Economy with Room for Growth
No. 2 2004 April/June

Over the past five years the Russian economy has been
demonstrating high growth rates. At the same time, factors
influencing the dynamics of this development have changed
repeatedly, with the devaluation of the ruble and an increase in
the prices of export commodities playing the key role during the
first stage. Nonetheless, the bulk of Russian enterprises, having
learned to work in market conditions over the reform years, have
made the most of their competitive advantage – Russian products
have begun aggressively replacing imported goods, while Russian
exports witness a rise in demand.

Many analysts have insisted that a weak ruble should be the
basis for economic growth. That was one possible option for
recovery. However, had such a strategy been pursued, it would have
resulted in the preservation of the old economic structure, and in
hindering programs which are intended for improving the living
standards of the population.

Now that the ruble has been steadily strengthening or, I should
say, has not been weakening, we are witnessing a significant growth
in investment and a vigorous modernization of our production
assets. Many Russian goods successfully compete on the domestic
market with foreign goods in terms of their price and quality. It
is noteworthy that investment now accounts for the major part of
our economic growth.

Naturally, it would be wrong to say that we have fully utilized
the potential for growth due to investment:

the economy has mostly been developing due to internal
resources, while the inflow of external investment remains
relatively low;

the huge savings of the population remain untapped.
Macroeconomic stability and insurance of the citizens’ private
deposits in commercial banks should become the key solutions to
this problem;

the financial infrastructure ensuring investment flows between
economic agents remains underdeveloped;

the shortage of investment targets due to the non-transparency
of companies, the absence of in-depth credit histories and obscure
ownership structures, present real problems. Potential investors
simply cannot adequately assess their investment risks, hence the
total amount of investors is limited. By 2007, all large and
mid-sized Russian enterprises are to gradually shift to
international accounting standards – this will be an important step
toward resolving the investment problem.

Structural reform is closely related to attracting investment.
However, Russia’s economy is not short of investment resources;
rather, it is short of investment ideas. It is simply impossible
for Russia to swallow a larger investment inflow than it has at
present. An energetic structural reform could mend the

The non-market sector should be reduced as much as possible.
Unprofitable enterprises should inevitably fall under bankruptcy
procedure; companies, fully or partially owned by the state, should
not be provided with (often covert) preferences and benefits. These
companies should eventually be privatized. Finally, it is necessary
that we strengthen those efforts that are aimed at stimulating the
emergence of competitive offshoots of the infrastructure

Certain steps have already been taken in these areas. Bankruptcy
procedure has been improved, and privatization continues. A lot has
been done to streamline the infrastructure monopolies. As of today,
the greatest progress has been made in reforming the energy sector
and the railway transportation system. In the energy sector,
restructuring of the national grid (Unified Energy Systems) will
continue, while a step-by-step liberalization of energy prices will
be implemented. The reform of railway transportation should create
a competitive environment for independent commercial offshoots of
the Russian Railways Co. to engage in various support

Russia’s reform of the gas sector is ‘in the pipeline.’ In the
next two to three years, state regulation of gas prices is to be
replaced with the regulation of gas transport tariffs, while gas
production and sales are to be liberalized.

Along with the reform of the infrastructure monopolies, it is
necessary to exercise more effective control over economic
concentration, since the promotion of fair market competition is
one of the most important and undeniable functions of the state. To
minimize any negative effects of that interference, this year the
principles of anti-monopoly regulation will be reviewed. Mechanisms
will be introduced for preventing abuses caused by a company’s
domineering position on the market (currently, only control over
the emergence of such a position is exercised).

At the same time, efforts should be made to improve the
anti-monopoly regulation procedures, above all those which will
facilitate market players’ applications for court hearings against
breaches of legislation.

Fifteen years of market reform have already passed but,
unfortunately, the list of structural anomalies in the Russian
economy is still too long.

A favorable business climate, together with comfortable social
conditions, can only be ensured by an effective state; this remains
one of the most pressing challenges of our day. The state machinery
in its current condition not only impedes business activities, but
it ineffectively performs its social functions. It actually hinders
the restructuring process which is direly needed by the nation.
Unless administrative reform is accomplished without delay,
Russia’s ongoing transition to a democratic and economically stable
nation will be complicated.

The main guidelines for reform have already been determined. The
reform efforts should focus on the reduction of state interference
in business, the elimination of the overlapping functions of the
state agencies and the delimitation of the powers and authority of
the executive bodies. Finally, it must promote the emergence of
self-regulating organizations which in the long run will take over
certain regulating functions in the economic sphere.

The state is simply incapable of effectively monitoring all of
the processes taking place in the economy, let alone regulating
these processes. Such attempts cause excessive bureaucratic
red-tape and an expansion of the state machinery, as well as the
worsening of the administrative burden. Wherever possible, it would
be reasonable to pass over the state’s functions to expert
organizations, i.e. market players. But it is important to make
sure that these organizations do not use their regulating functions
as a tool for suppressing competition – they should work in the
interests of the entire market. This year it will be necessary to
hand over some of the state’s functions to self-regulating
organizations, review the functions of the control and supervisory
agencies in order to reduce their range, and further improve the
licensing system.

