3.2 The Positive Effects of the Customs Union Agricultural Sector of Kazakhstan

The mainstream neo-classical economic analysis views regional economic blocks as the “second best alternative” for economic growth. Therefore, the membership in WTO is always preferred to the membership in other regional blocks. But this logic best suits the interests of the more industrialized countries which benefit from exports to underdeveloped WTO member countries not encountering with any serious barriers. China’s dominance in consumer products sector of the Kyrgyzstan’s economy can be seen as an evidence of this. After thirteen years of the membership of Kyrgyzstan in WTO there were no serious technology transfers or investments in production sector from any of the WTO member countries.  The only benefit was the opportunity to re-export Chinese goods to other members of EURASEC through huge markets established in Kyrgyzstan like Dordoi. ⁴⁹

Greater Market Size for Exporting

Kazakhstan gains access to market of Russia and Belarus with more than 150 million population. It creates opportunities for domestic producers of Agricultural goods to export, will attract foreign direct investments, and will motivate establishment of joint ventures with Customs Union member countries’ companies and third countries’ firms. Russia takes advantage of access only to more 25 million population market of Kazakhstan and Belarus. Therefore, in terms of increasing market size Belarus and Kazakhstan gain more than Russia.

Our country with its powerful economic potential will enable us to feel confident within the newly established Custom Union of Kazakhstan, Russia and Belarus. Despite some warnings, there will be more positive effects from the Customs Union than the negative ones for Kazakhstan. Thus, the elimination of customs barriers for the transit of goods and services within the customs area will stimulate economic activity and increase trade turnover. In addition, in the long run under a single economic space scientific-technical and production potential of enterprises producing products with high added value will be combined. This is a very important step towards the new industrialization of our countries. The investment climate of the three countries will change substantially, since foreign investors will have a new market with a population of more than 170 million people. Also, the creation of Single Customs Space of the three states will let to have 14-17 percent of GDP growth by 2015.

Lower Cost and Easier Transportation

Kazakhstan businesses will benefit from lower costs and easier transportation of goods through territory of Customs Union countries. Petrol from Kazakhstan can be transported to Belarus Refineries and sold to Europe (Kazakhstan may use Belarus refineries, n.d.). Transportation is one of the most important problems for Kazakhstan export potential. Customs Union in addition to increasing of market size for export, provides easier access to third countries, especially EU.

A customs union is an association of two or more countries to encourage trade. The countries making such an arrangement agree to eliminate tariffs and other restrictive regulations on trade among them. It is a discriminating trade arrangement since the liberalisation only includes the countries that are members of the customs union and they formulate and administer a common foreign trade policy in regard to tariffs and other trade restrictions against third countries.

To discover whether this new situation of a customs union has led to trade creation, trade diversion, trade expansion or a combination of the three, it is necessary to define them. Trade creation will occur when there is a shift from a higher cost to a lower cost producer, i.e. in country demand will shift from the expensive protected domestic product to the cheaper product from the partner country, implying a shift from a less efficient to a more efficient producer. Trade diversion will occur when imports from the efficient or cheap world producer are replaced with imports from a less efficient and higher cost partner country. That country's product can be sold more cheaply in the home country than the world's products because the customs union imposes a protective tariff on the imports from the world, while leaving the imports of the partner country tariff free.

The removal of a whole range of non-tariff barriers, i.e. government protection in procurement markets and a plethora of differing product standards leads to an immediate downward impact on costs. More substantial gains will be generated by completion of the EU internal market. There will be a new and pervasive competitive climate and firms can exploit new opportunities and make better use of available resources.

Attraction of Foreign Direct Investments – FDI and Joint Ventures in non-raw material sectors

Joining the Customs Union provides Kazakhstan with opportunity to attract Foreign Direct Investments in manufacturing sector. The Customs Union establishment motivates non-member countries to engage in FDI (Jaumotte and Florence, 2004). In case of Kazakhstan non-member countries companies prefer export entry mode because it is ineffective to build production facilities in Kazakhstan due its small market size. It is easier to open distribution channel with few people working and export to Kazakhstan and take advantage of low Customs tariffs.

