A Phased Strategy for Opening Armenia’s Western Border

1. A Phased Strategy for Opening Armenia’s Western Border Armenian International Policy Research Group Torosyan, Gagnidze, Beilock

2. Introduction This study: • outlines a plan to open Armenia’s borders with Turkey • examines likely changes in trade flows between Armenia and Turkey • discusses how open border will affect other countries in and around the region, including: Azerbaijan, Georgia, Iran, and Russia

3. Literature review Polyakov “Changing Trade Patterns after Conflict Resolution in South Caucasus”, 2001 • uses a gravity model to estimate trade flows between Armenia and Turkey • estimates are overly optimistic: the overall effect on Armenian economy from border opening is calculated to be as much as 38% of the the size of GDP.

4. Literature review AEPLAC’s “Study of the Economic Impact on the Armenian Economy from Re-Opening of the Turkish-Armenian Borders”, 2005 • estimates a gravity model of trade to calculate short and medium term effects of border opening. Uses CGE modeling to estimate longer term effects of border opening. • too conservative in estimates of potential economic effects of border opening.

5. Current access to Turkey Currently almost all overland trade between Armenia and Turkey takes place via Georgia. There are two major border passages that are being used for Armenian trade with Turkey: • passage G1 - south of Batumi • passage G2 - south-west of Akhaltsikhe An additional passage that is sometimes used is G3 south-west of Akhalkalaki. No railroad between Georgia and Turkey.

6. Current access to Turkey

7. Strategies for Opening the Border There are at least six potential border crossings by road and one rail connection between Armenia and Turkey. Stage I: Opening two passages to handle initial traffic and test systems. A1 – Metsamor A2 – Gyumri

8. Strategies for Opening the Border Stage II: As traffic volumes increase, both countries could set up additional border crossings. Options: A3 - Margara village A4 - Bagaran village A5 - Haykadzor village A6 - Paghakn village

9. Looking at the Region What are some of the potential benefits of open borders to the following countries of the region? • Azerbaijan • Georgia • Iran, Gulf States • Armenia • Turkey

10. Azerbaijan The scenario around which the project has been developed is the opening of borders between Turkey and Armenia, but not between Azerbaijan and Armenia. However, Turkey closed the border in support of Azerbaijan. Ending it without Azerbaijan’s acquiescence would be politically difficult, at best, and more likely impossible. To have Azerbaijan’s consent, concessions favoring Azerbaijan could be negotiated.

11. Armenia’s Potential as aTransshipment Corridor • north-south routs through Armenia are both longer and more difficult than other routes • in an east-west direction, Armenia has considerable potential for transshipments: between Baku and Kars or Istanbul, routes through Armenia are as short as or shorter than alternative routings and have to negotiate fewer natural barriers (i.e. mountain ranges). • moreover, the only rail connection between the Caucasus and Turkey is through Armenia.

12. The Georgian Buffer Our study assumes that full cessation of the closed border between Armenia and Azerbaijan (“mainland”) is impossible. Fortunately, the main east-west rail line and roadway connect Armenia and Azerbaijan via Georgia => carriers and freight can transit between Armenia and Azerbaijan without crossing a common border.

13. Transshipments via Armenia With an open border between Armenia and Turkey, Turkish carriers would be free to transit Armenia, improving linkages between Azerbaijan and Turkey. Armenia’s rail system also could carry transshipments of freight bound to or from Azerbaijan. There would have to be • non-discriminatory treatment of cargoes • at or near cost level fees

14. Access to Nakhichevan Armenia could consider effecting a partial opening of the border with Nakhichevan. This might be conceived of as Stage III of a phased opening, giving better access to • South Armenia • Nakhichevan • Iran

15. Georgia Because of the closed border, Georgia has had a virtual monopoly over surface freight movements to and from Armenia. For many years Georgia levied surcharges on all freight to and from Armenia. Recently Georgian government has taken steps to lower transit fees for Armenian trade, and also to limit unofficial payments on the road. Virtually all freight moving between the West and Azerbaijan uses Georgian roads or rails and its ports.

