diversifying russia.pdf

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Harnessing regional diversity

Diversifyingrussia


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About this report

The EBRD seeks to fostertransition towards openmarketoriented economies andpromote private entrepreneurialinitiative in central and easternEurope, the Baltic states,

southeastern Europe, theCommonwealth of IndependentStates and Mongolia. To performthis task effectively, the EBRDneeds to understand the keyremaining transition challengesthat these countries face.

Russia, the largest economy

where the EBRD operates,

aces a very specifc and

difcult challenge the task

o diversiying its economy,

ending its heavy reliance on

exports o oil, gas and other

minerals. This publication

looks in detail at policiesthat can help to achieve

economic diversifcation.

It pays particular attention

to Russias regional diversity

and uses evidence rom a

number o surveys conducted

jointly by the EBRD and the

World Bank, including the

Business Environment and

Enterprise Perormance

Survey and the Lie in

Transition Survey.


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Contents

Diversifying Russia/ Contents

02 Preace

04 Overview

04Improving the business

environment in Russias regions

42 Regional variation in the business

environment: survey-based evidence

44 Regional business

environment profles

46 Dierences in attitudes to corruption

47 Uneven implementation

o liberalisation reorms at

regional level

48 Policy implications49 Reerences

03Entry, exit and growth o frms

32 Introduction

32 The entry and contribution o SMEs

34 Competition in product markets

34 Barriers to exporting

35 Business environment: new survey

evidence

37 Policy implications

39 Reerences

02How diversifed is Russia?

20 Introduction

21 Russias product space

24 From regional diversity to a

diversifed economy

28 Conclusion

29 Reerences

01Diversifcation roma comparative perspective14 Introduction

14 Pathologies o dependence on

natural resources

16 Russias natural resource wealth

16 Experience with diversifcation

17 Conclusion

17 Reerences

90 Acknowledgements

05The management dimension

52 Introduction

52 Management skills in Russia:

survey evidence

52 Factors determining the quality o

management


55 Reerences

06 Skills and migration

58 Introduction

58 Russian education in context

61 Migration


65 Reerences

07 Innovation in Russia

68 Introduction

68 Russian innovation rom a

comparative perspective

72 Role o the public sector in innovation

72 Reorming Russias research

arrangements

73 Inrastructure or innovation

75 Innovating through industrial policy

76 Tax treatment


77 Reerences

08 Financing innovation

80 Introduction

80 Constraints on the unding o

innovation

81 Russias fnancing landscape

87 Policy implications89 Reerences


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2

Preface

As much o the rest o the world struggles to cope with the

ragmentation o manuacturing value chains and strives to move

up the value-added ladder, Russia continues to rely on a largely

commodity-based growth model. But or all its extraordinary

endowments, the country does not have sufcient reserves to

sustain economic growth solely on the basis o the extraction and

refnement o natural resources. And even i it did, international

experience suggests that commodity-based policies lead to

weaker growth in the longer term. Moreover, such policies

are very oten associated with weak institutions and unequal

distribution o income and wealth.

A range o policies have been tried with a view to diversiying

the Russian economy. The pioneering Gre programme under the

frst Putin administration contained a broad range o measures

designed to stimulate both the entry o new frms and the growth

o existing small and medium-sized enterprises. Putins second

term saw determined state-led eorts to stimulate innovation

and kick-start strategic non-commodity industries. The Medvedevpresidency was then marked by the global fnancial crisis. While it

broadly curtailed direct aid to specifc sectors, the balance sheets

o state-backed fnancial institutions expanded dramatically.

President Medvedev also launched a number o high-profle

initiatives aimed at stimulating innovation.

Despite these eorts, the Russian economy is arguably

more dependent on natural resources today than it was at the

turn o the millennium. The governments heavy investment in

the promotion o high-tech industries has yielded only limited

results. While China and India have both managed to dramatically

increase the percentage o exports o goods and services

accounted or by inormation and communication technology, the

corresponding shares have hardly changed at all in Russia. Barely

20 per cent o Russias manuacturing exports are products with

high skill content.

President Putin has now been elected or a third term and

a new government is in place. This report takes a close look at

the challenges that the new administration aces, basing its

assessment on a unique dataset drawn rom a range o recent

surveys and literature. Based on a research project involving a

large team o Russian and international economists, it sheds light

on the strengths and weaknesses o the measures attempted to

date and outlines the key elements o a strategy to diversiy the

Russian economy. While there is no silver bullet, the report puts

orward a combination o horizontal policies aimed at improving

the general climate or innovation and broad-based growth and

vertical policies tweaking existing state-led initiatives in order toincrease the likelihood o diversifcation succeeding.

Horizontal policies should ocus on improving the general

business environment in the country. Given that Russia is

commonly depicted as a centrally run monolith, the extraordinary

variation in the business environment across the countrys

regions is striking. This diversity suggests that policy initiatives

at the ederal level will ace serious challenges, but also that

institutional development could be promoted through the transer

o experience and competition between regions. That opportunity

has not been lost on the government, and considerable eort has

recently gone into improving the measurement o perormance

and strengthening incentives or regions to improve the local

investment climate. The report strongly endorses this approach

and suggests ways in which this could be developed urther.

It also suggests means o strengthening the implementation

o ederal reorms at the regional and local levels namely

improvements in the transparency o local government and

the establishment o eedback mechanisms or businesses

and individual citizens.

Federal policies must also place greater emphasis on skill

ormation. Russia has a long tradition o high-level research and

a culture o excellence in its secondary schools and universities.

However, the overall quality o education still does not compare

to that seen in the worlds fnest education systems and there arestrong signs that it has deteriorated over the last decade. More

needs to be done to link education with the needs o industry,

and industry must be given incentives to improve vocational

training. Importantly, Russia also needs to open its borders

to skilled migrants.

Generally, access to fnance has improved in Russia, but

there are still signifcant fnancing gaps at the initial stage o the

innovation cycle. The government should aim to take minority

stakes in privately managed unds, rather than attempting to

launch or majority-own investment unds. The grant programme

run by the Russian Foundation or Basic Research is an important

step orward in terms o achieving a more eective allocation o

resources. Private-sector participation in the governance o such

programmes is critical in bridging the divide between universities

and industry.

Harnessing potential

Much o the debate about innovation in Russia concerns the

issue o fnding resources. Consequently, people oten overlook

the act that demand or innovation is also critical. Companies

and organisations must have incentives to innovate. Much o

this demand comes rom frms competing on the international

stage. In Russia, the number o exporting frms is very small, as

the economy is dominated by government and monopolies and

government monopolies with limited pressure to innovate.

This vicious circle o small numbers o internationally competitive

companies, limited pressure to innovate and little need toinnovate needs to be broken.

Given the extent o these challenges, it is understandable

that successive Russian governments have tried state-led policy

initiatives with a view to breaking the countrys dependence on

natural resources. The report discusses several o these projects

and develops some general principles to bear in mind when

Breaking dependenceon natural resources


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3Diversifying Russia/Preface

assessing and potentially modiying them. The overall objective

must be to harness the states catalytic potential while ensuring

that decisions are made in a transparent way and ultimately

lead to a sustainable structure consistent with a well-unctioning

market economy. This requires engagement with private investors

at an early stage and a willingness to ultimately cede ull control

to the private sector.

The EBRD has tried to play a role in some o these state-led

projects and could get involved in uture projects in order to

promote these objectives. We worked with the Russian Venture

Company at an early stage and have recently engaged in ruitul

cooperation with Rusnano and Vnesheconombank (VEB) on the

basis o memoranda o understanding. I will now sketch out a

way orward or the major state-led initiatives on the basis o this

report and the EBRDs own experience.

The Russian Venture Company, which was originally modelled

on the successul state-led ormation o a venture capital

industry in Israel, experienced serious problems when it was

frst established. It has since gone through a series o dierent

guises, but has now returned to its original ormat as a und o

unds and currently backs 12 unds investing in more than 100

companies. The emphasis here must be on creating transparent

governance and bringing in private investors, preerably investors

with signifcant international experience.

