An excerpt from a study "Impact Assessment of Lithuania's Integration into the EU on Relations between Lithuania and Kaliningrad Oblast of Russian Federation" prepared by the Institute of International Relations and Political Science, Vilnius University. The study was co-authored by LFMI Policy Analyst Ramūnas Vilpišauskas

What are the issues?

One of the factors that will influence future conditions for business and economic growth in the Kaliningrad Region (and the Baltic sea region in general) is the process of Lithuania and Poland's eventual accession into the EU. Due to its geographical position, Kaliningrad would be surrounded by the EU customs union. The accession of Lithuania into the EU will imply the adoption of the EU Common Commercial Policy including the alignment of customs tariffs, commercial protection policies and other measures. This in turn will imply changes in rules regulating the KR's trade with neighboring countries and, consequently, changes in transaction costs. Due to geographical and proximity factors, Lithuania and Poland can be considered to be natural trading partners of the KR; trade regime changes related with EU accession deserve the attention of all interested parties.

As an enclave region of another country - the Russian Federation - and potentially surrounded by the EU, the KR may represent a unique case in the history of the EU and its enlargements. While there have been cases in the history of the EU when some foreign territories were given (usually temporarily) special status in terms of their trade relations with the EU, there is one major difference that differentiates these cases from the KR. When certain territories were granted special trading regime status by the EU they have, as a rule, been linked to acceding EU member states by historical or political ties and therefore aimed at preserving existing trade regimes. For example, this could be said about the overseas Commonwealth territories that were granted association with the EU after the accession of the Great Britain, the Faeroes island which was granted a free trade regime, or Greenland, which was granted association status with the EU due to their links with Denmark. However, in the case of future EU enlargement there seems to be no precedent which could form the basis for a special trade regime between the EU and the KR, particularly as it is not linked by such a trade regime to any acceding neighbor countries, and is itself part of Russia.

The trading status of the KR inside of an enlarged EU is an issue that is receiving increased attention particularly from Russia, the EU and Lithuania. The issue can be dealt with as a part of EU enlargement process or as a part of a strategy focusing on longer-term relations between Russia and the EU. Several factors are important in estimating the likely impact of EU enlargement on the KR and likely policies to deal with this issue.

First, the possible economic impact on trade has to be estimated to identify possible increases in barriers to trade and trade opportunities, their overall significance, and the balance between trade creation and trade diversion. This paper presents preliminary estimates based on trade flows between the KR and Lithuania as well as likely changes in barriers to trade as a result of EU membership.

A second and related question is that of appropriate policies. To extend the benefits of EU enlargement to the KR and Russia in general, the further development of cooperation policies might be necessary. Obviously, the parties involved here are the Russian federation and the EU. The main issues are (1) how much flexibility or specificity is likely to be given by the Russian authorities to the KR in terms of its different status from the general framework of Russia-EU relations - or how centralized the process of developing Russia-EU relations will be; and (2) how much innovation is likely on the part of the EU (and to some extent Russia) in dealing with the KR's trading status. The future trading status of the KR will depend on how these questions are dealt with. The issues are discussed below after a brief presentation of trade figures characterizing trade between Lithuania and KR. The chapter concludes with policy suggestions on extending the benefits of EU enlargement to Russia, and Kaliningrad in particular.

The current situation: trade and its regulation between Lithuania and Kaliningrad region

Lithuania's accession into the EU is likely to change the legal framework for trade between Lithuania and the Kaliningrad region. From the date of accession, Lithuania will adopt the EU's Common Commercial Policy, which entails among other things the alignment of import customs tariffs, commercial protection instruments and agreements with third countries. The resulting changes are likely to affect Lithuania's trade relations with Russia in general, and Kaliningrad the region in particular. It should be noted that exports from Lithuania are unlikely to be affected given that Russia (including the KR) applies the Most Favorite Nation (MFN) treatment to goods originating in Lithuania as well as to goods originating in the EU. Due to the KR's status of a Special economic zone, it applied special treatment to some of imported goods; nonetheless, no changes in import regulations are likely to arise from EU enlargement.

