/" /"q STUDIES OF ECONOMIES IN TRANSFORMATION Trade and Payments Arrangements for States of the Former USSR Constantine Michalopoulos and David Tarr 2 FILE COPY Report No. :11 69 Type: (PUP) T'itle: TPADE AND PAYMENTS ARRANGEIIENTl * v Author: MiICHAI,OPOUTIfl C Ext. .: 0 Room: Dept.: STTDIES OF ECONOMIES iN TEPANS IIN /~~~~~~~~~~~~~~~~~~~~~~~~~~ --k @ - ------------ - - i\ ..r.. ._,..< THE WORLD BANK RECENT STUDIES OF ECONOMIES IN TRANSFORMATION PAPERS No. 1 Country Department III, Europe and Central Asia Region, Food and Agricultural Policy Reforms in the Former USSR: An Agenda for the Transition STUDIES OF ECONOMIES IN TRANSFORMATION PAPER NUMBER 2 Trade and Payments Arrangements for States of the Former USSR Constantine Michalopoulos and David Tarr The World Bank Washington, D.C. Copyright ( 1992 The International Bank for Reconstnuction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing September 1992 Papers in the "Studies of Economies in Transformation" series present the results of policy analysis and research on the states of the former USSR. The papers have been prepared by World Bank staff and consultants and issued by the World Bank's Europe and Central Asia Country Department 111. Funding for the effort has been provided in part by the Technical Cooperation Program of the World Bank for states of the former USSR. In light of the worldwide interest in the problems an-d prospects of these countries, dissemination of these findings is encouraged for discussion and comment. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries ithey represent. 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Permission to copy portions for classroom use is granted rhrough the Copyright Clearance Center, 27 Congress Street, Salem, Massachusetts 01970, U.S.A. The complete backlist of publications from the World Bank is shown in the annual Index of Publicaions, which contains an alphabetical title list (with full ordering information) and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from the Distribution Unit, Office of the Publisher, Department F, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'1ena, 75116 Paris, France. ISSN: 1014-997X Constantine Michalopoulos is senior advisor, Europe and Central Asia Country Department III at the World Bank; David Tarr is principal economist, Country Economics Department, Trade Policy Division at the World Bank. Library of Congress Cataloging-in-Puablication Data Michalopoulos, Constantine. Trade and payments arrangements for states of the former USSR / Constantine Michalopoulos and David Tarr. p. cm. - (Studies of econoomies in transformation ; paper no. 2) Includes bibliographical references. ISBN 0-8213-2260-5 1. Former Soviet republics-Commercial policy. 2. International clearing-Former Soviet republics. 3. Foreign exchange-Former Soviet republics. 4. Currency convertibility-Former Soviet republics. I. Tarr, David G. II. Title. III. Series. HF3626.5.M52 1992 382'.3'0947-dc2O 92-31863 CIP Foreword In early 1992, trade among the 15 states of the former USSR had declined dramatically, and trade relations were in disarray. There is evidence that the pattern of trade that had developed in the former USSR was far from optimal and insufficiently linked to the international trading community. However, it was widely feared that, given production linkages, too rapid a decline in interstate trade could aggravate unemployment and prove extremely costly for all of the states. Urgently needed was a transitional trade and payments arrangement that would encourage market-determined realignment of the trade patterns and absorption of these economies into the international trading community in the long run, while reducing the more immediate costs of the transition. This study, a joint product of the Europe and CentralAsia Department 11/and the Country Economics Department, presents the contours of a transitional mechanism for the states of the former USSR. The study discusses the incentives in the interstate trading environment of 1992 that have led to interstate export controls and the decline in interstate trade and proposes solutions that address the incentive problem. It explains how interstate trade can evolve from intergovernmentally determined and controlled trade to enterprise-to-enterprise trade. The impact of the free-rider problem present in the 1992 monetary system on the incentive to import on an interstate basis is analyzed. The study proposes methods for allowing enterprise-to-enterprise trade after the introduction of new, possibly inconvertible, currencies by independent states. The advantages and disadvantages of a clearing union, a payments union, and an auction market for rubles in countries with new currencies are discussed. The study explains why enterprises face little competition from imports from outside the former USSR now, but why external import competition may become a serious concern after the introduction of new currencies or convertibility. It evaluates the case for preferential trading arrangements among the 15 states as a transitional device for easing unemployment and elaborates why any differential protection provided should be moderate and transitory. The study is intended for trade policy analysts and decisionmakers in the 15 states of the former USSR and their advisers. All those who are interested in the role that trade and payments arrangements can play in facilitating a successful transition to the market economy should find the study useful. Russell J. Cheetham Director Europe and Central Asia Country Department IIl ii A ckno wledgemen ts The authors wish to acknowledge helpful comments from Lawrence Summers, Jaime de Melo, Parvez Hasan, Nancy Birdsall, Arvind Panagariya, Dani Kaufmann, Sunil Gulati, Martin Schrenk, Bart Kaminski, Erik Nielsen, Ernesto Hfernandez-Cato, Anne McGuirk, Takeo Shikado and participants at seminars held at the World Bank, OECD, and the UNDP Trade Expansion Conference in Kiev. They thank Nellie Artis and Maureen Colinet for logistical support. iv Table of Contents Introduction I The Situation Today 3 The Web of Interdependence 3 The Terms of Trade 4 Trade and Payments Policies 4 The payments regime 4 The trade regimes 5 Transitional Arrangements 9 Policies for Export Controls 9 Reducing State Trading and Promoting Enterprise-to-Enterprise Trade 11 Import Controls 12 Tariffs for revenue 12 Tariffs for protection 12 Payments Arrangements 14 In the ruble zone 14 For states with new