Russian Economic Reform

www.jeffschubert.com

called "Dictatorial CEOs &
their Lieutenants: Inside the Executive Suites of Napoleon, Stalin, Ataturk, Mussolini, Hitler and Mao."

1992 Article: “Russian Reformers and the IMF Get It Wrong.”

I first visited Russia in October 1991, after also visiting Hungary, Poland and Czechoslovakia. I again visited Poland and Russia in April/May 1992, and wrote the text below. In 1992 I met with Richard Layard, the British economist, who was then an adviser to the Russian Government. He told me how he and a fellow economist (who was Polish) boarded a Moscow-based plane in London with the idea that reform needed to be carried out gradually and with care. However, by the time they arrived in Moscow they had decided that it would be best to implement reform as quickly as possible, including the use of “shock therapy”. Layard told me that they thought there was a “less than 50% chance of this working, but it was worth a try”. Such—“worth a try”—was the low standard of economic advice being offered to Russia at that time.

Text of my May 1992 article:

“The economy of the Russian Federation will almost certainly deteriorate over 1992 and 1993. In particular, industrial production is likely to decline significantly in the state enterprise sector and both unemployment and underemployment will rise. Given the breakdown of much of the system of relationships that made the centrally planned economy, there is probably little that can be done to prevent this fall.

What economic policy makers can do, however, is influence the extent of the fall. Unfortunately, the Government’s pronounced economic policies (as outlined in the ‘Memorandum on the Economic Policy of the Russian Federation’ which was agreed with the IMF in March) are likely to exacerbate the difficulties. If implemented, they may even carry some risk of pushing the economy into an abyss.

The essential flaw in the stated economic policy is that it is one that is designed to appeal to the West in the pursuit of international financial help. Moreover, this appeal to the West is really to that side of Western opinion that believes that markets can solve all problems if only governments would get out of the way. Thankfully, for the West at least, not all Western opinion makers and governments have such an extreme view, let alone act on it.

The Russian Government’s program would be tough and ambitious even by Western standards. In particular, a program of the Government’s type might impede structural reform in a Western country by putting too much emphasis on fighting inflation and not enough on keeping the level of demand and production high enough to ensure that both existing and new enterprises have an incentive and an ability to invest to produce market goods and services.

This is precisely what happened in New Zealand in the late 1980s and the early 1990s. In the early 1980s New Zealand had a reputation as one of the most government controlled economies in the OECD. A comprehensive and effective program of privatization and micro-economic reform (eg by reduction of subsidies) was undertaken and there has been little criticism of this. Unfortunately the heavy emphasis on fighting inflation (which included the use of a very tight monetary policy) led production to stagnate and the level of employment in 1992 to be lower than in 1986.

Yet, for all of its government controls in the early 1980s, New Zealand was a long way from being a Russia. It already had a very large and experienced market sector. But even here, the lessons were clear. Structural reform takes a lot of time and effort and the macro-economic policies must be appropriate.

Closer to home, for Russia, is Poland. After much bravado about the success of its economic policies in 1990, the Polish economy has deteriorated significantly.

A number of experts on the Polish economy now point to three main lessons that should be learnt from the Polish experience. Firstly, too much emphasis should not be placed on reducing inflation and achieving currency convertibility. (The inflation issue lesson is the same as for New Zealand.) Secondly, a very great degree of focus needs to be given to basic issues such as the taxation system, banking system, legal system etc. which allow market economies to function effectively. Thirdly, there needs to be greater recognition that privatization is necessarily a slow and complex process.

If the Government’s ‘Memorandum on the Economic Policy of the Russian Federation’ is to be taken literally, Russia is to repeat many of the Polish (and New Zealand) mistakes.

Firstly, the ‘Memorandum’ says that it is intended to reduce the average monthly level of inflation to between 1% and 3 % in the last quarter of 1992. This is a fairly low and precise target and might be possible given the reversal of excessive price rises in the first part of 1992.

