles as veicles to finance the amount of t.e subsidy to Sd. which is the farm- d en' new supply curve and reflects their (private) costs of producing an additional unit of OU4)UL Recommendations for Tmde Policy in the Fanners expand production untl Sd intersects P., Transition and resources are wasted because too muchcoton As part of the structnl reform program. is produced The waste of re urces is eflected in Uzbelkstan should focus on providing a supportve the triangle above Pw and below Sd, at the margm incentve fiamework for trade that is fiee from the the cost of the resource embodied in dth additional reU ctions on exports and imports (sate orders, unit of cotton produced exceed the value of tiat sta tding, and an export licensing system) that additional unit on the world markeL distort production and trade Wbat it needs is a pol- icy framework that evens the playing field in all The Payments Framework for Trade productive activities for domestic and foreign mar- Until 1994, the payments system posed yet kets by moving toward market and intemational another obstacle to trade expansion with large pnces that mainuin government mvenue duing th aears, currencyi mconvertbity, and a reliance on flsion through privatizaion and t.c elimination barter and clearing aanngements. In 1994, Of most import subsidies that i U Uzbeldstaa tansfered some $600 million in gold into the world tnading community by supporting its abroad as colateral for trade credits, allo ng much ahon to the GA1T. of its trade to clear through payments in correspon- Kcveaue concemrs can be met through privati- dent accounts held by the governent in foreign zation begining with trading. telecommunications, Swiss banks1 However, t.e inconveribility oft. and hansportation companies-, a land leasing pro- sum sti pr_es a major impediment to tade and gram in agrcultwe; the imposition of uniform to the achievement of macroeconomic stabilily. trade taxes (on imports or exports) with few The payments systems for trade among e exuemptions; and the phasing in of a value added Soviet republics coDlapsed as byperinfiation of t.e ta on imports. The design of a new legal frame- ruble led to aflight from rubl currency holdings. In wor w also be important. to ensure property the absence of a cleating mechanism and convert- ighs, oderly bankuptcy, enforcement of business ibl currencies the payments system ceased to contr. The introduction of a fuly convemi function and clearing between the official corre curency and full access to foreign exchange will spondent accounts at the Bank of Moscow became he critical along with a clearing up of intemational a matter of bilal negotiations. and domestc areasm Trade with Russia is governed by a bilateral To reduce the adjustmentcosts associated with trade agreement that provides for a techmnical b th movement of resources fom contracting to ance to setde net trade transactions. Sipniiiant pay- expandig sectos and to avoid t. risk of short run ments probems remain however, because technical reversal of the trade liberalization process, reforms baances can be used only to setle the trade balance should be phased in and should involve changes at not individual transactions. Russia demands cash various stages- immdia medium term, and long payment for many of its exports to Uzbeistan, run. But if the pace is too slow, opponents of trade while Uzbek products do not obtain similar teat- reform have time to mobilize to undercut the pro- ment from Russian m4pouem Vgam HIigh tax ras, explicit and mplicit should be reparations for the establishment of a multi- emiated rapidly along with any exemptions- As laer clearing bank using the ruble as the unit of tax rats ar reduced, the tax base shotild be broad- account came to a halt in early 1994. In its place ened and voluntary compliance encouraged so that remains the network of govenmment-held coDrespon- fiscal revenues do not fall too draticaly during dent accounts at commercial banks that use hard the transitionL |,1ZEW:rArn TRDE REFom w A ConaN BASID E oNoMy 209 Guiding the reform should be the objective of To estimate P., we began with a price of removing the state from trading activity. Tht $1,065 per ton, based on bMinistry of Agriculture would involve authorizing private trading compa- figures of $1,060 and $1,070 per ton for 1992. mes and also abolishing the state order system, par- These prc reflect a $40 and $148 per ton discount ticularly for cotton. Producers should be aUowed to due to uncertainty of quality and delivery. C(hese sell cotton frely at market prices, both domestial- discounts are consistent with the $88 per ton dis- ly and intemationaUy, without state interf A count reported in World Bank 1993a. The dollar cotton exchange could be set up at the commodity price was converted to rubles using an exchange exchange. The currency surrender requirement rate of 1,100 rubles per dollar. [Source: Ministry of should be abolished, and foeign cunucy should be Agricoltue. feely bought and sold by all banks at markt rate The auction of foreign currency at the central bank * Pd= 500,000 rubles perrto that is now restricted to few commercial banks should be reformed immediatly. Membership in This esimate is the nidpoint of three diffaent GAIT should be pursued actively. There is not a esimates provided to the World Bank mission by path to growth dhough state control of trading the Ministry of Trade: 400,000 rubles, between activity fbrUzbektal The history of many smila 500,000 and 600,000 rubles, and between 400,000 failed attempts throughout the wald amests to that rmbles and 600,000 rubles. 'Pc= 141,000 rubles per ton Annex: Data Used to Develop Estimates for the Cotton Sactor, 1992 Based on an average of prices from May 1 to Civen assumptions about the price Lasticities June 28 for grade 1 cotton fiber provided to the of domestic supply Ce =1.5) and demand ( 7 =2), agricutral trade mission by the Ministry of he various changes and transfers are calculated y iAcuJuz_ the following formulas. 3@055n: etrEmmfaxsegsto Pf=Pwtl(-rf)=1,112,925mublespertolL * Gross resource transfer fr-om farmers to S"~w -p ,1,2 ulsprtn &VIlCtt f(Pww Pc) 0 85Qq] + [PfQr tp% expor tax. - 0.85;0] - Subsidy Cotton f omanfs pay an expor tax of 5 pernt * Subsidy fom govermnent to fim: sQT on cxport sales of the free-quota output and the excess over quota output This price is consistent * Reduction in domestic consumtpdon: Qd[1 wih dte prce of 950,000 rubles per ton provided to - (Pw/Pd)eJ1 the agriculturl mission by the Ministry of Agriculture. The 5 percent export tax was still * Conser subsi. (Pw - PARd appLied as of August 1994. *Increase in domestic production QrW;Pf)e6-1] *5 Qg.2l100t11 * Qr= (-OS)Qq 1.345.000 ton. *Increase in export earnings: [Pw(Qd- * 0.85Qq =1,088,000 tons. Qd)] + [Pw(Q'rQ The Ministry of Agriculure provided an esti- The data used in these fomulas are as follows mate of the total production of raw cotton fibre (%]. Thee is no infomation on the quota amount * Pw = 1,171,500 rubles per ton f.ob. or the excess over quota; the excess over quota was Tashkent assmed to be 5 percent of the quota mount : i t) TIaat- IS TnB NEW INDEPENDENT STATEs * Qd=192,000. Notes * QdQd= (P/Pdh)T This chapter draws on work of a Word Bank mission led * by dte auDors and comprising JosE Meadez (Arizona Stat * =3,456. Univesity), Helga Muller (World Bank). Refik Erzan (Bogazici University). Carlos Rodriguez (Center of Calculating the change in domestic consump- Macroc-onomic Studies, of Argentina) and Hong Wei (World Bsnk. The authors benefited from helpful substan- tion requires an estimate of domestic consumption tivc comncats from Dani Rodrik. M4ichael Miclady, Alam and of the own-price elasticity of demand, -q. Winters. Costas Michalopoulas and David TarT. Athony Domestic consumption is approximately 15 percent Aylward and Steino Bertozzi as in its prion of reported output, and is assumed to have a value I. M y,webdeie wto lower domestic prices of imponrd of -2, a modest estimate since over 50 percent of foodsal and energy. teXtile products are eported to consuners having 2- Note that in 1993. bard cunency exports included signif- alternative supply sources. The formula is simply icant gold saes which were previously reflected s foreign the definition of the own-pnce elasticity of demand: res 3 INrEALOKA handles all foreign trade (export/iport * (kIQT= (yP,f,)eE of consumer goods, equipm se and te with counties in the far cst (em. China Indonesia) and those near thc QT= 1,447,000 tonL border (e.,& Afgbaisan); UZAGROmIEX handes trdj in agricultuwl goods; INNOVATSIA handls ali technolo- gyc xnstr s by. for instance, assisi joint ventMs or con- The production level under fee trade is derived ducting feasibility studies; UZMEDIMPEX handles in a sinllafashion. Ihe formula is the defiition of imports and cxport of medicul equipment and medicine; the elasticity of domestic supply, in light of the UZPROMMASHIOPX handks exports and imports of raw mataials, gas and oil UZLEGIMPEX handles the economy's structul rigidities (the state ordr sys cxpt and imprt of light induy pducts which consist tem), we assume a modest supply elasticity of 15 largely of textiles; and PROMSYRYO handles the export and import of industial raw materials. Four companes * a= $496 per ton, handle intenational transporation: LZINTRANS and UZVNESHTRANS (now a Germnm-Uzbek joint venture known as Centrl Asia Trns) provide anspodt srvices for To obtain an estimate of the subsidy per ton of all types of products to foreign and CIS counties, while cottn fiber, we began with an estimate of the sub- tWO Clpaties lint thehnsw'e to agicultural producd sidy to agriculture as a whole developed in World ZGROROMTAS and UZPLODOVOSVTRANS. Bank (1993a). Next, we assumed that the cotton Refeenes subsectores share of the total subsidy would equal Micbialopoubos Costs and David Ta:rr 1994. Tedchi its share of the total tansfer out of agricultur, Nowe n Alerna PayasArrangemenrs for Trde which for 1992 was 78 percent. The total subsidy to Among th Newly ndBependen Suae. Washington, D.C TheWorld Bank. cotton was then divided by the total 1992 produc- tion to obtain a per ton estimate of $496. The World Bant 1993. 'Uzbekistan: An Agenda for tion tD obtain a per tDn esfimaw of $496. Economic Reform". Report No. 11683-UZ Waingtn D.C. 11 Institutional Policies for Export Development John Nash Lrecnt years most developing counties bave come to rec- ognize the importance to their davelopment prospects of a suc- cessul export statea. Among the benefits of a more robust export sector are stronger links with the world economy that allow for the transfer of technology to improve productve effi- ciency and incread foreign exchange carnings with which to puchase needed imports. From the tigersr of East Asia to dte more recent success stonies in the Western Hmisphere, all * Ensuring Access to counties that have attained and mntained bigh growth rates imported Inputs have done so on the basi of rapid expansion of exports Many policies of the Soviet Union had tde opposite effect servies opm Export of discouraging exports. Ihe oientation of the central planning nappaatus toward self-sufiicieucy led to managed trade, sup- * Financial Services ported by vanous implicit and explicit taxes and restictions on exports These included controls on domestic prces to keep * Concluding Remarks them below world price levels, quantitative barriers, and exchange controls. The pric differentials cred by these con- trols have led to large-scale ille exports, accompanied by massiv corrupton. While some successor states have reduced or eliminated such restictions, many have continued the old policies, some- times with sligbhtmodification Ihe problem is especially see for raw materials, but is also serous for manufactred exports. Meanwhile, tade and payment arangements have broken 212 TkAnE IN rmE NEW INDEPENDrW STATES down. As a result exports have been declining tion services. Successful export policies facilitate rather than growing, and much of the remaining access to these pmductive inputs. The third section trade has taken place through inefficient mecha- discusses how this should be done. nisms such as barter. The expeience of countries around the world Ensuring Access to Imported Inputs shows that many of the most important policies for Countries have several options for ensuring encouraging exports are not specific to the export expoes quick, reliable access to imported inputs sector. Though it is important to ensure that at world prices. These are across-the-board duty- exporters receive duty-free and restriction-free free imports, duty exemption or drawback schemes, access to morted inputs, it is even more impornt and export processg zones (and related schemes). to ensure a reasic exchange rae and overall macro- economic and trade policies that are conducive to The Duty-Free Option stability and growt in the economy as a whole. To One way to ensure exporters access to import- promote exports, pnrioty should be given to elimi- ed inputs is to make the whole economy a duty-flue nating gross macroeconomic disutions. Even the zone, by imposing no duties or otherrestrictions on bst policiCs for promoting expots cannot flly off- mimp (except goods restricted for secuity or pub- set the antiexport bias of unsatisfactory general lic health considerations). T can also be no con- economic policies. Since taxes or restrictions an trols on access to foreign exchange for impots. exports are still prevalent in the countries of the Hong Kong and Singapore,l two of the most suc- foxmer Soviet Union, the most urgent tasks are to cessfii exporting economies, have taken this remove these, stabiize macmeconomic imbalances, appmroach. This has the obvious advantage of elim-.- and reform the exchange systems (chapter 13 of dtis nating the antiexport bias inherent in resticting or volume). Next in the context of an apprpriate gea- taxing umport It also has the vitue, not shared by cral poicy framework certain instinutional policies the other schemes discussed below, of imposing lit- aimed at supporting the epr sector will become tle admisttive burden on the government and important This chapter focuses on issues of great- almost no paperwork requirements on exports. It est relevance for manufitmed exports, gives exporters more flexibility about wher to Exporters to world markets face avery compet- locate (they are not tied to one location, as they are itive environment Most exports fom developing with some other schemes) and what and when to countries are produced in accordance with the spec- produce (they can try to export something new ifications of the buyer Buyers want products to be without fear of having to pay import duties and sipped ready for sale or use upon arrival, with litle Penadties if they find thmselves unable to export or no further preparation (Keesing 1983, 1991). the shipment within the allowed timefiame)} That means that the exporter must have available Although they continue to maintai many otber everyting needed to bring the product to dtis pointt cstrictions on trade, some countries of the former Buyers change specifications quickly to meet Soviet Union have very low tariffs on imports changing demand in the world maret, and they Some, such as Uzbekistan2 and the Kyrgyz requr on-time delivery. Thus, exporters must also Republic, appear to be following the Hong Kong be able to adjust quickly. To be competitivc, then, and Singapore model by eliminating (or refaining exporters must have access to al necesary import- fron imposing) tariffs on impors altogether. Most ed inputs at world prices without delays, and on a of Ukraine's taiffs ae between zero and 10 per- reliab basis. Ensung that access is the purpose of cent, though a few ae as high as 30 percent But the various duty exemption and drawback schemes most pmts are exempt or enter under preferentia described in the next secton. arangements that subject them to rates of only 2 to Production of exports also requies nontanglble 5 percent Russia's tariffs are not very low, but it inputs, such as financial, marketing, and informa- has a free-trade agreement with all the otber coun- irJsrrnilNA. PronjuN irag lExrotRr DVELOPMENT 213 tries exceptthe Baltics and Ukrain and it charges ers do not have to exporl 100 percent of their pro- no tariffs on imports from Ukraine (IMF 1993). d.ctic'n to qualify. The systems should also provide Some central Asian countries have entered into for exemption or rebates on indirctr taxes paid on their own frce-trade agreements, as have the inputs into exports, which requires estimating the Baltics. Even on imports from the rest of the world fraction of hnports that were incorporated into the tariffs are relatively modest in most countries, export between S and 15 pment.r Countnes have successfully used several van- These tariff regimes were not motivated by a ants of this approach (Keesing 1991). Indonesia, desire to provide free-trade status for expotes and Tbailand, and Korea (before 1975) used exemption other controls are in place that restrain trade. But scbemes. Korea now uses deferred drawbacks, the relatively low rates imply that, in contrast to while Mexico uses a temporary admission anrange- many developing countries, some of the countries meat that is similar to exemption. In Indonesia are not relying heavily on import duties for revenue exporters present an export plan showing the tech- or for protection for inefficient domestic produce nical input coefficients for the imported inputs they That puts dtsc countries in an exccllent position for need, with a bank guarantee for the tariffs on the adopting free trade as an export strategy, though imports. If the products are not exported within a ther will be some revenue implications. For most set period, the manuniture or the bank is liable for counies, even those that currently have low tais, the duties. Sinilarly, in Taiwan, major, regular adopting this strategy would sdll imply an impor- exporters can put their duty liabilities "on accounr tant policy shi, since it would equi elimnating with a bank guantee and the liabilities are cam- excbange coatrols, at leastfor curnnt account tras- celed upon proof of export within eighteen months. actions. Ukraine, for example, has low tariffs on Fims that do not export all of thir production and most imwts but uses strngent exchange controK ar not eligible for this schme must pay dutis, but which are especially dmaging to smal firms (see they can get rebates quicldy. chapter 3 ofthis volume). Several practical lessons from expenrence with For economies without tariffs, and for those hese schemes in other countries are relevant forthe with very low input taiffs, the issues discussed in countries of the former Soviet Union. First, if this section are not of crucial importance compared implemented properly, duty exemption and draw- with other problems in trade policy. As currencies back schemes are the most useful tool for unprov- in some countries have appreciatd, however, there ing exporters' access to imported inputs where has bee increasing pressure to raisc tariffs. Latvia imports are taxed. Their big advantage is versatili- and Lithuana recently raised their tariff, though, ty. Unlike export processing zones or bonded war- even so, they remain moderate by thc standards of house systems, they can be used by all exporters. developing countnes (Bakic News, October 15-22, This is an especially valuable characterstc for 1993). In any case, as tariffs inease, having a snai and first-time exporters, who are likely to be scheme for exempting exporters becomes more local entpreneurs. Consequently, tbesc, moze tan imporantL oter schemes, can encourage the development of a domestic entrepreneurial base, which is needed in Duty Exempon and DrawbadcSckeSmws te former Soviet Union. Duty exemption and drawback schemes A second lesson is that they are not easy to exempt exporters frm paying tariffs on imported implement sucesfuy. Although most countries inputs used in the production of export, or allow have exemption or drawback programs on thei them to get a rebat whether the exports represent books, they are widely used by exporters in only a all or a faction of their total production. Thus, few countries outside of Asia. To be successful, a Unike th export processing ze and in-bond man- scheme must meet two partially conflicting goals- ufacing arrangements discussed below, produc- On the one Land, it must ensure that exporters get 214 TRADE IN TMH NEW INDEPNDENT STATES all the imported inputs they need quickly and reli- technical coefficients, it may be useful to have a ably and that thcy do not pay duties. On the other dmwback scheme for exporters of products for hand, it must protect against "leakages," in the form which coefficients have not been documented. The of goods sold illegally in the domestic market or caveat is that it may be easier to guard against abuse tariffs illicitly evaded. The one goal argucs for of a drawback system, since funds are reimbursed keeping documentation requirements and bureau- only upon proof of actual exports. In cases where cratic procedures simple, while the other objective institutional weakness would lead to rampant abuse requires more control. The more protected the of an exemption scheme, and whbae tariff revenue domestic market (the higher the tariff structure), the losses would be a serious problem, there is a geater the incentives to cheat, and so the more dif- stronger case for using a drawback scheme until the ficult it is to reconcile these conflicting goals. For enforcement machinery can be strengthened. better or for worse, most countries have tilted the Fifth, if possible, there should be some provi- balance toward guarding against leakages. As a sion for indirect exporters (sellers of domestically consequence, exporters consider the systems as produced inputs to exporters) to get exemptions or unduly burdensome and slow and do not use them. drawbacks for duties and indirect taxes on the Third, the successful schemes in Asia and a imported inputs used in the supplies they sell to &w other countries are generally based on technical export producers. Including indirect exporters is input-output coefficients that show how much of a very demanding administratively, :however. Taiwan given input is used in manufacturing a given prod- (China) used a system that mnimized the burder. on uct, on average. With coefficients available for a govermnent administation by giving the full large number of commonly exported products, amount of the drawback (for duties paid oc inputs computation of exemption and drawback entide- used directly and indirectly in the exports) to one ments can proceed rapidly, without the need for party, leaving distribution to the parties involved separate documentation for each shipmenL (In (Wade 1988). But many other countries have been Taiwan, China, coefficients for about 6,000 export unable to develop a workable system. products are published and revised yearly.) Ideally Finally, exemptions and drawbacks should be exporters should be entitled to an automatic exemp- available on a nondiscretionary basis to all exporters. dion or rebate based on these coefficients, but with In some countries, entitlements to exemptions and the option of documenting that their product or rebates are granted as part of a fiscal incentive shipment used more input dtan the coefficients package after a firm presents an application to a inply. Clearly, this arrangement is quite intensive ministry. In these cases, they are often given to in its administrative machinery, which could make import-substtute producers, undemining the objec- implementation of this kind of scheme difficult in tive of the system. This arangement also provides countries of the former Soviet Union. an opportunity for producers to limit competition by Fourth, subject to the caveat below, exemp- lobbying against giving incentives to new entrants. tions are generally preferable to drawbacks. Drawback systems typically do not allow exporters Expot Processing Zones and Bonded to automatically circumvent nontariff barrers to Warehouses imports, whereas exemption or temporary admis- Export processing zones (EPZs) and bonded sion schemes do. Also, from the point of view of warehouse facilites allow exporters to import the exporter, it is costly to have funds held by the inputs duty-free and without restriction and use govenmuent- particulary in an economic environ- them for manufactmring exports in one geographical ment of high inflation and interest rates and a short- location.3 The products made ther cannot general- age of trade finance, as is common in much of the ly be sold in the domestic market, though some former Soviet Union. Of course, even with a well- countres allow a small fracton of output to be sold functioning exemption scheme based on standard locally. An EPZ differs from a bonded warehouse INSmIUlONAL PouLCs FOR ExPorr DEvaLonurr 215 in that it is usually an industrial estate, with infra- long enough to make judgments about their effec- structure and factory space that is rented to tenants. tiveness. About twenty-five (42 percent) of the sixty Also, EPZ tenants are often exempted from non- are largely successful as measured by the employ- trade taxes and from regulations related to labor ment and exports generated and cost involved, eigh- (foreign and domestic) and foreign exchange. These teen (30 percent) are failures, and the rest some- systems are of interest only to exporters who plan to where in betwccr (World Bank 1992). Most of tile export all, or nearly all, of their production. For this successfuL ones are iu Asia, with a few others in reason, most of the users of such facilities are for- r-sta Rica, the Dominican Republic, and Iamnaica. eign investors who are not interested in local sales. The unsuccessful cases have low occupancy The major advantage of EPZs and bonded rates and impose a high cost on the govermnent warehouses is that the policy regime can be set up (infitructure investment opeating cost, or both). relatively quickly. The administraive requirements Ihe underlying problems are often a poor policy and prerequisites are not as great as for exemption environment Cmterventionist regulations, for exam- or drawback schemes, mainly because the required pie); inadequate implementation of EPZ regula- modifications of customs procedures are not as tions, resulting in slow customs clearance and extensive, excessive paperwork; poor choice of location; and However, theirmimportance in the overll pack- bad management, often including overbuilding age of policies for economic development should based on unreaistic projections of demanad for not be oversiated- The performance of EPZs bas space. not been very good when other policies have been Two featues of the policy regimes in countries antithetical to exports. At best, they can serve as a with successfu EPZs stand ouL One is that the small part of an export-oriented policy package. countres all have relatively stable macroecononic Some 4 to 5 percent of developing countries' environments, with modeate inflation and exports come from EPZs and somewhat more from exchange rates favorable to expores. EPZs cannot bonded warehouses (World Bank 1991). EPZ attract investors to a country whoseother economic cports are generaUy intensive users of imported policies are unsatisfactory. The second is that the inputs; most EPZ firms are assembly operations for best EPZs am rn by an exceptionally efficent - electronics or garments. The local value added is lic body along business lines (the East Asian EPs) usually less than 25 percent, and net foreign or are privately owned (recently developed EPZs in exchange earnings only 15 to 20 percent of gross the Westrn Hemisphere). Often, publicly run EP2s export proceeds. And at least part of the net earn- succumb to the problems cited above. Public offi- ings are held in foreign currency accounts by the cials are often under pressure to locate the zone in foreign-owned EPZ firms (Warr 1989). That means outlying, underdeveloped regions of a country, that the linkages with the domestic economy are areas with the worst infrastructure and highest-cot limited, a major limitation of EPZs even in transportation, making it hard to attract investors economies with otherwise successfiu EPZs, like without high subsidies And in most countries pub- Mauritius (achette and Nash 1993). The natre of lic sectors are inflexible in matters of humg, firin& the operations also means that opportunities for contracting, wages, and other personnel matters and transferring technology to local entrepreneurs are often have salary scales that malk it hard to com- limited. And, for reasons discussed below, the tax pete with the private sector in attracting good n- contributions of EPZs to the host country are also agers. --ite limited. Govermments in a number of countries of the The administrative simplicity of establishing former Soviet Union have shown an interest in EPZs does not imply that they are easy to make suc- establshing EPZs or bonded warehouses. The gov- cessful. About sixty of the eighty-six EPZs in twen- emient in Latvia is considering a proposal for an ty-seven developing countries have been operating EfZ (Baltic Business Report. February 1993). In 216 TRDE wN THE NEW NDaER ENr STATS Lithuania, there is an association of EPZs, though exclusive rights to develop future EPZs as well. the law is only now being drafted and none has Such a legal monopoly could have large costs in the actually begun operation (Balfc News, December future, if the initial developer turns out to be a poor 18-24,1993). manager or to have limited funds to invest in In Russia, where import duties pose a pmblem Latvia. The government is also reported to be using for exporters (chapter 2 of this volume). the govem- site selection as a criterion for deciding whether to mant is developing EPZs. Draft laws on EPZs have accept the proposal, which could eliminate one of been discussed, but not passed, and the new cus- the main advantages of private ownership (site toms code includes provisions on bonded ware- selection based on economic and financial criteria houses (as well as exemptions and drawbacks), and rather tban political). Overall, a better apprach to implementing regulations are being drafted. Severad te EPZ legislation would be to put in place a trans- areas have been declared free economic zones parent framework for approval of EPZ proposals, (FEZs), essentially making them large EPZs with automatic approval for pmposals tht meet the Among them are areas in Nakoddka, the Kurile criteria, rather than negotiaing with investors on a Islands, and Moscow's Sheremetyevo Aiport; sev- case-by-case basis. eral othes arein the planing stage (East European Most countries of the fonner Soviet Union Invesmunt Magazine, Fall 1993). Each one seems ought to promulgate laws to filitate; the establish- to bave its own package of incentives, with most ment of EPZs and bonded warehouses, but with including sinplfied customs procedures, direct careful attention to the lessons of experience else- local registration of joint ventures, guarantees for where and only as a small step in an overall export forign investors, and some tax breaks. srategy. The development of EPZs should not steal Lack of coordination and agreement between attention from more important reforms to improve fed and regional authores, has been a problem the overall business environmenL The sources of however. For example, the first FEZ, at Nakodka, compive advantage for these counties appear to was technically begun in 1990. and in October 1992 be their highly educated populations and natral the Nakoddka FEZ Committee adopted the neces- resource endowments. These fiaor thc development sary regulations to allow duty-free import for of industries requiing skilled labor or those based exporL But after only a month the Fedeal CustoWs on resource processing. The industries usually Service suspended the duty-fre regime, claiming attracted to EPZs are low-skiled assembly opera- that the regional authority could not act unilaterally. dons. For this reason, no one should expect spectac- But thc federal authority had no alternative duty- ular resuts faom EPZs alone. fiee regime, since the federal law on EPZs has yet EPZ laws and regulations should be based on to be implemented. The Nakoddka zone finally private ownership and development of the zones, opened officially in May 1993. Some eighty firms including the infrtuctue of tbc zone. That wil from the Republic of Korea have announced plans lessen the problems related to site