09.11.2004
Should Russia Play Economic Catch-Up Games?
№4 2004 October/December



 By the end of
President Vladimir Putin’s first term in office a new paradigm of
economic development had taken shape in Russia. The main goal of
this economic policy is ‘national competitiveness,’ and the state
and business have been encouraged to focus their efforts on
attaining this goal. In the past, the main focus was placed on
liberalization and reducing the state’s role in the economy for the
sake of an abstract idea of increasing economic efficiency. Today,
the goal set for the nation looks definite and very clear to the
public. ‘Competitiveness’ obviously means a strong Russia that must
reinforce its political position in the world by gaining economic
weight.

 

Although
the idea of national competitiveness looks very attractive on the
surface, it makes no economic sense. Nevertheless, in Russia, this
idea has found equal support from both liberal economists and
proponents for a state playing a more active economic role. The
national competitiveness concept was first voiced by liberals from
the Ministry for Economic Development and Trade in order to
validate a course toward further liberalization. It was then
actively pursued by ‘statist’ economists. Today, this concept is
being used to substantiate greater state involvement in economic
development, as well as to provide a new lease of life to
‘industrial policy.’

 

The
evolution of this concept is not accidental. Dirigisme is an
inalienable component of the struggle for national competitiveness.
Eventually, the idea voiced to revive the policy of economic
liberalism can easily become its grave digger.

 

According
to modern economic theory, both liberalism and dirigisme can
promote economic development: everything depends on particular
conditions and

methods
for pursuing a relevant policy. Yet, a choice that supports either
one of these economic policies does not need to be justified by
competition with other countries. The notion of ‘national
competitiveness’ is a typical political slogan which lacks any
economic theoretical substantiation. This concept (in its Western
version) was first criticized by the American economist Paul
Krugman (his essays on the issue were published in the book Pop
Internationalism, The MIT Press, 1996). Too much focus on national
competitiveness could easily sidetrack attention from vital
economic reform, above all, those aimed at reducing state
interference in the economy.

 

In
the words of economic theory

 

Increasing
a country’s competitive edge on the commodity markets is usually
linked with a growth in exports and cuts in imports. However, it is
often the case where this formula fails to testify to the health of
a country’s economy. According to the national account identity
(used to calculate the GDP), suggesting that exports less imports =
savings less investment, it is possible to increase net exports
(exports less imports) by widening the gap between the savings of
Russian citizens, firms or the state itself and investment in the
Russian economy or, in other words, by increasing investment in
foreign assets. The national account identity is the accounting
double-entry method for computing the GDP. It is obtained by
equating GDP that is estimated on the basis of expenditures (sum
total of private consumption, private investment, government
expenditure and net exports) with GDP that is estimated on the
basis of income (sum total of disposable private incomes, i.e.
added value produced in the country less taxes, and public
revenues, i.e. taxes).

 

In
reality, growth in foreign asset investment has been promoted by
capital flight (judging by the export surplus, the Russian economy
in the 1990s was among the world’s leaders in terms of its
competitiveness), repayment of the sovereign debt, or the
acquisition of overseas assets by the state. In countries where
there are serious restrictions on the movement of private capital
(e.g. China), the state acquires overseas assets through the use of
its Central Bank reserves. But in the modern world, where the
mobility of capital is very high, this policy is rarely successful:
government assets moved overseas are rapidly offset by a new inflow
of private assets. These are attracted by high interest rates which
the Central Bank of any country must maintain in order to
‘sterilize’ the money supply which has been affected by an
accumulation of reserves. A more efficient method is to create
stabilization funds in order to accumulate tax revenues which can
then be invested in overseas assets.

 

As for
Russia, increasing its competitive capacity on the commodity
markets is possible due to an accelerated outflow of private
capital or growth in funds that have been accumulated in the
stabilization fund. However, both these measures lead to a
worsening of the population’s living standards, since they require
keeping real exchange rates at a lower level and do not imply
growth of investment in the economy.

 

Meanwhile,
growth in the population’s prosperity (not only in the long run,
but also in the short term) and growth in investment are the main
goals proclaimed by the competitiveness policy. The contradiction
is obvious.