Evaluating the stance of monetary policy is difficult in any country. Monetary policy was not tight enough in 1991 and this is one of the factors contributing to very high inflation. However, there has been a significant risk that the tighter monetary policies in early 1992 in the pursuit of very low inflation would combine with attempts to tighten fiscal policy to crush the economy. This would impede the process of reform and recovery. Not only do existing enterprises need bank credits to restructure, and new enterprises need credits to begin, but budget deficit reduction inspired large decreases in government expenditure may launch a vicious circle of lower expenditure, weaker economic activity, lower tax revenue, increased budget deficit, lower expenditure etc.

There are some signs, however, that the ‘Memorandum’ will not be taken literally in this area. After a very tight monetary stance in the first two months of 1992, there has been as easing of monetary policy and an increase in central bank credits to commercial banks (and thus industry and agriculture). While this has probably increased the risks of higher inflation, it was probably necessary to avoid an almost complete industrial collapse in late 1992.

Secondly, while the ‘Memorandum’ discusses structural changes there is too little emphasis on the need for rapid and vital reforms in the accounting, banking and legal spheres, including anti-monopoly legislation. It is almost as if this very important component of an effective market economic system will rise by itself.

This criticism also applies to an aspect of macroeconomic policy. It would be acceptable to all but the most ideological anti-government Westerners that a larger than suggested Budget deficit (in the memorandum it is suggested that the deficit should be 1% of GDP in the first quarter of 1992, down from over 20% in 1991) would be acceptable if it could be financed by selling ruble denominated government securities into the domestic market. Even recognizing the difficulties, an insufficient amount of attention is being given to developing a market for such securities.

Thirdly, the mooted rapid pace of privatization in the ‘Memorandum’ is unachievable and dangerous. According to the memorandum, the ‘programme for 1992 envisages the privatization of 50 % of enterprises (organizations) in the building materials industry, wholesale trade and public catering, of 60 % of enterprises in the food industry, agriculture and retail trade, as well as 70% of enterprises in the light industry, construction, automobile transport and repair.

The pace of privatization is unachievable because of the lack of an existing market and institutional framework to support it. This pace is dangerous because of the massively disruptive effect that ownership changes and reorganization will have on the already mangled process of production in medium and large enterprises. Small enterprises and some service sectors, of course, may be privatized rapidly with less disruption. The other danger with rapid privatization of larger enterprises is that its lack of control may deliver many state assets into the hands of only a few groups who will then exercise monopoly powers and control over the economy. This appears to be a particular danger in Russia.

Having made these points, it should be emphasized that the Russian Government should not change its basics policy direction.

Rather than changing the direction of reform, the Government should slow the overall pace of policy change and re-orientate towards the building of mechanisms and institutions that will allow a market economy to function. This would reflect a recognition that one economic system (irrespective of how badly it is functioning) cannot be replaced by another “overnight”. In practical terms, this means that the Government would need to continue to play a significant role in determining both production and prices in parts of the economy. Some State plans would still be needed not only to ensure the continued production of many useful goods and services, but to ensure that as massive defense production is wound down the freed resources (both man and material) are put to some productive use. The market itself, will not be able to handle this huge task.

Finally, it is worth putting the view that Russia needs to find its own way of reforming. It may be that countries such as Hungary or those of East Asia provide more appropriate examples of what to do than the very “free-market” approach. It is more likely, however, that they will only provide bits and pieces. A very thoughtful and pragmatic approach is needed, for the risk remains that economic reform policies orientated excessively toward acquiring international financial help may end up doing more harm than good.

Past Articles on the work of each of the 21 Expert Groups can be accessed here:

National Technology Initiative – “Waiting for High-Tech Tooth-Fairy” !
5

Overview (of full paper)

This paper argues that Russia’s National Technology Initiative (NTI), which aims to boost the country’s future high-tech production and exports, is likely to achieve little and should be severely modified or even abolished. The NTI concept of focusing on selected “new markets” that are expected to exist in 2035 is misguided. Its execution process, particularly the use of the Rapid Foresight methodology, results in recommendations that are banal or vague.