selection and to begin operations in an area of th zone allocated management, as well as the govenment's exposure to dtat country, making consumer goods, electonic to financial risk The gDVeMeMCts financial Involve- product, and food products. Over 240joint-venture ment, if any, would be limited to investmentin infra- firms have also expressed interesL structre in the surrunding a-a and the tax revenue In the Baltics proposals for EPZs appear to be forgone through tax exemptions to zone tenants and based on the private ownership model (Balrc developers This government involvement should Business Report, Febrary 1993). In Latvia (and be kept small commensurate with the limited ber- pehaps other countries) negotiations over whether fits cxpected forte rest of the economy. In particu- and under what conditions to grant pemission to lar, the govemment should look skeptically at any build an EPZ appear to involve a single potential proposal for-expensive public investments for the investor, whose plan would give the EPZ developer zones that it would not make othrwise. lNsrmmoNAL POIXS FOR ExPOKT DsvELoPMEio 217 Successful EPZ legislation elsewhere has criminatory manner. Exempting imports, for exam- ensured that fims locating in EPZs (including the pie, creates a bias against domestic producers who EPZ management) enjoy certain nghts These must pay the VAT and then sell their products in include the right of 100 percent foreign ownership competition with impor that do not pay the tax. and 100 percent profit repariation. exemption from Likewise, the failure to give approprate treatment all forig exchange controls, rapid customs clear- to exporls creates a bis against export sales. ance (which may require locatng customs facilities In Ukraine for example, there have been sev- in the EPZ and allowing customs officials to be eal changes in the way the VAT teats exports. Tle paid by the EPZ to work overtime), rapid response current method clearly creates problems for exports to investment applications, and minimal reguiatoxy by differentiating trealment acording to destination controL especially over biring and firing decisions. and type of transcion. Exports to brd currency Although tax incentives Cin addition to exemp- destinations are not charged the VAT and are tions from import duties) are usualy included in apparently eligible for rebate of the VAT paid on EPZ promotional packages, surveys have indicatcd inputs. Imports in these curenes are charged the that ivestors consider other factors that create a VAT, but only on the differee between their bor- favorable business envionment to be more impar- der prce and their domestic seling price (the mar-- tant to their location decisions. Tax breaks, if any, gin). Exports to other counties of the former should be modest and should be in the fonm of low Soviet Union are not charged the VAT, but neidter rates over along period, raterdtan a zero rate fora are they eligible for xebate of the VAT paid on short period ("tax holidays"). Tao !hlidays tend to inpt; imnports from these counties are not charged attract dustries and finns that invest liltle up front the VAT. The VAT is assessed on all barter trade, and therefore realize heirprofits eady in their ens- with no rebates for VAT paid on inputs, creating a tence. Afte the tax holiday exps in one country, double bias against barter exports. such firms, because of their low fixed coStS, can Russia levies the VAT on imports (their ful easily move to another, or more commonly, threat- value), but not on exports, and exports are eligible en to relocate to get essentially permanent tax-fiee for rebat of the VAT paid on their inputs. status (Warr 1989). Countries of the former Soviet However, around one-third of al imports seem to Union should avoid tax holidays and should devel- be exempt from the VAT. The VAT is not charged op a hamonized policy on tax incentives to avoid on imports from other countries in the former bidding wars for foreign investors. Even so, not Soviet Union with which Russia has negotated much tax revenue should be expected from EPZ free-tade agreements. Such exemptions exacebate firms, since experience sbows that thyae adept at the transshipment problem inherent in fre-trade transfer picing with parent companis to minimize agreements; counties that are not parties to the their tax liabilities. agreement will try to sbip goods to Russia through a country that has low (or poorly enforced) tarffs to Treatment of Value Ado'ed Taxes avoid paying Russin tariffs and VAT. In the confiLsed economic environment hat fol- Inconsistency in how the VAT is applied to lowed the breakup of the Soviet Union, many ofthe trading parters can crate a bias against expos new independent countries established a value For aVAT designed on the destnation prnciple, as added tx (VAT). One of the VArs major advan- itis in most countries, the full rate should be charged tages over other types of taxes is its neutraity: it On the value of imports, and the same rate should be creates no artificial incentives relative to a regime applied to domestic producers' value added (the dif- without a VAT. Another is its broad base, allowing ference between the value of their production and the government to collect a lot of revenue with a tieir cost of inputs). All expOtS sholdd be eligible relativly low tax rate But both of these advantages for an exemption ora rebate for taxes paid on inputs are undermined when the tax is applied in a dis- (imported or domesticaUy produced) for their 218 TAN ma zNEw INEPEN nT sTAT exported producuon. Admi nistativey, this shoud development consutants, engineering and produc- probably be handled as part of the duty drawback or tion consultants, export market research and analy- exemption system. If the VAT is applied in this sis firms, foreign firms' buying offices and agents, way, the domestc relative pnces of import-compet- forign tade consultaurs, mnnagement consultants. ing goods, domestic goods, and exotables will be marketing conslnts, prcment and purhasing the same as they would be without a VATE agent, product inspection and quality control firms, Some counties of the former Soviet Union shipping agents and freight forwardes, testing and applied the VAT on an origin principle. The tax is certfication laboratories, trading (import-export) chargd on the value added of all goods produced in firms, and varhousing and strag fims (Keesing the country, both those exported and those con- and Singer 1990). Some of these services are sumed domestically. Like in a destination-based important only for elatively mature export indus- system, the effcct is intenally neutral (domestic rei- tries. (oduct design advice for exmmple, is useful alive prices stay the same). But exports to countics only for finns that are not producng acording to that use a destination-based VAT are taxed twice buyers' specifications.) But most of these services To eliminate this prblem, countries of the former are needed by exporters at all stages of develop- Soviet Union ought to harmonize te way they men Theseserns havebeen readily available to apply the VAT. exports in each of the Asian WJigerss (Kecsing 1988). Services for Export Development The seem to be brgely mavaiable in the for- Through link with part comPanies abroad, mer Sovit Union. Even m Latvia, one of the morc foreign investors in the export setor of an economy business-friendly of the coames, the low quality typically have ready access to assistance pmducing -or absee-of service provides has been identi- or markting teir produs on world markes They fied as an important constraint on export expansion also have access to international capital markets to (chapter 6 of this volume). One of the few service fnnance their investments and fill their need for providers is the Chamber of Commerce, which trade finance. Indigenous investors in developing mainains a small information center based on ref- economies are not usually nearly as connected- ereace books and information from its members certainly not those in the former Soviet Union. and clients. For a small fee the chamber also facili- tates the issuance of certificates of origin, which are iInfomfaion and Commercal Senices requird under the free-trde agreements with To sell their goods successfully in a rapidly EFTA and for Generalized System of Prefences changing world economy, exPort&s need tO haveC (GSP) access. The Chamber of Commerce in ready access to information on the demands of Lithuania also provides general business-related potential buyers, on how to run dteir businesses so information, but it is not adequate to serve the needs that they can meet those demands at competitive of exportes. prics, and on how to get information on their prod- The Estonian Export Council has been more ucts to the buyers in the outside world. Exporters active in providing export services A joint public- need to know what buyers are lookdng for, what priva enterprise with m bership fees and sevice they cxpct export to do, and how to contact them charges, it is 80 to 90 percent self-supporting. It car- (Keesing 1991). They also need toD kow how to man- ries out research tailored to individual client's ag their finnand gaiztheirt tchical processes needs, provides infomaon on finns to potential to produce in the most efficient way possible. buyers, organizes trips to trade fais, and issues a Some of the many service providers that monthly publicaion on trade-related matts, exprters find useful are accounting and auditing including an excelentsummary of laws and regula- fims business publishem credit rating and check- tions. It has been investigating the possibility of ing firms, customs expediters, design and product establishing a -Trade Point,? a contact for potential kNsnTunroNAL POLICEs FOR ExPorr DEvELOPmENr 219 traders to get information through an automated Frms in the foamer Soviet Union that have information retrieval system linked to other coun- links with international partners can rely on their tries around the world, as recommended by UNC- know-how for many of their marketing and other TAD (UNCTAD 1993). In addition to the council, service needs. Some firms in Russia are doing that exports have access to information from the now. This is one of many reasons why suchlinks Euroinfo Center, an EC network of 1,000 business are valuable and should be encouraged as a mattr information offices, which has been working in of policy. Estonia under the Ministy of Foreign Affairs for Exporters that arm just getting started and that over two years. Exporters and importers can also have no foreign partners will be likely to purchase avail thcmselves of the services of mote than 100 services firm other providers, rather than gomg "in private companies regstred as customs clearance house" Government policy should facilitate the agents- development of local providers and exporters' In Russia marketing problems rank high on the access to foreign providers. To a large extent. the list of obstaces for exporter One critical problem first objective can bestbe met by establishing agen- is that potential exporters lack information on stan- emaly probusiness environment and then letting dards related to samtary or safety concerns in exoTr- pmviders set up shop to meet the needs as they nal markets. Whilemostexports of "strtegicgoods" arise That is how customs facilitators sprang up m are marketed through foreign trade organizations, Estonia, for example. For mzny kinds of servics manufactured products s=ee to be marketed largdy however. intemational companies will be far better throgh links with foreign partners. The foreign pepared than local ones to meet exporters' needs. trade organizations have not generally developed The government should allow foreign companies to overSeaS mareting capabilities, sinee the goods establisu branch offices locally. Also, for countries they have dealt in have not requed much market- that do not yet have convertible currencies, ing. The Rnssian Chamber of Commerce has not exporters need to be allowed easy access tD foreign given much overseas markcting support eitder, exchange to pay foreign consultants and to travel other than to organize some tade fis overseas for abroad themslves. exporters The Chamber has been more aciuve in On the public sector side a potential source of sponsoring fairs in Russi It also provides inspec- services to exporters is the official trade promotiot tion services for imports and exports and helps oraization. Most developing countries have such resolve trade-related disputes. ognis, but neary all of them have been inef- There are a number of approaches for provid- fective (Keesing 1991)> The bad overal policy ing needed services to exporters. dtrough both the environmentin many couries has diminished their public and private sectors- Most of the services, usefulness. Their success in East Asian countries including much of the information needed by fims, was due at least pardy to their establishment after are firm-specific. For all the reasons thathe private the pro-trade policy famework was in place sector is the best supplier of other firm-specific (Keesing 1988). Also, these organizations were goods and services, it is likely to do abetteriob dtan started on a scale smallerthan those in many devel- the public sectr in meeting these needs of exportes. oping countries recentdy-and dtey remained sever- There are generaly many sources in the pnvate sec- al orders of magnitude smaller, relative to their tor, including firms that supply the services com- economies' exports. mercially, chambers of commerce, and tade associ- There is a good case for providing some ser- ations. In thc sucessful expoing economies of vices dtough an official trade promotion organiza- East Asia most of the information flow was within tion Servces with charactics of a "public the private sector (Keesing 1988). Private tding good"-when provided for one fim, they provide companies even maintained dthir own overseas benefits for other firms as wel or for society at offices for mketing and intligenc services large-may, in principle, be most efficiently pro- 220 TRADE IN TE NEw INDEPENDENr STAllS vided through a public agency. However, the ser- vision ol the service (Keesing and Singer 1990). vices that meet this definition are quite limited. One Services to individual firms, if provided at all, problem with some trade promotion organizations should be charged on a fidl cost-recovery basis. For is that they ae oveexteded, tiying to provide ser- the most part such services should be left to private vices that could be better provided by commercial suppliers. firms, rather an restricting their activities to the provision of true public goods Tasks that have Financial Services some public goods characeristics include maintai- Like other commercial enterpises exporters ing commercial representation abroad for promct- require two kinds of financial sevicesr one is cedit hag the country's image and business climia for for working capital and to finance their purchase of investors and buyers, facilitating parucipaton in capital equipment and the other is payment acita trade fairs, collecting information of widespread tion for asferrig funds from buyer to sedler interest on outside markets, and matching firms to poteial buyers in a nondiscintory way. Trade Finance in the Fonner Soviet Union Intemational experience shows that it is easy Boh types of financial services are inadequate for trade promotion organizafions to become a drain in the former Soviet Union today.! In interviews on the tcasury while providing little help to with enterwises in Russia, the lack of financing for exporter Somc lessons are implicit in the discs- impmrting components and machinery was ranked sion above: start small, keep the listof responsibii- as the second most importa consaint (after prob- ties short and do not epect positive results if poli- lems with marketing capacity) on their ability to cies are unsatisfiactory. At the curent stage of entcr word markts. More than half the enterpises export development in most countries of the fome indicated dt the most important source of financ- Soviet Union, small-scale public-private informa- iag for these imports is export earngs; more than tion colecion and dissemination efforts along the half their export earmings are used this way. lines of the Esnia model may well be sufficient Commercial attaches i the interviews considered Suessfl trade promotion organizations also poor banking services and delays in financing for share certain charactics Among tetm subsmn- trade activities to be significat problems. tial autonomy from the govenment bureaucracy Though it had other serious flaws, the mdcha- (they are not part of ministries), competition frnom nism for financing trade in the Soviet Union had the private sector (they are not monopoly suppliers one virtue in common with modem systems: the of sersices), and specific mechansms to ensure pri- role of banks in insuring buyers and sellers aginst vase sector involvement in how they are organized tle dsk that the other paty in the transaction did not and what they do (Graubart 1992). perform as planned. For trade within or among In general, trade promotion organizations republics, the seller's bank paid the seller 85 per- should charge fees that cover most of their costs, as cent of the transaction amount upon sbipment, then is the case in Estonia Despite somne pctical limi- coUected full payment from the buyer's bank, which tations, fees should be graduated to the extent feasi- in turn debited the buyes accunt upon deivery or ble to reflect thedegree of public good charac of (if funds were insufficient) extended a loan. The each service. For example, since market research sellers bank then remitted to thfe sedler the 15 per- may have spillover effects for many fims, even if cent still outsnding. For exports to CMEA part- pririly usel- to one, there is some case for par- ners, the process was different, but the export was tialy subsidizing iL But if there is some reason to still paid upon shipment For trade with partners subsidize a sevice, that is better done through a outside tie CMEA, Vnesheconombank (VEB) pro- scheme that gives exporters vouchers that can be vided letters of guaantee for Soviet Unon importers used in partial payment to the supplier -of their if requesd by forcign sellers and usually rquied choic, ratber than thugh direct publicsector pro- guarantees frm foreign banks for the sale of IN5I[UUONM. PaLciES FOR EXPORr DEvELOIUEN 221 expo The major problem with this system was up another 5 to 10 percent of interstate trade. This that it guaranteed that any losses incurred by the would imply that only about one-third of interstate bamks would ultiely be absorbed by th central tade was caried out by the banking system. budget, thus elimiuating any incentive to take The mechanisms of fund transfer were changed actions to minimi riskl (For details, se the annex in 1991 after the monobank system was abolished to this chapter). and commercial banks were allowed to operate. With the collapse of the Soviet Union, a new Banks in Russianow have to go through cash settle- bank was created to replace the definct VEB. The ment centers to clear every transaction, dammatically continuation of the old payment request method slowing the clearing process. Large noncash trans- fueled a growth in interuenterise arrears since it did fers rely on paper delivery and in a country as large not CncouragC suppliers to check the crdibility of as Russia, the result is delays of thre to four weeks their partne Suppliers still cpected the banking ia intercity payments within Russia. compared to system to colIect payments from buyers. But dre three to seven days in 1991. Delays in intersta new commrcial banks did not want to fiance the tansfers are even longer and result in a huge crdit anrs and shifted the bmden to the trading enter- foat in favor of the Centrl Bank of Russia. In a pnises. In response the Cetral Bank of Russia pro- higbly inflationay envimet such delays are dis- hbited commercial banks from delhiting the astrous for the liquidity of enterprises and confi- accounts of their clients without receiving penris- dece in trade contracts. sion kom the owner of the account (a "payment A decree of July 1992 prohibited direct fand orderj. Under this synm banks react to enteprise transfers between regional cash clearing centers of requests to make payments to sellers, without con- the countries of the fonner Soviet Union, but the cem for the underlying trade contracL The critical resticton was relaxed as counties created their role of banks in helping to ensue that payment was own currencies. The wvidr use of commercia made as the goods were delivered was clnmated banks' direct correspondent accounts and more istenly, the Central Bank of Russia did not take mechanized facilities has reduced some intercity any initiatives to encourage banks to facilitate the and interstate fund trander delys. Russian com- enforcement of trade contracts or to provide trade mercial banks may now maintain correspondent transacion-based finance. The result was that enter- accounts in Ukrainian conmercial banks, and vice prises were forced to use riskier methods to finance versa. aearing transactions through these accounts tad transactions. can reportedly rake as fiew as three days. The most common method has been advance Commercial banks have not yet estabLished a payments forced by monopoly selles with buyers system of granting loans based on careful screening bearing the risk of scUers' nonperformance. The for project profitability or loan payback criteria. second most widely used method of finance- Nor have they begun to grant loans based on self- imposed on wek sellers with huge inventories by liquidating trade transactions, even though this buyers short on working capital-has been a com- wouldbe one of the bestways to selectloans. So far bination of cash on delivery and defnred payments. Russian banks have granted loans mainly under Interenterprisc arrears is another common method pressure from shareholders, when the loans were of trade finance. Also, a significant portion of trade backed by collateral, and when the central bank between ex-Soviet republics has been carried out extended a directed line of credit for on-lending for outside the banking system through barter and specific industnes or purposs. direct cash payments. There are no reliable hard Data are not generally available on xactly numbers, but the best estimates of informed how trade with countries outside the former Soviet observers suggest that barter trade probably consti- Union is being financed. Various assessments sug- tutes moretan half of interstate tade, and that cash gest that foreign banks provide from 10 to 40 per- and other means of direct payment settlement make cent of payment services for Russian enterprises 222 TRDE IN THE NEW INwDEENrDEN STATES tading with third countries, not counting the offi- The first stage, which could be implemented cial credit lines of Western governmcnt and multi- immediately, would be a document against payment ateal credit agencies. For Russian enterprises scheme. Getting it started will simply require almost all import payments made firom offshor changes in the order of payment and paper flow in accounts are advance payments, while a fairly large the banking system The paper flow will be the percentage of offshore export payments are cash- same as in the old payment request method- The on-delivery. The bulk of settlements made from supplicr's bank takes the shipping documents and Russia were undertaken by two banks- payment request fmm the supplier, mails them to Vneshtorgbank (VTB) and the Intemational the buyer's bank and instructs the bank cA the MoscowBusiness Bank. terms of releasing the documents to its cientL (Any Some 60 percent of export payments are cash- fees can be split by the banks.) The buyers bank on-delivery, about 30 percent are sight letters of ensures that the buyer obtains title of ownership credit, and the rest are usance letters of aedit (bank only agaist payment Unlike in the old sdeme, guarantees that payment will be made over time). however, the buyer's bank does not take responsi- The low share of usance letters of credit is due to bility for payment collection. The atactiveness of the small share of manufacauing exports, which the scheme is that it can be introduced immediately usuaUy require sales on a deferred payment basis, by decrees of the central banks, and commercial and the inability of the banking system to finnce banks will have few problems with implmentatipon, exporte who are wlling to sell on credit Russian sInIC they are already famEiar with the scheme's exporters for teir part, are so desperate to sell teir basic elements. often uncompettive manufactmued goods for hard Since the scheme does not allow suppliers to currency that they are willing to take the risk of sell on credit-which is critical for many enterpis- nonpayment even when exportigto aeas of higher es producng manufactuing goods (especally those commercial risk (such as to developing countries under conversion)-te second strp could be build- and Eastmrn Europe). ing a documents against acceptance scheme. Tlis wi requi creating a legal instument of enter- Poicy rnplicafons prise-to-enterpise debt that banks can use as a The breakdown of the old paymentrequest sys- promise to pay"-a promisory note or bill of tem has enormously increased the-risk of commer- exchange. UntiI the 1930s bills of exchange (and cil transactions for both buyers and setlers. The promissory notes) were used extensively for domes- risks are magnified by the lack of a well-function- tic and internatonal trade paymcnts in the Soviet ing system of contrct enforcement. he problems Union. The 1937 law on bills of exchange is still are particularly acute for intemational trade, though effective, and therefore provides a legal basis for domestic trade is encumbered as welL These prob- implementing the systm immediately, at least in lems will only be filly resolved with the develop- Russia The benefit of both the document against ment and enforcement of a modem commercial payment and document against acceptance schemes code. But some things can be donein dte short term is that the buyer is protcted from the risk of non- to ameliorate tem What is needed are steps to performance because goods are received prior to encourage the development of a systcm of trade payment, and the supplier is protcted from the risk finance intermediated through the banking system, of nonpayment because the bank will not release similar in some respects to the payment request sys- documents to the buyer unless the latter pays (docu- tem, but based on modern documentary payment met against payment) or acoepts the shipment with methods. Tlhese would be most useful in facilitatng a legally enforceable promise to pay later (docu- trade within and among countries of the former ment against acceptance). Soviet Union, but would als improve the system of Documentary collecdon methods do not pro- trade with other parners as weLL tect suppliers from the risk that buyers will not lNSItIuIONAL POLxES FOR ExpoRT DsVELoPMENT 223 accept the merchandise when it is delivered. To United States, as well as dte Bank of England, have lessen this risk, a docmmentary letter of credit long used such "billsW as the basis for their credit meahod of payment should be developed. The major facilites This rediscount facility should largely difference betwieen documentary colection and replace the current practices of some central banks, docuentary credit is that the bank not the buyer, which issue credit mainly through credit lines parantees that payment will be made (if the suppli- diected to selected entrpises or setors. er performs). As in documentary collection, it is Each central bank should support the develop- easier to begin by building a mechanism whereby ment of letter of credit mechanims by issuing cri- the bank guarantees immediate payment on delivey teia and regulations clearly defining what kind of (sight letter of credit). As banks accumulate the instruments are eligible forrediscounting. This will. credit history of their clients, they will be in aposi- in tum, encourage the stand ion of the docu- tion to guarantee payments of their customers at a ments and contacts. The citeriashouldaim to make fixur date (usance letter of credi). the instrumnts widely accepteL For instance, the A two-step approach might be considered for Central Bank of Russia codd revise its dree of July introducing sight lettes of credit. At fist, if a sup- 1992 so the letters of credit ame in line with stan- plier musts the buyeres bank, tdhe leter of credit dards of the International Chamber of Commerce, scheme can be considered as a modified version of which would make them internationaRy acceptable. the existig payment request scheme. The buyer's Ultimately. all commercia bankes must be bank would open sight letters of credit by blocking asked to handle modern methods of payments and the relevant funds on the current account of the related trade finance mechanisms. In Russia, how- buyer. The issuing bank would require afull deposit ever, the use of rediscount mechanisms should be from the buyer, remit payable funds to the suppli- limited initially to international standard banks in ers bank, and deposit them in on-cal corepon- order to reduce the risk of misuse of the mecha- dent accounts. This scheme ties up te funds of the nisLn5 buyer (which would have occurred anyway in the Other measures, most requirng legislative case of advance payment), but offers protection action, could improve the foundation for the trade from the sees nonpeformancerisk As a scond finance system. For example, several measures step, as trust between reputable banks is built, these could be taken to strengthen contract enforcement banks ill be in a position to confirm each otheres passing a bil of exchange act allowing bills of letters of credit without askdng for prior deposit of exchange to be badked by property, creating private funds. notary offices that offer certification of protested -The most important policy role in the develop- bills of exchange, creating an interstate arbitration ment of such a system is that of the central bank in court (encompassing disputes about bflls of each country. In place of the dir credit lines now exchange), obliging commercl banks to expedite being extended, each centmal bank should develop collection of payments fm clients deemed liable rediscount facilities for these short-tem self-liqui- to pay under court decisions, and creating a special dating trade fianc insumnts, which will encour- file of the collection orders issued by courts or arbi- age commercial banks to participate in financing tration bodies and instructing banks to debit the domestic and intemational trade. To avoid discount- accounts of their clients tD fulfill such ordes ing nonperforming loans, only loans backed by export or domestic leters of credit, bills of intersate Clearing Afangements exchange, and other negotiable instrmments should Interstate trade has been disrupted not only by be included in the facility ThIes are relatively the breakdown of the bankdng system, but also by secure forms of financial insuments, because each fears that exports to countries with inconvertible is backed by an underlying transaction and is self- currencies would result in the accumulation of liquidating. The Federal Reserve Systm of the unwanted balances in these currencies, uncol- 224 TRADE IN THE NEW INDEPENDENr STAlES lecuble arrears, or transshipment of the products to especially in the economic context of the former hard currency areas These feaus have kept alive the Soviet Union. A proposal fora milatels clearing system of blatera trade agreements with provisions facility under the Intertt Bank garnered some for compulsory delivey and agreements on maxi- interest, but appears to have foundered in early mum volumes of goods that may be traded widtout 1994 for reasons discussed by Gros in his comment restriction, on this chapter. The restblishment of a viable system of trade finance based on correspondent banks and trade Longer-Term Issues conducted in a mutually acceptable cuency is one Some governments, concerned about the prob- step in resolving these problems. Anodter might be lems exporters frce in receiving credit, eecially to establish a mukilatea clearing facility, either a long-erm post-shipment credit that would allow clearing union or a payments union. Both types of manufiaces to offer deferred payment to buyers, facility