Back to basics
Russia’s president has been reelected, the electoral stir is settling down and it’s now time for everyone – including the head of state and other high-ranking officials – to go back to governance routine.
Any president in any country would first of all deal with the low rate of the national economy growth. According to the Federal State Statistics Service, over the last seven years (between 2011 and 2017) Russia’s annual GDP growth averaged 0.7%, totaling under 5% over the said period, which is less than in a single year during the period of booming oil prices (i.e. prior to 2008). 2018 forecasts are a bit more optimistic (with a growth rate between 1.8 and 2%), but any specialist in financial reporting would say that such a growth is within a statistical discrepancy.
The low growth is coupled with the sliding down income of the population. The process has been taking place for four subsequent years after the Sochi Olympics which happened to become a dividing point in the national political history. In 2014 Russians’ real disposable incomes dropped by 0.4%, in 2015 by 4%, in 2016 by 5.9%, in 2017 by 1.7%.
It is noteworthy that the income drop is greater than the GDP stagnation. It may be possibly explained by the fact that Russia’s national GDP is to a significant degree supported by the defense industry and strategic and image-building projects – which do not improve wellbeing of the population. According to Natalia Orlova, economist at Alfa-Bank, 90% of investments growth in 2017 was due to just four major projects, namely: Kerch Strait Bridge from the continental Russia to Crimea, large-scale renovations in Moscow, three-fold expansion of Moscow through acquisition of nearby territories (New Moscow), and Power of Siberia pipeline.
Henceforth, both the hardly existent economic growth and the nosediving population incomes are the major challenges which the president and the new government will certainly have to address.
There are some traditional recipes for that which any qualified economist, whether Russian or European, can name. Still, there is also a feeling that such recipes will not be accepted by the authorities since they do not match the authorities’ vision of the sources and backbones of political stability and country’s strength.
Cost-intensive state
Any traditional recipe would certainly include a recommendation to reduce the involvement of the state in the national economy. It is hard to make an accurate assessment of that involvement at the moment. According to a report by the Federal Antimonopoly Service, presented in 2016, the share of the government corporations in the national GDP reached 70% in 2015 (against 35% in 2005) and thus doubled over the preceeding decade. Economists Alexei Krivoshapko and Mattias Westman produced their own assessment of the state is put at 41% of the national economy. Whatever is the right figure, it is quite evident that government-owned banks and corporations now dominate in most industries. A large corporation is often a source of inefficiency. In Western countries though, the negative impacts of the existence of state-run industrial concerns and visionless politicians are partially balanced out by the alternateness. The lists of the top corporations are regularly renewed at an ever-accelerating pace.
A government-owned corporation has a number of systemic faults. Its top executives, for example, are linked to the government, while their motivations are determined by the market to a limited degree only, but rather by the orders received from the government official. Besides, such a corporation is absolutely certain it will live forever since it can always be supported by the state. Besides, state corporations are very successful lobbyists which is evidenced by the results of negotiations on tax abatements for the oil and gas industry which incessantly requires additional preferences.
It is convenient for the government to deal with large state-owned banks which can at any moment be impelled to finance important strategic projects. Still, disregarding rules of the banking market inevitably results in elevated bankruptcy risks, and the state budget has to subsequently allocate lots of billions of rubles to rescue state banks. Saving Vnesheconombank state corporation cost about RUR 200 bln ($3.5 bln), Russian Agricultural Bank has since 2015 received government subsidies of some RUR 50 bln, while VTB and its subsidiaries were paid approximately RUR 300 bln from the National Wellbeing Fund.
State corporations’ force field
Most diverse activities of state-owned corporations produce other negative impacts on the economy as well. While the public sector is expanding, it is affecting mentality of private businesses too.
An epitome of the public sector expansion is the control VTB bank recently gained over Magnit supermarkets chain which was one of the last large private companies in Russia. There are lots of ambiguities in the said acquisition deal and it is evident a retail chain is a non-core asset for a bank. Nevertheless, one more private company is now owned by the state. As Dmitry Potapenko, a well known consultant in retail trade matters, prognosticates, it may now be expected that the government will attempt to acquire Х5 retail chain and will eventually use the formerly private supermarket chains to establish a government-owned Rostorg. Nobody knows if that is really so, but it does look at times that large and profitable private corporations such as Nornickel metals and mining company are sort of relics in the current Russian business environment and it will only take some time before they are made part of the state-run economy. That is why the irritation towards oligarchs and their wealth, at times observed in social networks, media publications and in public opinion generally, seems kind of outdated since the true tycoons are not the individuals whose companies have already been one way or another appropriated or acquired, but top managers of state corporations who simply took over such companies.
