Trade Sustainability Impact Assessment of the Free Trade Area in the framework of the Enhanced Agreement between the EU and Ukraine

Transcription

1 Trade Sustainability Impact Assessment of the Free Trade Area in the framework of the Enhanced Agreement between the EU and Ukraine Ref: TRADE06/D01 Final Inception Report Client: European Commission, Directorate-General for Trade Submitted by Rotterdam, 5 April 2007

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3 ECORYS Nederland BV P.O. Box AD Rotterdam Watermanweg GG Rotterdam The Netherlands T F E netherlands@ecorys.com W Registration no SKH/AC15564/increp 3

4 Content page 1 Introduction Development of Trade Sustainability Impact Assessment tool Summary negotiations of Ukraine and effects for the EU Structure of this Inception Report 9 2 Methodology Causal Chain Analysis (CCA) Scenario analysis and CGE modelling Sector and horizontal issue case study methodology Consultation and dissemination strategy 17 3 Including CGE Modelling into the TSIA Context for the baseline scenario and expected scenarios The Computable General Equilibrium Model CGE Rutherford-Tarr Multi-country model The Model Use and gathering of data Service Oriented Enterprise model for Ukraine The Model Use and gathering of data Summary 22 4 Update on EU-Ukraine trade studies and agreements The Partnership and Cooperation Agreement (PCA) between the EU and Ukraine The Action Plan for Ukraine from the European Neighbourhood Policy (ENP) The prospect of deep free trade between the EU and Ukraine (CEPS, 2006) Prospect for EU-Ukraine Economic Relations (CASE Ukraine, 2006) 27 5 Consultation & dissemination strategy The network of key stakeholders The tools, methods and strategy for the consultation process and dissemination of knowledge A consultation & dissemination time-plan 35 6 Timeline and way forward Present a clear and transparent time schedule for the duration of the TSIA study Error! Bookmark not defined. SKH/AC15564/increp 4

5 6.2 Reporting requirements Changes in the proposal compared to the tender application Methodological changes Human Resources Management 39 Appendix A CV Mrs. Nora Plaisier 40 Appendix B References 41 SKH/AC15564/increp 5

6 1 Introduction This Inception Report is the summary of our intended approach towards achieving the goals presented in the Tender application and requested in the Terms of Reference. It clearly states for each stage of the study what are the intended actions and what tools we are going to use. We will make use of all relevant documents to achieve these goals and where the documents diverge, we make clear in this Report, what our inclination and interpretation is. 1.1 Development of Trade Sustainability Impact Assessment tool Since 1999, the EU has used the Trade Sustainability Impact Assessment (TSIA) tool to flank its trade negotiations with other countries and to use it as a methodological framework to look into the economic, social and environmental impacts of the (anticipated) trade negotiation outcomes. 1 Over time, the tool has been adapted and improved and grown to become an indispensable part of the approach of the EU to trade negotiations and sustainability. 2 The combination of academic and empirical research combined with a strong consultation component in support of and in continuous exchange with the trade negotiations is a powerful asset. The TSIA framework has two core elements of analysis: Trade sustainability impact assessment (TSIA) This part gives an integrated assessment of potential economic, social and environmental impacts of trade negotiation outcomes; Consultation process This part entails the communication with key stakeholders and dissemination of results of (parts of) the TSIA and is crucial for the support, transparency, credibility and legitimacy of the study. In line with the indications by the European Commission, we will treat each of these two core elements as equally important. These two core elements will come forward in the following four reports that will be produced, discussed and disseminated during the flow of the study: Inception report (this document); General analysis report (to conclude Phase 1); Interim report including the Workshop report (to conclude Phase 2); Final report (to conclude Phase 3). 1 2 Kirkpatrick, C. and N. Lee (1999). EC (2006). Trade Sustainability Impact Assessment of the EA EU-Ukraine 6

7 At all phases of the TSIA, the consultation process is included and intertwined with the reports that are being produced. In fact, the interim reports are designed to create discussion, receive feedback and critiques and provide ECORYS and CASE Ukraine with the opportunity to exchange opinions, convince and build support for the study and study outcomes in the coming months. In Figure 1.1 below the indispensable interaction between the reports and the consultation process is presented. Figure 1.1 Overview of the TSIA reports and consultation process Inception Report Global Analysis Report (Phase 1) Interim Report (Phase 2) Workshop Report presentation incorporation comments & continuous feedback presentation incorporation comments & continuous feedback presentation incorporation comments & continuous feedback CONSULTATION PROCESS Presentation Inception Report First general comments, First methodological comments (online), Requests for feedback key stakeholders (esp. EC) check incorporation Presentation Global Analysis Report General methodological comments, specific comments quantitative analysis, outcome / assumptions comments ( /online), Requests for feedback key stakeholders check incorporation Presentation Interim Report Specific comments on quantitative methodological comments (online), Requests for feedback key stakeholders Workshop Report (part of Interim Report) Comments from key stakeholders present at the Workshop in-depth discussions check incorporation Final Report presentation Presentation Final Report (Including all comments key stakeholders, findings global analysis report, findings interim reports, findings workshop report, policy recommendations, in line wit ToR) In Chapter 6, the consultation and dissemination strategies will be further elaborated upon. 1.2 Summary negotiations of Ukraine and effects for the EU As we mentioned in our proposal, since 1989, when the Berlin Wall fell and subsequently since 1991 when the Soviet Union disintegrated, the landscape of Central- and Eastern Europe has changed dramatically. Ukraine became an independent country and has gone through a deep process of transition which has included privatisations, deregulations and at times high levels of (political and economic) instability. Trade Sustainability Impact Assessment of the EA EU-Ukraine 7