would allow interstate wade to be transacted are contemplating establishing govemment agen- through any bank, even one without a correspon- cies to grant or guntee such CrdiL For example dent account in the parmer country. At each end of the Russian goverment's Manufacured Expon the tansaction (payment or receipt of payment) the Development S&aegy Paper proposes creatig an buyer and seller would deal with thmr own domes- agency to provide insurance and guarantes for tic bank. Each bank would pay or receive payment export credit, as well as an export-import bank to in domestic cuency from its central bank- Each finnce exports of tunkey plants and heav, equp- central bank would maintain an account in the nent on crediL Citation of shorter-tern credit lines clearng facility, which woud be debited orcrdiced is also being considered. Lilwwis, th Ministry of for each transaction in somc clearing init of Economy in Estonia is studying the establishment account. (This could be dollars, SDRs, or even ofan export credit program rubles, if they stabilized enough t become a good These steps are probably not ft highest prion- store of value.) At some established interval each ty for exrt policy nght now Operating such central bank's account in the clearing facility woud schems properly will require a great deal of imsti- have to be settled in the clearing unit of account or tutionulding firsL Attention now would be better some other muualaly acceptable curency. In the directed to getting the finacial sysm as a whole former Soviet Union, it might make sense to adopt on sounder footing, while promoting exports the ruble as the currency of setdement A clearing through some of the steps outlied in earlier sec- arrangement should complemen, not substitute, for tions of this chapter. the use of correspondent accounts A tader should Even in the longer run, it is debatable whether have the option of carrying out a transaction dtese schemes are the best way to develop exports. through eithermechanism. Experience in other countries (such as Mexico and The major differcnce btwen a clearing union Zimbabwe in the past or, more recently, Bulgaria and a payments union is how soon accoumts must be and Slovenia) shows that revolving funds for settled. The settlement period is short for a clearing exporters to use for importing inputs have often union-generally no longer than a month-where- proved to be unneeded or wasteful (Ceesing 1991). as a payments union allows counties to accumulate A major problem is that they do not revolve-they deficts over a prolonged period. Theren lies its are steadily eroded by exporters who do not repay danger. In other payments unions, countries with the loans. Automatic preshipment credit gurantee the worst macroeconomic policies, which usually schemes like those used in Korea have yet to work are also running the biggest trade deficits, have well outside that country. been reware by being alowed to run up sizable The conclusions of one in-depth study of ars. To avoid this pervse incentive stucture, a exportcredit and insurance schemes in a number of clearng union is preferable to a payments union, OECD and developing counties also cast doubt on INrnTaoNaLPoLxcEs FoR ExpoRT DEvELopmwcm 225 the efficacy and desirability of these programs Exporters also need access to services. Most (Fitzgeald and Monson 1989). The prgrams gen- information and marketing services are best provid- eilry support only a small fraction of exports-less ed by the private sector (domestic or foreign), and than 10 percent of exports in nine out of ten coun- there are aledy signs that private firms a spring- tries studied. Despite providing modest support to ing up in some counties of the former Soviet Union exports, in most cases, these schemes are financial- to pmvide some of these services For services with ly unprofitable and require subsidies. One reason is some public goods charateistcs, it may be advis- that exportrs are probably better than the agencies able to provide them through an official organiza- at distinguishing dsky from nontisky wansactions, don or to provide a modest subsidy for their provi- sa they will choose to insure only the worst risks sion by the private sector. Experience of other ("adverse selection'). Another problem is that the countries counsels caution, however. If official availability of subsidized insuance undermines the trade promoltion oraitons are set up, their goals development of other market-based risk reduction should be limited 2nd well-defined, their suctes instrumets, such as letters of credit private ins- should ensu pnvate nsctor involvemet, and tbey ace, and self-insurance. And any official guarantee should be funded at least in part by user fees for program is likely to find itself in commercial dis- their services. pinus over whether suppliers have met the terms of The breakdown of trade links among the con- their conact tries of the former Soviet Union was both a symp- tom and a cause of the breakdown of the trade Concluding Remarks financ system. One part of the trade fnance sys- The countries of the fanner Soviet Union face tem is gradually being reestablished as banks set up the formidable but necessary task of replacing tade correspondent accounts in other countries of the policies that discourage trade, especially exporM former SovietUnion. Anotherstep hatwould faci- withpolices thatrecognize tbebenefitsof enhanced iate trade is the creation of a system of documen- trade links with the rest of the fomer Soviet Union mry colection that would evolve into a trade and the outside world. To successlly met tis finrance systm based on letters of credit, as used in challenge, they will need to move on many fronts. the West Until then trade links could be strength- The most important actions wil be macroeconom- ened dtrough a clearing union among tie countdes. ic, but institutional policies ar aIso important Exporters, especially of manufactured prod- Annex Trade Finance in the Soviet Union ucts, need duty- and restriction-fre access to Before Mid-1992 imported inputs, including capital equipment. raw Tradeamongcountriesof theSovietUnionwas materials, and intermediate goods. One way to based on the payment request method of finance. ensme this access is to open tie economy for every- lhe supplier shipped goods to the buyer, but released one. This approach has the important advantage of shipping documents to tie buyer's bank along with eliminating all antiexport bias, even that which the request for colection of payment (payment comes indirecty from import restrictions on prod- request). To ensure immediate payment to the sell- ucas not used by exporters It als avoids the admin- er, the seller's bank automatically granted a post- istrative problems that come from giving exporters shipment loan at the time the payment request a specia status. If tariffs or restictions are imposed (backed by shipping documents) was submitted by on some imports, exporters must be exempted or the supplier. The postshipmcnt loan was up to 85 allowed to recoup their duty payments. Hre, there percent of the invoice value (meant to reflect the are tradeoffs. Exempdon and drawback schemes am underlying cost of the merhandise). The supplier's more versatile but more difficult to administer than bank extinguished the loan on receipt of acual pay- schemes based on export processing zones or bond- ment from the buyer and credited the remaining 15 ed warehouses. percent of the proceeds to the suplier's accounL 2:26 TRADN M Na loEPuMEr STAIS The buyer's bank took one of three actions on transferable rubles, crediting and debiting corre- receipt of the payment request. First, the buyer's spondent accounts held in the IBEC by authorized bank automatically debited the buyer's account if it national banks. If required, IBEC provided auto- had sufficient funds, released the shipping docu- matic short-term crediting (which could subse- ments (confinuing title of ownership for the goods) quently be rolled over and even converted to medi- to the buyer, and notified the supplier's bank that um- and long-term loans) in transferablc rubles of the payment request had been honored. Second, if any overdraft run by a member country as a result the buyer had insufficient funds but was within of unbalanced bilateral trade The main method of credit ceilings, the buyers bank extended a pur- payment used by Soviet foreign trade rganizations chase loan (by honoring the supplier's payment in trade with CMEA partners was similar to that request), released the shipping documents, and noti- used in domestic tade-a payment request with fled the supplier's bank that the payment request subsequentacceptance. had been honored. Third, if the buyer had insuffi- After the shipment of goods to a foreign buyer cient funds and was above the credit ceiling, the by a domestic producer, the foreign trade organiza- buyer's bank held the shipping documents (along tion created its own invoice based on CMEA prices with the payment request) and did not honor the and submitted it along with the shipping documents payment request of the supplier. In this case the to Vnesheconombank (VEB). VEB immediately supplier's bank had to roll over the postshipment paid rubles to the foreign trade organization at tie loan to the supplier until the buyer was in a position official rate between the transfeable ruble and the to pay. The third option was rarely used because the ruble; the payment was then passed on to the buyer's bank usuaUy provided a loan, under pres- expcrter. At this stage the transction was over for sure from the planning authorities, the exporter. VEB immediately sent documents to In theory, the payment request method protect- the bank of the importer, the national central bank. ed both tading partners from risks of nonpayment In trn, the importer's bank automatically debited and n eBuyers were protected because the invoice value in local currency (at the official settlement was tied to satisfaction in terms of deliv- exchange rate) from the importees account and ery and quality of goods, and suppliers were pro- subsequently passed on the shipping documents. tected because the buyers bank was responsible for The claims of VEB against the importer's bank collection of payment and released docmnents to were settled by IBEC by crediting VEB's corre- the buyer only against payment or a loan. One of spondent account against the authorized bank of the the banks in the transaction absorbed the risk, but importer in transferable rubles. After receiving doc- any bad debt accumnulated by the banks was written uments from the authorized bank, the importer had off by the State Bank and ultimately absorbed by the right to deny payment within fourten days. the govermevt budgeL Non-arms length trade with countries outside This system automatically provided preship- the CMEA (China, Finland, India) was financed ment and postshipment finance based on the trade through bilatal clearing agreements and did not transaction. Other preshipment financing needs of rely on any multilateral credit institution such as the enterprses were met by their own working capital IBEC. Any bilateral overdraft beyond certain limits (the share of working capital in total capital was was setded either in convertible currency or in addi- usualy 50 to 60 percent). tional merchandise. The same payment request Trade between the Soviet Union and other method was used in bilateral clearing agreements CMEA states was based on annual bilateral proto- with other socialist countries, as in trade with cols in which governments agreed to supply certain CMEA. When enterprises shipped goods (usually quantities of listed goods. The International Bank machinery, equipment, and military hardware) to for Economic Cooperation (IBEC), created to their counteparts in allied countries on the basis of finance CMEA trade, counted each transaction in intergovernmental credit agreements, VEB received INsTrmTIoNAL Poucs poR Expor DeaoprEN 227 ruble payments directly from the Ministry of Long-term loans constituted the bulk of tade finance. Finance immediately after the shipmenL Importers The risks of nonpayment by buyers in industrial were meant to pay their governments, which in turn countries were low, because foreign trade organiza- settled with the Ministry of Finance of the Soviet tions dealt with large reputable companies that had Union. The Ministry of Finance authorized the For- long-term traditional relations wit the former eign trade organizations to collect payments in kind Soviet union. The risks of nonpayment by the buy- and to distnrbute any received goods (such as tropi- ers f om developing countries were somewhat high- cal fruits and sugar) among final consumers at er, but the government exercised political pressure domestic prices, to enforce payment. All risks of nonpayment were Only 15 percent of Soviet trade was undertaken internalized by the VEB (and thereby the budget). with hard currency partners. This trade was usually financed through modem methods of paymnents and settled by documentary collection. VEX usually Notes required letters of guarantee from reputable banks This chapter has benefited from suggestions by Berard to support bills drawn on foreign buyers. The VEB Hoekman, Don Keesing, Michael Michacly, Costas pMichalopoulos. David Tor, Jonahan Waltmes, and L Alan provided such letters for buyers in the Soviet Union Winters. upon request firm foreign suppliers. A small part of r * ~~~~~~~~~~~~~1. Otber more recent SUccessfu cxm .such as Chile this wade was conducted on the basis of documen- and Malaysia, have low tauriff raes of about 10 percent try credit Internationl partners viewed the finau- 2. Uzbekdstan temporaily litd impo riffs unil mid- cil obligations of foreign trade organizations and 1995. VEB as undertakings of the governmient and usual- 3. Under a bonded warehousc system. a fim can import ly did not require anything in addition to acceptance without paying duties and store the inports "under bonr by foreiga trade orpnizations. Letters of credit runtil they arc re-ported or used in making products that by forein tradeorganiztions. Ltters ocredit thc exported& were usually required if the length of credit provid- - . ~~~~~~~~4. This section draws heavily an World Bank (1993). ed to buyers exceeded the usual three- to six-month terms. Suppliers were satisficd wii letters of credit 5- The World Bank has recently recommended that interna- opened by the VEB and usually did not seek confir- don" standard banks fonn the cure of the new financial systen in RussiLa. These banks would finance sucoessfu mation by foreign banks. private fums and highly creditworthy public enterprises Trade with these countries was monopolized under a special incentive structure applied to carefully by foreign trade organizations and trade finance selected banks. One of the important requirements dint individual banks must meet in order to qualify as inlta- was monopolized by dte VEB. Unlikc industrial tional stndard banks should be the potential and willing- enterprises, foreign trade organizations did not have ncss to build the capability to implement modern methods their own current assets and had to rely entIrely on of payment and the related ade finance mechanisms. loans from the VEB, although these were usually disbursed automatically. In practice<, VEB worked References as a single clearing and crediting unit for all foreign trade organizations. Baltrc Buincss Repirt, various issues. The VEB provided regular short- and long-term Bakic News, various issues. postshipment and import finance for foreign trade Esst European rmresuwtMagazn. Fall. 1993. organzations and, in the late l980s, for large state- orgamzauons and, in the late 1990s, f.r Imp state- Fitzgerald, B., and T. Monson. 1989. Preferential Credit owned enterprises. Because the share of manufac- and Insurance as Means to Promote ExportC World tired goods in exports to hard currency markets was Bank Resarwh Observer4 (1) 89-114. small, the percentage of export letters of credit in Umubart S.1992. "Institutional Support for Nontraditional total trade was negligible- Long-term postshipment Exports In J. Nash. ed. Costa Rica: Strengthening finance was provided by the VEB for the sales of Links to th World &xonom. UNDP and World Batk munitions and construction,ofmiitaryit. Trade Expansion Program Country Report 9. munitions and construction of mlitary instlations. Washington, D C. 228 TRADE IN TlE NEW INDEPENDENT STATES Hachette, D., and J. Nasb, cd. 1993. Mauritius: Toward Nas, J.. cd. 1992. Cos Rica: Strengthening Links to the the 21sr Century. UNDP and World Bank. Trade World Economy. UNDP and World Bank Trade' Expansion Program Country Report 12. Washington, Expansion Program Country Report 9. Washington D.C. D.C. International Monetry Fund 1993. "Trade Policy Reform Thomas. V.. and J. Nish, eds. L991. Best Practices in in te States of dte Former Soviet Union." EBS/931158 Tade Poley Reform. New Yort Oxford University .;eprember 23. Washington, D.C. Press. Keesing, D. 1983. linking up to Distant Mrket South to UNCrAD. 1993. 7he Trade Poia Programnu. Geneva: North Exports of Manufactured Consumer Goods' UNCTAD, Tmdc Efficienqc Iniative Americen Econmk Review 53 (May): 333-42. ___. 1991. "Policies for Export Development." i . Wade, IR. 19S. TaiwnO China's Duay Rebate System. Thomas and J. Nash, eds. Best Practkes in Trade World Bnk, Trade Policy Divson. Washington, D.C. Policy Reform. New Yodc. Oxford UrnversxwPresa¶ Warr, Peter 0. 1989. "Export Processing Zones: The 1988. The Four Successful Exceptions: Official Economics of Enclave Manufacturing?' World Bank Export Promotion and Suppor for Exporr Marketing in Research Observer. 4:1 Korea. Hong Kong. Singapore. and Taiwa& China. UNDP and World Bank Trade Expansion Prograin World Bank. 1992. Export Processing Zones. Policy and Occaional Paper 2. Washington. D.C Researcb Sees 20. Industy and Ener Depwament Washington D.C ceesing, D, and A. Singer. 1990. How Support Services Can Expand Mnwwfacntd Exports: New Metods of World Bank 1993. RJsia. Joinin he Wo.rd Economy. Assistance. Policy Research Working Paper 544. Report No. 12108,1993. Washingon, D.C World Bank, Trade Policy Dvision. Washington. D.C. Comment on Chapter 11 The Genesis and Demise of the Interstate Bank Project Danel Gros By the end of 1993, within two years of the collapse of the Soviet Union, all former republics had introduced their own currencies.1 While most economists had expected this outcome, there has been considerable controversy about e speed As a response to the difficulties of 1992, ten with which the ruble zone disintegrated CS sta agred toward the end of the year to cre- and about whether it would have been use- ate a multilater payments system to be operated fud to create some tasitional anangement by ajoit4 instution, the Interste Bank However, to minimiz the disruption that came with the Interstate Bank agreement was never imple- this monetary disintegration. Tfhe dissolution of the mble zone, winch lasfd for most of 1992 and 1993, was very cosdy in ec- A Brief HstoSr of te Interstate Bank nomic terms. Payments within the former Soviet When the USSR broe up, the ruble beca Union became very difficult as the official chan- the common currency of fifteen independent coun- nels on which enteises and banks had to rely at tres Eah cunty had an incentive to create as the beginning were quicldy blocked. The difficul- much ruble credit as possible since the inflationary ties that arose within the ruble zone were mainly impact wo,ld be borne by the others. Russia recog- macroeconomic: Russia did not want to run sur- nized this problem and, in July 199, Starr- to con- pluses with the rest of the CIS and staTted tO block trol flows of fimds from the other ne- . dent payments when it discovered in early 1992 that the states through a systern of corr counts accounts of the other central banks with the withtheothercentrbanks.P ±z _ ,cone- Cntal Bank of Russia showed large imbalances spondent accounts were bilate , zame inpos- This led to a period during which most payments sible to offset deficits and surpzust . a multilater- were organized bilaterally between central banks. aI basis. Momover, with the other new ident Had there been immediate full convertibitity~ pay- states running lage deficits with Russia, the Central ments could simply have been switched to i om- Bank of Russia felt that it had to block payments. mercial banks. But convertibility was established The result was a severe payments crisis, increasing only gradually, and for a variety of technical rea- dollaization, and a rise in barter trade and cash sons it took commercial bkans some time to estab- 10nsac1ons. lish a rudimentary network of correspondent bank- After several failed attempts to reconstitute a ing relationshuips.2 true ruble zone with a common central bank, the 230 TRADE IN TIlE NEW INDEPENDBE STATES CIS heads of state, meeting at the CIS summit on The main meason for the delay was that the fatle October 9, 1992, in Bishkek the Kyrgyz Republic, of the Interstate Bank was linked to that of the ruble concluded an agreement on a single monetary sys- zone. Although the clearing mechanism of the tem and on a concerted monetary, credit, and Interstate Bank had been designed to work as wel exchange rate policy for states stil using the nrble. with separate national curencies as under a ruble The aim of the Bishkek agreement was theoretically zonc, some people argued tat as long as the recon- to establish a clearly defined ruble zone- That stitution of a (possibly smaller) ruble zone remained explains why some countries insisted during nego- on the agenda, the Interstate Bank should not be ser tiation of the Interstae Bank (October-December up. This argument was no longer tenable after 1992) that it should be a joint central bank with Russia introduced its own ruble banknotes in conmon decisionmmaing on tie basis of one state- August 1993 and after the ruble zone was effecive- one vote. It also explains why the eventual agree- ly removed from the political agenda because all ment establishing the Interstate Bank sill contained countries (except Belarus and Tadjikistan) had vague rcferences to central bank tass rejected the offer to create a new type ruble zone- However, a decision by the heads of state at The Interstate Bank could then be viewed as a solu- Bishkek summit called for establishment of a CIS tion for some of the problems created by the disap- working group -tO prepare specific proposals on pearance of the mble zone, the limited convertibili- the activities of the Interstate Bank, first and fore- ty of the new currencies, and the lack of an efficint most on the creation of a payments mechanism?' In payments system the final months of 1992 negotiations on the Thelnterstae Bankintendedtonramultllat- Inteste Bank in which IMF and EU experts par- erw payments mechanimn on the basis of the ticipated, focused increasingly on the bank as a Russian ruble among the member states' central multilateral payments mechanism, and the idea of a banks. The central bank would infom the Interstat joint central bank was moved to the background. Bank each day of the amount of imports from the The clear focus on multilatera clearing and settle- other states that they wanted to pay for The ments enabled Ukraine, which was introducing its Interstate Bank would provide a multlateral clear- own currency at the time, to join the negotiations ing service and inform member states of their and sign the agreement establishing the Interstate cumulative debtor or creditor position. The system Bank together with nine other countries on January was to run on an initial credit line from the Central 22,1993. Bank of Rissia (fixed at 300 biUlion rubles), but The most contentious issues during the negoti- there would be no additional credit. Central banks ations were the subscription quotas. the credit ele- running up against their debt limit were expected to ment, the currency, the decisionmaking procedure, hold the amounts of imports they wanted to pay and membership. (See annex 1 for details.) through the system to the exports declared by the After agreement had been reachzd on most of other partner countries (or face expulsion). It was these issues at the expert level in December 1992, explicitly foreseen that the Interstate Bank would the treaty establishing the Interstate Bank was final- operate in parallel to the commercial banking sys- ized at the CIS stunmit of January 22, 1993. The tem and would never be made obligatory. (See treaty languished thereafter, and no concrete steps annex 3 for details.) were taken to actually set up the Interstate Bank for The first decisions implementing the Interstate nearly a year. Ratification by national parliaments Bank agreement were adopted at a meeting of the began only in June 1993 and was never completed. central banks of the member states in Moscow on The Ukrainian parliament never got around to vot- December 8, 1993. (he timetable of the official ing on the treaty though most other countries negotiations and other events related to the (including Russia, Belarus, and Kazakstan) did rat In-erstate Bank is briefly set out in annex 2). fy the traty in the end. Following tbat, no additional steps were taken to set Cower THE GENESIS ANiD DEMIE Or THE INTERSTAn- BANK PKl;h]FLT 231 up the Interstate Bank. Moreover, in the meantimc, Bank, particulady since any benefits for Russia considerable progress had been made toward con- appeared so modesL vertibility and the creation of an acceptable pay- ments system in Russia (and some otier small C3S Was the Interstate Bank a Good Idea? countries). So the rationale for setting up the The payments mechanism embodied in the Interstate Bank is disappearing fast, and if such Interstate Bank was intended to allow enterprises developments continue, it will no longer make and banks throughout the C1S to make payments sense to set up the Interstae BankL using familiar proedures so tbat the introduction of new currencies or odter macroeconomic develop- Reasons for the Demise of the Interstate ments would cause no trade disruptions. In the Bank absence of a multilateral clearing mechanism the Wy rwas the Interst Bank never setup? One opposite happened. Additional restictions were reason is that most CIS states were interested only placed on trade and payments, and many trade ties in obtauning furder cbeap credit or cheap oil fiom were broken. At first Cm late 1992 and carly 1993) Russia. The leaders of many CIS states were not payments continued to be channeled through the really interested in creating an efficient multilateral accounts of central banks, with the resut that coun- payments system. tries (exceptRussia)introducedvanous couvertibi- To the extent that the advantages of an efficient ity restaints on imports from other CIS countries in payments system were only dimly peceived, them order to achieve bilateral balance with each parner. was a typical fee nder problem. No individual CIS The Interstate Bank, by providing a multilateral country had alarge incentive to investpoliical cap- clearing mechanism, would have eliminated the ital in pushing for the Interstate Bank since the problems of partial convertibility and would have institution would work only if everybody participat- made it easier for firms to live in tiis environment. ed and the benefits would accrue to all member A lot of anecdotal evidence suggests chat large countres, entepses (mainly in Russia) with doDlar accounts Finally there was, and still is, a deep-seated abroad were able to continue to do business within tendency in many CIS countries to wait for Russia .the CIS because they could transact business in hard to take the initiative. But, Russia never took the curency. But most enteprises were not able to fol- necessary steps to set up the Interstate Bank low this route. The transaction costs were enor- because it had little political reason to do so. mous. In 1992 and early 1993 business newspapers Russian leadens believed, correctly, that Russia did in a number of CIS countries carried the adverdse- not need such an institution since it ran a surplus meats of financial firms offering to make payments with all CIS countries. Convertibility was viewed within the CIS (mostly to Russia) for fees in the as the first-best solution and attainable immediate- range of 20 to 30 percent of the value of the tans- ly, so there was little need to discuss anything else. action. There was also consderable opposition to any offi- Over time, the importance of the central bank cial payments mechanism fron some of the radical correspondent accounts declined, and commercial refonners in the Russian government, who feared banks were apparently allowed to deal direcdy with that establishment of the Interstate Bank would each other. Slowly, new payments channels were lead to more pressures on Russia to extend cheap established through the nascent commercial bank- credit3 This was basically a political judgment, ing system. However, this took time and implied since the Bank's charter explicitly excluded any very large transaction costs in some cases4 if the furtier credit. In Russia, where crating any type of many stories told by bankers in Russia are to be public institution is difficult, this weak opposition believed. One simple, additional, technical reason was sufficient to halt all the practical steps that why the Intste Bank would have been usefil is would have been needed to set up the Interstate that it could have processed a large volume of pay- 232 TRkAErI THE NEW IDEPENDr STATS ments, yielding economics of scale not available to the gains from multlafralism, asking: by bow the small correspondent account networks that have much would trade have to contract if all former sprung up so far. republics tied to achieve bilateal balance? It was What were the economic costs of thc absence found dtat the forced reduction in trade would be of a clearing and payments mechanism in 1992 and equivalent to about45 to 6 percent of the income of 1993? It is of course difficult to say exacty what the CIS counties other than Russia. For Russia the would have happened had the Interstate Bank been impact would be equivalent to only 1.5 percent of created speedily. But there are at least tro easons income. By comparison, the same exercise for te to beLeve that dth cost of the disorderly disintegra- EC countries at the time Europe retuned to con- tion of the ruble zone was substantiat one has to do veribility in 1958 shows a gain ten times smaller in with the effect of shrinking trade on output and one terms of GDP. Multilateral trade was thus much with the growth of bilaaism and its ncgative more important to the conties of the former Soviet impact on trade. Union than it was for the EC countries in 1958. Though there is still great controversy about Since the EC counties constituted the bulk of the this argument, simple analysis of the output decline members of the Euopean Payments Union, this across a number of Russian industries sugests that implies that the Interst Bank might have been he decline in intestate trade widtin the former muchmorenimportatfor the GS thantheEuropean Soviet Union had a significant impact on output. Payments Union was forEurope in the 1950s.5 Duchene and Gras (1994) regress the outputdecline The argument tbat all in can tade of almost 100 products or sectrs of the Russian should in any case be allowed to fade away since it economy agamst a number of sectorm indicators, was dictad by central planners rather than com- such as the share of oil input, the share of output paratve advantage was shown by Gros and going to the military, the increase in profitability Dautebande (1992) notto be valid. resulting from a switch to world makrket prices, to name the most important. Most of these indicators Conclusions are not sigficantly correlated with te demline in An efficient multilateral payments system output between 1990 and 1992. The one indicator could have slowed the collapse of inter-CIS tade, that shows a robust and significant relationship is with signficant positive effects even for Russia, the share of gross output going to other foimer which depends less on such trade tan the other CIS republics (the estmated coefflcient was 035 to countries. At any rate, the creation of the Interstate 0.39). With an average of 18 percent of output Bak could have done no harm since it would not going to other republics of the Soviet Union in have halted or even slowed the move toward con- 1990, a reduction in that trade of 50 percent could vertbifity. The opposition from radical reformers in explain afaR in output in Russia of about 3 percent. the Russian govemment (and some Westem advis- The actual decline in intertate trade was probably en) was mistaken. As long as the first-best solution, much larger than that, butLte amount is impossible generalized immediate convertbiity, was not in the to document While this is only a fraction of the cads, a second-best solution in the form of the overa drop in output in Russia, it is still a substan- Interstate Bank would have been appropriate. tial cost that might have been avoided or mitgated. Moreover the argument that the Interstae Bank For the other countries of the former Soviet Union would have resuted in more cheap credit from the costs must have been much higher bece their Russia is also not tenable in the face of the clear economies were more dependent on inte e trade rules on settlement in the Interstate Bank agree- The Interut Bank would have allowed the ment, which included strictimits on available cred- CIS counties to overcome the illism in trade iL These rles would have forced member states to that was so prvalent in 1991-93. GOrs (1993) used bring their overall trade with the other membeTs data on trade flows among the counties to quantify into balance (or face expulsion from the system). by COMer THE Gss AND DasusE OF THE INTRsFATE BANc PRojEcr 233 adjusting their exchange rate or by pusuing tighter credit, the others wil not decline the offer. monetary and fiscal policies. This mechanism zThe final wording is not clear, but dtere is would have been preferable to the ad hoc technical an upper limit equal to one month of credits given by the Central Bank of Rusia. exportls. The Interstate Bank, however, never became operational The other CIS states did not really CurCency whinch sesEfiezu should take ndestand the mportance ofmultilatlra tade and plac (ESB Agreement, ArL 1). The always waited for Russia to move first No individ- Western experts advised the creating of a ual CS country was ready to use its political capital new accountig uit; most states (except to push for the Intestate Bank since it would have Russia, Ukine. and Belarus) wanted to received only a small share of the economic gainsf6 use the ruble. In the end, the ruble issued by Russia never took the necessary steps to set up the the central bank of the Russian Federation lIntea Bank because its leadas felt no need for waS choseL such an institution since Russia ran a surphls with . D *Decrsiomnaolg procedure (ISB Charer all CS counitries. At 7) Russia argued, for obvious reasons, Annex 1: The Main Issues during the for weigted voting (the Western exper Negotiations supted this); the Central Asian represen- - iau~~~~~~~~~~~ves insisted on one state one vote- Five main issues emerged during the negotia- a tions on the ltersat Bank taty that were con- Weighted voting won ouL ducted at the expert level between October and * AMabership (ISB Agreement, Art. I and December 1992 by reprsnaves from an CIS 9). The October 1992 Bishkek agreement states: provided for the possiblrity of establishing ' Subscripon quotas tte cap of t a payments union with non-ruble zone Imernatc Bank (ISB Ageementc Art 4). WUntries (Bishkek Agreement Art. 13). Should die quotas be of equal size or linkd This happened within the context of the to each member's foreign tade turnove? Interstate Bank, as non-ruble zone coun- This issue tumed out to be not very r- tries became founding members. Moreover, tant snce dte bank would only clear pay- other, non-CS countries could participate ments. It was nevier to have any net posi- in the multilatera clearing as nomnembers tion. The capital would only be used to pay simply by opening an account widt the for buildings and the like. The initial capi- Intersate Banl tal wa eventually fixed itS billion rubles. Annex 2: Tlime-Table of Negotiations and * Creit elment (ISB Agreement, ArL 6). other Official Acts Credit mi8ht be extended to cover deficits up to a certain (cumulative) ceiling. 