Russian policies of accelerated development of the economy

Publication date
Thursday, 21.03.2002

Pavel Zhukov

International conference "Post-Communist Economic Growth" Moscow, March 20-21, 2002

Liberalization of operations with foreign currency and banking activities, industrial policy, overall improvement of the investment climate, Russia's participation in the European integration processes and its possible joining the euro zone in future.

When one makes a review of Russia's development in the period between 1992 and 2001 one can draw a conclusion that there exists a certain "critical level" of some busi-ness climate (comprised of the investment climate, the macroeconomic situation and market expectations). Falling below this level makes the economic activity fade, reaching above it will cause an economic and investment growth. A self-sustaining economic activi-ties fading happened in the period of 1994 - 1998. But taking as a starting point that be-tween 1999 and 2001 Russian economy showed a manifest capability of a self-sustaining economic growth, one can make a supposition that the economy of Russia has overcome this "critical level" of business climate. A slower economic growth rate at the end of 2001 though as well as an evident manifestation of a recession at the beginning of 2002 makes one doubt this. What are the business climate factors that call for most doubts?

1. Economic growth problems in Russia.

As regards the recession of 1994 - 1998 it is evident that the main (critical) drags on the expansion of the economy were mistakes by the government in the budget sphere and monetary policy. By the example of Russia (and not only Russia) one can see that the macroeconomic situation and economic policies by the government are of a decisive im-portance for economic growth (at least for countries with weak economies), other condi-tions catch up with the growth or deteriorate following the recession.

A possible reason for this is that a sustainable development prerequisites confi-dence of subjects of the economy in macroeconomic policies of the government and positive assessments of prospects of internal market development. The major economic mistakes of the 1994 - 1998 period were connected in the first place with an ex-cessive strengthening of rouble (sequent of "the Dutch disease", a problem that was only acknowledged recently), in the second place with a hyper-yield of the GKO-OFZ (which absorbed the lion's share of investment resources and even turnover means of enter-prises) and in the third place with an unprecedented monetary compression. All these mis-takes brought to an economic drag, crisis of non-payments by enterprises, a budget crisis and a serious exacerbation of social problems.

The 1998 devaluation played the role of a genuine "shock therapy" for the economy of Russia. Year 1999 witnessed a little (that passed nearly unnoticed) financial revolution in the real sector: total profits excessed total losses, profits having an uptrend, losses hav-ing a downtrend. In other words, the real sector of Russia's economy on the whole be-came profitable. This put an inglorious end to the then starting to develop theories that the whole of the real sector in Russia allegedly produced only a negative added value (and existed only at the account of a covert crediting provided by raw materials branches). We saw how restoration of undistorted price reference points in conditions of an econ-omy very close to a market one caused a quick improvement of all sphere of eco-nomic life. The problem of non-payments practically became a problem of the past; barter and promissory notes turnover were reduced to a minimum. In the years of 1999 - 2001 Russian economy not merely restored the pre-crisis GDP, but also displayed steady growth trends. Real wages and salaries in 2001 exceeded the level of the beginning of 1998 by approximately 20% (though real incomes of the population on the whole were merely restored to the pre-crisis level). All these positive trends against the background of a lower inflation rate in many cases can be referred to the positive effect of the monetary policy of the Bank of Russia. To the credit side of the Government one can also refer a better collection of taxes, a considerable increase of budget revenues that resulted in a surplus of federal budgets in 1999 - 2001, an appreciably better budget discipline and finally elimination of the problem of under-financing fr om the federal budget (together with the highly questionable practice of tax offsets).

Positive changes in the business climate have become a fact: the economic situa-tion vector started quite visibly pointing in the direction of upsurge in national economy, this upsurge lasted for 3 years and this fact was quite distinctly acknowledged by eco-nomic units having become the basis for their investment plans. However, this does not mean that the political and business elites understood the reasons for economic growth correctly and were ready to pursue corresponding policies everywhere. The contrary is more likely: the majority of documents by the Government and comment by economists before 2001 pointed to the opposite. The economic growth was attributed to the rouble de-valuation only, later to oil prices growth, sometimes their comment looked quite incoherent. Understanding of the fact that the economic growth was called forth by a self-sustaining internal demand development started to form only by year 2001.

There are first signs of understanding of the fact that one of major reasons of Rus-sia's macroeconomic problems is "the Dutch disease". Though "the Dutch disease" is still understood in a very primitive way: as a surplus of foreign currency on the currency mar-ket, which provokes over-evaluation of rouble exchange rate. But neither this simplified version was taken into account in defining economic policies. The main objective is still de-fined (like before year 1998) as a lower inflation rate, and it is still understood as nearly an end in itself in economic policies (it is implied that the state does not play any role further, the rest will be done the "invisible hand of the market"). A stronger real rouble to US dol-lar exchange rate remained one of instruments of this lower inflation rate policy.

