Remarks on Strategy 2020, Russian Academy for the New Economy

1. Remarks on Strategy 2020, Russian Academy for the New Economy Gerard Roland, University of California Berkeley

2. Introduction • Very impressive document outlining economic policies in a large number of areas. • I will formulate remarks on the main orientations and formulate ideas for discussion. • When thinking about economic policy, easier to identify wrong policies than to formulate right policies. • When formulating policies, difficulty of distinguishing between “ideal policy” and optimal policy in a given context taking into account political constraints, institutional inertia, culture and ways of thinking, administrative capabilities, etc…

3. Introduction • When thinking about enhancing long run growth, improvement of institutions is the first thing that comes to mind given both economic theory (fundamental importance of institutions for growth) and reality in Russia (bad institutional record). Report highlights some of the main institutional weaknesses. • However, it is important, when trying to formulate policies that can work, to see what can be done given the existing realities and historical inertias.

4. Basic growth framework • Useful to look at growth in the light of growth theory. • Growth depends on 4 things: growth of labor force, capital accumulation, human capital accumulation and total factor productivity (TFP). • Growth of labor force severely limited due to demographics and migration difficulties. • Capital accumulation constrained by savings and difficulty of attracting foreign investment. • Human capital is a relative strength that can be used. • Total factor productivity is the most important force of growth. It has been high especially in the early 2000s but can be significantly improved.

5. Total factor productivity • Total factor productivity is residual. Typically composed of: • Technological innovation • Improvements in allocation of resources • Institutions. • Innovation and institutions are partly separate (innovation efforts possible without institutional improvements) but also highly complementary.

6. Historical strengths and weaknesses of Russian economy • Useful to look back at Russian economy in the beginning of 20th century at the times of Count Witte and Stolypin (interesting source: Miller, 1927, The Economic Development of Russia. 1905-1919). • Pockets of industrialization with rapid expansion of oil, steel, railways and heavy industry. Vigorous development of agriculture (!), strong exports of energy, natural resources but also agricultural products. • Coexistence of minority of modern urban, industrial centres (St. Petersburg, Moscow, Kiev, Kharkov, Vilna and Riga, Baku) with large pockets of backwardness and rural poverty.

7. Historical strengths and weaknesses of Russian economy • Growth of industry relied a lot on foreign investment and Western technical assistance. • Centralized state apparatus with strong repressive arm, very efficient secret police crushing anarchists and forcing Bolsheviks to innovate organizationally to survive. • Push Northwest towards Baltics and Southwest in Balkans and Caucasus exploiting decline of Ottoman empire.

8. Historical strengths and weaknesses of Russian economy. • Constants in Russian economic development: • Huge territory with diverse geography and transport challenges • Low population density • Inequality of development related to these factors given scarcity of resources with small pockets of concentration of development and backward areas • Importance of natural resources to support economic development • State centralization and authoritarianism • Long history of serfdom and little tradition of private property of land. • Build on the strengths to further development and robust growth.

9. Strategy for growth • Importance of formulating a few policy priorities on which resources can be concentrated to obtain success. • My impression: report too negative on energy sector. Wish to diversify exports is welcome but not easy to implement. • Russia will be for a very long time one of the world’s major suppliers of gas and oil. Middle East is so unstable that Russia’s role is likely to increase as major supplier in all of Eurasia. Should become China’s major supplier. Its natural reserves are tremendous if one takes into account permafrost reserves.

10. The energy sector • Important to go beyond narrow view of the energy sector as only provider of export revenue with volatile prices depending on world market. • Just as energy was fundamental to the world economy in the 20th century, in the 21st century, energy technologies play always greater role: • technology to exploit, store and transport natural resources • technology to increase efficiency of energy. The latter will become more and more important. Electricity sector in Russia is very obsolete for example. • Given preponderance of energy sector in Russia, potential for innovation in technologies of energy use and exploitation.

11. The energy sector • Given the existing human capital, there is potential for high tech developments in the energy sector. • Several conditions need to be fulfilled for this to work: • strong connection to science via research universities • Geographic concentration of high tech scientists, engineers and entrepreneurs • Access to finance and to venture capital • Absence of institutional barriers • Efficient infrastructure to operate. • Links to manufacturing and ease of operating with international supply chains.

12. How to address credibility and scarcity of resources. • Huge problem of credibility when it comes to Russian state apparatus. • Predatory behavior of bureaucrats towards small and medium entrepreneurs repeatedly denounced but seems difficult to overcome. • Risk that ideas for institutional reform are not believed and that no effect ensues. • Report mentions trade-off between inertial and progressor scenario.

13. Development of Free Economic Zones • In principle, development of a few well-located free economic zones (FEZ) with well-thought institutional design has the potential to create virtuous circle and contribute significantly to Russia’s growth. • There exist special economic zones in Russia already but it is not clear that they have been well-designed nor that the potential they can represent for Russia’s development has been even remotely exploited.