1992 Discussion focused on whether to set the October9 Agreement of CIS heads of state "on a credit ceiling for each country as a function single monetary system and a concert- of trade turnover or of actual receipts for ed monetary, credit and exchange rate one or two months. Since Russia would policy ofte states which have retained provide most (probably all) of the credit, the mble as legal tender" (Bishkek the discussion on this point was somewhat agreement) concluded at Bishkek, academic: if Russia does not want to pro- Kyrgyz Republic; decision of CIS vide credit, the others cannot force k to do heads of state at Bisbkek to set up a so, and if Russia wants to provide ample working group on the Intersme Banl 234 IhADE m ME MIW 1NDEWDENr STA1ES Oct-Nov Russia, with the help of EC expets, agreement; no decions tken because prpars draft "Agreement establishing aqualified majority was not presenL the Interstate Bank. Nov. 15 CI Consultative Coordinating Nov-Dec Russia, with help from the IM, pr- Committee reiterates strong support pares a draft charter for the Interstae for Interstate Bank and calls for "orga- Bank, three meetings of CIS working nizaional- meeting of lntstate Bank group of experts wnth participation of board by December 10. IMF and EC experts result in final drft ageement and charter for the Dcc. 8 First ful -orgniitionala meeting of Interstate Bank lnterstat Bank Board in Moscow con- centates on personnel maters Mr. 1993 Gershhenko elected chainnan of the January22 Approval by heads of stae of draft Intertat Bank board and Mr. Savanin agreement iniialed at expert level with appointed president of the Intertate two changes: unit of account is the BanL ruble issued by tbe Central Bank of R-ssia,, and votes on the counciAnnex 3: The Payments Mechanism of the Rude, and votes on the council am Interstae Bank distnrbuted as follows : Russia 50 per- basi cent, other members' ~ Te basic principle of the multilatera pay- ments mechanism of the Inerste Bank was that a fixed on the basis of inua-Soviet trad particiting country, say country A, would no in 1990. longer sette internationil payments with obe par- M:ach Joint DIMFEU wcrk ing group begins ticipants individually but would deal directly with peparations and consultations on tech- the Intate Banl The central bank of country A nicai aspects of clearing and settlemt would send all its payment ordes for imports from stem.a the other partating countries to the Interste Bank after converting all payments into the unit of April21 Seven contacting parties decide to set account used by the Intest=ate Bank. Themultlater- up "Organizing Committee" at tie al clearing system foreseen i the Mnsk agreement level of central banks, chaired by Mr would use the (Russian) ruble as the unit of Savanin of the Bank ofRussia. account The ban's role would then be to clear al May 14 CIS heads of state "recommend" that tractions between country A and the other par- the Interstate Bank agreement and ticipating countries. The clearing woud result in a charter be ratified in member states single entry in th correspondent account of country and preparations be made by July 10 A. Each participating country would have a single for the Interstate Bank to begin opera- conreondent account in the Interstate Bankl The tions on October I- clearing was to be done each day, with the Intemate Bank calculating the net deficit or surplus of each June30 Ratification in Russia, Belarus and ony Kaahsa had ahay ratificd; a cuty umCrzalChofn hadie alutready rafleo These daily balances (flows) could then be number of other countries follow. used to calculate a cumuative position (a stock) for August 20 First meeting of the Itutt Bank all participating countries. At the end of the first board in Moscow to make decisions day the cumuative position would be equal to the implementing the Interstat Bank deficit or surplus of that day (plus the opening bal- ance). For all following days the cumulative posi- CoMMEurN THE Gemss AND DEMsE aOF T EM RS ATE BANrI Ptoncr 235 Lion at the end of the day is equal to the previous on Interstate Relations, (EES-AGIR) financed by tde day's cumulatv position plus (or minus) te TACIS program of the Euope Union. I wish to thank Professor Gerard DuchEne for his cofabomation and FPlp surplus (or deficit) plus (or minus) the interest on Comeis for his very efficient assistance. the pmvious day's cumulative position- 1. Except for Tdjikiscan, which is in the midst of a civil An important aspect of the systm was to be a war and continues to use the Russian mble. limit on the cumulative deficit, or debtor position, 2 E Esoian enterpises, which operted in a fav- any country could build up equal to one month of able manncroronmic framework, initialy had great difi- export receipts (the imports from the country con- cuty orignizing their payments with Russia after the intro- cemed that are declared to the Interstate Bank by duction of the kroon. t-he other member countries over a one-month pen- 3. And firm one of their wesen advisors Mast middle- od). levcl onponents of the Intersta Bank remained when the 'flagship' reformers abandoned alt govemment duties in If a country's correspondent account was in early 1994. deficit on the settlement day (day fifteen of a fif- teen-day period) the country could pay the amount 4. Te commeral banking system is not effiient enough to fiuly enae trade among CIS ountries to reover to a of the deficit to the Intersme Bank or obtain a set- normal market-driven leveL Tis does not men that ia- dement credit up to the crdit limit If the deficit CS trade should recover to its prereform level Gras and Dautebande (1992) show that there should be a radical excecded this limit, the cxcess sum had to he set- rorientation of trade tward the EU and theWest in gamer- fled. That means that fte deficit country would have atL to pay the excess in convertible currency or gold by 5. Considerng the radical reorientation of trade likdy for purchasing rubles for them or by borrowing rubles atl CIS couaries these esimas are canly on the hig from other countries (but not firm the Interstate side if one takes a medium-perspective. However. the pur- pose of the nteCrst Bak was to smooth the transition, so Bank). In case of a surplus, the surplus would fist the short-nm pesective adopted hae is appropriat be used to redee setdement Ioans obtained on pre- 6. PoliticaHly. the Interstate Bank was not popular in a vioUs settlement days and then any remaining sur- number of countis since it implied closer ties with Russia plus would be deposited in the account ofthe credi- tor country to be used as desircL The end-users of the system, private banks and References enteprises, would not be concemed with this mech- Duchene. Gerard, and Daniel GrOs. 1994. A Coaaiv anism at all. Importers would pay their national Srudy af )rupur Decline in Transition Economics. central bank in national currency for the export con- Center for Euopean Policy Smdies. Brussels. tract they wanted to pay. Each national central bank hGros, DanieL 19931 Bilaemlivn versus Muldkeralim in would he responsible for setting the exchange tae the FSU: What is the potential gain from the ISS? so that imports approximately mvered exports (plus Canter for European Policy Studies. Brussels other hard currency sources). Gras. Daniel. and Berenice Dautrebade-. 1992. "Inermational Trade of Former Republics in the Long Notes Run: An Analysis Based On The 'Gravity' Approach" This contribution is hased on the work of a group of advis- CEPS Working Document 71- Center for European em from the European Exportive Sevice - Advisory Group Policy Stdies, Brusses. Trade Perfornance and Access to OECD Markets Bartlomici Kaminski AtX dependenc the counties of the fonr Soviet Union were ill-prepared to exploit the opportmities offered by imter- natioa mrkets. The shock of die disintegration of dte com- mon economic space of the Soviet Union was significantly greater forte new states than was the breakdown of the Council for Mutual Economic Assistmce (CMEA) to its East Eunpoa - Tendencies in Trade members. Althugh East European countries had been ith Performance mcmbers of the Soviet bloc, they had had considerable discre. tion in their freign economic policy and had mainied some N OECD Trade Bareis mutonomy in their domestic economic policies. They were not part of a single command economic system, because Moscow * Access to OECD Marets had not succeeded in imposing integmed supranational plan- Since the Dissolution ot ning within the CMIEA. Nor were dtey part of a unified budget the Soviet Union system which, in the Soviet Union, had redistibuted inoms * Vulnerability to Trade mng the republics. As aresult, te countries of Eastn Europe Remedy Measures had less misdcveloped economic stuctmes, although teir abil- ities to adjust to international markets had also been impaired * Conclision by past misaiocations of resources. I=lcuster trade performance in the aftermath of tbe Soviet break up was a combination of unfavorable initial conditions, limited progress in macroecnomic stabilization and libeaza- tion ef foreign tmade, contaction in impw t demand in the for- mer CMBA countries, and limited access to Organizaion for Economic Cooperation and Development (02M) markets in 238 TRADE iN Nll NEW INDEPB STATES addition, many countries, especially the land-locked Most countries of the former Soviet Union have former Asian republics. had to deal waith inadequate a long way to go before they can benefit from efli- transportation infrastructure) ciency gains usually associated with the move Geography and transportation problems toward integration with the intenational economy. accounted for the fact that the foreign trade of the The Soviet Union, which exported mainly oil and Soviet Union had been the preserve of European odier primary commodities that ihd not face signifi- republics. Excluding Russia, Ukraine. and Belarus, cant bamre was not much concerned with condi- the combined contribution of the other republics tions of maret access. The situation is radically dif- amounted to less than 7 percent of total Soviet ferent now that countries have formal economic exports in 1990-91- Russia alone accounted for sovereigpty. Foreign tade is of direct relevance to about 78 percent, Ukraine about 13 percent, and the welfare of the new sate-espcially the small- Beis about 3 percent. The two largest Asian erones that are heavily dependent on exteral inter- Tepublics, Kazakhstan and Uzbekistan together actions. And as demand in the countries of the for- accounted for only less than 4 percent in 1990-91, mer Soviet Union and former CMEA contracted, and the Baltic and Transcaucasian republics' share access to OECD markets has become critically was 25 pecnt The cental Asian republics had a importanL In addition to inherting the legacies of negligible share, in large measure because their central planning& the coumtries of the fomer Soviet exports of energy were attnbuted to Russia By Union inherited the Soviet Union's position at the 1993 this picture bad changed significantly, with bouom of OEC import prefrnce schenes, facing the Baltic and cenal Asian states having substan- adverse tariff margns and more restrictive nontariff tily expanded shares in total exports, oiginatig barriers than othercounries. Although market acces in the former Soviet Union. has impod markedly since independence, the for- While some ibrmer CMEA economies were eign economic relations of the new countries have able to cushion the impact of the colapse of import not yetbeen fuly 'normaiizedL demand in the former Soviet Union by expanding thi exports to OECD counties, the new indepen Tendencies in Trade Performance dent stas have faced a more daumting challenge. Trends in trade that had been discernible since The republics tended to be inward-oriented- their the mid-1980s aoelrated in 1992, when interstate shares in exports to the rest of the world were sig- tade contracted severely and trade with the rest of nificantly lower than their shares in interstate track% the world shrank as well or stagnted. Preliminary rflecting stare monopoly on foreign trade at the estimates indicate that the trade declie with the rest union level and the centrally controlled internal of the world seems to have bottomed out in 199223 division of labor 2Not surpisingly, inate trade In 1993 exports to countres outside the former accounted for a much larger share of their total Soviet Union grew by 5.7 percent and imports feil trade than was the case among EU economics by 64 percent The OECD predicts afurtherexpan- (Michalopodos and Tarr 1992). Links with the sion iexocts and an increase in imports in 1994. world economy were tenuous at best: except for Russia and UJkraine, shipments outside the Soviet The Growing Importance of OECD Market Union in 1989-90 accounted for less than 15 per- The share of OECD markets in total exports cent of exports (to other countrines of the former outside the former Soviet Union increased from Soviet Union and the rest of the world)- This situa- abut 46 percent in 1980 to 53 percent in 1990, 72 tion contrasted sharply with tat of European percent in 1991, and 73 percent in 1992_4 However, CMEA members, whose shares of non-CMEA the increased shares during 1990-92 were the result exports in this period ranged between 46 percent not of expanding exports (they remained stagnant at (Bulgaria) and 76 percent (Romania). (s about US$30 billion), but of contacting exports to Economic Bulletin for Europe, vol 43, 1991). other markets.5 The Soviet Union was a marginal TRwAE PEFoRMANE AND AOcEss To OECD MARs 239 Table 12.1 Exports from the Former Soviet Union to the OECD, 1990-93 (millions of U.S. dolars) 1893 Value ot OECD P ntdHnge EU EFrA Oer OECD 1993 wvorks Ab OEDMpmr htm bom capta AS 1990a 1992 1993 1990 19W 1990 182 13 199$ 1992 1993 1990 1992 1993 dar) Anfnenia 53 12 9 17 79 23 6 3 4 4 0 26 2 1 3 Azwijan 227 57 96 42 168 148 20 45 62 0 2 17 1. 1 14 Bolarus 1,210 231 378 31 163 900 179 304 18D 19 26 130 30 40 37 Georgia 160 108 95 59 87 107 91 45 19 2 2 34 10 23 17 Kazaldstan 519 151 457 88 302 358 84 302 68 20 31 63 37 42 28 Kygyz Rpublic 26 9 16 63 180 24 1 9 3 6 1 -1 1 3 4 Moldova 85 25 64 75 253 69 21 30 11 2 1 5 1 2 15 Russia 22,437 27.390 26,816 120 98 16,66B 20.179 17245 3.345 3,478 3.073 2424 3.509 2.183 182 TajllStn 183 34 116 64 343 125 12 65 23 2 13 31 13 20 23 Tueanistan 55 90 275 495 305 43 40 157 10 25 33 2 4 2 78 Uklaine 3,631 1,144 2,01O 55 176 2813 772 1,105 517 112 110 301 170 217 39 LUbekstan 464 151 576 124 380 310 113 481 37 8 19118 10 7 29 Estonia 63 374 471 748 126 26 79 169 28 144 250 9 13 23 300 Latia 114 547 884 775 162 65 131 682 43 40 154 6 9 27 330 Litwarha 208 641 872 419 136 131 549 721 55 70 78 23 22 22 236 TOt 29,434 30396433,133 113 107 21,843 2276 21,383 4.40W 3,929 3,791 3,187 3,831 2613 116 Noa a. Republicexpos in 1980 weecompated on thebasis ofOEMD impa.smusingGoDskomsts offic estimatesofcpn to vas OCDregions as wgm Souzc:CS In _ rSatianoerterss (t992); UNECE(1993); 199 and 1993; OBCD impartsas eportedto the United Nauions COMrRADE rnords partner for most OECD countrics during 1988-91, shift to less processed raw maerials (for example, with a share in OEC) trade of around 1.2 percent from petroleum products to crude oil exports. Within the OECD, the European Union (EU) was absorbing a gowig propoion of exports from the E&poit Pefformance in OECOD Markets former Soviet Union: its share increased from 71 While a country's trade pattens are determined percent in 1991 to 74 perenti 1992. to a lare extent by past patens of producton and The conaction in exports from the former dLe ease of adjustnent for different industries, the Soviet Union to non-CEC) markets was much experience of transition economies demonstrates larger in primary commodities than in industr thatprogress in macroeconomic stabilizaton and in products. Between 1990 and 1992 the value to non- the establishment of market-supporting institutions OECD markets of primary commodity exports contnrbutes to improved export performance and (SITC 0 to 4 + 68) feil by 65 perceat while that of significant changes in the composition of exports total exports fell by 52 percent.6 The value of (Balcerwicz and Gelb 1994). Reiection of trade exports of prmlary commodities to the OECD fell is also a measur of progress in dismantling central byjust2 percent Thusr prmay commodity exports planaing. The transition economies of Central to OECD economies increased from about 50 per- Europe experienced a surge in exports to OECD cent of total exports in 1990 to 82 percent in 1992.7 marnkts during the frst year following radical sma- The share of primary cormnodities in exports from bilization and economic transformation prgrams the former Soviet Union to the OECD remained sta- (Kaminsld 1993). How have the countries of the ble at about 76 to 78 peezt, although it fel slight- forme Soviet Union fared in terms of their exports ly in 1992, mainly because of falling prices and a to OEC markets? 240 TR^DE N mW NEW INDEPNENtr STAi!s A comparison of exports (by value) before Simiaies in Net Trade Penfomnance independence in 1990 (based on Goskomstat est- At the time of independence, the outside for- mates of trade for the former republics) with eign trade of the new states displayed remarkable exports in 1992 and 1993 gives an indication of the simIlaides, as demonstrated by their net trade per- direcon of change (table 12.1)9 formance in major product groups based on net Despite dteir previous dependence on fiscal trade performance indexes (table 12.3).t (Indexes transfers from Moscow and substntial industrial- range in value from -I for a product that is imported izauon under central planning, the Baltics succeed- but not exported to +1 for a product that is exported ed in increasing their outside exportsY They sub- but not imported, so that a positive value denotes stanially rediected their trade flows, mainly to net exporter status and a negative value indicates net OECD market Their share in exports from the for- importer status.) These indexes clearly expose the mer Soviet Union to the OECD increased fiom 1.3 failure of Sovietplannes to develop agiculture and - .rcent in 1990 to 5.1 percent in 1992 and 8.3 per- intenationally competitive industrial sectors as well cent in 1993-if Russia is excluded, that share rise as their aversion to consumr products All the coun- from about 6 percent in 1990 to 44 percent in 1992 tries of the former SovietUnion are net importers of and 59 percent in 1993. For some Asian republics- food products, textiles (except Armenia, Estonia, notably Turkmenistan and Uzbekistan-ar increase and Lithuania, see table 123), and machinery tans- in exports can be attributed in large part to more port equipment and net exporters of agriculural accurate allocation of expls follownng the dissolu- mateals, and fuels (except Estonia and Kyrgyz ton of the SovietUnion. On aper capita basis, their Republic). The bias of cental planners in favor of exports to the OECD remain very luw, however heavy industries is evident in th net exporte stas (see table 12.1). of the more devdeloped European countries (except Tn 1992 prmay commodities accounted for Estonia) and of some Asian countries (Georgia, the bulk of expors to the OECD, with fiuls, ors, Kazakstn Kyrgyz Republic) in iron and steel. and metals being the major export eaners even for The net export stams of all new independent countries that had no naturals t source endowments states in agricultural materals, ores and metals, and (see table 12.2). For some countries, reexports are fueds (except Estonia, Kyrgyz Republic, and easy to identify. For instance, the largest item in Tajiistan) cannot be explained by a similarity in Latvia's exports to OECD countries was petroleum the distrbution of natual resources. Rather, 4Jis products. Although Latvia has no known oil similarity in net trade status is due to past patterns deposits and no refineries, crude oil accounted for of investment location and to transshipments and 9 percent of its OECD exports in 1993 and petrole- reexports of surpluses obtained in barter exchange. um products for 40 percent Similaly, according to the 1990 production staistics, the Baltics did not OECD Trade Bariers mine orproduce ores and metals, yet ores and met- The new states that emerged from the dissolu- als accounted for 35 percent of the total value of tion of the Soviet Union inherited the adversarial Estonia's exports to the OECD, 13 percent of trade relationship betwen OECD countries and the Latvia's, and 26 percent of Lithuania's-most of Soviet Union.L2 Though these countres became them probably reexports from Russia. Russian members of the MF and World Bank within a year firms engaged in reexport activities as well, mainly of independence, they are still not members of the of products originating in the Asian countries as GATT and their foreign trade relations await full the low share of fuels in Azerbaijan's exports normalization.13 Because trade between OECD would suggests. Oveall, however, because of countries and the new countries of the former Russia's enormous natural resources endowment, SovietUnioninftirfrst y of independence was reexports cannot be as easily estimated as is the govemed by the samie conditions of acoess as had case for the Baltic states.10 applied to the Soviet Union, those conditions war- Table 12.2 Commodity Composition of Exports from the Former Soviet Unlon Kyrgyz Arrnena Azoebaan Belaaru Georgta Kazakhstan Republ Moldva Russia Taflkiskan Tuwmenlstan Uklaine Uzbekiasan Estonla LaOW L.lhuanle MWlknsofU.S. dffas Allgoods{OtoB) 12 57 231 108 161 9 25 27,390 34 90 1,144 151 374 547 641 Prtaiycommodities(Oto4+68) 4 51 141 102 86 2 16 21,362 33 83 802 144 221 430 496 All foods (0+1t+22+4) 0 0 5 2 3 0 2 11,299 0 1 S a 27 18 42 Agdcutumlnaterlals(2-22-27-28) 0 8 30 2 9 1 0 1I9'8 16 52 52 138 37 47 29 Oresandrmetals(27+28+68) 0 3 38 14 51 1 4 3,308 18 3 154 4 131 59 167 Fuels 3) 3 40 07 84 23 0 8 14,788 0 28 603 2 2 296 259 Allmanutacturos(51o848) 8 6 87 5 as 1 10 4,465 1 a 319 6 149 113 137 Chmlauls(5) 0 2 37 0 17 0 2 1,516 0 0 141 1 24 39 60 Textles and clotg (65+84) 1 3 9 0 0 0 5 150 a 3 35 1 68 20 s0 Imn andsteel(87) 0 0 4 4 46 0 0 777 0 0 103 0 2 7 5 Machlnewyandtmnspt (7) 0 0 36 0 0 0 1 982 0 2 57 0 19 12 11 Not dasuled(9) 0 1 2 0 0 6 0 1,524 0 0 19 1 1 3 4 Pemni Allgoods(Oto9) 100 99 100 99 IOo 10w 100 100 I 1w 100 100 lo t 100 100 100 Prlmayyommoaloes(Oto4148) 34 89 S1 96 57 24 61 78 98 92 70 98 9 79 77 AI foods (0+1+22+4) 2 0 2 2 2 4 10 5 0 1 3 0 7 3 6 Agdcurtualmaater(ls(2-22-27-28) 1 14 13 2 6 10 2 7 46 58 6 92 10 9 4 I Ofesandmetals(27+28.68) 3 6 17 13 34 10 17 12 53 3 13 2 35 13 26 Fuels (3) 28 70 g9 78 15 0 32 54 0 31 49 1 7 54 40 Ai manuiacture (5 tO 4108) 6B 9 38 5 43 a 39 16 2 7 29 4 40 21 21 Chen*uls(5) 2 4 is 0 11 2 7 8 0 0 12 1 8 7 9 Textlte anddothfrt(60+84) 9 a 4 0 0 0 lo 1 0 4 3 1 15 4 6 Iron and ate (67) a 0 2 4 W 0 0 3 0 0 9 0 0 1 1 MacNnhliandtmneport(7) 1 0 16 0 0 3 6 4 0 3 a 0 a 2 2 Not cdasslled (9) 0 1 1 0 0 66 0 6 0 0 2 0 0 1 1 Note: Expn of Estonia, Lithuania, and Laxvia have not been corrected for possible reexporls. Items in pauenlbcus mepresent Stadad Intemadonol Tmde Clssificatlon (SIQC) categories. Source: Derived from UN COMTRADE mecords. _ : :~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~% 242 TRADE IN THE NEW INDEPENDENT SrATES Table 12.3 Indexes of Net Trade Performance In Markets Outside the Former Soviet Unlon In 1992, by Major Product Group Aguitria Ores & Textleos & hun & Machinery All Ailfoods matedals metals Fuels Chericals clothing sted traSport manufache Total rest of wodd Anrnnia -0.99 0.82 0.95 1.00 -0.40 0.01 -0.27 -0.93 -0.05 Aaerbeljan 40.98 0.98 0.72 0.70 -054 -027 -092 -0.97 -0.85 Belarus -0.75 0.87 0.70 0.83 0.36 -0.07 0.29 -0.49 -0.18 Estonia -0.61 0.91 0. -0.03 025 0.12 -0.60 -0.78 -0.31 Georgia -0.86 0.93 0.99 1.00 -0.33 -0.89 0.99 -0.92 -0.48 Kazdkhstan -0.95 0.90 0.75 0.99 0.36 4.96 0.55 -0.83 -0.20 Latvia -0.69 0.93 0.93 0.89 0.39 -0.15 0.92 -0.84 -033 UithuanIa -0.49 0.86 0.97 0.94 0.46 0.01 0.89 -0.72 -0.10 Kyrgyz Republic -0.95 0.75 0.99 -1.00 0.67 -0.94 0.89 -0.11 0.00 Moldova -0.02 0.60 0.89 0.94 -0.40 -0.50 0.39 -0.21 -0.13 Russia -0.69 0.90 0.80 097 020 -0.82 0.39 -0.50 -0.29 Tajikslan -0.99 0.98 1.O 0.00 -058 -0.80 0.12 -0.99 -0.88 Turkmenistan -0.95 0.99 0.87 0.9 -0.82 -0.35 -1.00 -0.92 -0.86 Ukraine -0.76 0.63 0.75 0.81 027 -0.47 0.45 -0.79 -0.34 Uzbeldstan -1.00 1.00 0.45 0.92 -0.33 -0.87- -0.74 -0.95 -0.81 Tade uit OECO counries Armenia -0.99 1.00 0.97 1.00 -0.70 0.51 -1.0 -094 -0.01 Azerbaijan -0.94 0.97 0.55 0.65 -0.84 0.82 -0.99 -1.00 -D.87 Esonia -0.68 0.91 0.93 -0.06 0.07 0.17 -0.62 -0.80 -05 Belarus -0.85 0.87 0.9B 0.91 -0.03 0.01 -0.58 -0.68 -0.47 Georgia -0.86 .8B 0.99 1.00 -0.88 -O3 0.99 -0.95 -0.58 Kazaldtan -0.65 0.84 0.94 0.68 -0.39 -0.76 0.48 -1.00 -0.47 Kyrgyz Rpubric -0.11 -0.02 0.98 -1.00 OS3 -0.93 -0.69 -0.88 -0.79 Latvia -0.77 0.93 0.92 0.89 OAO 0.15 0.84 -0.86 -0.37 Uthuaria -0.64 0.85 0.99 0.95 0.44 0.12 0.75 -0.83 -0.17 Moldova -0.77 -0.50 1.00 0.78 -0.35 0.38 -0.52 -0.87 -0.48 Russia -0.69 0.90 0.90 0.98 -0.07 -0.67 -0.02 -0.7B -0.52 Taietaln -0.99 0.95 1.00 nva -0.87 -0.53 0.11 -0.99 -0.90 Turkmenistan -0.94 0.99 09 0.99 -0.71 -0.05 -1.00 -0.92 -0.87 Ukrai -0.82 0.73 0.90 0.97 -0.07 -.16 0.25 -0.86 -0.54 Uzbekstan -1.00 0.99 0.84 0.92 -0.82 -053 -1.00 -0.99 -0.94 No The value of he net uade peformance index anges from-I fora product dca is impoed b anotexported to I foraprod dt tis exported buit not hnptot& Soucre Derved frm Unitd Natons CONITRADE recds. rant a bref overview. Moreover, almost all the non- trally planned economies and faced considerably tariff bamriers faced by Soviet exporters are still in higher tariffs than simlar, competing goods export- place, and the new countries are even more vulnera- ed by otier countries.14 Tariffs in the United States, ble to escalation of trade barriers than was the Japan,andtheECweresome70to90percenthigh- Soviet Unic.i, whose major export earner-oil, er than the average tariff on aU imports in these gas, and gold-were not heavily burdened by non- three markets. For all manufactured goods com- tariff banriers. bined, the 6.7 percent tariff applied by the EC on Soviet goods was more than twice as high as the Tariff Barriers avenage duty all exporters paid on these same prod- The Soviet Union faced adverse tariff margins ucts and three times the corresponding rate facing in OECD countries and more restrictive nontariff developing countries (see Table 12A4). These bamiers than those faced even by its European adverse tanff margins allowed other suppliers to CMEA partners. Exports from the Soviet Union displace (divert) potential exports from the Soviet were subject to restrictions imposed only on cen- Union. TRADE PERFORMANCE AND Access To OECD MARKmo 243 OECD preference schemes accord different ization strategies can stimulate overall industrializa- tariff treatment to suppliers from various countries. tion and growth (Roemer 1979). Among the bene- The EU has preferential trading arrangcments like fits cited are avoidance of the deteriorating terms of the Lomd Convention, the protocol with EFIA for trade for primary commodities, increased employ- free trade in manufactures, European Association ment opportunities associated with the production Agreements with Central European counties that and export of manufactures, achievement of impor- envisage a gradual introduction of free trade for Lant linkages with other sectors of the economy, nunufactures, and regional preferences extended to improvernent of human capital through learning countries like Morocco, Tunisia, and Turkey. The effects, and the greater stability of prices of processed EU also used more restrictive nontariff barriers goods compared to primary commodities. However, against the Soviet Union (quotas, variable levies, trade barrier escalation in major international mar- discretionary licensing schemes) and with higher kets is an important constraint to furthier processing frequency than against other trading partners in commodity exporting countries (see Balassa (Olechowski and Yeats 1982). The United States 1968 for an early statement of this point, or later gives preferences to selected developing countries studies by Helleiner and Welwood 1978 and Yeats under the Generalized System of Preferences (GSP) 1979). Trade barrier escalation raeans that tariffs and also has important regional preferences under (and nontariff barriers) are low or absent on the Caribbean Basin Initiative. The United States unprocessed commnodities but rise with the degree also has free trade agreements with Canada, israel, of fiurther processing, creating a bias against trade in and Mexico that are aimed at phasing out duties processed commodities. with these countries. In addition, the main device The higher the escalation the higher the effec- differentiating access to the US market among vari- tive rate of protection afforded by tariffi and other ous sources is most-favored-nation (MEN) status. trade restraints and the more foreign expoers must The Soviet Union was blocked from eligibility by reduce returs to domestic labor and capital.15 the 1974 Jackson-Vanick amendment linking the Empirical studies have shown that some low nomi- granting of MFN status to a country's emigration nal tariffs that appear to be unimportant may con- policies, so Soviet exports were subject to discrimi- ceal high rates of effective protection. natory taiffs. Because entrprises and foreign trade organiza- tions in the Soviet Union, which exported mainly Vulnerability to Trade Banier Escalation energy, industrial inputs, and low value added prod- A relatively high share of Soviet exports to the ucts for further processing, were indifferent to rev- OECD consisted of unprocessed or semifabricated enues generated by exports, they had no incentive commodities-items whose further processing today to respond to higher tariffs by moving to less pro- could potentially offer important benefits to the new tectd product groups. Effective protection in states of the former Soviet Union. Some economists OECD markets is quite high in several sectors in have argued that natural resource-based industrial- which new independent states (Armenia, the Table 12t4 Avemge Tariffs Facing Soviet Exports of Selected Manufactures In the EC, 1990 (percent) Imports from USSR (tLS.