13.04.2004
Business to Replace Geopolitical Ambitions
№2 2004 April/June

Russia’s global influence to a great extent depends on its role
in the international division of labor. The country has mostly been
a producer and supplier of raw materials – they account for nearly
80 percent of its exports. At the same time, Russia mostly imports
high added value products (machinery, equipment, and consumer
goods), and the balance of its export services and technologies has
been steadily negative. Crude oil and gas (55 percent), metals
(around 19 percent), and timber (around 5 percent) have been the
main export commodities. The need to do away with the economy’s
dependence on the export of natural resources has been a recurring
theme in the president’s annual state of the union addresses, as
well as in the government’s economic development programs.

What is wrong with specializing in the export of natural
resources (mostly oil and gas)? Many analysts insist that the
prevalence of raw materials amongst a nation’s exports can be used
as a lever for exercising its global influence. Since the demand
for oil and gas in the developed nations (the biggest importers of
these commodities) is expected to grow, and Russia has the world’s
biggest gas and oil reserves among non-OPEC member countries, it
can become a stable supplier of oil and gas to the Western nations
and China. This would facilitate Russia building a stronger
economic relationship with the developed nations.

How justified is this strategy? First, the world is unlikely to
face shortages of the main natural resources in the future, while
the development of alternative energy technologies (such as fuel
cells using hydrogen) could significantly change the demand for
these commodities. Also, the currently favorable situation with oil
and gas exports is due to market rigs and contingencies (irregular
oil supplies from Iraq, Nigeria and Venezuela); it does not reflect
shortages of energy resources. The unprecedented increase in global
natural resource prices over the past five years is economically
unfounded – they may remain at the same high level for some time,
but Russia should not set its hopes on that.

Europe – the most diversified market in the world, with a high
level of competition – remains the main consumer of exported
commodities. The European Union – which accounts for nearly 98
percent of Russia’s exports of crude oil and gas to countries
beyond the CIS – has declared the diversification of the sources of
its oil and gas supply imports as a goal of its energy policy. In
particular, the EU seeks to reduce its dependence on oil and gas
imports from Russia (on account of the EU expansion, this year
Russian oil supplies will make up 33 percent of Europe’s net oil
imports, and gas supplies will stand at more than 50 percent).

Second, according to the existing foreign trade model, Russia’s
domestic consumer demand is largely satisfied by added value
created abroad. Dependence on the imports of high-quality
equipment, technologies and consumer goods poses a threat to
Russia’s economic security, and keeps it technologically
undeveloped. This sort of specialization in foreign trade may
eventually turn Russia into a second-rate economy, and Russians
risk losing potential jobs for, as mentioned above, the bulk of
added value (and, therefore, jobs) continues to be created
abroad.

Is it possible for Russia to radically alter its role in the
world economy? If the answer is yes, it will not be easy. The
products of the Russian manufacturing sectors can most effectively
compete in third-world countries. The demand for Russian weapons
and military hardware is limited. The ongoing brain drain from the
country seriously undermines the base for developing Russia’s
hi-tech sectors. In terms of the key criteria determining a
nation’s competitiveness (such as labor productivity and the
efficient utilization of resources), Russia is lagging behind other
emerging markets. The Russian food industry has been inspiring a
certain degree of confidence recently, but this is a sector where
Russian goods will inevitably face particularly tough protectionist
measures abroad. Therefore, Russian food producers will be
hard-pressed to find capacious markets outside the country. The
situation can be alleviated only through international legal
instruments, but Russia is still ‘disfranchised’ in international
trade: due to disagreements with the EU, Russia’s accession to the
WTO seems to be delayed for an indefinite time.

Incremental changes in expanding the exports from non-resources
sectors are possible, though. But this can be achieved only if the
state invigorates its structural policy, including by resolutely
pursuing structural reform. Combined with Russia’s integration into
international legal institutions regulating trade relations, this
policy implies the support for competitive high-tech export sectors
of the economy and creation of incentives for more efficient use of
economic resources. So far, the debates about the industrial policy
in Russia have led nowhere (the Cabinet prefers to stimulate
economic development exclusively through tax and foreign exchange
rates). Structural reform in the energy and transport sectors has
virtually stalled. Besides, it has become obvious that the WTO is
not particularly keen on seeing Russia in its ranks. The situation
may gradually improve, but this will require an understanding of
the country’s present whereabouts and will take quite some time.
Meanwhile, the export structure has remained unchanged over the
past seven or eight years.

