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A bittersweet victory: Ukraine’s Association Agreement with the EU

After more than ten years of negotiations, the Association Agreement between the European Union (EU) and Ukraine came into full force in July 2017. The Agreement, which establishes an economic and political association between the two parties, had been provisionally in force since January 1st 2016.

July 10, 2017 - Oksana Khomei, Alena Permakova, Dmytro Sydorenko and Balazs Jarabik - Articles and Commentary

Ukraine AA

In the lead-up to the Eastern Partnership Vilnius Summit in 2013, at which Ukraine initially declined to sign the Association Agreement, providing the impetus for the protests that would become the EuroMaidan revolution, the EU hoped Ukraine would make an “irreversible choice” and orient itself towards the West once and for all. Pro-European Ukrainians wanted closer association with the EU to ensure support for their struggle against Ukraine’s oligarchic system, and Moscow felt increasingly nervous about Ukraine’s westward drift. Misjudging how the Agreement might affect Ukraine’s polarised politics, the EU ultimately sleepwalked into a conflict with Russia.

The Agreement is confusing in part because the EU wanted to offer more than a simple trade agreement to Ukraine after the Orange Revolution in 2004. Accordingly, Brussels proposed what scholars have dubbed “integration without membership.” While Moscow tried to slow down Ukraine’s Western integration efforts, some member states pushed to speed it up. These clashes of external interests exacerbateda deepening internal political conflict that culminated in the EuroMaidan revolution, leading to former President Viktor Yanukovych’s ouster in February 2014.

In the end, Russia’s aggressive reaction to the Maidan protests clarified Ukraine’s geopolitical choice. Ukraine’s subsequent ratification of the Agreement has brought the country even closer to EU and even further away from Russia.

Until now, domestic and international political considerations have overwhelmed the economic calculus for integration. The original estimates of the benefits of integration were too optimistic, while projections of Ukraine’s need for assistance were too conservative.

The implementation of technical elements of the Agreement is progressing well, and Ukraine is making strides towards modernisation. However, as this paper argues, if the question is no longer where Ukraine belongs and EU membership is not on the horizon, economic and social considerations inevitably will return to the fore in Ukraine’s relationship with the EU. The Agreement’s design defects—Brussels cannot offer adjustment to Ukraine in exchange for opening up its markets, as such funds are reserved for member states—were swept under the rug. This should change.

For Ukraine’s sake, more attention needs to be devoted to details and less to dogmas. Managing expectations, reducing rhetorical solidarity and increasing support and meaningful conditionality will further help Ukraine become a European state on account of its governance rather than on the basis of its geopolitical orientation. The risk for the EU is not that Kyiv will make another U-turn, but rather that its neighbour will be mired in internal struggle for decades to come. 

Design defects

The Association Agreement has six parts: 1) General Principles; 2) Political Dialogue and Reform, Political Association, Cooperation and Convergence in the Field of Foreign and Security Policy; 3) Justice, Freedom and Security; 4) Trade and Trade-related Matters (DCFTA); 5) Economic and Sector Cooperation; and 6) Financial Cooperation, with Anti-fraud Provisions.

The Deep and Comprehensive Free Trade Agreement (DCFTA) is ultimately the most important of these parts, aiming to enhance trade relations while facilitating convergence to EU regulatory standards on food safety, public procurement, competition policy, intellectual and property rights, and a host of other issues.

Early on, the debate surrounding the DCFTA suggested that geopolitical considerations would trump economic arguments and financial calculations. Dogma trumped details, as European leaders rushed to bring Ukraine into the EU’s orbit. As Olga Shumylo-Tapiola summarised in 2012, “estimates provided by the 2004 EU-funded Feasibility Study and confirmed by the 2007 Impact Assessment indicated that the DCFTA would deliver ‘welfare gains of the order of 4-7%’ and concluded that in the long run these gains could be doubled or tripled.”A 2007 Ecorys study, meanwhile, showed that the DCFTA would result in a 5.3 per cent growth of real GDP and an expansion of exports for the majority of economic sectors. In 2014, a local think tank calculated a 12.3 per cent increase in welfare and 9.9 per cent expansion of exports.