currencies 15 The Scope for Cooperation on Interstate Trade 17 The terms of trade 17 Trade preferences 18 Customs union or free trade area 20 Conclusions and Policy Implications for the World Bank 21 Summary of Policy Recommendations 21 Trade regime toward third countries 21 State trading 22 Payments arrangements 22 Interstate trade policy 23 The Role of the World Bank 24 Notes 25 References 33 Annex Tables 37 V - --- - - - ----- ----- -1 - Introduction The establishment of 15 independent and payments regimes these countries are in states in the economic space of the former the process of establishing with third coun- USSR--each embarldng on systemic reforms tries. In addition, there are some essential on a different scale and at a different pace-- complementary reforms which must be is wreaking havoc on the trade among them. undertaken for a successful transition includ- There is speculation that this trade may soon ing, macroeconomic stability and the com- collapse. In the longer term, the heavy mercialization and privatization of enterpris- interdependence in trade among these states es. Without the former, enterprises will not would have in any case to change signifi- receive better price signals from trade liber- cantly because much of today's trade is not alization. Without the latter, enterprises based on economic principles of comparative will not respond efficiently to the improved cost and locational advantage. But a large, price signals. sudden disruption in trade patterns could hurt output and incomes in all the states, undermining public support for reform, and retarding adjustment. All 15 states would thus benefit by establishing transitional mechanisms that avoid serious disruptions of trade flows in the short term--and that support their longer term adjustment and integration into the world economy. This paper examines the causes of these disruptions and suggests trade and payments arrangements that miti- gate them and encourage the transition to a market economy. Although the emphasis is on policies for interstate trade and pay- ments, such policies are investigated in the context of the broader international trade 1 I _ ~~2 The Situation Today In 1991 exports of the 15 states to the 60% when it is placed on an equal footing rest of the world amounted to $70.2 billion, with other trade.2 down 32% from 1990. The declines were especially large to former CMEA countries Brada (1992) has argued that, for analyz- in Eastern Europe, with the largest drop in ing trade flows, the former Soviet Union can machinery and related products. - be viewed as an intranational CMEA, except that a supranational power planned trade Trade among the 15 states accounted for flows and the pattern of investment and between roughly 60% and 90% of their total specialization. But the central planners' trade. Russia was the least dependent on investment preferences reflected comparative interstate trade (with such trade accounting advantage only in a very limited way, either for 61% of the total), while for all other among the states or against the rest of the states, interstate trade accounted for more world. In particular, the collapse of sales of than 80% of total trade (table 1). No firm the machinery and related sectors in Eastern estimates on the evolution of interstate trade Europe in 1991 suggests that these sectors are available for 1991, but it is widely lack comparative advantage. It is thus likely reported that it declined even more than that a large part of trade in manufactures trade with third countries. among the 15 states is trade diversion and will vanish in the long run without preferen- The Web of Interdependence tial treatment.3 The demise of the CMEA is instructive The recession in Eastern Europe in 1991 for the future of trade among the 15 states. has been attributed in large part to the sud- Several studies (Biessen 1991, Brada and den decline of trade among the countries of Mendez 1985, Havrylyshyn and Pritchett the former CMEA. The greatest output 1991, and Collins and Rodrik 1991) have declines were in countries most heavily estimated that although the total external dependent on the Soviet market, such as trade of the CMEA countries was not exces- Bulgaria.4 Since the states of the former sive, intra-CMEA trade clearly was'--and Soviet Union depend even more on interstate that such trade will decline by as much as trade than the countries of Eastern Europe 3 Trade and Payments Arrangements for States of the Former USSR on CMEA trade, and since all of them 15 states. The collapse of the monetary and except Russia depend on interstate exports payments system had a particularly adverse for more than 20% of their G(NP (table 1), impact on trade--and greatly affected the the possible output decline is substantial. trade policies of all countries. The key question is not whether interstate trade will decline, but how fast it will do so. The payments regime. Russia alone can expand the money supply by issuing cash The Terms of Trade rubles, but the central banks of all states in Using international prices for products the ruble zone can create credit in rubles. that enter interstate trade is an. essential step Since inflation in the ruble zone depends on toward improving resource Ellocation and aggregate ruble creation, there is, without integrating these economies into the world monetary policy coordination, a free-rider economy. But there is a problem: the wide problem. Monetary restraint by some cen- divergence between domestic and interna- tral banks can be exploited by others able to tional prices means that using international expand their money supply independently. prices on would result in significant terms- This impedes efforts to stabilize the ruble of-trade gains and losses for different states. and poses major difficulties for trade and Preliminary estimates indicate that raw payments. Countries prefer not to export material and energy exporters would gain goods for rubles since their central banks and machinery exporters would lose. Russia can independently expand ruble supply. and Turkmenistan would have big terms-of- Because the ruble is inconvertible and there trade gains. Belarus, Moldova, and the are no constraints to creating ruble credits, Baltics would have big losses (10-20% of states are unwilling to incur ruble surpluses GDP). Azerbaijan, Kyrghyzstan, and Uz- in interstate trade because of the transfers bekistan would suffer little, if at all.5 Fur- they