8 Ukraine and the European Union Over the past 18 years, the Ukraine has been growing closer and closer to the European Union, which is reflected not only by observed international trade flows, but also by deepening levels of cooperation. The Partnership- and Cooperation Agreement (PCA) signed in 1998 and further cooperation agreed on 21 st of February 2005 are good examples of this. Notably after the Orange Revolution, the following core points were reflecting the closer cooperation between the EU and Ukraine: (1) Early consultations on an Enhanced Agreement (EA) between EU and Ukraine were initiated and would be taken forward as soon as the political priorities of the ENP Action Plan had been addressed; (2) Possibilities for closer co-operation in the area of foreign and security policy were explored, including European Security Defence policy, particularly with regard to Transdnistria. Ukraine would also be invited, on a case by case basis, to align itself with EU positions on regional and international issues; (3) Trade and economic relations between the EU and Ukraine were to become deeper. The review of the existing feasibility study on establishing a Free Trade Area between Ukraine and EU would be accelerated with a view to enable an early start to negotiations once Ukraine has joined the WTO. This issue is of the utmost importance for this TSIA; (4) Further support to Ukraine s WTO accession was given and Ukraine was offered continued assistance in meeting the necessary requirements. The EU was one of the first partners to conclude its bilateral protocol with Ukraine in March 2003; (5) Support for Ukraine s legislative approximation process was stepped up, including the use of instruments borrowed from the Enlargement process such as TAIEX and Twinning; (6) Efforts in the fields of democracy and rule of law should be an immediate imperative and further targeted assistance including support for strengthening of civil society is envisaged; (7) Access to funding from the European Investment Bank (EIB) was maximised, making up to 250 million of EIB lending available to Ukraine, and provide increased financial assistance to Ukraine through the relevant instruments in order to help Ukraine to pursue its reform process. As mentioned in the Terms of Reference, already in 1998, a Partnership and Cooperation Agreement (PCA) was concluded between the EU and Ukraine that will be automatically renewed if not requested otherwise. This partnership covers the traditional areas of cooperation like trade in goods and services, business opportunities, investment, sector policies (e.g. energy), etc. In 2005, also the EU and Ukraine agreed on an Action Plan under the European Neighbourhood Policy (ENP) to further strengthen bilateral relations. In 2005 it was decided in the EU s General Affairs and External Relations Council (GAERC) to initiate early consultations on an enhanced agreement between EU and Ukraine, to replace the PCA at the end of its initial 10-year period, as soon as the political priorities of the ENP Action Plan have been addressed. A deep and comprehensive Free Trade Area (FTA) is to be negotiated including substantive regulatory components to further enhance the EU-Ukrainian economic and Trade Sustainability Impact Assessment of the EA EU-Ukraine 8

9 political relationship. This FTA is going to be negotiated based on the assumption that Ukraine will become a member of the WTO roughly around the Summer of This aspect, also, is important for this TSIA of the effects of the FTA, because WTOmembership will serve as the baseline scenario for this study. The effects for the EU member states are important issues to be included in this analysis. As examples we think of SPS issues and agriculture. Building on WTO membership, as is outlined in Chapter 4, Ukraine is going to negotiate an FTA in the context of an Enhanced Agreement with the EU that will go beyond the WTO commitments of Ukraine, aiming at a deeper level of cooperation. The FTA negotiations will not only focus on the remaining tariffs but also on regulatory approximation, non-tariff barriers and technical standards. For a summary of the European Neighbourhood Policy (ENP) and the Enhanced Agreement, we refer to Chapter Structure of this Inception Report In this Inception Report, ECORYS and CASE Ukraine indicate the approach taken towards this study. In this respect the kick-off meeting is highly appreciated by ECORYS and CASE Ukraine because it has yielded invaluable additions of interpretation and relative importance. We got useful information and appreciated the fact several DGs were present. The comments from the kick-off meeting have been inserted throughout this Inception Report. According to Chart 1 of the Handbook (p. 12), the Inception phase can be split into two components to analyse the impact of the FTA for the EU and Ukraine (culminating in the two reports required by the Terms of Reference, p. 16): the Inception Report and the Global Analysis Report (to conclude Phase 1). In line with the Terms of Reference, this Inception Report serves as the starting point for the subsequent Phases 1, 2 and 3, and will provide the European Commission with the following: An overview of our methodological approach to the study, including the various phases (Chapter 2); Including the Equilibrium Modelling in the TSIA (Chapter 3); An update on EU-Ukraine studies, including the CEPS Feasibility Study (2006) 3 (Chapter 4); A description of the consultation and dissemination strategy (Chapter 5); The summary of the way forward including a timeline for the study (Chapter 6). For the Global Analysis Report (Part 1), we will then use this input to start the screening and scoping (using Causal Chain Analysis), to preliminary identify priority issues and to continue our stakeholder analysis (that starts already with this Inception Report). This split between the Inception Report and the Global Analysis Report (both in Phase 1) is a 3 CEPS (2006) Trade Sustainability Impact Assessment of the EA EU-Ukraine 9