The first person, which drew public attention to a redundant reinforcement of the rou-ble exchange rate, was apparently Andrey Illarionov. The econometric methods that Il-larionov used for an empiric calculation of the coefficient that correlates foreign currency exchange rate and economic growth (GDP growth) were not quite convincing, as far as the quantity of data used by him was obviously insufficient to prove the correlation. Though, the relation of the desirable relationship between baskets of goods prices in differ-ent countries and economic levels (per capita GDPs) deduced by him seems to be quite adequate, also because it is based upon the well known and theoretically and empirically proved effect of Balace-Samuelson.

According to estimates by Illarionov the real rouble to US dollar exchange rate grew in 1999 - 2001 by 27%, the exchange rate to euro by 36%, while the real exchange rate compared to currencies of the main trade partners of Russia grew by 68%, which had a critical effect on competitive abilities of Russian goods and commodities. Consumer goods imports increased in 2001 at the rate of 40-60% and more, imports as whole in 2001 grew by 20%.

It should be noted separately that in 2001 rouble even in its nominal value showed to be stronger than the German mark and euro. That would have been a won-derful achievement had the economy of Russia at least remotely been catching up with the German economy! But the problem lies not only in the fact that dollar is an unfit reference point for rouble. The problem in all probability lies in the fact that strengthening of rouble shall not happen quicker than growth of the GDP (rather even of real incomes of the popu-lation in accordance with the effect of Balace-Samuelson).

Let us approach the relation of economic growth and foreign currency ex-change rate from a point of view that differs from the one used by Illarionov: let us estimate losses of Russian GDP in 2001 originating from an overestimated rouble ex-change rate. To make such an estimate we will use the share of total demand increment met by imports. Compared to year 2000, when only 21% of total demand was met by im-ports, the figure for 2001 amounts to as much as 43%. It is easy to calculate that should 2001 retain proportions of 2000, GDP growth would have been not 5% but 8%. Illarionov gets close values on the basis of econometric methods (though his data are insufficient). One cannot but agree with Illarionov that these targets are required by the economy of Russia, if we wish to plan achieving an average European development level in 10-15 years. This calculation allows to indirectly support Illarionov's conclusions about re-lations' coefficients for economic growth in Russia and real rouble exchange rate. There should be made a reservation, though, that is true only of year 2001.

2. Foreign currency liberalization and industrial policies.

The principal symptom of the Dutch disease is a redundancy of foreign currency on the currency market of the country (due to export of a considerable part of extracted raw materials), which leads to over-evaluation of the national currency exchange rate, de-creases competitive abilities of other than raw materials branches of the economy and im-pedes economic growth on the whole.

In this connection the basic problem that should be solved to neutralize the distor-tions caused by "the Dutch disease" is a sterilization of "the redundant foreign currency" and its non-admission to the free foreign currency market. Possibilities for such a steriliza-tion that the Bank of Russia has (purchase of redundant foreign currency on the currency market) are evidently limited (by the target values of money stock and inflation). That is why one should completely agree with the experts that say that certain additional meas-ures are required: establishment of a reserve fund in the federal budget, accelerated re-payment of debts etc.

Nevertheless, these measures seem to be completely insufficient. Most adequate measures today would be the ones to liberalize foreign currency exchange for Russian enterprises. A decisive step should be take to a complete convertibility of rouble by elimination of restrictions both for Russian and foreign enterprises when they convert rou-bles to dollars and by introduction of less rigid restrictions about keeping foreign currency means in foreign banks. It is evident that also today they can do this using semi-illegal methods using offshore companies and transfer billing, but these operation should be brought out into the open and made legal.

Certain restrictions concerning operations with capital that should be probably retained, but should deal only with converting foreign currency into roubles when capital operations are performed (but not investments, that is conversion itself). But also here restrictions should be minimal. If such liberalization is performed, the major symptom of "the Dutch disease", redundancy of foreign currency, can be coped with with-out a reinforced state control (that distorts market reference points). Moreover, one can make a supposition that an excess control of conversion of roubles into foreign currency has been exacerbating this problem.