The highly ambitious Rusnano, which was originally oundedin order to oster the establishment o a high-tech niche in

the nanotechnology industry, was transormed into a national

innovation ramework by its dynamic CEO Anatoly Chubais. While

the design o this national ramework might have been somewhat

dierent had it been conceived as such rom the very beginning,

Rusnano now has strong management and signifcant capital,

Erik Berglf

Chie Economist

EBRD

and has attracted some o the fnest talent in the country. Its

management aspires to ollow international best practices in

terms o investment standards and has declared its intention

to eventually privatise the und. The immediate aim is to bring in

external investors and open up its governance, but the long-term

objective must be or the government to reduce its stake to less

than 50 per cent o the unds share capital.

VEB has rapidly expanded its activities since it was re-ormed

as Russias state development bank around fve years ago. Since

then, its management has been striving to build competence

and adopt state-o-the-art procedures or investment.

Understandably, the government uses the bank to solve specifc

problems, using VEB even more than the majority state-owned

commercial banks. However, VEB should also continue seeking to

co-invest alongside private-sector investors in order to enhanceboth transparency and investment practices.

Investing in innovation

The most recent o these high-profle state-led initiatives is

VEBs Direct Investment Fund, which was set up with a view

to co-investing alongside leading international investors. The

Direct Investment Fund has established inormal links with

a number o highly qualifed potential co-investors and has

now made its frst investments. It has invested, alongside

private partners, in the unifed Moscow Stock Exchange and

the power generating company OGLK-5. However, it is still too

early to say how successul it will be in meeting its objective o

generating signifcant oreign direct investment across a range

o sectors. Nevertheless, having competent management and

now a stronger supervisory board and international advisory

board increases its chances o eventually fnding experienced

international private-sector partners who can help to attract skills

and oster innovation.

Finally, Skolkovo Innovation City the Russian Silicon

Valley is probably the most high-profle and ambitious

government project ostering innovation and diversifcation. The

Massachusetts Institute o Technology has been contracted

to build a local campus, attracting investment rom some o

Russias fnest research universities. A number o global leaders

in high-tech industries have pledged to help build fve science

clusters. Tax and other legal exemptions have been granted,

creating an attractive environment or investing companies.However, eorts should be made to extend these conditions to

the rest o the country.

Getting these state-led initiatives to deliver will take signifcant

eort and resources, and success is not guaranteed. Ultimately,

the success o Russias diversifcation eorts rests on its ability

to harness the countrys tremendous regional diversity, improve

the overall business environment and re-establish educational

excellence on a par with advanced economies. Only then will

Russian and oreign investors commit sufcient capital and skills

to break the countrys dependence on natural resources.


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4

1. IntroductionFew discussions o Russias economic policy in the last decade

have neglected to reer to the need or the country to alter the

composition o output and trade. Sometimes the policy objectivehas been termed diversication, and on other occasions it has

been called modernisation. But whatever the terminology used,

Russian policy-makers have always stressed that a radical shit

away rom a natural resource-based economy is a central policy

goal. During the 2012 presidential campaign, ormer and uture

president Vladimir Putin rearmed the Russian authorities

commitment to stimulating the non-commodity sectors o

the economy, improving the business climate and making the

economy more attractive or oreign direct investment (FDI). At

the same time, he conceded that, despite signicant reorm

initiatives over a number o years, until now, no signicant

change has occurred.1

Indeed, in 2012 Russia remains highly dependent on its

natural resources. Oil and gas now account or nearly 70 per

cent o total goods exports, and the structure o exports has

narrowed somewhat since the mid-1990s. Oil and gas revenues

also contribute around hal o the ederal budget. The non-oil

scal decit has averaged more than 11 per cent o GDP since

2009, while the oil price consistent with a balanced budget is

now in the region o US$ 115 per barrel and rising. The economy

also remains highly energy-intensive, not least because o the

persistent under-pricing o energy seen until recently. And unlike

other leading emerging markets, Russia has ailed to sustain

large infows o capital and much-needed FDI. In 2011 capital

fight totalled more than US$ 80 billion.

This report seeks to understand why more progress has

not been made, basing its assessment on careul analysiso potential barriers to successul diversication in Russia.

It reaches three main conclusions. First, despite signicant

eorts to improve the business environment and strengthen

competition in Russia, implementation in this area has not been

particularly successul because top-down reorm initiatives

have paid insucient attention to the enorcement o new laws

and regulations, particularly at the regional and local levels.

Second, government initiatives aiming to develop new high-

technology sectors have had a disproportionate ocus on the

unding o innovation, but neglected skills and education, which

are essential or structural change. Third, while a case can be

made or the state having a role in the promotion o innovation,

the governments interpretation and implementation o this role

has, or the most part, been skewed, with insucient emphasison areas such as improvements in the quality o government-

Overview

Leveraging regionaldiversity foreconomic growthSustainable long-term growthin Russia requires economic

diversifcation to reduce thecountrys dependence on naturalresources. To achieve this, Russianeeds to broaden and reocusits diversifcation strategy. Thisrequires much greater eorts toimprove education and skills, aswell as the business environment,at both the regional and the

national level. Russias enormousregional diversity can be leveragedin order to achieve these aims.While there is also a need ortargeted policies in support oinnovation, these should ocus onimproving incentives or market-relevant research and developmentand complementing private sector-

led sources o fnance or early-stage frms.

1 Vladimir Putin, Russia needs more technology and less corruption, FT

Beyond BRICS, 30 January 2012.


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5Diversiying Russia/ Overview

it is used to establish ederal rules that monitor and incentivise

implementation particularly by ostering transparency

and creating eedback mechanisms or both businesses

and individuals.

The report is based on a host o evidence collected in

Russia over the past decade, particularly the last three years.

Perhaps the most important contribution in this respect lies in

its harnessing o evidence rom Russias regions. This includes

evidence on the regional implementation o ederal legislation

designed to oster rm entry, which is based on annual surveys

conducted by the Centre or Economic and Financial Research

(CEFIR) since autumn 2002 or 20 o Russias regions. The report

unded research, incentives to commercialise this research,

and the development o private sources o early-stage and

innovation nancing.

Progress in these areas is challenging, but by no means

impossible. Indeed, the shortcomings identied in this report

have increasingly been recognised by the Russian authorities

themselves, who have begun to broaden and adjust their

diversication strategy as a result. State-led eorts to promote

innovation have been extended in the last two years. There has

been a greater emphasis on skills, eorts have been made to

attract oreign co-nancing, and a broader view has been taken o

the sectors that are worth unding. In addition, new and promising

eorts are being made, led by the Agency or Strategic Initiatives,

with a view to improving the business environment.

The report contains a number o specic ideas andrecommendations that could be o assistance in the next phase

o Russias diversication eorts. These are summarised below.

Beyond these specics, a recurring theme in this report relates

to Russias enormous regional diversity, which we document

in some detail. From the perspective o reorm eorts, this

can complicate matters, but also represents an opportunity.

There are opportunities, or example, in the area o skills and

education, where regions can (and have begun to) collaborate

with companies in setting up training programmes, or with

regard to the business environment, where regions (particularly

regions that are not rich in natural resources) may have (or be

given) incentives to compete. Furthermore, the gap between

ederal legislation and regional implementation can be helpul i

Oil and gas now accountor nearly 70 per cent ototal goods exports, andthe structure o exports

has narrowed since themid-1990s


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6Overview / Diversiying Russia

3. How diversifed is Russia?Russias output structure may, at rst sight, appear to be

reasonably diversied. However, the export structure which

indicates the areas in which a countrys products are competitive

in international markets and, to some extent, predicts a

countrys growth potential tells a dierent story. Not only are

Russian exports highly concentrated in natural resources, this

concentration has increased over time: the shares o oil, gas and

other minerals in Russias exports are higher today than they were

15 years ago. This is partly a refection o higher international

commodity prices, but even when measured using constant

prices, the share o commodity exports has, i anything, increased

somewhat over the years.