All studies emphasised the long-term success of the implementation of the legislation harmonisation schedules embedded in the DCFTA. Much less was written about the actual costs of modernisation to Ukrainian industries, or about the potential economic and social consequences.

As László Bruszt and Julia Langbein found in 2017, complete trade liberalisation and regulatory integration with the EU, as foreseen by the Agreement, may impose costs on domestic actors that cannot be remedied by corresponding EU assistance. Ukraine’s state restructuring efforts, they found, were not supported by corresponding assistance to local industries, though this is standard practice for membership candidates. And the question of membership is indeed on member states’ minds: a 2016 Dutch referendum on the Association Agreement was partly driven by concerns that even though the Agreement does not include a membership promise, Ukraine would enter the antechamber of EU membership.

Ukraine’s civil society has been putting its hope in the idea that the EU’s normative standards will help reduce oligarchs’ grip on the country’s politics, the state, and its resources. The fact that Russia is developing its own integrationist project, the Eurasian Economic Union, has further fueled (geo)political infighting; the choice between East and West was starker than ever.

Duty calls

The DCFTA also involves the bilateral removal of import duties. 95 per cent of EU import duties on industrial goods and 84 per cent of EU import duties on agricultural products have already been cancelled. Various industries have been given ten years to reduce tariffs, while the car industry has been given 15.

In theory, the removal of tariffs should help Ukraine stabilise its economy by correcting balance of payments disparities, and by providing time to bring domestic production to European standards so that exports can compete with European products. However, the EU has quotas on certain products, including agricultural ones that are crucial for Ukraine. As the main products that generate exports are subject to quotas, the removal of tariffs cannot be expected to lead to a serious increase in export earnings.

In a recent paper, Veronika Movchan, Iryna Kosse, and Ricardo Giucci identified some quotas that could be limiting factor for Ukrainian export growth. For example, exports of sugar in 2015 were equal to the quota amount, with the import tariff above quota reaching 507 euros per ton for selected products. For such products, including wheat, poultry, oats, and processed tomatoes, exports were slightly higher than the DCFTA’s quotas.

To acknowledge and address these issues, the European Commission proposed temporary autonomous trade measures, recommending new duty-free tariff-rate quotas (TRQ) for eight farming products for a period of three years. MEPs ultimately voted against TRQs for four of the eight products (tomatoes, wheat, and urea, a raw material used in fertilizers).

Trade trends: More EU, less Russia

According to the Ukrainian State Statistics Service, Ukraine’s share of exports to the EU increased from 25 per cent in 2012 to 37 per cent in 2016. However, the main reason for this was the rupture of trade relations with Russia after Moscow annexed Crimea and began instigating the war in Donbas, not the signing of the DCFTA. Exports from Ukraine to the EU in 2012 amounted to 17.1 billion dollars, but by 2016 this number had fallen by almost a quarter to 13.5 billion dollars.

Indeed, a Bertelsmann Stiftung assessment of the impact of the DCFTA suggests that Ukraine’s disappointing economic performance is related largely to the conflict in Donbas. The Russian market had been crucial for Ukrainian exports (accounting or 24 per cent of all exports in 2013), in large part because of the sophisticated machinery and equipment built in southeastern Ukraine and exported to Russia. This market will be extremely difficult to replace.

Still, the negative trend in trade with Russia was evident even before the EuroMaidan revolution, and accelerated when Russia introduced informal bans on Ukrainian food products in 2013. Notably, the decline in economic activity in Russia and Moscow’s sanctions on EU exports have decreased business for the Ukrainian brokering and logistics companies that traditionally worked in Russian markets.

The conditions of the Agreement guarantee an increase in agricultural production, though this is not expected to provide sufficient employment to account for the economic losses in southeastern Ukraine. The consequences of de-industrialisation have been widening the quality of life gap between the southeast and the western parts of the country in recent years. Sadly, the costs of trade liberalisation are being borne by the southeast, the region that has already suffered the most from Russian aggression.