 

The
contradiction in the competitiveness concept forces its advocates
to promote exports while keeping out imports; this occurs not so
much on the national level, as in particular sectors. Such sectors
are often described as “high added value” sectors. The biggest
added value sectors are the capital-intensive industries, but in
Russia the unchallenged leaders in this respect are the spheres of
oil and gas production and transportation. Even in such sectors as
car manufacturing (more specifically, car assembly), the light and
food industries, as well as tourism, added value is substantially
smaller. Thus, speaking about high added value sectors in the
context of increasing competitive capacity is incorrect.

 

The
nation’s competitiveness concept has remained popular since it was
constructed analogously with the notion of ‘company
competitiveness.’ But whereas a company losing its ability to
compete can improve its products and/or corporate governance
system, or close up shop, a country cannot pull out of business.
Instead, a country must regulate its real exchange rate so that the
national account identity equation can be satisfied and the
produced goods thus become competitive again. Naturally, as a
result of such changes, the country’s residents grow poorer and are
able to buy less imported goods. However, goods produced inside the
country remain competitive.

 

When
considering competitiveness mechanisms, it is necessary to take
into account the principle of competitive advantages. This states
that if a country has an absolute advantage in terms of labor
productivity, under conditions of free trade it will only produce
goods for which it has a competitive advantage. Therefore, if labor
productivity and production efficiency rates grow in all sectors of
the Russian economy, part of it will still be unable to compete.
Thus, Russia will have to make up for the loss by importing
relevant products from abroad. In this case, Russian enterprises
will compete for available labor against each other, rather than
against the Chinese or U.S. companies.

 

A
little white lie?

 

Competition between countries, along with the need to ensure
national security, has often served as a solid argument in favor of
unpopular reforms. Reforms by Peter the Great and Alexander II –
and, in a certain sense, the Stalinist repressions – were carried
out precisely with the purpose of increasing the country’s
competitive capacity. Even Nikita Khrushchev’s economic policy was
pursued under the slogan of “catch up with and overtake the United
States.” It seems as if the Soviet Union would not have needed to
build or produce anything, had there been no America. So maybe it
is worth using the competitiveness slogan for political
purposes?

 

The answer
is yes and no. The term can be useful when it is necessary to
explain why social policy tends to toughen. The need to increase
the competitive edge of a nation was cited by Bill Clinton in
defense of his move to reduce the U.S. budget deficit. But quite
often the competitiveness idea has been exploited to sidetrack
public attention from the really vital and stubborn problems, and
it seems that Russia has chosen this path.

 

Over the
last few months, the state’s all-out attack on private business has
been the most important trend – suffice it to recall the YUKOS
case, numerous official statements concerning the “social
responsibility” of business, the purchase of Guta Bank by the Bank
for Foreign Trade under dubious circumstances and on bizarre terms,
and so forth. Those steps fit in quite well with the slogan –
having advanced to the national level of the idea – of increasing
the country’s competitive capacity and economic diversification.
Eventually, by gaining control over the natural resources sector,
the state will be in the position to easily use the revenues it
generates to increase other sectors’ competitive capacities; the
growing market share of the state-owned banks will facilitate this
process. However, these moves cannot be justified, even when the
argument is centered on the pursuit of a more sensible industrial
policy that is aimed at promoting economic growth. Industrial
policy can bring about relative advantages in a very limited number
of sectors, while large-scale diversification of the economy can
only reduce the efficiency of the export sectors and, therefore,
reduce living standards across the country.

Russia’s
liberal economists try to take advantage of the nation’s
competitiveness policy in order to justify the need for further
institutional reform. It is obvious, though, that in this
particular case competition itself is not the decisive incentive.
The current high level of bureaucratization in the economy poses
serious problems to the effective use of resources and long-term
economic growth. Russia needs economic growth to markedly improve
the living standards of the population, rather than attempting to
achieve the living standards of the Chinese. But previous attempts
to defeat bureaucracy, while not appealing to problems of global
competition, have failed. It cannot be denied that despite certain
positive changes, reforms aimed at reducing the state’s role in the
economy have flopped. Is it possible that calls for increasing the
competitive capacity will yield success in the reforms at the
present time? Theoretically, this is possible, but in practice it
seems very unlikely: there are at least as many solutions for
attaining the desired level of competitiveness by expanding the
state’s intervention in the economy, as there are solutions aimed
at the de-bureaucratization of the economy.