$mn0in) Developing Countds SovietouWrs Affexotes AM manufactured goods 2,171 2.0 6.7 2.8 Chemicals 775 1.6 7.7 3.5 Plywood and veneer 79 0.8 7.1 1.4 Paper manufacturms 43 1.5 8.7 7.1 Souic: Daived fiom he World bank-UNCTAD SMART dauabme 2.44. FTRADE IN THE NEW INDEPBD STATES Baltic states, Belarus) should be ab'le to increase that variable import levies in Switzerland and processing. In general, effective tariff rates aveag Sweden, which are applied extensively to apicul- more than twice the corresponding nominal rate- tmrl imports, often have ad valorem equivalets of indicating that OECD trade barriers have a far more over 100 percent restrictive effect on imports than a superficial analy- For manufactures, nontariff batriers were high sis of nominal rates would tuggest (Laird and Yeats as well, especially in the EC, Sweden, and 1987). Switzerland. Almnost 20 percent of Soviet exports to the EC faced nontariff barriers, with leather and NontariffBarners leather goods, textile yarn and fabrics, ferro"m met- As a result of post-war trade negotiations under als, clothing, and footwear facing especially tonmi- the GATr, tariffs have declined dramatically in dable barriers. A survey by Laird and Yeats (1990) importance as instruments of protectionism in all suggests that the level of protection provided by OECD countries. Average tariffs now range from nontariff barriers in the EC lay between 30 and 50 0.2 percent to 6 percent, MFN tariffs on industial percent for textiles and clothing and between 20 and products average about 6 percent, and GSP tariffs; 30 percent for ferrous metals. Hamilton (1984, are about 2 percent The main instruments of pr- 1986) estimates that the protection provided by teclionism have become nontariff barriers, includ- META's nontariff barriers for textiles and clothing ng quantitative restrctions (Multibre Arrangement, was at least as high as that in the EC, and probably agricultural pmducts), voluntary export restraints, somewhat higher for agriculture. In consequence, restrictive licensing requirements, variable import uontariff barriers often constituted a major impedi- levies or flexible import fees, and import surveil- ment to Soviet exports and, in specific sectos, will lance. For example, EU imports of agricultural almost certaiy prevent any significant trade products, textiles, footwear, and motor velicles are expansion. subject to such measures. Another very effective A sense of the importance of OEC) nontariff group of nontariff measures is related to the so- barriers to the countries of the fomer Soviet Union caled trade remedy laws agaist "unfair' trade. can be obtained by comparing bundles of their Antidumping investigations and undertakings dis- exports to the OECD (see table 122) with nontariff courage importers fron placing orders for products barrier coveage ratios (table 12X5). In general, the under investigation as well as for those falling into share of a country's exports subject to nontariff the same group because of the fear that antidump- tade barriers tends to be laWer for countries whose ing duties will increase import cost exports include a high share of agncultua prod- Between 50 and 70 percent of food exports ucts, iron and steel, and texiles and clothing, and from the former Soviet Union encountered nontar- smaller for countries specialWing in labor-intensive iff barriers in OECD markets. More than three- engineering and consumer goods, fuels and ores, quarters of food exports to Finland and Sweden and metals. Agricultural product groLps suffer the encountemed nontariff barriers, as did almost 70 most from nontariff barrers. Although exports of percent of food exports to JapanL EC nontariff bar- food products account for only a small propordon riem applied to 80 percent of Soviet meat and sugar of total exports to the OECD (and the fifteen coun- exports and to slightly less than half of all fresh and tries in te aggrgate are net importers of theseprod- preserved fruit products. These nontariff barrers ucts), efforts to expand exports (assuming the 1992 often reflect very high levels of nominal protection export baskets) would encounter formidable bau- against foreign suppliers. For example, the UN ers. For instance, agricultural products accounted Food and Agricultual Organization estimates an for about one-third of the Baltics' exports to non- average level of protection in the EC and Japan for OECD markets but for only 3 percent (Latvia) to 7 cereals, dairy, and sugar products of 100 to 300 percent (Estonia and Lithuania) of their OMCD percent; Laird and Yeats (1990, chap. 5) calculate exports. Nontariff bariers protecting agriculmt in .. .. .... . .... ... TRADE PERFORMANCE AND AccEss ro OECM MARis 245 industrial countries, seem to be behind this discrep- the EU have levied antidumping taiffs on imports ancy. Similarly, around one-fourth of exports of of urea (used for making fertilizers) originating in agricultural materials-more than 30 percent of the former Soviet Union.16 Also inherited have exports for some countries-face nontariff barries been mntidumping cases filed in the United States in the EU. Iron and steel, important exports formany concerning titanium sponge and uranium and in the countries of the former Soviet Union, face enor- EU against corundum originating in Russia and mous barriers in the EU (68 percent of tariff lines) Ukraine; ferro-silicon from Kazakhstan, Russia, and and Sweden (94 percent). In brief, nontariffbarriecs Ukraine; and potassium chloride from Belarus, may prvVent any significant expansion of exports in Russia, and Ukaine. These restraints are added to some sectors. the "standard" nontariff measures discussed earlier. The response of OECD govenments to the Acd ess to OECD Mklet Since the Dissolulian emergence of fifteen new independent stats coping offteSovietUrnon with enormous economic problems was slow and Though the cuntries of the formerSovietUnion uneven. Except for the Baltic states. imports from at first faced most of the discdminatory measures other former republics in 1992 were subject to the previously accorded to exports from the Soviet same restrictions in many OECD markets as those Union, the conditions of market acce *s began to tbat had been applied against imports fri. the iprve toward the end of 1992. Many taiff restric- Soviet Union (table 12.6). Tbe U.S. government tions specifically targeted against the Soviet Union, granted MEN sus to some of the new countries in wheter for economic (central plaming) or political 1992, and to the remaining in 1993, except for consdations, have been removed, andexports from Azerbaijan, which faces 30 pecent tariffs compared most countries now receive either MNN or GSP with the average MFN rat of 5 percent GSP status, treatment in OECD markets. Some countrics, how- which puts a country on the sane tariff footing as ever, ate still subject to the antidumping tariffs and designated developing countries, is much more sig- investgations undertaken against the Soviet Union. nificant than MFN status in reducing adverse tariff Since 1987, for example, both the United States and marn For instance, GSP preferential rates Table 12.5 Share of All Tarff Une Products that Face Nontariff Barriers for Major Product Groups Originatng in the Former Soviet Unron, 1991 (percent) Productgroup (SITC) EU Finlaw Jan Sweden Swtedand U.SA. All food products (0+1f22l+4) 39 77 68 76 46 33 Fresh and frozen lish 26 63 100 78. 0 0 Agdiclbural materils (2-22-27-2) 26 0 23 7 20 6 Wood and lumber (24) 21 0 0 0 0 0 Ores, minerals, and metals (27+2845) 3 0 0 29 9 0 Fuels (3) 1 a 0 1 0 0 anufactrs (5 tD 8-68) 16 3 10 26 18 1 Chemical ewents (51) 4 0 13 30 16 5 Iron andstesl (67) 68 0 0 94 10 0 Trmasporteqtpment (73) 0 0 0 13 60 0 CIbliing (84) 83 0 71 65 100 0 Mlsaieous manufactures (89) 17 0 2 19 7 0 AlNnonenergygoods(Oto9-3) 19 4 18 29 21 5 Al goods (0-9) 19 5 19 30 24 6 Not Noataiff bkrir indude qua ceilingp on impom rinuding all Malifibm Aunagemea and othcrtextilc quotas3] 'ol- niary expo saints product-speufic drgs suchw anuidumping a=d coumnain duties, sive licenig requirrmes_ and iable import levis or fe,dble imuprt LsL Source Derived fiom ariff r of die Worid Bk-UNCrAD SMART daabase 246 TRADE IN mm NFU IinDPEmwrr STATnS embrace 63 percent of all combined nomenclature ing provisions-18 Estonia, (whose exports increased tariff lines in EU imports, with most of them (94 fivefold). seems to have benefited far more than percent of GSP items) subject to zero percent Latvia and Lithuania from these agreements. By rates-17 This share is even higher for industrial prod- contrast, exporters from all three Baltic states ucts (74 percent all at zero percent). The impact on gained from the improved conditions of access tariff levels is hniutd. GSP status reduces the aver- under GSP status in EU markets: the value of their age MFN duty on manufactures (excluding chemi- exports increased by more than 100 percent-per- cals) from 8.1 to 6A4 percent (Laird and Yeats 1987, haps because of the larger size and greater proximi- 95). For 16 percent(1,468 tariff lines) of tariff lines, ty of Germany, a major market in the EU, than M:EN do not apply (541 tariff lines covering mosty Norway or Switzerland in EFrA. agricultural and fishery products) or are equal zero Trade relations with.the EU. the most impor- (927 tariff lines). tant trading partner of the countries of the former The Baltic states have "outperformed" other Soviet Union, havc been governed by the 1989 Trade countres of the former Soviet Union in obtaining and Cooperation Agreement with the Soviet Union. better market access. Thanks to their sovereign sta- In October 1992 the EU Council of Ministers tus before World War II and strong political sup- adopted a framework for negotiating more exten- port from Nordic countries, they had moved very sive agreements with the newly independent coun- quickly up the pyramid of preferences in many tries. After the Baltics, Ukraine was the first to sign OECD makets (table 126) -Ihey ootained GSP sta- a new Partnership and Cooperation Agreement with tus in the EU (as of January 1,1 992), a year earlier the EU, in March 1994. The agreement provides for than the other countries, and have had GSP status mutual MEN treatent, the removal of quauitative in the United States since Febmary 1992. Moreover, restrictions, and the future establisbment of a free the Baltics signed Cooperation Agreements with the trade area Negotiation of fre trade area is condi- EU dtat replaced the earlier trade and cooperation tional on Ukraine's progress in establishing a mar- agreement between the EU and the Soviet Union ket economy, to be jointly reviewed in 1998. and in July 1994 signed the free trade ageements Market access for sensitive goods was not included covering industrial products. These trade agree- in the agreement except for a provision promising ments provide for the establishment of a free trade negotiation of separate agreements for coal and area for industrial goods and for future EU mem- steel and nuclear materials (trade in textiles and bership for all three countries. They call for the EU clothes is subject to separate agreements already in to dismantle all resrictions and baniers on indus- force). The EU concluded similar trade hlbealizing tial products as of January 1, 1995. These agree- agreements with Moldova and Russia The EU ments pave the way for fixture full-scale association Council of Ministers plans to ensure cooperation agreements, similar to those in force between the agreements with Belaus by the end of 1994 and EU and former European CMEA members. begin negotiations with Armenia, Azerbeijan, and Bilateral free trade agreements (FTAs) with Georgia- EFTA countries (except Austra and Iceland) signed in 1992 and early 1993, grant the Baltics "sewnd- Vulnerability to Trade Remedy Measures bcst" access (afker the EU) to ERA markets, which Despite significant improvement in conditions have wtaditionally accounted for a significant pro- of madket access in major OECD countries in 1993, portion of their exports. The Baltic FTAs contain nornalization of foreign economic relations for provisions offering duty-free access for almost all countries of the former Soviet Union remains industra products, with no phase-in periods (Sorsa incomplete. They are not members of the GATr, 1994,28). These agreements cleary contributed to and their continuing use of state trading makes them a rapid expansion of trade between the Baltics and vulnerable to trade restricting measures. The Baltics Nordic EFTA members despite some tade restrict- are the only countries that have signed agreements Table 12.6 Trade Status of Countries of the Former Soviet Union with OECD Countrles, as of Janu&ry 1994 European Unton Austria Swltzietnd Flnhand Norway Sweden Canada United States Japan MFN GSP MFN GSP MFN GSP MFN GSP MFN GSP MEN aSP MFN GBP MFN GSP MFN GSP Armenla 1/92 1193 a 1/92 3/93 Yes b No 2/93 No 1192 No No No 1/92 4/92 4/92 No Yes d No Azerbeilan 1192 1/P3a 1/9Z 3/93 YOS b No 2/93 No 192 No No No 1/92 11/92 No No yeSd NO Bularus 1/92 1V93a 1/92 3/93 yes b No 2/93 No 1192 No No No 1/92 11/92 2/93 NoC yesd No Georgia 1/92 1193a 1/92 3/93 Yos b No 2/93 No 1/92 No No No 1/92 11/92 8/93 No No No Kazakhstan 1/92 1/93a 1/92 3/93 Yes b No 2/93 No 1/92 No No No 1/92 11/92 2/93 4/94 yesd No Kyrgyz Republic 1/92 1193 a 1/92 3/93 Yes b No 2/93 No 1/92 No No No 1/92 11/92 2/92 12/93 Yes d No Moldova 1/92 1/93a 1/92 3/93 Yes b No 2/93 No 1/92 No No No 1/92 11/92 7/92 No Yes d No Fussia 1/92 1193a 1/92 393 Yos b No 2/93 No 1/92 No 1/92 No 1/92 4192 8/92 10/93 Yes No Talikistan 1192 1/93 a 1/92 3l93 Yes b No 2/93 No 1/92 No No No 1/92 11/92 11/93 No Yes d No Turkmenlstan 1/92 1/93a 1/92 3/93 Yes b No 2/93 No 1/92 No No No 1/92 11/92 10/93 No Yes d No Ukralne 1/92 1/93 a 1/92 3/93 Yes b No 2/93 No 1/92 No No No 1/92 4/92 6/92 0/94 yes d No Uzbekistan 1/92 1/93 a 1/92 3/93 Yes b No 2/93 No 1/92 No No No 1/92 11/92 1/94 Noc yes d No Estonla 1/92 1/92 1/92 7/92 FTA 04/93 FTA--1V92 FTA--07/92 FTA -07/92 1/92 4192 12191 2/92 NO No Latvia 1/92 1/92 1/92 7/92 FTA.-04/93 FTA--05/93 FTA--07/92 FTA--07/92 1/92 4/92 12/91 2/92 No No Lithuania 1/92 1/92 1/92 7/92 FTA..04/93 FTA-01/93 FTA-.07/92 FTA-.07/92 1/92 4/92 12/91 2/92 No No Note: Dates ae listed by month/year; FrA=frc trade agrmement, a. Granted on an exceptional and tempomry basis. b. Continuation of the 1948 agreement with the Soviet Union. c. Undereligibility reviw by the U.S. govmnment, d. De facto applied since January 1992. Source: Office of the U.S. Trade Representative- EFrA secetaiat; United Nations Economic Commission for Europo .. U~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~p -.4 248 TRADE IN lE UEW INDPERND STAmES that foster an institutional enviromrnentconducive to ing investigations initiated by the EU against coun- "deep integation" with OECD countries. tries of de fonner Soviet Union incrased from one Production stucrs inherited from decades of in 1991 to eleven in 1992.19 The region accounted cental planning and the incomplete transition to a for 38 percent of all antidumping investigations. market economy make the countries of the former During the first three-quarters of 1993, the Soviet Union especialy vulnerable to protectionism Commission of the European Union initiated in OECD markets. Rcmaining government price antidumping investigations against imports of and trade interventions make exporters an easy tar- unwrought alumninum (orginating in all fifteen coun- get for trade remedy laws against "nfairr" tade, tries, but tareed primay againstRussian exports), including antidumping measurs. The stas of the ferro-silico-manganese, and ammonium nitrate. It countries as "nonmarket economies" (which allows imposed provisional or definitive anlidunping duties the country initiating an autidumping proceeding to on ferro-cbrome (Kazakhsan, Russia, and Ukraine); disregard a producer's actual costs and use costs in corundum (Russia and Ukaaine); ferro-silicon a compaator market economy to assew the extent (Kazkstan, Russi and Ukraine); isobutanol (Russia); of alleged dumping) and theirlack of legal expeti and potassium chlorde (Belarus, Russia, and Ukraie in dealing with highly technical and complicated (vadious issues ofthe Official Journal oftheEuompean antidumping proceedings intensifies their vulnera- Communities). The United States initiated fewer bility to such actions. Moreover, the surge of antidumping ases (against ferro-silicon originating exports of some products to OECD countries fol- in Kazakhsta Russia, and Ukraine; uraniumn from lowing trhe Tedieton of sailes from fonner CMEA Ukraine and Tajkilstaz and siliconmanganes from and developing country trading partners have Ukraine) after the dissolution of the Soviet Union, increased the exposure of exporters to various perhaps reflecting the fact that exports of primary import-rnstricting actions. commodities were directed mainly to the EU The incomplete liealization of prices and the (USITC 1993a, b, c)Y0 foreign trade rgime, compounded by the collapse Russia and Ukraine, the two largest economies of interstate trade links and shrinking domestic of the former Soviet Union, were the most fiequent demand, has heavily distorted export incentives, subjects of EU antidumping investigations and Subsidized transportation costs, bank credits, and imposition of duties. They were followed by energy prices have made some sectors artificially Kazakhstan, Belarus, and Georgia. U.S. antidump- competitivem international markets. Macroeconomic ing investigations were resticted to Kazakhstan imbalances and inflation have provided an extra (ferro-silicon). Russia (ferrosilicon), Tajikistan incentive to maximize earnings in hard currencies (uramnium), and Ukraine (ferosilicon, uranium, and rather than in rapidly depreciaing domestic curLe- silico-manganese). cies by diverting commodities friom domestic mar- There is some evidence that a lack of legal kets. With the collapse of domestic demand, con- expertise in dealing with the highly technical and sumption of industrial inputs has also declined, complicated antidumping proceedings contributed leading to cuts in imports and to increased surpluses to unfavorable rulings. In imposing a provisional diected to intenational markets. In some primary antidumping duty on imports of isobutanol originat- commodities, the region has turned from a net ing in Russia, the EU Commission notes that "No importer to a net exporter. Russian exporter replied to te Commission's ques- The proliferation of antidumping actions tionnaire."21 Ostry (1993, 13) reports that exprers against exporters from the mgion is illustrative of from the former Soviet Union accsed of dumping problems triggered by the incomplete trwsition uranium on U.S. markets decided to fill out -the (and of the temptation for countries allegedly thousands of pages of necessary paperworkc with- "injured" by the flood of cheap imports to resort to out seeking legal advice. They failed to reurn some protectionist measures). The number of antidump- of the forms and blundered on others. As a result, TRADE PERFORMANCE A AccEss ro OECD MARES 249 the investigation was delayed, and a 'voluntary" ily dependent on trade with Russia- For all of them, quota was in effect until its completion (USITC however. OECD markets, especially the EU, have 1993 c). Countries ofthe former Soviet Union are at substantially increased in importance. a further disadvantage because of their status as Dcspite enormous differences in economic nonmarket economies or state trading economies. development and natwal resource endowment in thc These designations allowed antidumping authorities new independent states the composition of exports substantial discretion in assessing dumping margins to the OECD displays striking similarities. The (Hindley, 1993). A producer in a market economy countries are specialized in primary commodities. is selected as a proxy, and a refeence price is con- Agricultural materials, ores and metals, and fuels structed based on that producer's costs, without have been their major foreign crency earners. regard for actual produiction costs. The danger The lackluster trade performance in OECD remains that even when prices are fully liberalized markers was due to initial struuctal impediments in these countries. their status as nonmarket including the breakdown in supply linkags among economies will change with a considerable lag. For enterprises of the former Soviet Union. and to slow stance, although Poland has liberlzed practicaily progrss in macroeconomic stabilization and trade all adeables, and introduced a lieral and manspar- libealzation. But the conditions of acces to OECD eru trade regime, it is still classified as a nonmadret markets have also contributed. Normalizaion of economy n relevant GAIT statutes, commercial relations by OECD governments has Just the tht of an antidumping investigation lagged behind the pace of change in thse countries, can drve expors to negotiate -voluntary" restraints. with the dismantling of central planning and state This technique is frequently used by US. producers monopolies over foreign trade eliciting delayed (Destler 1992, 158). The EU frequently imposes responses except from Canada. For most of their quanitative restictions, instead of waiting for mdependent estensce, these countries faced adverse exporters to cutail their own exports. For instance, tariffmargis on exports to their major OECD mar- in response to the French govemment's request, the kets And except for the terminatien of specific EU recently limited imports of aluminum to a glob- quantitative restrictions in the EU against exporters al quota of 60,000 tons. But no matter what proce- from formerly planned economies, other nontariff dures are employed, the outcome is always the barriers have remained in effect. Antidumping tar- same: a deterioration in market access. For produc- iffs and investigations initiated against producers in ers in transition economies, facing depressed the Soviet Union before January 1, 1992 were not demand at home and the disappearance of tradition- suspended: the dissolution of the Soviet Union went al markets, and having little experience in market- largely unnoticed by those rsponsible for protect- ing and operating in competitive interational mar- ing domestic markets in OECD countries- The use ket$ the consequences may be severe- of antidumping measures against them is facilitated by the fact that they have not yet completed the Conclusion transition to markets, they are not protected by For the countries of the former Soviet Union, GAIT statutes, and the lack of experience in deal- trade is in flux, reilecting their adjustment to a new ing with technical issues of market access. external environment Trade flows are incrasingly With the contraction in domestic demand and detenined by ecoonomic considerations Acordingly, interstate trade, exports have become critical to the their trade with some developing countres and for- survival of many films and to the balance of pay- mer CMEA partners, which had been artificially meats position of many countries. Success in trans- sustained by the Soviet Union for political reasons, forming a former planned economy into a market has contracted. Interstatc trade still accounts for the economy hinges on sustained exports to the West, bulk of total trade for these countries, except for for at least two reasons- Frst, the colapse of intm- Estonia and Russia. Many of the countries are heav- regional trade, to the extent that it reflects the elim- 250 TRADE IN THE NEW INDEPENDENT STAES ination of distortions inherent in central planning, is nontariff trade barriers would allow them to benefit not a short-term shock. With the introduction of more from the efficiency gains associated with convertible currencies, consumers and investors are trade expansion and with a more predictable frame- able to make decisions on the basis of economic work of interstate trade. considerations. Because of the higher competitive- Linking market access with performance ness of Western suppliers, demand for most invest- under IMF and World Bank supported programs ment goods and durables has shifted away from of stabiization and structural adjustment and expe- these former partners- Although trade with coun- diting membership in the emerging World Trade tries of the former Soviet Union and former CMEA Organization would convey the message that the members may increase once the economic slump in West has a stake in the successful transition to mar- the region is over, it will not return to its previous ket-based democracies and so is willing to assume levels. OECD economies will remain a major some of the cos0t of the adjustment. Successful exporter and importer for transition economies. restructuring in the East will thus be accompanied Second, the demise of the Soviet common eco- by some readjustment in the West. The quicker the nomic space led to a contraction in aggregate eco- mutual adjustment takes place, the better for all nomic activity. Expanding export to OECD markts parties involved- And, linking market access with would moderate dte decline in aggregate economic the pace of transition would provide an extra stim- activity and make it easier for govermments to con- ulus to move along quickly with economic reforms. rol their budget and fight inflation. Consequently, a lack of a significant improvement in market access Notes could undermine macroeconomic stability and The author wishe to acknowledge helpfusl comments front threaten the trnsition. Costr Michaloponlos, L. Alan Winters, and Alexander What can be done to improve access to OECD YeatL markets? Fis4 OECD governments might consider L Infastucture bad been developed to serve the division gnting GSP treatment to al countries of the for- of labor witbin the conunon (aurarkdc) economic spinc. Transportation in the Soviet Union. organized mainly mer Soviet Union- That would put their exporters around railways, was focused on Moscow. Road transport, on the same tariff footing in OECD markets as used mainly to feed the railways. accounted f:orasmall por- tion of total freight thus indicating a limied stock of trcks. exporters from countries at similar levels of GDP The quality of wads was very low. One study found that per capita. Second, OECD governments should fewer than half of roads were suitable for cars. (see consider suspending trade remedy actions against Independent. 3 September 1991, as quoted in McAuley "disruptive" imports originating in countcls that have in place sustainable stabilization and stnrucral 2- The greater involvement of Russia in external ansac- adjustment programs supported by the IM and the dons was the result of seval facron its natual resources endowment; the centaization of foreign tade opeions World Bank. Because of inherited distortions, for- in foreign trade organiaions, located mainly in Moscow; mer centrally planned economies cannot be expect- the tmnsporation infrastructure, whicb prevented other potenial net porters (especially those from Central Asia ed to move instantaneously tD competitive markets. of raw mateials from gaining access to world nmkets They should not be penalized for being economies in tansition. 3. Tbe analysis of trade flows is based primarily on partna trade sistics reported to the United Nations COMTRADE lird, accession to the GAiT should be expcJ records Other sources (mainly CIS official data as weil as dited to allow these countries to become founding easiates of the UN Economic Commission for Europe) arc members of the World Trade Organizaion. Once also used. In the case of inportant tading patters that did not report to the United Nations trade data base or provided specia admission procedures are in effect, member- incomplet informadon (for instanc, in 1992 India and ship could be made conditional on observing GAIT Hungary eported trade with Russia but not with other for- mer republics, whilc the former Czechoslovaia, Bugaria, rules in their trade relations with each other and and Iran did not provide ct United Nations with infornia- with GATT members. GAfT disciplne-commit- don on tbe trade). The trade flows of the Baltic states, ting tD binding tarffs and forswearing the use of vo'Ig transshipment are not corcted unless oterwise indicated. TRADE PERFORMANCE AND AccEss OEcD iMAETS 251 4. For detailed dama on directions of Soviet exports, total total exports from the former Soviet Union excluding and by republics, see Kaminski and Yeals (1993). Th data Russia. for 1992 ar derived from the UN COMTRADE databae 5. China was an exception. The value of total exports to I. The net tade performance index (NTI) is calculated China almost doubled from US$2,051 million in 1991 to acconding to the formula: US$4,017 million in 1992, with Russian sales of aircraft -M accounting for most of the increase. China's imports from I 9 whc i is a product or a prodwt Russia anounted to USS3,526 million (as reported by NI= group, X[ is exports. and f is China in the UN COMTRADE data base). (+ M!iO impom 6. Among develuping country paruers China is again an exception. Although the share of primary commodities in 12. This section draws heavily on Kaminski and Yeats China's imports from the fonmer Soviet Union declined (1993). from 16 percent in 1991 to 14 percent in 1992, the value of dtse imports incemased substantially from US$334 million 13. As of April 1994, Gceorgia. Tajikisan and Uzbdkistan to USS537 million. The bulk of imnpoas of primary com- had not applied for membership in the GAT,. while modities was from Russia (USS337 million) which Azerbaijan. Bdlarus, Kazakehstan, Kyrgyz Rcpublic. and accounted for 89 percent of primary comnmodities and 81 Turkanenismn had obsv status. The remaining counties percent of total imports from the former Soviet Union into accession to the GATr is being processed. China. Not surprisingly, given its size, endowment in natur- al resources and geographical proximity, the second most 14. For example, Soviet exports of undenanred ethyl alco- important trading partner of China among former Soviet hol faced an EC tariff of 73.8 percent which was 42 per- Union countries was Kzzakhstan - its total sales to China ccwtage points higber dmn the averag duty that developmg were USS141 million with USS24 midlion in primmy com- countries pay on this product and more than 30 percent modites. (Deiived frnm China's ade statisics in th UN higher tan the average duty on all exportes combined. COMTRADE data base.) Approximatdy te samne advese taiff margin (41 pecent- age poins) applied to expors of unfur d aple juice. 