By Simon Schmidt

Introduction

In 2004, the European Union (EU) began to shift its focus in foreign policy towards its neighbors in the East. Not only did eight Eastern European countries join the EU, the political union also developed the European Neighborhood Policy (ENP) which aims to engage the countries at the border of the newly enlarged EU. As a key principle, this plan involves a deeper economic integration to achieve prosperity and stability in the participating countries.  Regarding the Caucasus Area, the Eastern Partnership (EaP), which is a multilateral co-operation initiative embedded in the ENP, involves Armenia, Georgia and Azerbaijan. 

It leaves out Turkey since Brussels and Ankara have opened talks about Turkey’s application to accede to the European Union since the late 1980s. Being considered a strategic ally to the EU, the supranational organization has included Turkey into the European Union Customs Union (CU) in 1996.  This agreement shows Turkey’s special status in terms of the EU enlargement policy. But its role as a bridge head for trade has yet not reached out towards its neighbor Armenia.

Turkey closed the border to Armenia since the outbreak of the Nagorno-Karabakh conflict in 1993 to show support for Azerbaijan. Even though relations between the two countries recently improved, official trade still doesn’t exist. However, the latest efforts of rapprochement legitimate a discussion on a reopened border. Both countries underwent a comparable path to achieve economic prosperity by emphasizing European Integration. Direct trade between Armenian and Turkey might therefore be of mutual interest. This research attempts to analyze the economic benefits an open border between Turkey and Armenia could have for Armenia as well as for a stronger prospective European Integration. By taking estimated benefits and also risks and limitations of an open-border into account, we can draw conclusions on supportive measures in the process of a potential border opening.

Methodology

Since this paper is aiming to put the border opening into context with a deeper European Integration we are first analyzing the existing economic cooperation between Armenia and EU. We hereby examine the reform progress included in the ENP action plan and the outcome of established trade relations once for the EU and Armenia based on economic data. Second, Armenia’s overall trade situation will be taken into account. The focus in chapter two is set on trade regimes, the most important economic partners and the current status quo of transportation from and to Armenia. Afterwards, chapter three is summarizing current Armenian-Turkish trade relations and is providing several expected effects of an open border for Armenia. This projection is followed by an overview of potential risks and limitations that can accompany the border opening.

Chapter 1: Economic ties with the EU

The ENP and Armenia

The first relations between the European Commission and Armenia have been established in 1996 through a Partnership and Cooperation agreement. Regarding the ENP, the Action Plan for Armenia was created in 2006 after negotiations between Armenia and the EU and runs for a period of five years. The implementation of the ENP is ought to achieve a high level of integration for Armenia by granting the country the possibility to participate in key aspects of EU policies. In economic terms, investment, growth shall be stimulated.  The ENP includes eight priority areas that are approached by Armenia with EU support:

• Strengthening democratic structures
• Strengthening human rights
• Encouraging further economic development
• Improving investment climate
• Converging economic legislation and administrative practices
• Developing an energy strategy
• Contributing to a peaceful solution to the Nagorno-Karabakh conflict
• Enhancing efforts in regional cooperation

The ENP therefore covers a broad range of European Integration issues. It is pointed out that Armenia is ought to commit itself to common values rooted in European principles. Second, legislation, norms and standards of Armenia shall be advanced by achieving a high level of approximation regarding the EU framework. From an economic perspective, many reforms are undertaken to approximate Armenian business environment to EU standards.

Concrete actions to enhance trade between the EU and Armenia included are for instance the establishment of EU-Armenia bilateral trade agreements, the harmonization and facilitation of custom legislation and cooperation regarding the definition of standards for certification of importers, exporters and transporters.

In general, the European Commission assesses Armenia’s performance on implementing ENP reforms to be positive. Economically, progress has been recorded regarding development of customs administration, improvement of Armenia’s business climate and the implementation of laws reducing technical barriers. However, several reform processes are still ongoing or have been slowed down during the financial crisis in 2009.  Moreover, it is pointed out that more efforts need to be undertaken to sign a Deep and Comprehensive Free Trade Agreement (DCFTA) with the EU. Especially quality control mechanisms and institutions, which are comparable with EU standards, need to be established.