14. Development of Free Economic Zones • No need for restriction of sectors or government definition of which high tech sector should be developed. • Importance of strong institutional independence from the Russian government (like Hong-Kong for China). Russian government should not be present. FEZ should be quasi-independent without any controlling hand of central government (authoritarian controlling tradition). Condition for credibility which is in turn key for investment and attracting FDI. • Concentration of scarce resources (talent, know how, finance, good governance) helps create condition for high tech take-off.

15. Development of Free Economic Zones • Creation of top world-level research universities with large endowment attracting talent from best universities in the world. No interference from Academy of Sciences. • Source of endowment and financing of FEZ can be energy rent • Create environment friendly to start-ups, foreign firms investing in the zone. Free-trade zone for import and export. • Create infrastructure for high-tech manufacturing and tax advantages for labor. • No tariffs on goods produced in Free Economic Zone.

16. Development of Free Economic Zones • Spillover effects are plenty. • Possible expansion of FEZs. • Better credibility and trust from foreign investors • Technological spillovers • Competition effects domestically and internationally. • Better domestic support for market-friendly institutions and for market economy • Elite network creation • Better integration in global trade and manufacturing chains. • Reverse brain drain.

17. Comparison with the Chinese experience of SEZ • The Chinese experience with Special Economic Zones was a huge success but had a different objective: start the creation of an export-oriented manufacturing sector. • Conditions were created (infrastructure, labor supply, infrastructure, friendliness towards FDI) to make it a success. • Objective with Free Economic zones in Russia should be development of high tech start-ups based on innovation and improved institutional framework. • Many “science parks” and special high tech zones are a failure because they lack presence of top science institutions and top talent, do not have incentives for entrepreneurship but too many incentives for rent-seeking for government subsidies.

18. Comparison with the Chinese experience of SEZ • It is necessary to study better the successes and failures of special economic zones across the world as well as the Russian economic experience. • Basic principle: easier to achieve localized than nation-wide success because of concentration of resources and provision of different institutional framework, less need to deal with other issues (country scale, social problems). • Success can then be emulated later on a larger scale based on the local experiences.

19. Energy prices • It does not make sense to keep prices below world prices. Report has some good ideas for reform. • Buffering social consequences of high prices is best done by lump sum allocation of a given energy at low price and sale of quantities above at market prices.

20. Role of monetary policy • In my view overemphasis in report of role of monetary policy for growth. • While high inflation is not conducive to growth, one has to be flexible on monetary policy especially in view of current world economic environment. • Another element that is neglected is the Balassa-Samuelson effect. In case of emerging market economy like Russia, it is likely to be non negligible especially given the big TFP increases in the 2000s. • Dutch disease issue in the 2000s has been exaggerated in Russian press. • I do agree with preference for inflation target rather than exchange rate target.

21. Lessons from other countries • Vietnamese enterprise Law could be imitated, making enterprise registration one window quasi-automatic process without checks by regulatory agencies. Was a huge success. Given bureaucratic meddling, success would be less but it is worth trying. Is important complement of policies to promote competition. • Chinese meritocracy in government can probably not be imported given lack of meritocratic tradition but elements of fiscal federalism can: • Make local governments residual claimants on part of the tax base (different possibilities: decentralize certain tax appropriations, fiscal contract with central government over income taxes, …)

22. Lessons from other countries • Study the success of Brazil. • What happened in Kazakhstan? Why the institutional improvement? • Learn from some of the advantages of German technical education (Realschule plus apprenticeships) • Experience of Singapore and Hong-Kong in fighting corruption (little hope here unfortunately, like Berlusconi proposing crackdown on tax evasion).

23. Agriculture? • Nothing in the report on the role of agriculture. • Before communism, agricultural exports from Russia were booming. • Some land is of very high quality. • Communism completely destroyed agriculture and transition did not revive it. Agriculture is one of the areas where transition reforms were the most botched. • There is room for entrepreneurial activity in this sector and it should be given more attention. Can be revived in a thoroughly modernized way despite very imperfect transport infrastructure system and confused legal situation. Agro-food entrepreneurship should be actively encouraged. Very important for quality of life and living standards.

24. Other remarks • Alcohol issues seems understated in the health chapter. • Impossible to deal in a satisfactory way with higher education system without dealing with the Academy of Sciences and the separation of research and teaching. • E-passport for workers could become be abused and create shackles • Inconsistency between emphasis on lower social expenditures and claims of more pensions for middle class. • The fiscal chapter does not discuss enough allocation of tax authority between levels of government. • Discussion of the experience of oil reserve fund would be useful.

25. Other remarks • I agree with strong emphasis on housing policies. I did not understand all aspects well (why ownership is typically of houses, not of apartments) • Big improvements possible in housing construction with potential welfare effects, together with improvements in energy use. Big potential for competition in this sector. • Investigate earned income tax credit as a way of helping the poor. Better than means-testing. • Banking. Developing of online banking can reduce transaction costs but also reduce size of informal economy. • Retail services can be vastly improved.

26. Conclusion • While the report is very thorough on all fronts and I agree with many of its conclusions, important to handle the institutional question heads-on in a realistic way given the credibility problem of the Russian state apparatus. • My proposal is to investigate thoroughly idea of Free Economic Zones in all aspects and propose it as a flagship for an experience that must succeed. State leaders can get credit while not feeling too threatened by it.