As a result of these trends, Ukraine’s top exports have changed over the last three years. Agriculture has become the most significant Ukrainian export, accounting for more than 40 per cent of total exports in 2016. Information technology and telecom services are the only service categories that have grown since 2014. Service exports experienced a considerable slowdown largely due to lower demand for transport services, material resource processing and business services.

As of June 21st 2017, there were 281 Ukrainian companies with the right to export to the EU, most of which produce food and animal byproducts. This growing positive trend also highlights that factors limiting Ukrainian exports to EU are holding strong: challenges in complying with the EU’s food safety, sanitary and phytosanitary measures, as well as low demand in the EU due to a lack of trading partners, are currently limiting exports. After all, Ukrainian exporters have taken advantage of only 26 of 40 tariff quotas available to them.

The formal implementation of EU norms, standards, and practices offers no guarantee that Ukrainian enterprises will modernise and become economically competitive. Businesses have identified inconsistent customs procedures, bureaucratic delays, corruption and arbitrary decision-making processes as seriously hindering their ability to export. What is more ,Ukrainian certificates are often not recognised in EU countries. As a result, companies that want to supply products to the EU have to go through an expensive and lengthy certification process abroad.

Identity politics as a regulatory framework?

The government of Ukraine seems to be engaged in a rhetorical historical exercise when it comes to regulation—part of its broader embrace of identity politics. In December 2014, the government adopted a decision to abolish the Soviet system of standardisation. At the time, Prime Minister Arseniy Yatsenyuk announced that Ukraine would completely abandon the Soviet system and move to European standards as early as 2016. In January 2015, the parliament adopted a law on the adjustment of Ukrainian legislation to come into line with EU laws on technical regulation and conformity assessment. However, the Ministry of Economic Development and Trade has since counted 15,000 state standards developed before 1992 that have yet to be eliminated. The deadline to move to European standards has been pushed back to January 2019.

In addition to the removal of old standards, Ukraine must also adopt new ones, created in harmony with EU rules. Much attention has been paid to the standards established in the Agreement on Mutual Recognition of Certificates of Conformity for Industrial Products by Ukraine and the EU (ACAA). As for other industry standards, in 2015 Ukraine implemented 2,700 harmonised standards out of the 40,000 international and 20,000 European standards that need to be adopted. Between 2014 and 2016, Ukraine translated only about 1,300 standards; the rest were adopted without being translated because of the lack of capacity among Ukrainian authorities. In short, Ukraine has a long way to go.

Actual barriers: Access and awareness

Macroeconomic stabilisation has undoubtedly been Ukraine’s biggest success. Ukraine suffered a severe recession in 2014 due to the combination of its excessive borrowing and Russian aggression. Avoiding financial collapse, the country was able to clean up its banking and oil and gas industries, in addition to diversifying its energy supply—measures that were possible only because of the support offered by and conditionality imposed by Western institutions.

Ukraine receives more financial assistance from the EU than any non-member state: up to 11 billion euros between 2014-2020, to be dispersed though macroeconomic loans, direct budget support, and investment from the European Investment Bank (EIB) and European Bank for Reconstruction and Development (EBRD). Only about 665 million euros (or six per cent of all assistance) is not being dispersed through loans (Poland, which is often compared to Ukraine in its size and structure, received about 70 to 80 billion euros in direct support from 2007 to 2013. A significant share of these funds were directed to infrastructure projects. For 2014-2020, the EU has earmarked another 70 to 75 billion euros for Warsaw).

Attention should now be directed to the micro level. The small business sector (SME) constitutes 99.9 per cent of all Ukrainian enterprises and accounts for about 70 per cent of the workplace. Low levels of awareness about the Agreement and a chronic lack of investment—according to the Ukrainian State Statistics Service, the share of savings in fixed assets decreased to 12.9 per cent of GDP in 2014 while public capital investments amounted to only 0.43 per cent of GDP in 2014 and 1.3 per cent in 2016—constitute the most serious barrier to local businessesbenefitting from the DCFTA.

Without access to affordable financing, SMEs will be unable to adapt to the new rules, which may have serious consequences, including for local labor markets.