16. What’s in for Georgia? Open borders between Armenia and Turkey may reduce the volumes and/or premiums for Georgia from Armenian transit traffic, but is unlikely to threaten transit trade to/from Azerbaijan going through Georgia. If transit traffic through Nakhichevan were permitted, Georgian importers and exporters would benefit from improved access to Iran and the Gulf States. Georgian importers and exporters would also benefit from improved road and rail access to some parts of Turkey.

17. Increased Competition in Turkey? There is a possibility of negative effects of export diversion for Georgia when Armenian-Turkish border opens. The magnitude of this effect would depend on how much overlap there might be between Georgian and Armenian exports to Turkey. To determine the extent of that overlap we use export similarity technique, also known as Finger-Kreinin Index (FKI).The index ranges from 0 (no overlap) to 1 (complete overlap).

18. More Compliments than Substitutes Armenian and Georgian export flows to the EU in 2004 did not have a big overlap: FKI is calculated to be 0.182=> Armenian and Georgian goods are not very close substitutes in European markets. Products that do overlap either have a small share in overall exports in both countries, or are homogeneous in nature => Development of Armenia-Turkey trade will not have a very strong diversion effect onGeorgian exports to Turkey.

19. Iran, and the Gulf States Opening the border with Turkey will allow shortening of travel distances to • Iran (to Tabriz, by road) • Syria (to Aleppo, by road and rail) • Lebanon (to Beirut, by road and rail) • further to the south. Railroad from Gyumri will allow convenient access to Greece (Thessaloniki) and other European counties.

20. Russia? Trade benefits from open border would be magnified if road and rail transits through Abkhazia were also restored.

21. Estimating Changes in Regional Trade Pattern To assess potential trade flows between Armenia and Turkeya gravity modelis developed and estimated. Model features: • Countries: transition countries, developed European countries, Turkey, and Israel • Estimation: data for 1999 are used to estimate the model, data for 2004 are used to predict potential trade flows between Armenia and Turkey.

22. Results: TE Imports from Europe and Turkey

23. Results: TE Exports to Europe and Turkey

24. Estimating Changes in Regional Trade Pattern Our model explains 75-80% of total variation in trade for sample countries. Most of the coefficient estimates are highly significant and are in line withexpectations. To check the robustness of our results we estimate Armenia-Turkey trade volumes for 2004 and compare them with actual data: Estimated Actual Imports from Turkey $33,887,690 $37,498,051Exports to Turkey $3,918,173 $1,200,233

25. Results: Open Border Effect After obtaining gravity model estimates we calculate the increase in trade that will result from border opening • estimated volume of Armenian imports from Turkey is $51,041,170, some 50% higher than with closed border • estimated volume of Armenian exports to Turkey is $5,404,574 which corresponds to 38% increase in exports

26. Results: Reduced Distance Effect If we adjust distance as well to reflect shorter travel time increase in trade volume is likely to be even higher: • each 10% of reduction in distance will lead to 15.6% increase in imports from Turkey • each 10% of reduction in distance will lead to 12.6% increase in exports to Turkey

27. Results: GDP Growth Our estimates are for 2004 levels of GDP and GDP per capita. However, due to • High rates of GDP growth in Armenia • Turkey’s emphasis on increasing GDP we are likely to observe a further expansion in Armenia-Turkey trade relations. GDP growth rates in 2005 were 5.6% in Turkey and 13.9% in Armenia. This would increase our exports estimates to Turkey by 23.8% ($1.3 mln.), while imports from Turkey would be 20.8% higher ($14 mln.)

28. Results In addition, we should take into consideration the fact that with open border there will be railroad connection between Armenia and Turkey, which is not reflected in our model. Hence, there is another important factor that will influence trade volumes between our two countries.