Russian Economic Reform

Some Russian economic policy makers and commentators seem to want to look to the Chinese economy for ideas and guidance about how to “modernize” the Russian economy.

Too much concentration on China is a mistake when considering Russian economic reform.

The Chinese economy is structurally quite different to the Russian economy because its small agriculture holdings produce mainly for the domestic market and its large scale manufacturing for domestic consumption and exports. China is also coming from a generally much lower level of economic development than Russia, and is less susceptible to fluctuations in international prices for its exports compared to prices of its imports – ie in the “terms of trade”.

In my view, one “successful” economy that might be better studied to compare Russia with is that of Australia. The basic structure and dependencies of the Russian and Australian economies are very similar when considered from an economic policy point of view. Mining accounts for about 55% of Australia’s exports and about 10% of GDP. The respective numbers for Russia’s oil and gas are about 60-65% and 10%.

Not too much should be made of the exact data, in part because differing definitions and such factors as the outsourcing to the “services sector” of various functions (transport etc) by resource based companies affects the comparative data (and this outsourcing will be greater in Australia than in Russia). Official Australian economic statistics are also amongst the best in the world, while Russian official statistics are very second-rate (which is itself an area where Russia needs to carry out significant reform).

The Australian Treasurer (a position equivalent to the UK’s Chancellor of the Exchequer) gave his 2011-12 Federal Budget Speech to the Australian Parliament on 10 May 2011. It contained the following headings and sub-headings:

Economic Outlook (ie prospects world economic growth, and forecasts for Australian GDP, inflation etc); Productivity, including sub-headings of workforce Training and of Infrastructure development; Health Care and Schools; Cost of Living (ie real wages and pensions); Regional policy; Small Business and Manufacturers; “Getting the Budget back in the black” (ie achieving a Federal Budget Surplus rather than a Deficit); “Economy in Transition” (including – “Global economic weight shifts from West to East — bringing growth and dynamism closer to Australia than ever before” and converting “unprecedented mining investment boom into an opportunity boom for more of our people”.)

These issues, plus others, are the sort of issues (after swapping the terms “oil and gas” for “minerals”) that are also relevant to present-day Russia.

Considering the experiences of Australia may help Russian economic policy makers get some perspective on the present Russian situation and on the way forward.

The Russian and Australian economies are significantly affected by fluctuations in their respective “terms of trade” — in Russia’s case, mainly caused by changes in oil prices, and in Australia’s case by mineral exports. Although it also needs to be recognized that oil price fluctuations have generally been larger (and more frequent) than mineral price fluctuations.

When the “terms of trade” are very favorable (ie export prices are high compared to import prices) the perceived need, and thus pressures, for more general “productivity” enhancing reforms to boost GDP per capita is not widely appreciated because the economy – and population — is benefiting from higher prices for the same export volume. However, when the “terms of trade” are unfavorable (ie prices for those exports have significantly fallen) the economic debate about “productivity” in the wider economy gets greater attention.

And, so it is the case now!

In Australia, a longish period of very favorable “terms of trade” (now at the highest level since records began in 1870, and mainly driven by high prices for minerals exports to China) has dulled the appetite for economic reform. In Russia the recent global financial crises induced crash in oil prices has meant that discussion has returned to the need to boost “productivity” in order to boost the longer-term living standards of Russians.

While there are macro-economic benefits from strong Australian terms-of-trade, Australian manufacturers and the internationally traded services sector (such as education and tourism) are being adversely affected.

Present discussions about economic reform (with goal of “modernization”) in Russia are very similar to that which took place in Australia in the late 1980s and in the 1990s. Australian reforms were eventually carried out in such significant areas as trade liberalization, privatization, labor markets, measures to increase competition and improve taxation (with the introduction of a VAT under the name of a GST or “goods and services tax” in 2000).

The result was significant surge in “productivity” and living standards that was not related to the “terms of trade”.

In theory, Russia has already put in place many of the basic institutional structures that Australia (along with most modern economies) has — and which have had a positive effect on “productivity”. These include an independent Central Bank, privatisation of many significant government owned assets, a government organization (in the form of the Federal Anti-Monopoly Service) to defend and promote competition, and a more effective taxation system.

Of course, there have been some problems and on-going debates in Russia. But this has also happened – and continues to happen – in Australia.

Some of these debates in Australia are about nuances of policy, and some have no obvious answers. A particular example in Australia is the wording of the most important part of the legislation on competition law (Trade Practices Act).

In Australia, some infrastructure assets have been privatized against nearly all standards of common sense (eg Sydney has only one major airport, and it has been privatized allowing the effective extraction of monopoly rents), and some PPPs (public private partnerships) have resulted in toll-roads that are not well integrated into the broader transport system.

Accompanying this, at the present time, there is some debate about the age and quality of Australia’s infrastructure – including its electricity distribution networks.

Most recently there has been a vigorous debate in Australia about taxing “super profits” of companies extracting and selling natural resources.

As things now stand, from July 2012 a new Minerals Resource Rent Tax (MRRT) regime is scheduled to apply to the mining of iron ore and coal in Australia. The proposed tax – which will be in addition to existing corporate income taxes – will be levied on 30% of MRRT assessable profit, where assessable profit is defined as assessable receipts minus deductible expenditures.

