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Regional economic integration of Moldova: overview of the options

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Valeriu Prohnitchi / October 5, 2003
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Moldova and the poles of economic attraction

Moldova lies at the crossroads of economic potential of three distinct geo-economic areas, namely Eastern Europe and post-soviet Asia, Central and South Eastern Europe (former socialist countries or their successors) and European Union. Although all of them are directed towards EU, Central and South Eastern European (CEE) countries may be viewed as a distinct group characterized by specific economic patterns developed as a result of transition to market economy.

Since 1997 there is a tendency of balancing Moldova’s trade with the three areas. CIS share reduced from 70% in 1997 to 55.8% in 2002, this decline has continued throughout the first half of 2003 with 52.9% respectively. Throughout 1997 — 2002 EU share in the exports raised from 10.3% to 23.2%, whereas that of CEE from 10.9% to 12.9%. On the other hand, imports are more balanced: over January — July 2003, 42.1% of the imports came from CIS, 28.2% from EU, and 17.1% from CEE. As for foreign direct investments, CIS accounts for around 49%, followed by EU with only 36%.

Despite the traditional economic ties with the former soviet republics, EU has a far greater power of attraction for Moldova than the East, as its purchasing power exceeds by far that of Russia and Ukraine. According to the foreign trade gravitational theory, if it were not for certain economic, political and cultural factors, Moldovan foreign trade with EU would have exceeded that with CIS. The aforesaid factors include among others tensed political relations with Romania, prohibitive customs tariffs imposed by EU, inconsistency of quality and technical norms, unstable investment climate, and last but not least incompatible Moldovan and European business culture.

Once the aforesaid factors are eliminated it would be possible to conduct a structural adjustment of the foreign trade and foreign direct investments to Moldova by increasing the EU share (of course without diminishing the total CIS one). We believe EU integration would contribute to the achievement of this task and would have a positive impact on the economic development and economic security of Moldova. However, in contrast to the claims of the Chisinau leadership, EU integration runs counter to a deeper integration within the Eurasian regional structures.

Economic effects of being part of CIS

Statistics indicate that from 1995 (Moldova joined CIS in 1994) to 2002 the share of Moldovan exports to CIS in the total amount of exports decreased by around 1.1 percentage points per year, in the case of Russia the decrease was even greater — 1.5 percentage points. During the said period, exports to EU increased on average by 1.66 percentage points. Having said that, what kind of economic integration are we talking about if there is a constant decline tendency?

As for the foreign direct investments, one may say CIS didn’t play any role at all in this respect. The considerable share of Russian investments in Moldovan economy is due to personal contacts between Russian businessmen and Moldovan politicians, rather than to CIS. A part of the Russian capital was invested in Moldova as a result of converting the debts into securities issued to the Russian creditors.

As they are outlined in the founding documents, the economic reasons for establishing CIS are rather ambitious. The major goal is creating “a single economic area”, however a detailed outline of this concept is nowhere to be found in the official documents. Needless to say, since CIS was established not even a free trade zone was made possible. Interestingly, Russia, the greatest verbal promoter of the integration permanently opposed the establishment of such an area.

Moldovan trade with CIS countries was based on bilateral agreements rather than on favorable terms agreed at a multilateral level. Even the multilateral trade agreements have been revised and denounced several times. One can hardly say that CIS has ever existed from an economic point of view.

Therefore, breaking away from CIS would not bring to an end any multilateral trade agreements of major importance for Moldova. In the time period between breaking away from CIS and association to EU, Moldovan trade with Russia, Ukraine, Belarus and Kazakhstan might be regulated by the same bilateral agreements. Even if some unfavorable economic conditions surface in the meantime, I suppose those would be produced by the CIS punitive actions rather than by the economic developments as such. In the eventuality of joining EU, bilateral agreements would have to be renegotiated in line with EU customs policy.

The new Single Economic Area

The establishment of the Single Economic Area (SEA) by Russia, Ukraine, Belarus and Kazakhstan at the Yalta Summit in September 2003 heralds the end of CIS. The establishment of the SEA only by four states was determined by the impossibility to reconcile the interests of all the post-soviet actors within a larger framework. At least Russia, Belarus and Kazakhstan are sincere in their desire to integrate. Ukraine, however, is a different story. President Kuchma put his signature under the agreement for electoral rather than strategic reasons. Nevertheless, this is the country to have a saying either in the consolidation or downfall of SEA.