If Russia wants to make serious advances in future high-tech “production”, it needs a technology policy that puts more emphasis on promoting Russian “usage” of presently available technologies. Much technological progress actually flows from the initiatives of “users” of present technologies and the feed-back they give to “producers”.

The threats to Russia from increased multi-country economic/trading blocs/alliances and inaccessible “global value added chains”, used to provide justification for the NTI, are overstated.

Apart from education – which is the only redeeming feature of the NTI – one of the best ways for the Russian government to improve Russia as a high-tech “producer” is to push structural economic reform because increasing competitive pressures encourage organizations to become better “users” of high-tech.

If Russia does not become a better “user” of high-tech, there is a risk that other countries will get greater benefits than Russia from any Russian developed high-tech products. If such Russian high-tech products were actually to be developed using government budgetary funds under the NTI (or any other government program), this would also mean that Russian tax-payers were subsidizing high-tech “users” in other countries.

Irrespective of government policy actions (including the NTI), the rapid pace of technology change and falling technology prices (relative to other prices) means that, at the country level, “users” can easily receive greater economic benefits than “producers” because of improvements in their “terms of trade”.

Reasons for this paper

This paper had its genesis during the author’s participation in the 2016 “Foresight Fleet” (four boats) journey down the Volga River in May. Jointly organized by the “Agency for Strategic Initiatives” (ASI) and the “Russian Venture Company” (RVC), it aimed to consider various aspects of the “National Technology Initiative” (NTI) which is billed as “a program for creation of fundamentally new markets and the creation of conditions for global technological leadership of Russia by 2035”. I found it to be (at least on my boat, the “Global Markets / World”) an intellectually stifling event. The discussion groups on pre-designated topics supposedly produced considered group recommendations. But, they in fact, operated to produce forced recommendations as the generation of output quantity was prioritized over output quality. Talking to the few other foreigners (and quite a few Russians) on my boat, I found considerable agreement with my views. On 21 July, I attended a NTI forum at VDNH.

Conclusion (of full paper)

While the NTI might at first seem an attractive idea, it quickly losses its luster when it is considered in detail. The suggested measures to allow Russia to escape the “resources curse” and diversify its output of goods and services basically come down to using a dubious forecasting methodology to identify future “new technology order” or high-tech “national champions” despite the lack of evidence of advantages, and despite the risks of failure in an era of rapid technological change.

Import-substitution (even if limited to “part of key technologies”) may boost some industries for a time, but the great risk is that lack of ongoing competitive pressure will impede broader “digitization” in the economy and the use of high-tech.

The Rapid Foresight methodology being used to identify trends and new markets is a very simplified version of more “classical” foresight methods – based on the Delphi approach — which themselves are of dubious utility in that they tend toward exposing the obvious. Even if a form of foresight methodology is to be used, the Foresight Fleet would seem to be an unnecessary expense that produces banality, repetitiveness and vagueness.

The “national security” justification for the NTI cannot and should not be easily dismissed. In the view of this author, there is little doubt that proposed groupings such as the Trans-Pacific Partnership (TPP) and the Transatlantic Investment Partnership (TIIP) are motivated by a combination of economic and political aims.US Secretary of State, John Kerry, makes no secret of this: “I have worked from day one to emphasize that foreign policy is economic policy and economic policy is foreign policy. Without a doubt, these trade agreements are at the center of defending our strategic interests, deepening our diplomatic relationships, strengthening our national security, and reinforcing our leadership across the globe. And the importance, my friends, cannot be overstated.” “Even as we seek to complete TTIP and strengthen our bonds across one ocean, we know that our future prosperity and security will also rest on America’s role as a Pacific power. Central to that effort is the adoption of TPP.” (Kerry even related the TPP to events in the South China Sea.) While the TIIP and the TPP may not proceed given the election of Donald Trump as the next US president, the basic motivations described by Kerry will not go away.

However, the election of Trump and the recent Brexit vote in the UK occurred against the great majority of domestic and international corporate opinion, and suggest that some of the NTI arguments about economic/political blocs/alliances with closed “global chains creating additional value” are significantly overstated. Moreover, there is little evidence that China has a particular wish to form or participate in such closed blocs/alliances. China’s “One Belt One Road” (OBOR) initiative is virtually the anti-thesis of this.

