Russian Economic Reform


“Free Trade Zones” and Medvedev stuff!

Published on November 20 2011
Posted by: jeff

The Strategy2020 team of Expert Groups is completing its final report for delivery in December. Initially commissioned by Prime Minister Vladimir Putin, it now appears that Dimitri Medvedev – as future prime minister – will be taking the running on this issue even before he steps down from the presidency. The Expert Groups have been quite critical of a number of the policies pursued by Putin, both as president and prime minister, and many of their ideas seem closer to those of Medvedev. But Medvedev is now in a much weaker political and psychological position than before announcing his decision. Putin now has the uncontested upper hand, even before legally assuming the presidency, so I am not sure that it makes much difference which one of them is the “curator” of the Strategy2020 project. 

Moreover, policy making is not on hold while this document is being finalized. The two most notable related issues reported last week were about “Free Economic Zones” and the possibility of the return of sales tax. 

Prof. Gerard Roland, from Berkeley in the USA, last week told a joint meeting of Expert Groups that the interim Strategy2020 document had ignored the need the need for “free economic zones”. He said that “a few well-located free economic zones (FEZ) with well-thought institutional design has the potential to create a virtuous circle and contribute significantly to Russia’s growth” and that “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”.

By definition, there would be not tariffs on goods produced in the FEZs. But Roland’s suggestions were also a bit more pro-active than this. According to him, the “objective with Free Economic zones in Russia should be development of high tech start-ups based on innovation and improved institutional framework”. The government would need to “create infrastructure for high-tech manufacturing and tax advantages for labor”. Roland’s also suggested the “creation of top world-level research universities with large endowment attracting talent from best universities in the world”.

Thus, Roland’s idea seems to incorporate some of the ideas behind the creation of the Skolkovo innovation center (Medvedev’s vision of the basis of a Russian version of “Silicon Valley”) with the more traditional ideas of Free Trade Zones.

Where Roland differed from Skolkovo, however, is that there would be “no need for restriction of sectors or government definition of which high tech sector should be developed”. Officially, Skolkovo is focused on energy efficiency and energy saving, nuclear technology, space technology, medical technology, and strategic information technology.

According to Roland, the “basic principle” is that it is “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.”

Roland reportedly justified his proposals by saying that Russia’s “huge territory gives rise to spatial and transport challenges, low population density, uneven development with small centers of growth and peripheries, dependency of economy on natural resources and highly centralized state”.

However, while Australia has the same geographical and natural resource issues mentioned by Roland, albeit on a smaller scale, I see no reason for Australia to introduce Free Economic Zones is any of the guises suggested above. While it can be argued that Russia has some special needs it is also the case that Russia’s poor public administration and corruption means that concessions (such as tax) and other government assistance are likely to be abused.

Indeed, in my view, what the Russian economy really needs is less direct government interference in the allocation of resources (including by such things as Free Economic Zones, Skolkovo, tax concessions), and much better general public administration. It is the latter where emphasis should be put.

The sales tax issue was in the past briefly addressed by several documents posted on the Strategy2020 website. The only reasonable argument for the return of sales tax (it was abolished in 2004) is the desire to promote “decentralization”. Different rates could be set in different regions (or municipal areas) as a source of own tax revenue. As the Ministry of Finance has continually pointed out, a uniform nation-wide sales tax would essentially be the same as an increase in the rate of VAT (except that tax may apply to sales of goods and not services) because both are taxes on final consumption.

Discussion of sales tax is also now being given an additional push by general budgetary pressures (and the deficit in the pension fund).

Elvira Nabiullina, the Minister of Economic Development, says that she does not think VAT (at 18%) or the profit tax rate (at 20%) – which she describes as “competitive” – should be changed, and is receptive to the reintroduction of sales tax.

Presidential aide, Arkady Dvorkovich, who has in the past favored regional sales taxes, has reportedly now gone a step further and suggested that VAT be abolished and replaced by a sales tax. He says that this would eliminate the problem of corruption associated with VAT reimbursement (ie false claims by companies that VAT has been paid on goods purchased) and “remove the burden on the production chain”. I don’t know whether Dvorkovich has in mind a sales tax at the retail or wholesale level, but in my view abolition of VAT would be a backwards step. VAT is a very good tax when administered properly, and I would be very surprised if other officials agreed with his position.

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