The cigarette conundrum

Is the customs union a success?

In 2010, Kazakhstan formed a trade union with Russia and Belarus to spur regional trade.  The three countries would lower their trade barriers to one another (barriers to other countries were another matter) and thus begin to integrate their economies.  Or…did they?

Here’s a simple-minded answer.  If the three economies are merging, at least with respect to traded goods, then the international price differentials for those goods should dwindle.  Eventually, the prices of two identical goods – say, a tomato in Russia and one in Kazakhstan, both from the same farm – should differ only by the costs of transporting the exported fruit and of arranging the sale.  If the price differential exceeds these costs, then an entrepreneur can profit by purchasing tomatoes at the cheaper Site A and selling them at the more expensive Site B.  Supply will decrease at A, raising its price, and increase at B, lowering its price.  The price differential (the B price minus the A price) will diminish until it just covers the transport and transaction costs.

For example, suppose that a tomato in Kazakhstan costs five tenge to grow and one tenge to ship to Russia.  If the two economies are integrated, then the tomato should sell for the equivalent of six tenge in Russia and for five in Kazakhstan.  If the Russian price is seven tenge, then the prospect of a tenge of profit will induce exports to Russia until that price falls to six.  But if the two economies are still separate, then the price differential may persist, since a trade entrepreneur cannot easily attempt arbitrage.

Pricing puffs

Do such price differentials actually exist?  To answer this question, consider the cigarette.  It may be ideal for trade (more so than cement, anyway) since its value well exceeds its transport cost.  Some brands may carry a higher price than others, because smokers think them better.  But the cost of transporting a cigarette by a given distance is pretty uniform across all brands.  If the Russian and Kazakhstani economies are integrating, then the price differential for a cigarette of a given brand in the two countries should be about the same for all brands.  If the differential is six tenge for a Winston, then it should also be about six for a Parliament.

A few weeks ago, the Kazakhstani business weekly Kursiv’ published cigarette prices for eight brands in Russia, Kazakhstan and Kyrgyzstan.  For the first two countries, the price differential for a pack varied sharply over the brands, from 69 tenge for the brand LD West to 146 tenge for Parliament.  Relative to the average price differential, a measure of the dispersion in the price gap – the standard deviation – was 27%.

Curiously, the price differential for Kazakhstan and Kyrgyzstan was not as large  – just from 48 tenge (for Parliament) to 86 (Marlboro).  Relative to the average price differential, the standard deviation was only 18%.                  

Moreover, Russian and Kazakhstani cigarette prices are diverging.  On average across brands, a one-percent increase in the price of a Russian pack relates to a rise of just over one-half of one percent in the price of a Kazakhstani pack (controlling for the prices in Kyrgyzstan).  Since the Russian price is already higher than our price, the gap between the two may well widen when they rise in response to a hefty cigarette tax that Russia plans for the next few years.  The two national markets may not merge; they may drift apart.  But the data are too scanty to permit us to be sure of this.                    

As I said, this approach is simple-minded.  We can’t draw hard-and-fast conclusions about the customs union from a sample of prices of only eight cigarette brands at a particular time.  But the data do raise a larger question:  What has the union accomplished, aside from tightening Russia’s grip on Kazakhstan’s economy?  --Leon Taylor, tayloralmaty@gmail.com

References

Murtazyn, Azat.  Dim s ‘dordoya’.  Kursiv’.  August 29, 2013.  Page 2.