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International Trade and Finance
Notes "destination" system. For trade within the CIS, exports are taxed but imports are not, the "origin
system." Participation in the customs union will require a value added tax that is harmonized with
the system applicable in the customs union, i.e., the current mixed system. Berglas (1981) has shown
that under certain assumptions (including flexible exchange rates) the origin or destination systems
are equivalent and do not tax the trade regime if designed properly. Since the VAT rates of most CIS
are approximately equalized, the allocation of real resources and trade flows among the other CIS
countries is not seriously affected, but it is important to harmonize these taxes within a mixed system
to avoid arbitrage and distortions.
What is more likely to be a problem with a mixed VAT system is the allocation of tax revenues. Even
if the VAT rates are harmonized, countries with a trade deficit within the customs union and a trade
surplus outside the customs union will experience an adverse transfer of VAT tax revenues toward
the partners in the customs union with the opposite trade pattern. To illustrate, suppose the trade of
Azerbaijan is balanced overall, but it imports exclusively from, say Russia, and exports exclusively
outside the customs union, and that Russia has the opposite trade balance.
Since the destination system applies on trade outside of the CIS, and the origin principle applies on
trade within the CIS, Azerbaijan would collect no VAT tax revenues (neither on its imports nor its
exports), and Russia would collect all the VAT revenue on trade (Russia collects VAT on both its
exports to Azerbaijan and its imports from the rest of the world). Thus, even though the mixed VAT
system would not change relative prices and is therefore non-distortionary because there is no impact
on the allocation of resources, in this example it would represent a transfer of VAT revenues from
Azerbaijan to Russia.
Dynamic Effects
In general, there are two basic ways in which the rate of output growth can increase: First through a
faster growth of factor inputs and second through increases in the growth of total factor productivity.
Assuming no changes in population growth and in labor force participation rates, the growth of
factor inputs essentially boils down to the rate of investment in human and physical capital. Total
factor productivity on the other hand is thought to be dependent in the medium and long term on
improvements in technology and knowhow.
More generally, access to a diverse mix of products including modern technology appears to be very
important for the growth process. New and diverse technologies are constantly appearing and these
new technologies allow an increase in the productivity of both capital and labor.
The question that needs to be addressed then is how a customs union among the CIS countries will
affect output growth through its impact on access to technology that enhances productivity and
through its effects on the rate of investment in human and physical capital.
There is some evidence that developing countries total factor productivity is positively related to the
access of technology and knowledge embodied in imports from developed countries. In the case of
CIS and other transition economies, access to diverse and modern intermediate products from world
markets appears especially crucial as these economies attempt to transform themselves from an
industrial structure that was inherited from the era of the former Soviet Union, i.e., that was outdated
and frequently not based on comparative advantage. It is very important that these countries move
away from reliance on technologies that are available only in the countries that were part of the
former Soviet Union, since the most dynamic and modern technologies are found elsewhere. Yet,
tariff protection for products that are produced in the customs union will discourage the introduction
of new products and technologies from outside the customs union and free trade area, technologies
that would boost the growth and development of the CIS members. Thus, on the question of enhancing
growth through improvements in total factor productivity the effect of the customs union (and for
that matter of the exisitng free trade area) on all its members is likely to be very negative.
There are several ways through which a customs union could affect the rate of investment in member
countries: (a) through a change in tariffs and hence in the cost of imported capital equipment that
changes the rate of return on investment and the rate of capital accumulation; (b) through affecting
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