Earlier this year, the Russian President had asked several high-ranking public officials and advisers to develop competing economic plans for the next legislature after the elections in March 2018. The Western financial and economic press – especially the FT - has covered this so-called ‘beauty contest’ between three main reform strategies: The first one elaborated by the prime minister Dmitry Medvedev, the second one by former finance minister Alexei Kudrin, and the third – and in my view most interesting one – by the Stolypin Club headed by the Presidential Commissioner for Entrepreneurs’ Rights Boris Titov. (see here, here, and here).

At the occasion of a visit of the Faculty of Governance and Politics (Факультет управления и политики) at the State Institute for International Relations MGIMO in April this year, I had the opportunity to engage with the proposal elaborated by the Stolypin Club, headed by Boris Yurievich Titov. My – selective – comments on the Titov/Stolypin strategy have now been published in Forbes Russia: http://www.forbes.ru/biznes/351425-uroven-zhizni-vazhnee-vvp.

The article is in Russian, but here is the original (somewhat longer) text in English:

Current problems and reform strategy: The right kind of strategy for the right kind of growth

The “Growth Strategy” report elaborated by the team of the Presidential Commissioner for Entrepreneurs’ Rights – Boris Yurievich Titov –  provides a very comprehensive and astute analysis of Russia’s current economic situation and problems. In particular, Russia’s heavy reliance on natural resource exports (‘resource trap’) and the main solution to the problem to diversify the Russian economy and create high-quality jobs are very relevant. Here, the document also outlines an interesting and comprehensive reform strategy that aims to develop particular sectors with high-value added activities, great potential for exports of complex products, and that are able to generate high quality – and hence well-paid – jobs for skilled workers.

Historically and in comparative perspective, this seems indeed like the most promising and sustainable growth strategy. Indeed, growth for growth’s sake will not achieve the very ambitious goals set out in the document, namely to guarantee a “dignified, long, and interesting life of every single citizen” (p.51) through increased living standards. The document rightly points to the importance of a broad view of national wealth including ecological factors (p.7). These considerations seem crucial to achieve the aim of improving living standards and not just increasing per capita GDP. In order to achieve this goal, the strategy developed in the report aims at promoting a specific type of growth – export-led, but in high-value added sectors – and not just any kind of growth. Indeed, economic growth can be achieved in different ways – especially in a resource rich country – and it can in fact even lead to masking the real economic problems rather than helping to overcome them. Thus, jobless growth will not address Russia’s current issues. Ecologically disastrous growth is self-defeating in the medium and long-run and in contradiction with objectives about living standards; excessive primary resource-export fueled growth is bad for other sectors (‘Dutch disease) and will increase dependency on international markets. The key question that the new growth strategy for Russia needs to address is hence how to get the right kind of growth (i.e. in high-value-added, relatively knowledge- and skill-intensive sectors,) that is sustainable in the long run.

Here, a first important insight of the report is that such ‘high quality’ growth can only be achieved through a comprehensive and complex reform strategy. The document acknowledges this in the ‘basic principles’ of the reform strategy on page 14, which seem very relevant and important. In particular, the first one of these principles ‘Consistency & Complexity’ hints at a crucial insight: none of these reforms can succeed in isolation; but they need to be adopted and implemented as part and parcel of a package of reforms. P.14 states: “None of comprehensive decisions might become the ‘key link’ by itself, all decisions should be applied in complex.”

This statement is compatible with a key insight from the academic field of Comparative Institutional Analysis (CIA) of national business systems, which stresses the importance of ‘institutional complementarities’ among different spheres of an economic system for such a system to be successful. In other words, since successful economic activity relies on more than one input factor, policy changes will always require acting simultaneously on more than one institutional sphere. Thus, in order to stimulate growth of high-tech start-up companies, it is not sufficient – albeit necessary – to provide financial capital through the promotion of venture capital markets; rather, such firms will also require highly-skilled workers, technology input, and managerial skills for their leadership. Therefore, measures to stimulate financial capital flowing into this sector can only be expected to lead to the desired growth push if in parallel there are reforms in the spheres of education and training, entrepreneurial/managerial skills provision, and research and development among others.