entail. Deficit countries would also thermore, if international prices are passed rather have goods than ruble credits in their on to the final user, consideralble economic banking system, since their central banks restructuring could be required in activities can independently create ruble credits. that depended on underpriced itputs (both in Russia, which appears to have accumulated domestic and interstate trade). an interstate trade surplus in early 1992, has established a monitoring mechanism for To offset the terms-of-trade deteriora- interstate transfers (correspondent accounts tion, some states have tried to exploit what- of the central banks) that may trigger in- ever monopoly power existing linkages and creased trade controls. It fears that, without the transportation network gives them. The controls, even larger transfers may result as terms-of-trade adjustment is nevertheless energy prices are liberalized. unavoidable, and the only question is how fast it will occur. With the dissolution of the Gosbank, there has been a dramatic decline in the Trade and Payments Policies efficiency of the interstate banking system-- this when the Gosbank guarantee for inter- In the first half of 1992, near chaos state transactions has been removed, and characterized the trade and payments in the credit has been tightened. A network of 4 Trade and Payments Arrangements for States of the Former USSR correspondent accounts has been established mentation of the detailed protocols was among the central banks of the 15 states, delayed until March 1992, and it has been and all payments orders are cleared through fraught with many problems. the central banks and their correspondent accounts. The system has become clogged The measures have reduced trade flows at higher levels: it takes up to 2-3 months to to levels significantly lower than envisaged clear an interstate payments order. In an in 1991. Problems appear to have arisen environment of high inflation, the long especially in trade between Russia and delays imply greater risks and costs in using Ukraine and the Baltics. And Armenia, due the banking system.6 to the conflict in the area, has suffered from reductions in oil deliveries through Azerbai- For a variety of reasons--to allow con- jan. Most governments, in public state- duct of an independent monetary policy, ments, appear to be endorsing steps to avoid the free-rider problem, exert claims maintain interstate trade. But in practice, over seignorage, introduce an exchange rate their efforts have focused on enforcing the that would allow the adjustment of national bilateral arrangements and not on freeing relative prices with the rest of the world, trade and creating an environment for enter- and assert national identity--various states prise transactions. are planning to introduce their own curren- cies: Estonia did so in June 1992. Ukraine, * Quantitative restraints on exports: Moldova, and the Baltics are planning to do Perhaps the most significant barrier to trade so. Others might follow soon. The new in early 1992 was the widespread use of currencies pose no problems to trade, if export licenses. All 15 states are maldng these currencies are convertible for trade widespread use of them, both for interstate transactions. But if they are not, it will be and convertible-currency-area trade. necessary to develop institutions that support interstate trade. Otherwise trade among The motivation for export licenses comes entezprises will be severely hampered-- from four considerations: First, and most forced into barter even more than now or important, is the problem with the payments channeled through bilateral state-to-state regime: other states are afraid that any agreements, as in the past. accumulated ruble balances may become worthless when they adopt new currencies.7 The trade regimes. Governments have Second, the price liberalization in different attempted to "protect republic resources" by republics, folowing the initial price liberal- establishing export controls through quotas ization by Russia in January, has varied and licenses affecting the bulk of their considerably. Price differences are signifi- exports both to hard currency markets and cant across different states, and the prices of to others of the 15 states. Although it was many products, notably energy, are kept envisaged in 1991 that interstate trade would below the world level. Governments have be conducted primarily on the basis of maintained these differences by establishing bilateral agreements and protocols that quantitative export restraints for many prod- specified the goods to be exchanged up to ucts. Third, until recently, supply shortages fixed volume limits during 1992, the imple- led most states to try to keep goods at home. 5 Trade and Payments Arrangements for States of the Former USSR Even today, many states are reluctant to ing volume.9 In principle, world market accept rubles for goods because they fear prices are assigned, but for settlement, trade that currency reform in other states wil values are revalued from dollars into rubles, render any accumulated nible balances commodity by commodity, in a negotiation worthless. Fourth, those directing the re- that takes the domestic price in rubles into mai.nng institutions of state economic con- consideration. So, notional relative prices in trol see export licensing as one of their last rubles are closer to domestic prices than available tools. relative prices in dollars.10 Finally, many products under the obligatory lists specify * Import protection: The 15 states maximum permissible prices. have very low formal import restraints. Import licensing has largely been reimoved, Indicative-list trade is similar to Eastem and tariffs are either low or nc't applied. European trade in 1991 after the demise of But, implicit protection is extremrnely high the CMEA, but with some important differ- due to the impact of export restraints on the ences. Enterprises in the different states real exchange rate and to the protective ecs nepie ntedfeetsae effect of foreign exchange ratioteing. So, may engage in contracts with each other effect of foreignxc g. Swhere they define all the terms of the sales, despite the absence of explicit restraints on c . De- .. . . .... ~mcluding price and credit conditions. De- imports, import competition is weak in most sectors. pendg on the state, 1,000 to 1,500 prod- ucts are on the indicative lists. The state * State trading through bilateral