24.03.2003
Russian Petrodollar Will Have to Move Back
№1 2003 January/March
Vladimir Yevtushenkov

Vladimir Yevtushenkov is Chairman of the Committee on Scientific-Technological Innovations and High Technologies under the Russian Chamber of Commerce and Industry.

Vladimir Yevtushenkov is Chairman of the Board of Directors of
the Sistema Joint Stock Financial Corporation, a member of the
Board of Trustees of Russia in Global Affairs.

Vladimir Yevtushenkov

The belief that Russia predominantly exports raw materials has
been firmly entrenched throughout international economic circles.
But for the first time in its history, Russia’s export structure is
beginning to change. Along with the traditional exports of oil,
gas, steel and lumber, Russia is increasingly exporting intellect.
While Europe is experiencing a shortage of 1.2 million skilled
information technology (IT) specialists, 1.3 million Russian
programmers, physicists, biologists and other highly trained
professionals are waiting in the wings. The market economy and the
scientific community seem to coexist concurrently in Russia,
without merging into a “knowledge economy.”

Economic Growth Followed By Slowdown

The brain drain provides direct evidence that particularly
valuable knowledge and technologies are failing to find adequate
demand in Russia. During the last two years, Russia’s high
technology sector only accounted for up to 1.5 percent of its gross
domestic product, which roughly corresponds to the relevant levels
in Eastern Europe and Latin America.

Russia now ranks 63rd in the world in terms of its competitive
ability outlook, which makes it hard to detect qualitative changes
in its economy, although there is certain progress. Since 2000,
Russia has maintained macroeconomic stability which was reflected
in its budget surplus. It has maintained moderate inflation rates
and adequate hard currency reserves. The population’s power of
consumption has increased, while the country’s GDP has jumped 21
percent over the last four years. Industrial production has been up
30 percent, and the output of the engineering sector saw an
increase of 5 percent. Russia’s partnership with the West – no
longer inhibited by political squabbling – has made it possible for
the country to advance closer to joining the WTO and win
recognition as a market economy state.

Last year, as post-crisis economic growth trends gained positive
momentum, Russia finally got the chance to consider the desired
course for its growth, as well as the pace and quality of that
growth. In fact, the debate was initiated by the government which,
having focused on institutional restructuring, drew a line under
the stage of market-aimed transformation of the economy. But what
comes next? Are there any more incentives for industrial
growth?

Many politicians and entrepreneurs are concerned about certain
trends which have manifested themselves in the Russian economy. The
main factors that led to economic recovery in Russia after the 1998
crisis were the ruble’s devaluation and high international prices
for commodities, while manufacturing costs and the price for
services of the natural monopolies were relatively low.
Manufacturing has grown primarily due to the revitalization of idle
capacities and the domestic production of goods replacing imported
goods. But the potential for new growth in this field has been
mostly depleted.

The presently revived economic model of the mid-1970s, based
predominately on the export of raw materials, can only bring
temporary relief. The high level of natural resource consumption
and power intensity in the Russian economy, combined with a low
efficiency of labor, will inevitably lead to an economic slowdown
in the near future. The reason is that the costs of the
manufacturing industries are quite substantial and their investment
potential is weak due to price hikes for the products and services
of the natural monopolies – prices they charge increase at a faster
rate than in other sectors. Besides, Russian goods cannot compete
effectively on the international market because the ruble’s
exchange rate is kept too high.

Most analysts agree that in the coming years economic growth
will continue in Russia, but growth rates will slow down (last year
the country’s GDP was up 4 percent and it is expected to grow 3-3.2
percent this year). An economy based on the export of raw materials
may prove risky and collapse if world energy prices become
unstable, or should Russia’s oil, gas and metallurgical industries
contract.

The day draws near when enterprises producing high-added-value
products will discover that their investment funds are empty and
they will consequently lose the very ability to manufacture
high-tech products. As before, Russian petrodollars will have to
make up for shortages of science-intensive products, but this is
detrimental for Russia in general, as oil yields substantially less
wealth to the country in relative terms. While one ton of crude oil
yields up to U.S. $20-25 in profits, a kilogram of the aviation
industry’s output generates profits up to a thousand dollars, and a
kilogram of science-intensive products in high-tech sectors
(electronics, communications) can yield profits up to U.S.
$5,000.

Unfortunately, the government has yet to clearly articulate its
position in the debate on how to move Russia away from its
dependency on fuel and commodity exports. The cabinet has only
published quarterly reports on GDP growth rates, but has not
provided an analysis of qualitative changes in the economy and
prospects for the future.

