KYIV BLOG: The EU is not ready for Ukraine

KYIV BLOG: The EU is not ready for Ukraine
Ukraine's agriculture sector is too big for the EU to be able to swallow it as a member without causing a revolution in industry across the continent. / bne IntelliNews
By Ben Aris in Berlin April 21, 2023

Two events in the last week have highlighted that the EU is not ready to make Ukraine a member: five countries have banned imports of cheap Ukrainian grain; and talks on the eleventh sanctions package have died before they started.

Five countries – Poland, Hungary, Slovakia, Romania and Bulgaria – have banned, or threatened to ban, imports of cheap Ukrainian grain, which could have put their own farmers out of business.

Bottled up by a Russian naval embargo of Ukraine’s Black Sea ports, millions of tonnes of grain has been sent west by train and dumped at on Central European markets at prices that undercut local producers.

Nominally this grain was destined for Africa to head off a potential food crisis but that is a myth. It is true that African countries remain heavily dependent on imports of Russian and Ukrainian grain. And it is also true that if they are cut off some countries would face shortage or famine. But unblocking Ukraine’s grains exports ended up largely benefiting Western companies who had contracts to use the grain as animal feed for industrial purposes.

Ukraine and Moldova were given EU candidate status last June, but in reality the former is very unlikely to be allowed to accede for years. The problem is Ukraine is an agricultural powerhouse and home to some of the most fertile land in the world, the famous “black earth” regions.

It is also the third most populous country and as the poorest nation on the Continent, now worse off than even lowly Moldova, if Ukraine were granted the free movement of labour capital and goods that comes with membership, its agricultural output would rapidly swamp the rest of Europe. The rise of right-wing parties in Europe has already made immigration a political hot potato in many countries, and opening the gates to millions of Ukrainian migrants would be a difficult pill to swallow; some 6mn Ukrainians had already left the country to look for work before the war started and another 6-8mn have followed since then as refugees.

Europe’s Common Agricultural Policy is baked into to the core of what the EU does, and eats up about a third of the EU annual budget. It has an extremely powerful lobby that is likely to resist Ukraine’s accession for as long as possible, as Ukraine’s membership would turn Europe’s agricultural sector on its head.

It’s all about the money

Talk of a famine in Africa has been a ruse by Eurocrats to mask the bigger underlying issues associated with imports of cheap Ukrainian grain.

In reality only 17% of Ukraine’s grain exports ended up in Africa last year, whereas 36% went to the EU and another 47% to Turkey and Asia combined, according to the Wilson Centre, a fact that the Kremlin has also gleefully pointed out.

“Indeed, contrary to popular perception, the majority of grain exports that were shipped out of Ukrainian Black Sea ports didn`t go to the poorest and most [needy] countries but rather to Europe and Turkey,” the Wilson Centre reported in January.

During the last five months of 2022 after the grain deal came into effect, more than 12.3 tonnes of grain were shipped from Ukraine, with 44% of it being corn rather than wheat (29%).

The main destinations of the cargoes were Spain (2.5mn tonnes), China (2mn tonnes), Turkey (1.9mn tonnes), Italy (1.3mn tonnes) and the Netherlands (898,000 tonnes).

“Most of the grain that had been held up in Ukrainian silos after February 24 was corn (not wheat), contracted by international companies, not necessarily to feed people but, for example, to use as biofuel or animal food. Therefore the agreement wasn’t designed to immediately avert famine in countries like Yemen or Somalia but rather to stabilise the market and contain prices, which in turn hurt countries’ ability to purchase food,” the Wilson Centre reported.

Europe has been struggling to cope with sky-high inflation, mostly driven up by record energy bills and soaring food inflation. As soon as the Istanbul grain deal was signed last July, wheat prices immediately returned to normal. (chart)

This year is seeing more of the same. As of March 2023, over 23mn tonnes of grain and other foodstuffs have been exported via the Black Sea Grain Initiative, according to the Council of Europe, but again, very little is actually going to Africa: so far this year only 456,000 tonnes of wheat have left Ukrainian ports en route to Ethiopia, Yemen, Djibouti, Somalia and Afghanistan. Once again the bulk of Ukraine’s grain exports are headed to Europe.

In its report, the Council of Europe says that 45% of Ukraine’s grain exports goes to “developed markets” but only identifies the remaining 65% as going to “developing” markets, which could include the Central European countries. It does not report how much grain has been sent to Africa.

The export of cheap Ukrainian grain has affected European markets far more than African ones. The low cost of wheat has been a non-monetary policy godsend for European central bankers, as it can bring down inflation rates.

However, the downside of this policy is the extremely powerful agriculture lobby is upset, as domestic farms are unable to compete with the copious amounts of cheap imported grain.

As prices tumbled Poland quickly banned imports of Ukraine’s grain until the summer – an essential source of foreign exchange earnings for cash-strapped Kyiv. Warsaw was quickly followed by Budapest and Bratislava. Sofia and Zagreb, which are suffering from the same problem.

Ukraine is on course this year to run a $38bn budget deficit, but earned about $20bn from grain exports last year. Cutting Kyiv off from one of its biggest markets would blow a hole in the already very distressed budget.

The European Commission acted fast. Within days Poland was told that it can’t make a “unilateral decision” and was told to unblock both imports and transit to the rest of Europe.

Poland demanded compensation for its farmers and President of the European Commission Ursula von der Leyen quickly rolled out a rescue package that includes €100mn of subsidies for EU farmers. That money would come on top of €56mn package that was provided for farmers in Poland, Romania and Bulgaria last month.