To measure the impact ENP actions and reforms have made to the Armenian economy, we are going to investigate several areas of interest. First, we look at the 2006-2010 trade flows between the EU and Armenia.

Figure 1. Armenian trade with the EU 2006-2010 in mill. Euro

Figure 1 shows an overall increase of the Armenian imports, in average 7.2% annual growth. Exports to Europe however increased in average by only 0.1%. The 2008 financial crisis showed its effects on the Armenian economy by reducing both imports and exports in the following year.  One can therefore see that Armenia’s trade deficit has been increased by the higher share of European imports. By taking a look at the trade composition it gets obvious that the EU27 mainly sold Machinery and transport equipment (33.7% of Armenian imports in 2010) and several types of manufactured goods (34.6%) to Armenia. In contrast to that, Armenia’s exports consisted mainly of base metals and derivatives (64.3% of Armenian exports in 2010). The most important export countries of Armenia in the EU have been Bulgaria (15.2% of overall export) and Germany (14.2%). Overall, the EU represents Armenia’s most important trade partner (2010: EU import 27.4%; EU export 49.6%).

To gain a more detailed view on Armenia’s economy, we further look at the Foreign Direct Investments (FDI) during the last years. In 2009, FDI inflow worth $770 Mill. has been reported. In the same year, Armenia’s FDI stock as percent of GDP increased to 41.6% from 29.6% in 2008. Despite this augmentation, other comparable countries like Georgia and Kazakhstan show a higher FDI stock. Among the five top investing countries in Armenia, three EU countries can be found. 

Table 1. 2009 FDI distribution in Armenia by origin

Country	Share in total FDI 2009 (%)	FDI 2009 (in mill. USD)
Russia	53	384
France	27	197
Argentina	7	48
Italy	5	33
Germany	3	19

The major proportion of FDI is located in the Communication sector (20.9%) and the production of electricity (29.1%).  Even though the European engagement in the Armenian market is noticeable, one can see that mostly sectors attached to infrastructure development are affected and not knowledge-intensive industries that are able to increase overall competitiveness. Georgia, also a participating country of the ENP, attracted the biggest FDI share in the industry sector ($229 Mil.).

As to GDP growth, Armenia showed strong growth rates before the impact of the financial crisis in 2009 (2007:13.7%, 2008: 6.9%), during which its economy contracted by 14.2%. In 2010, the economy entered a slight recovery, achieving a GDP growth of 1%. GDP per capita (PPP) has reached $5.700 in 2010, hereby regaining the level from 2006. After its climax in 2008, in which PPP marked 6.300$, the financial crisis resulted in a drop to $5.500 in 2009.

Outcome for the EU

When summarizing this data, one can conclude that above all the European countries have intensified their presence in the Armenian market and were able to conduct better business in the South Caucasian country than before the launch of the ENP. Institutional reforms in Armenia and the commenced adoption of EU regulatory standards eased market entrance for European companies. Due to higher exportations, the EU’s trade balance towards Armenia increased, resulting in a dominant trade position hereby exceeding Russia. From a geopolitical perspective, the EU was able to increase its influence into the Caucasian area near to the borders of Russia and Iran. This is mostly due to the increased economic dependency created by a higher European share of Armenia’s trade balance and the granted economic aid.

Outcome for Armenia

Armenia itself was able to go through several years of strong growth which was also due to an intensified economic cooperation with the EU. The South Caucasian country could largely reduce its economic isolation and receive important EU financial assistance. Fundamental economic and social reforms have been launched until the country got severely hit by the financial crisis which slowed down the reform process and contracted the Armenian economy. Overall, the commenced trade and customs facilitations included in the ENP haven’t been striking enough in order to augment Armenia’s exports perceivably. It can be detected that Armenia’s exports to the EU only slightly increased during the ENP and EaP. The next chapter analyzes Armenia’s trade and transportation status in general and examines trade relations with other countries.

