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Economic Policy Research Project “Perspectives of Intra-regional Trade in ECO Countries
JSC «Economic Research Institute» of The Ministry of Economy and Budget Planning of the Republic of Kazakhstan
Sh. Zhakupova, Director of the Center for Strategic Development and Economic
Research
Sh. Ibraimova, Head of Department
R. Bissekenova, Senior expert
А. Tasbauova, Senior expert
G. Karashulakov, Senior expert
The article describes the main results of the research aimed at determining the prospects for the
development of intra-regional and inter-regional trade in the Economic Cooperation
Organization (ECO). The internal and external economic factors that impact on the development
and trade flows between the countries of the ECO and the promising areas for foreign direct
investment (FDI) in the development of trade relations are identified, the role of monetary units
of the ECO region in the intra- regional and inter-regional transactions are examined.
The enlargement of regional cooperation in trade, investment and industry is deemed to be one
of the most important objectives of ECO; these areas are becoming increasingly important in the
relationship between the member countries. ECO strives to increase the growth of trade within
the region and the development of inter-regional trade is identified as a priority for the
organization. The organization formed regulatory framework promoting the development of
intra-regional and inter-regional trade and attracting investment into the ECO region as well.
The present research is aimed at determining the prospects for the development of intra-regional
and inter-regional trade in the ECO countries as well as testing the following hypotheses:
- bilateral trade in the ECO region can reach 20% by 2015;
- the national currencies of the ECO can be used as the single currency in the region.
In order to achieve mentioned aim and prove the hypotheses the deep analysis have been
implemented, that includes the analysis of external and internal economic factors of interregional trade of the ECO countries, analysis of the impact of the global economic crisis on
intraregional trade, the identification of the promising areas for FDI in the development of trade
relations between the countries of ECO, the identification of barriers for ECO transit trade, the
study of the role of ECO region monetary units in intra- regional and inter-regional transactions.
Literature review. One of the most important insights from international economics is that there
are gains from trade. This is why countries trade with each other; trade simply provides both
ends with bilateral benefits. Why countries benefit from trade is mainly due to the fact that
countries are different from each other and with different possession of the natural resources.
Krugman and Obstfeld (2003) states that by trading, each country can do the things it does
relatively well and export these goods and import those goods that others do better. Furthermore,
countries trade to achieve economies of scale in production which is when countries specialize in
the goods they do relatively well and hence can produce at a larger scale and more efficiently
and thus creating a comparative advantage in producing these goods. A country has a
comparative advantage in producing a good if the opportunity cost of producing that good in
terms of other goods is lower in that country than in other countries. Trade benefits arise when
countries export the goods in which they have a comparative advantage.
Once a country has a comparative advantage in producing a good, specialization in that good
will make production more efficient. This efficiency creates a lower cost of production hence the
good can be sold at a lower price and this price fall will create a rise in demand for the good.
Relative price of a product, the price of one good in terms of another good, is one of the main
factors that influence demand and some of the other factors that affect demand are income,
preferences, and price of related goods (Krugman and Obstfeld, 2003).
There have been many disputes of pron’s and con’s with ECO membership as well as what the
effect has been on trade. When estimating the effects on trade patterns most economists and
scholars used the gravity model of world trade which is a convenient measurement to determine
effects on trade flows. This discussion has been further extended with the introduction of a
common currency in the ECO region.
Jahangir Khan (2010), estimated a gravity model using an international dataset on bilateral trade
for 137 countries in 2005, to address the subject of whether ECO trade is too low and whether
the present level of trade is accounted for by regional integration or unilateral liberalization.
Obtained results of the study investigated that trade between ECO countries was lower than
predicted by the equation of gravity functioning and confirmed the theory that the scale of trade
at present was assigned to regional agreements rather than unilateral liberalization. Jahangir
Khan (2010) suggested larger scope for regional cooperation among ECO member countries.