10 deviation from previous TSIAs but in line with the ToR and our budgetary man-hour proposal. Trade Sustainability Impact Assessment of the EA EU-Ukraine 10

11 2 Methodology Regarding the overall methodology, a few core components can be identified and need to be worked out further and in more detail in comparison to the tender documents. These core methodological components are: Causal Chain Analysis (CCA) (worked out in section 2.1); Scenario analysis and CGE modelling (worked out in section 2.2); Sector case study methodology (worked out in section 2.3); Consultation and dissemination strategy (worked out in Chapter 5). 2.1 Causal Chain Analysis (CCA) CCA is a conceptual tool used to identify the relevant cause-effect links between the trade measures proposed and the economic, social and environmental impact this trade measure may have. What is imperative for a realistic impact assessment is that the CCA is applied to significant links between trade negotiations and their impacts. In the first phase, Phase 1, of the TSIA CCA is used to provide insights into the Global Analysis, as a tool to provide preliminary screening and scoping as well as indicating possible priority issues. CCA is also going to be used in Phase 2 of the TSIA, but that will be explained below in paragraph 2.3. Figure 2.1 shows in a slightly adapted way compared to Chart 3 of the Handbook (p. 35) how we view the way Causal Chain Analysis should be applied within the TSIA framework for the Global Analysis part of the study. Exogenous and endogenous factors influence a baseline (pre-defined) scenario. The exogenous factors are present but determined elsewhere, while the endogenous factors are the possible change variables because of the FTA negotiations within the Enhanced Agreement between the EU and Ukraine. The change in baseline scenario to initial economic impact as a consequence of the FTA negotiations depends on the strength of specific effects (like for example the size of sectors, levels of international trade, market structures or regulatory environment). Subsequently, the initial economic impact affects the production structure which in turn affects the economic, social and environmental impacts. This means there is an indirect effect of the initial economic impact on the specific fields. On top of that there is also a direct influence of economic impact. Finally, the economic, social and environmental impacts of the FTA negotiations between the EU and Ukraine determine sustainable development. Trade Sustainability Impact Assessment of the EA EU-Ukraine 11

12 Figure 2.1 Causal Chain Analysis: from trade measure to impact on sustainable development Policy influence (for Phase 3) mitigating or enhancing measures Influence exogenous factors Negotiate different level of FTA different effect on trade measures (endogenous variables) Exogenous Factors: - Structural change - Pre-existing economic, social, environmental & legal framework - Political factors - Infrastructure - Knowledge & development - Non-EU market access Endogenous Factors: -Trade (in goods and services) - Technical barriers to Trade and SPS - Capital movement & payments - Competition - Intellectual Property Rights - Trade facilitation, customs and RoO - Trade and sustainable development - Energy Baseline Economic Conditions Influence SWOT to have different change from baseline to initial economic impact Initial Economic Impact Influence effect of initial economic impact on production systems Production Systems Influence specific SWOTs to have different effects of production systems on the three types of impacts Economic Impact Social Impact Environmental Impact Influence three types of impact on sustainable development Sustainable Development The effects of the FTA negotiations on sustainable development therefore run through the light blue arrows. For example, if the FTA between EU and Ukraine alters the regulatory framework regarding technical standards of agricultural products (technical barriers to trade), the baseline economic scenario changes because trade patterns change, and so do (international) market conditions for producers and consumers. This will change the behaviour of (agricultural) producers as well as EU and Ukrainian consumers (following price changes) which in turn will have an economic, social and environmental impact related to sustainable development. However, in addition to the Handbook we show also already at this stage how via the light yellow arrows, policy measures taken (enhancing or mitigating) can influence the various cause-effects. Thus Figure 2.1 shows how at what stages flanking policy measures may increase the positive and mitigate the negative impacts of the FTA negotiations between the EU and Ukraine, since we believe policy can influence various stages and should not wait till the effects are over. 2.2 Scenario analysis and CGE modelling The approach ECORYS and CASE Ukraine take towards this part is covered in paragraph 2.3 in detail. The general methodology, however, runs as described below. Trade Sustainability Impact Assessment of the EA EU-Ukraine 12

13 Scenario analysis Two scenarios will be developed regarding future consequences of the FTA negotiations within the EA between the EU and Ukraine in order to assess prospective consequences of the negotiations. The more information ECORYS and CASE Ukraine have available on where Ukraine currently stands, the more realistic these scenarios can be. That is a logical deduction since the scenarios will be based on assumptions regarding the context and starting position (the baseline scenario) that may or may not include a continuation of recent trends with respect to Ukraine s economic, social and environmental performance, depending on various processes Ukraine is in right now (e.g. WTO accession). Information support from the European Commission with regards to this situation and the status will be highly appreciated. In Chapter 3, a more detailed analysis will be given. We will carry out two scenario analyses to predict the likely consequences of outcomes of the FTA negotiations. These quantitative outcomes can be of economic, social and/or environmental nature. Given the focus of the TSIA on sustainable development, the model outcomes will be screened and then analysed in-depth regarding this aspect split out, again, in the fields of economic, social and/or environmental sustainable development. This is shown in Figure 2.2 in stylised form. Figure 2.2 Framework for Quantitative Analysis through CGE modelling Baseline Economic, Social and Environmental Conditions (baseline scenario) Scenario Definitions CGE Model Integrated Quantitative Framework Macro-economy and sector Quantitative Economic Outcomes Quantitative Social Outcomes Quantitative Environmental Outcomes Quantitative impact on sustainable development Economic Analysis Social Analysis Environmental Analysis Trade Sustainability Impact Assessment of the EA EU-Ukraine 13