Industry Bears Its Cross

At the beginning of the 1990s, the Russian economy could not
open its doors to high technologies because it had a specific
background. The market reform in Russia was strongly influenced by
the Soviet Union’s industrial heritage, and most importantly its
defense industries. Resources were employed for the needs of the
defense industries on a massive scale, thus leaving the ‘civil’
industries on sparse rations and doomed to technological
backwardness. (This is one of the factors which distinguished
Russia from the West, where all of the economic sectors were
relatively homogeneous in technological terms.) The result was a
catastrophic drop in product quality and the forced utilization of
the raw materials base to support the new economy.

The change of political systems seemed to only aggravate the
situation in the research and production sectors of the civil
industries: instead of modernizing them, the government chose to
free them from the fetters of state control, and thereby pushed
them toward further decline.

Ten years have elapsed, but Russia has yet to overcome its
technological ineptitude, while the world increasingly requires
valuable knowledge and skilled researchers and professionals. The
Russian economy still consists of obsolete industrial structures,
whose maintenance does not call for accelerated technological
development and the implementation of information technologies on a
broad scale.

The other reason is the ‘human factor.’ The most influential
forces now shaping Russia’s economic strategy (including political
parties), have concentrated themselves around sectors exporting raw
materials and extracting industries, where the technological level
is not too high and where business management is not too
sophisticated.

An analysis of the Russian industry’s ability to compete in the
world markets indicates that only 3–5 percent of its products can
corner the markets of the industrially developed nations. Only a
quarter of Russian technologies meet international standards, and
with many of these technologies competitive advantages are lost
already at the production stage.

The share of enterprises engaged in innovative activities has
grown from five percent in 1997 to 14 percent in 2001. Yet the
share of innovative products in Russia’s total industrial output
has not exceeded 5 percent (even in the machine-building and
metal-working sectors it amounts to not more than 10 percent).
Profit rates (and, therefore, investment attractiveness) in high
processing industries are substantially lower than those in
extracting industries.

Innovative business infrastructures have been developing very
slowly. To compare: in the Finnish city of Oulu, with a population
of approximately 100,000 inhabitants, there is a university and a
techno park with an area of 70,000 square meters. In St.
Petersburg, which has a population of five million people, there
are 80 institutions of higher learning, but the total area of its
techno parks is less than 15,000 square meters.

I will now dare to express the general view of the Russian
industrialists, who regard the development of high-tech sectors as
their main priority: the reforms of the past decade have not laid
the foundation for a structural breakthrough in what concerns the
primary sources of economic growth. The Russian economy’s prospects
for the future lie in revolutionary restructuring of the economy in
general, rather than in ‘de-industrialization’ (replacing the heavy
industrial economy with a more service-oriented economy).
Industrial production should not be sidetracked, but rather
transformed on the basis of modern financial, information and
management technologies, as well as the invaluable services of
Russia’s scientific and innovative centers.

Russia has presented to the world many successful developments
in the high-tech field, including those on the cutting-edge of
global technological development. Among them, it is worth
mentioning technologies for manufacturing crystals for the
electronic industry (Fomos Technology, Moscow), the development of
semiconductor structures (Physics and Engineering Institute, St.
Petersburg), biological microchips for medical needs (Biological
Chips Center, Molecular Biology Institute, Russian Academy of
Sciences, Moscow), laser microchips and microlasers (Firn Research
and Development Center, Krasnodar) and plasma chemical reactors for
utilizing toxic waste (International Thermal Physics and Power
Engineering Research Center, Novosibirsk).

These examples represent a desperate breakthrough despite the
numerous tax and bureaucratic obstacles which these facilities must
confront. In fact, those positive developments are not happening
due to the efforts of the state. In many respects, this is contrary
to the state’s intentions, as promising producers have failed to
find real support in the country. Existing concepts for the
development of various sectors – the automobile, machine-tool and
timber industries and metallurgy, for example – actually concern
weak industries which the state plans supporting. But money
allocated from the budget and tax breaks for these industries are
actually lost on them, since their technologies are antiquated.
Their level of management is inadequate and they cannot effectively
compete in the international markets.

In Soviet times, the public negatively reacted to the waste of
budget money, when it was ‘buried in the sand’ or used to ‘heat the
sky.’ Those projects have now been replaced by secretive projects
backed by lobbyists, like High-Speed Railways or Union TV-sets –
they enjoy the state’s support via all sorts of financial, tax and
other preferences, in fact, via all-embracing protectionism. The
public is not informed about their goals, time frames or actual
financing agreements – nor are the people given any public notice
about the beneficiaries taking responsibility for possible negative
consequences of their ventures.

Players belonging to the “new economy” have developed a special
new style of economic activity: the intellect manages the capital,
as opposed to serving it. Therefore, the high skills and knowledge
of employees who compose the backbone of smaller and mid-sized
science-intensive and IT companies are the primary movers for
economic growth. They can become the most active promoters of
economic growth on the condition that capital and knowledge are not
alternative. But for the time being, only Russian capital related
to raw materials is full of life, while knowledge remains
dormant.