As a result, the range o exported goods where Russia enjoys

a comparative advantage is limited at present. Moreover, itis concentrated in product areas that are poorly connected

to potential new higher-value-added exports in terms o the

technological inputs and skills required to produce them. This

makes economic diversication particularly challenging and may

provide a rationale or an active role on the part o the state. It

highlights, in particular, the need to pursue policies that will help

to establish a much broader skill base, with a view to successully

bridging the gap between the existing skill set and the skill set

needed in order to move over to innovative exports (a gap that

exists in terms o both technical skills and management skills).

Analysis at regional level suggests that specialisation has also

been on the rise within individual regions. However, diversication

at the level o Russia as a whole does not necessarily require

economic diversication in individual regions. On the contrary,

Russias enormous regional diversity could be leveraged in order

to achieve economic diversication, as individual regions develop

their own comparative advantages and specialise with a view to

reaping the economic benets o clustering.

That said, the experience o the last two decades suggests

that such discovery o new comparative advantages may not

also draws on a new nationally and regionally representative

survey o the business environment and rms perormance,

which was conducted by the EBRD and the World Bank in 2011-

12 and looked at the situation in 37 Russian regions.

The remainder o this overview summarises the main ndings

o the report, sometimes combining material rom a number o

chapters, but broadly retaining the sequence in which analysis is

presented in the main report. A concluding section describes the

main policy implications.

2. Why diversiy?

There is no strong economic argument as to why diversication

is necessarily advantageous. Indeed, most policy discussions

relating to countries economic strategies are concerned with

specialisation more precisely, the question o how to achievemore productive specialisation. Empirical evidence suggests that

specialisation is most pronounced at either end o the income

spectrum. When countries are rich, they tend to be more highly

specialised, but the same is true o countries that are poor and

largely agricultural. Middle-income countries such as Russia,

however, tend to be more diversied in terms o both output

structures and trade. Cross-country evidence indicates that

specialisation begins occurring, on average, at an income level

that is signicantly higher around 65 per cent higher than

that currently seen in Russia.

In a nutshell, the argument in avour o diversiying Russia lies

in the act that excessive dependence on the natural resource

sector Russias main area o specialisation at present is

undesirable. Thus, diversication is necessary as an intermediate

stage allowing the development o new industrial capabilities,

potentially providing a platorm or uture specialisation in

Russia. These areas should initially complement and in time

replace natural resources as the main driver o Russias

growth. Underlying this view is a body o international evidence

suggesting that, while natural resources can play an important

role in giving societies a developmental push, they are rarely

associated with strong long-term growth. They are also less likely

to create jobs, given the high capital intensity typically observed

in natural resource sectors. In addition, Russias natural resource

wealth may not be large enough to achieve and sustain high

levels o per capita income in the long term. New deposits may

be discovered in the uture, but these are likely to be in remote,inhospitable areas with high extraction and transportation costs.

There are two main reasons why exports o natural resources

may not be conducive to growth in the long run. First, fuctuations

in commodity prices result in macroeconomic volatility, which

discourages investment across the economy, not just in the

natural resource sector. Second, and most importantly, it is much

more dicult to improve the business climate i the economy

is dependent on natural resources, as the presence o natural

resource revenues encourages rent-seeking behaviour and

weakens constituencies that support institutional reorm. This, in

turn, undermines growth in non-commodity sectors.

Hence, diversication is necessary as a means o improving

the business environment. But a better business environment

is also a necessary precondition (although by no means the onlyone) or diversication. In the conclusion, we return to the central

question o how Russia can break out o this vicious circle.


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environment include corruption, the availability o workers with

adequate skills, the power supply, transport inrastructure and

access to nance. Importantly, innovative rms tend to regard

these constraints as a bigger problem than rms that do not

innovate, and the dierences between the two are largest in the

areas o skills, customs and trade regulations, and corruption.

The 2011-12 BEEPS survey, which was the rst to include

regionally representative samples or 37 o Russias regions,

also shows that those regions dier signicantly in terms o the

business environment. For example, corruption is considered to

be the primary constraint in 11 o the 37 regions surveyed, but

in 7 other regions the primary constraint is access to nance,

and in another 7 regions it is access to skills. Elsewhere, access

to land, competition rom the inormal sector and access to

physical inrastructure are viewed as the most pressing issues.Even neighbouring regions oten have very dierent business

environment proles, pointing to dierent priorities or policy-

makers. In the Primorsky Region, or example, the most binding

constraint appears to be access to land, while in the neighbouring

Khabarovsk Region, various aspects o inrastructure appear

to constrain local businesses most: transportation, access to

electricity and telecommunications.

As corruption appears to be one o the most important

country-wide constraints on rms operations, the report

looks in greater detail at regional variation in perceptions o

corruption. Interestingly, in a number o regions, a large majority

o respondents tend to view corruption not as a problem, but as

a solution, where regulation is costly or impossible to comply

with. In other regions, businesses view corruption primarily as a

problem. In those regions where corruption is viewed mainly as a

problem, corruption also tends, on average, to be regarded as a

much more signicant constraint on business. While corruption

may appear to be more problematic in such regions, it may in act

be less entrenched and easier to address than in regions where it

is predominantly accepted as a solution.

Over the last decade, a number o reorm initiatives have been

launched in Russia with a view to addressing some o these

shortcomings. For example, a series o laws passed between

2001 and 2004 limited the number o scheduled inspections

undergone by rms (as well as requiring authorisation or

unscheduled inspections), removed licensing requirements or

the majority o previously licensed activities, and introduced aone-stop shop or rm registration. An independent competition

authority was created in 2004, and a new competition law

was passed in 2006. Moreover, a 2008 law allowed small and

medium-sized enterprises (SMEs) to acquire state property where

they had leased it or at least three years. In light o these eorts,

why has more progress not been made in terms o improving

competition and the business environment?

The answer is that enorcement o those new laws has been

weak and selective (although it appears to have improved over

time). To give one example, a law passed in 2002 removed

licensing requirements or the majority o previously licensed

activities. The number o licences issued then declined, as one

would expect. But as recently as 2009, more than hal o all

licences obtained by rms were or activities that no longer hadto be licensed. Background research conducted or this report

shows that liberalisation reorms are enorced to a much greater

extent in regions with more transparent local governments and

that such enorcement translates into better economic outcomes

in terms o the growth o small businesses in the region.

happen automatically and will require specic policy eorts

both at the national level and, crucially, at the regional level. A

key priority in this respect is to establish a supportive business

climate through a combination o national measures (discussed

in Chapter 3 o the report) and improvements at regional level

(discussed in Chapter 4). Another key ingredient in successul

diversication is the availability o skills, an issue discussed in

detail in Chapters 5 and 6. Chapter 5 ocuses on management

skills, while Chapter 6 looks at general skills. Finally, the

development o new production and export capabilities requires

policies and nancing that support continued innovation (issues

addressed in Chapters 7 and 8).

4. Constraints on frm entry and growth:national and regional

Shits towards new products and sectors occur through the

entry o new, innovative rms and their subsequent growth.

Unortunately, Russias business environment has not, so ar,

been particularly conducive to the entry or growth o rms. Firm

entry rates, which were high until approximately 10 years ago,

have since decreased sharply, alling below those observed

in countries belonging to the Organisation or Economic Co-

operation and Development (OECD). Small rms make only

a modest contribution to the economy, and the contribution

o medium-sized rms (those employing up to 250 people)

is particularly small, at only hal the level observed in the

European Union (EU).

Consistent with these acts, eective competition levels in

product markets are lower than in OECD countries, particularly inthe high-value-added manuacturing sectors. This could be both

a result and a cause o the lack o dynamism in non-commodity

private sectors. With low levels o rm entry, incumbent rms can

keep their margins high. However, the power o incumbents may

also be a reason why new rms nd it more dicult to enter and

grow. At the same time, growth through exports appears to be

more dicult in Russia than elsewhere. In 2008-09 just 3 per cent

o Russian rms exported, compared with 15 to 17 per cent in the

United States and France. The xed costs o exporting relating,

or example, to customs regulations or problems obtaining VAT

reunds are much higher in Russia than in other countries.