Jahangir Khan (2006) evaluated the degree of potential trade flows between Pakistan and the
nine member countries of ECO and the main concern in the study was to explore that intra- ECO
trade had large potential for Pakistan and as compared to its potential it obtained lower share.
The outcomes achieved from the gravity model had a positive and significant impact on intraregional trade. Additionally it was recommended that the member countries trade less with each
other than what would be expected. In those countries which had a same geographical border, the
volume of trade was quite limited. The benefit of geography and the survival of trade preferences
between ECO member countries could be extended to cover-up potential trade towards
neighboring countries. Main hypothesis drawn from the results was that intra-regional trade had
high potential for the regional countries.
Felipe and Kumar (2010), used a gravity model to study the ‘bilateral trade flows’ and ‘trade
facilitation’ relationship. Moreover they estimated the gains in trade resulting from
enhancements in trade facilitation for the Central Asian nations. Trade facilitation was calculated
through the World Bank’s LPI (Logistic Performance Index). As a result of enhancing trade
facilitation in Central Asian countries, their outcomes showed significant gains in trade. In the
case of Azerbaijan the gains vary from 28% to as much as 63% for Tajikistan. Moreover,
intraregional trade rose by 100%. Amongst the components of LPI, they found that the
maximum increase in overall trade comes from advancement in infrastructure, followed by
logistics and effectiveness of other border agencies and customs. The outcomes also showed that
the increase in bilateral trade, due to an improvement in the exporting country’s LPI, in hightechnology, highly sophisticated and more differentiated products was greater than the increase
in bilateral trade in low technology, less differentiated and less sophisticated products. For the
Central Asian nations this is mostly important to lessen their reliance on exports of natural
resources and expand the manufacturing base by shifting to more sophisticated goods. Beyond
their borders when they take a look at markets, trade facilitation plays an essential role.
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Zarzoso (2003) focused on the effects of preferential agreements between various economic
blocs and areas and not only approximate a gravity equation which illustrates the effects of
weight comparison on preferential agreements but also, shows the dependency of other
determinants on bilateral trade flows such as geographic proximity, income levels, population,
and cultural similarities. Zarzoso (2003) investigated that variables which were traditionally
involved in the gravity equation not only present the anticipated marks but also highlighted the
role played by intra-bloc effects.
The current situation. Many factors influenced the ECO countries trade in 2000-2010. In the
region there are both historically preconditions and barriers to bilateral trade of the ECO
countries.
The prerequisites of a tenuous relationship between the countries of the region are as follows: the
lack of access to sea in many countries of ECO and their topography multiplicity cause the
increase of additional transport costs and transport time required for international shipments in
the region. Also the relatively weak trade ties between the countries of Central Asia and the
countries that were not part of the former Soviet Union during the Soviet era are worth
mentioning.
After the collapse of the USSR the barriers appeared to trans-border trafficking of goods, people
and vehicles between the ECO countries. Such barriers as macroeconomic, trade and structural
policies pursued by region governments can be reduced through regional cooperation in trade
policy, transport and customs transit.
The first decade of the XXI century in the countries of ECO was a period of economic recovery
from the deep recession during the transitional processes that took place in the 1990s. In all the
countries of the region the good growth was registered for example the average annual GDP
growth rate exceeded 10% in Turkmenistan and was above 8% in Turkey and Uzbekistan. Thus,
domestic demand in these countries, including the demand for imported products has grown
significantly.
Other macroeconomic factors directly affecting foreign trade include the inflation and the
exchange rate. In 2001-2010 the inflation in the region was high enough. Between 2007-2008 the
nominal exchange rates against the U.S. dollar in the region behaved differently for example
some were becoming stronger (Kazakhstan, Kyrgyzstan, Turkey) and others remained stable
(Afghanistan, Turkmenistan, Azerbaijan) or weakened (Tajikistan, Uzbekistan, Pakistan, Iran).
