Time to Seal the Deal

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After more than a decade of negotiations to enter the WTO, Russia is now waiting only for the United States to OK its membership bid. Last week Russia made an important concession on the issue of financial institutions. Although Russia has reserved the right to prevent foreign banks from opening their own branches in the country -- an issue considered to be the main factor preventing an agreement with the United States -- it has given ground on the question of insurance companies. Foreign insurance companies will be able to set up their own branches, as long as total foreign ownership does not exceed 35 percent of the overall insurance sector in Russia.

Agreement over these issues sparked widespread hopes that a deal could be reached before the G8 summit in St. Petersburg. That hope, however, was crushed, and although U.S. President George W. Bush made clear that the aim was to bring Russia into the trade club, he said Saturday that more discussions were needed.

Failure to seal an agreement thus far is a product of U.S. negations being driven by political rather than business and economic issues. The American Chamber of Commerce in Russia, which represents the interests of U.S. businesses, has been a strong supporter of Russia's WTO bid. But this kind of support appears to have fallen on deaf ears in Washington, where concerns over human rights and democracy have overshadowed the economic issues.

Russia deserves an admission ticket to the trade club. Its economy is in better shape and less regulated than the Chinese economy was when it joined in 2001, and it would be more than a stretch to claim that China had done more to democratize its society. In fact, Washington's approach to China was clearly led by business interests, with politics taking a back seat. Of course, China is the United States' third-biggest trade partner, while Russia is No. 26.

With an agreement on financial institutions, the outstanding issues are related to agriculture and the protection of intellectual property rights. On agriculture, U.S. concerns over Russian subsidies and other protective measures have not been fully assuaged, and the negotiations have reportedly now stalled on issues related to Russian imports of beef and pork. Russia accounts for 0.4 percent of total U.S. exports, and although last year U.S. exports of food and livestock accounted for 22 percent of total U.S. exports to Russia, this represented less than 0.1 percent of total U.S. exports.

From the viewpoint of trade relations, it is hard to understand why negotiations between Moscow and Washington have been so difficult, as the mutual relationship is very insignificant. The United States accounts for 2 percent of Russia's total trade, while Russia makes up a mere 0.7 percent of the U.S. total.

Protection of intellectual property rights remains a weak spot in Russia. Despite television images of bulldozers crushing pirated copies of DVDs, CDs and computer software, these items are quickly replaced and remain easily available. In 2004, the cost of piracy to the U.S. music and movie industry was estimated at $13.4 billion, and a U.S. report cited Russia and China -- already a WTO member -- as the biggest offenders. The difficulty of cracking down on piracy in Russia, however, is partly the result of simple economics. A licensed DVD currently costs as much as $25 in Russia, or about 7 percent of the average monthly salary. In the United States, a DVD goes for about $30, or 1 percent of the average monthly wage.

Despite the remaining hurdles, an agreement between Moscow and Washington remains imminent, as both countries have more to win than to lose from Russian membership. The United States is seeking support from Russia over Iran and North Korea's nuclear programs and is also looking to reduce its dependency on energy supplies from OPEC, so striking a deal with Russia on WTO membership appears to be a small price to pay to improve the political dialogue between the two countries.

For Russia, WTO membership would be positive, although potential benefits from tariff reductions are likely to be insignificant, mainly because Russia has gradually liberalized its tariffs and the current average trade-weighted tariff of around 8.5 percent is relatively low. Furthermore, WTO membership has tended to be more beneficial for countries with a large manufacturing sector, such as China. Russia is a major producer and exporter of commodities. Questions remain about the ability of the WTO to bring discipline to the oil industry, which is governed by global markets and OPEC.

The main benefits of WTO membership are likely to arise from the liberalization of Russia's own market, and especially from reforms and the removal of barriers to foreign direct investment in service industries like telecommunications and the financial sector. Increased market access to foreign investors will put pressure on domestic players and could thus act as a catalyst for enterprise-led reforms.

The banking sector could possibly be the big winner, which in turn would be a victory for individual depositors and creditors. In 2001, the Center for Economic and Financial Research said that: "The main dilemma for the Russian financial sector has to do with improvement of the investment climate and protection of creditors' rights, not with WTO membership." This still holds true. WTO membership could help to convince more foreign banks to enter the Russian market, which could only be a positive. Although Russia has retained the right to prevent foreign banks from open their own branches, the country's strong economic growth and consumer boom have created huge interest from foreign banks. Nevertheless, foreign banks' expansion into Russia's financial sector has been, and will continue to be, a gradual process. This will allow domestic banks to improve their own operations in preparation for a more competitive environment.

WTO membership will also pave the way for the European Union to open negotiations with Russia on a free trade agreement. The EU is Russia's largest trading partner, accounting for more than 50 percent of the country's total trade, and the ongoing process of EU enlargement means the EU is likely only going to increase in importance as a trading partner. The benefits for Russia from free trade with the EU would depend on the coverage of any agreement. As with the WTO, a free trade deal would be limited if it only covered reductions in tariffs. But Russia could benefit significantly from a deal that stimulated regulatory reforms and included trade in services, which is more likely to be the case.

The main Russian concerns over WTO membership come from certain industries and the agricultural sector, which are convinced that joining will flood Russia with cheaper imports, worsen unemployment and generally prove harmful to the domestic manufacturing and agriculture sectors. WTO membership would not, however, mean that Russia would lose its right to employ protective trade policies. For example, Russia would retain the right to impose protective measures temporarily in any industry determined to still be in its infancy. Russia has also been granted a five-year grace period before it has to lower tariffs on certain products and open its agricultural market to outside competition. And while it is true that increased international competition may be harmful to certain industries in the short run, in the longer term, remaining outside the WTO and avoiding this pressure to restructure would be even more harmful.

Peter Westin is chief economist at MDM Bank.