Administrative reform has been launched. At the initial stage,
4,095 out of 5,318 state functions were analyzed, and 1,708 of
these functions (42 percent) were found to be redundant,
overlapping or requiring reduction in terms of the scope and sphere
of their implementation. Approximately 20 percent of the redundant
functions relate to essential spheres of economic life (licensing,
the issuance of permits, out-of-court suspension of business
activities, etc.). To review such functions would require, in

making it possible to suspend an organization’s activities
solely through the courts and only if there is a direct threat to
the people’s life and health;

replacing, wherever possible, licensing with control over market
players by self-regulating organizations;

stripping government agencies of their control functions
(primary data collection, laboratory research and tests), with the
state only retaining its supervisory functions.

The major state codes and approximately one hundred federal laws
will have to be amended to make all of this possible. Part of the
required legislation has already been drawn up.

In particular, draft laws have been formulated which call for
stripping federal ministries of certain functions. These include
the Ministry of the Interior (vehicular inspection), the Ministry
of Finance (part of functions related to state regulation of
auditing), and the Ministry of State Property (part of functions
related to state regulation of real estate appraisal). A law has
also been drafted on the handover of real estate inventory
functions to the market.

The remaining functions of the executive will be divided among
agencies so as to rule out conflicts of interests between them.
This means that the sector now responsible for the establishment of
rules will be separated from supervisory functions, as well as from
service operations and the management of state property. This stage
of administrative reform is to be completed within the first half
of this year.

During the second half of the year, the remaining state
functions will be analyzed in order to perfect the methods for
their implementation, and bringing the financing of the state
apparatus into line with the range of its functions and
effectiveness. At the same time, there are plans for drawing up
legislation on the general requirements for administrative
regulations, as well as a framework law on the quality standards of
state services.

While excessive interference of the state in the activities of
the economic agents is being reduced, debates are now underway for
the introduction of procedures for substantiating state
interference in the economy in individual cases. In order for such
a provision to be properly observed, a mechanism will have to be
introduced for regular evaluation of the regulating measures, which
could lead to the potential rejection of the state’s interference
in certain cases.

An important characteristic of the state is the efficiency of
its judicial system and law enforcement agencies. Unfortunately,
the abuse of authority by police and prosecutors has provoked a
serious setback in this state sector. It takes months or even years
to complete even the simplest cases, making litigation costs
inadmissibly high for average people and small businesses.

The judicial system should not be the means for the illegal
appropriation of property rights. On the contrary, it should
effectively protect those rights. In terms of economic
diversification, particularly important is the protection of
intellectual property rights. Therefore, reform should in the least
be aimed at perfecting mechanisms for the protection of property
rights, settlement of corporate conflicts, and arbitration.

Reform of the state governance system should be a top priority
over the next few years. Naturally, this will require institutional
restructuring in a broad range of critical economic spheres. These
include, above all, tax reform, better oversight of natural
resources and finances, as well as new measures for making the
economy more transparent. I will not dwell in detail on these
issues, since they have long been in the focus of debate by the
experts. At this time, it is important that we give consideration
to social security, education and health care, since these are
spheres that are particularly significant for all citizens.

Presently, the quality of state-provided medical services is
unsatisfactory, while the quality of public education leaves much
to be desired. There has been a rise in ‘under-the-table’
transactions in these domains, while the personnel lack the
necessary incentives for providing high-quality services. We must
admit that the proclaimed principle of free education and medical
services has not been observed in practice. Where it is observed,
the quality of the services in most cases is impermissibly low.

By preserving this situation, we are not only reducing living
standards, we are undermining the nation’s long-term competitive
advantage – the high quality of its human capital. So, poor
education and health services are not just a social problem – it is
a direct challenge to Russia’s sustainable economic growth.

What measures need to be taken to improve the situation? The
prescription remains the same – more freedom for the educational
and medical institutions. Competition will do its work. The system
of health insurance should work as an insurance system, rather than
a system for financing the existing medical infrastructure. Higher
educational institutions should be given the right, as well as
learn, to legally make money through professional training. To make
higher education more accessible, the state should provide
guarantees for educational loans to every Russian citizen.

On the whole, I am positive about the prospects for Russia’s
economic development in the coming years. Even if oil prices go
down substantially, the growth rate of the Russian economy will not
be negative. In the coming years, economic growth will largely be
promoted by ‘new’ companies formed in market conditions and
targeted at exacting consumers. The state, for its part, should
create the prerequisites and support such companies. To be able to
make prudent and effective moves, the state should become more
transparent for society and its goals should be serving the
interests of society and the business community.