More generally, evidence rom the 2011-12 round o the

Business Environment and Enterprise Perormance Survey

(BEEPS) suggests that Russian rms continue to be constrainedby a wide range o shortcomings in terms o the business

environment. The report uses comparable survey evidence

compiled since 1999 to show that the severity o such constraints

is approximately the same today as it was in the mid-2000s. The

main obstacles cited by Russian rms as regards the business

Evidence rom BEEPS(2011-12) suggests thatRussian rms continue to

be constrained by a widerange o shortcomings inthe business environment


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The main policy lesson, thereore, is not only that policy-

makers need to pick the right reorm areas, namely those areas

that constrain rms the most (which can vary signicantly rom

region to region, as the new data show), but also that they must

ensure the eective implementation o national reorms. This

could be acilitated by establishing eedback mechanisms

whereby the abuse o rules can be reported, promoting greater

transparency in terms o institutions and governance in the

regions, and introducing programmes to improve civil servants

awareness o the regulations in place.

5. Human capital and skillsIn several respects, Russias human capital compares avourably

with that o most other countries with such income levels. One

important exception, however, is the quality o management aspecic type o skill that has been neglected until now. Evidence

rom international surveys as well as a large number o case

studies shows that the quality o management can aect rms

perormance. New survey evidence shows that Russia is not only

lagging behind advanced countries in this respect, but also trails

most o Europes other transition economies, as well as China.

The poor management skills seen in Russia are partly a

refection o the business environment: analysis shows that

product market competition, export activity and the presence

o multinational companies all areas in which Russia lags

behind are associated with better management at the

sectoral and national levels. They also refect, in part, a lack o

eective management training. Business administration remains

underdeveloped in Russian higher education. No Russian

business school currently appears in the list o the top 100 MBA

(Masters in Business Administration) programmes compiled by

the Financial Times.

Looking at skills in general, there is abundant evidence

suggesting that a lack o adequate skills is a signicant constraint

on Russian rms. This is revealed not only by the business

environment surveys discussed in the previous section, but also

by a more targeted survey o Russias leading recruitment rms

conducted at the end o 2010. The picture is one o widespread

skills gaps, which are particularly pronounced in relatively

innovative activities. At the same time, educational attainment

scores measured primarily by the OECDs Programme or

International Student Assessment (PISA) indicate a decline(or at best, stagnation) in terms o cognitive skills in Russia.

Policy emphasis on resource targets combined with a largely

ineectual decentralisation process has resulted in a lack o

improvements in educational standards and outcomes.

Reversing the decline in cognitive skills could have a strong

impact on long-term growth. Merely by catching up with the best-

perorming transition countries, Russia could achieve increases

o between 0.07 and 1 percentage point in its long-term annual

GDP growth rate. This would also support diversication, which

requires the accumulation o new capabilities and skills that dier

rom the sets o inputs and knowledge used at present.

Improving relevant skills in Russia will require changes to both

the public education system and private business and perhaps

initiatives that straddle the two. There is signicant scope orgreater experimentation with the management and unding

o schools across Russia. As regards primary and secondary

education, recent experimentation with dierent institutional

ormats or school management in countries such as Sweden

and the United Kingdom provides interesting models that could

Oil price whichbalances thebudget

US$115

Potential increase inannual growth raterom improvementsto education

up to

1%

Approximatecurrent per capita

income in Russia(in US dollars)

13,000

AT A GLANCE

Net private capitaloutfow in 2011US$80billion


11/96


scarcity o this kind o investment in Russia has, predictably, had

a detrimental impact.

The Russian governments approach is based on the view

that the lack o innovation refects a market ailure that is best

addressed by means o appropriate public policy. This initially saw

the directing and unding o innovation in certain predetermined

sectors and technologies (such as nanotechnology). More

recently, though, eective eligibility criteria have been relaxed in

order to cover a wider range o areas. Such vertical or sectoral

industrial policies have, however, had very mixed results in other

countries, particularly when the emphasis has been on public-

sector unctions, rather than acilitating collaboration between

the private and public sectors. This can be seen most clearly

in the nancing o innovation. Recently, greater attention has

been paid to establishing a business environment that acilitatesinnovation, but reorms in this area remain incomplete and are yet

to bear ruit.

The cornerstone o public policy in the eld o innovation

has been the provision o public unding. The most prominent

examples o such policy eorts are Rusnano, a state-owned und

co-nancing investment projects in the nanotechnology sector,

and initiatives such as the Russian Venture Company and the

Direct Investment Fund. As in other countries, the prole o the

companies supported by means o government unding looks to

be skewed towards relatively mature, low-risk activity, rather than

truly innovative activity. This may be perectly consistent with both

commercial viability and the objective o modernising the relevant

industry, but may not necessarily address the perceived shortall

in terms o innovation.

Although government nance has occasionally proved to be

a successul catalyst, ostering innovation and, in particular, the

growth o a venture capital industry, or every Israel there are

countless examples o countries that have tried and ailed to

use and manage public resources in the service o innovation

and/or diversication. Furthermore, most successul instances

o government involvement in venture nance have seen

governments investing in privately managed unds. In Russia,

the usual risks surrounding government involvement in venture

unding will need to be managed careully. These include a lack o

transparency, an absence o neutrality when allocating resources,

the introduction o multiple objectives and weak governance.

Recently, attempts have been made to mitigate such risks bystrengthening the governance o state-sponsored nancing

vehicles and seeking to co-nance projects with oreign strategic

and institutional investors.

potentially be applied in parts o Russia. The one thing that these

dierent approaches have in common is their willingness to

tolerate greater diversity in the supply o education, oten with

the state remaining responsible or the provision o nance and

oversight o the curriculum. In certain regions, there is already

evidence o some such steps being taken. In Kaluga, where

an automotive cluster has been ormed, investors have been

hampered by the poor state o the vocational training system. In

response, they have joined orces with the regional government

to set up training centres. These are largely state-unded, but

have also received nancial support rom the rms in question.

Complementary measures such as tax incentives encouraging

workers and rms to take up training opportunities can also

be helpul.

At the same time, the signicant skills gaps that the reportdocuments could, in part, be addressed by means o a more

fexible and open set o migration policies. At present, Russia

operates a restrictive migration regime, which, combined with

linguistic and cultural barriers, strongly limits the employment

o highly skilled migrants. While other countries actively seek to

attract talent, Russia has eectively spurned this option, leaving

other countries (with some degree o success) to attract Russian

talent instead.

6. Fostering and unding innovation

Since the mid-2000s, the Russian governments modernisation

strategy has ocused heavily on the promotion o innovation,

particularly in high-technology areas, using a set o policy

instruments such as technology parks and dedicated non-

bank nancing vehicles that have been adopted airly widely

in other countries. However, despite pockets o success, survey

and other evidence suggests that although incumbent rms do

introduce new products and processes (which may occasionally

be associated with productivity improvements), there is still a real

paucity o entrants and survivors in innovative sectors, notably in

the high-technology areas that the government has targeted.

There are a number o reasons why innovation particularly

the shit towards new, higher-value-added areas o activity has

not yet taken o in Russia. For a start, the supply o high-quality

research rom public-sector institutions remains limited and

is unlikely to improve in the oreseeable uture. Until recently,

little attention was paid to the critical need to link research withdemand in the market. Indeed, or research conducted in public

institutions, the incentives and vehicles acilitating this process

have been largely absent. The legal ramework has recently

begun to evolve in the right direction, but recent changes are yet

to yield results. The incentives or private companies to invest in

research and development (R&D) also remain limited, whether

in terms o tax or because o the general nature o the business

environment. There is clearly scope or urther scal incentives or

innovation, so long as these remain simple in terms o design and

target specic activities, rather than broad sectors.

Moreover, an economys ability to innovate will always be

determined by the skills and capabilities available, which are, in

turn, undamentally shaped by its education and training system.

In Russia, as noted above, the quality o education and traininghas ailed to improve and has, in some instances, deteriorated.

The quality o management is also likely to have had an adverse

impact. In this respect, experience in other countries shows

unequivocally that oreign companies tend to be major drivers

o innovation, oten in collaboration with local companies. The

An economys ability toinnovate will always bedetermined by the skills

and capabilities available,which are, in turn, shapedby its education andtraining system.


