The Russia-China agreement is a warning for the EU

SMOGORZEWSKI Rosyjsko-chińskie porozumienie przestrogą dla UE jamnik

In Europe the discussions about the construction of the Nord Stream 2 pipeline, Brexit and the crisis in the Eurozone dominate the public discourse. The further east we go the more we hear about the deepening cooperation between Russia and China.

The recently completed negotiations on a trade agreement between the Eurasian Economic Union and the People’s Republic of China is a clear reflection of this trend. The agreement between the Eurasian Economic Union (EEU) and the People’s Republic of China is important for two reasons:

  • as the next stage of balancing the United States and European Union’s economic influences in Europe and Asia through the deepening of cooperation between regional groups – this phenomenon expresses the hopes for the continuation of peace in the region of Eurasia;
  • as a challenge to the economic position of the EU in the world, due to the attempt to shift the economic center of gravity in Europe this could lead to the escalation of tensions between Brussels and Moscow.

Integration à la russe

Russian projects for the integration of the post-Soviet territories have not been widely appreciated thus far, but they are now boldly entering the arena of the emerging new international order, which is promoted by Beijing. The most important of them is the Eurasian Economic Union (EEU), created January 1st, 2015 as a result of consolidation of the previously existing Customs Union and the Common Economic Space.

The EEU currently has five members – Russia, Belarus, Kazakhstan, Armenia and Kyrgyzstan. The GDP of the EEU amounts to over USD2.2 trillion, which accounts for 3.2 per cent of global GDP (for comparison, the GDP of the United States and the People’s Republic of China account for about 25 per cent and 15 per cent of global GDP, respectively), while its industrial production reaches the value of USD2 trillion, which is equivalent to 3.7 per cent of global production. The Eurasian Economic Union’s share in world exports is 3.7 per cent, and its share in imports is 2.3 per cent.

The official reason for the establishment of the EEU was the need to provide an economic counterweight to the European Union and to Beijing’s intensified regional projects in Southeast Asia, such as the free trade area with ASEAN, the AIIB and the One Belt One Road (the New Silk Road). The EEU project assumes the liberalization of regulations concerning the free movement of labor, goods, capital and services, as well as a far-reaching agreement on strategic economic sectors, such as the energy sector, agriculture and industry.

In contrast to the development of cooperation within the EU, no specific statements have been made within the EEU regarding the introduction of a single currency so far. This is not necessary, however, as the Russian ruble is the de facto official currency of the union.

Critics say that the cooperation within the framework of the EEU is based on the particular interests of Russia, including its political interests. So there is a gradual, multi-level development of close ties between Moscow and its sphere of influence designated by the Kremlin. This is also in line with Russia’s President Vladimir Putin’s vision of international order based on the balance of power and influence. This order is being constructed through multiple channels, with the use of strategic sectors such as the energy market. For this purpose Russia has been using, on the one hand, the EEU, and on the other hand, also cooperation with countries that it has so far been ambivalent about, to put it mildly. One example of this is China, and Russia’s initial lack of support for its Eurasian expansion.

Importantly, the projects consistent with the Kremlin’s aforementioned vision are in practice built in opposition to the Western economic and political model. The latter, in turn, is based on concepts and political values created and disseminated by the West itself, such as economic liberalism and the rule of law. Hence, in the current international situation we should not be surprised by Moscow’s shift towards the Far East. From this perspective Russia in now closer to China than to the EU.

The financial crisis of 2007-2008 and the drastic drop in oil prices have drowned out opinions about the high quality of economic integration in the Eurasian region. The decline in enthusiasm was intensified by the effects of economic sanctions imposed on the Kremlin as a result of the annexation of Crimea and participation in the destabilization of Ukraine. On the other hand, by legitimizing the projects conducted by China in Asia and Europe – the AIIB, the NDB and the One Belt One Road – Moscow is showing that the strategy of building economic unity of Eurasia is spread out over many years and provides for multiple directions of activities, under the condition that these activities are in line with the vital interests of the Russian decision makers. It seems that they now include an economic alliance with Beijing. The question of how long this will last remains open.

