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Evolution of Russian Industrial Policy: the clash of theory and

practice

WORKSHOP: ‘TRANSITION ECONOMICS MEETS NEW STRUCTURAL ECONOMICS’

Boris KUZNETSOV bkuz@bk.ruHigher School of Economics, Moscow

School of Slavonic and East European Studies at UCL June 25-26 2013

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Motivation – key research questions

Motivation: Why Russian experience may be of interest for IP

researchesRussia is not the only but a quite rare case of a

large country which has not been trying to facilitate industrialization but rather had been fighting deindustrialization.

During the 20 years of transition Russian policies several times switched from one concept of structural policy to another. It has used a wide range of IP instruments and , thus, has a long history rich with failures which provides a good ground for analysis of determinants if not of successes but at least of flops of IP.

Alas, Russia in particular can’t have a sustainable growth without IP: major revenues are concentrated in a few industries and locations and have to be redistributed in one way or another. The Russian IP is now at a cross-roads again due to the crisis and the changing environment. It is on a quest for theoretical base and new concepts. The result to some extent will determine a long-term trends for Russian economy.

NSE/TE conference, June 25-26, 2013

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Motivation – key research questions

Stages of IP evolution and structural changes

NSE/TE conference, June 25-26, 2013

1992-1998Transition shock

1999-2006Market –driven growth

2006-2008State-driven growth

2009- 2013Crisis and recovery period

“Washington consensus “ concept, little of declared IP, actual policy

”New” IP, experiments with horizontal instruments of “creating conditions”

Attempt to set IP high-tech priorities and to implement “Development Institution” in a form of State Corporations

Re-setting of priorities: infrastructure projects, military industrial complex

Results: diminishing Manufacturing (From 33% of jobs in 1990 to 22% in 1998), growth of Trade (8% =>15%)

Results: slower but the same trends -Manufacturing (From 22% of jobs in 1998 to 19% in 2006), growth of Trade (15% =>17%)

Results: growth of investments (mostly state-driven), stabilization of the structure but without the change of the trajectory.

Results: manufacturing dropped 20%, bounced back and is stagnating. Little private investments and FDI.

“It’s easier to ride a horse in the direction it is already going “

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Stage 1: endowments used or wasted?

• Comparative advantages revealed =>Structural changes toward “natural” endowments, i.e. resources, energy intensive goods.

• Wasted endowments: o capacities and competences in high-tech industries

(military oriented) == up to 30% of Russian GDP prior to the reforms;

o R&D competences o Education and healthcare (Human capital)o Competences in state managemento Morals o Trust (civil contract between state, society, business)

New institutional system has been created. BUT not of the Market but of Transitional type, full of institutional traps.

“Politics is the art of the possible”Otto von Bismark

Benchmarking Russia’s structure:

Industry

5%

10%

15%

20%

25%

30%

35%

40%

45%

1,000 2,000 3,000 4,000 5,000 6,000 7,000

GDP per capita at PPP in 1995 US$

Industry benchmark

Russia in 2002

Change from 1990

Market economies

Shar

e of

em

ploy

men

t in

indu

stry

Source: World Bank CEM Report of 2005

Benchmarking Russia’s structure:

Market services

0%

5%

10%

15%

20%

25%

30%

35%

40%

1,000 2,000 3,000 4,000 5,000 6,000 7,000

GDP per capita at PPP in 1995 US$

Market services benchmark

Russia in 2002

Change from 1990

Market economies

Shar

e of

em

ploy

men

t in

mar

ket

serv

ices

Source: World Bank CEM Report of 2005

Stage 2: Macroeconomic environment in the 2000-s

• Formally the macroeconomic conditions in the 2000-s were extremely favorable for Russian economic development and provided good chances for pro-active IP: high growth of demand, low interest rates, inflow of FDI, strong trade and budget surplus.

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Jan/05 Jul/05 Jan/06 Jul/06 Jan/07 Jul/07 Jan/08 Jul/08 Jan/09

0%

50%

100%

150%

200%

250%

300%

350%

World prices dynamic (Jan 2005=100%)

Нефть Газ Сталь Алюминий

05_1

05_2

05_3

05_4

05_5

05_6

05_7

05_8

05_9

05_1

0

05_1

1

05_1

206

_106

_206

_306

_406

_506

_606

_706

_806

_9

06_1

0

06_1

1

06_1

207

_107

_207

_307

_407

_507

_607

_707

_807

_9

07_1

0

07_1

1

07_1

208

_108

_208

_308

_408

_508

_608

_708

_808

_9

-6

-4

-2

0

2

4

6

8Real interest rate

2005 2006 2007 2008

0

20

40

60

80

100

120

13.126.8

54.6

81.6

6

8.6

12.7

18.6

FDI (accumulated, $bln)

Total Manufacturing

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Stage 2: Time to throw stones?