Impact on reforms: Lots of formalities, little action

Upon ratification of the Agreement, the government tried to define implementation responsibilities for state bodies. The EU-Ukraine European Agenda for Reform was developed jointly as the first concrete reform roadmap. The Action Plan on the Implementation of the Association Agreement for 2014-2017 was approved by the Cabinet of Ministers in September 2014. Moreover, “Strategy 2020,” which was adopted as apresidential decree and included a roadmap for 62 reforms, has priorities that closely align with the Agreement’s. These include judicial reforms, the fight against corruption, the improvement of state tax policy, and administrative (“state governance”) reform. Other reforms are related to the financial sector, monetary policy, the development of export potential, decentralisation, etc. Last but not least, Prime Minister Volodymyr Groysman’s 2017-2020 Priority Action Plan contains five objectives, which closely resemble the Agreement’s priorities: economic growth, good governance, human capital development, rule of law and the fight against corruption, and security and defence.

Overall, Ukraine under the Agreement is obliged to implement around 350 legal acts by 2025. Government reporting highlights progress in judicial reform, public procurement, public administration, reform of law enforcement agencies, energy, and decentralisation. Civic monitoring on legal provisions, however, shows that only eight of the 44 legal reforms were implemented in 2016. Nevertheless, reforms in public procurement, energy, banking, decentralisation, along with the broader macroeconomic stabilisation, are widely acknowledged as successes.

Meanwhile, two breaches of the DCFTA—export duties for metal scrap were increased, and a ban on exports of wood logs was introduced—suggests that the government will have a much more difficult time protecting some critical industries.

The bogeymen of reforms, according to civic monitors, are the parliament for its slow and bureaucratic procedure of approving legal acts, as well as governmental agencies for their weak skills in developing drafts in accordance with EU standards. Both a lack of political will and a lack of government capacity is consonant with Ukraine’s captured politics, which so often caters to vested or individual interests. These issues did not come out of the blue, and they will not disappear even in the face of harsh Western criticism.

Political association: Competing interests

Ukraine’s visa-free regime is the most “tangible” result of the integration process for ordinary citizens.The government’s victorious mood, however, is tempered by public opinion polls: 57 per cent of Ukrainians do not see visa liberalisation as a real success in part because they cannot afford to travel abroad. What is more, it took many years to achieve:visa liberalisation dialogue between the EU and Ukraine started back in 2008, and the implementation of the Visa Liberalization Action Plan for Ukraine was closely monitored, with six progress reports being issued. At the same time, the number of Ukrainians working in the EU (legally and mostly in Poland) has steadily increased since the EuroMaidan revolution.

Because the EU needed its visa liberalisation regime to reflect new geopolitical realities, a suspension mechanism was included to address concerns about migration, despite the fact that similar concerns about a visa-free regime in Moldova leading to increased migration never materialised. If Kyiv experiences any significant rollbacks of anti-corruption or rule of law reforms, however, Brussels can now suspend the visa-free regime.

Decentralisation and the civilian security sector should be regarded as the most successful elements of the European Agenda for Reform Ukraine, adopted in July 2014 by the EU and Ukraine. Although incomplete, decentralisation reformshave already brought significant change to Ukraine. New regional administrations now have more responsibility for local services and many authorities have larger budgets than their predecessors, allowing them to improve things like roads and schools. However, the reform process has proceeded without a conceptual consensus: authorities in Kyiv, wary of relinquishing too much power, have not shown the same commitmentto decentralisation as their Western partners.

The new patrol police, with its transparent recruitment process, increased remuneration, and training under the supervision of Western experts, has gained the trust of the Ukrainians.  Still, Ukraine suffers from a very high crime rate, with all types of reported crime increasing. According to the head of an EU rule-of-law mission,this was to be expected due to Ukraine’s post-revolutionary political turmoil, its economic crisis, and the conflict with Russia, as illegal firearms are now readily available across the country.

Information warfare and rule of law

Ukraine’s business environment has not improved much in recent years: the country moved up only one place this year on the World Bank’s Doing Business survey, from 81st to 80th. Ukraine has essentially maintained the same, low ranking on Transparency International’s Corruption Perception Index over the past several years.