In 2009, almost all of the local currency devalued against the U.S. dollar. However, in 20002010 the rate of nominal depreciation of these currencies was much lower than the rate of
inflation in these countries during the same period of time. Only in Afghanistan and Kyrgyzstan
the average annual inflation rate was below 10% and in Tajikistan and Uzbekistan they exceeded
20%.
Another group of factors that have an impact on foreign trade in the region is related to
management issues. It is known that many countries in the region have corruption and inefficient
functioning of state institutions. This is reflected in the values of worldwide governance
indicators calculated by the World Bank. According to these indicators the quality of public
administration of all of the ECO countries except for Kazakhstan, Azerbaijan and Turkey belong
to the lowest quintile. Poor governance leads to increased transaction costs and reduces the
predictability of international supply and thus has a negative impact on trade. In addition the
inefficient state institutions, responsible for the promotion of trade, fail to eliminate quickly the
existing trade barriers and implement government trade policies.
3
Changes in the macroeconomic and structural policies in the region and environment occurred in
the background of deep institutional changes associated with the newly gained independence and
the transition to the market economy. In the 2000s the basic market institutions in the ECO
countries were already running and the population is mainly adapted to the new conditions. All
this greatly affected the foreign trade in 2000-2010.
In addition to internal policies and structural problems a variety of external factors impacted on
foreign trade of the ECO countries in 2000-2010.
The impact of external factors on the ECO trade resulted in the change of export situation
especially terms of trade. The important factor for the countries was the price fluctuation in
international commodity markets. International prices of energy commodities and metals grew in
1999-2008 and fell sharply in 2008-2009 and restored in 2009-2010. All the countries except for
Afghanistan and Pakistan are engaged in the export of various energy products and metals, and
some countries in the region are heavily dependent on energy imports. Therefore the world price
fluctuations had a major impact on the region.
The global crisis has had a big impact on the investment. The decline in world production has
forced investors to reconsider the direction of investments so as for the first time ever the
investment in emerging and fast-growing economy exceeded the investment in industrialized
countries. However for the ECO the impact of the crisis on investment was low for example in
ECO there was a decline in investment during the crisis, but the role of investment in the growth
of the economy in the coming years (2010-2012) retained the importance of the pre-crisis level.
The negative impact of the global economic crisis influenced the import reduce to 26.8%.
However, import was recovering faster than export. According to the statistics of the ECO
Secretariat, ECO's total exports has not yet reached pre-crisis levels, and the average annual
growth rate amounts to 18.5%, in 2009 the fall in exports reached 35.9%
In the 2009-2011, in the structure of trade the import of goods in the ECO region dominated, in
particular the import of petroleum and mineral products, machinery, nuclear reactors, iron and
steel, etc. It should be noted that the export of goods to the ECO region has been made according
to the same commodity groups: mineral products, petroleum, iron and steel, etc.
Comparative analysis of foreign trade of the ECO has identified some common features of all the
countries in the region. Firstly, the export of all countries is dominated by commodities
(hydrocarbons, metals, cotton and other agricultural products). Secondly, export performance is
closely related to changes in the prices of key export commodities in international markets.
Thirdly, three countries which have shown the highest growth of exports during the decade
(Kazakhstan, Turkmenistan and Uzbekistan) are the countries rich in hydrocarbons, the terms of
trade of these countries have improved dramatically.
Moreover the trade across the region countries is not balanced; the countries have a large
positive balance or a large trade deficit.
In countries with a large positive balance export revenues are accumulated in sovereign wealth
funds and either kept or used to finance public investment programs. Countries with large trade
deficits finance them with remittances, income from informal re-export and foreign aid. Some
countries in the region can generate significant foreign exchange earnings from the illegal drug
trade, but it is unlikely that these resources are used to finance imports. Income from illegal
activities is concentrated in the hands of a small group of individuals who have not invested in
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the country, but mainly derive these funds outside the region. Therefore, the inflow of currency
from illegal exports is mainly balanced by capital outflow from these countries.