But contrary to the established simplified notion "the Dutch disease" makes itself manifested not only by overestimation of rouble exchange rate, but also by other market reference points distortions. Profit rate in raw materials sector is higher, labour utilization is lower compared to other sectors. That is why it draws out the lion's share of investments and the best skilled workers, but its development is not accompanied by a higher total de-mand. One should also take into account the increasing social stratification and the fact that 10% of the population that are well provided for consume almost exclusively imported articles. In this way "the invisible hand of the market" is powerless here (as far as price reference points are distorted).

Are deliberate industrial policies to overcome these distortions required in Russia, or can we place economic polict at a complete disposal of those who have real financial resources, that is biggest financial groups (headed by "raw materials oligarch")?

For one thing, it is evident that interests of these financial groups are clearly not identical to interests of Russia's economy. In many respects they behave like transnational corporations (which they usually are). Nevertheless they are still Russian corporations get-ting their principal revenues in Russia and are viewed throughout the world as Russian corporate bodies.

In the second place, one should take into account that the raw materials complex of Russia is a reality which one cannot get rid off (that would also be inexpedient). It cannot be isolated from the rest of the economy. It can neither be forced to invest into the rest of the economy.

In the third place, one should take into account that budget resources of Russia to pursue industrial policies are limited. The budgetary system faces a lot of completely dif-ferent problems in defence, law-enforcement, social support to the population and numer-ous state services to the public (including education and public health), these tasks have a priority as apposed to industrial policies the need of which is not that evident.

Fourthly, the wide-spread deceitful notion that the core of the matter is that the state should collect its "nature rents" and use the revenues to develop other sectors does not stand up to criticism. In market economy conditions for withdrawal of such "superflu-ous" financial resources from the raw materials sector are quite limited. Raw materials en-terprises have at their disposal lots of "justifiable self-defence" methods: more complicated structures, transfer billing showing higher expenditures and lower revenues, offshore com-panies and so on (let alone political lobbying). Due to this attempts to withdraw "superflu-ous revenues" from the raw materials sector can only be fruitful to a certain lim it.

Thus, for purposes of industrial policy there is only one objective left: to persuade "financial and industrial groups" (predominantly raw materials and export groups) to establish vertical integrated financial and industrial groups (resembling South Korean "chabols" or Japanese corporations) and invest into Russian economy. This objective is completely feasible. As a matter of fact, they don't need to be persuaded, they are doing this by themselves. Why their investments into other sectors are so small? The reason is that the Government is not trying to establish the required conditions, their eco-nomic policy are vague and an industrial policy is completely lacking. In the absence of in-dustrial policies the big business lacks required guiding lines.

It would be a naive supposition to think that the big business is capable of working out guiding lines for industrial policies, that would mean thinking "for the government" (a thing that private business has neither a wish, nor clear incentives for). Just as naive would be thinking that the big business would ignore a government industrial policy (though it's clear that following an industrial policy will always be guided by one's own in-terest).

What the big raw materials business needs most of all to make its investments to the economy of Russia is a confidence in government policies. The fact that confi-dence is still lacking is the fault of the government. Among other things one needs confi-dence in legislation, macroeconomic stability and most of all in positive outlooks for Rus-sian home market development. Export projects are also surely possible, but in conditions of enhancement of protectionism in the world trade they become more risky.

Therefore, an industrial policy for Russia is an absolute prerequisite, not for state redistribution of resources from the raw materials sector to other sectors, but fore encouragement of capital investments into other sectors: to eliminate market distortions caused by "the Dutch disease".

3. The Investment Climate in Russia.

While the macroeconomic situation and business conditions are decisive for short-term development outlooks for Russia's economy, long-term growth is determined by the investment climate, which includes a long-term macroeconomic stability, legislative invari-ability (that ensures investors' rights), business infrastructure development (including the sphere of financial, legal and other services) and other components (financial and legal transparency of companies, custom in business intercourse etc.).

A long-term macroeconomic stability is not understood by investors as values of an-nual inflation and even concrete values of foreign currency exchange rate. Only predict-ability is required of these values. A long-term stability is understood first of all as a stable growth, the higher the growth, the higher is the investors' interest in it. When annual growth rate is at the level of 3-5% investors' interest is frugal, growth rate of 8-10% makes interest active (investments into growth points is a part of strategy of biggest corporations). When the growth is zero or negative investors' interests are aroused only by export-oriented projects.

Thus, assertions that say that an inflation lower than a certain value (e.g. 10% per year or even 15% per year) is required for investments and a long-term growth are com-pletely unfounded at least for developing countries that Russian can also be referred to. What is absolutely required (though insufficient) for a good investment climate and a long-term growth are a short-term economic growth and short-term positive assessments of bu-siness conditions.