The one redeeming feature of the NTI is the newfound emphasis on education. This should assist Russia to become a better “user” of existing and future technologies. This would also help achieve some of the NTI “new technology order” aims by allowing Russian producers to more readily take advantage of the feedback that “users” give to “producers. Better “usage” would also allow greater advantage to be taken of existing possible network effects.

Apart from education, one of the best ways for the Russian government to improve Russia as a high-tech “producer” is to push structural economic reform – because rising competitive pressures encourage organizations to become better “users” of existing technology. The “resources curse” is not always such a bad thing, as Australia has demonstrated by becoming a good high-tech “user” rather than a “producer”.

The rapid pace of technology change and falling technology prices means that “users” can easily receive greater economic benefits than “producers” because of improvements in their “terms of trade”. This is a particular possibility when the “producers” are a very small part of the economy in one country, but the “users” are a very large segment of an economy in another country.

If Russian high-tech products were actually to be developed using government budgetary funds under the NTI (or any other government program), this would also mean that Russian tax-payers were subsidizing high-tech “users” in other countries.

Russia should radically change the NTI or abandon it. At the very least, it should not proceed with any future Foresight Fleets and abandon Rapid Foresight as a policy tool.


English language pdf version of full document can be accessed here: http://russianeconomicreform.ru/wp-content/uploads/2017/01/NTI-ENGLISH-VERSION.pdf

Russian language pdf version of full document can be accessed here: http://russianeconomicreform.ru/wp-content/uploads/2017/01/NTI-RUSSIAN-VERSION.pdf

Published on June 30 2016

John Besemeres’ reckless ignorance of Russia

John Besemeres’ article “Ukraine conflict exposes Western weakness on Russia” published on the Lowy Institute for International Policy” internet site (10 April) shows a fundamental and reckless ignorance about Russia.

See: http://www.lowyinterpreter.org

Besemeres writes that Russia “claims to be afraid of being encircled by hostile states, and to have been humiliated by the West’s supposedly triumphalist expansion into its backyard (its ‘sphere of privileged interests’). This is largely a propaganda myth; the Western expansion was a bit reluctant and apologetic, caused above all by the desperation of former Soviet vassals for protection from any Russian recidivism. Russia’s volatile opinion polls suggest, however, that after years of intense propaganda most of Putin’s subjects have come to believe the hostile encirclement narrative. Some who spend a lot of time talking to Russian officials and propagandists start to repeat these claims of encirclement and humiliation, and present them as their own superior insight into the Russian mind. They would do better to reflect on them more critically.”

Besemeres is right that “propaganda” has played a role in the “hostile encirclement narrative”, however that does not mean that there is not some basis for it nor that the “some” that he mentions have no insight into “the Russian mind”.

During the 7 years or so that I have spent in Russia since I first visited Moscow in 1991, I have often been reminded by quite ordinary people (not “Russian officials and propagandists”) about the Nazi invasion and, even occasionally about Napoleon.

The “Russian mind” clearly has this feeling of “never again” etched into it.

For example, on 25 February 2008, I wrote that that about 6 months earlier I was in a park in Pushkin on the outskirts of St. Petersburg when a 10-year old girl pointed out to me that “this is where the Germans were beaten”. Several days later, in the evening, I hailed down a private car to take me to Pushkin. The driver, a lawyer looking for a little extra money by acting as a taxi for me, volunteered the same point about the Germans.

See: http://www.jeffschubert.com/index.php?id=55

I also covered some such issues in a 5 March 2001 (ie 14 years ago, Besemeres should note!) presentation to the Australian Institute of International Affairs (Sydney Branch) on the subject of “Missile Defence”.

See: http://www.jeffschubert.com/index.php?id=57

It should be remembered that as a real event which affected a nation, the Nazi invasion is much more significant than Gallipoli in 1915 or the 9/11 attacks in the US; but look at how the ANZAC story has come to have meaning in Australia and the US has responded around the world to the terrorist attacks. The mind is not always totally logical and devoid of feelings.

