Without Trust the Best Programmes Cannot Be Carried Out Even Partially

At this year’s April Conference on Economic and Social Development, speakers in the first expert discussion on strategies for Russia’s development discussed growth prospects for the Russian economy. The main speaker was Chairman of the Board at the Centre for Strategic Research, Alexei Kudrin.

The Main Objectives for the Russian Economy

Though some of the latest GDP forecasts are better than previous ones, they do not envision growth rates of more than 1.5%-2% before 2020 under a no-change scenario, which ‘we cannot find pleasing,’ Alexei Kudrin said during his talk.

Russia cannot achieve higher growth rates without overcoming various structural problems in its economy. This includes Russia’s dependence on oil – according to Kudrin, Russia has not yet moved away from its old economic model – as well as the weak state of public administration, which does not allow for resources to be focused and distributed properly. The government does not have a clear enough plan of action, and investors face a serious level of uncertainty because of this.

Other fundamental problems can include a drop in size of the employable population in Russia. Over the next 15 years, Russia will lose 10 million working-age individuals, and an increase in the retirement age can only partially compensate for these loses.

Russia also does not have sufficient investments. One reason for this is sanctions, which have virtually closed Russian companies off from the foreign debt market. Sanctions also lead to a technological lag in the Russian economy since they stop the exchange of industrial and other modern technologies.

Steps towards structural and institutional reforms, according to a forecast from the Centre for Strategic Research, allow for Russia’s economic growth rates to increase to 3%-4% per year. Unlike in previous years, when this type of growth largely stemmed from household consumption, the growth Kudrin’s Centre is forecasting comes from investments and workforce productivity. The Centre predicts that increased investment in fixed capital will boost GDP by 1.1-1.2 percentage points, while the use of labour resources will climb 0.2-0.3 percentage points. In addition, total factor productivity stemming from business model changes and a decreased administrative burden on entrepreneurs will rise by 0.7-1.0 percentage points.

Between 2002 and 2015, workforce productivity grew by 55%. ‘But in order to reach our target, we need to double workforce productivity by 2035,’ Alexei Kudrin added.

By 2033-2034, equipment exports should surpass imports. The percentage of machinery and equipment in exports should rise from the current 8.3% to 30%, while the share of oil and gas should fall from 52% to 37%

The real effective exchange rate of the ruble will rise, and by 2020 the effect of devaluation on the economy will largely level out. If domestic demand is unable to support economic growth, Russia will need to boost exports, first and foremost exports of goods and investment equipment. According to the Centre for Strategic Research’s estimates, by 2033-2034, equipment exports should surpass imports. The percentage of machinery and equipment in exports should rise from the current 8.3% to 30%, while the share of oil and gas should fall from 52% to 37%. ‘And herein lies the diversification,’ Kudrin emphasised. ‘This is a bold forecast, but without achieving these targets, we will not be able to compete.’

A key factor in achieving these goals is an increase in the trust of the public and investors towards government institutions. Without this, even the best of programmes cannot be carried out even partially. Reform is critical in the public administration system, as are personnel reforms, the optimisation of administrative and other processes, and the digitisation of these processes, which will lower the volume of control and supervisory activities currently paralysing companies’ activities nowadays. For now, the process is going in another direction – between 2003 and 2016, the number of government powers and functions has doubled.

Mr Kudrin is also certain of the need to ‘free private enterprise.’ This is the country’s ‘mental problem,’ and there will be no growth without private investment. Competition must be supported and small and medium enterprise must develop. In addition, deregulation and decentralisation are important if cities and regions are to develop.

Why Russia Cannot ‘Miss This Opportunity’

Russian Finance Minister Anton Siluanov, who agreed that increased growth rates could not be achieved without structural reforms, noted that the situation today is ‘not all that bad.’ Whereas last year GDP fell 0.2%, this year the government is expecting 2% growth. Russia has a ‘solid base for investments,’ ‘a strong balance of payments,’ and ‘no bubbles on the financial market,’ but besides this oil and gas dependency is declining, as is inflation (in 2017, inflation may be only around 4%).

The government has a ‘clear programme’ for balancing the budget under new macroeconomic conditions, the Finance Minister said. This isn’t simple however, he added, and the government has to limit previously approved programmes and decrease federal spending. Overall, after the difficulty of the last two years, the Russian economy has become ‘healthier,’ industry is growing, and competitiveness is strengthening, Siluanov noted.

It is important not to ‘miss this opportunity’ and adopt measures that will allow the economy to continue growing. In this sense, it is important that macroeconomic parameters and the government’s tax policy be predictable. The Finance Minister added that the tax burden on honest businesses would not increase; on the contrary, tax administration will be simplified. The government will streamline non-tax payments as well, and legislation will be prepared to provide a clear list of such withdrawals.

‘We are rightly being criticized that we don’t pay enough attention to human capital,’ Siluanov continued. Despite a significant amount of resources being spent on education and healthcare, these areas can still be transformed to allow budgetary funds to be used more effectively and to allow the quality of life in the country to improve.

The tax burden on honest businesses will not increase; on the contrary, tax administration will be simplified

Workforce productivity must increase first and foremost in the public sector. Discussions are now underway concerning how much companies with state ownership should pay in dividends. ‘I’ll say it again – under current conditions where the government has not raised the tax burden, we have the right to ask for at least half of state-owned companies’ profits, and this is subject to distribution,’ the Finance Minister added.

A plan of action will be created based on the recommendations of the Centre for Strategic Research and the Economic Development Ministry. This plan will lay the foundation for government action over the next several years, Mr Siluanov concluded.