7? This expansion was compounded by exports of surpluses and differenials of 15 percentage points or more occurnred in some primary commodides that had previously been on half the taiff tine products (Derived from tde World imported. For instance, the former Soviet Union shiftcd Bank-UNCrAD SMART database.) fwm a net importer of zinc and lead to a net exporter. In the ca of lead, the forma Soviet Union bas been a net 15Tbe concept of cffctiveprotection. which measures the exporter since 1988. with the 1992 surplus becoming influence of protection on value added in a production equivalent in terms of volume to its peak net imports in process, pxovides useful insights into the effects of escalat- 1986 (Sheales 1992,559). ing trade barriers over commodity processing chains. Specificaly. the cffetie race shows the pecentae redue- 8. All the usual caveats concening the low quality of these ion in value added foregn exporters of processed com- data apply to this analysis. which is further hampered by modities must absorb in ord to compete in the proected reexport activities which are recorded in OC trade sta- market (sec Grubel, 1971, hfr a nontchnical discussion of tistics as imports from a reexporting country. To rtain con- the concept of effective rate of protection). Due to the sistency with the OECD wade data for 1992. Goskoastat's importance attached to the issu, the World Bank identified estimates of the shares of various markets in total outside processing chains for 49 individual commodities that are shipments republic were used as weights and applied expoted by developing counties in prmaty and prooesed agans the value of OECD imports from the Soviet Union forms. See the appendix to Safadi and Ycats (1993) for in 1990. details. AU stages of these chains are defined in terms of the SITC system in order to facilitae analyscs of intena- 9. Interestingly, according to all predictions (with the tional trade in these items. notable exception of Brown and Belkindas 1993). the Baltics and Belans stood to lose maost frm the demise of 16. The main exporters are Belarus. Georgia, Tajikistan, the Soviet Union. Their demomrted capacity to redirect and Uzbedsran. k is interesting to note that despite higher tbeir tradc goes against these prdictions. However, inde- tariff their exports rose from 57,231 tons in 1991 to 94,432 pendence tuned out to be an aecsvely cxpensive propo- tons in the fust eight months of 1992 (Intational Trade sition for Belarus, which gave up its economic sovereignLy Repmort, April 21,1993). by opting for full integration with Russia. 17. An imsportant caveat is that many oF these imports are 10. Yet, owing to favrarble geograpbic location and com- subject to GSP prefea rates only within quota amounts mitment to economic reforms, the Balties in general and and to MFN rates above them. As a result. their sgnifi- Estonia in particular stand out 34 even if after subtracting cance is overstated. the value of reexports of crude oil ores, nonfermus metals, 18 These stem mainly fro th bilateal natr of the and minerals from their OEBD exports. In 1992 the valne 1B cstem miAcs from th out EtrA ou - of Latvia's and Lithuania's exports to the OECD almost areements By limiting rles of origin to one ETA wan- doubled and that of Estonia incrcased fourfolL Their com- try, they favor resource-intensive products by protecting bined share in total exports 6 the region was larger than prodc of inputs in the two partner coutics and thereby that of Ukraine and accounted ft r around 40 pwarent of d m against higher-stage pcssed products For an in-depth discussion, see Soram (1994). 252 TRADE IN THE Nv INDEPENDENT STAls 19. See Eleventh Annual Report from the Commission to Hamilton, C_ 1986. "Agricultural Protction in Sweden." the European Parliament on the Community's Anti- EuropewReviewofAgricEudraFxonncs 13 (no.l) Dumping and Anti-Subsidy Activities (1992). Historical levels were consistenty ower, just onc aniddamping itves- Helleiner, G.K., and Douglas Welwood. 1978. Raw tigation initiated in 1959 and two investigations in 1990. Material Processing in Developing Contrries and Reductions in dth Cmadian TariW Ottawa: Economic 20. The U.S. Intenational Tradc Commission (USlTC) Council of CanadaL found that Tajikista's exports of umnium did not injure or threaten the U.S. industry with -material injury" but that Hindlcy. B. 1993. -elping Transition tdough Thade EC those of Ulraine (excluding lhigy enriced uumnum) daL and US Policy toward Exports from Eastern and The USlTC rccommended antidumping duties on imports CcntralEuropef BRDWorkingPaper4. of ferrsilicon from Kazakclsta, Russia, ad Ukraine. IMF (Intcrnational Monetary Fund). 1992. Economic 21. See Commission Regulation (EEC) No72093, item A Revieiw Comnn Issues and Irerepiic Rehaions in (7) in Official Journa of the European Commnunities Nol the Former USSL. Washington D.C 246/12.2 October 1993. _ 1993. `Estonia" JMF Economic Reviews 4. Washngton D.C. References Kaminski B. 1993. How the Market Transitin Affected Balma, B. 1968. "The Sturc of Protection in ndustia Export Performance in the Central European Countries and its Effects on the Exports of Pmcessed Economies." Policy Rescarch Working Papers 1179. Goods from Developing Countries." in UNCTAD's World Bank. Inteaional Economics Department, The Kennedy Round Estimated Effects on Tariff Iafin:d Trade Division, Washingto D.C Barriers. New York United Nations. _ 1993. `Thc InpaCt of the Dissolution of the Balccrowicz. L. and A. Gelb. 1994. 'Macropolicics in Soviet Union on Trade in Primary Commodities." Transition to a Market Economy: A Three-Year World Bank. International Economics Department, Perspective." Paper presented at the World Bank ltmadtional Trade Division, Washin , D-Cr Annual Conference on Dcvdloipment Economics. Washington D.C. April 2829. Kamnisk B., and A. Yeats. 1993. YOECD Trade Barriers Faced by the Successor Stats of the Soviet Union." Brown, S_ and M- Belkindas. 1993. "Who is Feeding Policy RardhWo&ingPaper1175 WorddBank Whom? An Analysis of Soviet Interpublic Trade" In The Former Sovic Union in Transition, Vol.l. Laird. S- and A. Yeats. 1987. "Tariff-Cuttig Fomuas- Washington, D.C: Joint Economic Committe, US. and Complications." In A. Olecbowski and 31 M. Congrss, Us. Governnnt Prntng Office. Fmger, eds. Th UNWay Rorud A H=wbt for the Mudiareral Trade Negotiaios. Washington. D.C.: Bureau of National Affair. Intenadal Trade Reporter. Worl Bank. various issues. Washington. D.C 1 1990 Qutitiv Metos for Trade Banier CIS lnfomation Ceuter for Statisics. 1992. Foreign Trade Analysis. International Economics Department, of Sovereign Repablcs and BaRc Economies in 1990. International Trade Division, Washington, D.C Moscow. London: Macmillan Pss - Commission of the Eumpean Community. 1993. Eleventh McAuley. A. 1991. "The Economic Consequences of Anual Reportfrom ithe Comm to die Euipean SovictDisintegration." Sovie rEconwoy7 3. Parliament on the Conunity's And-Dumping and Ani-SubsidyAcdviuies. Brussel Michalopoulos, C., and D. Tarr. 1992. "Trade and Payments Arrangements for States of the Former Commission of the European Union. Official Jowi of usSR. Studies of Eonomies in Trnsformtion. 2. Eirpea Comninyz Brsseln Vaious issues. Washngtn D.C.. World Bankl Destler. LJ. 1992. Amerian Trade Politi:s. Washington, Olechowski, A., and A. Yeats. 1982. "The Influence of D.C.: Institute for Internaional Economics with the Nontiff Barriers on Exports from Socidalist Countries Twentieth Cetury Fund. of Easte Europe. Discussion Paper 6_, UNCrAD, Grubel. H. 1971. "Effective Tariff Protection: A Non- Specialist Introduction to the Thcory, Policy Ostry, 5. 1993. The Threat of Managed Trade to Implicaons and Controversies." In Herbert G. Gubel Transforming Economies, Group of Thirty. and Hairy G. Jobson, eds, Effective TariffProtection, Washngton, D.C. Genevt GATr Secretara Roamer. M. 1979. Resource Based Industrialization in Hamilton, C 1984. 'Swedish Trade Restrictions on Developing Countries: A Survey of the Literature. Textiles and Clothing." Slandinaviska Enslcilda Cambndge, Mass.: Hvard itu for Imatonal Banicen Qualy Review no. 4: 103-12. DevelopmenL Tun PoRwMcz AND AccEss To OECD MARxt 253 Safadi, R- and A. Yeats 1993. "Asian Trade Barriers United States Intemational Trade Commission (US1TC). against Primary and Proessed Commodities." Policy 1993a. Ferrositicon from Kazakbstan and Ukraine. Research Working Papers 1174. World Bank. US[IC Publication 2616. Washingon. D.C International Economics Dcparunent, International Trade Division, Washington. D.C. -. 1993b. Ferrosilicon from Russia and Venezuela. USITC Publkcation 2650. Washington, D.C Sheales. T.C. 1992. %(iaera Industies in the CIS: Tbreats and Opportunities for Australia. Agriuardral and 199.3c Urnium from Tajikistan and Ukraine., Rsourc Quaerrly4(4). USITC Publication 2669. Washingun D.C Sorsa, P. 1994. Regional Integration and the Baltics- World Bank 1994. Global Economic Prospects. Which Way" Workd BanLk nteauional Economic Washington, D.C. Deptauntn International Trade Division, Washington, D.C. Polcy Recommendations Constatne Michalopoidos and David G. Tan" Previous chapters in this volume hae shown that thes lishment of fifteen independent states iu the economic space of the fomer Soviet Union-each embadring on stemic reforms on a diffent scale and at a different pace-has created many difficulties for trade among them and with the rest of the worldt * T rade Policy in the ContwdAlthough thcre has been progress in trade reform, its pace and oF Broad Eonorric Reforrn scope have been uneven In most countnes trade mcentives are highly distorted, trade and payments institutions are underdeo- * Trade Policy veIoped, and the state continues to be heavily involved in trade. Much remains to be done in support of their objeciive of longer * Payments Arrangements term adjustment and integration into the world economy. This chapter summanzes thc main recommendations for trade and * Access to International payments reform to achieve that objective. Theserecommenda- Markets tions are placed in the context of the broader complementaiy refonms required for a successful transition, in particular. * The Political Economny of macroeconomic stabilization and commercalization and pnva- Trade Reform tization of enterprses. Trade Poricy in the Contexd of Broad Economic Reform The first main lesson of the experince with trade reforms in the fifteen countries of the fonner Soviet Union is the importance of the liakages between macroeconomic stabiliza- tion, enterprise reform, and internationl trade and payments policy. Estonia and, to a lesser extent, Latvia, Lithuania, the Kyrgyz Republic, Moldova, and Russia are the countries in our 256 TRADE IN THE NEW INDEPENDENF STATES study that have made the greatest strides in trade which has expanded exports most effectively reform. They have also made the greatest progress among states of the former Soviet Union, has an with macroeconomic stabilization. Ukraine and effective, decentralized distnbution network.1 By Uzbekistan, at the other extreme, have large distor- May 1994 Estonia had tansferred half of its state- tions in their trade regimes and heavy state inter- owned enterprises to private ownership or control.U vention. Not surprisingly, the two countries have Estonia has also attracted private foreign direct also failed (as of mid-1994) to adopt macroeco- investment forjoint ventures, as in the texules and nonmic policies for stabilization. Inflation has been apparel sector. These joint ventures have led the rampant in both countries, and most of the adjust- way in exports in these sectors. ment to international prices has yet to come. One concem with stabilization policies in There are several complex links between Eastern Europe has been the wory that combining macroeconomic stability and trade reform. Without rapid trade liberaliation and the use of a fixed macroeconomic stability, high inflation will prevent exchange rate as a nominal anchor could result in enterprises from receiving better price signals from overvaluation of the exchange rate, creating undue trade liberaliation for reorienting production competitive pressure on domestic enterprises from toward profitable exportables or import substitutes. imports and imposing heavy adjustment costs on Macroeconomic stability also helps in establishing economies not yet capable of adapting to the new currency convertbility, a critical component for price signals. This problem has not emerged in the addressing the payments problems that have con- former Soviet Union so far. Few stabilization strained trade, especialy among the new indepen- efforts have used the exchange rate as an anchor dent states (see chapter 5 on Estonia.). Trade reform (the currency board arangements in Estonia and is part of price and enterprise refonms that are criti- Lithuania are exceptions), and formal controls on cal to macro-economic stabilization. The chapters imports have by and lar been minimaL The prob- on Russia, Ukraine, and Uzbeistn emphasize how lem so far has been too little competition from the lack of a hard budget constraint, reflected in the imports rather than too much. presence of large subsidies on imports and dircted The exchange rate has tended to be underval-- credits at negative real interest rates, has impeded ued rather than overvalued primarily for two rea- stabilization. In contrast, the progress Russia has sons. One is that financial demand for foreign made in stabilization during 1994 owes a great deal exchange has been very strong in almost all coun- to the reduction of subsidies and directed credits to tries. Residents, reacting to an economic climate of enterpnses. large fiscal deficits, high rates of inflation, and neg- In the long run, the prvatization of producing alive real interests, sought a store of value other enterprises is also important to export perfonnance than domestic currencies. Domestic assets did not and the success of trade reform. Without privatiza- meet the need because of unclear property rights, so tion, enterprises will not respond efficiently to the residents chose to hold foreign exchange, both improved price signals. Even more important, the domestically and abroad, where the latter resudted in lack of innovation that characterizes state-owned capital flight. A second reason for the undervalua- enterprises will make it difficult for them to com- dion has been the extensive use of export restraints, pete in sectors where quality improvements are in the form of licenses, taxes, and foreign exchange important, such as the machinery sector, and so to surrenderrequirements at below market rates, by all improve export perfornance. In the short run, how- but the Baltic states. When exports are restrained, ever, removing the state monopolies on distribution the ability to import is restrained by the reduced may be the more important area for privatization. availability of foreign exchange. By artificially The relatively poor export performance of the restraining export to the convertible currency area, Kyrgyz Republic has been attributed in large part to countries forgo foreign exchange earnings that, if problems in the state distribution network. Estonia, available, would cause the market price of the for- POucY RncoweAwoNs 257 eign exchange to fall (the real exchange rate to progress. At the same time they need to exercise appreciate) and make imports less expensive.3 vigilance to ensure that as the real exchange rate Also, increasing the price of foreign exchange starts appreciating in response to effective stabiliza- in market-determined environments (or reducing tion, the implicit restraints on imports are not the quantity available for imports in rationed envi- replaced with formal restraints that would tend to ronments) are inport subsidy programs such as impede futire adjustmenL those in Russia in 1993 and in Uzbekistan today. Allocating foreign exchange at below market rates Trade Policy to preferred importes, as in lkraine, has a similar Perhaps the most important recommendation effect. Because neither the import subsidies nor the regarding trade policy is that governments should foreign exchange were generaBy provided for reduce their direct involvement in international goods that competed with domestic production4 the trade. While many countries, in particular the effect was to reduce the amount of foreign Baltics, have made long strides in reducing state exchange available for competitive imports. trading, in other countries state trade organizatons There are four broad conclusions to be drawn or other public entities continue to dominate inter- from this discussion of stabilization, enterprise national btde-ade in cotton in Uzbekistan and reform, and trade policy. First, progress with reform gas in Turkmenistan are two examples. In general, in the three areas tends to be mutually reinforcing, the biggest changes are needed in trade among the though it is clear that trade reform alone cannot suc- countries of the former Soviet Union.L Govemments ceed in the absence of progress on the other two. need to stop directing what, how much, and at what Second, the countries that have reformed the slow- price commodities should be traded and start doing est have often maintained that their strategy will what governments of market economies do about reduce the high cost of transition. One of the impor- international trade. Usually, that roe is to provide a tant findings of the sudy is that the slow adjustment policy and xegulatory environment conducive to strate has typically backfired in the new indepen- trade and to help establish the financial and institu- dent states since the slow reformers, such as tional infiasucture that would fcilitate enterprise Ukraine, Uzbeistan, and Georgia, have not arrest- to enterprise trade (see chapter 11). ed their output decline and still face most of their The obligatory lists and bilatal clearing that adjustment costs in the future. On the contrauy, the are a continuing part of interstate trade in 1994 are Baltics, which are the countries that have reformed incompatible with a market economy and sbould be the fastest, have done the most in the way of reori- eliminated quickly. Because governments choose enting production and trade. At the same time, the which products are on the lists in bilateral negotia- near term growth forecasts for these states are rela- don, it is govenmments rather than market forces and tively optimistic: in Estonia output expansion began comppamtive costs that define and control such trade. in 1993, and in Latvia and Lithuania, the decline Experience with obligatory lists in the CMEA has appears to bave bottomed out and some output shown that the process leads to losses of dynamic expansion was expected by late 1994. efficiency as well. When enterprises improve the Third, privatizing producing units is critical to quality of their products, it is extremely difficult to effective long-run export performance, but privatiz- obtain a higher price through the govemment nego- ing trade and distribution channels and attracting tiation process, resulting in little or no product joint ventures in producing units may be more innovation. Obligatory lists are often implemented important for expanding trade in the short run. through state orders or planning (Russia, the Kyrgyz Fourth, the principal imperfections in the trade Republic, and Moldova are exceptions), which means regimes of the new independent states are in exports that the country is not maling the desired transition not import, and thus it is in the domain of export from central planning to the market. The perpetua- restraints that these countries must make the most don of state orders and obligatory lists hampers the 258 TRADe IN mmE NEW INDEPENDENT STATES introdution of a hard budget constraint for the affect- export licenses characterized trade between the new ed enterprises and, more broadly, retards the intro- countries, but today dais trade should be conducted duction of market principles in enterprise operations. directly between enterprises.6 If countries wish to Although by 1994 the list of goods traded keep domestic prices below world prices-general- under state obligation was narrowed to a short list ly, an ill-advised practice-export taxes can be used of a few commodities (except between Russia and for this purpose without export licenses (see below). Ukraine), the distortionary impact of the obligato- ry trade remains pervasive. Countries such as Export Po"';Jes Uzbekistan use obligatory lists as a means of tax- For so- commodities, notably oil in Russia ing the agriculturl sector on exports to Russia (by and Kazakhstan and basic raw materials and food- offering domestic producers low prices) in order to stuffs in several other countries, governments have subsidize the energy-using sectors on imports of chosen to maintain export restrictions to keep Russian energy. The international transactions are domestic prices below world prices. The aim has likely to occur at world market relative prices since been to keep the consumer prices of food and other Russian interstate energy sales were no longer sub- necessities low to achieve social objectives and to sidized in most cases by 1994 (sales to Belarus are ease the adjustment of enterprises to the market an exception, and there may be others). environment. But export restraints are not the best Where state obligations to export continue, instruments for achieving these objectives. The however, that does not have to imply a need to social safety net is more appropriately fashioned impose state orders and quantity regulations on pro- through targcted transfers in income or in kind, ducing enterprises. Instead, the state could use pro- while assistance to enterprises, where appropriate, curement agents to purchase goods for interstate should be provided through explicit budgetary sup- trade as Russia does through Roskontrakt portL Diversifying state trading contracts would allow International Trade. Export restaints (licenses, other traders to acquire the experience in handling quotas, taxes, and surrender of convertible currenwcy bulk conunodities in intemate trade that is required at below market rates) to convertible currency areas in a market-based trading system and would are undesirable because they reduce foreign encourage competition. Private companies should exchange earnings and distort resource allocation. be given equal access to these contracts (including But if circumstances argue for the use 4 export equal access to the financing provided by ministries restraints (say, because of an inability to raise bud- of finance to facilitate the state trade), and state for- getary resources quickly to provide financing for eign trade organizations should be encouraged to the social safety net or Ar enterprise restructring), privatize. Since even small countries typically have then the choice of instrument matters. Though thousands of companies (mostly small) that engage export licensing and export quotas are commonly in trading services, free entry and nondiscriminato- used, the preferred tool is a variable export tax set ry treatnent should demonopolize trading services. to equal the diffeence between the world price and Ukraine's experience shows that the private trading the domestic price. companies are much more dynamic and responsive First, a tax on exports is transparent. The gov- to the needs of their clients than state tading com- emient and exporters know how much the export panies, are capable of performing the same func- tax costs in forgone forzign excham.ge per unit sold3 tions, and are, in fact, stepping in to perfonn distrib- Second, an export tax allows exporters to engage in ution services when the state trading network has contracts with the certainty of being able to deliver. performed inadequately.5 With export licenses the uncertainty about receiving Indicative list trading has also outlived its use- a license makes it difficult for exporters to enter fulness. It made some sense as a transitional.device into contracts. Third, a licensing system wastes during a time when the free-rider problem and resources. Since licenses have substantial value POLICY RCOMMENDATIONS 2.59 ("rents"), potendal exporters will devote consider- of governments to relinquish control of the produe- able resources to obtain the license and capturc the don and trade of key energy products and raw rents, wasting resources for society. Fourth, an materials. Had they done so, the risk of accumulat- export tax generates govermment revenue, helping ing unusable balances or arrears would have been ease fiscal problems.9 borne by producers or traders rather than govern- The only commodities needing quantitative ments. export controls are those that countries are required In sum, countries need to focus expeditiously by international agieement to limit, such as in the on programs to privatize the distribution and trade Multifibre Arrangement (MFA). In such circum- of energy products and raw materials, as well as to stances, it is best to auction export licenses, an address the payments problems constraining inter- arrangement that ensures that only the agreed-on state trade (see below). Export controls are infeiior quantities are exported, while transferring the rents instruments for addressing these problems. There is from the licenses to the state (which reduces waste- no reason, except for the free trade area considera- ful rent-seeking of enterprises). Competition anong tions discussed below, to maintain two tade suppliers at the auction allocates the licenses to the regimes, one for the other countries of the former most efficient domestic suppliers, maximizing the Soviet Union and one for the rest of the world. rents retained in the exporting country.10 Exporters should be left free to sell in whatever The principle of converting quantitative export country the best (after tax) profits can be made. restraints to export taxes and then gradually reduc- ing the taxes had gained acceptance in several coUn- lImport Policy tries by 1994. It is strongly recommended that Protection. Protection and trade preferences quantitative export controls to hard currency areas are the two major issues of import policy. be eliminated in courtries that still retain them, such Undervalued real exchange rates have provided as Ukraine and Uzbekistan.. high levels of implicit protection that have, by and Intersame trade. Countries have been more laige, permitted countries to get by with little for- reluctant to reduce quantitative restraints on exports mal protection against imports. However, countries in interstate Wade, although the reasons for the con- such as Ukraine and Uzbekistan, which have made trols were no longer applicable in most cases. The limited progress in overall liberalization, still con- demise of the ruble zone and the introduction of trol imports through the allocation of foreign new currencies by most countries eliminated the exchange. By nid-1994 a significant appreciation problems of free-riders and differential progress in of the real exchange rate in several countries price liberalization.1t Countries appear to want to (Estonia, Latvia, Lithuania, and Russia) changed control interstate trade for a different reason. They the situation. Industrialists started to pressure for want to minimize sales to countries with noncon- protection. Though nontariff barriers have not been vertible currencies of commodities for which they instituted, substantial new and differentiated tariffs believe there is a ready market in convertible cur- have been put in place or are under consideration. rency countries. They fear that unwanted balances The main justification for such tariffs has been the in nonconriertible currencies or uncollectible arrears protection of domestic industry.12 will accumulate or that countries will tranship those Tariffs are preferable to quantitative restraints commodities to the rest of the world. These export on imports for all the reasons elaborated above on restraints take the form of bilateral clearing range- the advantages of export taxes ov-wr export licenses ments with obligatory shipmnents or of quotas show- and quotas. Experience suggests that tariff protec- ing maximum pernissible volumes to be purchased tion should be moderate (perhaps no more than 10 for particular products. to 15 percent), transitional, and declining, though While these might appear to be legitimate con- each country would need to tailor its tariff stuctre cerns, they derive fundaunentally from the failure to its own circumstances.13 260 TRADE IN TM NEW INDEPENDENr STATn Temporary and declining protection may be a Trade prefer' '?s. Governments of the fifteen means of easing the adjustment to a market econo- countries have taken an ambivalent stance toward my for industries that have never faced competition. policies that would provide preferential treatment to With significant unemployment, the optimal path of trade with each other. There have been many public tariff policy (which trades off the marginal social statements of support, and severa preferential costs of increased unemployment fiom tariff reduc- arangements have been put in place among certain tion against the marginal social benefits of a more groups of countries, based essentially on differential rapid adjustment of factors) is to adjust the tariff tariffs and taxes. Some governments (Ukraine, for gradually to its long-run low level.14 example) have also attempted to use the obligatory There are several reasons for avoiding high tar- portion of bilateral clearing aurangements to obtain iff barriers. First, if tariffs are high, industries that preferential treatment for their exports in other new benefit from them will resist liberalization, even independent states. At the same time, several gov- though tariffs to ease adjustment should be tempo- ernments have taken steps to inhibit eports of some rary. Once the government slips its liberalization of the most important tradables to other countries schedule, expectations are altered, and the advan- through nonlariff barriers and have introduced high- tages of transitional protection are significantly &r tariffs or taxes on impors from other new coun- reduced. tries with which they had not concluded free tade Second, protection if a second-best means of aangmts. For example, before April 1994 Russia easing the burden of adjustment. No matter what levied import duties at double the MFN rate on the justification for protection, the welfare gains are imports from the Baltic states and Moldova. Latvia greater with a production subsidy (for enterprises applies higher export taxes on goods going to new showing promise of adjustment) or a tariff com- independent states with nonconvertible currencies bined with a subsidy on consumption, with the Iev- These arangements give rise to a number of els declining over time15 The problem in this case policy issues: is that fiscal constraints in the fifteen states make it * Are trade prefnces a useful instrument difficult to recommend the use of subsidies in sup- for easing the adjustment costs of enterpris- port of enterprise restructuring-although, notwidt- es facing international competition? standing these constraints, several countries contin- * Are the current arrangements sutable ue to provide large subsidies, without targeting, Are th a object an d, if for through the budget or the banking system with addressig that objective ad, If not, how adverse consequences on stabilization and stmc- do they need to bemodied? ttuing. But the temptation would be great to keep * Are trade preferences likely to be important tariffs high indefinitely or to design made-to-mea- in stabilizing and eventually reversing the sure tariffs industry by industry to "ease" the transi- declne in interstate trade? tion-a dangerous road because protection supports noncompetitive enterprses and preserves the ineffi- The argunent in favor of trade preferences as cient industrial structure. Then the economy will an instumnent of adjustment policy is an extension not produce according to its comparative advantage, of the argument for moderate and time-limited sup- and the efficiency gains and higher growth rates port to domestic industry. A first-best solution from an outward orientation will not be achieved, would be to pmvide explicit, transparent subsidies Third, high tarifEs, even during a transition, dis- through the budget. A second-best solution is to criminate against exports.16 Both tariffs and an provide modest time-limited and declining tariffs. undervalued exchange rte protect import-compet- The question is whether it might be appropriate to ing industries but use of the exchange rate is provide such protection on a preferential basis for preferable to high tariffs because an exchange rate trade with some or all the other countries of the for- that is not overvalued also encoiuages exports.'7 mer Soviet Union. Pouca REcoMmaNDnAoNs 261 The basic justificatio, for providing protection to be very difficult to negotiate with many of the on a preferential basis is the strong interlinkages of fifteen countries. A free tade area does not require the production network inherited from the planning agreement on the extnal tariff, which seems to Tegime of the former Soviet Union, which in some offer an important advantage. But the benefits are industries established a few very large plants that likely to be greaer for an arrangement that covers a produced for the entire country. If the new coun- substantial amount of total trade, a condition that tries protected only their own national markets, then may be difficult to achieve, and some coordination they will not have protection in the bulk of their tra- on third-country tariffs is useful even in afree trade ditional market, the rest of the former Soviet Union. area If tariffs to third countries in a free trade area Without a preferential trade area, most states will differ significantly, that is likely to induce smug- likely continue to be unabk to sel their soft goods, gling from low-tariff countries to high-tariff coun- as states search for the least-cost, quality-adjusted tries, allowing the low-tariff countries to capture the supplier. 