Effective regional economic cooperation provides closer ties in infrastructure, transport, finance
and communications. In this direction, the ECO has achieved a certain success by assisting in the
implementation of the commitments of its member countries as well as developing the private
sector and thus achieving its goals. ECO achieved considerable success in the trade as a result of
various initiatives, including the ECO Trade Agreement, which came into force in April 2008.
ECO’s Development and Trade Bank, which has a capital of 500 million U.S. dollars is an
integral part of regional efforts to promote trade and investment. It is clear that trade is the most
effective tool in facilitating and promoting inter-regional relations.
According to the results of recent years, ECO’s profits from intra-regional trade show growth.
High levels of ECO’s intra-regional trade are observed with the EU-27, APEC and the CIS.
Among trading partners ASEAN countries as well as individual countries are observed.
Prognosis. In the present study based on a comparative analysis of all intra-regional trade in the
period from 2000 to 2011 there was conducted a forecast of ECO’s foreign trade indexes till
2030.
Thus, there is an increase of ECO’s exports to the world in 2030 up to 1 711.5 billion U.S.
dollars, with an average annual growth rate that will be 8.4%. In the structure of the ECO Turkey
makes main exports to the world, the export will amount to 58.5% in 2030.
Exports within the ECO region in 2030 will amount to 272.3 billion U.S. dollars with an average
growth rate of 12.5%. The main exporters in the ECO region are Kazakhstan, Pakistan and
Turkey, which occupy 76.1% of the total exports of the ECO region. The share of regional
exports of the ECO in gross exports will increase from 8.1% in 2012 to 15.9% in 2030.
1800000
1711454
1572860
1600000
1448473
1400000
1336769
1237850
1148873
1200000
1060732
980533
1000000
907618
841364
782487
800000
715277
653187
602769
549584
600000
501681
463997
429810
403741
400000
Kazakhstan
Iran (Islamic R
Pakistan
Turkey
Afghanistan
Azerbaijan
Kyrgyzstan
Tajikistan
Turkmenistan
Uzbekistan
200000
0
World
Figure 1 – Exports of ECO countries to the world, millions of U.S. dollars
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
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Imports of ECO to the world in 2030 will amount to 1 507.5 billion U.S. dollars, the average
annual growth rate of 7.4% will develop. The main importers are Turkey and Pakistan, which
amount to 38.1% and 25.7% of total imports of the ECO to the world, respectively.
Import of ECO in ECO region will grow up to 270.9 billion U.S. dollars in 2030 with an average
growth rate of 10.4%. The main importers within the ECO region are Iran (38.3%), Turkey
(14.7%), Afghanistan (13.3%), Uzbekistan (10.2%), and Kazakhstan (9.0%). These countries
generally constitute 85.6% of total imports in the ECO region. The share of the region's imports
of ECO in gross imports will increase from 10.8% in 2012 to 18.0% in 2030.
Figure 2 –Imports of ECO countries in the world, millions of U.S. dollars
The results of calculations for the forecast showed that intra-regional trade of ECO in the gross
turnover amounted to 16.9% in 2030 increasing for 7.4 percentage points compared with 2012.
This increase in intra-regional trade is mainly due to Kazakhstan, Iran and Turkey.
The average annual growth rate of trade turnover of ECO in the world according to the
calculations will be 7.9%, while the growth rate of intra-regional trade turnover could reach
11.4%. It should be noted that the growth of intra-regional trade will be faster than trade with
countries outside the ECO region.