ar- has no obligation for this part of the trade, but the products are subject to export licens- rangements- By March 1992, an extensive rngemen By laterc 1992 agrenextesiv ing. Both states in a bilateral protocol agree nletwork of bilateral trade agreemenlts had t uoaial rvd xotlcne o been signed by the 15 states.8 These proto- to automatically provide export licerrses for cols divided trade into three categories: obligatory-list trade, indicative-list trade, the quota amounts in the protocols. and enterprise-to-enterprise trade. Products on neither the obligatory nor the indicative lists may be freely traded In the first category, trade is conducted enterprise-to-enterprise, the third category of on the basis of a large intergovernmental trade. This leaves many products to be barter of 100 to 150 of the most important traded free of restraints, but the most impor- produrts in0 interstat tre Ti s portin of tant products are still in the first two catego- products in interstate trade. This portion of trade resembles (but is not identical to) the nes. old obligatory trade of the CMEA. Com- mitments carry the obligation of the state to Two added institutional features of fulfill the contract. All exports undler this Russia's trade regime toward the other category are licensed and generally must be states, including the Baltics, are important. sold to designated specific enterprises in the First, this trade is not subject to export taxes importing state. An effort is made in the that apply to third countries. Second, many negotiations to roughly balance this portion products under the lists are subject to maxi- of the trade--by assigning prices and adjust- mum price controls. 6 Trade and Payments Arrangements for States of the Former USSR The absence of export taxes gives enter- barter sales among enterprises within Russia prises an incentive to divert exports to the declined to 20% in March 1992, from 80% others of the 15 states. But there have been in January 1992 and an even higher percent- significant problems of fulfillment in the age in late 1991.12 But barter in interstate obligatory trade. Price controls, which trade remains high for several reasons. reduce the incentive to export, are the main First, due to the provisions in the intergov- reason. In addition, the system of state emmental protocols, price controls are much orders has either broken down or become more prevalent in interstate than in domestic less effective. So, enterprises often do not trade. Second, interenterprise-arrears are a supply the agreed quantities, because they large and growing problem in most states. do not fimd it profitable or do not have the Enterprises ship goods and discover that needed inputs. there are no funds in the buyer's bank ac- count. Third, added risks are involved in In early 1992, major questions remained normal trading with-out-of state enterprises. for both types of list. For example, how For example, courts to resolve commercial and how frequently would trade imbalances disputes are national and are biased toward among the states be settled. Rubles, con- the home country enterprise, so that two vertible currency, and additional goods national tribunals often reach opposite con- shipment have been proposed as means of clusions. payment. And proposed settlement periods have ranged from a month or less to a year. In sum, the dissolution of the USSR As long as trade is conducted under bilateral poses problems. Licensing and quantitative govemment agreements, the issue remains: controls are linked in part to the conduct of how much are governments rather than trade through state-to-state agreements. The markets imposing choices? reduction of barter is linked to the establish- ment of a suitable payments mechanism and a Barter: Inflation accelerated in 1991, the stabilization of the ruble. And the but with price controls on most products, it establishment of new, possibly inconvertible was repressed--that is, it was measured not currencies raises additional payments ques- in price increases but in increased quantity tions for the conduct of interenterprise trade. shortages. This resulted in extensive queu- Superimposed on all these issues is the ing and massive losses (in time and other significant terms-of-trade adjustment that resources) in an effort to obtain the goods many states will need to make when trade under severe shortage. As Kornai (1980) moves to international prices. documented, when price controls result in shortages, enterprises turn to barter to ob- tain both their needed inputs and consumer goods for their workers."' With the price liberalizations in early 1992, the pressure for barter in each state was significantly reduced. Some prelimi- nary estimates indicate that the percentage of 7 I Transitional Arrangements In the longer term, trade among the 15 reduce foreign exchange earnings. Given states would be facilitated by two things. the prevailing market exchange rates of One is the establishment of currencies that more than 100 rubles to the US dollar in are convertible on current account, including early 1992 in most of the 15 states, workers perhaps a convertible ruble zone and possi- were earning only about $10 a month, dem- bly other currencies. The second is the onstrating the very high value of convertible adoption of a trade regime with low and currency. By restraining exports to the uniform tariffs, free as much as possible of convertible currency area, the countries nontariff barriers on either exports or im- forgo convertible currency earnings which, ports--to allow unregulated enterprise-to- if available, would cause the real exchange enterprise trade." We address here the rate to appreciate and make imports less question whether tariff preferences should be expensive. In effect, the restraints on ex- extended to commodities produced in others ports impose a significant implicit tax on of the 15 states and what form such prefer- imports.4 Although governments have not ences should take. But the situation now is imposed significant tariffs on imports, the so far removed from this longer term policy export restraints limit imports and protect environment that the key questions relate import-competing industries. Moreover, by primarily to transitional (often second-best) reducing export earnings, the export re- arrangements--which nonetheless would be straints raise the amount of financing coun- improvements and would move policies in tries need from abroad to