Actually, Russian industry has two possible directions for its
development. The first would see the state pursuing a more hands-on
policy with a prevalence of direct budget subsidies toward
industries and certain ambitious projects. These would be
accomplished through administrative tools (this approach is
well-known in regard to the early stages of industrial
development). The second method regards those policies aimed at
creating indirect financial and economic incentives for the
production of competitive products. Russia’s specific geopolitical
position and its history do not allow for a rapid shift to the
latter model. But the former option is also unacceptable, because
defining investment sectors by the state will inevitably lead to
economic disproportions.

Many analysts agree that its over-regulated centralized economy
was the deeper cause of the Soviet Union’s collapse. That economy
failed to withstand competition with the more flexible,
market-based systems of the developed economies. But liberal
economic transformation in the new Russia has not created
conditions for a technological leap forward either. The concept of
an ‘all-embracing,’ self-sufficient (isolated from the world)
economy, which does not define technological priorities, even in
theory, has remained unchanged.

Maneuvering Resources Is A Must

The experience of the leading industrial nations has put an end
to the debates concerning whether Russia can do without global
economic specialization. Sustaining an ‘all-embracing’ economy is
very strenuous even for industrially developed nations. For
instance, the United States has dropped the development and
production of their audio, video and other science-intensive
domestic appliances. Britain has relinquished production of its
automobiles. Germany has given up production of its nuclear power
generation systems. Japan gave up large-scale production of
aircraft and aerospace equipment. The very notion of ‘national
product’ is losing its significance, because products are becoming
the property of international production.

The emergence of a new economic system radically changes the
belief that there is a direct link between a nation’s ‘production
volume’ and its actual economic potential. Knowledge can multiply
the results of economic activities more efficiently than any other
production factor. The traditional concept of a country’s current
competitive edge, associated with its GDP volume and growth rate,
is giving way to the notion of a competitive outlook, depending on
the level of new technology applications.

During the past five years, American corporations (except the
government and private individuals) obtained more patents per annum
for inventions and technological improvements than foreign
companies, government agencies and private individuals elsewhere in
the world. At the end of the 20th century, IT and communications
companies accounted for more than 20 percent of equity capital in
the United States, 18 percent in Britain, 14 percent in Sweden, and
11 percent in Germany.

Programs that provide support to industries existing in Russia
cannot be described as significant since these funds are
negligible. According to the Institute for Comprehensive Strategic
Research, even though the total number of federal programs and
subprograms has been reduced with the purpose of concentrating
resources, around 130 programs are still in effect. Each of them
provides around 2 billion rubles (65 million dollars) a year to
relevant industries.

But according to estimates, the modernization of the Russian
industry will require somewhere between 100 billion and 200 billion
dollars in the next five years. Where will these funds come from?
There are grounds to suggest that Russia will opt to rely in its
development on integrated business groups (IBG) – mostly holding
companies and strategic alliances. Anyway, they will be the first
steps on this path, while foreign investment will play a less
important role. In this respect, the prevalence of raw materials
producers in the country’s GDP is its natural advantage, and
presents a historic opportunity.

Having proved their viability during the 1998 crisis, IBGs have
accumulated the main resources for nationwide development –
financial resources, skilled personnel, competent managers and
advanced technologies. They bear the risks of technological
innovations and introduce advanced technologies. They give birth to
hosts of smaller innovative companies and are solvent consumers of
their products. Russia’s eight largest IBGs, excluding Gazprom and
Unified Energy Systems, account for more than a quarter of Russian
exports.

In fact, IBGs play in Russia a role similar to that played in
developed nations by institutional and financial entities – the
creation of such entities in Russia would take decades.

The recent economic crisis in East Asia has raised doubts about
the role of the IBGs in economic development. But it must be
remembered that Russian integrated business groups are different in
principle from those in East Asia (in particular, South Korean
Chebol conglomerates). IBGs in East Asia were formed under the
state’s direct control to pursue its industrial goals. On the
contrary, Russian IBGs emerged as private entities, rather than
under the state’s economic supervision. They rather influenced
economic policies than pursued a particular agenda of the
state.

Further development of market institutions along ‘Western’ lines
will most likely lead to a gradual reduction of the role of IBGs in
the Russian economy. But today they are the only existing real
mechanisms for the transfer of capital from the raw
materials-exporting sectors to the manufacturing sectors.

Naturally, conflicts are inherent to this mechanism. The
‘invisible hand’ of the Russian market in its current shape
watchfully protects monopolies producing raw materials. For
example, while the tax burden – the ratio of taxes to financial
resources which these enterprises retain for their disposal – is
now around 53 percent in the Russian machine-building enterprises,
it is just 34 percent in the oil production sector. ‘Maneuvering
resources’ – i.e. moving them out of the raw materials sectors into
the high-technology sectors – will inevitably turn the scales and
off-balance the current political and economic ‘status quo’ in the
raw materials sector now receiving the bulk of revenues.