In connection with this one should point out that the priorities of the economic policy of the Government are fundamentally senseless, because it puts as foremost objectives a lower inflation and rouble exchange rate growth. Such priorities cannot cause a long-term growth; they will bring to a new crisis similar to the 1998 crisis.

At the same time it also evident that positive short-term outlooks are not enough for a long-term growth. Among sufficient conditions should be also included stability and trans-parency of legislation that will ensure protection of investors' rights, as well as a developed business infrastructure with financial services (banking and others) as a core.

Among persistent serious problems that are important for a long-term eco-nomic growth one can name the following two: lack of real mechanism to turn sav-ings into investments and lack of confidence in rouble as a dependable currency in a long-term outlook.

The first problem is in many respects a consequence of a bad banking system, which lost trust irrevocably in 1998. One can argue about the reasons, but the result is indubita-ble: in more than 10 years of market changes in Russia there was registered a record-breaking number of banks, but an adequate banking system, which can accumulate sav-ings and finance investment projects, has not been formed. Today there are literally speaking just a few banks capable of that, and only two actually state banks, "Sberbank" and "Vneshtorgbank", that possess assets enough for investment activities.

One can spend 10 years more in discussions about national banking system, but it is quite evident that should restrictions on foreign bank activities persist a full-fledged banking system in Russia will not be formed in these 10 years.

Banking deposits, though, is not the only (and even not the main) mechanism to transform savings into investments. There are known, at least, two mechanisms more: shares and bonds (with lots of variants, to say nothing of unit investment funds and the like). Finally, insurance policy is one of the major savings mechanisms throughout the world and insurance companies are the biggest investors, being most serious rivals with banks. Admitting foreign insurers to the Russian market is also a pressing question. But a mere cancellation of restrictions for foreigners will not lead anywhere should problems of savings and investments security persist.

Savings and investment security is impeded above all by legislative obstacles. Own-ers don't feel secure, as far this feeling is not supported by the legislation: the act of bankruptcy, the joint-stock companies act, the equity market act, the criminal legis-lation etc. To the same category of obstacles can also be referred corruption in the law-enforcement and the judicial systems, as well as non-transparent and corrupt authorities as a whole. Shortcomings in the legislative and law enforcement systems give rise to a negative public attitude, a legal negation mood of public agents and unacceptable in civi-lized countries custom and usage in business intercourse. This is a serious handicap for economic growth, too. Less visible, but not less important are the obstacles represented by an underdeveloped business infrastructure: transport, telecommunications, and ser-vices. To give an example: Moscow's and Moscow Region's leadership in business and investment activities is in many ways explained in particular by a favourable business in-frastructure.

To ensure a long-term and stable economic growth a mere non-interference by the state into the economy is not enough, a certain government economic policy is required. This policy shall at the least eliminate the obstacles for investments and at most will en-courage them.

A policy of European integration can become one of the most important com-ponents of this kind of state economic policy. It is clear that this policy can only be viewed in the context of overall integration of Russia into the world economy. This policy does not exclude, moreover it rather presupposes, a more active cooperation with the USA, China, India, the Arab countries, the Latin American countries, Japan and so on. Surely, it is not a question of being geopolitically biased. One should understand, though, that in the first place even business cultures of European countries are not identical. Sec-ondly, they are strikingly different form the business culture of the USA (in spite of its Brit-ish roots), let alone Japan. And, thirdly, business cultures of China, India and the Arab world are even more different from European ones.

It follows that Russia is either going to aspire to build up its own special business cul-ture (which is unfeasible because Russia's economy is poor, it also pointless) or is going to look for its own niche in the All-European culture (which is most logic, bearing in mind its economic, cultural and historic relations with Europe).

4. Preconditions of a stable economic growth in Russia: its European inte-gration and transition to euro.

Talking about Russia's participation in the processes of European economic integration one should in the first place view the steps aimed at encouragement of in-vestments, creation of mechanism to transform savings into investments and aimed at protection of investments. Calling off restrictions on foreign banks and insurance companies activities is a prerequisite, but this is not all. The state shall take clear steps to work out and pursue a sensible policy aimed at encouragement of investments into production of goods in Russia and protection of these. It should not be a question of financial guarantees at that (this would be a fallacious way leading to corruption). It is a question of systematic work to eliminate legislative shortcomings, unwise administrative barriers, erroneous tax barriers impeding investments, a question of unfair competition control, malbankruptcies control, measures to fight violation of shareholders' rights, abuse of rights and abuse of the law-enforcement system etc. In this sphere one hears lots of positive declarations (sometimes contradictory), but real improvements are still hardly visible.

