A general equilibrium evaluation of the fiscal costs of trade liberalization in Ukraine

The establishment of an Association Agreement/Deep and Comprehensive Free Trade Agreement (AA/DCFTA) with the European Union (EU) would be the next significant step towards Ukraine’s deeper integration into the world economy. Despite widely expected additional welfare gains, the signing of the AA/DCFTA at the Third Eastern Partnership summit in November 2013 in Vilnius was suspended by the Ukrainian government due to geopolitical concerns and a severe economic and financial crisis in Ukraine coming along with high external debt and a substantial public budget deficit. This puts the fiscal consequences of Ukraine’s continued liberalization into focus, as transition and developing countries face higher fiscal costs associated with trade integration. Accordingly, this paper contributes to the literature by analyzing the part of the potential EU-Ukraine DCFTA which leads to a loss of tariff revenues, namely the tariff elimination. In particular, we apply a static Computable General Equilibrium (CGE) model for the single small open economy of Ukraine and focus on the effects of Ukraine’s unilateral tariff elimination by simulating three scenarios reflecting different means to compensate for the loss of tariff revenues. It turns out to be important to take these costs into consideration while modeling trade liberalization, as the results vary significantly across the scenarios.