The state can create conditions for this maneuver in order for
the transition to be rapid and effective. Governmental efforts
aimed at keeping particular weak sectors afloat in the market
should be replaced with support for technologically promising
companies (including regional companies and small and mid-sized
businesses) – first and foremost, those ensuring vital national
interests in electronics, biotechnology, high-technology
machine-building, power engineering and transportation.

The desired criteria for the choice of future pacesetters in the
national industry should be transparent and clear to the public.
The ability to increase added value, as well as a high innovative
potential, should be decisive among the criteria as they would lay
the foundation for dynamic development in the future. Other
important criteria include a company’s profitability and assets
structure, timely budget payments, transparency of internal
finances, abilities for creating new jobs, etc.

These are the fundamentals of a concept developed by the
Industrial Policy Committee of Russia’s Union of Industrialists and
Entrepreneurs. Many of the ideas which derive from this Union
provide the basis for the government’s decisions and, hopefully,
assist the head of state in policy-making. President Vladimir Putin
stated in his live television address on December 19, 2002: “Our
legislation should create incentives for the development of the
so-called new economy, that is, the economy based on information
technologies, the economy of the 21st century.”

The Union’s concept outlines specific instruments for pursuing
industrial policies. Let us cite the main ones among them.

A reasonable pace should be found for bringing tariffs for
services of the natural monopolies to international levels. Russian
monopolies now tend to resolve their investment problems by
automatically increasing tariff rates and shifting the burden on to
consumers. A reasonable balance should be found between the
interests of natural monopolies and the manufacturing sector.

Tax rates should be structured for ensuring equal terms for the
producers of raw materials and manufacturing industries; this will
make their investment attractiveness more comparable with each
other.

Customs policy should be reviewed so that it would create a most
favorable environment for investments in the high technology
sector. Presently, Russian customs make no difference between
exports of highly and low processed products (for example, round
timber), which undermines incentives for science-intensive
production.

Finally, the national currency’s exchange rate should not be
overstated. A compromise is needed between the interests of major
importing companies, which are interested in a strong ruble, and
the interests of exporters and suppliers to the domestic market,
which desire a weak ruble. Any rapid strengthening of the national
currency could ruin the manufacturing sector, while it would secure
the economy’s reliance on exports of raw materials.

The ultimate goal of this industrial policy is improving the
ability of the Russian producers to compete in the market, meeting
international standards and expanding the share of Russian
companies in the domestic and world markets.

Business And The Rules Of The Game

We can see that there is a triple requirement for creating a
favorable environment for the development of high technology in
Russia – the tender shots of the ‘smart’ economy, the necessary
financial resources which are held by the IBGs, and the state.
Their roles are not comparable at this time; Russian business has
yet to exist equally on all fronts and it does not control national
resources.

The state’s role as the main vehicle in modernization will be
crucial. Now that it has sharply reduced purchases of industrial
products, and the economic borders are open and Russian producers
are unable to compete with strong foreign rivals, the state’s
support for Russia’s high-tech sectors is vital.

Authorities are involved in innovative processes in developed
economies on such a large scale that in the United States there has
emerged a new term – the ‘semi-state economy’ – to describe close
interaction between the private sector and government agencies.
According to cautious estimates, the share of high technology will
exceed 40 percent in the combined GDP of all nations during the
first quarter of this century.

But while relying on the state as the main driving force in
economic modernization, it would be good to avoid two extremes. One
of them ensues from a dominant political idea that the state’s role
should strengthen in Russia – quite often this is perceived as the
strengthening of the bureaucratic apparatus and letting it make
decisions beyond public control. For the private sector to be able
to effectively realize its mission, it should be allowed to rely on
clear rules of the market economy. It must be able to take an
active part in the shaping up of those rules, while the state
should guarantee their observance.

The other extreme is the total denial of the state’s
constructive role in the economy. The government has been
persistently stating its plans to reduce the state’s involvement in
the economy as a panacea for all misfortunes, as the main
precondition for economic growth. But the economy’s deregulation
does not necessarily mean its modernization, and the free market
can hardly define society’s needs and preferences which we are
speaking about.

Russia’s economic transition from a resource-intensive model to
one which is based on high technology is only just beginning. The
current situation is characterized by clashes between existing
economic elites and forces of the ‘new economy.’ But the way for
resolving this simmering conflict is predictable. Only a transfer
of investment resources from extracting industries to high-tech
industries will lay the foundation for the country’s long-term
development and allow for the growth of its economic and political
influence in the world.