However, exports from the KR to Lithuania will be directly affected by Lithuania's accession into the EU, as the Lithuanian foreign trade regime will be replaced entirely by the one applied by the EU. The scope of this change will depend on two factors - the quantity of trade flows from the KR to Lithuania, and the differences between current trade regime applied by Lithuania and the one applied by the EU (for example, how different are the import duties applied by Lithuania and the EU to the goods originating from the KR, and whether an increase or decrease in import tariffs is to be expected).

Foreign trade plays important role for the small and open economies of both Lithuania and the KR. However, the relative weight of each other's foreign trade turnover is different. Lithuania is among the main trade partners of the KR while the KR plays only a minor role in Lithuania's foreign trade turnover. In 1997, Lithuania was the second largest market for exports from the KR with a share of 9.4 percent, although this figure declined slightly in recent years and in 1999 equaled 5 percent . At the same time, the share of imports from the KR to Lithuania constituted only 0.78 percent of Lithuania's imports and later decreased by several times .

Lithuania's trade with Russia and the Kaliningrad region (preliminary data)

	Exports to:						Imports from:
	1997		1998		1999		1997		1998		1999
	Mln. $	%	Mln. $	%	Mln. $	%	Mln. $	%	Mln. $	%	Mln. $	%
Russian Federation	969	21.4	680	15.3	330	9.15	1355	23.8	1782	26.8	1208	21.1
Kaliningrad region	191	4.21	168	3.76	65	1.79	45	0.78	19	0.28	10	0.17
Total	4534	100	4455	100	3611	100	5697	100	6648	100	5725	100

Source: Lithuanian Customs Department

Several tendencies can be observed from these trade figures. First, the trade volumes of Lithuania with both Russia and the KR have recently decreased. This tendency reflects the general trend after the economic crisis in Russia in August 1998, therefore any evaluations have to take into account this factor. Still, even in 1997, i.e. before the crisis, the share of the KR in Lithuania's imports did not exceed 1 percent of total imports. Therefore, changes related with EU membership will affect very small share of Lithuania's imports. However, trade relations between Lithuania and the KR are characterized by significant asymmetries in trade shares. Lithuania's membership in the EU might affect a relatively higher share of the KR's exports to Lithuania, which in 1999 continued to be their second major export market after Poland.

Second, although relatively speaking, Russia is much more important for Lithuania as a source of imports (particularly imports of mineral products) than of exports, the opposite could be observed for Lithuania's trade with the KR. Exports from Lithuania to KR have continuously exceeded its imports from the region. Therefore, a large share of Lithuania's trade turnover with the KR will not be affected by EU membership.

Third, imports from the KR to Lithuania are much more diversified than Lithuania's imports from Russian Federation. The latter is dominated by mineral products, namely crude oil and natural gas, while imports from Kaliningrad are more diversified and include timber and its articles, paper, metals, wheat, food stuff, fish, etc.

There are two aspects that illustrate much higher levels of product differentiation in comparison with Lithuania's imports from Russia. First, as it was noted, there are many more product groups exceeding the share of 1 percent of imports from the KR to Lithuania. Second, the total share of products imported from the KR to Lithuania exceeding 1 percent of imports is only 57.49 percent (as opposed to almost 80 percent in case of Russia), which also illustrates a very differentiated and widely spread structure of imports.

The comparative data illustrates that the impact of EU membership on import customs duties is more diversified. Although imports in most natural resources and unprocessed products (including coal, wood or skins) are not taxed by the EU, the general level of protection on products imported from the KR is likely to increase. The highest increases are likely in cases of imported agricultural and food products. The impact of non-tariff barriers might also be most significant in the cases of some foods, fish, and some other product groups.