14 Scenarios define the scope of the evaluation and reflect the extremes of a likely range of realistic outcomes of the trade negotiations between the EU and Ukraine. Modelling In order to quantify the impacts on sustainable development of a possible FTA outcome, various modelling techniques are available. For the general overview, Computable General Equilibrium models (CGE-models) are used. This class of models can provide insights into the effects of trade and investment liberalisation on trade flows, trade balances and economic welfare. For sector or regional analyses other tools like inputoutput models and gravity models are available. Some of the major issues that need to be solved are those of NTBs, capital accumulation and last but certainly not least: imperfect competition and market structure. The place of CGE modelling in the quantitative framework is shown in Figure 2.2. The advantages of modelling include the possibility of a quantitative assessment of any type of impact and the fact these quantitative results rely on clear hypotheses and assumptions. For the first phase of this project, modelling techniques can help to provide useful insights. The disadvantages of modelling results is that even the general equilibrium models (CGEs) provide only a partial analysis because of lack of data and the fact the models are inherently static. Berden and Van Marrewijk in the Journal of Development Economics (forthcoming, 2007) 4 have looked at the dynamic welfare effects of trade restrictions, which is a good addition to these models because it gives indications as to what the long term FTA effects are. Modelling, moreover, ignores a large part of the trade agenda like trade in services, trade rules, market access, legal issues like intellectual property rights and trade rules and investment. 2.3 Sector and horizontal issue case study methodology The purpose of this inception report is to provide the European Commission with an overview of the consultant s approach to the sector studies coming up in Phases 1, 2 and 3. Regarding the sector case study methodology, we follow the methodology previously mentioned in this inception report Lee and Kirkpatrick (1999 and 2002). Once Phase 1 is completed, leading to the focus on specific sectors and horizontal issues (at least 5 sectors and three horizontal issues, as specified), the Terms of Reference require the following answers from Phases 2 and 3, the detailed sector/issue analysis phase and the final overview and recommendations phase: - A detailed assessment of the economic, environmental and social impacts of possible results according to the two scenario outcomes relevant for the specific sectors and horizontal issues through CCA; 4 Berden, K.G. and C. van Marrewijk (2007, forthcoming), On the static and dynamic costs of trade restrictions, forthcoming in the Journal of Development Economics (2007). Trade Sustainability Impact Assessment of the EA EU-Ukraine 14

15 An assessment of the expected significance of these impacts for the sector under investigation, using quantitative and qualitative techniques; Identification of the social groups and geographical areas most likely to be affected positively or negatively by the negotiation outcomes (as assumed in the two scenarios); Organise a Workshop in Ukraine to interact extensively with key stakeholders in the process, in particular Ukrainian business, administration and civil society in order to create transparency and inputs for the detailed sector studies and study outcomes; A proposal for effective flanking measures that either mitigate or enhance the (expected) effects at sector level of the negotiation outcomes this is presented in a stylised way in general in Figure 2.1; Continuously contribute to the debate and dialogue of the TSIA methodology in general and the TSIA on the FTA between EU and Ukraine in particular and involve all into the sector studies. Lee and Kirkpatrick (1999 and 2002) as well as the EC Handbook on TSIA (2006) and the Terms of Reference specify the steps that ECORYS and CASE Ukraine will follow: 1. Inception Report (this report); 2. General screening and scoping Global Analysis Report (concluding Phase 1); 3. Detailed assessment Interim Report (including a workshop report) (Phase 2); 4. Results Interim Report / Final Report (Phases 2 and 3). Ad 1. Inception report This inception report indicates the approach taken towards the analysis of the sectors and builds upon the application by being more concrete on the methodological issues and chosen approach. Ad 2. General screening and scoping Global Analysis Report During Phase 1, in the general screening and scoping, we use basic indicators to identify the current situation of the Ukrainian and EU economies, their interlinkages in goods, services and capital flows and the size of various sectors. Also we will look broadly at the issues indicated in the Terms of Reference that are likely to be included in the FTA negotiations, which are: Trade (in goods and services), Technical barriers to Trade and SPS, Capital movement & payments, Competition, Intellectual Property Rights, Trade facilitation, customs and Rules of Origin, Trade and sustainable development and Energy. It is these issues, the strength of the links at sectoral levels between the EU and Ukraine and the estimated impact sizes that matter a great deal for the selection of the sectors and horizontal issues for the detailed assessment in Phase 2 (see Ad. 3 below). Right now we are looking at more than five sectors and three horizontal issues in order to be able to drop some during this Phase: Sectors: Agriculture, Mining/Extraction, Food, Textiles, Metallurgy, Energy, Telecom, Chemicals, Machinery and equipment, Distribution services, Transport and Construction; Horizontal issues: Investment conditions, Government procurement, Competition Policy, FDI, Trade & trade in services, SPS, Technical standards and Intellectual Property Rights. Trade Sustainability Impact Assessment of the EA EU-Ukraine 15