'They will then collectively suffer a decline tariff revenues. in export demand for their uncompetitive industries To counter smuggling. rules of origin are need- before they can adjust and reorient output But ed.19 And for a rules-of-origin system to function under preferential trade agreements, there would be effecdvely a well-d:veloped customs service is scope for continuing preferential trade in these less required. Russia has indicated its intention to imple- than fully competitive products.18 ment a certificate-of-origin system, implemented Note, however, that the justfication is for time- trough the relevant industry group of the chambers limited preferential protection. As explained in of commerce in countries with which it has negoti- chapter one, in the Eong run there is a need for a ated a fee trade agreemenL Although the Russian major reorientation of trade. Trade with the rest of Department of Customs has estimated that the sys- the world needs to increase, while the arbirary and tem wfll not be cosdy to implement, there is reason excessive dependence on interstate trade generated to believe chat if tariff differences across states are by the planning system needs to be reduced. Thus in large, the costs of enforcing such a system will order not to discourage the long-nm integration of become very high.20 these economies into the global trading network, it These problems suggest that a temporary free is important that the preferences be temporary and trade area with moderate tariffs but extensive prod- decline on a preannounced schedule. After a suit- uct coverage may be the most suitabe altenative to able transition the preferential trade area could be pursue.21 Even such an arrangement may be diffi- terminated by lowering tariffs to the third countries cult to put together. however, and weaknesses in the and raising them to members of the preferential customs services wil result in implementation dif- area. It is difficult to gauge how long such a tempo- ficulties Some people argue that establishing such rary arrangement should last In 1992 we had preferential anrangements would give the wrong argued that it should not last longer than five years signals to industries that sooner or later have to be (Michalopoulos and Tarr 1992). Given the difficul- reoriented to the international markeL And even a ties countries have encountered in adjustment, five temporary agreement will protect bad industres as years may be too short It should always be consid- well as good, resulting in considerable trade diver- eredc however, that the longer an arrangement lasts, sion. Some states-especially small ones, for which the more entrenched protected interests become and an open competitive environment is especially the more difficult the transition may be. important in the long run-may regard as excessive Serious implementation issues arise for both a dte trade-diversion costs of parficipating in a prefer- customs union and a fee trade area, the two options ential trade area, even temporarily. Fmally, the for a preferential trade area. A customs union implenentation of preferential trade areas in many respircs agreement by all the countries involved on parts the world has not been successful, leading to a common external tariff. Such ageement is likely further skepticism about the effectiveness of such 262 TRADE iN Tm NEW INDEEsDENT STXmm an arrangement in the former Soviet Union (see de erential trade ama with the states of the fonner Melo and Panagariya 1992). Soviet Union is likely to be a step backward. But In 1994, only the free trade area negotiated for all countries, there is litfle point-other than an amnong the Baltics and the recently implemented expression of political solidarity-in joining a free customs union between Russia and Belarus appear trade area unless some of the key constraints affect- to conform to the institutional arrangements sug- ing interstate trade ar addressed through the gested above.22 The arrangements for free trade arrangement or in parallel with iL areas negotiated by Russia with several countries as well as the arrangements in Central Asia are not Payments Armngements free trade areas in the sense above. Participating With the breakup of the Soviet Union, coun- countries continue to apply their export restraints tries had to establish individual links with corre- against each other (and continue to use state trading spondent commercial banks in financial centers. arrangements). These actions are inconsistent with There appear to be few problems with paymaents free trade principles. They reduce trade, some of arrangements for trade with the West In some which may be efficient even in the long ru- If cases, however, (Ukraine, forexample) intemation- countries really want to expand trade with each al trade is still conducted within the framework of other in an efficient way, they will have to modify bilateral trade agreements because of a scarcity of these "fiee traw ammanents. foreign exchange and continued governmcnt Countries need to carefully assess the advan- involvement. The domestic payments systems of all tages and disadvantages of free trade armgements. these countries are still inadequate, hampering trade A free trade area alone would not have a significant and contributing to the continued use of barter (see impact on interstate trade unless other important chapter I1). constraints are addressed, such as the payments hese problems ae sma, however, when com- problems. If countries adhere to the recomnenda- pared to the payments problems that continue to dion for maximum tariffs of 10 to 15 percent, the plague interstate trade. For ruble-denominated trt- preference margins for partnes free trade areas arc actions long delays in payments and clearing of bal- not lfikely to provide much advantage. Some states ances through the banking system, in a context of may find it preferable to participate in preferential high inflation, have discouraged trade and encour- trade anangements with some other countries of the aged less efficient private barter arrangements. The forner Soviet Union, such as the arrangements scarcity of foreign exchange and the need to con- among Kazakhstan, the Kyrgyz Republic, Russia, serve hard currency for transactions with the rest of and Uzbekistan. This arrangement allows smaller the world have also discouraged the denomination countries to preserve their principal markets without and setdement of interstae trade in hard currencies. incurring the coordination problems of a larger The introduction of several new national cunrencies grouping. or quasi-curren cies that are more or less inconvert- The key issue for the smaller countries is ible has raised additional questions about the unit of whether to join a meaningfil free trade area involv- account and the method of setdement to be used for ing Russia, which is their main markeL Countries interstate trade transactions. whose competitors do so would be at a disadvan- tage on sales in Russia unless tbey also joined such Currency Convertibility an arrangement (for example, Moldovan producers Currently convertibility should be the goal of face competition in Russia and have lost market all countries, at least for current account transac- share due to the discriminatory tariffs). For some tions. A key requirement is the establishment of a states such as the Baltics, which have already sub foreign exchange market with uestricted access. stantially reoriented their trade away from Russia If convertibility is achieved, then it becomes and dte former Soviet Union, participation in a pref- immatenal whether transactions and settlements are Poucy' Rzcomme4DAmNOs 263 made in "hard currencies or in each other's cunrrn- accounts they need to open and the mnount of hard cy becaue they would be interchangeable. The currency they need to keep on deposit,." availability of finance, the stability of the exchange The principal advantage of trade based on dol- rate, the existence of forward cover, global trading L-rs or othier hard currencies is that they are relative- conventions, or similar considerations would then ly stable currencies that represent stores of value. determine the currency used. Traders may wish to The most serious impedfiment to hard currency- avoid denominating trasactions in rubles despite based trade in the preset environment is the limited covetbility because it is not perceived to bea access to hard currency in many couintries of the good stare of value and there is no forward cover, former Soviet Union. Auctions or markets for dol- Trade between Estonia and Russia, for example, is irs exist in many countries, but the supply of hard usually denominated in kroons because of its currency is limfited becauise of taxes, exchange suir- greate stability. Whichever currency is used, settle- render requirem-ents and the general incentive of nments would he made trough correspondent core- enterprises that earn foreign exchange to hold on to mercial bank accounts. A growing network of such it as a store of value, and hedge against inflation. accounts has evolved. among commercial banks in Moreover, to limit thec demad for dallars ther are the former Soviet Union and can be used for this constraints on access to thes markets that limit the Purpose. converibliy of domestic currencies into dollars for Estnia and Latvia have demonstrated that it is the purpose of conducting trade. For example, bids possible to establish currency convertibility early for buying dollars through the interank markets in on, provided that appropriate macroeconomic poli- Ukraine are subject to screening anid approval. cies are pursued. Estonia achieved convertibility To conduct trade in dollars or other hard cur- using a currency board system backed by substan- rencies through a network of correspondent tial gold reserves; L.atvia, with fewer reserves, used accounts banks will need to accumulate a store of a floating exchange rate, suggesting that a strong dollars to satisfy the transactons demand for dollar- foreign exchange reserve position is not a require- serviced trade. There is an interet cost for main- -et for convertbiblly tamning these deposits that is equal to the differenice. between the interest earned on the accounts and the Trading with Inconvertible Currencies opportunity cost of these hinds- Thus, the interest ConmwuneraBankc-BasedSoluiioa.Conrespondent cost of the transactions demand for dollars is a cost accounts in commercial banks can he used to con- to thee countries of trading in dollars rather than duct inte-rstate trade even when the national cunrrn- their own national currencies. For countries or cy is not convertible. Trade would be denominated banks whose cost of borrowing dollars on intern- in a currency, such as the dollar or the Russian tional markets is quite high, these costs may be sub- ruble, with markets maintained in that currency. smtaniu. Trade can be denominated and settled in hard An additional cost is the transactions fees that currency if commnercial banks establish reciprocal must be paid to commerial banks in developed correspondent accounts in dollars in each other's market economies for processing th transactions. It banks. An alternative would be for commercial may be,, however, that the fees for the transactions banks to maintain hard currency accounts in rep- do not increas because of the greater perceived utable banks in developed market economies and to reHiability of Western banks in the 1994 environ- arrange for transfers on behalf of their clients ment and the relative efficiency with which they tirough those accounts. Commercial banks in the proes transactions. For some transactions, particu- former Soviet Union are already using this arrnge- lay large ones, banks in the former Soviet Union ment to facilitate trade, with developed market have been known to hold funds before crediting economies. For individual commercial banks this accounts, to reap the benefits of the float. These approach reduces'the number of correspondent banks also have a greater risk of default Problems 264 TRADE N 1HE NEW NINDepaNET STAfIS such as these may induce some enteris to ina futures comracts would have to be based on engage in bartr and other costly activities to avoid an index of inflaton. It woldd be simpler to denom-. the banking system, which would increase the ral inate futures contrcts in dollars and then to settle in tkansactions costs of trade. rubles based on an accepted aucton me between the An alternative to hard currency is to denomi- ruble and the dollar at an agreed time in the future. nate trade in Russian rubles and use the existing This arrangement reduces the risk of ruble-selted system of coriespondent bank accounts for rubole fuure contracts to the foreign exchange risk, settlements. (For technical requirements, see Sachs which is inhrnt in dollar setlement as welL and Upton 1992.) Commercial banks in countries Risks of nonpayment by buyers and nonperfor- introducing new currencies have opened correspon- mance by sellers are typically handled through dent ruble accounts in Russia, and Russian com- insurance svices, trade contract enforcement, and mercial banks maintain cosrespondent ruble appropriate metods of payments (notably letters of accounts in those countries. These types of arrange- credit), mechnsms that are not avaiable in Russia ments have been used to conduct some of the trade and most of tie other states of the former Soviet between Russia and Ukraine, Russia andj3elarus, Union. Leners of credit guaanteed by Western and Ukraine and Belams since late 1992. banks for dollar-denomiated transactions are avai- Correspondent bank accounts bave also been used able, however, and this mechanism is already used for trade between Russia and other states (Armenia, to guarntee payment for import firom Western Kyrgyz Republic, and Moldova), as wel as countries. That means that tradas that use the ruble between Ukraine, Belams, and other countries. A as the basis of intmtate payments trough commer- few of the larger banks in Russia and Ukine main- cial bank correspondent accounts in the former tamn multiple coneWondent accounts and claim to Soviet Union take rsks tat can be avoided if the process transactions in two to thme days, an enor- dollar and Western banks are employed. mous improvement over the months kt took in 1992 Countries with inconvertible currencies face a to use the central bank correspondent accounts. tradeoff in the choice of ruble or dollar between However, there are reports of long delays in lower trnsactions costs with the ruble from avoid- Ukrainc for obtaiing rubles. ing inter costs on dollar deposits to service trade While using rubles for the conduct of trade and flight fiom the mble because of its high rate of would avoid te. need to obtain hard curency on infltion. The higher the rate of inflation of the world mares to service the tansactions demand ruble, the better is the choice of the dollar. On the for money for trade,24 there are other serious prob- other hand, if trade finance is available from Russia lems in denominaing trade in rubles. The most in rubles, that coud be an important inducement for important problem is the high rate of inflation, denominating trade in rubles. which discourages exporters fom accepting pay- The scarcity of foreign exchange and problems ment in rubles.5 An additional risk, given the insta- with the use of correspondent accounts and with the bilty of the exchange rate, involves ruble-denomi- ruble as a store of value have driven much enter- nated payments for contracts in the fuitre. The prise-to-enterprise trade between countries with absence of futures markets in most of the newly inconvertible currencies to barter terms. Barter, independent states makes it difficult for traders to which is intrinsically less efficient, will be aban- hede against an adverse movementin the exchange doned if a well-functioning payments system is rate on futures contrad.s even in dollar-denominat- established. Countries should strive to strengthen ed contracts. Contracts denominated in Russian the payments system of commercial bank core- rubles pose sinilar foreign exchange risks for non- spondent accounts while working toward convert- Russian agents. with the additional problem of ibility. At the same time, although state trading reaching agreement on a price in the future denomi- barter arrangements should be discouraged, privat- nated in a rapidly inflating currency. Ruble-denom- ly ranged ba orpaymnts arrangements during PoucY REcoMmNDEAnoNS 265 the interim should not be discouraged. Provided the ing through correspondent bank accounts. The key barter deal is arranged by individual agents acting advantages of such a scheme are that it saves on on the basis of market signals, private barter trade scarce foreign exchange by permitting denomina- reflects the fact that the individual agents find barer tion and settlement in rubles; permits multilateral more efficient than the banking system; moreovcr, clearing, which is especially important for trade private barter should respond to the principles of among participants other than Russia; offers some comparative advantage. Regulations prohibiting interim credit and some protection of value, unlike private barter do not attack the cause of the prob- corrspondent bank arrangements which offer nei- lan, which is macrocconomic instability and pay- ther, and provides an additional way to arange for ments difficuties. effective enterprise to enterprise payments and Muitilareral Clearig Arrangements. If con- reduces the incentive to bartr. The arrangement vertibility is not achieved for a number of the new also carries some risks, however. It could distract states, these countries might consider establishing from efforts to promote convertibility, and it multilateral clearing arrangements through their remains to be seen how clearing and settlements centml banks. The objective of multlateral ckaring through such a mechanism will compare with the swould be to facilitate trade by providing efficient speed of correspondent bank arrangements. Also, and secure settlement of payments forenterprise-to- the persistence of large imbalances in interstate enterpnse transactions on a multilaterl basis. trade may lead many debtors to try to increase the Secondary objectives could include the elimation amount of intem finance offered, transforming the of remaining payments restrictions on corespon- arrangement into apayments union. This could lead dent banks transactions and savings in the use ef eitdr to its demise or to the de facto rceemergence scarce hard currency resources. of Russian financing, though the payments system, A simple multilateral clearing mechanism can both of which would be undesirable. be operated through participating central banks. More grandiose proposals for stimulating Countries would have to agree on a number of tech- interstate trade, such as a payments union, have nical issues, such as the institutional arrangements also been proposed, but are counterproductive. A (who will act as the clearing agent), the establish- payments union wili discourage development of a ment of a clearing unit of account (linked, say to the network of correspondent accounts among com- SDR), eligible transactions, the amount of interim mercial banks since central banks will try to chan- finance provided and the extent and nature of con- nel payments through the payments union where ditions attached to its provision, and the period, the country receives credit And, other things terms, and currency of setlement. equal, a payments union will allocate credit to the Such a scheme was being developed under the countries adopting the worst macroeconomic poli- Interstate Bank, which was to have been operated cies (see annex). through the Central Bank of Russia with participa- Whatever the payments alternatives. however it tion by most the new independent states other than is imporlant that information about them be made the Baltics. The Interstate Bank was to have operat- widely available to enterprises so that they can avail ed with a two-week setdement period in rubles or themselves of the emerging oppormnities. At the hard currency and interin finance limited to one same time, efforts are needed to strengthen other moni's exports (for details, see Gros's comment to elements of the system, such as documentary credit chapter I 1)_ Plans for the bank appeared well and the domestic payments systern, that facilitate advanced in late 1993, but became derailed- intcrnational payments related to interstate trade. . There are several reasons why such a clearing arrangement could still be pursued as a transitional Access to Intemational Makets mechanism, as long as it does not distract from tie In the short run the key constraints in expand- long-term goals of convertibility and trade finane- ing exports to the rest of the world are supply side 266 TRADE IN THE NEW INDEPENDEnT STATES problems, quality control, and export policy rater designing their trade policies. For example, the than market access issues. Yet market access prob- European Union has alleged that, witb transport and lems exist, and unless actions are taken now, they energy prices below world market levels, some sec- are likely to become more severe. tors are artificially competitive. Although moving The most important step countries can take is prices toward world market levels is inherently to join the GATT. That would give countries some desirable, commodity subsidies available on a protection from the arbitrary imposition of controls nondiscriminatory basis (such as natral gasm which by other countries, including other former republics is used in U.S. chemical exports) are not considered of the Soviet Union. Too often, the new indepen- to be countervailable. Moreover, unfair trade actions dent states have used trade as a weapon in their agaionst these countries have typically been precipi- political and economic relati&as with one another. tated by the undervalued achange rates rather than To join the GATE, counties would have to under- by explicit dumping Indeed, prices of raw materi- take trade reforms along the lines recommended als are usually priced lowerin domestic markets than abo re. For countres that do undertake such for export, making it difficult indeed to argue that reforms, accession to the GATT should be expedit- these countnes were "dumping" their raw matrals. ed to the extent possible. In addition to explicit measures to enhance Designation as nonmarket economies by most rade access, the international community needs to OECD countries and a concentration of exports- provide technical assistance and advice in the other than raw materials and energy-in sectors design and establishment of institutions that support where nontariff barriers are prevalent are two of the expansion of international trade. Such assistance is principal problems of market access for these wcn- needed in various areas, from payments systems to tries. quality standards and export promotion activities. The broad solution to these problems is for Several countries already have some assistance pro- OECD countries to reduce their nontariff barriers- grams in place. While it is important that they be The Baltics have eased this problem by negotiating strengthened, they should not be viewed as attema- special access arrangements with the EU and EFTA. tives to actions to improve market access. But for most of the new independent states lifting Fmally, OECD countries need to eliminate the the designation as "non-market" economies is of vestiges of the cold war firom their trade regimes. more immediate relevance since the designation Implementing their stated intention to terminate the makes it easy for OECD countries to reach positive COCOM arrangements controlling exports to the findings on dumping cases and acilitates the impo- Soviet Union of products embodying technologies sition of protective measures. The problem threat- with both civilian and military applications would ens to become even bigger as supply-side con- be an important step. straints ease. Clearly, the countries themselves must make progress in introducing market reforms and The Political Economy of Trade Reform eliminating state trading practices. That is already TIhe top priority task on the domestic front is to happening, though more slowly in some countries reduce state intervention in international trade, than in others. It is also important that OECD gov- especially interstate trade, where such vestiges of emments move quickly to clhange the smtus of these central planning as state trading and state orders countries as soon as they have introduced the essen- still remain. Reforms are likely to be resisted by the tial elements of market reform, as demonstrated, entrenched bureaucracies in branch ministries or perhaps, by their having reached agreement with ministries of foreign economic relations since akey the World Bank and the IMF on programs of struc- part of these reforms is to remove from ministries tual adjustment and stbilization, functions that can be performed by the private sec- OECD govermments also need to consider the tor while retaining and strengthening functions tbat specific problems transition economies face when improve the environment for trade. Solutions will PoucY RECOMMENDATIONS 267 differ in individual countries, but at least one coun- have announced their intention to lower export try (Moldova) decided to abolish the Ministry of restraints will succeed in doing so. Foreign Economic Relations. Other important tasks More broadly, because of Russia's importance include strengthening the payments system and in interstate trade, its policies are likely to set the other institutions supporting trade. External assis- tone for trade policy in many of the other countries. tance may be vital in strengthening these institu- For example, a decision by Russia to tenninate all tions. state trading, including obligatory lists, is likely to A major challenge will be to resist growing have a profound impact on countries that have pressure to impose import controls. As countries made little progress in liberaizing their trade join the GATI, international pressure will con- regimes. At dhe same, Russia needs to exercise care tribute to binding tariffs. The sa;ne interest groups in its leadership on interstate trade and payments: that succeeded in getting directed credits at negative many governments zealously guard their new inde- real interest rates and subsidies through the price pendence, and they are loath to participate in system or budget transfers are likely to shift their arrangements that reduce-or appear to reduce- attention to import controls as a means of delaying their eedom of action. restructuring and adaptation to the market environ- menL These pressures will intensify as countries Annex: Problems with a Payments Union adopt stabilization mneasurs that eliminate directed Clearing or payments unions are sometimes credits, reduce other explicit or implicit subsidies, recommended for countries with different incon- and lead to appreciation of the real exchange rate. vertible curncies Unless institutions are devel- Countries need to be vigilant in their opposition to oped to &ailitate direct trade among individual such measures-which are likely to expand to agents without govenment foreign exchange encompass antidumping and countervailing rationing, trade will be hampeed. A clearing union duties26-because they can lead to the same ineffl- allows tansactions to be denominated in a common ciencies as previous policies. unit of account (say, for convenience, in U.S. dol- The political economy issues may be some- lars), while permitting private agents to pay for what different with regard to export controls. imports and to receive payment for exports in their Although GATr accession agreements do not typi- national currencies. Settlcments are made in con- cally address export restraints, it may be that export vertible currency, and multilat balances among controls prove easier to dismantle than has been the participating countries are paid in full after faitly case with imports. With import barriers, the benefits short settlement periods. The proposed Interstate of protection are typically concentrated in a few Bank (see Gros's comment to chapter 1 1) is a clear- industries that lobby the government Those who ing union. A payments union differs from a clearing lose from the import protection are a diverse lot, union by allowing for substantial credit in the settle- and the costs of the protection to any one individual ment of the multilateral balance. or industry are typically insufficient to motivate Clearing and payments unions are not them to lobby against the protection. The logic is employed between countries with convertible c-r- opposite for export restraints. The costs of the rencies. Both clearing and payments unions are restraints are concentrated in the industry that is inferior to convertibility, and care should be taken restrained by themL It will lobby the government to that establishing such arrangements does not retard remove the restraints. But the benefits of the export progress toward convertibility. These arrangements restraints are spread to diverse groups throughout are also not employed within a country or within a the economy, and they will generally have insuffi- conimon currency area that has an inconvertible cient economic interest in the restraints to lobby the currency, because direct trade among individual government in their favor. Thus there is reason for agents is possible in all of these cases through the cautious optimism that countries such as Russia that use of domestic currency. 