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45,0
44,4
43,4
44,1
43,0
42,1
40,0
37,6
Kazakhstan
33,1
35,0
30,1
30,0
27,7
25,7
24,6
25,0
20,0
24,3
24,8
25,8
21,8
19,7
18,9
18,2
Afghanistan
17,0
9,2
6,6
11,1
10,4
Kyrgyzstan
Tajikistan
13,0
Turkmenistan
8,9
7,5
6,6
5,0
16,9
16,5
10,6
9,3
Azerbaijan
17,0
14,6
9,2
Turkey
21,3
18,4
14,8
14,4
15,0
10,0
Iran (Islamic Republic
of)
Pakistan
29,7
28,6
World
Uzbekistan
6,1
6,2
6,5
6,9
2015
2020
2025
2030
0,0
Figure 3 – The share of regional trade in total trade turnover of ECO
As a result of made forecast the hypothesis of achieving 20% of bilateral trade turnover in the
ECO region by 2015 was refuted. The calculations showed that by mentioned period the intraregional trade in the ECO region will be 9.3%.
Export competitiveness. Export competitiveness of ECO was determined based on the Lafay
index and the comparative advantages in foreign trade were revealed.
On the basis of the calculations the main importer of the ECO countries considered to be Turkey,
then Afghanistan and Iran. The largest exporter in the country of ECO considered to be Turkey,
Kazakhstan, Pakistan and Iran.
The analysis revealed the following characteristics of bilateral trade in the ECO region:
- comparative advantages of the ECO countries in relation to each other are the primary
products, raw materials, i.e., characterized with predominantly material;
- Lafay index calculations showed that the most of the benefits of trade in the region are specific
inter-bilateral, i.e. "One country is one set of non-recurring export basket". This shows a clear
qualitative division of labor (specialization) in ECO.
- In addition, the existing comparative advantage of one country is over- concentrated i.e. the
product with the maximum amount of import or export is exported / imported mainly from key
trading partner, the other ECO countries are lagging behind on this product ;
-exception is Iran, which exports carefully diversified across products and partners, for example
a leading export basket is delivered to 8-9 of the ECO countries, while other exporters of ECO
trafficked to 1-2 countries in the region;
- being the largest supplier of goods to ECO, Kazakhstan imports comparably small volume of
goods, which may have a deterrent effect on the export of the ECO partners.
FDI attraction. The favorable investment climate in the region and attracting the foreign
investment provides an impetus for the development and integration and plays an important role
in intra-regional relations. Attracting foreign direct investment requires a stable and predictable
investment climate. To encourage FDI the region countries need to maintain a strong skilled base
and modern infrastructure.
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Openness to FDI promotes the development of trade relations. The possible effects of investment
measures related to trade, trade measures as well as legislation and obligations under WTO and
bilateral investment agreements are expanded. Today there are 30 bilateral investment
agreements between ECO countries and nearly 200 ones with the countries outside the region of
the ECO.
According to the international statistics the ECO countries attract 2.3% of global inflows of
foreign capital to the region, and invest 0.8% of global investment. As the main investment
funders among the ECO countries stand out Kazakhstan and Turkey, and they, along with Iran,
Turkmenistan and Pakistan attract investment to the region.
Based on the comparative analysis of all intra-regional trade operations for the period from 2000
to 2011 upcoming trends for foreign direct investment were identified to the development of
trade relations between the countries of ECO. To this effect volume of foreign direct investments
was taken into account as inflow of investments, stocks and shares of the countries in
international trade of different economic sectors.
In general, in the ECO region the bulk of the attraction of foreign direct investments is financial
sector, including the banking sector and the stock markets. Also, construction sector transport
and communications as well as mining have high potential of capital investment. In terms of the
context of regional countries Turkey, Iran and Kazakhstan are more attractive for foreign
investments.
Prospects of an introduction of a single regional currency. The transition to a single unit of
account would allow to the member countries of the ECO region to move away from the dollar
dependence when trading with each other. The use of a single currency would contribute to the
growth of bilateral trade, promotion of the common market investments and the facilitation the
conditions for labor migration, reduce of transaction costs and the weakening of the exchange
rate risks which would have a positive impact on the economic development of the membercountries of ECO.
It should be noted that the real unification of national monetary systems of the member-countries
of ECO organization will inevitably face major challenges. They are caused by the fact that each
of the countries has their economic interests which causes difficulty when formation a single
monetary policy. Creation of a single currency is a difficult process and it requires both the
development of economic relations between the partner countries and the convergence of
economic mechanisms.