This insight has two implications for the growth strategy outlined in this document: firstly, it might be important to more systematically think about the interactions between the measures taken in different spheres, and which complementarities will be required for the desired growth effect in manufacturing to take place. Here, the experience from other countries such as the Visegrad countries or Sweden – which very successfully shifted from a focus on low-tech manufacturing to high-tech industries during the 1990s - could provide valuable further insights. Secondly, in practical terms, complementarities suggest that the reformers will have to focus on coordinating reforms across different institutional spheres (e.g. education & training, corporate finance, research and development, labour markets etc.) in particular where different ministries and authorities are concerned. The acknowledgement of complexity, which I believe constitutes an acknowledgment of the need to reform various institutional spheres in parallel, is crucial and one element that reforms in other countries have often not gotten right.

Implementation: Legitimacy of reforms and reformers

The document also acknowledges that the implementation of the strategy hinges crucially on the ‘support and efforts of every social group’ (p.51), which hints at the question of legitimacy of the reforms and the reformers. Indeed, it is an open question how much appetite for reforms there is in the Russian population. The document states that real disposable household income has dropped by 13% between 2013 and 2016, which clearly shows a need for action. However, GDP per capita in Russia currently is at around $8,5000; There are international studies that argue, that as long as GDP per capita does not fall to around $6,000, the population’s appetite for radical reforms will be very limited. If this estimate is correct, this would suggest that it may currently still be difficult to garner enough popular support for radical reforms in Russia and indeed to convince the relevant authorities that such a reform strategy is sensible. The appetite for reform among the Russian people and authorities can also be expected to fluctuate with the oil price and the associated rents from hydrocarbon exports – a common phenomenon in countries affected by the ‘resource curse’.

Here, one further consideration that the growth strategy may need to take into consideration is which elements of the current (natural resource-dominated) Russian model constitute in themselves obstacles to successful reforms. Thus, while the reports rightly points to the importance of a modern infrastructure to providing sustainable economic growth (p.2), infrastructure spending in itself is part of the problem of the current model in as far as the Government may rely on large infrastructure projects (mega-projects) to create jobs and growth for growth’s sake. Infrastructure development will only help to achieve the goals set out in the document, if it is of the type that promotes entrepreneurial and productive activity. In this sense, the decrease of expenses on articles stimulating economic growth in the 2017-9 budget (p.5) is not necessarily bad news where they concern infrastructure investments that do not directly reply to any real public- or private sector demand for such infrastructure.

Similarly, the report envisages a continuation of state subsidies for consumption to help poorer Russians and to stimulate certain sectors (p.29). While it is obviously important to consider collateral measures, which absorb the shock of the reforms on potential losers from the changes, subsidised consumption may slow down the implementation of the new strategy. Indeed, subsidised consumption may stimulate Russian production in the short run, but may in the long run reduce firms’ incentives to upgrade into higher value-added activities. It may thus hamper the development of internationally competitive products that can become drivers of export-led growth. Here a balance will have to be found between supporting parts of the population without at the same time creating roadblocks to reform.

Judicial and bureaucratic reform

The report rightly points to judicial reform as one key area in need of reform. The role of institutions and the Rule of Law would indeed seem like a key area of concern in the establishment of a successful economic model in particular if one of the key goals is to stimulate international joint ventures and technology transfer into Russia (‘doors opened inward’ p.40). Here, a related, but still distinct aspect is that the state bureaucracy may need to be reformed as well. Indeed, research on various successful latecomers to the world economy, such as Japan and – more recently – Brazil, shows that one key element of successful industrialisation and economic growth is the existence of an ‘embedded but autonomous’ state bureaucracy that is governed by technocratic and meritocratic principles, rather than by political loyalties or by too narrow ties with businesses. The existence of a bureaucracy and of civil servants that are both relatively independent from politics and not captured by business interests is key to implement successful policies. This could be an additional consideration to be addressed under question 4 (pp.46ff).