12/96


A urther question concerns the impact that such public

unding o innovation has on private-sector unding and

investment. At this stage, it is not possible to see with any

accuracy whether recent initiatives have led to additional

investment in R&D or pushed out private investment and unding.

Given the scale o the resources invested in Rusnano,it is likely

that some crowding-out has occurred. However, this experiment

with public venture unding is a relatively recent development, so

it is dicult i not impossible to evaluate at this stage. It will

be important in the uture or an open, rigorous and independent

evaluation o these public venture unds activities to be carriedout and or the government to send a signal arming its intention

to gradually cede majority ownership o entities such as Rusnano

to private investors.

Furthermore, evidence indicates that private-sector unding

or early-stage companies or initiatives in Russia is largely i

not entirely absent. Early-stage investing, as practised in some

advanced economies by angel investors and spin-os rom

multinational rms, is still largely lacking in Russia. The act that

this remains the case may be directly related to the wider actors

that have, among other things, deterred multinational rms rom

operating in Russia and undermined incentives or private agents

to invest in local ventures.

Although incumbent Russian rms, including SMEs, have

had greater access to organised credit (principally through banknance), external unding or R&D can still be highly problematic.

At the same time, specialist nance or start-ups and small

innovative rms has remained very scarce. To address these

limitations, small grants or researchers could be complemented

by grants or entrepreneurs. Taking an idea to market depends

not just on the quality o the innovation, but also on the business

model and the strategy adopted. Consequently, small grants

at an early stage can be particularly benecial i they provide

entrepreneurs with access to business support services and

advice. The constraining actor in Russia, as in many emerging

markets, remains the act that this support is limited and/or

skewed mainly towards the provision o physical inrastructure

(such as industrial or techno-parks). Rather than trying to direct

matters through a government agency or ministry, a better

solution would be to establish an independent authority with

governance shared between the government (as the initialprovider o unding) and representatives o the private sector

in the orm o both local and international rms. It is obviously

essential that the procedure ollowed when allocating grants

be transparent, expeditious and subject to oversight and

subsequent evaluation.

Although innovators need assurances that unding will

remain available throughout the cycle, their ability to securely

derive rents rom their innovation is also a critical consideration.

Patent protection and the ability to enorce contracts play a

central role in this regard. In neither instance is the situation in

Russia particularly supportive. In this context, legislation passed

in December 2011 with a view to establishing an intellectual

property rights court by 2013 is a step in the right direction.


13/96


Second, the governments modernisation strategy needs

to place greater emphasis on education and skills. The

evidence in this report points to a deterioration in the quality

o skills and human capital, including a limited supply o high-

quality management skills. This particularly aects innovative

companies. Although limiting or eradicating these constraints

is ar rom straightorward particularly in a very large country

with signicant regional variation the broad policy direction and

options are airly well understood. They involve decentralisation,

empowerment and the diversication o supply. This need not

imply privatisation (as greater diversity in the supply o education

can be reconciled with state unding and government oversight

o the curriculum), merely a move away rom a purely public-

sector operation. Transparency through public participation and

eedback mechanisms not least input rom potential utureemployers is also essential.

Last, but not least, the role o the state needs to be reduced

or reocused in those areas where it currently has the most

detrimental impact on rm entry and growth namely, all areas

where there is the potential or corruption and other orms o rent-

seeking (including licensing, inspections, tax administration and

customs). Eective reorm in this area is dicult, as it involves

the state reorming itsel akin to a man pulling himsel up by

his own bootstraps. This is hard to achieve in any country, but

is particularly dicult as research shows in countries with

signicant revenues rom natural resources.

Russias best hope in this and other areas (such as skill

creation) may be its regional diversity and opportunities to

exploit the relationship between its ederal and regional levels o

government. Regional diversity can lead to competition on the

basis o the quality o local government, particularly or regions

that are not rich in natural resources and are thereore dependent

or their revenues on the creation o vibrant non-commodity-

related tax bases. Constructive competition between regions can

be urther incentivised through mechanisms or the allocation

o ederal transers. Reorms at the ederal level can also be

used to limit rent-seeking at the regional level. Indeed, this was

the intention o laws passed in the early and mid-2000s aimed

at liberalising rm entry and reducing inspection requirements.

With respect to such reorm eorts, the main conclusion o

this report is that top-down legislation is not enough. It needs

to be supplemented by a strategy promoting enorcement. Thesingle most important tool in this respect is transparency the

establishment o inormation channels that monitor enorcement

and invite public eedback. By the same token, the roadmaps or

the improvement o the business environment that are currently

being drawn up by the governments Agency or Strategic

Initiatives are a promising development, but it is crucial that

this initiative be extended right down to the level o individual

regions work that is now beginning.

In time, eorts along the lines described in the previous

paragraph should bear ruit beyond the connes o economic

diversication by improving the quality o government institutions.

This will, in turn, have a broader impact on growth and the

general quality o lie in Russia. There is little reason to question

the old adage o an open society being best suited to creativeand productive activity. To paraphrase ormer president Dmitry

Medvedev, the task is to create a country that Russians

themselves want to live in.

7. ConclusionThe Russian government is right to make economic diversication

and modernisation a high priority. Moreover, this report agrees

that the state has an important role to play in supporting the

diversication o the economy. At the same time, the report

also shows that, despite signicant state-led eorts since the

mid-2000s, the Russian economy has not diversied, many

sectors continue to suer low levels o productivity, and shits

into higher-value-added activities have been limited. In particular,

attempts to establish competitive high-technology sectors not

least by means o state support have, as yet, borne relatively

little ruit. And in the arena that provides the greatest incentives

or innovation and the toughest test o viability export

markets the evidence shows that relatively ew Russian rms

compete internationally, with very ew doing so in higher-value-added sectors.

Diversication in Russia has had limited success so ar, partly

because reorm eorts have not been able to eectively address

undamental obstacles to private sector-led rm entry, innovation

and growth, and partly because state-led innovation initiatives

have been slow to address impediments to innovation outside

their main ocus area (namely the unding o high-technology

projects). I it is to be successul, Russias modernisation strategy

must be both adjusted and broadened.

First, the state must adjust its ocus with respect to direct

support or innovation. While access to nance has generally

improved in Russia, nancing gaps at the earliest stage o

the innovation cycle show that there is no alternative to the

development o a private venture unding industry. To achieve

this, the state must stop taking centre stage when it comes to

the nancing o innovation and take up a supporting role. Looking

at experience in other countries, governments involvement

in venture nance has been most successul when they have

taken minority stakes in privately managed unds, rather than

attempting to start or majority-own investment unds. Grant

programmes (such as the programme run by the Russian

Foundation or Basic Research) can be useul, particularly

i they are also directed at entrepreneurs, rather than just

research activities. International experience suggests that

such programmes work best i they are subject to a governance

structure that includes strong private-sector representation.

And beyond the provision o nance, there remains signicantscope or enhancing both private and public-sector incentives

encouraging market-relevant R&D or example, by adjusting the

way that R&D expenditure is treated or tax purposes, by providing

researchers in government-unded institutions with a wider range

o options as regards the commercialisation o their inventions,

and by improving the quality o public-sector research.

The Russian government

is right to makeeconomic diversicationand modernisationa high priority.


14/96

12


15/96

13

key facts:

Diversiying Russia/chapter 01

Us$20,0002070%Approximateincome per capitathreshold beyondwhich countriesstart specialisingin areas ofcomparativeadvantage

estimatednumber ofyears ofproduction leftfor Russiasknown oilreserves

Share ofoil and gasin goodsexports ofRussia

01:Diversifcationrom a comparativeperspectiveInternational experience shows thatcommodity wealth is oten an impedimentto growth outside those natural resourcesectors, as an abundance o naturalresources tends to weaken institutions,increase macroeconomic volatility anddivert capital and labour rom othersectors, raising labour costs and makingit more difcult to establish a broad skillsbase in the economy. At the same time,Russias reserves o minerals are notlarge enough to make Russia prosperousin the long term. Consequently,diversifcation away rom naturalresources is Russias key developmentchallenge.