Besides, the expanding public sector effects the businesses which formally remain private, since in the present-day Russia a great number of private entities are not interested in the market but rather in winning tenders arranged by government agencies or state-owned enterprises and companies. This is a huge sector of Russia’s economy and the upper part of that iceberg is exposed by Forbes magazine in its Kings of Government Procurements rating). That sector is formally private, but is since long subordinated to the government as far as motivations and purposes of its operation are concerned. The magnitude of that sector inevitably diminishes effectiveness of the Russian economy since the key actors in government procurements direct their efforts not at improving production efficiency but at establishing close contacts with organizers of public tenders and at meeting their requirements and ideas of what is really needed. The market of the government procurements does have its own vision of a competition, but that is not a market vision nor a market competition.
To what degree the current stagnation of the Russian economy is a cause of the drop in foreign investments due to a crisis in foreign politics, is still a question to be answered but it appears the matter is not of a prime importance. Researches by both the Russian Presidential Academy of National Economy and Public Administration and private think tanks reveal that Russia is rather facing some excess of investment resources which have nowhere to go. That is a common sequence of a stagnation though when business people see no prospects for new projects. Improving business environment to encourage launch of new projects is thus becoming the state’s major priority in the current economic conditions.
It is noteworthy that an important factor influencing operation of businesses in Russia is abundance of shortcomings in the national law enforcement and, specifically, in the judicial system which awards acquitting judgements on rare occasions only and at times can even reverse verdicts of juries. Boris Titov, Presidential Commissioner for Entrepreneurs’ Rights and a recent presidential candidate, has repeatedly pointed out that a great number of criminal prosecutions of business people are contracted by other entrepreneurs – their partners or competitors. That practice tells a lot about the essence of the law enforcement. These days, a failure to repay a sizeable corporate loan to a bank may result in a criminal prosecution of company executives on fraud charges.
What will not be done
The problems thus are clear. So it may be now forecasted how the reelected president and the new government may address them. Answering the question is rather simple since the policy preferences and imperatives of the authorities are well known. Since the declared values are stable and have been displayed for over a decade, the steps of the authorities are quite predictable.
They will first of all and by all means oppose privatization and public sector downsizing. Lack of budgetary resources though can induce opposite decisions, as already was the case in the past. The problem is though, a successful privatization can only happen if managers of the companies to be privatized take active part in the process. At the moment, Herman Gref, CEO and Chairman of the Executive Board at the Savings Bank, seems to be the only top executive actively supporting his corporation’s privatization. It is therefore quite possible he will initiate gradual sale of minor stakes of the Savings Bank’s shares to patch up country’s budgetary gaps.
Any shift in the fiscal policy’s priorities from defense to social spending may not be expected until international tension is eased. Therefore, it should not be expected in any foreseeable future.
The authorities are not inclined to substantially liberalize the law enforcement and reduce their pressure on businesses. Most petitions submitted by Boris Titov have brought no result. Law enforcement practices and legislation development evidence that authorities increasingly tend to make owners of companies criminally liable for their performance irrespective of the formal specifics.
Four points of success
What are the likely steps of the authorities? They can certainly behave irrationally by granting targeted assistance – as long as resources for that are available. Judging by the accumulated experience, Russia’s authorities are also capable of pursuing a relatively successful and reasonably rational policy of stimulating national economy growth in four areas.
The first one is financing innovations and awarding benefits to innovation companies via development institutions. Nobody would claim these days that resources for supporting startups are insufficient. Still, there are some concerns about the future of even the already funded startups which often see Russia’s market as an unfavorable one. One of the reasons for that is repellency of major Russian corporations to any innovations.
The second area is advancing digitalization and expanding infrastructure for the new communication formats. This area is fancied by the Russian government which hopes it may this way modernize the economy through technical solutions and not economic or social reforms. Russia indeed moves along the digitalization road quite briskly even though has not succeeded yet in creating a new economy sector capable of making a noticeable contribution to the national GDP.
The third one is building an industrial infrastructure, developing technological clusters, connecting production facilities to power supply lines, etc. Regional authorities actively participate in this process since it is in fact one of the very few spheres which local governors, in an attempt to make their regions more attractive, can influence at all. Their efforts have already improved Russia’s position in the Doing Business rating. The other contributor to that improvement was the power sector reform accomplished ten years ago. True, availability of production facilities does not generate investment inflow per se, while the constantly decreasing effective demand reduces efficacy of the said measures.
The forth area is protectionism and stimulating emergence of new industries through closing domestic markets for foreign competitors. The most evident examples are localization of the pharmaceuticals industry by barring imported medicines from government procurements, development of vehicles assembly lines, intensive development of domestic cheesemaking by imposing countersanctions. The said measures of protectionism damage consumers and, strategically, do not promote economy development in the long run, but nevertheless, nascence of new producers is visible.
Therefore, no strategic changes or economic growth acceleration may be expected. The economy though can adapt to any environment and in case the country is not involved in any military conflicts, no dramatic drop in oil prices is experienced and no other force majeure occurs, the growth of the national economy will be low but nevertheless positive. It may be hoped too, that new industrial sectors, advanced businesses and innovation companies can help establishing sufficient horizontal cooperation networks which may operate relatively independently of the federal policies.
Development of innovation projects and companies is thus the only palatable phenomenon observable in the present-day Russian economy.
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By Konstantin Frumkin