Customs Union with Moscow or Free Trade Area with Brussels:
Which Way is Kiev Going?

May 12, 2011
Anthony T. Salvia
Director, American Institute in Ukraine

Two of the most prominent Western observers of Ukrainian affairs—Taras Kuzio and Adrian Karatnycky—have differing views on where Ukraine is heading. Kuzio says the United States, influenced by the spin of President Yanukovich’s PR advisors, believes (erroneously) that a moderate faction of the Party of Regions is in control and seeks close relations with the West—just what Washington would want to hear.

But the reality, says Kuzio, is quite different. Yanukovich’s record—from rejecting NATO membership for Ukraine, to extending Russia’s lease on its Black Sea naval base, to his general authoritarianism (including the pressure he has brought on former Prime Minister Timoshenko)—clearly indicates he presides over an administration that is, at its core, Putinesque and pro-Russian.

Karatnycky says the precise opposite: a moderate faction is in control and seeks improved relations with the West. He sees Yanukovich’s prosecution of Leonid Kuchma, his appointment of Yushchenko crony Marina Stavniychuk to a key administration position (enabling her to put the kibosh on efforts to elevate Russian to the status of an official, state language), and his administration’s chastisement of Ukraine’s “divisive, Russophile” education minister Dmitriy Tabachnik, as “unmistakable signs of political liberalization.”

Karatnycky sees all this as evidence of Kiev’s commitment to a pro-European course comprising the negotiation of a “deep and comprehensive free trade area” with the EU, and resistance to “financial incentives and other blandishments” emanating form Moscow to join the Russia-Belarus-Kazakhstan Customs Union.

Certainly, Yanukovich, under the influence of what appears to be the moderate, pro-European, vaguely Russoskeptic team of Levochkin, Boiko, and Gryshchenko appears to be headed in the direction discerned by Karatnycky. Energy Minister Boiko’s recent statement that Russia’s South Stream project constitutes a threat to Ukraine’s national security calls to mind the rhetoric (and the mind-set) of the Yushchenko years.

Where is Ukraine going under Yanukovich? Let’s consider the choice facing Kiev between joining the Russia-Belarus-Kazakhstan Customs Union and negotiating a free trade arrangement with the European Union (short of full membership, which is not on offer). Which option is best for Ukraine?

In joining the Moscow-sponsored Customs Union, Ukraine would get some very real carrots (and not a few sticks if it does not), whereas the European offer is entirely nebulous. No one knows how Ukrainian enterprises would fare when European firms, with their superior financial resources, enter the Ukrainian market. Nor can anyone be overly optimistic about demand in Britain, France and Germany, for example, for Ukrainian manufactured goods. All things being equal, Ukrainian agricultural products might be able to make a go of it, but things are far from equal: European agriculture is lavishly subsidized, which raises real concerns about the prospects for Ukrainian food and grain exports.

Moreover, the EU, which views Ukraine as too big, too poor and too corrupt to be easily absorbed, refuses to assure Kiev that the conclusion of a free trade arrangement would lead, at some future date, to full membership.

Russia, by contrast, offers real benefits: join our Customs Union, and we will charge domestic Russian rates for the gas you import from us. That represents a huge potential boon to Ukrainian state finances and to ordinary Ukrainian consumers of energy. It would get Ukraine out from under onerous IMF demands that it reduce Naftogaz's vast operating deficit by raising the rates it charges to Ukrainian homes and businesses. Ukraine would gain unimpeded access to a market of some 200 million people that has been growing economically by an average of 7% per annum since 2001 (compared to 1.5% in the EU in the same period.) In short, joining the Customs Union would give a major boost to economic expansion and employment at a time of hardship for many Ukrainians.

So much for the carrots, what about the sticks? When the Customs Union goes into effect in January 2012, Russia and its partners will impose a 10.5% customs duty on goods entering the zone compared to the 4.5% Ukraine charges.

Thus, Ukraine would face a considerable impediment to exporting to Russia—by far its largest trading partner—and would be tempted to retaliate by raising tariffs on Russian imports. Sergei Tolstov, Director of Kiev’s Institute of Political Analysis and International Research, (Директор Института политического анализа и международных исследований) recently warned against a trade war with Russia, saying it would “ruin the Ukrainian economy and lead to the degradation of Ukraine’s industrial base.”

As Ukraine cannot join both groupings, what should it do?

In view of the EU's refusal to offer Kiev a road map to EU membership, I would recommend going with Russia's offer. In addition to the very real benefits enumerated above, such a move would curtail Europe and the West’s ability to play Kiev against Moscow and vice versa to the detriment of both.

There are no such discernible, virtually quantifiable benefits to joining a free trade area with the EU, only the vague feeling that Ukraine has moved one step closer to joining the magic circle of modernity, the inner sanctum of progressive humanity. But that’s pretty cold comfort considering that what Ukrainians need are jobs, economic expansion, and internal development.

Economist Vlad Sobell says that the danger in the current tug-of-war between Europe and Russia over Ukraine is the potential recrudescence of a bloc mentality, of the re-division of Europe into estranged, competing spheres. He calls on Moscow to aid Ukraine’s “deep industrial restructuring,” and on Brussels to offer a “credible” road map to Ukrainian membership. Meanwhile all parties should strive for an “upgraded relationship between Russia and the EU/NATO, underpinned by Russia’s membership in the WTO and addressing all aspects of the economy and security.”

Sobell is no doubt right. He suggests—in common with Kuzio and Karatnycky—that what is at stake here is Ukraine’s geo-strategic orientation. He is also right when he suggests that it would be better to coordinate policy between Europe, Russia and Ukraine than force the latter to choose between competing offers. Sadly, no such coordination exists, and Ukraine must choose. Unless Kiev can negotiate a much better deal with the EU that the one now on offer, the Customs Union is the way to go.

With Kiev and Moscow as members of the same Customs Union, the West would perceive the futility of “divide and conquer” in the East. Ukraine and Russia would then be able to jointly approach Europe about forging the pan-Eurasian entente that will spell the definitive end to the Cold War division of the continent.

It would be too bad if President Yanukovich felt constrained by domestic political considerations from joining the Customs Union, but that is his call to make. At the very least, in negotiating with Brussels, he should insist on tangible benefits on a par with those being offered by Moscow, rather than vague assurances that may or may not materialize. Europe should not make the mistake of thinking Ukraine has nowhere else to go.