Read more »

Published on April 12 2015

Boris Nemtsov, the Russian economy, and “Western” hypocrisy

Today, I will attended (as an observer because as a foreigner, who does not have to live in this country, I feel that I can comment on Russia but I must let Russians run their own affairs) the mourning procession for Boris Nemtsov in Moscow. In some ways the murder of Nemtsov is the most significant event in Moscow since Boris Yeltsin used tanks to blast the White House in October 1993 (I was also in Moscow at that time).

Of course, the murder of one man (even a man of Nemstov’s stature) does not compare to the hundreds of people killed in 1993.

What makes the Nemtsov murder so significant is that it has occurred against the present back-ground of the events in the Ukraine and strong anti-Putin sentiment in most “Western” countries, and is the latest in a series of such killings of Putin critics — including Anna Politkovskaya (an investigative journalist, was shot dead outside her Moscow apartment on Putin’s birthday in 2006) and Alexander Litvinenko (by radiation poisoning in London, also in 2006).

Putin has already totally lost the trust of “Western” political leaders. The additional negative feelings resulting from the Nemtsov murder will mean that even if the situation in the Ukraine improves it will be very difficult for “Western” sanctions to be eased. Positive sentiment toward Russia will be zero; indeed, any sentiment will be negative!

Read more »

Published on March 01 2015

Litvinenko, Borodin and Pugachev in London, and the Yukos $US50bn

In the week beginning 1 February, I emailed a survey to 1,750 of my Russian connections on LinkedIn (about 1,500 are “finance executives”). It should be borne-in-mind that these people will be much more “Western”-orientated than the general Russian population – a fact attested to by the extensive use of English in their profiles. You can see the profiles of the 1,750 here:

https://www.linkedin.com/profile/view?id=330346389

I also emailed the same survey to about 200 academics and journalists living outside Russia, but whom I knew had an interest in Russian issues.

The questions covered the Alexander Litvinenko murder Inquiry, the situations of ex-Russian bankers Andrei Borodin and Sergei Pugachev, and the Hague-based Permanent Court of Arbitration award of $US50bn to former Yukos shareholders.

Most of the questions asked could be answered within a “yes”, “no” or “don’t know” format. Not surprisingly, given the politically-charged nature of the issues, both Russians and those living outside Russia gave a hefty dose of “don’t know” to many of the questions. So, I will focus first on those questions where there were the fewest of such answers – and, I will provide some of my own views!

I asked whether former Russian bankers Andrei Borodin (formerly Bank of Moscow) and Sergei Pugachev (formerly of Mezhprombank), who now live in the UK, were criminals guilty of fraud. In Borodin’s case, 46% of Russian respondents said he was guilty, 11% said no, and 37% answered “don’t know”. In Pugachev’s case the corresponding numbers were 46%, 8% and 38%.

I do not claim to know a great deal about the Pugachev case, but in my view Borodin in clearly a crook – so, I was surprised that the “yes” vote was not much higher. But then, to my additional surprise, not one of the non-Russian respondent answered “yes”!

I drew two conclusions from the Borodin results. Firstly, financially savvy Russians themselves often do not know whom to believe – thus the high proportion of “don’t know” answers – because of a considerable distrust of the government, and that this can more generally distort good thinking. Secondly, many non-Russians either know very little about Russian financial issues, or they have a bias against the Russian authorities – indeed, how else could I explain the fact that Borodin has been granted political asylum in the UK!!

Ever since I first visited Russia in 1991, I have felt that the British (including most of its mass media) are generally quite unsophisticated when considering Russian issues – and the same goes for British economists (see left hand column entitled 1992 Article: “Russian Reformers and the IMF Get It Wrong.”).

Read more »

Published on February 08 2015

Moscow as an International Financial Center (IFC)
10

This article initially appeared in the December 2014 issue of “Baltic Rim Economies” published by Pan-European Institute.