 

How to Change the Attitude Towards Human Capital

According to HSE Rector Yaroslav Kuzminov, structural transformations are usually associated with economic reforms that impact total factor productivity, or TFP. But the Russian economy will also develop thanks to labour, more specifically human capital – that is, thanks to an individual’s ability to earn money himself or herself and make money for their employer and country as well. Factors associated with human capital lie at the foundation of economic growth reserves, and they are able to contribute an additional 10% of GDP in total by 2035.

Yaroslav Kuzminov identified three components behind these factors: way of life and medicine, education, and migration. The first, way of life and medicine, contributes without special effort from the government – the length of time people are capable of working will increase by way of inertia, as will the culture of their behaviour. This does not mean, however, that investments in medicine are unnecessary; in fact, they will contribute to this effect even more.

Between 20% and 25% of the population do not master basic competencies and are essentially doomed to low wages throughout their lives

Education must help the population obtain and raise their qualifications, master new technologies, and become prepared to run their own business. This instruction must begin during childhood, which does not happen in Russia. Between 20% and 25% of the population do not master basic competencies and are essentially doomed to low wages throughout their lives. (For comparison, this percentage is just 5%-7% in Finland.) In this respect, Russia is similar to Mexico or Brazil, but in those countries this problem is softened by larger demographic growth, while Russia does not have an alternative. ‘We have to stop treating human capital like air that isn’t worth anything,’ the HSE Rector noted. Increased investment in education by the government and society therefore becomes even more important and will certainly pay off.

Under the current conditions of the Russian labour market, migration is an important source of labourers. The country simply cannot get by without migrant labour, but it is important to understand that immigrants will gradually increase the burden on the social system, as well as the risks surrounding socio-political stability. On the other hand, in five years Russia will likely face real competition for migrant workers from Asian countries.

What Fosters Economic Flexibility

One of the main challenges for the Russian economy, according to First Deputy Governor of the Russian Central Bank Ksenia Yudaeva, is low workforce productivity and, as a result, a very low ability to compete in sectors outside of the oil and gas industry. This is all while the Russian workforce has become cheaper (when wages are measured in euro) than not only many Eastern European countries, like Poland, but also than China. The gap between the wages of Chinese and Russian manufacturing workers might come to 20% this year. ‘This shows what kinds of reserves we have for boosting economic efficiency,’ Yudaeva said. ‘We cannot allow ourselves to manage costs as ineffectively as before.’

The Russian workforce has become cheaper (when wages are measured in euro) than not only many Eastern European countries, like Poland, but also than China

Another challenge lies in Russia’s pull towards the ‘raw materials super cycle.’ This dependency remains very high, which is why Russia needs mechanisms that allow the economy to adapt quickly to external changes while maintaining stability. One such mechanism that brought flexibility to the economy and softened the blow of the losses incurred due to external shocks was the move to a floating exchange rate for the ruble. Lowering inflation and keeping it at a low level also brings stability to the economy since this allows consumers and businesses to plan out their activities for the long term. Ksenia Yudaeva noted that an example of a tool that creates more stable conditions for the development of business is budgetary law.

But a developed economy is also characterised by a well-developed and high-tech financial sector that has gained the trust of both business and society. The activities of the Central Bank, Yudaeva said, are aimed at achieving this goal. ‘But we have to structure and execute measures in consultation with market participants,’ she concluded.

How to Solve the Trust Problem

HSE and RSPP President Alexander Shokhin said it was right that attention was mostly being paid to the predictability of economic policy. But some things that are important for business are not currently covered in the programme being prepared for the government. ‘We aren’t talking about the assertion that the tax burden will not increase, but about the specific technology for carrying out this approach,’ Shokhin explained. ‘For example, if spending on human capital increases, then it is obvious that a tax hike is unavoidable. Then we have to decide on our priorities. We have proposed a methodology to the government for assessing the fiscal burden, and this includes taxes and non-tax compulsory payments. We would also like to work with the Finance Ministry on assessing the maximum fiscal burden so that businesses and the government have a shared sense of what this is,’ he added. Shokhin also warned that the social insurance system is approaching a crossroads, and a decision will soon need to be made as to whether current insurance principles are to remain or whether there will be a return towards a single social tax (calls for this are becoming more common).

Mr Shokhin also noted that in discussing development programmes, many economists have become bogged down by the growth rate paradigm. ‘But if bets are placed on an environment being created that is more favourable than in competing countries, then we have to make our way through structural and institutional reforms of a different kind,’ he added. In that case, Russia will have to accept that the main growth driver is economic freedom, which is not possible without the protection of property rights and an increase in the number of small business owners. In this case, the KPI strategies for economic development will consist not of growth rates, but of metrics such as decreased state ownership and increased ownership by small and medium businesses.

RANEPA Rector Vladimir Mau agreed that growth rates are not unconditional indexes for measuring the success of development programmes. Macroeconomics is unable to provide for, and can even destroy, growth prospects, he said.

Overall, new technologies require us to rethink our understanding of what ‘long-term’ means in the economy. Long-term investments are not absolute success measures. Vladimir Mau said technologies related to short-term investments were prospective. These are not technologies where labour costs do not matter; instead, this means that one mustn’t expect investments to move from China to Russia just because Russian labour has become cheaper. Countries are now starting to compete for trust in the system of public administration and in political institutions. But the trust problem can be solved practically. According to Mr Mau, by achieving 4% inflation the Central Bank demonstrated that the government is capable of not only promising something good for business and society, but keeping its promise as well.

Oleg Vyugin, who is a board member at B&N Bank and a professor at HSE, warned, however, that many necessary economic solutions (like pension and tax reform) are closely linked to politics, which is why they are not always popular. ‘There is no balance of interests in society, and so long as this is true, it will be fairly difficult for the government to follow the correct economic course of action,’ he concluded.