Memorandum by Mr Pekka Sutela, Head of
the Bank of Finland Institute for Economics in Transition (BOFIT)
RECIPROCITY IN
EU-RUSSIA RELATIONS
Opinions expressed are those of the author and
should not be construed as reflecting the views of the Bank of
Finland, Eurosystem or other authorities.
Evidence prepared for the Sub-Committee on Foreign
Affairs, Defence and Development Policy of the House of Lords
Select Committee on the European Union
The EU has a neighbour, which with a share of
aggregate outside trade of just a couple of percentage points
is relatively unimportant as a trade partner, especially as far
as EU exports are involved. But this country is a key producer
of an imported commodity, without which trains would not run,
airplanes would not fly, and our every-day life would be highly
problematic. The neighbour, naturally, is Switzerland, and the
commodity imported to the EU is watches.
There are two reasons why we regard import dependence
on Russia and energy, particularly gas, as being hugely more important
and problematic than our dependence on Swiss watches. First, Swiss
watch production can be easily substituted by either importing
watches from other sources like Japan or by establishing sufficiently
large-scale production within EU. Quality might not be the same
and the brands not quite as prestigious, but workable enough alternatives
to Swiss watches would be available at a reasonable cost. Though
the need for and availability of energy are not given magnitudes,
and there are major substitution possibilities between different
energy commodities, there are major sunk costs and economies of
scale involved. They make substituting Russian gas with—say—Italian
wind-power quite difficult. Second, Swiss watches are produced
by a number of private companies quite independent from any political
goals the Swiss authorities might have. Situation concerning hydrocarbons
is completely different. Globally, a very major majority of oil
resources is controlled either by states or by state-controlled
companies. All major exporters of gas to the EU are government-controlled
national monopolies. Political and strategic considerations are
bound to have a role in their decision-making.
There is a third factor of relevance, distinguishing
government-controlled companies in an authoritarian capitalist
system like Russia from those in a liberal capitalist country
like Norway. The political goal of a liberal capitalist state
like Norway is basically very simple: to enhance the welfare of
the Norwegians. Though the planning horizon might be longer, this
does not differ substantially from the decision making rule of
a privately owned company: maximize the owners' wealth. Therefore,
the existence of this political mandate does not make the behaviour
of the Norwegian gas producer any less simple, transparent and
understandable than it would be without any such political ownership.
The goals of an authoritarian capitalist state like Russia are
inherently more complex and more poorly understood. This is partially
because the whole phenomenon of authoritarian capitalism is not
that old, and it is not understood whether the system is feasible
in a stable manner and over a longer period of time. The previous
possible examples in Germany and Southern Europe decades ago came
to an end for a number of basically non-economic reasons, and
modern China and Russia differ from them in many aspects. In fact,
even the comparison seems hardly founded. Also, authoritarianism
as such implies missing or severely limited accountability and
gives more room for personalised decision-making, where aspirations
may have a variety of motivations. Property rights tend to be
badly defined in authoritarian capitalism. This is even more so
when the state in question should be seen as a revisionist one
in international relations, as may increasingly be the case with
Russia. This does not only concern the rights and obligations
of foreign companies operating inside these countries, but also
the foreign operations of companies based in these countries.
Thus, appetizing as the comparison is, Russian
energy is not exactly like Swiss watches. Still, both are basically
commodities, and recognizing this, the burden of proof should
always be on the one wanting to subject their markets under political
decision-making. True enough, increased governmental control over
hydrocarbons globally and ensuing energy nationalism are among
the major recent shifts in the world economy, but still it is
rather less than self-evident that consumers should react to such
changes by further increasing the degree of political control
of their related markets.
The least that should be expected from Europe
is a clear decision on whether we should regard energy carriers
as economic or political commodities. As the previous discussions
hints, both conclusions can be argued for, but perhaps the EU
remains too diverse to be able to make the choice. In addition
to more general differences in the existing European variants
of liberal capitalism, reflected in matters like attitudes to
competition and national champions, EU countries differ widely
in existing energy endowments, past investment decisions with
their usually very large sunk costs and political orientations
concerning the desired future energy mixes. This limits what the
calls for common energy policy and speaking with one voice to
outsiders might possibly mean in practice. There are a number
of layers involved. While some unification of the rules of the
energy game as well as interconnecting of previously disjointed
domestic markets are feasible and probably should be aimed at,
going much further may be both infeasible and also undesirable
for other reasons. No European energy policy could convince a
number of member nations that going nuclear is one way to the
future. Other nations abhor the idea of using more natural gas.
Trade policy is in the competence of the Commission, but this
is sometimes difficult to detect in the case of trade for energy
commodities, partially because so many other dimensions are involved
too in decisions on energy. If, as some put it bluntly, the idea
were to establish a buyers' cartel of—say—gas, a simple
question arises. What might be the implementation mechanism of
such a cartel? In a simple Mafia-type cartel it is four men with
guns in a black car. In the case of OPEC, it is something much
more complicated and civilized. Nobody has come up with proposals,
what the implementation mechanism might be in a European gas buyers'
cartel.
Reciprocity is perhaps the key term in trade
policy: concessions in—say—market access should only
be granted when the other side also grants similar or comparable
advantages. Economists have traditionally had their problems with
the concept. One saying, attributed to Joan Robinson, the late
Cambridge economist, asks whether you should start throwing stones
in your harbour when you see your neighbour doing just that. More
often than not, maintaining a trade barrier hinders welfare in
the country doing that. If your neighbour starts shooting in her
leg, there should be no rational need to emulate that.