Von der Leyen also proposed taking “preventive measures under the applicable trade rules” in regard to certain grains such as sunflower and rapeseed, spokeswoman Dana Spinant said.

Brussels has previously insisted that any unilateral bans on the Ukrainian exports were “not acceptable” and noted that trade policy is solely an EU responsibility.

EU is done with sanctions

Europe’s need for affordable inputs from Eastern Europe has also brought the sanctions drive to an end. There have been ten rounds of sanctions, but each round has become progressively weaker and has contained more calve outs and exemptions as the less enthusiastic members of the EU – led by Hungary – try to protect their economic interests.

The latest package, the tenth package of sanctions, was the weakest, containing little more than the addition of around 120 people, many of them from Russian media, and a few commercial banks.

Work on the eleventh package is underway, and countries like Ukraine and Poland want the state-owned nuclear power monopolist Rosatom and the diamond miner Alrosa included, but that is a bridge too far for many EU members.

“We are done,” one of the EU officials working on the bloc’s future sanctions told the Financial Times. “If we do more sanctions, there will be more exemptions than measures.”

Several earlier rounds of sanctions were already significantly watered down thanks to vested sovereign interests. The fifth sanctions package included bans on EU shipping, but thanks to Greek lobbying on behalf of its a very large shipping fleet, the ban was softened to allow Greek ships to work with Russia on non-European routes. Greek ships increased their share of Russian cargo from 35% to 55% as a result, the Institute of International Finance (IIF) reported at the time. Likewise, the reluctance to sanction Alrosa is a result of lobbying by Belgium, as the city of Antwerp is a major international diamond trading centre.

By far the most effective and painful was the “massive package” of sanctions that were rolled out only days after the invasion of Ukraine, that included the CBR sanctions that froze some $300bn of the Bank of Russia’s reserves and the SWIFT sanctions that in effect cut Russia’s banking sector off from the international financial system.

Last month Europe’s top diplomat Joseph Borrell admitted that the EU has run out of ideas on what to sanction next, and von der Leyen also said not to expect anything new in the eleventh package, which only would focus on making the previous sanctions work better. That has been accompanied by Western and Russian diplomats travelling the world to drum up support for their sides.

Sanctions have reached the point where they do more harm to Europe than they do to Russia. Russia’s economy has been battered by sanctions, but it has weathered the story far better than expected. This year Russia is anticipated to grow a little, but it will be expanding faster than Germany and the UK, both of which are in, or close to, recession as a result of the unfolding polycrisis.

The irony is that the same arguments apply to Russia as they do to Ukraine. In 2001 Putin travelled to Brussels and met with the then-president Jose Barroso and asked that Russia be allowed to join the EU. But Russia is also an agricultural powerhouse, also home to black earth and together with Ukraine one of the biggest grain producers in the world. However, more than this, Russia has three times the population and is a powerhouse in a number of other sectors too.

Barroso rejected the request out of hand. That led Putin to launch his Eurasian Economic Union (EAEU) project that would, in theory, allow the EU and EEU to tie up and create a single market “from Lisbon to Vladivostok”. Those dreams are smashed now, but keeping Russia outside the EU actually suits Brussels very well: Europe remains in deficit for many of the key inputs that Russia supplies like metal, energy, grain and fertilisers. Russo-EU trade turnover peaked in 2012 at €203bn – a level that China is about to reach.

But as it is outside the EU, and always will be, trade between two can be regulated and Europe can take advantage of Russia’s grain production, for example, without having to pay the common agricultural policy (CAP) subsidies it would pay a member. From this perspective a tie-up between the EU and the EAEU would make a lot of sense.

Common Agricultural Policy 

Europe’s CAP is the major obstacle in the way of Ukraine’s membership. Poland, Hungary and Slovakia have moved to block imports of Ukraine’s grain at a time when the Ukrainian economy is on its back foot and agricultural output is down by a third from normal. And even then these countries can’t compete with it.

If the Ukraine became a member of the EU then foreign investment would pour into the sector and billions would go into improving shipping and rail links to tap Ukraine’s full agricultural potential.

Another problem would be that as a member, Ukraine would become eligible for billions of euros in subsidies under CAP. Launched in 1962, CAP was designed to ensure food production and, crucially, to support farmers' income as they typically earn 40% what non-agricultural workers get, according to the EU. Given that Ukraine is currently paying some of the lowest wages in Europe then the EU would be on the hook to subsidise the entire sector’s payroll. These subsidies already account for about a third of the entire EU budget. (chart)

The power of Ukraine’s agricultural sector has already led to severe restrictions on the quotas of duty-free exports to the EU under the Deep and Comprehensive Free Trade Area (DCFTA) already in place. These quotas are typically used up in first the first few weeks of each January and set at very low protectionist levels. The DCFTA is neither deep nor comprehensive.

And it is not just grain at issue. Ukraine produces enough eggs to supply almost all of Europe. It is a major producer of poultry and would put most of Europe’s already struggling chicken farms out of business. Before the war started it was already producing a quarter of the world’s sunflower oil and remains a top ten producer of wheat, barley and honey, according to the Financial Times.

Being self-sufficient in food production is not just a question of economics. It also widely seen as a question of national security. The economic principle of comparative advantage argues that the EU should abandon its attempts to feed itself with the ecologically damaging intense farming techniques and simply outsource a large part of its food production to Ukraine. But having just come out from under the rock of over-dependency on Russian gas, the last thing politicians in Brussels would vote for is to make the EU dependent on Ukraine for something as basic as food. But with Ukraine a full member of the EU that is what they would get.