In the second place it is required to view a possible government investments pol-icy that would encourage an economic growth. It is true, that should the government fi-nance investments projects by 100%, this situation will lead to nothing but an enhanced corruption. Should the state financing percentage drop to 10-20%, provided that the rest of means will be acquired though sales of shares of the future company, governmental support can be combined with public interests. In this case investments by the govern-ment will not be substituting private ones, but will serve as an accelerator of the invest-ment process. Funds for these investments can be obtained by floating government bonds. In future the government share of stocks should be sold to pay off the bonds and pay the interests. In some infrastructural investment projects (construction of hydroelec-tric and nuclear power-stations, railroads, ports etc.) the government share can also be higher, up to 50% and even more. This is possible in cases when the construction project is required to implement government region development programmes.

Last (but not least), there can also be a question of a consecutive stabilization of the monetary policy to bring the inflation to the average European level, diversify export, accumulate sufficient reserves and ensure a follow-up stabilization of rouble ex-change rate.

Already today one can set the task envisaging a future (in 10 years) integra-tion of Russia into the European monetary system (with a transition to euro). After that (not before) one can put on the agenda a gradual stirring up of collaboration with the EEC and finally joining the European Union.

Under which conditions this kind of integration will be feasible and advanta-geous for Russia's economic growth?

In the first place, it will become possible after Russia joins the WTO and Russian exporters accept the rules of this organization (also including the informal ones: giving up dumping pressure). This will provide conditions for a diversification of Russian export in the direction of processed goods and products (for now Russia's export is too dependent on mineral resources and metals, which causes high price risks).

In the second place, integration will become a topic only after the inflation rate will drop to the level of 3-5% per year, same is true about stable economic growth, stabi-lization of rouble exchange rate in several (about 3 to 5) years and accumulation of am-ple foreign currency reserves.

An ample size of foreign currency reserve is a foreign currency reserves size that covers at the minimum the broad monetary base (cash money plus commitments of the Bank of Russia to banks) and at the maximum covers all liabilities of the Bank of Rus-sia excluding the capital (that is including means of the budget and off-budget funds). These conditions are quite feasible: in 2001 they were fulfilled according to the maximum variant. It can happen that complying with these conditions according to the maxi-mum variant will become one of the criteria to check that money authorities pursue correct policies.

In the third place (this is the hardest of the conditions), certain minimal con-sumption standards shall be achieved in Russia.

For example, minimum wage in Russia should not lower than approximately 80-100 euro, and average wage should reach the level of 300-500 euro (as a guide). Mini-mum pension at that should be not less than 80 euro, an average pension not lower than 100-200 euro. These figures are surely quite approximate and can only be used as refer-ence points. They are substantiated by the following: transition to euro will be worthwhile only on condition that internal euro prices in Russia will not differ from average prices in Europe more than 1.5-2 times (naturally lower). The given figures follow from the above-mentioned supposition as well from the necessity to maintain a minimum of proper stan-dards.

It is evident that fulfilment of these conditions will take time and a minimum of 10 years' economic growth. But it is these terms that long-term Government programmes envisage and imply (in a declarative form) an economic growth.

What will Russia gain by joining the European monetary union?

Firstly, Russia would stabilize its national currency. Wages and pensions would not be exposed to inflation risks and a stable internal consumer demand would provide a good foundation for a long-term economic growth.

Secondly, Russia would become a participant on the European capital market. This would put an end to the discussion about "mild" and "rigid" monetary policies, strengthening or devaluation of rouble, as well as many other analogous disputes. One can make a supposition that such a problem as capital flight would be off the agenda as a national problem.

Thirdly, in assessments of investment programmes in Russia foreign currency and other macroeconomic risks would not be present, which would make them more at-tractive and result in attracting conservative investors, hence to qualitatively new invest-ments.

Fourthly (but not lastly), this would render economic and political relations be-tween Russian and Western Europe a completely different level, hence provide real po-litical and economic conditions for Russian to join the EEC subsequently.

It is quite clear that before Russia joins the European Union it shall have solved many problems, both economic and political. Russia would have to abide by European views on the issues of home and foreign policies. In the long run, this is not just an eco-nomic, but also a political choice. If one makes a supposition that this choice can be made in future, joining the European monetary system would be a most decisive step to go over from words to deeds. A mere admittance of this kind of task as a future ob-jective for economic policies (if only for 10 years) would be a marked step of not only really getting closer to Europe, but also to ensure conditions for a long-term economic growth.


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Proceedings of the conference have been published in a serie "Working Papers" №40

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