268 TRhnE IN 1E NEW INDEPENDENr STATES Advantages of a Clearing Union difficult Countnes that art pursuing the worst nacro- In addition to facilitating direct trade among economic policies may run the largest deficits and individual agents, a clearing union economizes on draw most heavily on the credit. Pcrversely, balance the use of lhzd currency reserves since only the mul- of payments support would go to the countries whose tilaemral balance needs to be cleared in hard curen- adjustment progrms are least worthy of support29 cy; individual transactions are conducted in national In this way, a payments union may prolong inap- curncies. Moreover, since only the multilateral propriate macroeconomic policies; in particular, it balance is relevant to settlement, a clearing union may prolong the period during which the country removes any incentive to discriminate bilaterally operates without a convertible currency (see below). among trading partners within the clearing union.7 Moreover, participating nations may have a greater need for balance of payments support to finance Disadvantages of a Payments Union imports from outside the payments union, but the In a payments union, only part of tfie multilat- credit provided to the payments union is restricted eral balance needs to be paid until a country to balance of payments support within the region. exhausts its credit limiL Payments unions are soMne- Direct lending to individual countries for balance of times recommended in the hope that they will payments support rather than credit through a pay- somehow accomplish one or more of the following ments arrangement would thus make more sense. objectives: provide balance of payments support prvide an incentive for regional trade, or establish Incentive to Regional Trade a payments facilit among countries with inconvert- It is sometimes argued that a payments union ible currencies. But supeior instumments are avail- will encourage intraional trade, but only prefer- able to meet each of these objectives: the first encesfor intmegiond trade at the level of import- objective is best met by bilateral balance of pay- ing agents can do that A payments union provides ments support, the second by a preferential trade an incentive to a country to trade on an intraregion- area, and the third by a clearing union. And it is al basis. But how will the goveming authorities well established in economic theory that the instu- assure that the incentives to the country are trans- ment that most directly attacks the problem at hand mitted to the individual agents who make the deci- should always be used.28 A payments union does sions to import? Ihe country will have to offer not direcdy attck any of- the three objectives men- financial incentives to its agents to import from tioned above directly. Moreover, a payments union within the payments union, most easily executed creates some important problems without convey- tbrough its trade regime. Through higher tariffs or ing advantages that cannot be obtained from a com- other bariers against third counties (such as stricter bination of the other instrments. foreign exchange rationing) the softness of the pay- ments situation can be internalized in the decision- Balance of Payment Support making proces of individual agents. For some First, consider the question of who provides the countries imposing tariffs on third countnes would credit to start a payments union. Countries of the represent a step backward in their trade regime.30 region, including Russia, seem unwilling to provide The level of tariff preference for intraegional trade the substantial credit needed to start the payments is best determined through the negotiation of a pref- union. Should donor nations or multilatenrl institu- erntial trade area, wlhch directly considers the costs tions step in to provide the credit? The problem with of trade diversion and the benefits of trade creation. their doing so is that credit is provided for debtor nations within the payments union. But since the Facilitating Payments among Agents in rules of payments unions allow access to cedit on Coutifes with Inconvertible Currencies the basis of predetermined credit limits, imposing Though a payments union, like a clearing conditions on this balance of payinents support is union, can directly facilitate transactions among POLICY RECOMMENDATIONS 269 individual agents in countries with inconvertible demand could not be met by domestic suppliers at a price currencies, it does so while providing credit that is acceptable to the autorties. not necessary to accomplish that objective. And that S. In the event that state puithases presere a monopoly in creates problems. distribution, deconcenradion through antimonopoly action may be considered a second-best solution to terminating Such arrngements may discourage the devel- smtatPurchases. opment of correspondent accounts in commercial & The couties of Cenirl and Easter Europe usd a sys- banks and the convertibility so necessary to full ten of indicative lists after thc demise of the CMEA, but integration into the world economy. If a country the lists did not prevent a significant collapse of trade witl receives credit through participation in the multilat- the ofonner Soviet Union. See Tarr (1992) for an analysis of indicative lists and other transition devises employed after eral payments union, its central bank wiD have an the demise of the CMEA. incentive to force agents to channel their payments 7 Ih export tax would therefore dedine as the domestic for imports through the payments union instead of price is liberalized toward the wodd price. through commerc bank corespondent accounts. & In some cases, substibtuing the equivalent export tax for In conclusion, bilateral balance of payments a quota my call for an expt tu above 100 percent Such support, a clearing union and preferential wading high and uneven incendves in the trde regime cause greater disbortions than a morc neutral trde tax regime and arrngements more directy and efficiently attack sihoul be avoided (Tbomas. Nash, and others 1991)- the problems that a payments union seeks to addres. Allof thee mor direc instumentsmay Q. Auctioning of licenses or quotas can be used as an alter- address. All of these more direct instruments may ntive under cetin conditions it yields the sme rests as be usefiully employed, an export tax 10. Such an auction system was envisaged by the Russian NorSe Ministry of Forcign Economic Reltons and authorized by DiEctive 90 of the Russian Federaion. 1. Pinto, Belka and Krajewsli (1993) found that the state 11. The diffierent pace f price decontrol in the ruble zone owned entaprises in Poland were succcssfl in expanding w a motvaton for export licenses. but with indepen eqxots after the major Polish refoms in 1990. But Pinto and van Wijnbrg (194) explned dt this sccess dent currencies export taxes ratr than licenses can dependent on the anticipated privatization of these firms. Managers endeavonrd to create a positive record of pcrfor- 12. Tariffi have also been introduced for revenue purpose mance before privatization_ Pinto and van Wijnbergen also A fundamental priniple of commodity taxation however, note that the absence of subsidies was also an important is that netral taxes (taxes that do not discriminate between part of the successful expot cxperience. See also Winters imports and domestic sources of production) are the most and Wang (1994), -whD mintain that the highly devalued efficient at generating revenue. Thus. in theory, a tariff (in exchange rate of early 1990 combined with excess capacity the pure sense as a tax that discriminates against imports) ia the state-owned enterpriscs was 'nportant in cxplaiining should not be used for revenue purposes alone. This argo- export succfss. ment needs to be qualified, however, where a country has a 2. This is as large a greater percentage of private- ownership generally inefficient domestic tax system but collects as achieved in any otber country of the former Soviet impst taxes efficiently. The rlative efficiency of tax col- Union with the possible exception of Russia. See Nulis lcCton may dominate the neutality principle, and import (1994) for an elaboration on Estonia and Lieberman and taxes could be used for revenue, as in many Sb-Sahan Nelli (forthcoming) on Russia. African countries. Value-added taxes have been imple- mented in many of the states, but it taes tine to turn the 3. Morc generally, there is an equivalence between a tax on VAT into an effective nondiscriminatory tax collecting exports and a tax on imports in terms of the impact on mechanism. Given the short-rn difficulties of genernnng imports. The intuition for this theormn is that while import revenue in many of the fifteen states, it may prove usefu tariffs rcstrain imports directly, export taxes restrain on occasion to impose taxes on trade, including import tar- exports and foreign exchange earnings. Since a country iffs, as a temporary measure until efficient domestic tax requires foreign exchange to import, a country cannot collection systems are in place import if it does not export Although goverments have 13. Word Bank experience suggests that deeloping coun- not imposed significant tariffs on imports, the export tres that have been succsugl in stimulating growth and restraints limit imports and protect import-competing tnes have maintained tariff siture that do not eceed industries as if there were tariffon imports. 15 to 30 percent (Thomas, Nash, and others 1991). 4. In some cases, such as wheat in Russia, import subsidies Recognizing that political pressures for protection are were provided for a domesticay produced good; but these bound to persist, it may be tactically advantageous for goV- subsidies were provided only to the extent that domestic crments in the new independent staes to aim for some- 270 TRADE IN THE NEw INDPENDENrSTAT what lower tariff ranges, which may enable them to main- Baldwin (1969) has argued that protcCtion will gcncrally tain a liberal regime. not address the externalities. Morcover, protection is sel- dom associated with incrcasing efficiency, and it frequently 14. The most thorough development of this argument is has the oppositc effect (homas and oLhers 3991). Mussa (1984). Under the assumption that fte onl3 instru- ment of intervention available to the govermment is the tar- 18. Havrylyshyn (1994) argucs against a temporary prefer- iff, he shows that in the absence of unemployment or other entia trade area because it will calcify the old trading rela- distotions, the optimal time path of the tariff is immediate tionships, but he does not argue for immediate free trade. free tude, even when there arc costs of adjustmCnL of fac- Rather, he proposes a phased adjustment to free trade along tors of production. He has several qualifications, howevcr. MFN principeis for each of the countrics The argunent for First, myopic expectations by potentially displaced workers a phased reduction of protection, rather than a rapid reduo- are a justification for gradual adjustment toward free trade. tion in protection, must be based on a saving of adjustment Second. concern for the income of workers in shrinking casts. But if the reduction of protection is along MiN lines, industries will also justify a gradual adjustment such that without regional preferences, there will be considerably the industry contracts at roughly tk speed of nomal aSri- less saving on adjustment costs becamus te tditional mar- tion of factors in these industries. The most important qual- ket for many of the goods of domestic industries is the for- ification in our context is based on Mussa's tentative mer Sovict UJnion, not the present domestic markets. assumption that faster liberalization will increase unem- ployment. The optimal commereial policy ovecr timc should 19. Another reason for moderate tiird-country tariffs: even be one that balances te marginal social costs of unemploy- within a free trade ara, the high-tariffcountries bear a dis- ment with the margina social benefits of fasLtr adjustmcLt. proportionate share of the trade-diversion costs, because Challenging the assumption that trade liberaltion has a the high tafs inducc more trade-diverting imports from significant effect on unemployment is a nineteen-country the partner countries. study by Papageorgiou. Choksi and Michaely (1990). They found that the effect of trade liberalization on unemploy- 20. A variety of problems may develop as a result of a cer- menat has becn small. Often the reallocation of labor was tificate-of-origin system. Fxst, rent-seeking and rent dissi- within sectors, caesing less disruption than feared. This pation may develop, espeidally for illegal certificates of ori- would argue for a faster transition toward the long-mn low gi. Second, a system in which certificates of origin are tariff weC it not for the fact that in the fifteen states unen- checked for their authenticity to detrmine the true origin ployment is likcely to be high fromothershocks.,so that the of the goods is likely to add significant delays to border marginal unemployment cost of another displaced worker processing and add to corruption at the borders. Both will be higher. delays and corruption are already reported as a significant problemL Finally, the system may contnbute to producer IS. Jagdish Bhagwati. V. Ramnaswami, T.N. Srinivasan, associations exercising carte-like price control in the issu- and Harry Johnson have developed this proposition in a ing country. See World Bank (1993) for details. series of articies. The arguments are summarized in Bhagwari (1971). 21. These problems also highlight thc possibility that if a free tradc area is implemented, pressure wlil be applied to 16. Expordng industries are taxed by tariffs in a variety of the high-tarf countries to lower their tariffs. The free trade ways. First, the tariff causes the real exchange rate to area may thus result in good policies driving out bad ones appreciate and therefo reduces the return to exporting in domestic cuncy. Sewcnd, exporters must pay tie import 22. Belaus. hownevr, applies its VAT on both exports and tariff on their imported intermediate inputs. RebaLing this imports which is a bias against all imports (or exports), tax through duty drawback mechanisms is often attempted including those from (to) Russia but these mechanisms are often cumbcrsome and unsuc- cessful And the tariff induces import-competing industri_s 23. See Michalopoulos and Tair (1994) for an explanation to drive up tne price of primary factors in competition with of how a typical transaction would be carried out in prac- exporing industries. tice and for an elaboration of the arguments discussed in this section. 17. Despitc tbese considerations, very high tariff protection has been proposed on an interim basis for socialist 24. This will convey an advantage for Russia, as it will not economies in transition (see McKinnon 1991) to protect need to obtain dollrs on world markets to service trade set- industries with negative value added. This argument could tled in dollars. Moreover, other countries will maintain be valid if the negadve value-added industries will become deposits in rubles in correspondent accounts, thereby efficient compedtors on world markets and if this would increasing the transactions demand for rubles and allowing not occur without government intervention because of Russia to gain seigniorage. In theory, the additional externa;lits. Corden (1992) has noted that this argummt is segniorage gain to Russia attributable to increased transac- a specia case ofthe infant-industry argument, wbich would tions demad for rubles from the other FSU states could be also apply to positive but low valu-added industries. The distributed by Russia to these countries through Russian industries of the fifteen states have, however, received pro, compesation payments, which would result in advantages tection for decades, and it is hard to visuaLize these old neg- to all paicipants. In practice, an agreement on distribution ative value-added industries being classified as infants, of seigniorage may well be unacctable to Russia. Russia ones in which enaities to invesment cxist at cannot migbt however, be willing to provide mble finance in its be capured by the firms. Even if there were such cases, plam To the extent that Russia is willing to provide financ- - PCJY' RECOMMENDAMONS 271 ing in rubles, this may induce other countries to denomi- Brown, Stuart, and Misha Belkindas. 1993. "Who's nate trade in rubles and usc rubles as a means of settlement. Feeding Whom: An Analysis of Sovict Interrepublic Trade." In Former Soviet Union in Transition. 25. The monthly rate of inflation of the Russian ruble wns Washington, D.C.: Joint Econom;c Committce, U.S. over 20 percent as of November 1993 (almost 00 percent Congress. annually), but declined through the spring of 1994 (see chapter 2 in this volume). Bruno, Michael. 1992. 'Stabilization and Refotm in Eastern Europe: A Preliminary Examination." Paper 26. Pressures for protection through the antidumping and presented at the World Bank-IMF conference on the countervailing duty laws have arisen in Estonia and Latvia fall of output in Eastern Europe. June 4-5. Washington. in 1994. D.C. 27. If a network of debit-credit positions exists among th Collins. Susan. and Dani Rodrik. 1991. Eastern Europe countries without a cIcaring union there is an incentive to and the Soviet Union in the World Economy. bilaterally discriminate. The home country will favor Washington. D.C.: Institute for International importing from countries that owe the home country money Eonmics. and discourage importing from countries to whom it is in debt Corden, W. Max. 1974. Trade Policy and Economic WeLfarr. Oxford: Clarendon Press. 28. This has been developed by a number of author, most .1992. "Integration and Trade Policy Issues in the notably Jagdish Bhagwadt Harry Johnson, V. RamaswaniL ex-Sowiet Union." Policy Research Working Paper and T. N. Srinivasan. See, for example, Jagdish Bhagwad 915. World Bank. Policy Research Department. (1971). Intemational Trade Division, Washington. D.C. 29. Although not supported by significant external aid, this Dornbusch, Rudigcr. 1992. 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POUCY RBCoMmU1NDAITONS 273 Smchs, Jeffrey, and David Lipton. 1992. "Renmaining Steps Thomas, Vinod, John Nash. and others. 1991. BDes to Achieve n MarketBased Monetary Systcrnm" Paper Practices in Trade Policy Reform. New Yorka Oxford presented at the conference on the Change of University Peas. Economic System in Russia, Stockholm School of Economics, June 15-16. Stockholm, United Nations, Economic Commission ror Euope, 1990. Economic Bulletin for Europe. Vol. 42. Geneva: UN Saldanha, Fernando. 1992. "Seif Management Theory and Secretariat Yugoslav Practice," in B. Milanovic and A. HKilman eds., The Transitr-a from Socialsm in Eartern Eumpe: 1991. Economic Bulletin for Europe. Vol, 43, Domestic Restructuring and Foreign Trade, The World Geneva: UN Scraiat. Butk Washington D.C. 1 W992. Economic Survey of Europe in 1991-1992. Scherer, F.M. 1980. Indujzrial Market Structure and GeneYa UN Secretariat Economic Performonce. Chicago: Rand McNally. Ward, Benjamin. 1958. "Te Firn in Illyria: Market Senlik-Leygonie, Claudia, and Gordon Hughes. 1992. Syndicalism."American Ecnomc Rview 48:56649. "Industrial Profitability and Trade among the former Soviet Republics." Paper presented at the Economic Webster, LeilaL 1994. "Russ's Newly Privaized Finns." Policy Panel, April, Lisbon. Finace and Private Setor Development (FDD) Note No. 2 Washingtin, D.C.: The World Bank Tar,, David 0. 1990a "Quantifying Second Best Effets in Grossly Distorted Markets: The Case of the Butter Winters. L. Alan, and Zhen Kan Wang. 1994. Eastern Market in Poland." Joural of Comparative Economics Ev;pe's Ink "ationa Trade. St. Marins Prs. 14:105-19. Williauon, John. 1992. Trade and Payments After Soviet 1990b. 'Second-Best Foreign Exchuage Policy Disintegration. Washington. D.C.: Institute for in the Presenmc of Domestic Price Contols and Export International Economics Subsidies." The World Bank Economic Review. 4(2):175-93. Wnrld Bank 1993. Russic Joining the World Economy. Was*ington, D.C.- . 1992. "Problems in the Transition from the CMEA: Implications for Eastern Eurpa" Communist World Bank. 1993a. Statistical Handbook States of the Economies and Economic Transjonnaoion 4(1): 2343. Former Soviet Union.. Washington, D.C. 1994. "The Terms-of-Trade Efcs of Moving 1994a. Kazufdstan: Economic Report. to World Prices on Countries of the Forner Soviet WconomIc D.C. Union. Journal of CompariveEconomics 18:1-24. Wnit[n, DC 1994a. The Welfar Costs of Price Controls for 1994b. Uzbekistan. Country Economic Cars and Color Televisions in Polandi Contrasting Memorandum-Subsidies and Transfers. Wasington, Estimates of Rent-Seeking from Recent Experiencc D.C. The World Ban* Ecoanomic Reviw 8(): 415-443. 274 TRADE IN THU NEW INDEPeNDeNT STATES Name Index Aslund, A., 138 Meo, J de., 262. Balassa, B., 243 Mendez, J., 14 Baldwin, R., 270 Meyermans, F., 57 Baldcrowicz, L., 239 McKinnon, R., 20,270 Belkri, M., 269 Michalcy, M., 270 Belidndas, M., 276251 Michalopoulos, C.,7, 16,27,238,261,270 Bhagwati, J., 270,271 Mussa, M., 270 Biessen, G., 14 Brada, J., 14,20 Nash, J., 215, 269, 270 Brown, S., 27,251 Nellis, J., 269 Bull, G., 94 Oblath, G., 7,20,21 Choksi, A., 270 Ofer, G., 2, 20 Christensen, B., 52 Olechowskd, A., 243 Collins, S., 14,20 Orlowski, L., 183 Corden, M., 270 Panagariya, A., 262 Dautrebande, B., 232,235 Papageorgiou, D., 270 de Melo, M., 2 Desder. I. M., 249 Pinto. B.,269 Duchene, G., 232 Polak 1., 271 Pritchett, L., 14 Easterly, W., 20 Ramaswami, V., 270 Fischer, S., 20 Roemer, M., 243 Fitzgerald, B., 225 Rodrik, D., 14,20 Gelb, A., 239 Sachs, L., 135, 138, 264 Graubart, S., 220 Safadi, R., 251 Gros, D., 54,57,232,235 Saldanha, F., 20 Gylfason, T., 53 Sheales, T., 251 Hachene. D., 215 Singer, A., 218, 220 Hansson, A., 133, 135, 138, 139 Sorsa, P., 246, 251 HEavrylyshyn, O., 14, 270 Snivas, T.N., 270 Hdlleiner, G., 243 Tarr, D., 7, 16, 17,20,21,25,26, 119, 142, 167, Hindley, B., 249 183,238,261,269,270 Johnson, H., 270 Thomas, V., 269,270 Jones, E., 54,57 van Arkadie, B., 133 Kaminski, B., 180, 185,239,251 van Wijnbergen, S., 269 Karlsson, M., 133 Vanous, L., 7,21 Kaufmann,D., 109, 111 Wade, R., 214 Keesing, D., 212,213,218,219,220,224 Wang, Z., 14,269 floedf, V., 57sd,.2 Krajewski, S., 269 Ward, P., 217 Laird, S., 244, 246 Webster, L., 20 Lieberman, L, 269 Welwood, D., 243 ipton, D., 264 Winters. L. A.. 14,269 Mese, K, 7, 21 Yeats, x, 180,243,244,246,251 Suwucr INDEX 275 Subject Index A Bankruptcy laws (enforcement in Estonia), 120 Barriers to entry, (in Russia), 49 Adjustment to liberalization, temporary and declining protection to easc Barter, adjustment, 260 agreemenes, 2 protection as second-best method of easing as a result of foreign exchange shortages and adjustmcnt, 260 inconvertble curencies, 16,284 trade preferences as instrument of adjustment Barter trade, policy, 260 in Estonia, 127 Antidumping, 13-14,245-49,267 Kyrgyz Republic, 188, 194 Latvia, 147, 151 Agriculture, 67, 76; pressure for import protection, Lithuania, 165 (in Estonia), 124 Moldova, 174 Argentina, (comparison with Ukraine), 84 Russia, 37,46,52,62 Arrears by enterprises (interenterprise), Ukraine, 71,76,82,95, 101, 104 in Estonia, 120, 131 Kyrgyz, 189 Bilateral trade agreements (involving countries of Latvia, 143 the fonner Soviet Union) Lithuania, 159 by-Estonia, 125 Moldova, 176,184 by Kyrgyz Republic, 191, 205 Russsia 45,48 by Latvia, 150 tlkraine, 66, 86, 98 by Lithuaia, 164 Anrears in bilateral trade, by Moldova, 176 involving Latvia, 150 by Russia, 30,46 involving Lithuania, 165 by Ukraine, 73,76 involving Moldova, 184 Black rmarket for hard currency, (in Ukraine), 95 involving Uzbekistan, 208 Budget constraints, (hard and/or soft), 256 Auctions, in Estonia, 1 19, 124 (of currency inEstonia), 127 Kyrgyz Republic, 188, 194 (of export quotas in UJkraine), 73 Lithuania, 159 (of foreign exchange by Moldova), 177, 184 Russia; 31 (of foreign exchange by Kyrgyz), 189 Ukraine, 66 (of foreign currency by Uzbekistan), 209 Uzbekistan, 200 (of U.S. dollars in Ulkraine), 78; (in Kyrgyz), 195 C B - Capital flilht, 12; in Estonia, 126 BalticFree TradeAgreement, 126 Russia, 61 Baltics, - Ukraine, 70, 83, 110 role in transshipment of unrecorded and/or ille- Central planning (Soviet style), 6-8 gal exports of Russian products, 3, 122, 126, anti-export bias of, 146, 161 142, 145, 167 cause of trade diversion for manufactued Barkng crisis, (in Estoniain 1992), 139 goods, 14 dismantling of (in Russia), 58 276 TRADE IN THE NEW INDEPENDENT STATES little regard for comparative advanlage, 6, 14, Effcctive protection, 149, 163 29Enry2 overvaluation of ruble, 7 Energy, 2 China, (trade volume with Russia maintained), S Exchange rate mechanism, in Estonia, 116 Chile, (comparison with Ukraine), 108, 113 Kyrgyz Republic, 195 Chisnau Interbank Foreign Currency Exchange, Latvia, 143 (Moldova), 177 Lithuania, 158, 160 Moldova, 181I Clearing union, 267-68 Russia, 30 Collapse of output and collapse of trade (relation- Ukraine, 66,77 ship between), I Uzbekistan, 209 Collapse of trade, (intenational), 2. (interstate), 3 Exchange rate, real (depreciation/appreciation) in Estonia, 123 Cotton, estimated welfare cost of implicit taxation Kyrgyz RepubLic, 189 in Uzbekistan, 205-208 LKyvi3, 150 Convertibility of national currency, (crucial com- Lithuania, 162, 164 ponent for addressing payments problems), Moldova, 176, 178, 180, 184 256; (nonconvertiblity of most new currencies), Russia, 32-33 16; and multilateral clearing arrangements, 265 Ukraine, 69 in Estonia (koon), 116-117, 126, 133 Uzbekistan, 203 Latvia Qlat), 142 Lithuania (lita), 158 Export processing zones, (EPfs) and bonded b -.thuainiae(lita, 158 warehouses, 214; in Russia, 216, in Latvia, 216 Ukraine, 86 Uzbekistan (sum), 208 Exports (importance of uecorded and/or imegal), Russia (mble), 229 3 Council for Mual Economic Assistance Export controls and import protections (relation- (CMEA), 5 ship between), 8 Cross subsidies, Export licensing, (uncertaint about obtaining), in Kyrgyz Republic, 188, 192 ;!58 Moldova, 180, 183 in Kyrgyz Republic, 194 Russia, 47 Latvi, 146 Ukraine, 75,78 Lithuaia, 16 uLituania, 161 Currency board system, (in Estonia), 116, 135; (in Moldova, 174 Lithuania), 158 Russia, 46 Ukraine, 75,98 Customs law, 38 (Russia) Uzbeldstan, 203 Customs controls, (lack of in Russia), Ea Export perfaomace. (qulty pmblems m Rusis). 63 D Export quotas, Defiense-related production, (R-assia) 48 in Estonia, 146 Latvia, 161 Discrimination by OECD countries against coun- Lithuania, 162,169 tries of the former Soviet UniOn, 13 i. Idova, 174 Duty drawback system, 213, (in Estonia) 123; (in Russia, 41, 46 Latvia) 147 Ukraine, 69 Expori restraints, administration of in Russa,60; in Ukraine,72 -.adlistered in nontansparent fashion, 9 Economic Coopeation Organizaion, 195 as a means of controlling enterprises, 9 -exporer registers in Russia, 44 SuBECr INDEx 277 tariff equivalents of, 9 0 limited in Estonia, 123 validation of export prices by Moldova, 178 General A!crement on Tariffs and Trade (GATT), Export taxes, (Latvia's applicadon for membership) 153; in Estonia, 122, 131 (Lithuania's application for membership) 168- Kyrgyz Republic, 194 69; (Moldova negotiating membership in) 176; Latvia, 142, 147 (Kyrgyz Republic's intention to join) 195; Lithuania, 161 (advantages to membership) 266 Moldova, 174 Generalized System of Preference (GSP), 14 Russia, 43, ; German deutschemark, 116, 135 Ukraine, 75 Uzbekistan, 203 H F Hanseatic City, 116,141 Financing foreign trade, collapse of payments system in Ukraine, 106 j correspondent accounts involving private banks, in Ukraine, 79; in Estonia, 126; in Illegal exports, 25 Lithuania, 165 hnport licensing, efforts to improve in Moldova, 183 in Estonia, 123 network of correspondent accounts, 229 Moldova, 174 letters of credit, 223 Russia, 39 problems with lack of infrstrucure, 8 Ukinej 76,98 role of private, commercial banks in Russia, 45 Uzbekistan, 205 under central planning. 220 transfer of gold abroad (Uzbeldstan), 208 Inport protection, Finland (comparison with Estonia), 115, 121, 135. by central allocation of foreign exchange, 12, Flat personal income tax, 133 by import subsidy program, 12, 13 Food security, 179 by undervaluation of exchange rate, 9, 12, 123 Foreign exchange market, (laissez fair in Estonia), import quotas, 76, 163 155; (well functioning and competitive in Moldova), 177, 181 inport subsidies, Foreign exchange as a store of value, 12 Uzbekistan, 208 Foreign exchange surrender requirements, Import tarif, in Estonia, 126 in Estonia, 123 Moldova, 177, 181 Kyrgyz Republic, 194 Ukraine, 78, 102 Latvia, 148 Uzbekistan, 203 Lithuania, 163 Foreign investment, 128, 129, 167 Moldova, 175, 179 - ~~ ~~~~ ~~~~~ ~Russia 30, 40, 61 Foreign trade statistics (credibility of), 2, 21-25 Russi, 30,406 Ukraine, 75, 76 Free rider problem in money creation =-d trade Uzbekistan, 2)3 deficits, 15. 16,44 Index of administrative controls, (Ukraine) 109, Free trade agreements 112 by Estonia, 125 - India (collapse of trade with Russia), 5 by Ukraine, 77 Frequent changes in trade regime, 142, 163 Indicative lists, 18,125,176,191,258 Futures markets (absence of), 264 Inflation (hyperination), 15,256 278 TRADE IN nlE NEW INDEPENDENT STATES in Estonia, 116, 118, 119 Monetary overhang, 31 Kyrgyz Republic, 188 Monopoly of domestic industry, Latvia, 142 in Esonia, 122 Lithuania, 158 K tyflyz,19 Moldova, 171 Kyrvyz, 194 Russia, 30 Mlatvia, 144,19 Ukraine, 67, 97 Moldova, 180, 183 Uzbekistan, 200 U . - . . ~~~~~~~Multifiber Arrangeffcnt (ME;A), 259 Information and commercial services for exporters, 218 Multiple exchange rates, 34, 39, 58 Interstate Bank history, 229-33, 265 Interstate (FSU) Trade, high concentration of, 14, correspondent accounts and, 15 Obligatory lists, 17, 132, 177, 191, 257 Oil shale, 127 J Output, contraction in, Joint ventures, 41, 196, 256 Estonia, 119 Kyrgyz Republic, 188 | Lat~~~~~~~~~~1via, 143 L Lithunia, 159,166 Labor mobility, (constrained in Estonia) 120; Molduva, 171 (hampered by regulations in Lithuania) 159 Russia, 31 UJkraine, 66 Laffer curve, 110 UzbIkian, 200 Latvian Shipping Company, 146 Lerner symmey theorem, 21, 52 P Lers of Credit, 225,264 Payments problems as a severe impediment to Local government regulation of business, 49 intenta trade, 15 Payments union, proposals for, 265 M Purcghaing power parity (Pm) for imports and Mafia, 90, 99, 101 exports. 32, 123 Pricacontrols, 16, 180 Market access issues in exporting to OECD mar- kets Price reform, antidumping actions, 245-49 in Estonia, 116 Estonia already familiar with western standards, Latvia, 142 128 Lithuania, 158 nontariff barriers, 244 Moldova, 172,175, 197 problems faced by Russian firms, 50 Uzbekistan, 199 problems faced by Moldovan finns, 180 Privatiation, (important for export performance tariff barriers, 242 and trade reform), 256; tariff and nontariff barriers by OECD countries, in Estonia, 120, 129 13 Kyrgyz Republic, 196 threat to future export expansion, 13 Latvia, 144, 154 voluntary restraints, 249 Lithuania, 159 Material balances, 73 Moldova, 181 Russia, 49 Migration, 119 Ukraine, 68,84,86 Minimum prices for valuation of agricultural Uzbelrstan, 200 imports, 148 SuWECr IMnc 279 Producer-price support law for agriculture, 124 State trading companies/monopolies, 256; Protection from undervalued currency, 259; Kin z Republic, 196 in Estonia, 135 Kygy Reulc 9 Latvia, 148,150 Litnia,162, 164,170 Lithuania, 163 Moldova, 172,176, 180 Rus,siai, 7 Russia, 30 Llcraine, 75 Ukraine, 67,68,78 Protectionist pressures, Uzbelistan, 203 in Estonia, 9, 124, 134 Stratgic exports, 43, 73 Kyrgyz Republic, 188 Latvia, 150 Subcontracting contributing to exporting and for- Lithuania, 161-164 eign investment, 123, 127 Moldova, 178, 180 Supply response to liberalization, 47, 54 Russia, 30,40 Ukraine, 82 System for Worldwide Interbank Fiancial Telecommunications (SWIFT), 127 Q~~~~ Quality of nontraditional export products, s Tariffs preferble to quantiatve resaints, 259 R Terms of trade changes, 16-17; R ~~~~~~~~~~~~~~in ERstonia, 119, 127 Redirection of export from the countries of the Latvia, 142 former Soviet Union to OECD markets, 240 Moldova, 174 Kyrgyz, 189 Reexports, (of Russian raw materials) 62, 161; LTkaine, 71, 77 178 Regional cooperation in trade and payments, 19 lbird Way, (Ukraine), 82 Rent-seeling ac.vities, Trade, contraction in, in Russia, 41, 42,59 in Kyrgyz Republic, 189 UkmRine, 71, 80, 93 Moldova, 174 Uzbekistan, 204 Russia, 35 Ukraine, 65,70,86 Return to Europe, (Estonia) 13- Uzbekistan, 199 Rosconstract (govenment purchasing agency in TradW, composition of, Russia), 39,43,62 in Estonia, 122 Ruble, overvaluation of at official exchange rate, 3 Kyrgyz Republic, 189 Latvia, 146 Ruble zone, disintegration of, 229 Lithuania, 161 Moldova, 173 S Russia, 37 Ukraine, 71 Services, trade in, 122 Uzbeldsman, 202 Shutfle traders, (in Russia), 37 Trade, diredon of, State distribution system, (problems with in Kyrgyz RepubHcI 189 Ukraine), 83 Latvia, 145 State trading, 17; and obligatory lists, 17,46,76. Latvi*a 164 150, 176, 191; indicative lists, 18, 47,77, 125, Moldova, 172 150, 176,191; problems with managed trade, Russia, 37 19,257 -Ulaine, 71, 91 Uzbekistan, 202 280 TRAm IN THE NrW INDEPwEENT STrATS Transit trade, 145, 161 Moldova, 179 Russia, 41 U Uzbekistan, 203 Variable export taxc, 258 Undervaluation of real exchange rate, 256 VAT treatment of exports, 216, 217 Unofficial economy, 106 Unofficial trade, 94 W U.S- dollar, 158 Wage rates (average monthly in U.S. dollars for new independent sLates), 12; V in Estonia, 132 Kyrgyz Republic, 189 Valuta ruble, 22, 175 Latvia, 150,142 Value added tax (VAT), Lithuania,158, 162,164 in Estonia, 116,134 Ukraine, 68 Kyrgyz Republic, 188, 195 Uzbekistan, 200 Latvia, 151,154 Welfare cost of trade restrictions, 53, 56 Distributors of World Bank Publications ARGENTINA EGYPI, ARAB REPUBLIC OF KLIMA SAUDI ARABIA. QATAR Cala NHIsclSRL M Alum. Afric leokSfbeS (lEA. 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