• Special zones (Chinese type) => failed due to selection bias and the Government not being able to agree to lower taxes for business.

• Large innovation projects (co-financing private projects) => mostly failed due to lack of competence, corruption;

• State program to overcome “digital divide” => partly successful , but truncated to E-government project =little impact on the economic structure;

• Venture funds = failed due to low competence and mutual distrust between business and the Government

• Special regimes for foreign car producers => mostly a success but not sustainable

• …

- How many crops of potato you have a year?- Well, about 50, I’d say.- How is that?-Well, we plant it on Monday and dig it up next Sunday.- But why? -Too hungry to wait longer.

Russian joke

Main reasons for failures were:- Low quality of state officials;- The state’s “greed”, i.e. unwillingness to provide public goods for private sector- Lack of mutual trust, low property rights protectionMost important: efforts of the Government were not supported by private sector

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Motivation – key research questions

Stage 3: towards State capitalism?The results of attempts to change the structure by horizontal measures were disappointing. It looked as the policy of “creating favorable conditions” for everyone (open access institutes in the terminology of D. North and his colleagues). The Government decided to take the future into its own hands by re-creating a powerful state sector which would be the major driver of diversification.

It was a three-fold approach: (a) to concentrate financial instruments for modernization in state-controlled banks and “development institutes (Development bank, Rosnano, etc.); (b) the same time to concentrate industrial assets in several huge corporations (Rosneft, United aircraft, United Shipbuilding, Rostechologii , etc.) and (c ) – to invest into large-scale infrastructure projects (APEC-summit, Olympic games, federal highways, etc).

This type of policy presumes even higher standards of state management. It’s early to judge but it will be another flop, probably.

NSE/TE conference, June 25-26, 2013

?“The single most exciting thing you encounter in government is competence, because it's so rare. “Daniel P. Moynihan, American Politician

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Lesson one. While implementing IP one should pay attention not only to economic considerations but to political constraints. The question of “What the state should do to facilitate favorable structural changes?” should be accompanied with the question: “Why the state would do it?” The model of the policy should adequate to the governments capacity to implement it.

Russian Lessons for NSE and TE“… there are governments and governments. When asked, therefore, What are the functions of government? we must ask in return, Of what government? Different states have different conceptions of their duty, and so undertake different things. “Woodrow Wilson, the 28th President of the United States,

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Lesson two. In spite of the “death” of Washington consensus, institutions still do matter. They are twice as important in case of pro-active IP. One of the basic problem with IP in either traditional or NSE form is that the government is presumed to be exogenous to the structure of the economy, i.e. selecting priorities in accordance with national strategic goals or comparative advantages. It’s rarely the case.

Russian Lessons for NSE and TE

Money will go where the political power is . . . . It will go where the union power is mobilized. It will go where the campaign contributors want it to go. It will go where the mayors and governors as well as congressmen and senators have the power to push it. Anyone who thinks government funds will be allocated to firms according to merit has not lived or served in Washington very long.

—Senator William Proxmire, 1983

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Russian Lessons for NSE and TELesson three. The success of the policy

strongly depend on coordination between the state and the private sector. And this coordination presumes the dialog and a certain amount of mutual trust. This trust is difficult to achieve but it can be lost easily. The trust is easier to find if the state do not participate in commercial projects, do not aim at getting direct monetary returns from initiatives , focusing on producing public goods.

Well, comrades billionaires, and now we’ll play the game

“Who wants to became a millionaire?”

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Russian Lessons for NSE and TELesson four. While implementing any type

of structural policy it is important to design from the start alternative scenarios, including the scenario of exit from the policy with minimal losses. Nobody can (or rather should) be sure the strategy is the right one and/or the selected instruments will be working.

“Be afraid not of hunger and plagues,Nor of jail, nor of living in rags.Fear only Him, who will come and will say:“Come with me. I’ll show the Way!”

Alexander Galich, Soviet poet

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Thank youfor your attention