To improve Ukraine’s business climate, Parliament has annulled 367 resolutions and acts considered to be of economic significance. As a result, transparency has been significantly improved. A big step in eliminating corruption in public procurement was the launch of the “ProZorro” e-procurement system.

Furthermore, top officials are now required to declare their assets in an “e-declaration” registry. The Ministry of Justice, meanwhile, has begun providing public access to several important governmental databases. Ukrainians can now access data on public procurement, the state register of legal entities and individual entrepreneurs (indicating entities’ ultimate beneficiary), urban planning documentation and a variety of other matters of public interest. Meanwhile, the clean-up of state oil and gas behemoth Naftogaz, gas diversification, and increased heating tariffs should decrease corruption in key sectors of the economy.

New anti-corruption agencies have also been established in Ukraine. While the country has an impressive body of anti-corruption legislation, however, the challenge is now enforcement. As corruption is a one of the most important issues for Ukrainian citizens, it is the subject of a constant “information war” being waged by political opponents. The politicisation of corruption now contributes to the perception that graft is rampant and reduces resistance to corrupt behavior in society.

Similarly, the war in Donbas has become fodder for information warfare. In order to mobilise the West, Kyiv, rightly, has emphasised the role of Russia in the conflict in the east. The gain in Western political support has come with a corresponding loss of investor confidence, however.

Relatedly, the fight against Russian propaganda—another aspect of information warfare—is now reducing media freedom. Ukraine is now one of the most dangerous places for  journalists, and the high-profile killing of journalist Pavel Sheremet in a car bomb attack in July 2016 remains unsolved.

Arguably, the rule of law and state management remain the biggest obstacles to improving Ukraine’s investment climate. Judicial reform kicked off on June 2nd 2016, when Parliament adopted changesto the constitution in accordance with the Venice Commission’s recommendations.  The courts and law enforcement institutions, such as the General Prosecutor’s Office (GPO) and the Security Services of Ukraine (SBU), however, remain “old fashioned” in their approach to governance: these institutions are nowadvancingvested interests as well as the president’s efforts to consolidate power.

This power consolidation is chipping away at Ukraine’s democratic credentials. Political violence remains unpunished: no one has been convicted for the killing of protesters during the EuroMaidan revolution or for the May 2nd 2014 violence in Odesa, which left nearly 50 people dead. It seems that there is a lack of willingness to conclude these investigations at the highest levels of politics.

To its credit, the EU is trying to aid state building. It developed a 355 million euros State Building Contract and set up the EU Advisory Mission for Civilian Security Sector Reform in Ukraine (EUAM) to concentrate on the restoration of the rule of law, and the Support Group for Ukraine to sustain reforms and offer advice.

The Ukrainian standard

Although the advice being offered is international, the management remains local. The impact of the Association Agreement on Ukrainian administration and policy formulation remains limited due to Ukraine’s underwhelming standard of governance.

Fierce political competition within Ukraine is often hailed as a democratic virtue. However, as the OECD’s 2006 Ukraine’s Governance Assessment concluded, due to continuous confrontation and a lack of transparency, trust between the main political institutions and actors has been broken and societal confidence in politicians has been eroded. Although the EuroMaidan revolution and subsequent Russian aggression brought an end to geopolitical competition in Ukraine and eliminated the former ruling Party of the Regions, the country’s governance standards have not been improved.

Ukraine’s strong paternalistic attitudes are among the central risks to reform—something that is rarely acknowledged in the West. Others are the politicisation of government institutions, the patrimonial nature of Ukrainian politics, and the winner-takes-all approach to governance that has fueled political infighting since independence. Vested interests in the patron-client system of politics and a mentality of self-preservation in the bureaucracy continue to dominate.

Low official salaries for public servants remain an obstacle to attracting highly-qualified professionals to public administration. The government has adopted a Strategy of Reforming Public Administration, which divides policy and administrative functions, introduces transparent competition, and envisages a significant increase in civil servant’s wages. The implementation of this strategy, however, has been chaotic at best.

How to stabilise Ukraine?