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14

Consolidated government expenditure (fiscal accounts)

Public consumption and investment (national accounts)

% of GDP

Source: Russian Finance Ministry, Rosstat and authors calculations.

Chart 1.2

Public expenditure in Russia as a percentage of GDP

0

5

10

15

20

25

30

35

40

45

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011Share of oil and gas

in goods exports

Value of oil at international prices

as a % of GDP

Share of oil and gas revenues

in federal budget (direct)

1997 2011 or latest

%

Source: US Energy Information Administration, IMF, Russian Finance Ministry, Rosstat

and authors calculations.

Chart 1.1

Share of Russian oil and gas in selectedeconomic indicators

0

10

20

30

40

50

60

70

80

chapter 01 / Diversifcation rom a comparative perspective

Diversifcation rom acomparative perspective

1Dmitry Medvedev, Go Russia!, 10 September 2009. 2See Guriev et al. (2009) or a more extensive discussion o this point.3Guriev et al. (2009).4Karl (1997).5In the national accounts, some items o government spending (such as transers) may be recorded as

private consumption by the recipients o those transers. This explains the dierence between the two

measures o the size o the state in Chart 1.2.

1. Introduction

In an artcle n 2009, the Russan Presdent emphassed the

mportance o economc dverscaton: Achevng leadershp

by relyng on ol and gas markets s mpossble. In the end,

commodty exchanges must not determne Russas ate; our

own deas about ourselves, our hstory and uture must do

so.1 Yet the Russan economy stll remans heavly dependent

on commodty exports, and ths dependence has, anythng,

ncreased snce the md-1990s (see Chart 1.1 and Chapter 2 ordetals). Ths has, n turn, led polcy-makers to mplement a set

o ntatves amed at reversng ths relance on natural resources.

Ths chapter brefy sets out the ratonale underpnnng

Russas quest to dversy, thereby layng the oundatons or

the remander o ths report. In short, that ratonale stems rom

the act that Russas wealth n terms o natural resources s

lkely to be an mpedment to growth outsde o those specc

sectors, but s not, at the same tme, large enough to brng long-

term prosperty to Russa by tsel. The chapter ends wth a bre

overvew o other countres experence o dverscaton.

2. Pathologies o dependence on natural resources2.1 Institutions

Excessve relance on natural resources tends to be problematc

or several reasons. These nclude the corroson o economc and

poltcal nsttutons, an adverse mpact on the compettveness

o other sectors, weaker productvty growth and ncreased

macroeconomc volatlty.2 Indeed, there s a body o evdence

ndcatng that an abundance o natural resources commonly

undermnes nsttutonal ntegrty and vtalty, not least because

commodty rents and other lens are easer to approprate n

the presence o weaker nsttutons. In turn, compromsed

nsttutons, such as property rghts or courts o law, lmt the

growth o other sectors o the economy, as economc agents

ace hgher transacton costs or ear arbtrary expropraton.

Crucally, wthout stable nsttutonal support, the prvate sector

may not have ncentves to nvest or nnovate. Avalable cross-

country evdence also supports the vew that there s a strong

lnk between the sophstcaton o exports hgher-value-added

manuacturng and agrcultural exports as a percentage o total

goods exports and the qualty o nsttutons. Not only do moredversed economes tend to have better nsttutons, but the

qualty o nsttutons appears, n turn, to be the key determnant

o long-term changes n the sophstcaton o exports n a cross-

country context, controllng or the ntal structure o exports, the

level o ncome and other relevant actors.3

A urther benet o dverscaton stems rom the act that

a need to ncrease revenues rom cost-senstve ndustres n

tradeable sectors (such as manuacturng and agrculture) s

lkely to mpose greater dscplne on governments as regards

mprovng the ecency o publc spendng and the qualty o

publc servces.4 Ths s partcularly mportant or a country

such as Russa, where the publc sector accounts or a large

percentage o the economy n terms o spendng (see Chart 1.2).5

Moreover, the Russan publc sectors share o spendng grew

steadly durng the natural resource boom o the 2000s (n lne

wth developments n other commodty-rch countres), ncreases


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15

Oil prices (US$ per barrel) Real effective exchange rate (index: 2005 = 100)

Source: IMF International Financial Statistic s, World Development Indicators and authors' calculations.

Note: Oil prices are expres sed in real terms (on the basis of 2008 pric es) using US consumer price index

(CPI) data.

Chart 1.4

Oil prices and Russias real effective exchange rate

0

20

40

60

80

100

120

140

160

Dec-93

Dec-94

Dec-95

Dec-96

Dec-97

Dec-98

Dec-99

Dec-00

Dec-01

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

State and municipal Mixed state and private

Source: Rosstat and authors calculations.

Chart 1.3

Breakdown of employment in Russia by type of ownership

0

20

40

60

80

100

%


6Calculated using the EBRDs Lie in Transition Survey (LiTS); see EBRD (2007).

that were closely related to the loss o compettveness seen n

sectors not related to natural resources. The state stll accounts

or more than 40 per cent o total employment, although prvate-

sector employment has been rsng slowly (see Chart 1.3).

A host o avalable measures suggest that the qualty o

nsttutons n Russa s relatvely low and has not mproved

sgncantly n recent years. For example, n varous requently

cted global rankngs o poltcal and economc nsttutons,

Russa has occuped postons rangng between 78th (2010

Hertage Foundaton Index o Economc Freedom) and 167th

(2010 Freedom House Index o Poltcal Rghts) n the world.

Dependence on natural resources also tends to be assocated

wth ncreases n economc nequalty, as commodty rents (that

s to say, revenues net o extracton costs) tend to be dstrbuted

narrowly. Hgh levels o nequalty can, n turn, have a negatvempact on long-term growth, not least by lmtng access to

educaton, captal and other less tangble resources. On the bass

o standard measures o nequalty, such as the Gn coecent,

Russan socety appears to be arly unequal, but perhaps not very

unequal (wth a Gn coecent o 42 per cent, compared wth

25 per cent n Sweden and 54 per cent n Brazl). However, that

moderate Gn coecent conceals a very large concentraton o

wealth at the very top end o the dstrbuton. For example, the lst

o the 500 wealthest ndvduals n the world compled by Forbes

ncludes 39 Russans, compared wth 19 people rom Brazl, a

larger economy wth smlar ncome per capta, and a mere 9

rom Turkey. Russa also has a arly lmted mddle class relatve

to ts level o ncome, estmated at around one-quarter o the

populaton.6

2.2 Volatility, Dutch disease and growthA hgh degree o dependence on natural resources sgncantly

ncreases economc volatlty on account o fuctuatng revenues

rom commodtes, whether due to changes n world prces or

changes n export volumes as deposts are depleted. In turn, that

volatlty and assocated uncertanty dscourage nvestment n

physcal and human captal. In addton, perods when commodty

prces are boomng oten see hgher demand or non-tradeable

sectors (such as servces and constructon). As demand n non-

tradeable sectors rses, so do ther prces, and the real eectve

exchange rate ncreases (ether through nomnal apprecaton

or as a result o consstently hgh nfaton). Indeed, the Russan

rouble has apprecated strongly n real terms over the past

decade, n lne wth developments n ol prces (see Chart 1.4).

Increases n real exchange rates result n hgher labour costsacross all ndustres, as wages n tradeable and non-tradeable

sectors tend to be algned wth each other. Hgher wages and a

stronger currency lead to a loss o compettveness n tradeable

sectors (manuacturng and agrcultural sectors not related to

natural resources). Ths leads to a structural sht n the economy,

whereby the percentage o total output and employment

accounted or by non-tradeable sectors rses (termed Dutch

dsease).

Commodty-nduced macroeconomc volatlty can be reduced

by means o specc macroeconomc and structural polces,

notably by promotng nancal deepenng and establshng a

soveregn stablsaton und. Fnancal deepenng helps economc

agents to smooth out consumpton and mantan nvestment n

physcal and human captal throughout the commodty cycle.

