Eastern European Markets
Eastern European Markets
The 10th of April, 2004

Professor Kari Liuhto:

Some decades ago the East and the West used to be rivals, now they should be regarded rather as strategic partners who comprehend that their mutual future lies in their co-operation. Our mutual future lies in the co-operation via which these partners can overcome new threats shadowing peaceful development in Europe and beyond.

In the beginning of April, three former Soviet republics – Estonia, Latvia and Lithuania – also joined NATO and in May they will become EU members. Neither the NATO expansion nor the EU enlargement towards the East builds a new dividing line in Europe, as long as the ultimate goal is to integrate the whole of Europe under the umbrella of these organisations. Both NATO and the European Community have changed significantly from what they used to be some decades ago, and hence, their eastern enlargements should not be regarded as a threat but as a new reality in integrating a Europe of the 21st century.

Here, I want to stress that the European integration does not necessarily mean membership of the EU. Integration can take place also without this membership. In my opinion, the EU’s neighbourhood policy, supported by the EU’s northern dimension creates a stable foundation for peaceful economic and political processes in Wider Europe.

The EU25 borders upon many countries of Southern Mediterranean and several CIS-countries, of which Russia can be considered the most significant. Even if Russia is large, territorially some five times larger than the EU, one should acknowledge that Russia is so much smaller than the EU when measured in economic terms.

The Russian population is only a third of the population inhabiting the enlarged EU. The Russian GDP is less than 15% of the enlarged EU measured at purchasing power parity. Russia's share of world trade is below 2%, whereas the EU represents a fifth. Russia is both a small investor and a small recipient of foreign direct investment. According to the United Nations, Russia has invested just 18 billion dollars abroad and received 23 billion dollars as foreign direct investment. The respective figures for the contemporary EU are over 100 times higher, indicating the strong role of the EU, both as a global investor and an attractive investment target in the world. In fact, the EU members’ investments abroad represent one half of the global foreign direct investment (FDI) stock. In other words, EU firms are behind every second dollar crossing foreign borders throughout the whole world.

Russias natural resources emphasizes its role

Even if the aforementioned economic indicators stress the modest role of Russia in the global economy, Russia’s role gains notable emphasis when analysing her natural resource basin. For instance, Russia has considerable forest reserves – a fifth of the world total, various strategic minerals and substantial oil and natural gas resources. Russia possesses some 5-10% of the world's oil and nearly a third of the globe’s natural gas. The oil and gas reserves of the EU are less than two per cent of the world total. As Russia consumes only a small proportion of her oil and gas production, she has become one of the largest energy exporters in the globe. Russia ranks as number two in oil exports after Saudi Arabia and number one in natural gas exports.

The economic structures of the EU and Russia complement each other. Russia exports mainly fuels and other natural resources to the EU, whereas the EU’s exports to Russia consist, to a large extent, of machinery and vehicles, aiding Russia to reform her economic structures.

The EU is even today clearly the most significant trade partner and investor for Russia. The EU15 accounts for almost 40% of Russia’s foreign trade. After the enlargement, the EU covers more than half of Russia’s foreign trade. Last year, EU-Russian trade totalled nearly 70 billion dollars. As a comparison, Sino-Russian trade was less than 12 billion and that of US-Russian trade, was not more than seven billion. Finnish-Russian trade is close to that of the US-Russian trade figures, despite the economic size difference between the USA and Finland.

Currently, the EU covers roughly 40% of Russia’s inward FDI stock. After the approaching enlargement, the Union’s proportion of the Russian inward FDI stock will go over 60%. In this context, one needs to admit that such a jump should mainly be explained by the EU membership of Cyprus, which is the biggest FDI investor with a 20%-stake in Russia. As we know, actual Cypriot firms are not behind the investments from Cyprus to Russia but Russian-owned companies, which move capital back to their home country via their Cyprus-based subsidiaries.

Whereas the European Union is clearly Russia’s main external partner, Russia’s share in the Union’s external economic relations is relatively modest. Currently, Russia is the Union’s fifth biggest trade partner after the USA, Switzerland, China and Japan. Russia accounts for less than 5% of the Union’s external trade, though the Russian share is to grow after the accession of ten members into the Union.

Russian companies have already arived

Russia’s proportion of the EU’s inward foreign direct investment stock is barely visible, but in some new members, Russian firms have managed to gain a relatively strong foothold. For example, Russia’s share of the Latvian and Lithuanian FDI stock is over 5%. In Estonia, Slovakia and Poland, it is slightly over 1%. Although the respective figures for Cyprus were not available, I guess that Russian capital is strongly present there. In Finland, Russian firms have invested over 300 million euros, accounting for almost 1% of our inward FDI stock.

The aforementioned figures have been compiled from the national statistics but as far as I am concerned the statistics do not reveal the whole truth. The real proportion of Russian investments is higher in many East European states, since many Russian firms do not invest directly but indirectly via some other country, such as Cyprus or some tax havens.

Therefore, I would argue that the Russian companies have already arrived in the future EU, particularly its easternmost parts and Cyprus, and hence, Russia can directly benefit from the new possibilities of the expanding Single Market via the internationalisation of her corporations towards the West.