Chapter 2: Armenian trade and transportation status

Trade regimes

Armenia is a WTO (World Trade organization) member since 2002. It therefore has a liberal foreign trade regime with two import tariffs (0 per cent and 10 per cent), no taxes on export and no considerable quantitative restrictions. Looking at the trade development since 2002, a strong export increase can be detected which is largely connected to the tariff facilitations of the WTO membership. From 2002 to 2003, Armenian exports augmented by nearly 36%.

Table 2. Armenia’s trade development since WTO accession (in mill. Euro)

	Import	Export	Import change	Export change
2002	710.784	363.672
2003	921.240	493.632	5.56%	5.44%
2004	972.504	520.488	5.56%	5.44%
2005	1297.224	701.208	33.39%	34.72%
2006	1577.952	701.208	33.39%	34.72%
2007	2352.816	829.656	49.11%	16.97%
2008	3186.792	761.184	35.45%	-8.25%
2009	2391.192	511.344	-24.97%	-32.82%
2010	2699.208	749.592	12.88%	46.59%

Another mentionable measurement to foster trade facilitation is the general arrangement of the EU Generalised System of Preferences (GSP) from which Armenia benefited from 2006 to 2008. It provided preferential access to the EU market in the form of zero duties on 3.300 products and reduced tariffs for other 3.900 goods. Since 2009, Armenia is participating in the special incentive arrangement for sustainable development and good governance (GSP+). This allows Armenia to export 7.200 products to the EU without any customs duties.   Chapter one however showed that European imports from Armenia remained at a consistent level despite the implementation of the GSP+. Table 2 also illustrates that the customs facilitations since 2006 didn’t increase Armenian exports as significantly as the WTO accession. Armenia does also have FTAs with most CIS countries, e.g. Russia, Ukraine, Belarus, Kazakhstan, Kyrgyzstan, Moldova and Tajikistan.

Trade partners

Next to the EU, Russia is Armenia’s main trading partner reaching 22.1% of imports and 15.9% of exports. Economic ties with Russia are especially close in the energy sector. The Russian company Gazprom supplies Armenia with gas through a pipeline running through Georgia. In 2008, Armenia imported 2.2 billion cubic meters of natural gas from Russia. Overall, 80% of Armenia’s energy system is rated to be under Russian control. After the EU and Russia, the United States mark the third most important export partner, while China follows Russia concerning imports.

In 2010, the volume of bilateral trade with Iran was about $283 million. However, Iranian imports exceed exports from Armenia to a large extent (imports: $228 Mill. exports: $55 Mill.). The number of Iranian tourists has risen in recent years, with estimated 80,000 Iranian tourists in 2010. The land connection with Iran is the second transport corridor for Armenia next to Georgia which enables direct Armenian-Iranian trade without transit. Georgia only represents about 2.2% of Armenia’s external trade. The closure to Turkey and Azerbaijan also limits Armenia’s trade with North-Eastern Iran since the quickest route to major centers in Iran (e.g., Tabriz) passes through Turkish and Azeri (Nakhichevan) territory. Transportation through Georgia is Armenia’s most important transit route, since trade to the EU is conducted via Georgian harbors. For this reason, we will examine the transportation through Armenia’s northern neighbor country in detail.

Transportation through Georgia

The closed western border of Armenia doesn’t only keep the Turkish market away from Armenian businesses; moreover all goods being sent to Europe must be transferred via Georgia and then be loaded on ships sailing across the Black Sea. The mere transport costs when shipping goods through Georgia to Europe are much more expensive than using Mediterranean harbors or the Turkish counterpart Trabzon in the Black Sea.