maintain imports the direction of the longer term optimal at levels required to sustain domestic pro- environment. duction. Policies for Export Controls For some commodities, notably oil, governments need to maintain export restric- Export restraints to the convertible tions because the domestic price is tempo- currency area (notably licenses, taxes, and rarily being kept below world prices. The surrenders of convertible currency at below principal tool of export restraint that most market rates) are undesirable because they governments prefer is export licensing. For 9 Trade and Payments Arrangements for States of the Former USSR such commodities, however, variable export ing the rents retained in the exporting coun- taxes set equal to the difference between the try.17 world price and the domestic price are a preferable export restraint--for four rea- The principle of rapidly converting sons.15 quantitative export restraints to export taxes and then gradually reducing export taxes to First, a tax on exports is transparent. the convertible currency area has gained The government and the public know how acceptance in many states. Reservations much the export tax costs in forgone foreign have nevertheless been expressed about exchange per unit sold."6 Second, an export applying these principles in interstate trade tax allows exporters to engage in contracts in the near term. The first and perhaps with the certainty of being able to deliver, most fundamental reason for quantitative subject to the tax. If an exporter cannot controls in interstate trade is the govern- deliver the product within a specified peri- ments' desire to avoid surpluses or at least od, either the offer is not valid or penalty maintain balances in interstate ruble pay- clauses take effect. If there is uncertainty ments. Second is the microeconomic prob- about receiving an export license, exporters lem that price liberalization has not been will find it difficult to engage in contracts. coordinated among states in the ruble area. Third, a licensing system wastes resources-- There is a fear that goods would flow to through lobbying for the licenses and other states where prices are not controlled. forms of rent-seeking. Since licenses have Imposing a differential export tax structure substantial value ("rents"), the potential for a large number of commodities in such exporter will devote considerable resources a setting appears far more cumbersome to obtain the license and capture the rents, administratively than simply continuing the wasting resources for society. Fourth, an previous export control mechanism. A far export tax generates government revenue, superior approach would be to extend price helping ease fiscal problems. liberalization to almost all commodities, inherently desirable in any case." The only commodities needing quantita- tive export controls to third countries are For the few commodities that are sup- those for which states face inlernational posed to adjust to world prices during a agreements requiring them to limit their transition period, it may be necessary to exports, as in the Multi-Fibre Arrangement apply export restraints in interstate trade (MFA) or for specific products in EC mar- through, say, quotas or licenses. This is to kets. In such circumstances, it is best to prevent reexporting by other states of prod- auction export licenses. Such a system ucts underpriced domestically in relation to would ensure that only the precise quantities world markets as well as hoarding products agreed on are exported, and the rents from before the scheduled increases. But with the licenses would accrue to the state, reduc- export taxes to third countries and export ing the wasteful rent-seeking of enterprises. controls in interstate trade (two instruments Moreover, competition among suppliers at already in use for these commodities), gov- the auction would allocate the licenses to the ernments should then be in a position to most efficient domestic suppliers, maximiz- remove two other controls that are redun- 10 Trade and Payments Arrangements for States of the Former USSR dant: quantitative restraints on exports to If these products are to be supplied at less third countries, and price controls in domes- than market prices in interstate trade (as tic and interstate markets. Russia has agreed with energy products on an interim basis for some countries), some Bilateral balancing of trade through kind of state commitment may be required. whatever means puts trading relations in a Otherwise, exporting firms would raise the straight jacket and is inimical to the develop- price to the market. This again emphasizes ment of markets and the allocation of re- the importance of reducing the number of sources according to comparative advantage. goods subject to price controls. Attempting to maintain bilateral balances in ruble trade is a short-term expedient during Contrary to practice, however, a state the current unsettled period when monetary obligation to export does not imply the need policy is not coordinated in the ruble zone to impose a (planning) system of state orders and the central banks of the states in the and quantityregulations for producing enter- zone can expand credit independently. prises. Instead, the state could use procure- ment agents for the purchase of goods for Reducing State Trading and Promoting Enter- interstate trade that are subject to price prise-to-Enterprise Trade controls. The agents would be authorized to pay a price slightly above the controlled Obligatory lists, incompatible with a domestic price, which should induce sales to market economy, should be eliminated at the the procurement agents. Except for these earliest possible date. First, in a bilateral products, and possibly for a basket of goods negotiation, governments are responsible for exported in return by the oil-importing choosing which products are on the lists, so countries, there is no justification for export it is governments rather than market forces controls or list trading. and comparative costs which would define and control trade. Second, experience with To control excessive inconvertible imbal- obligatory lists in the CMEA has shown that ances within the ruble zone, it would be best the process leads to losses of dynamic effi- to coordinate monetary and fiscal policy. ciency. It is extremely difficult to obtain This would allow interstate trade within a the value of an improved product through framework of