The expected benefits from Ukraine’s Association Agreement have not yet “trickled down” to ordinary citizens. Ukraine has incurred costs resulting from the formation of the DCFTA as Kyiv has implemented regulations and reformed institutions—all while suffering heavy losses due to Russian aggression in the east. Meanwhile, the International Monetary Fund’s (IMF) support package to Ukraine has prioritised austerity and privatisation for the sake of macroeconomic stabilisation. Although Ukraine’s reforms have been dubbed “unprecedented” in relation to the previous 25 years, progress has been modest to date in many ways.

Ukraine’s poor economic performance has caused excessive stress on Ukrainian businesses and citizens. This stress is captured in public opinion polls showing that 72 per cent of Ukrainians believe things are headed in the wrong direction. Economic hardship is being addressed through communication initiatives that call attention to Ukraine’s modest economic rebound and once again emphasise the consequences of the war in Donbas and Russia’s role in it. Correspondingly, the government has been prioritising patriotism at home and sanctions on Russia abroad.

For the patriotic-minded elite, further diversification from Russia is a key priority even though doing so reduces Ukraine’s transit potential and plays into Moscow’s plans to economically circumvent Ukraine. Indeed, Moscow assumes that an unfriendly government will remain in power in Ukraine for an extended period of time. Most likely, the Kremlin will proceed with its policy of limiting its dependence on Ukraine, though it seems to want to do so gradually.

Notwithstanding the conflict in Donbas, this leaves the EU and Ukraine largely on their own to make the Association Agreement successful. But it is unclear whether the Agreement alone will ultimately prepare Ukraine for long-term development.  In order to transition from a resource-oriented economic model, Ukrainian production facilities and infrastructure will require substantial modernisation—a cost that has been neither clearly calculated by Kyiv or Brussels nor inscribed into the Agreement. Last but not least, based on the experience of other post-accession states, any aid that is given should be contingent on a significant de-politicisation of Ukrainian state institutions, and more robust EU engagement. Neither of these is feasible at the moment.

A series of practical steps could make a difference, however. Namely, Kyiv could finally follow the advice of the 2006 Ukraine Governance Assessment and embrace a policy of a “radical modesty,” i.e. acting modestly in rejecting grand reforms, and acting radically in accepting a modest reform strategy.

Instead of continuing their policy of shock therapy, Western institutions should let Kyiv stimulate the economy and boost consumption confidence. It is crucial to proceed with structural reforms while keeping in mind the need to minimise costs and maximise benefits in the short and medium terms.

The implementation of the Minsk Agreement could be coupled with a re-industrialisation programme. The EU should start thinking outside of its quasi-integration box: attraction (or soft power) does not necessarily bring stabilisation without benefits, and long-term investment is a better strategy than simply throwing money at a problem.    

The EU may embrace the consolidation of power in Kyiv but only if the Ukrainian government is serious about reforms` implementation—including the de-politicisation of state institutions—and continues down the path of decentralisation. According to the 2006 SIGMA assessment, the EU should “encourage main constitutional actors to evolve towards creating a democratic institutional environment where the checks, balances and limits to the exercise of power are legally defined and enforced.” This is by all means valid today. The implementation of the planned public administration  and judicial reforms will be particularly crucial in this regard.

The West should work with the full spectrum of political actors in Ukraine. Holding ruling elites to democratic and human rights standards needs to be taken more seriously. Otherwise, the West risks inadvertently supporting an autocratic drift.

Last but not least, the EU should encourage the ruling elite to embrace consensus building among political actors and reconciliation in society. This does not necessarily mean to give in pressure on the Minsk Agreements. Increasing the capacity of state institutions to address the plight of internally displaced persons (IDPs) and war veterans, and the socio-economic crisis in the separatist republics, would reduce internal instability.

Kyiv’s attempt to unite the country and mobilise Western support based on Russian aggression, has social (weak governmental legitimacy) and economic limits (low quality of life). The Ukrainian state will remain fragile so long as Kyiv is unable to move beyond these limits.

Oksana Khomei, Alena Permakova and Dmytro Sydorenko are Democracy Studies Fellows at the German-Polish-Ukrainian Society.

Balazs Jarabik is a nonresident scholar at the Carnegie Endowment for International Peace, where his research focuses on Ukraine and Eastern Europe.

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