DORMANT OPPORTUNITIES

Russia has a natural potential for fundamentally modifying its
foreign trade structure since it is the only genuinely Eurasian
nation. How realistic are the hopes that Russia’s role will change
in the international division of labor? Russia’s geographic
location as a transit nation is unique. The shortest transport
routes from Europe to Central Asia and the Asia-Pacific region –
the world’s key economic regions, with trade volumes between them
and Europe steadily growing – extend across Russia.

Russia can be a competitive transit nation. Transit across
Russia means the fastest shipments possible, compared with all of
the alternative routes. There are also other advantages: Russian
transport routes have a solid reserve of throughput capacity, while
transit cargoes shipped via Russia cross fewer borders than
alternative onshore routes.

Ignoring these potential reserves would be severe
short-sightedness. However, this potential has not been tapped to
date: currently, Russia’s export of transport services yields only
around $3 billion.

How much will Russia benefit from its transit services on the
Eurasian route? For many nations, export of transport services is a
key source of foreign trade revenues. For example, the Netherlands
and Hong Kong receive $20 billion and $13 billion respectively in
export revenues from transport services. They have small
territories yet they have successfully pursued strategies aimed at
promoting the development of transport hubs, effectively serving
transport flows linking the world’s major economic centers. They
sell services that are comparable to, for instance, exports of oil,
gas or metals (taken as separate groups of commodities) from
Russia. As a result, the share of transport services is quite
substantial in those countries’ national export structure, and they
are on the top ten list of the world’s biggest exporters of paid
services (Russia ranks 31st).

In December 2003, the Russian Cabinet approved a draft of the
country’s new transport strategy. It provides for introducing
dramatic changes in Russia’s foreign trade specialization in the
coming 10-12 years. As a key element of this strategy, the
government has set the goal of implementing the country’s transit
potential by developing a network of international transportation
routes running across Russia. These include:

– the Trans-Siberian corridor running from Russia’s Far Eastern
ports to border crossings and ports in northwest Russia. This route
is seen as an alternative to traditional sea routes used for
container shipments from Southeast Asia around India and via the
Suez Canal to Europe. Even without an upgrade, the Trans-Siberian
route can provide for the shipment of up to 150,000 containers a
year and yield up to $1 billion annually. In the future, its
capacity may reach 300,000 containers with revenues reaching $2.5
billion a year. To bring the Trans-Siberian corridor into accord
with modern requirements, line communications facilities will have
to be further developed and Far Eastern and Northwestern seaports
will have to be upgraded to link them with international services
lines;

– the North-South corridor intended for shipments between the
Persian Gulf nations, India and Pakistan across the Caspian Sea
with Eastern and Central Europe and Scandinavia. Its potential
annual capacity is 15-16 million tons of cargo, which could yield
Russia more than $2 billion in revenues;

– the Arctic Sea route. Despite the technical difficulties of
navigating the Arctic, geographically it is the shortest route
linking Europe with the Far East and North America’s west coast.
Potentially, in addition to cargo transit, it could carry Russian
exported goods that are now supplied to Southeast Asia by the
southern sea route via the Suez Canal.

Other transit projects call for opening ferry lines on the
Caspian and the Baltic Seas, a corridor for supplies from the U.S.
Pacific coast to northern China via Russian Far Eastern ports, and
cross-polar flight routes between airports in North America and
Southeast Asia.

By implementing the transit potential of the Eurasian routes,
Russia would gain an extra $8-9 billion a year in 2007-2008, and
$20 billion a year by 2015 (given the projected growth of shipments
on the Eurasian routes). It means that transit services can, in
fact, turn into a major source of export revenues, second only to
oil and gas export revenues. Furthermore, Russia would receive a
serious cushion against risks related to the potential
deterioration on the world commodity markets. The conditions would
be created for dramatically changing the country’s role in the
international division of labor by turning it into a Eurasian
transit nation. The opportunities for exporting Russian high added
value goods to South Asia and the Asia-Pacific region – the fastest
growing markets – would substantially expand. The development of
the Eurasian transport routes would give an impetus to developing
telecommunications, increasing manpower and cargo mobility,
revitalizing industrial and business activities, and bring other
economic benefits.