16 As suggested during the kick-off meeting, we will approach civil society and key stakeholders for suggestions regarding sectors and horizontal issues. The selection of the five sectors and three horizontal issues takes place, making use of the following screened and scoped outcomes of Phase 1: a. The (macroeconomic) importance of a sector/horizontal issue for Ukrainian EU relations (e.g. through share of GDP, employment); b. The size of the expected impact of the FTA within the context of the EA between the EU and Ukraine; c. The expected economic, social and/or environmental impact of the sector for the EU and Ukraine; d. The comments and feedback from the consultations with key stakeholders and civil society; On this basis we will propose to the Steering Committee the five sectors and three horizontal issues we can research in more detail. The sectors and horizontal issues, not passing for more detailed analysis in Phase 2, we leave in the general analysis in Phase 1 of the report with a clear indication, why they have not been selected for more detailed analysis. Ad 3. Detailed assessment Interim Report (including Workshop Report) As mentioned in the application, we take a fourfold approach to the detailed assessment bearing in mind the requirements specified in the Terms of Reference: 1. A review of existing sector studies and identification of sector trends (building on the outcomes of Phase 1); 2. A summary of the scenario outcomes for the sectors (building on the modelling outcomes of Phase 1); 3. Structured interviews with operators and representatives from industry and services this also takes place via the Workshop that will be organised during this Phase; 4. Analysis of relevant Ukrainian legislation and regulatory environment. These points will keep in mind the scenario outcomes and add the qualitative assessment to the preliminary quantitative analysis. Also this phase focuses much more on the sectors and horizontal issues chosen than on the global analysis in general. It is likely this is where we build upon the CEPS (2006) report in order to update the outcomes and add analytical insights relevant for policy-making. 5 The non-trade issues, like several horizontal issues, will be analysed using the available empirical data and a qualitative investigation of the impact they will have on the deepened economic relations between the EU and Ukraine and the economic, social and environmental impact aspects like SPS, government procurement and technical standards have. 5 CEPS (2006). Trade Sustainability Impact Assessment of the EA EU-Ukraine 16

17 Ad 4. Results Interim Report / Final Report Finally, the scenario analyses, detailed assessments and consultation moments (including the workshop and the non-trade parts of the Enhanced Agreement) culminate in the final report and policy recommendations that accompany the study outcomes. These outcomes may lead to further enhancing measures or to mitigating measures in case unwarranted effects are expected to follow. It is the non-trade parts of the EA between the EU and Ukraine that may serve as a basis for recommendation and follow-up for policy advice. 2.4 Consultation and dissemination strategy This section is presented in detail in Chapter 5. Trade Sustainability Impact Assessment of the EA EU-Ukraine 17

18 3 Including CGE Modelling into the TSIA We are aware of the conditions within which this scenario analysis has to be conducted, and have discussed so during the kick-off meeting at the premises of DG Trade on the 7 th of February 2007 as well. Because for the CGE modelling to be successful and to add quantitative value to the TSIA study, the following aspects need to be discussed: 1. The context of the baseline scenario needs to be clear and expected scenarios need to be defined as realistically as possible; 2. The CGE model that we envisage using, must be able to model and reflect some of the main issues required for this TSIA study; 3. The data used need to be as recent and useful as is possible given the large CGEclaim on data and resources; 4. The CGE model needs to provide general outcomes on which the detailed assessment can build and elaborate further 3.1 Context for the baseline scenario and expected scenarios In order for the CGE modelling to be effective and useful, the correct starting point, i.e. the initial situation needs to be defined. At present the following issues apply to the EU- Ukrainian and World-Ukrainian situation that are of importance for this analysis: The Enhanced Agreement between the EU and Ukraine aims at a Free Trade Agreement (FTA) that goes beyond the WTO rules and regulations. From the kickoff meeting we learnt that the envisaged starting point of the negotiations lies presummer ; The EC has indicated also specified in the Terms of Reference that likely topics to discuss are investment, trade in goods (industrial goods, agricultural products, processed agricultural products and fishery products), trade in services (financial services, transport and telecommunications), capital movement and payments, government procurement, competition, intellectual property rights, customs and rules of origin, trade facilitation, technical barriers to trade and SPS, trade and sustainable development and energy; There is a strong focus on regulatory approximation in addition to removal of regular trade barriers the latter of which is already being implemented in the bid of Ukraine to join the WTO that is envisaged to be concluded soon; The scenarios should reflect a range of possible outcomes with most ambitious and least ambitious -case scenarios. The scenarios define the scope of the evaluation and reflect the extremes of a likely range of realistic outcomes of the trade negotiations between the EU and Ukraine. As discussed Trade Sustainability Impact Assessment of the EA EU-Ukraine 18