The current Petroleum Resource Rent Tax (PRRT) regime will be extended to all Australian onshore and offshore oil and gas projects. It will be calculated in a similar way to the MRRT, but the tax rate will be 40% instead of 30%.

Russia is also still developing its overall system of taxing natural resource rents, and the end results may or may not be similar to Australia — but the Australian experience is worth examining.

The present debate about the dependence of the Russian economy on energy export prices and the need to have efficient/competitive manufacturing also mirrors the debate that occurred in Australia (often under the name of “industry policy”).

It has now generally been accepted that strident pursuit of “industry policy” is a dead-end, although such debates never completely die and the present strength of the $A is leading to a revival of the debate – even if, at this stage, it is less strident and conducted using different terminology.

Of course, Russia has a much larger potential domestic market for manufactured products, but targeting the development of particular industry sectors (whether under the name of “modernization” or some other name) is not particularly useful.

Some officials seem to think that Russia needs to be forced to “modernized” from the top. However they may interpret history, there is little to suggest that this is true in present-day Russia anymore than it has been true in Australia. There is no lack of desire to “modernize” in Russia except in organizations that benefit from the status-quo, and many of these are in the government sector – just as has been the case in Australia.

A major disadvantage of targeting industry sectors is its inherent flexibility, and Russian industry (like Australian) needs to be flexible if it is to prosper in an economy that is greatly influenced by fluctuations in natural resource prices – and thus the “terms of trade” and, almost inevitably, the exchange rate.

Such resource-based economies perform best with maximum flexibility in manufacturing and service sectors. Many individual firms in the non-resource traded goods sector learn that to survive they must boost their own individual “productivity” and flexibility in all areas of their business.

Larger lesser developed economies (including China) can, to some extent, adopt the approach of aiming for economies of scale in manufacturing. Indeed, the centrally planned economy of the ex-USSR was in earlier times, in some ways a reasonably efficient economic model when it came to large-scale production of basic “public goods” in the infrastructure area. But such forced industrialization can only be taken so far and eventually becomes counter-productive.

The Russian budget deficit is also getting the sort of debate attention that has occurred in Australia. After a $A50 billion deficit in 2010-11, the Australian Federal budget deficit in 2011-12 is expected to be $A23 billion (1.4% of GDP), and a small surplus of $A3.5 is expected in 2012-213.

Governments borrowing money is not necessarily a bad thing. Small and big businesses can do it to invest in new equipment or to develop new markets, and countries as a whole can do the same thing. Whether the Russian federal budget should be balanced, in surplus, or in deficit for a particular year (or even a series of years) depends on a large variety of factors.

As in many areas of macro-economics, many of those people who love to comment on budget deficit/surplus issues are really pushing their own political (or values) agenda. However, a balanced budget over the longer-term economic cycle is generally a sensible economic goal (or, at least, growth in nominal debt should not continually outstrip growth in nominal GDP).

Australia, like Russia, has a large imbalance in the taxation revenues available to the central government and regional (or, in Australia’s case, “State”) governments. Thus the Australian state governments necessarily receive various types of monetary grants from the central government – some of which are targeted to specific purposes, and some of which a general transfers. Because all income tax and VAT revenue is collected by the central government, this “fiscal-imbalance” is very unlikely to ever be eliminated in Australia – and, the same can be said about Russia! However, joint-efforts efforts need to be continually made to reduce the inefficiencies and misallocation of resources that results from regional governments not being responsible for collecting all the money they spend.

As in Russia, mining royalties are levied by regional (state) governments in Australia. However, the state governments in Australia are in a stronger position to ensure that they retain this right because of the nature of the Australian Constitution in which the individual states remain owners of on-shore natural resources.

Finally, additional observations on two specific areas of reform are necessary.

The first is business taxation. As in Australia, there are many actual and suggested Russian measures to promote SMEs (small and medium businesses) and innovations. These measures often sound good in theory (particularly to non-economists), but the implementation of these is often difficult (with an increase in tax “compliance” costs for business and tax “administration” costs for governments) and they are often easily abused – and particularly in a country with Russia’s level of corruption!

In general, it is best to keep such tax concessions to a minimum. This is the case, whether the tax in question is income based, consumption based (ie VAT) etc.

The second is the promotion of competition. Australia is not a huge market (the population is only little over 20 million) and the ACCC (the Australian competition authority) has at times been lax is using the existing legislation – for example, in the area of bank mergers – to promote competition.

Russian “productivity” would be enhanced by a very tough approach by its Federal Anti-monopoly Commission to cartels, and the Russian Central Bank should work harder to prevent a few large banks dominating the financial sector.

But it is not only good policies that are needed. Sensible implementation is very important. Russia’s history of “privatization” is a good case in point. Some of the general privatization ideas of the 1990s were good, but the detail and administration was absolutely inept – and stupidity, dishonesty and corruption prevailed.

Indeed, this sorry history has been clearly observed by ordinary Russians who wonder why they should try to be honest when so many thieves have been allowed to keep what they stole.

In conclusion, Russia is doing many things right in its attempts to boost “productivity” and GDP per capita. But, so much could easily be done much better.



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