In 2010 the Russian government launched the Moscow International Financial Centre (MIFC) project and sought international assistance, including from TheCityUK (the self-described “representative voice of Financial Services in the UK”). A Memorandum of Understanding between the MIFC Taskforce, TheCityUK and Vnesheconombank was signed in Moscow in 2011 in the presence of President Dmitri Medvedev and Prime Minister David Cameron.

Subsequently a number of reports were produced, mainly by TheCityUK and the IBRD.

Right from the beginning there were fundamental delusions. An early 2011 survey of “260 participants from leading Russian and foreign entities active in the Russian financial market” reported such views as Moscow as a “regional financial centre for CIS”, and “Moscow is where East meets West. It is a blend of different cultures and nationalities. It will be easy for everyone to come to do business”.

Read more »

Published on December 25 2014

Ukraine’s Poroshenko is going to Australia: WHY?
21

Ukraine President Petro Poroshenko will speak in Sydney on 12 December at a Lowy Institute function:

http://www.lowyinstitute.org/events/event-address-his-excellency-mr-petro-poroshenko-president-ukraine

Why is he doing this?  And why it is a bad idea!

Read more »

Published on December 09 2014

What do Chinese trade/investment people think about Russia (and vice-versa)?
20

During the first few weeks of November, I conducted two surveys regarding the attitudes of Chinese and Russians to closer economic and financial relations between their two countries. The surveys were conducted in Shanghai and Moscow, and showed an overwhelming desire — over 90% of respondents in both cases – for closer relations between China and Russia.

The Moscow and Shanghai responses to other questions in the surveys showed more divergence, and in particular seemed to point to the effect of the events in the Ukraine and of US led sanctions on Moscow attitudes.

Read more »

Published on November 25 2014

Moscow, London and Shanghai “money” !
10

In the first week of November I conducted an emailed survey of Russian (mainly Moscow) “educated middle class” attitudes to (mainly) financial issues in Russia and attitudes to Russia’s financial relations with China, the US, Europe, and the UK. Most of the over 1,000 people to whom I sent the survey were my LinkedIn “connections”. (I cast the net quite wide even though I suspected that many of my “connections” would have little interest in such financial matters.)

I wanted to get “financial expert” Russian feedback so, for the purposes of this article,  I subsequently pruned the data to remove all non-Russian respondents and also remove any who did not indicate that “about 50% or more” of their work time involved “thinking about financial issues”.

Read more »

Published on November 09 2014

Russia and China: what sort of “relationship”?
20

In June I spent some time in Moscow talking to Russian banks about financial developments in China,  where I am conducting research on “Opportunities and challenges in developing an international financial centre (IFC): Learnings relevant to Shanghai” for the Shanghai Institute of International Financial Centre (SIIFC), Shanghai University of Finance and Economics.

I decided to go to Moscow for several reasons.

Read more »

Published on September 06 2014

Effect of languages (Russian, English, Chinese) on economic and political power
1

The Russian Liberal Democrat party is reportedly seeking legislation to stop the “conquering march” of foreign words into the Russian language. It wants to punish those responsible for any violation of the norms of the contemporary Russian language”.

But it might be that the Russian language — and economy — needs some help from the Chinese language!

On my first trip to Russia many years ago I realized that I would need to learn Russian if I wanted to seriously understand the Russian economy and its politics. I put more emphasis on learning to read Russian than to speak it.

The Chinese language, however, is a different matter! Learning to read Chinese is extremely difficult and time consuming. Thus, I have concentrated on learning to speak Chinese rather than read. Fortunately, Chinese spoken grammar is simpler than either English or Russian grammar.

For example, the simple Chinese expression “wǒ” (written 我 ) is equivalent to “I” and “me” in English, and equivalent to each of “Я”, “меня”, “мне” and “мной” in Russian.

In reality, except for the rules of grammar, the English “I” and “me” are completely interchangeable – ie they mean exactly the same thing. The Russian case system means that “Я”, “меня”, “мне” and “мной” do often convey different meanings, but in my view Russian could be somewhat simplified (particularly in the presence of prepositions). For example, instead of “У меня” could have “У Я” !!!

What are the consequences (economic and political) of language differences?

Read more »

Published on February 21 2013