Take the example of the gas production chain.
Clearly, Russia is hurting itself by limiting as a matter of principle
the role of foreign investment in upstream production. It is true
that in an energy nationalist world international companies may
have no other choice than to accept a role as minority share-holder,
co-operator or technology provider, but by limiting as a matter
of political principle the set of possible co-operation modes
the Russian authorities are beyond any debate, intentionally or
not, hurting national welfare. Much technology is available from
the shelf, but some should always have suitable incentives to
be developed. In the case of Russia, less than full access to
foreign managerial and especially project management skills may
well prove the key loss incurred. Making decisions leading to
suboptimal behaviour hurts the national interest.
To a degree at least that seems to be understood
in Russia. Reflecting their basic differences as liberal and authoritarian
capitalisms, there is a clear tendency for the EU and Russia to
understand reciprocity in energy matters in divergent ways. For
the EU, the more market-oriented partner, it is primarily a matter
of commonly agreed access to markets and investments. After rules
have been established, let the best competitor win. For Russia,
the more state-oriented partner, it is primarily a matter of asset
swaps assumedly of similar value. But on the other hand, Total,
the French energy company, was given a limited minority role in
developing the Shtokman gas field without a Russian company being
given some similar access to French markets—not at the same
time at least. It remains to be seen whether such access will
be enough to facilitate the opening of this huge but very difficult
field in anything like the schedules frequently mentioned in the
public.
Though it should not be elevated to a matter
of black-and-white principles, the just-mentioned basic dissimilarity
in interpreting reciprocity remains and will be difficult to overcome,
as long as these variants of capitalism continue to diverge in
important ways.
Let us continue our practical experience. Should
the EU limit Russian access to downstream gas investment by applying
one or another interpretation of the principle of reciprocity?
The economist's first answer would be in the negative. If a Russian
company is able to make a higher bid, believing that it will be
a better operator of a distribution network, it should be allowed
to do so. This is so for a number of reasons. It is, first of
all, the general rule that the highest bid wins. If a Russian
company promises superior performance, it should be given the
opportunity to prove that it can deliver. If the attempt consequently
fails, the field is open for some-one to make a new bid, now for
the Russian-owned assets. If the owner acts by general market-based
rules, this will take place.
But is the assumption of acting by the rules
justified? Before addressing that, let us note that there is also
an important wider argument involved. Dmitri Trenin has argued
that there are two major Russian social forces for a better society.
The first one is the ongoing strengthening of the new middle class.
They demand more choice for their money, and therefore drive the
modernisation, diversification and opening up of the economy.
Perhaps, one might caricature, they—having turned from Soviet
subjects to Russian consumers—might one day even turn a
new leaf in Russian history by evolving further, into citizens.
The other social force is the internationalisation of Russian
business. Indeed, it is a peculiar sign of European lack of assertiveness
to think as many seem to do that this will rather lead to a Russification
of Europe than to a Europeanisation of Russian business.
Still, the economist's logic fails to convince
most ordinary citizens and seemingly also many decision-makers
in the EU. Part of the explanation is in the remarkable surviving
power of elementary Mercantilist thought. But there are other
explanations as well. First, while there is little doubt that
Russia would benefit from a more benign foreign investment regime,
there does not seem to be much reason to think that Russian producers
could actually bring more value into running gas distribution
networks or service station chains in the EU area. Others have
been practising those skills much longer. So why should the Russian
companies make higher bids? Are they overly optimist, burdened
with excess cash—or motivated by ulterior aims? That is
what the EU citizen is asking.
Second, indeed there is the point made earlier
about the unclear character of decision-making rules under authoritarian
capitalism. Perhaps the ultimate Russian producer, after having
thrown stones in his own harbour, starts doing that in other harbours
as well. That—running assets in an economically suboptimal
way—would hurt his business interests, but perhaps they
do not reign supreme. As pointed out earlier, property rights
are unclear under authoritarian capitalism. Therefore, so are
decision rules. Decisions like going downstream along the gas
production chain, closer to the consumer, make as such eminent
business sense. So does the decision to introduce reasonable prices
for exported gas—a measure that should also be defended
on the grounds of economic efficiency and ecological sustainability.
But with unclear property rights and decision rules, suspicions
of ulterior motives will always remain.
If a demand for reciprocity along the gas production
chain looks asymmetrical, there are other, more complicated examples.
What might, for instance, a demand for reciprocity in access to
real estate mean, when both the demand and availability of sea-shore
properties along the Mediterranean is hugely greater than that
along the Black Sea? Or, for that matter, reciprocity in entry
to universities?
The September 2007 EU Commission Communication
on energy policy has been widely discussed, and rightly so. From
the Russian point of view, the premise of granting similar positions
to EU and third country companies should be welcomed, not seen
as evidence of increased protectionism. It is a different matter
that the proposed ownership unbundling principle is not politically
feasible, for internal EU reasons. The same is very probably true
of the offered derogation, the Independent System Operator. Therefore,
this particular piece of argument should rather be regarded as
an opening of debate, not as the final word of the Brussels apparatus.
There is ample need for further debate, as the discussion above
hopefully also demonstrates.
2 October 2007
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