The first major cost driver on the shipping way to Europe is the land transport from Armenia towards the Georgian harbors due to the country’s landlocked geographical situation and the long distance. From an economic point of view, railway transportation to the Georgian harbors would be the logic solution. However, most transportation is being conducted via road because of better time efficiency and reliability. Second, shipping Armenian goods from the Georgian harbors Poti and Batumi represents a big cost factor especially in comparison to Turkish harbors like Trabzon and the ones in the Mediterranean Sea, which are able to ship a higher capacity. Harbors in the Mediterranean are also able to ship ocean container carriers. For Armenian businesses, the long transportation road to Georgia and the shipping route across the Black Sea therefore means a loss in competitiveness and an obstacle for EU-trade.

Table 3 compares the liner shipping connectivity between Georgia and Turkey. This index includes factors like container carrying capacity and average vessel size. It therefore reflects the overall capacity of a country’s harbors and its connection to world trade hereby representing an indicator for trade revenue.

Table 3. Liner shipping connectivity index, annual 2004-2011

	2004	2005	2006	2007	2008	2009	2010	Average Annual Growth 2004-2010	Growth 2010/2009	Rank 2010
Georgia	3.46	3.81	2.94	3.22	4.03	3.83	4.02	0.09	0.19	134
Turkey	25.6	27.09	27.09	32.6	35.64	31.98	36.1	1.75	4.12	29

Measure: Index (Maximum 2004=100)

One can see that Turkish ports and vessels attached to them can hold a much higher capacity than their Georgian counterparts. Of course it has to be considered that the Istanbul harbor is included in this index. However, Turkish harbors still outrank their Georgian counterparts regarding connection to world trade. Non-tariff barriers resulting from unofficial payments are also considered to be high for Armenian shippers in Georgia. Armenian businesses are struggling to address this issue due to their dependency on Georgian transportation. Georgia remains the only gateway for goods entering and leaving Armenia to the west. As a result from this dependency Georgia has great interest in keeping the current situation that grants the country a stable trade income and lifts its geopolitical significance. Armenia therefore relies on one single neighbor to reach its European trading partners, which is a delicate agreement that can cause major economic impact in case of unexpected political changes in Georgia.

Conclusion

Deriving from the contents of chapter one & two it can be said that Armenian foreign trade underwent several framework changes. Armenia’s accession to the WTO meant a strong trade increase due an easier market access for Armenia’s transitional economy. The enforced economic European Integration since 2006 made the EU Armenia’s most important trading partner and fostered the development of institutional reforms. Customs facilitations were also enhanced due to the application of the GSP+ agreement for the South Caucasian country. However, the unfavorable transportation status Armenia is facing leads to lost trade potential, especially in terms of exports to the EU. The closed border to 50% of Armenia’s direct neighbors also limits Regional integration and anticipates trade relations with Turkey. The next chapter is analyzing current Armenian-Turkish economic relations and prospective opportunities.

Chapter 3: Armenian-Turkish economic relations and opportunities

Status quo

The 325km land border between Turkey and Armenia has been closed since 1993. There are two main crossing points: the rail link between Kars and Gyumri and the Markara/Alican road bridge over the wide Araxes River near Yerevan. Turkey stopped the service on 3 April 1993 as part of sanctions when the Nagorno-Karabakh War broke out. Yet, there is recorded trade between the two countries which is conducted mostly via Georgia. Turkish exports to Armenia are worth about $200 Mill. whereas Turkish imports from Armenia only comprise $1.2 Mill. as of 2010. Thus, Turkish businesses operating in Armenia largely overweigh their neighbor’s counterparts. Despite this fact, Turkish businesses are also facing obstacles because of inefficient border crossings and an underdeveloped transport system. The current status of trading is therefore affected by inefficiency for Armenia and Turkey as well. An open border is economically a logical step to engage a new level of trade between both countries.