 

The need
for institutional reform in the framework of the national
competitiveness policy is sometimes explained by the need to
compete with other developing countries for foreign investment. In
theory, if one leaves aside the problem of volatility of capital
flows, this goal is identical to the objective of increasing
economic growth rates – after all, why else should investment be
needed? But there should be little reason for confidence that this
argument will be a weighty factor when we are speaking about the
reform of the xenophobic Russian bureaucracy, especially given that
inflow of foreign capital may be interpreted as the “selling off
the motherland,” which is tantamount to losing competition with
other countries.

 

Furthermore, talk of bureaucratic barriers obstructing the
development of business tends to be disappearing from the speeches
of the public officials, as increasingly more attention is being
paid to the collaboration of business and state. Recollections of
the Soviet times are still strong and talk about state investment
has been perceived with skepticism in the expert community. At the
same time, dirigisme and the idea of business and the state
cooperating on joint projects have grown increasingly popular. As a
result, we are just one step away from another idea, where the
state reserves the right to make demands on the business
community.

 

In the
West, the idea for increasing national competitiveness (and it was
here where such calls were first voiced) has been substantiated by
the ‘strategic trade’ policy and the concept of ‘emerging sectors
development.’ These theories are built around the argument that the
competitive advantages of a country change with its evolution and
the state can regulate this process. However, such theories fail to
consider the living standards issue, for example, or the situation
where the state’s refusal to purposefully change the structure of
competitive advantages would be the most reasonable step for the
nation.

As for the
emerging sectors development concept, its implementation faces
numerous problems and leads to the state’s weighty interference in
economic activities. In theory, only sectors where an economy of
scale exists at the sector level, not at the level of an individual
enterprise, fall under the definition of ‘emerging’ sectors. As a
result, even if the ability of imported products to compete is
limited, competition continues to remain very intense in those
sectors. In practice, however, this is rarely the case, and trade
restrictions as an industrial policy instrument are usually closely
linked with energetic antimonopoly policies or the state’s direct
intervention in business activities. Given that those sectors have
to compete for labor, the successful implementation of the emerging
sectors theory is only possible with respect to a limited number of
sectors.

 

True, this
policy may result (even if not always) in the overall growth of the
living standards of the population, and domestic companies which
are targets of this policy can gain a competitive edge on the world
markets. But strictly speaking, any increase in the country’s
overall competitive capacity is out of the question in this
case.

 

Import
tariffs or subsidies can serve as strategic policy instruments. In
the past, they were not used successfully in Russia and their
further use may be limited because they are unpopular, especially
in view of the country’s planned WTO accession. The idea of a
partnership between the state and business carries overtones of the
state’s direct diktat over entrepreneurial activities, or the
legalization of lobbying powers that is accompanied by the growing
opacity of business. However, the strategic trade policy does not
imply either of the two. Therefore, a turn to the latter slogan,
more neutral in political terms, may allow for substantially
limiting bureaucracy’s potential powers.

 

The
competitiveness rhetoric returns Russia to a traditional fight with
its own shadow, and talk about global competition diverts resources
for dealing with really pressing domestic problems. To break the
vicious circle of playing a never-ending game of economic catch-up,
we need to reform our bureaucratic structure which is seeking to
reap unearned income. However, this reform is being impeded by the
struggle for competitiveness.

 

Increasing
competitive capacity in Russia, like in other countries, is used to
increase the level of protectionism in particular sectors. But
unlike other countries, Russia has increasingly used the situation
to justify the state’s growing intervention in economic activities,
while building a system of relationships that permits the state to
boss around the business community.

 

I would
like to call on the Russian liberal economists and moderate
advocates of the so-called new industrial policy to drop the
program of the nation’s competitiveness for their goals. All things
considered, the best way to see one’s ideas translated into life is
to call things by their true names, rather than resort to Aesopian
language. Playing with trendy, yet faulty – from the point of view
of economic theory – concepts undermines the reputation of economic
scientists. But this is just half of the problem; worse, the
struggle for competitiveness can deal an irreparable blow to
Russia’s economic development.