After joining Customs Union Kazakhstan will use Common External Tariff – CET and increase import tariffs from non-member countries for more than four thousands goods. Import tariffs of goods to be used in production on territory of the Customs Union will be subject to lower or zero tariffs (Aitzhanova, 2009). Market size of Customs Union is about 170 million people and starting from July 1, 2010 Customs borders between member countries are eliminated. Therefore, above factors create incentives for non-member countries’ companies to use Direct Investment or Joint Venture entry modes in Kazakhstan market.

Why investors should choose Kazakhstan for Direct Investments and Joint Venture entry modes? One of the main reasons is light taxation in Kazakhstan and comparative ease of doing business among the Customs Union member countries.

History contains many examples of customs unions – the European Union, CARICOM, African Economic Community, Andean Community, Central America, NAFTA, WTO, and others. Each has brought benefits to member countries, but has also created complex problems. Customs unions have significant-ly..impacted..the..global..economy..and..politics.Creation of the new Russia-Kazakhstan-Belarus Customs Union has been a focus of attention for some time. One argument in favor of the Union is its potential to attract higher levels of foreign direct investment (FDI). How does this work? The idea of a customs union is a potentially significant investment-related trade measure, one that influences FDI flow into union member countries. Customs union essentially allows member states to introduce and implement measures advantageous to businesses operating in the region, and hence discriminatory to imports from outside the region .Experience..shows..that..the..effect..of..these..measures.on..FDI..flows is often immediate, sometimes even occurring in anticipation of the customs union’s approval and implementation. Early impact is a result of the tendency for the union to attract FDI from businesses based in non-member countries. This first of all means those businesses that currently export will become uncompetitive compared to member country producers who will benefit from the customs union. These foreign firms may undertake FDI in order to gain a “level playing field” within the union. Other firms may be drawn to invest by the enhanced attractiveness of market integration and economies of scale2.

The impact on FDI of the formation and/or expansion of regional trade agreements was evident when Europe moved from a sectoral Iron and Steel Community to a broader Common Market, then to the European Economic Community, and finally to the European Union. The imposition of a common external tariff created FDI impact similar to the tariff jumping induced by a single country’s use of tariffs to protect an attractive domestic market. However this impact is large for a customs union due to the larger internal market.

Announcement of the EC 1992 reform program prompted firms from EC member countries such as France and Germany to expand intra-EC FDI flows, positioning themselves to take advantage of the new market integration opportunities3. Businesses based outside the EC also increased their FDI within

the region, responding partly to the same market integration opportunities, but also seeking protection against competitive exclusion from the expanded market, thus reflecting concerns about “Fortress Europe”. The trade walls established by NAFTA and MERCOSUR created analogous conditions for potential FDI effects. In these cases, however, the regional accords more explicitly recognized the investment dimension, incorporating FDI-related provisions as part of the NAFTA agreement and, in MERCOSUR’s case, in a companion accord, the Colonia Protocol. Some FDI impacts are internal to the region, although they may differ depending on the region: for example, U.S. companies increased their investment in Mexico or Brazil, while Argentina’s cross investment in MERCOSUR is another example. The number of Brazilian firms investing in Argentina jumped from 20 to over 400 after the customs union was formed4. Other FDI impacts are seen when companies external to the region invest within the free trade area, either substituting for previous imports and/or to taking advantage of expected market growth.⁵⁰

Another interesting example was introduction of the Treaty establishing the Caribbean Community (CARICOM) that took effect in 1991. Since then, FDI flows into the CARICOM subregion have increased at an annual rate of 20 per cent, growing from $412 million in 1991 to $900 million in 19955. How will the new Russia-Kazakhstan-Belarus Customs Union enable the three countries to attract FDI?