Stablsaton unds can help to oset the mpact o a declne

n commodty revenues, whle also lmtng ncreases n real

eectve exchange rates when commodty prces rse. They can


18/96

16

Indonesia

Yemen

Nigeria

Malaysia

Mexico

UnitedStates

Ecuador

Bahrain

Iran

Algeria

Russia

Venezuela

Kazakhstan

Angola

Azerbaan

Gabon

Libya

Oman

SaudiArabia

Brunei

Norway

UAE

Kuwait

Qatar

7,989

8,529

11,182

11,200

12,735

15,792

20,040

24,767

US$ per capita

Sources: US Energy Information Administration, IMF and authors calculations.

Note: Selected countries only. Oil is valued at international prices.

Chart 1.6

Value of oil produced per capita in 2010

0

1,000

2,000

3,000

4,000

5,000

Venezuela

Iran

Australia

Nigeria

Malaysia

Russia

Oman

Azerbaan

Kazakhstan

Algeria

Qatar

Libya

Bahrain

Norway

SaudiArabia

Kuwait

Brunei

UAE

Kiribati

% of GDP

Source: Sovereign Wealth Fund Institute and World Bank.

Note: Selected countries only. Data are for 2008.

Chart 1.5

Assets of sovereign wealth funds

0

50

100

150

200

250

300

chapter 01 / Diversifcation rom a comparative perspective

7Rodrik (2011). 8BP (2011).9Imbs and Wacziarg (2003).

also be used as a vehcle or savng commodty wealth or uture

generatons. Whle Russa has establshed such unds, they are

relatvely small by the standards o other major ol exporters,

wth the total contents o Russas Reserve Fund and Natonal

Welare Fund currently standng at less than 10 per cent o gross

domestc product (GDP). Chart 1.5 shows that ths was also true

pror to the recent crss, as Russas stablsaton unds peaked at

just below 15 per cent o GDP n 2008.

Whle approprate macroeconomc polces can help to

manage volatlty, the wholesale shtng o resources nto

non-tradeable sectors durng commodty booms can weaken

long-term growth on account o derences n productvty, as

more dversed economes tend to possess sets o sklls that

are better able to acltate productvty growth. Indeed, there

s some evdence that t s these sklls that drve convergencebetween emergng and advanced economes. Convergence

tends to occur wthn hgher-value-added manuacturng

sectors, even convergence at the level o entre economes

remans weak.7

3. Russias natural resource wealthRussas natural resource endowments are substantal, but

probably not large enough to sustan a hgh level o average

ncome or the populaton as a whole over the longer term.

Indeed, ol producton per capta s already relatvely low by

the standards o ol-rch countres (such as Qatar and other

Gul states, as well as Azerbaian, Kazakhstan and Norway;

see Chart 1.6).

Ths pcture would reman broadly unchanged other

resources were ncluded, as ol s by ar the most mportant

export commodty both globally and n Russa, accountng or

more than 55 per cent o Russas goods exports (wth natural

gas accountng or only around 12 per cent, or nstance).

Consequently, contnung to specalse n ol and other natural

resources s unlkely to result n sgncant ncreases n Russas

average ncome per capta n the medum term. Moreover,

there s sgncant uncertanty as to how long Russas reserves

o natural resources wll last. Current estmates suggest that

Russas known ol reserves, ncludng elds located n the

Arctc, wll be sucent or 20 years o producton at the current

rate o extracton. Ths s a relatvely short perod: Kazakhstans

reserves, or nstance, are set to last or more than 60 years,

Saud Arabas or more than 70 years, and the Unted Arab

Emrates or more than 90 years.8 New reserves may be

dscovered, but these wll manly be oshore and n the Arctc,

where exploraton and extracton costs are hgher, reducngavalable rents (that s to say, revenues net o costs). In addton,

there s a possblty only hypothetcal thus ar that new

technologes could sharply reduce the mportance and prce o

ossl uels.

4. Experience with diversifcationMust successul economes dversy? Avalable evdence

suggests that as countres develop, they tend, ntally, to dversy.

It s only when per capta ncome levels reach around US$ 20,000

that some economes begn specalsng n areas where they

have comparatve advantages. As a result, measures o output

and employment concentraton such as the Gn or Herndahl

ndces ntally declne as ncome rses. Measures o the

concentraton o value-added then begn ncreasng agan, whle

measures o the concentraton o output reman roughly constant

(see Chart 1.7).9


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17

10,000 20,000 30,000 40,000 50,000 60,000 ,0

Herfindahl index of export concentration

GDP per capita (US$)

Sources: Feenstra et al. (2005), IMF and authors calculations.

Note: Based on data for 2000 for 156 countries. Dat a on GDP per capita are provided at purchasing

power parity on the basis of 2005 prices.

Chart 1.7

Specialisation and income per capita

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Iran

Lybia

Oman

Gabon

Bahamas

Iceland Kuwait

Qatar

Norway

United Arab Emirates

Saudi Arabia


10Both the general pattern and the income threshold at which specialisation begins to dominate are robust

across time periods, country samples and industry breakdowns; see Hesse (2008).11See, or example, Auty (1993).

There are many potental explanatons or ths pattern. At

earler stages o a countrys development, dverscaton provdes

nsurance aganst dosyncratc economc shocks, matches

dverscaton n consumpton patterns as peoples ncome rses,

and helps n the development o a broad sklls base, leadng

to stronger productvty growth. At the technologcal ronter,

however, the cost o copyng technologes becomes hgh, and

progress requres the nvestment o large amounts o physcal

and human resources n specc areas. As a result, resources

become concentrated n certan sectors, leadng to constant or

ncreasng levels o specalsaton. Indeed, specalsaton and

the queston o how to specalse eectvely s a key ssue

or advanced economes and eatures promnently n ther

polcy consderatons.

The emprcal threshold where dverscaton ends andspecalsaton begns s somewhat above Russas current per

capta ncome o around US$ 13,000.10 In addton, moves

towards specalsaton at hgher levels o ncome rely on the

dscovery o a countrys long-term comparatve advantages,

whch are based on a broad sklls base developed as the

country progresses through the mddle-ncome stage. Ths

essental dscovery process s sgncantly mpeded by Russas

consderable dependence on natural resources.

5. Conclusion

There s strong evdence that, n the long run, countres that

are rch n natural resources tend to grow more slowly than

other economes wth smlar levels o ncome and derent

characterstcs. Ths has sometmes been reerred to as the

resource curse.11 What s also clear s that specalsng

narrowly n the extracton o natural resources s assocated wth

consderable rsks to long-term growth. Indeed, gven Russas

current ncome level, narrow specalsaton would be a vable

strategy only t were able to ecently extract and sell much

larger volumes o commodtes (prmarly ol) at prces that were

consstently and relably hgher than those seen to date. Ths

chapter has also ndcated a range o other ssues assocated

wth commodty-based economes ncludng hgh levels o

macroeconomc volatlty and rent-seekng that provde reasons

to move away rom ths specalsaton.

In concluson, there s a strong case or seekng to dversy

Russas output structure and exports, movng away rom the

current dependence on hydrocarbons. At the same tme, ths

remans a very challengng task, as possessng an abundance

o natural resources tends to have a negatve mpact on the

operatng envronment or other ndustres through a numbero channels, rangng rom ncreases n real exchange rates (the

Dutch dsease) to the weakenng o the economc nsttutons

that underpn a dynamc market economy and entrepreneurshp.

The next chapter addresses the queston o just how undversed

Russas economy currently s, beore later chapters look at

barrers to urther dverscaton and the polces that are most

lkely to help acheve greater dverscaton.

Reerences

R. Auty(1993), Sustaining Development in Mineral Economies: The

Resource Curse Thesis, Routledge, London.

BP (2011), BP Statistical Review o World Energy, June 2011.

EBRD (2007), The middle class in transition, EBRD Transition Report

2007, Box 3.1, pp. 5859.

R. Feenstra, R. Lipsey, H. Deng,A. Ma and H. Mo (2005), World trade

ows: 1962-2000, NBER Working Paper 11040.

S. Guriev,A. Plekhanovand K. Sonin (2009), Development based on

commodity revenues, EBRD Working Paper 108.

H. Hesse (2008), Export diversifcation and economic growth,

Commission on Growth and Development Working Paper 21.

J. Imbs and R. Wacziarg(2003), Stages o diversifcation, American

Economic Review, Vol. 93, No 1, pp. 6386.