19 during the kick-off meeting, the starting point, t 0, is the situation where Ukraine has already joined the WTO. This is important information but on top of that, it is imperative for defining the most likely starting position as well as scenarios for analysis that there is good sharing of information between ECORYS and CASE Ukraine on the one hand and the European Commission and DG Trade on the other. This is why again we ask the European Commission to share with us the latest working documents regarding Ukraine s WTO accession and state of affairs with the EU as specified in the latest updates on the European Neighbourhood Policy Action Plans. Naturally, these documents will be treated with utmost confidence by the Consultant. 3.2 The Computable General Equilibrium Model CGE modelling is an important aspect of the TSIA since it delivers quantitative results in a general form that helps to define the necessary detailed assessments at a later stage of the study. With respect to the model to choose, we have analysed two alternative CGE approaches in cooperation with the Steering Committee that each have their positive sides and drawbacks. Already shortly presented at the kick-off meeting, we present below the two options. We have finally chosen the first option, based on what information and type of analysis the Consultant and Steering Committee envisaged and based on a discussion on the strengths and drawbacks of both models. 3.3 CGE Rutherford-Tarr Multi-country model The Model The methodology Harrison, Rutherford and Tarr (HRT, 1996)) employ is a computable general equilibrium multi-country model that uses several price-wedge distortions such as factor taxes in production, taxes on intermediate inputs, subsidies in production, valueadded taxes, import tariffs and export subsidies. Production involves the combination of intermediate inputs and primary factors (capital, skilled and unskilled labour, energy products). We assume a Constant Elasticity of Substitution (CES) function over primary factors and a Leontief production function combining intermediate inputs with factors of production composite. Primary factors are mobile across sectors within a region, but immobile internationally. Each region has a government and a single representative consumer. Demand for final goods arises from a Cobb-Douglas utility function. Within each region, final and intermediate demands are composed of the same Armington aggregate of domestic and imported varieties. The composite supply is a nested CES function, where consumers first allocate their expenditures among domestic and imported varieties and then choose among imported varieties. In the imperfect competition case firm varieties enter at the bottom of the CES function. This approach allows for the differentiation in preferences for home and imported goods. Trade Sustainability Impact Assessment of the EA EU-Ukraine 19

20 There is strong empirical evidence for modelling selected sectors as imperfectly competitive (e.g. Pratten, 1988). 6 Increasing returns to scale (IRS) in production will therefore be incorporated in selected manufacturing industries. Goods subject to constant returns to scale (CRS) such as agriculture, forestry or public services are differentiated by the country of origin. Products can either be sold at the domestic market or exported depending on relative prices and constant elasticity of transformation production function. In sectors subject to IRS, goods are differentiated at the level of firms. Firms set prices at the level where marginal cost is equal to marginal revenue. There is free entry, which drives profits to zero. We will make an assumption of large group monopolistic competition with constant mark-up over marginal costs. The study can also analyse elimination of non-tariff barriers (NTBs) and a reduction in border costs. The starting point will be the methodology applied by Harrison, Rutherford and Tarr - HRT (1996) in their analysis of the likely impact of the creation of the Single Market is used. We will single out two types of NTBs i.e. standard and border costs. The standard costs arise due to differences in regulations and technical standards between Ukrainian and EU markets. Exporters need to manufacture or package goods in forms which differ from those required for their domestic markets. The costs of meeting multiple standards therefore increase the cost of production for exports. The removal of these costs is assumed to make goods cheaper per se, and also to reduce margins as consumers become better able to substitute among Ukrainian and EU suppliers. One of the most observable barriers to trade is due to the existence of borders and customs formalities, which involve delays and various kinds of administrative costs. Reform of the customs rules and services envisaged under the FTA will lead to a reduction of border costs and delays. This will reduce the cost of exports and imports to and from the EU and should therefore lead to further efficiency gains. These are the sorts of effects that we will be able to evaluate using the CGE model discussed above. We will explore different assumptions as to the level of standard costs.. In addition the model will include two scenarios for each policy scenario. We will look at the short run implications with capital stock fixed and long run (or steady state) implications allowing for the growth of capital stock. This will allow us to formulate policy recommendations for different time horizons Use and gathering of data The model is going to cover several regions such as Ukraine, Russia, EU and the rest of the world. We are going to employ a 2004 social accounting matrix for Ukraine complied by CASE-UA. It covers 46 sectors (agriculture, 16 manufacturing sectors, 19 service sectors and disaggregated food products). The data for Russia and the EU are like the structure from GTAP 6.0 but are updated to Pratten (1998). Trade Sustainability Impact Assessment of the EA EU-Ukraine 20

21 Our estimates of border and standard costs will be based on a recent survey conducted by CASE Ukraine and they will be sector-specific. In December last year 510 companies responded to a comprehensive survey covering rules of origin, standards, customs procedures etc. (CASE Reports 68/2006). The costs of compliance with EU standards were estimated to constitute between 13 to 16% of investment. These costs will be reduced if companies can produce goods for domestic and export markets to the same standards and if the access to and prices changed by the conformity assessment centres improves. The cost of customs clearance was estimated to be around 6-10% of export value. Also a reform of the customs should decrease the costs related to customs clearance. The impact of those changes will be estimated for different variants of the cost reduction. Our simulations will allow us to study the impact of the WTO as a benchmark and then the impact of an FTA on international trade, production, welfare, employment, wages, return to capital and capital stock. 3.4 Service Oriented Enterprise model for Ukraine The Model The alternative is the SOE one-country CGE model based on Jensen, Rutherford and Tarr (2004) where they look at the impact of liberalising barriers to trade and FDI. It was applied to investigate the impact of liberalising barriers to foreign direct investment in services: the case of Russian Accession to the WTO and has been used to assess the impacts of WTO accession for ht Ukrainian government. The model is a CGE model that encompasses the improved market access, tariff reduction and reduction of barriers against multinational service providers. They assume that foreign direct investment in business services is necessary for multinationals to compete will with local service providers, but cross-border service provision is also present. The model incorporates productivity effects in both goods and services markets endogenously, through a Dixit-Stiglitz framework. Primary factors include skilled and unskilled labour; mobile capital, sector-specific capital in the energy sector reflecting the exhaustible resources, sector-specific capital in imperfectly competitive sectors, primary inputs imported by multinational service providers, reflecting specialised management expertise or technology of the firm. One category of sectors is competitive goods and services sectors produced under constant returns to scale like agriculture, forestry and construction. It also includes public services like education and post office facilities as well as key mineral industries. Goods produced subject to increasing returns to scale are differentiated at the firm level. For simplicity it is assumed that the composition of the fixed and marginal cost is identical in all firms producing under increasing returns to scale (both in goods and services). The third category is service sectors that produce in Ukraine under increasing returns to scale and imperfect competition such as telecommunications, financial services, business services and transport services. Trade Sustainability Impact Assessment of the EA EU-Ukraine 21