enterprise-to-enterprise trade the government negotiation process, result- without export constraints. Until such ing in little or no product innovation. Most coordinating mechanisms exist and given the important, obligatory lists are typically use of export licenses, indicative lists are implemented through state orders or plan- superior to obligatory lists. For products on ning, which mean that the state is not mak- the indicative lists, there would be no state ing the desired transition from central plan- obligation for the trade, and enterprises in ning to the market. the respective countries would negotiate their best terms on price, credit and other The main problem in moving away from aspects of the contract. such lists is that some goods--important in interstate trade--remain under price controls The indicative lists would be useful in and are adjusting to world prices gradually. three ways. They commit governments to 11 Trade and Payments Arrangements for States of the ___.-_'l. issue export licenses for the products ie - -'ue.20 Thus, in agreements up to the amounts sped% l. D. Tations men- They permit the removal of the produt : - ;- epure sense as a from intergovernmental price controLs. A-L52d -' - ganst Sports) they reduce the planning in economic de'z- . - sr ne alone. sion making.'9 Over time, as dom eslz prices are permitted to rise to irterna:,iorz.' to be qualified levels, export taxes to third cournmies d;-:ily inefficient export licensing for trade denominated t' ' OT:t collects import rubles would not be necessary. Thi s Azrve efficiency of also eliminate the need for lists, and Z; r -Jme the neutrality all trade to be conducted directly throun s could be used enterprises. For trade outside the riubħ . '.' . ub-Salhar Afri- zone, however, arrangements woukld veo s- ^ rt run difficul- needed to cope with payments amnong coun- the 15 states, it tries with inconvertible currencies. -o-t surcharges .r'd,-m v, measure until Import Controls -cction systems are There are very few formal import COt3- trols in the 15 states. To the extent tre. a ough explicit states use import controls, tariffs are prefer- vl noneKstent, there are able to quantitative restraints on imlports forts due all the reasons elaborated above, on the- t oni exports. The advantages of export taxes over exPa - foreign exchange licenses. Explicit tariffs, now vituall ihe value of the nonexistent, need to be considered for reve- icit tariff on all nue and protection. While the revenu currencyarea. arguments and protection arguments are change is obtain- usually complementary, they conflict in the ch- r nt exchge rate, the 15 states. A tariff for transitional protection most powerful pro- would require a preferential trade a - - rate iis signifi- which implies no tariff on intraregion I - - - i addition, for most trade. With between 85 % and 95 % ? of trade . access to for- being intraregional for most of the 15 states, '.'i various retention this implies relatively little revenue com- - e currency exporters pared with a tariff that has only the, revernu -- s cation of foreign objective, one that is applied on all trade. - quence, for a big change earnings. Tariffs for revenue. A fundamental pr= g exchange is ciple of commodity taxation: nreutral tes -a irnports, because that do not discriminate between imports ad - t often protect the domestic sources of production are the most . , ,'netir9g industries 12 Trade and Payments Arrangements for States of the Former USSR through their allocation decisions. Import- Based on experience of trade policy competing industries thus receive powerful reform, transitional tariff protection should protection from convertible currency imports be moderate, not to exceed tariffs in the 15- from the high price of foreign exchange and 30 % range (Thomas, Nash, and others from its central allocation. 1991). The tariff structure for any particu- lar country would obviously need to be The mirror image of this high protection determined case by case. from convertible currency imports is the strong incentive to import from within the There are several reasons for avoiding ruble zone rather than from outside, causing high tariff barriers. First, since their pur- export restraints within the ruble zone to pose would be to ease the adjustment and to proliferate. As long as enterprises trade generate revenues until more efficient meth- with each other in a ruble zone when the ods are developed, tariffs should be tempo- ruble exchange rate is undervalued and rary--and be reduced over time. But if foreign exchange is centrally allocated there tariffs are high, industries that benefit from is no need for further protection against them will resist liberalization. Temporary imports from hard-currency areas. protection may become permanent and once the government slips in its liberalization Once the ruble is no longer underval- schedule, expectations are altered, and the ued--or states create new currencies, requir- advantages of transitional protection are ing settlements of balances in hard currency- significantly reduced. -the incentive structure for trade will change markedly. There will be less incentive to Second, protection is a second best import from the other states, and there will means for easing the burden of adjustment. be greater competition from imports from No matter what the justification for protec- hard-currency areas. Temporary and declin- tion, another policy intervention will im- ing protection vis-a-vis hard currency area prove welfare more: a production subsidy or imports may then be needed to ease the a tariff combined with a subsidy on con- adjustment to a market economy. The most sumption.' The problem is that fiscal important reason is that with significant constraints in the 15 states make it difficult unemployment, the optimal path of tariff to use subsidies in support of enterprise policy (which trades off the marginal social restructuring. The temptation would be costs of increased unemployment from tariff great to keep tariffs high indefinitely or to reduction against the marginal social benefits design made-to-measure tariffs industry by of a more rapid adjustment of factors) is to industry to "ease" the transition--a very adjust the tariff gradually to its long-run low dangerous road because protection supports level. The In these circumstances, coun- noncompetitive enterprises and preserves the tries could use moderate and relatively inefficient industrial