Russia is still effectively pushing the idea of including subsequent countries in the structures of the EEU, even at the expense of the overall economic health of the union, and in spite of opposition from Belarus and Kazakhstan. Weak economies, such as Armenia and Kyrgyzstan, do not contribute to the strengthening of the EEU’s economic potential. This is mainly due to the necessity of subsidizing those sectors of the economy that would not be able to withstand the internal competition in the process of adaptation to the requirements of the EEU.

This is not particularly beneficial for Yerevan and Bishkek either. Armenia gave up on its efforts to become a member of the EU and chose pragmatic cooperation with Russia for political reasons. This is because Moscow was able to offer a more efficient protective umbrella in the face of tensions caused by the situation in the Nagorno-Karabakh Republic. EU membership would probably enable faster social and economic development. Meanwhile, in view of changes in the customs tariffs, Kyrgyzstan could lose a lion’s share of profits from the re-exportation of Chinese products. Despite all this, in 2016 alone the value of trade within the EEU increased by 38 per cent.

Cooperation means peace

European politicians and experts often underestimate the EEU as an entity capable of exerting economic influence in the region. The Asian countries present an entirely different approach in this respect. Nearly 40 countries, including India, Singapore and Turkey, have expressed a readiness to start negotiations on free trade agreements (or have already entered them). Such an agreement has already been signed with Iran. However, the Eurasian Economic Union’s most important partner in the east is still China.

The completion of the fast-track negotiations on a trade agreement along with a declaration of immediate launch of works on the technical amendments to the proposed agreement is another step towards the intensification of the strategic economic partnership between the EEU and Beijing. Only in the years 2008-2014 the cumulative Chinese investments in the countries of the Eurasian Economic Union more than doubled – from USD11bn to USD27.1bn. The liberalization of Eurasian trade will accelerate the expansion of Chinese capital even more.

Interestingly enough, Russia is not the main recipient of foreign direct investment (FDI) from the People’s Republic of China. Among all the countries of the EEU it is Kazakhstan that has the highest level of investment cooperation with China – almost 90 per cent of the cumulative FDIs in the EEU. In recent years, however, the value of Chinese investments in Russia has also increased. In 2011 they only amounted to USD125.9m and in 2014 their value reached USD1.27bn, while the share of Chinese investments in the overall FDIs in Russia increased from 0.2 per cent to 5.6 per cent. In 2015 the value of FDIs increased to nearly USD3bn. At the end of 2016, the Chinese ambassador to Russia announced that the value of Chinese investment in that country had increased to USD10bn, although that figure may be exaggerated.

The FDIs are generally implemented in the form of long-term loans and invested in the mineral and raw materials complex (up to 98 per cent of all investments). However, in recent times, Beijing has also been interested in agriculture and has attempted to locate its companies from this sector in the countries of the EEU. Chinese investments naturally reduce the competitiveness of domestic companies, which are usually non-specialized, have less capital and a lower innovation rate. At the same time, higher penetration of Chinese capital in the weak economies of the EEU could provide more stability, for example, in times of crisis. On the other hand, if there is a crisis in China, the FDIs located in the EEU will be withdrawn, which will in turn deepen the crisis inside the EEU. For the time being, however, there are few signs pointing to the second scenario.

The situation is different in the case of China’s trade exchange with the countries of the EEU. The clear front runner here is Russia, which in 2016 accounted for more than 85 per cent of exports to China (worth almost USD33bn). The imports to Russia account for more than 83 per cent of all imports from China to the EEU (almost USD45bn). Compared with 2015 there has been a noticeable decrease in exports to China, standing at 6.2 per cent. This phenomenon does not necessarily have to occur in the subsequent years. This is due to the fact that the supply of Kazakh natural gas to China was launched in October and the annual value of the contract is USD1bn. Meanwhile, imports increased by 4.4 per cent y/y.