In summary, there is a possibility of a slight increase in protection in Lithuania's imports from the KR after joining the EU. However, due to relatively small volumes of trade this increase will not produce significantly negative effects and its impact will depend on concrete product groups with the unlikely imposition of high imports duties. It should be acknowledged that the impact will be relatively more important to the KR than to Lithuania due to formers higher share of trade with the latter.

Extending the benefits of EU enlargement to the Kaliningrad region: policy solutions

Although no significant negative impact on trade between the Kaliningrad region and Lithuania emerges from the static analysis, joint Russian-EU initiatives aimed at reducing barriers to mutual trade might bring dynamic economic benefits to all parties involved. The main questions that have to be dealt with in this respect are: (1) how much flexibility is granted to the KR, i.e. whether Russian central authorities will further support the idea of a "pilot region", with EU trade relations with the KR being different from their relations with the remaining Russian territory, and (2) how innovative EU policies towards the KR are going to be.

Picture 1. Scenarios of maximizing the benefits of integration in the area of trade

As was noted the earlier, the policy solutions are dependent on two main factors: (1) how much flexibility is granted to the KR, i.e. whether Russian central authorities will further support the idea of a "pilot region" with EU trade relations with the KR being different from its relation with the remaining Russian territory; and (2) how innovative EU policies towards the KR are going to be. Depending on different combinations of these characteristics of EU and Russian policies, four scenarios of setting up the trade regime between the EU and the KR after the EU enlargement are discussed.

(1) Northern dimension. This scenario is the closest to the current, and therefore the status quo. It implies using the existing frameworks of cooperation between the EU and the Russian Federation and focusing on the regional cooperation projects, which are being currently developed. It singles out the KR in implementing projects in cooperation with other EU regions. Differently from projects in infrastructure, this scenario does not bring additional benefits in the field of trade, which is not included in the list of issues dealt with by the Northern Dimension initiative. However, this framework might be used to facilitate the exchanges between the border regions that might be relatively more affected by the introduction of the EU common customs tariffs.

(2) New initiatives between the EU and Russia. Contrary to the Northern dimension scenario, this initiative implies the most innovation and new policy initiatives in terms of relations between the EU and Russia. However, although such initiatives as the Association Agreement or even closer forms of cooperation and integration seem feasible in the long term, it has been stated by the Russian authorities that Russia does not intent to become associated with or in any other way linked to the EU by at least 2010. Therefore, if a policy solution is to be found before 2010, i.e. at the time of enlargement, which is likely to take place earlier, other options have to be considered.

(3) Partnership and Cooperation Agreement. This option implies using currently existing frameworks by the EU and approaching the issue of trade regime with the KR by liberalizing trade relations with the Russian Federation. As it was mentioned before, the possibility of the free trade area between the EU and Russia is foreseen in the PCA. However, it is closely linked to the accession of Russia into the WTO, even directly dependent on it, and on Russia's internal situation. In addition to the free trade area, issues related to non-tariff barriers need to be addressed in the framework of the PCA, and this is an equally challenging task for both parties.

(4) Kaliningrad as a pilot region. This option implies innovative policy on the part of the EU and giving more content to still vague idea of the pilot region by the Russian central authorities. As it was argued, the KR surrounded by the EU customs union will be the first case in the EU's history, therefore new solutions might be needed to avoid negative trade effects in relation to the KR. From the Russian side, this implies giving more autonomy to the region and agreeing to the different trade regime between the EU and the KR, and the EU and the rest of Russia. Free trade agreements, the alignment of product quality standards and certification procedures or selected liberalization between the EU and the KR are the possible options. Implementing them would bring new challenges such as strict control over the origin of goods.

Judging on the basis of how realistic and how beneficial each scenario is to all parties, the last two scenarios seem to be priority scenarios. While the full implementation of the PCA would bring the biggest economic benefits, its implementation might still be obstructed by practical and political difficulties, which might be avoided if the idea of the pilot region is implemented.