The reform of the financial system

The document underscores the crucial problem for Russian firms to access sources of external finance and notably credit. It outlines several promising pathways in which financial capital can be stimulated. The reform of the banking system seems like an important priority here, and the central bank could indeed play a crucial role here. Similarly, the proposal to establish a ‘Bad Bank’ to deal with non-performing loans as a step towards moving away from revoking bank licenses seems equally promising.

However, recent experiences in Western countries has shown that stimulating investment will only lead to beneficial outcomes if the demand for investment can be generated in the ‘right’ sectors of the economy. Flooding the market with money (e.g. through quantitative easing, QE) will not lead to sustainable growth in itself. It needs to be combined with accompanying measures of stimulating entrepreneurial activity rather than provide ‘cheap money’ to speculators.

Here, the use of the Bank for Development and Foreign Economic Affairs (VEB) and similar development institutes does seem like a potentially more targeted measure to stimulate specific areas of the economy. Indeed, several very successful cases of national development banks exist (e.g. Brazil’s BNDES, Germany’s KfW) and even the UK has recently established (in 2014) its own development bank (the British Business Bank) – modelled after the successful German KfW – to stimulate economic activity. Strengthening the role of the VEB and development institutes is hence a very sensible reform proposal. But again, I would like to stress that the reform of corporate finance needs to be considered in parallel to other institutional spheres in view of achieving the overall reform goals. Given that the stated goal is to promote the manufacturing and the SME sectors the reformers will need to make sure that other input factors – such as skilled labour – are available too, which may require additional reforms (e.g. of the educational system). Moreover, different types of production and industries require different types of finance: while physical capital-intensive production often requires patient-, long-term capital (e.g. through long-term bank loans), knowledge-intensive – but physical capital poor – start-up companies will require investors who are ready to provide funds without collaterals (venture capitalists). One important element of a successful growth strategy will hence be to not just stimulate the size of capital markets and the credit volume, but also to make sure the right type of finance is available depending on different sectors’ needs.

Economic Openness and Dependence

A successful growth strategy necessarily requires a successful integration of the economy in question in the international economy. The two-stage plan for an open Russian economy is very sensible and mirrors to some extent successful historical cases of industrialisation. Thus, the selective liberalization using ‘smart tariff principles’ outlined under the ‘doors open inward’ stage, have proven successful in various cases, e.g. the Newly Industrialised Economies (NIEs) of East Asia.

Similarly, the initial focus on sectors where Russia can build on its traditional strengths (MIC, agro industry, IT) is both reasonable and realistic. Of course, even during this first stage, the focus of the industrial policy should be on the highest value-added activities possible in each one of these industries. As an example, in the field of agriculture, focusing on organic- rather than conventional production may confer the Russian agriculture a genuine competitive advantage in particular if – in the mid-term – exports towards the EU and other high-income countries are considered once again.

One question that would merit further thought in relation to economic openness is the role that foreign capital should play in the new industrial policy either in the form of inwards FDI or portfolio investment. Several post-socialist countries have successfully re-industrialised their economies after the fall of socialism based on an industrial strategy attracting foreign FDI in relatively complex manufacturing goods (Hungary, Poland, and other Visegrad countries in particular). Others have focused more on (financial) services (e.g. the Baltic states). Both strategies have proven very successful for a period of time and have allowed these countries to catch up to some extent with Western living standards, but both have also more recently shown that the dependence on foreign capital, technology, and know-how, comes with certain risks for the countries in question. The stimulation of domestic consumption should hence not be neglected.

In sum, however, the Growth Strategy of the Presidential Commissioner for Entrepreneurs’ Rights is a promising policy proposal that distinguishes itself from other proposals by the comprehensive analysis of the problems facing the Russian economy; and the acknowledgement that the task is formidable and will require courage and circumspection to be successful.