Limited to four founding countries, SEA represents 90% of the CIS economic potential and is a self-sufficient structure from an economic point of view. If successful, SEA might become a strong pole of attraction for the rest of CIS countries. However, the latter are likely to be admitted only after making political or economic concessions to the initial founders.

Under the founding agreement, the following tasks are to be fulfilled in view of efficient economic integration within the SEA:

The adjustment of economic policies would necessitate a single currency, of course the Russian ruble. Moldova’s eventual adhesion to this agreement would make EU integration impossible. At a closer look at the document one may find that the founding states intend to establish a supranational body. In particular the agreement provides for the establishment of a single regulating body, to which member states would delegate some of their national competencies based on international agreements. Decisions adopted via level-headed voting (according to Article 4, the number of votes attributed to each member state shall be proportional to its economic potential) shall be binding for all the parties to the agreement. All the international draft agreements of the SEA shall be adopted only upon endorsement by at least three countries, which account for at least 2/3 of the SEA overall GDP. There is no doubt that such decision-making mechanisms enable Russia to control all the decisions taken.

Assessing EU integration

The key to SEA success is Ukraine’s willingness to cooperate. However, given that EU integration has been declared a top priority for Ukraine, it is very likely that SEA would have the same fate as many other CIS initiatives (ex. GUUAM and Eurasian Economic Union). EU is the only relevant option of regional integration for the Republic of Moldova, not only economically but also politically.

Nonetheless, EU integration means costs but also benefits. CEE countries, which already joined or are due to join EU, were meticulous in assessing the economic effects they were counting on. They also did their best in negotiating the most advantageous terms of accession. Given that Moldova’s negotiating potential is very low, we have all the reasons to believe that EU itself would decide the terms rather than Chisinau.

The main negative effect to be expected from Moldova’s accession to EU is an overturn in the trade balance with CIS, which currently accounts for 44% of the total foreign trade. Considering the present tendencies, it might well happen that before Moldova joins the European customs union CIS share would shrink even further. By mutually eliminating customs barriers, the trade diversion against CIS would be compensated/diminished by trade creation effects against EU. There might be an increase in Moldova’s trade deficit with EU, as Moldovan exports would probably grow slower than the imports from EU. Only by improving considerably the quality and structure of Moldovan exports this risk could be diminish.

Another risk is that inefficient domestic producers would be cast out facing tough competition from European producers. However, there are fields with great potential in Moldova, such as: agriculture and food processing, textiles, as well as such services as tourism, IT, banking, etc. The flow of foreign investments from the West would also increase, as was the case of CEE after their accession to EU. Due to cheap labor in Moldova, some of the investments currently placed in CEE might gradually migrate to Moldova.

Joining EU would also mean giving up customs tariff, which would then go to the EU budget. This might have a negative impact on the domestic budget, as currently customs is the main source of income in the national budget. Furthermore, there is the cost of implementing “aquis communautaire” to be considered. Moldova could partially decrease the cost if Romania provides the European legislation it had already translated into Romanian. During the accession, net budgetary effects were positive in CEE, due to the fact that those countries benefited of the EU structural budget funds. It remains to be seen whether Moldova would benefit of those funds as well.

There would be a social-economic impact as well. Prices would go up as a result of Moldova’s economic convergence however it would be compensated by a salary raise. It might be expected that the unemployment would rise as a result of bankruptcy of some state companies, on the other hand it is also expected that there would be new workplaces created as a result of direct foreign investments. In general, the most positive effect increased competition would bring — higher efficiency in allocating public money as well as better protection of contractual parties (ex. consumers).

Accession to EU would also require meeting financial and economic convergence criteria. The replacement of the national currency with the European one would diminish or even abolish certain national economic policy instruments (such as foreign currency or monetary policy), as well as limit the areas in which the fiscal policy is applied. These costs would be compensated by a greater stability in case of an international financial or monetary crisis, increased transparency of the prices and markets, diminished transaction costs, diminished interest rates and a lower risk rate in the financial sector.

We should also take into account that individual or sector costs might also mean social benefits. Loses one sector may bear or cast out companies might free resources which are to be allocated more efficiently into other sectors or companies. It is also necessary to compare political costs and benefits, not merely the financial ones, both in the case of EU and CIS. Otherwise, Moldova’s involvement in Eurasian integration processes following the argument of “cheaper natural gas” is nothing but a crime against next generations.

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