Open border effects on Armenia

For Armenian businesses and the country’s economy six open border effects are presented:

1. Improved access to European and Middle East markets and higher trade income

Direct trade with Turkey would offer Armenia significant benefits regarding market access. By being granted to transport goods via its western neighbor, Armenian businesses first profit from the access to the promising Turkish harbor Trabzon and to several Mediterranean ones. We demonstrated the comparative advantage of Turkish harbors compared to their Georgian counterparts in chapter one. Armenian businesses could therefore first improve marginal return in terms of European trade routes and second be able to serve economies in the Mediterranean Sea reaching from Israel to Italy more efficient than in the current situation. Moreover, since most Armenian goods are leaving the country’s capital Yerevan, which is near the Turkish border, the decreased geographical distance in comparison to Georgian harbors demonstrates even more possibilities for increasing trade income.

2. Business opportunities in Turkey

Next to the opportunities regarding economic partners overseas, Armenian companies can conduct business directly in Turkey. Especially the Eastern Turkish provinces at the border to Armenia show huge trade possibilities. It can be argued that the provinces Kars and Iğdır are underdeveloped and far away from any noticeable domestic metropolitan areas. The proximity to Yerevan offers Armenian businesses the chance to reach out for new opportunities in their immediate surrounding area. As an example, Armenian companies could be able to export basic household goods e.g. food, beverages. Furthermore, the Armenian construction materials sector can expand its business to its neighbor, hereby enhancing regional development and infrastructure improvement.

3. Reduced dependency and costs regarding Georgian transit

An open border with Turkey grants Armenia an additional western transportation possibility extra to the existing routes via Georgia. Armenian businesses will become less dependent from the northern Georgian transit and can therefore decrease the risk of trade failures. The Georgian monopoly in transportation of Armenian goods will also be ended. This can lead towards lower costs for businesses conducting their transportation via Georgia. In return, prices for Armenian export commodities will drop which adds to Armenian competitiveness. As currently approximately 70% of all Armenian trading goods are sent via Georgia, a change in this trade regime can have considerable impact on Armenian businesses. Armenian exports are currently concentrated on light and high-value products such as diamonds, jewelry and information technology since transportation costs only account a marginal share to the overall expenditures. It can be argued that especially EU trade will be simplified and enhanced when transport costs are considerably dropping. To project transportation cost savings for Armenian companies in case of a border opening the following calculation has been conducted:

A study made by AEPLAC argues that due to transport via Georgia, 20-25% of costs are added to the nominal value of Armenian goods. We use this founding as a basis for projecting the prospective transport costs via Turkey. In 2009, Armenia exported goods being worth about $698 Mill. 70% of this export value has been conducted via Georgia. By applying the assumption that 25% of the export value has been added because of transportation, the overall transportation costs account to $122 Mill. To come up with prospective transport costs we argue that the overall costs can be put in conjunction with the geographical distance between Yerevan and the Georgian harbor Poti (3,426km direct line distance). Deriving from this estimation we calculate annual transportation costs/km (23.933 $/km). Since the distance from Armenia’s capital to the Turkish harbor Trabzon (2,408km direct line distance) is shorter, the projected transport costs are expected to be $85.8 Mill. In conclusion, annual savings in transport cost account to 29.7%.

4. Increased tourism and people to people movement

An open border can also establish a considerable people to people movement between Armenia and Turkey which will boost the local tourism market. Armenians interested in historical sites located in the border area would have the chance to visit places like Ani or Kars. Also, travelling for international tourists can get easier and will lead to a higher frequency of tourists travelling from Armenia towards Turkey and vice versa. It is expected that many international tourists who travel to Turkey would also use the opportunity to visit Armenia after the border is opened. This can establish a considerable increase in new companies aiming to participate in the tourism market in the South Caucasus.

5. Increased expectations on further EU-support

Via the ENP, Armenia is receiving financial assistance as long as the country meets the conditions expressed in the Action Plan for Armenia. One priority area of the Action Plan which is monitored by the European Commission is “Enhanced efforts in the field of regional cooperation”. An open border with Turkey can surely be seen as an important event towards a cooperative cross-border engagement and can result in an increase in financial assistance in the medium-term.