structure with little or uniform tariffs.23 It is argued here that no adjustment. Then the economy will not countries should consider applying such produce according to its comparative advan- tariffs only to imports from hard-currency tage, and the efficiency gains and higher areas--to provide a margin of preference in growth rates from an outward orientation interstate trade. will be lost. 13 Trade and Payments Arrangements for States of the Former USSR Third, high tariffs, even duriig a transi- circumstances and whether they decide to tion, discriminate against exports.25 Tariffs join a regional trading arrangement. and a devalued exchange rate both protect the import- competing industries, but the Payments Arrangements difference between the two is that an ex- change rate that is not ovenvi2ueI also In the ruble zone. To reduce barter, it encourages exports. So, for trade, pocy, will be necessary over time to eLiminate the exchange rate is preferabdle tO a. §mL-i br price controls in interstate trade--and to achieving external balance, establish monetary stability, reduce inflation, and improve the system of payments. To Despite these considerations, very high relieve the unreasonable delays in processing tariff protection has been proposed on an interstate payments orders, major institution- interim basis for socialist ecnoomies in al improvements are needed in the system of transition (see McKinnon. 1991) to, protect interbank settlements both within and among industries with negative value added.26 Tis republics.29 Settlement centers (or clearing argument could be valid if the negative houses) should be reconstituted and permit- value-added industries will become efficient ted to clear interstate payment orders. The competitors on world markets and if this only reporting to the central banks required would not occur without governent iner-- of the settlement centers would be the net vention because of externalities. Corden change of positions of the commercial (1992) has noted that this argument is a banks.30 special case of the infant-industry argument, which would also apply to positive but low Another quite important reformn is that value-added industries. The indlustries of commercial banks in each state should be the 15 states have, however, received pro- allowed to establish correspondent bank tection for decades, and it is hard to visual- accounts in the commercial banks of other ize these old negative value-added industries states. This will have immediate benefits in being classified as infants,' ones in which speeding the processing of interstate pay- externalities to investment exist that can-not ments orders--and will possibly prove cru- be captured by the fins. Even if there cial as new currencies are introduced. were such cases, Baldwin (1969) has ar- gued that protection will generally not ad- As a result of the lack of monetary dress the externalities.28 Moreover, :protec- coordination within the ruble zone, credit tion is seldom associated with increasing mnay be created by aLI the central banks in efficiency, and it frequently has the opposite the ruble zone. There is a serious free-rider effect (Thomas, Nash and others :1991). problem when overexpansionary policies in one state lead to significant negative balanc- On balance, the general World Bank es that are automatically financed and result recommendation for moderate and relative in net transfers of goods and services from uniform tariff protection would seem lt the others without the receipt of convertible apply to tthe 15 states as wel. OuF eom currency in return. For Russia, which the tariff level and range would ha,ve to be expects to be the principal creditor in the set by individual states depending on their system, this implies the continuation of 14 Trade and Payments Arrangements for States of the Former USSR transfers to other states. Until effective is a simple multilateral clearing mechanism monetary policy coordination is established with convertible currency settlement, limited in a possible ruble zone, imposing limits on short-tern credit, and short settlement peri- aggregate credit offered the other states ods. Such a mechanism demands relatively through the correspondent accounts of the little convertible currency to facilitate trade, central banks may be the least inefficient but would still permit enterprise to enter- way for Russia to limit ruble trade surpluses prise trade. For this, it would be desirable and related transfers. to establish a multilateral clearing union to permit simultaneous settlements of claims Any state that wishes to remain in the among participating central banks--claims ruble zone must accept the need for mone- that arise from enterprise-to-enterprise trade tary coordination and restraint. Independent among the various states.3" In a clearing monetary policy is possible only with the union, only the multilateral balance within adoption of a new currency. Monetary the union would be settled in convertible coordination and restraint for states that currency, not all the bilateral balances. And remain in the ruble zone would address the transactions at the level of the enterprise free-rider problem. And if the ruble were to would be conducted in national currencies. become convertible, bilateral imbalances Settlements among the central banks would should not be a concern for surplus coun- be made in convertible currency after short tries. intervals, needed so that the credit outstand- iig is limited. For states with new currencies. If the new currencies are convertible for current ac- Such a system would economize greatly count transactions, and if the ruble is con- on the use of scarce hard-currency reserves vertible as well, interstate payments arrange- required to conduct interstate trade since ments could be conducted enterprise to considerably less would be needed to settle enterprise. Enterprises engaging in foreign multilateral imbalances than if all the trans- trade could obtain foreign funds and convert actions had to be denominated in hard cur- them to national currency without going rency and conducted through international through an inter-central bank clearing ar- bantks. Moreover, since only the multilater- rangement. Clearly, moving rapidly toward al balance is important to members of a current account convertibility of the ruble clearing union, the incentive to balance trade and any new currencies is the best guarantee bilaterally would be