The difference in levels of economic development of the states included in ECO, the lack of
sufficient financial resources in most of them, the weakness of market mechanisms and the lack
of development of the private sector in the economic system of a number of member countries,
the conformity of export and import products, excessive bureaucratic acrimony, permanent
structural changes in the work of ECO impede the process of economic integration. At present,
the ECO countries differ significantly in the structure of the economy, in external payments
position, in the structure of foreign trade and dependence on raw hydrocarbon deposits, monetary
policy which is conducted. All these differences should be taken into account when considering
the timing of the introduction and establishment of a mechanism for creation of single regional
currency.
The introduction of a single regional currency is possible in future provided that the convergence
of the economic parameters of the ECO countries is implemented, a significant increase in the
volume of mutual trade and investments.
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Recommendations. Based on the analysis of the impact of the global economic crisis on intraregional trade measures have been developed to manage the economies of the ECO countries for
the resistance to the system trade risks in the region, including :
1. In the case of shrinkage of exports, international reserves, creation of a stable negative balance
of trade balance and gap in the balance of payments the following measures are proposed:
- Selective tax incentives by industry, optimization of public spending, the fiscal rules;
- Strengthening of non-tariff barriers, reduction of interest rates on loans to export-oriented
industries;
- Diversification of exports, import substitution.
2. In the case of decline in tax revenues and the growth of government deficit, public debt:
- Selective reduction of interest rates on loans, an additional issue of government securities (GS);
- Control the refinancing rate and the minimum reserve requirements of national banks. These
measures are of general economic effect, freeing up liquidity creating price incentives for
producers;
3. In the case of a reduction of FDI inflow, real GDP reduction, low growth rates;
- Further implementation of infrastructure projects, public-private partnership, providing
stimulation for the attraction of FDI (privileges, SP, etc.), bilateral investment agreements.
In addition, recommendations were developed for the governing bodies of OEC within the
framework of intra- regional economic policy for the period from 2020 to 2030 which include
recommendations regarding monetary, fiscal, trade, investment and structural policies, in
addition recommendations aimed at improving institutional environment, food security, support
of international investments and trade in ECO:
- Crediting stimulation of industry sectors, construction, and promotion of financial activity.
These three sectors will be most vulnerable to external challenges and risks. It is proposed the
use of selective sectoral measures stimulating the demand: discounts when buying real estate,
investing in the production of building materials, the refinancing loan rates;
- Optimization of public spending, the elimination of inefficient budget programs;
- Development of an agreed line on the use of energy resources and transport services, the
development of common markets for certain products, particularly agricultural products;
- Development of cooperation in the field of transport, including the formation of a network of
international transport corridors in ECO;
- New structural and investment policy should aim at diversification of production in "traditional
industries", the development of industries based on domestic demand and support of sectors with
export potential are aimed at the development of sectors of "the economy of the future". One of
the forms of stimulation is a tax support of projects launched with the participation of foreign
capital;
- It is necessary to have a more strict control of the rebalancing of the rights and obligations of
investors and the state;
- To support the ECO countries with the lowest income in the formation of favorable conditions
for attracting foreign investments;
- For the ECO countries it is necessary to develop a special system of protection from the sharp
fall in world prices of basic goods of their export and sharp increase of import, worsening the
balance of payments;
- To create an international Investment and Environmental Committee of ECO, responsible for
the examination of major international investment concerning threat to environmental security in
the recipient country, as well as external effects;
- To introduce mechanisms of stimulating investments to agricultural production;
- To develop a regional monitoring system for the investment processes in ECO;
- To develop a system of economic indicators this controls the effect from private investments
for the creation of value chains and the creation of jobs in ECO.
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The recommendations can be used in the future to take measures for the development of
economic infrastructure and institutions functioning effectively, improvement of productivity
and enhancing of intra-regional and inter-regional trade in the framework of regional integration.
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