22 In this model, the capital stock is allowed to adjust to its steady-state equilibrium along with all of the model features employed in the WTO reference case. That is, the model allows for tariff and FDI liberalization with endogenous productivity effects as mentioned above. This is a comparative steady-state model, which assumes the capital stock is in its steady-state equilibrium in the benchmark dataset, but capital stock will adjust to a new steady-state equilibrium based on a fixed rate of return demanded by investors. It is an upper bound estimate of long-run gains in this framework of assumptions Use and gathering of data The model uses bilateral trade with the CIS (excl. Russia), Russia, New EU members with Free Trade status, New EU members with full tariffs, EU 15 with MFN status, New EU members with MFN status, Other European Countries with MFN status, African countries, American Countries, Asian Countries, Rest of the World. The sectors that can be analysed are: agriculture, hunting, forestry, fishery, coals and peat, hydrocarbons, non-energy materials, food-processing, textile and leather, wood working, pulp and paper industry, publishing, coke products, petroleum refinement, chemicals, rubber and plastic products, other non-metallic mineral products, metallurgy and metal processing, machinery and equipment, other production, electric energy and heat supply, gas supply, water supply, construction, trade, hotels and restaurants, transport, pipeline transit of oil and gas, telecommunication, postal services, financial intermediation, real estate transactions, renting, informatisation activities, research and development, services to legal entities, public administration, education, health care and social assistance, sewage, cleaning of streets and refuse disposal, social activities, recreational, entertainment, cultural and sporting activities, other activities. The model also includes different household types: urban households, urban poor households, rural households, rural poor households as well as policy parameters like barriers to FDI barriers in services, import tariffs and changes in world market prices (market access). For each sector this model yields output, employment, exports (also by region), imports (also by region) and price. The data used are those of 2002 and Summary In Paragraphs 3.3 and 3.4 the two models are worked out. Table 3.1 below summarises the two approached with some positive effects and drawbacks. Based on this detailed analysis we have finally opted for the Rutherford-Tarr multi-country CGE model based on the information from the Steering Committee that the effects from the EU side are also important and the fact that some of the initially indicated drawbacks of the RT multicountry model have been solved, including data availability and environmental variables. Trade Sustainability Impact Assessment of the EA EU-Ukraine 22

23 Table 3.1 Overview table of the two CGE models Issue CGE Model Rutherford-Tarr (3.3) CGE SOE Model for Ukraine (3.4) Advantages - Multi-country model (EU and Ukraine effects) - Used and made specifically for Ukraine s WTO accession running the WTO accession scenario provides the baseline for FTA study - Sub-aggregated agricultural data though not initially split out is available for flanking analysis - Many of the industries and issues in ToR explicitly modelled here: telecom, transport, chemicals, machinery, energy, financial services, trade flows, market access - Recent data additions through CASE Ukraine surveys (Dec. 2006) and more - Modelling of FDI, barriers to FDI and capital flows in static-steady state possible surveys can be carried out - Data updated for Ukraine and Russia - Services included until Inclusion of two types of NTBs (standard and border costs) - Household impacts are included: poor, rural and urban - The model allows for imperfect competition and different market structure modelling - The model allows for imperfect competition and different market structure modelling - Trade in services are modelled in this model - Modelling of different types of labour is possible - Many of the industries in the ToR are explicitly modelled here (46 sectors) - Environmental variables like sewage, cleaning of streets and refuse disposal, healthcare and social assistance, social activities, recreational, entertainment, cultural and sporting activities will be modelled Disadvantages - Based on GTAP structure with data from 2004 (though Input-Output change little over time) - The basic CGE model of Rutherford & Tarr not much added (social / environmental) - Dynamic effects of FDI not included in the model - Trade is services are modelled like trade in goods - Single-country model (no internal EU effects except for derived ones from Ukraine outcomes) - Agriculture is not split out into subcategories but aggregated - Based on GTAP structure with data that are from (though Input-Output change little over time) - The model does not group EU-27 as one group but puts Romania & Bulgaria in other areas - No inclusion of NTBs in the model Trade Sustainability Impact Assessment of the EA EU-Ukraine 23