removed. Note, how- against a payments-induced collapse of ever, that convertible currency settlement, trade. even within a clearing union, will probably reduce the demand for goods from others of If convertibility is not immediate for the 15 states. The reason is it will trans- either the ruble or for states introducing form incentives among enterprises in differ- currencies, it is not necessary to retain the ent states, which will no longer find it cumbersome system of bilateral agreements cheaper to import from another state. and state trading. A fairly straightforward solution to the conduct of trade and the An altemative mechanism has also been settlement of accounts among these countries proposed, based on a system of correspon- 15 Trade and Payments Arrangements for States of the Former USSR dent bank accounts with ruble settlements cies, large debit positions would be permit- (Sachs and Lipton 1992 and Williamson ted for trade within the union. The propos- 1992). In this scheme, commercial banks in als derive in part from an erroneous inter- the states introducing new currencies would pretation of the reasons for the collapse of open correspondent ruble accounts in com- the CMEA trade: that it was due primarily mercial banks of Russia, and Russian com- to a lack of financing to settle clearing mercial banks would maintain correspondent imbalances among CMEA members. In ruble accounts in commercial banks of these fact, the main reasons were the reduction in countries. An essential feature of the sys- trade-diverting trade and, as Brada (1992) tem would be that countries introducing has shown, the decline in the capacity of the their own currencies would have to allow a USSR to supply exportables. free market between their national currency and the ruble, and trade would be predomi- There also are several other, more gen- nantly denominated and settled in rubles."* eral problems with such arrangements (dis- cussed in detail in Michalopoulos and Tarr An important condition for such a 1991). For example, if there are persistent scheme is the stability of the ruble. And debtors and creditors within the union, it is several other technical issues would need to necessary to find a country willing to pro- be addressed--including how to obtain for- vide continued credit to members of the ward cover for ruble denominated transac- union although it may itself be facing signif- tions, and whether countries not receiving icant overall scarcity of foreign exchange. seignorage from ruble creation would be In the present situation, Russia would likely able to share in the benefits of using the be the persistent creditor, but it has shown ruble as a reserve currency. Although no willingness to extend such credit. In- technical solutions to these issues can proba- deed, it has taken steps to restrain trade bly be developed, a key issue for such a even within a continuing ruble zone in order scheme is political acceptability. Most to avoid extending credit. It is highly un- states planning to introduce new currencies likely that it would wish to extend credit to appear unwilling to continue to deplend in states leaving the ruble zone. practice or in appearance on Russian eco- nomic policies. This problem could be solved by provid- ing external credit to finance the debtor Despite the possibility of implementing countries. But then the question is whether these relatively simple payments mecha- the external credit is optimally allocated. nisms, proposals have also been made for Are these countries having continuing defi- the establishment of more elaborate pay- cits because of ineffective overall macroeco- ments union arrangements (van Brabant nomic policies? Is it not more appropriate 1991, Dombusch 1992, Havrylyshyn and that what a,mounts essentially to balance-of- Williamson 1991). The main difference payments assistance be extended on condi- between these arrangements and a. multilat- tion that an appropriate adjustment program eral clearing union is that while settlements is in place and their overall balance of would be made periodically in hard curren- payments is sustainable? 16 ______.i . ens Arrangements for States of the Former USSR A payments union n troduce intemational prices in its interstate here runs the risk thai trade. If it were to do so in its exports of use their payments upmcn a-,-i DU to others of the 15 states (it apparently take steps to introiu hasalready introduced close-to-international integrate with the interinattio.>R1 .a --I prices in trade with the Baltics), it would For a country to inluce . move the price of crude oil from 350 rubles nalize the softness of pa - n (plus a 28% value-added tax) to about union, it is necessary Jio X 130 a ton. At a quasi-market exchange interfere in the t-kad"'in! - rate of about 110 rubles to the dollar pre- tariffs, nontaiffr v-~-u - b-am, in mid-1992, this amounts to a 32- some countries is £Ray .o -ld increase. from a desired more r C ment." There is Thlus a ,: ;.he increase in prices of energy and credit is available, te o4her commodities could have severe ad- ated credit offer too za-.'-e. verse consequences for enterprises using focus trade with ae pa; eegy and raw materials intensively in than diversify ntd on:er. states. Their governments could By contrast, defico - aaermpt to cushion this impact in the short exhaust their uniLt eYnior ' :L;-:' .. -'n with temporary subsidies. But their payments union woud capacity to do so would be constrained by easing the transitk. - . dhe need to contain public sector spending suggest the need vo 8tD : a:-d fiscal deficits. In practice, states have than a payments co . :- attempted to mitigate the terms-of-trade transition. affect on their economy by trying to negoti- aie less-than-world prices with Russia in the exchange of energy and other commodities The Scope for Coop& . v :. contained in bilateral agreements. They huave attempted also to maintain the implicit A key question vh~at,'- ::imerrepublic transfers associated with the ing appropriate meas-n-S - . f r/g system as operated in the former collaboration and trade --:,- --2-.J and promoting the lc-m:r ! - ° their economies. As a general rule, to provide appropriate piice signals for the operations of economic The terms of t,a - ,'ts, it is desiable to eHminate the provi- important issues m''t-;-.....i' .> siori of transfers through the price mecha- how states would r . -n ismi and to provide explicitly for subsidies terms-of-trade adusj.sG.n. -