Ukraine's unconsidered losses from the annexation of Crimea: What should we account for in the DCFTA forecasts?

• DOI: http://doi.org/10.1111/rode.12574
• Author: Hannah Schürenberg‐Frosch,Zoryana Olekseyuk
• Published date: 01 May 2019
• Date: 01 May 2019

REGULAR ARTICLE

Ukraine's unconsidered losses from the annexation

of Crimea: What should we account for in the

DCFTA forecasts?

Zoryana Olekseyuk

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Hannah Schürenberg-Frosch

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1

German Development Institute/

Deutsches Institut für

Entwicklungspolitik (DIE), Tulpenfeld 6,

D-53113,Bonn, Germany

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FernUniversität in Hagen

Correspondence

Zoryana Olekseyuk, German

Development Institute/Deutsches Institut

für Entwicklungspolitik (DIE), Tulpenfeld

6, D-53113 Bonn, Germany.

Email: zoryana.olekseyuk@die-gdi.de

Abstract

In March 2014 Crimea unilaterally declared its indepen-

dence from Ukraine and joined the Russian Federation. The

separation of a part of a state's territory and economy is an

interesting matter to examine. The economy of Ukraine has

not only shrunk, but also changed its structure as Crimea

had a quite distinct production pattern compared to the rest

of Ukraine. Moreover, policy measures initialized before the

separation may have different effects once applied only to a

part of the former economy. This paper proposes a strategy

to model the separation of part of an economy and its inclu-

sion into another country and applies this strategyto the case

of Crimea, Ukraine, and Russia. Having constructed a model

for the new geographical and economic situation, we rein-

vestigate the possible effects of a Deep and Comprehensive

Free Trade Agreement between Ukraine and the EU and

compare the results for the situation with Crimea as part of

Ukraine. We find that the annexation of Crimea leads to sev-

ere economic losses for Ukraine which are partly overpro-

portional compared to Crimea's economic size. These

negative effects can be compensated by implementing the

DCFTA with the EU as we also show in our modelresults.

KEYWORDS

territorial changes, free trade agreement, CGE, Melitz, DCFTA, EU,

Russia

DOI: 10.1111/rode.12574

Rev Dev Econ. 2019;23:877–901. wileyonlinelibrary.com/journal/rode © 2018 John Wiley & Sons Ltd

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INTRODUCTION

In February 2014 the Crimean peninsula unilaterally declared its independence from Ukraine. In a

referendum in March 2014 the Crimean people declared their wish to join the Russian Federation.

Although the declaration of independence and the referendum are not acknowledged by Ukraine

and most of the international community, Crimea is de facto now a Russian republic and Russia

has put measures in place to integrate it into the Russian Federation. Hence, as a matter of fact the

economic capacity of Crimea is no longer available to the Ukrainian economy. As Crimea consti-

tuted 5.2% of the Ukrainian population and 3.7% of Ukrainian gross domestic product (GDP) in

2013,

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this is a non-negligible loss for the fragile economy of Ukraine.

The separation of a part of a state's territory and economy is an interesting matter to examine.

The economy of Ukraine has not only shrunk, but also changed its structure as Crimea had a quite

distinct production pattern compared to the rest of Ukraine. Moreover, policy measures initialized

before the separation may have different effects than expected, once applied only to a part of the

former economy. The separation of the Crimean economy from Ukraine leads to a loss of

resources (labor, capital, land, natural resources) but also to reduced foreign direct investment

(FDI) inflows, losses in efficiency and productivity, disrupted production chains and (temporarily)

closed businesses. In addition, unexpected migration needs to be considered. It is not straightfor-

ward to include this in an economic model. As such incidents are scarce, there is also only a very

small literature on the issue of territorial changes and their economic effects.

Ukraine's Deep and Comprehensive Free Trade Agreement (DCFTA) with the EU has been

broadly evaluated in the literature due to its implementation in January 2016. Various studies (see,

e.g., ECORYS & CASE-Ukraine 2007; Emerson et al., 2006; Maliszewska, Orlova, & Taran,

2009; Movchan & Giucci, 2011; Olekseyuk, 2016; Olekseyuk & Balistreri, 2017). quantify the

impact of this policy reform and suggest welfare gains for Ukraine ranging from 3% to 12%. How-

ever, all these studies are obsolete as they fail to consider the latest substantial changes of the

country's economy associated to Crimea joining Russia as well as the separatist movement in east-

ern Ukraine. Since the losses from the military conflict in eastern Ukraine are still growing

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and

cannot be reliably measured, the annexation of the Ukrainian peninsula has to be taken into

account while evaluating the DCFTA impact. This paper proposes a strategy to model the separa-

tion of part of an economy and its inclusion into another country and applies this strategy to the

case of Crimea. After having constructed a model for the new geographical and economic situa-

tion, we reinvestigate the possible effects of the deep integration between Ukraine and the EU and

compare the results for the situation of Crimea being a part of Ukraine with the de facto case of

belonging to Russia.

There are only a handful of instances of territorial change in recent years and hence only a few

papers proposing ways to model such instances with modern economic frameworks. The only

study also treating the case of Crimea was conducted by Barry (2014) and includes only a uniform

reduction of Ukraine's factor endowment induced by the separation of Crimea and the eastern parts

of Ukraine. The results indicate that Ukraine's real GDP will fall by nearly 15% and the welfare

will decline by US$7 billion. This is a surprisingly large effect, given that the losses for the

Ukrainian economy are only partly covered in the model.

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There exist three studies on the effects of a hypothetical reunification of Korea: Chang (1997),

Noland, Robinson, and Liu (1998), and Noland, Robinson, and Wang (2000). These papers, how-

ever, are not fully applicable to our research question as they treat the fusion of two formerly sepa-

rated economies. The papers model, more or less, only the installation of a free trade area with

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OLEKSEYUK AND SCHÜRENBERG-FROSCH