24 Though neither of the models is 100% adequate, with the major considerations that the SOE model of Ukraine is a one-country model while the Rutherford-Tarr is a multicountry model, that the SOE model is slightly more elaborate to assess also horizontal issues and services/fdi effects, that the data of the R-T model are more recent for EU and Ukraine (surveys CASE), that the R-T model more explicitly models social and environmental variables and models two types of NTBs, and that the CGE WTO analysis could yield the starting point outcomes in both models, we have decided to opt for the multi-country R-T model. Having added some important features to the multi-country model and updated recent data in line with requests from the Steering Committee, while not basing our analysis on the one-country model so we can analyse the effects for the EU endogenously instead of deriving them, we feel this in the end is the optimal choice for this TSIA study. This is also based on our analysis of the fact that the FTA is not just a tariff-reduction FTA but goes beyond tariffs alone. Trade Sustainability Impact Assessment of the EA EU-Ukraine 24

25 4 Update on EU-Ukraine trade studies and agreements In order to be able to understand the situation Ukraine is in currently and to get a first glance at the expected impacts of an FTA on the EU and Ukraine, we present summaries of the following core documents that are available at present because they define the context in which we operate during this study: The Partnership and Cooperation Agreement (PCA) between the EU and Ukraine; The Action Plan for Ukraine from the European Neighbourhood Policy (ENP); The CEPS (2006) study on an envisaged FTA between the EU and Ukraine; The Prospect for EU-Ukrainian Economic Relations by CASE-Ukraine. Having studied these documents in-depth, they provide much needed information on policy goals and the current economic situation to carry out the TSIA for the FTA between the EU and Ukraine. 4.1 The Partnership and Cooperation Agreement (PCA) between the EU and Ukraine The Partnership and Cooperation Agreement between Ukraine and the EU (PCA) signed on 16 June 1994 (entered into force on 1 March 1998) constitutes the legal base of the EU-Ukraine relations and establishes cooperation on a wide range of political, trade, economic and humanitarian issues that have to lead to progressive economic integration and deepening of political cooperation. A Protocol to the PCA was signed by the EU and Ukraine on 30 March 2004 to extend the application of the agreement in full to the 10 new EU Member States from 1 May As regards economic relations, the PCA includes provisions on the most favoured nation regime (the EU extends to Ukraine MFN Treatment), special regime for trade in steel and textile products, freedom of establishment (the PCA facilitates the establishment of production and services businesses in certain specified sectors in Ukraine and in the EU), approximation of legislation (Ukraine has committed itself to approximate its legislation with that of the Community) etc. The Agreement has a vast potential in such domains as natural environmental protection, transportation and telecommunications, space exploration. Creation of a free trade zone between Ukraine and he EU is assuming growing topicality and may materialize after Ukraine's accession to the World Trade Organisation. The PCA was initially concluded for the period of 10 years and expires by the end of It will be prolonged, however, if both parties do not request otherwise. Trade Sustainability Impact Assessment of the EA EU-Ukraine 25

26 In January 2007 the EU Council has passed a decision on negotiation of a new enhanced agreement with Ukraine replacing the PCA. However, the mandate for negotiations with Ukraine doesn't include the issue of Ukraine's perspective in the EU. Through this agreement, the European Union aims to build an increasingly close relationship with Ukraine, aimed at gradual economic integration and deepening of co-operation. 4.2 The Action Plan for Ukraine from the European Neighbourhood Policy (ENP) In 2003, the EU proposed a new framework for its relations with neighbours, including Ukraine, called the European Neighbourhood Policy. The main idea of the ENP is to encourage stability, security and prosperity in the neighbouring states without extending EU membership to them. The blueprint for the ENP was outlined in the Communication on Wider Europe issued in March 2003 (EC, 2003), and then elaborated in the ENP Strategy Paper, adopted in To make the ENP operational, the EU agreed with each ENP country a plan of action that specifies priorities that should be realised in the shortto-medium term (3 or 5 years). The EU-Ukraine action plan was drafted in late 2004 and signed in February It is to be implemented over three years. The Plan sets priorities in different policy areas and elaborates on what should be done to achieve them. In the economic domain, these include WTO accession, removal of non-tariff barriers in bilateral trade, improvement of investment climate, tax reform and approximation of legislation. Underling the EU s firm support to Ukraine s efforts for joining WTO, the Action Plan also foresees looking at the feasibility of establishing an EU-Ukraine Free Trade Area following Ukraine s accession to the WTO. Both Ukraine and the EU monitor the implementation of the Plan and exchange their opinions. According to the Commission ENP progress report for Ukraine good progress has been made since 2005, however, implementation of reform strategies has lagged behind since the beginning of 2006, mostly due to long pre- and post-election periods of political instability. Ukraine succeeded in various trade and trade-related areas, e.g. the WTO accession process has advanced considerably with the last legislative steps and accession is expected to take place in the coming months The prospect of deep free trade between the EU and Ukraine (CEPS, 2006) The report looks on the possible content, feasibility and economic implication of the possible EU-Ukraine FTA, assuming the WTO accession of Ukraine. They confirm the earlier results that a simple FTA will have only small impact on Ukraine s economic performance and even smaller to EU s. Deeper forms of market integration (FTA+) on the other hand could have substantial impacts especially if linked with governance reform in Ukraine. From a future economic perspective it would be very important for Ukraine to 7 Commission Staff Working Document, Communication from the Commission to the Council and the European Parliament on Strengthening the European Neighbourhood Policy, ENP Progress Report, Ukraine, 4 th of December Trade Sustainability Impact Assessment of the EA EU-Ukraine 26