The closer economic integration of Eurasia under the protectorate of the two most important powers in this part of the world – Russia and China – is a factor stabilizing the region. This is because of a mechanism in which economic cooperation means that it is not profitable to initiate conflicts. Secondly, the actions of the Russian decision makers show a willingness to seek peaceful solutions aimed at balancing the economic power of the United States, and these solutions include the negotiation of free trade agreements. It should be emphasized that these are purely pragmatic actions, which are not based on any foreign policy philosophy pursued by the Russian Federation or on any special penchant for cooperation.

The implications for the EU

In the framework of inter-continental trade in a globalized world, each new economic agreement involves trans-border consequences. This is especially true when it comes to the prospect of the creation of a free trade zone on a territory of nearly 30 million square kilometers and with a population of more than 1.5 billion people, which is additionally located in the immediate vicinity of the European Union.

The actions taken by Beijing and Moscow pose a significant challenge for Brussels. First of all, Chinese goods will cross the whole of Eurasia without any customs duties being paid. This region constitutes the main railway route for continental trade from Asia to Europe. From Russia, Belarus and Kazakhstan, Chinese goods can be sent to any location within the European Union.

What’s more, the longest border section separating the two blocks is the one between Belarus and Poland, with a few crossing points, the largest of which is Brest-Terespol. The main railway line connecting Berlin and Moscow, as well as the European E-30 route, are located here. These routes generally connect the European Union with the Commonwealth of Independent States, and therefore also with the EEU.

In the areas surrounding all the other border crossing points between the EU and the EEU in Lithuania and Latvia we will probably see the rapid development of Chinese infrastructure investments. This is because there will be an urgent need to increase the efficiency of freight transport, necessitating the construction of logistics and warehousing centers, and the location of all types of additional services. Moreover, through successive trade agreements China and Russia will most likely create excellent conditions for the development of their own enterprises closer to the borders of the EU.

In this perspective, it may turn out that EU producers, especially those representing SMEs, will not be able to effectively compete in the new reality of trade with the widely understood East. The European Union is not able to provide a protective umbrella for all economic sectors. Such a solution would also lead to a situation where the goods subsidized in the EU would no longer be attractive in terms of prices for partners from China and the EEU.

The main axes of cooperation between Russia (and the EEU) and the European Union are the strategic agreements of Moscow and Berlin concerning the energy sector. The decision-makers in Brussels seem to be in agreement in this area, mainly thanks to the German lobbying efforts. But the implications of the growing cooperation in Eurasia will not only apply to Germany. In this situation, it may turn out that, forced to accept the new economic status quo in the region of Eastern Europe and Asia, the EU will lose any means of exerting pressure on Russia.

China is the European Union’s second biggest trading partner. Already in mid-2016 it was predicted that if China is declared to be a market economy (in accordance with the provisions of the 2001 agreement on China’s accession to the WTO), as many as hundreds of thousands of workers in the European Union could lose their jobs. In December 2016, the United States, the EU, Canada and Japan denied the existence of a free market system in China, causing a significant diplomatic crisis. Not only does the European Union refrain from conducting talks concerning a possible trade agreement with China, but it has even distanced itself from the vision of close cooperation with Beijing. The political conflict with Russia also continues and the economic sanctions imposed by Brussels on that country still apply. The conclusion of an agreement between Moscow and Beijing could prompt an escalation of tensions between Brussels and the Moscow-Beijing tandem, in light of the measurable economic losses which it could bring for the EU.

If the free trade agreement between the EEU and China is implemented, Central and Southeast Europe will be playing a leading role. Integration projects in this area could therefore be a factor stabilizing the economic relationships in the EU-EEU-China triangle. The de-escalation of tensions in the European Union’s relations with Russia and China can only take place if all member states of the EU are involved and if their interests are taken into account.

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