6. Opportunity to create a “New Silk Road”

The creation of a “New Silk Road” is especially interesting to examine. While in ancient and medieval times trading routes from China to Europe across the Caucasus transported spices, textiles, glassware et cetera, Armenia holds the opportunity to reopen a major trading route connecting East and West. Looking at the Armenian export portfolio one can see that Armenia is holding a comparative advantage in the Jewelry, Precious Metals and Collectibles Industry. Competitive wage rates, tax privileges and skillful labors resulted in a world export share of 0.14% in this sector in 2008 in comparison to Armenia’s total world export share of 0.0073%.   In the near future, an open border to Turkey can bring up new markets for the Armenian mining industry and ease trade connections. Projecting a further political cooperation in the Caucasus, which can result in an open border with Azerbaijan in the long-run, Armenian mining goods are also able to be exported to Central Asian countries. The geographical situation of Armenia is clearly unfavorable in economic terms due to its landlocked situation. However, bordering several countries and being located in the Center of the Caucasus hereby connecting Europe and Asia, Armenia can function as an important land transport gateway. Political rapprochement surely is a basic requirement. An open border to Turkey can mark a first big step.

Risks and limitations

1. Limited customs facilitation between EU and Armenia

Armenia will be granted the tariff quotas included in the Customs Union (CU) agreement when trading with Turkey. However, regarding EU trade the benefits for Armenian companies will probably be minimal. Armenia is already profiting from the GSP+ agreement which is in force since 2009. Due to this agreement and Armenia’s membership in the WTO, there are currently no trade protection measures against imports from Armenia regarding the EU and other WTO countries. A prospective trade facilitation between the EU and Armenia e.g. by the usage of the third-country tariffs included in the CU with Turkey therefore can’t be considered to have a perceptible effect on Armenian exports.

2. Technical barriers in Armenia

For a stable long-term economic benefit especially regarding EU trade relations, several other steps need to be undertaken. The financial assistance Armenia is receiving has already been mentioned. Furthermore, technical barriers need to be tackled so that competitiveness of Armenian goods can be promoted. It is necessary to align Armenian and European Standards especially in regards to product quality. We pointed out that the need for these reforms is also included in the ENP action plan for Armenia. Cost of compliance with EU technical barriers, which mainly arises from the fact that Armenia lacks institutes of certification, must be removed to promote higher trade revenues in the long-run. An open border can only set the groundwork for a stronger alignment towards EU regulations due to a higher trade volume of basic goods and expected fulfillment of requirements included in the ENP action plan.

3. Societal challenges due to labor migration

A stronger People to people movement can also lead towards considerable migration flows between the two countries. Regarding Armenia’s population of about 3.26 Million people and an official unemployment rate of 27.5%, a high labor migration from Turkey might cause challenges for the small country. Citizens from the Eastern provinces, in which unemployment rate is considered to be about 17%, can try to find labor in their neighbor country. It is questionable how well the Armenian economy, which is still trying to overcome the shocks of the financial crisis, can cope with a high labor migration. Also, the Armenian institutional framework dealing with a high number of foreign labors might be challenged. Furthermore, the issue of illegal migration and human trafficking might arise in case of an open-border.

4. Non-tariff/non-official trade barriers

Without institutional preparedness regarding cross-border trade, non-tariff barriers such as unofficial payments, inefficient customs administration, weak rights enforcement and more are likely to arise. These non-official barriers decrease the potential benefit an open border can provide. It is therefore necessary to develop plans on how to carry out institutional reforms aiming to secure a profitable and efficient trade flow. It can be argued that these reforms need to be established before a border opening is accomplished so that they function as a precondition. In the current trade situation between Georgia and Armenia, non-official payments account for 22 to 25% of transportation costs via road transit. Armenia’s trade experiences with its northern neighbor should therefore be regarded as a useful lesson.

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