The international transport corridors program provides for
building ports, terminals, railways and motor roads. Nearly 80
percent of the Russian population live in areas close to the
international transport corridors, and the program’s implementation
would create more than 100,000 new jobs there.

NEW COMPETITIVENESS STRATEGY REQUIRED

How can such a maneuver help modify Russia’s role in the
international division of labor? For a country supplying raw
materials to the world market, the threat of finding itself in the
periphery of the world economy – or even in economic isolation – is
much greater than for a country that is economically based on
international freight traffic. There are many raw material
suppliers to the world market, with new suppliers of oil
(Kazakhstan, Brazil, Gambia, and Angola) and gas (Trinidad and
Tobago, and Qatar) emerging today. Competition has been increasing
in the commodity markets. If Russia builds international transport
corridors, it will be able to cancel the negative balance of its
export services and generate a steady demand for services produced
in Russia – with subsequent growth in jobs, capital inflow,
etc.

Until now, however, the Trans-Caucasian nations, above all
Georgia, have led the way in this sphere. Lacking generous natural
resources, but being favorably located for transit, Georgia has
drawn the attention of the major global geopolitical players – the
EU and the United States – and is now assigned a key role in the
ambitious Eurasian transit projects – TRASECA and the
Baku-Tbilisi-Ceyhan oil pipeline. Unfortunately, those routes
bypass Russia.

Already today, competition for future Eurasian freight traffic
is increasing. The TRASECA project, for example, has been launched
on the initiative of 14 countries, together with EU support.
Initiated in 1994, this project is aimed at creating a
Europe-Caucasus-Asia complex transport corridor that will run along
Russia’s southern borders and bypass its transport facilities.

The main rival route is via the Indian Ocean and the Suez Canal.
Even though it offers a substantially slower shipping rate, this
route has undisputed advantages: it produces no problems associated
with trans-shipping, border and customs control. Unless there
emerge serious problems around the Suez Canal’s throughput capacity
in the near future, the route will be virtually beyond competition
for Eurasian shipments. But for cargoes requiring rapid shipment,
land routes have no alternative. In this respect, TRASECA is the
primary rival to the Russian transit network.

For a number of reasons, Russia presently cannot offer a more
competitive route. Two reasons look particularly important. First,
the existing transport system needs modernization. Its network of
highways and terminals has low efficiency and requires an annual
investment of approximately $2 billion; the state will have to
provide the funds for capital investment in the core
infrastructure, as the rates of return are low while risks are
particularly high. To motivate private investors, special
legislative instruments (concessions, long lease) and tax regimes,
which are now lacking in the Russian legislation, will have to be
applied. The present railway management system is so archaic that
shipment by rail is four or five times slower than it should be,
given its high potential (the nominal cargo shipment speed is
high). This situation nullifies all the advantages of shipments
across Russia, and provides another argument for the reform of the
railway transportation system which would make it a separate
responsible sphere of business. This system should be able to
adequately serve any cargo carriers – not just those of the Russian
Railways Co.’s – on nondiscriminatory terms.

Second, the legal regulation for transit cargoes has to be
modified. Border and customs procedures must be facilitated, while
controls for ensuring safe shipping must be increased. High cargo
safety risks, together with the unpredictable actions of the border
and customs authorities, remain the main obstacles to shipments
across Russian territory, prompting shippers to give preference to
other transport routes.

Russia has much to do in order to improve its image in terms of
the freedom of shipment; it should reject the strategy of monopoly
on transport flows and replace it with a competitive strategy. It
should make its transport services market attractive. Certainly, it
is inadmissible to take advantage of control over transit in order
to attain geopolitical goals. It was not accidental that when
launching the TRASECA project in the mid-1990s, the EU officials
openly stated that the project’s goal was to create a serious
alternative to Russia’s transport monopoly, which had emerged in
Soviet times, and strip Russia of the possibility to block supplies
to Europe (as it happened, for example, when borders with
Azerbaijan and Georgia were shut in the wink of the 1994-1996
Chechen war). Any speculation on Russia’s geopolitical intentions
will harm its prospects for creating a Eurasian transit
corridor.

The benefit of Russia becoming a full-fledged Eurasian economic
power is obvious. Therefore, the idea of a Eurasian transit
corridor running through Russia deserves the special attention of
the government. Remaining idle on this subject would mean missing
an opportunity for promoting Russia’s economic development in an
extremely promising sphere of international economic
specialization.