As became evident earlier, the EU and Russia are economically interdependent, and enlargement will increase this interdependence. This mutual interdependence has already reached the level that allows me to call the EU and Russia twins. Perhaps a more appropriate word for them would be ‘Siamese twins’ due to their asymmetric sizes but certainly one of close interdependence. Being Siamese twins means in practice that what is good for one is usually good for another one, and vice versa, what hurts one also hurts the other one.

Due to their close interdependence, it became as a surprise for many, when Russia, in January 2004, listed 14 concerns in the context of the EU enlargement. This list included Russia’s concerns on higher tariffs in 10 acceding countries due to their EU membership, Russia’s request on increasing her steel and grain quotas, Russia’s concern on the minority situation in the Baltic States, the idea of a full-blown visa regime by the acceding countries for Russian citizens, and the future of the Kaliningrad region, to mention but a few of Russia’s concerns. As the Kaliningrad issue plays the key role in EU-Russian relations, I will comment on a few points related to it.

Kaliningrad needs economic freedom to maximise benefits from EU

The Kaliningrad region is a small region sandwiched between two forthcoming EU states – Lithuania and Poland. Kaliningrad’s territory is just a third compared to that of Estonia. Roughly one million inhabitants live in the Kaliningrad region, representing less than 1% of the Russian population. The Kaliningrad economy accounts for less than a half percent of the Russian GDP. In other words, the economic significance of the Kaliningrad region for the whole Russian Federation is rather peripheral.

Despite its small role in the Russian economy, the Kaliningrad region has received a lot of attention between the EU and Russia. For example, the transit issue between the region and the Russian mainland became a hot potato in EU-Russian relations.

In my opinion, this potato was much hotter in published news than in reality. I regard the transit issue as a technical matter, which can relatively easily be solved either via facilitated transport documents offered at inexpensive prices to the inhabitants of the Kaliningrad region or by further developing the maritime and air connections between the region and the Russian mainland.

A much more strategic question is how much economic freedom the Kremlin will give to Kaliningrad so that it could maximise benefits from the EU expanding to its borders.

When one follows the Western and Eastern media, one gets an impression that Kaliningrad is nothing more than a dark spot with a serious narcotics and HIV problem. Many media reports give an impression that Kaliningrad is a blocked zone within the EU. That is why the region is frequently seen as a sore in the Siamese twins’ heel. This does not have to be the case.

Even if the special economic zone in Kaliningrad has not fulfilled all the expectations planned for it, the Kaliningrad region can be considered as a pilot area instead of a problem area in EU-Russian relations.

How can the problem become an opportunity?

I believe that the Kaliningrad region could become an EU-Russian pilot area, where the EU legislation could be adopted, either fully or partially. The possible negative impact of such an exercise would be marginal compared to the potential it may offer in further developing EU-Russian relations.

By the adoption of EU legislation in the region, the attractiveness of Kaliningrad would increase. Foreign investors, and I do not mean only those searching for the glorious past of Koenigsberg, would find this small region in the new European map. Secondly, closer customs co-operation would result in the faster movement of goods. Thirdly, the region could become an optimal place for a cross-border entrepreneurship between Russia and the EU, as investors could use the lower production costs of Kaliningrad and have a foothold, via this region, in the Russian mainland, making Kaliningrad into a type of Hongkong of the Baltic Sea. I also believe that such an exercise would facilitate the travelling of Kaliningrad citizens outside the region.

As a whole, I believe that the Kaliningrad region could become the EU-Russian pilot region, which would aid in intensifying Russia’s integration towards the enlarged EU, even prior to the implementation of the Common European Economic Space. In fact, Kaliningrad could become a test zone before realising the Common European Economic Space in full. Hence, I argue that Kaliningrad should not be regarded as a problem region but a pilot region between the EU and Russia.

To conclude, I am convinced that the twins comprehend each other, and by the end of this month, understanding can be reached on the signing of the extension of the EU-Russian Partnership and Co-operation Agreement (PCA) to the future members of the Union with the adoption of a Joint Statement on the consequences of the EU enlargement for the EU-Russian relationship. Both the sides comprehend that a fight between twins does not contribute towards anything constructive. These twins, though having two heads, understand that their body is one, and hence, they share a common future.

Wider Europe means Greater Europe. However, Europe shall not be great before we fully comprehend the true meaning of integrating Europe, both inside the EU and the countries surrounding it. In order to contribute to this process, the Pan-European Institute organises a high-level conference called “New Europe 2020 – Visions and Strategies for Wider Europe” at the end of August (www.tukkk.fi/neweurope).

I wish that many of readers could attend this event, and via your participation in this conference you would make a contribution, not only in the building of Wider Europe, but above all, a contribution in building of Wiser Europe.

More information:
Professor Kari Liuhto
The Pan-European Institute
Turku School of Economics and Business Administration

Back to the top

Compiler Trade Web Site: Studies and Special Reports:
Studies on emerging markets/Index
Special reports an Business features/Index
Tutkimukjsia/Hakemisto (in finnish only)
Erikoisraportit/Hakemisto (in finnish only)

 TERMS & CONDITIONS / KÄYTTÖOIKEUDET. © Oy Compiler Ab. All rights reserved.