T. Karl (1997), The Paradox o Plenty: Oil Booms and Petro-States,

University o Caliornia Press, Berkeley.

D. Rodrik (2011), The uture o economic convergence, paper presented

at the 2011 symposium in Jackson Hole hosted by the Federal Reserve

Bank o Kansas City.


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19Diversiying Russia/chapter 02

key facts:

10310%Number ofproductswhere Russiahas revealedcomparativeadvantage,compared with513 in China

approximatepercentage ofworkforce employedin manufacturingsectors not directlyrelated to oil, gasor other naturalresources inaverage region

20%Share ofhighertechnologyproductsin totalmanufacturingexports

02:How diversifedis Russia?Oil and gas account or a large andincreasing share o Russian exports,currently making up around two-thirdso total exports. As a result, a largeproportion o Russias capital and labouris tied up in natural resources and relatedservice sectors. This makes diversifcation

a particularly challenging task, since theskills and technological inputs requiredby non-commodity exports are likely to beairly dierent rom those used in Russiascurrent exports. At the subnationallevel, diversifcation o the economy asa whole may be achieved by leveragingregional diversity, with dierent regionsspecialising in dierent areas.


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Sources: Rosstat.

Chart 2.2

Russian GDP by sector in 2011

%

Other services

Agriculture

Mining and quarrying

ManufacturingElectricity, gas and water

Construction

Wholesale and retail trade

Hotels and restaurants

Transportation and telecoms

Finance

Real estate

Public administration

Education

Health and social services0

10

20

30

40

50

60

70

80

90

100

Source: World Development Indicators.

Services Extraction, power, utilities and (prior to 2002) manufacturingManufacturing (separate data unavailable prior to 2002) Agriculture

Chart 2.1

Russian GDP by sector, 1990-2010

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

chapter 02 / How diversifed is Russia?

How diversifedis Russia?

1 See Kuboniwa et al. (2005) for a detailed discussion of how the output of the oil and gas sector is

recorded in the national accounts.

1. Introduction

Russia emerged rom the Soviet Union with a very particular,

industry-heavy economic confguration. In 1990 industry

accounted or around 50 per cent o GDP, while services

contributed only 35 per cent. Since then, the structure o the

economy has shited signifcantly, driven by two main actors.

The frst is the liberalisation o prices and Russias integration

into the world economy. As in most other transition economies,

this has led to the expansion o services and, in parallel, the

contraction o both industry and agriculture. The sectoralbreakdown seen in 1990 has now been broadly reversed,

with services now making up nearly two-thirds o GDP, while

manuacturing, in particular, accounts or just 16 per cent (see

Charts 2.1 and 2.2).

The second actor is the increase seen in international

hydrocarbon prices since the late 1990s, which has encouraged

urther specialisation in natural resources particularly oil, gas

and other minerals within the industrial sector. Increases in

hydrocarbon prices have also reinorced the shit rom industry

to services, as they have led to an improvement in Russias

terms o trade and an increase in its domestic purchasing power.

These have, in turn, raised wages and prices in the service

sectors. Thus, the de-industrialisation process that began in

the early 1990s has been reinorced by a shit in relative prices

resulting rom soaring oil and gas prices and strong increases in

government revenues.

Given the current breakdown o GDP (see Chart 2.2), the

Russian economy may seem airly diversifed. However, the

ofcial breakdown overstates the extent o diversifcation, as oil,

gas and other mineral resources are recorded all the way along

the production chain as mining and quarrying (the extraction

o those resources), as manuacturing (the refning o oil, or

example), as transportation (the moving o oil around the country),

as wholesale trade (trade in oil and oil products), and so on.1

Russian exports tell a clearer story (see Charts 2.3 and 2.4).

These show both the consistently large proportion o exports

accounted or by natural resources (with mineral products,

metals and precious stones making up more than 75 per cent

o Russias exports since the mid-1990s) and the sharp rise

in mineral exports resulting rom the natural resource boom

seen since 2000. By 2009 mineral uels accounted or nearlytwo-thirds o Russias exports in nominal terms up very

strongly rom around 45 per cent in the mid-1990s. The largest

contributors to exports are crude oil, which makes up 43 per

cent o mineral exports and 28 per cent o overall exports,

petrochemicals (22 per cent and 14 per cent respectively) and

natural gas (14 per cent and 9 per cent respectively). The next

largest commodity group is metals, which accounted or 12 per

cent o mineral exports in 2009, down rom 16 per cent in 2000.

Metals exports themselves are highly concentrated, with errous

metals accounting or 44 per cent o the total. Chart 2.4, which

calculates export shares using constant (2007) prices, shows

that most o the increase seen in the export share o mineral

products since 2000 can be attributed to higher hydrocarbon

prices. In other words, there has, in real terms, been very little

reallocation across commodity groups, so the concentration o

exports has remained broadly stable since 2000. However, even


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0

20

40

60

80

100

%

Source: Rosstat and authors calculations.

Mineral productsChemicalsMetals and precious stonesWood, pulp and paper Machinery and equipment Other Food

Chart 2.4

Structure of exports in real terms (at constant prices)

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

% US Dollars per Barrel. World price

Source: Rosstat and IMF International Financial Statistics.

Mineral productsChemicalsMetals and precious stones Wood, pulp and paperTextiles and leather Machinery and equipment Other Food Average oil price

Chart 2.3

Structure of exports in nominal terms

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

0

10

20

30

40

50

60

70

80

90

100

0

20

40

60

80

100

120


2 OECD (2011), p. 77.3 See Hausmann et al. (2007), Hidalgo et al. (2007) and Hausmann and Klinger (2007) or more details and

the application o this method to countries in Europe and Central Asia.

with constant prices, mineral products have risen slightly as a

percentage o total exports.

Alongside the shit in the composition o production and

exports, large shits have also been seen since 1990 in the

relative importance o Russias various trading partners and the

goods traded with particular countries. While trade with countries

in the Commonwealth o Independent States (CIS) has declined,

trade with the European Union (EU) has increased, driven

mainly by exports o mineral uels. At the same time, exports o

manuactured goods have gone mainly to other CIS countries,

attributable in part to historical relationships. Recent analysis by

the OECD has shown that, besides raw materials, manuacturing

exports have been dominated by low to medium-technology

items. Higher-technology products account or barely 20 per cent

o total manuacturing exports, which is very low by internationalstandards. Given the structure o exports, the contribution made

by high-technology industries to Russias manuacturing trade

balance has, accordingly, been highly negative.2

2. Russias product space

How easy would it be or Russia to move away rom its current

commodity-dominated export prole and diversiy its production

and exports? This question can be answered with the aid o a

method developed by Ricardo Hausmann, Cesar Hidalgo and a

number o co-authors,3 which uses detailed trade data to map

a countrys product space. This method assigns a value to

every product on the basis o the average income o the countries

that export it worldwide. On the basis o the values or individual

products, one can then measure the income associated with a

countrys total export basket (as a weighted average o the values

o exported goods). Furthermore, this method can be used to

measure the distance between each pair o goods that is

to say, the probability o a country exporting both products at

the same time (more precisely, the minimum o the probability

o it exporting product A, conditional on it being an exporter o

product B, and vice versa). Using this measure, it is possible to

map a countrys product space on the basis o the distances

estimated between the various exports.

The useulness o these country-specic product maps lies in

the act that, by showing the location o the countrys current

exports, they also indicate neighbouring product regions in which

a country might be able to develop a comparative advantage

relatively easily. This is based on the assumption that, although

the distance between two goods in the product space is based

purely on export patterns, proximate export goods rely on

similar sets o inputs (such as physical assets, knowledge andinrastructure) that are specic to that activity. Established

industries will generally have an organised supply o inputs and

other requirements, such that, rom a dynamic perspective,

the cost o introducing and producing proximate products will

be correspondingly lower and the chances o developing a

comparative advantage will be higher.

This implies that i a country specialises in products located

in a dense part o the product space where small distances

separate a large number o products, it is easier to capitalise

on existing comparative advantages and increase exports in

adjacent areas. By con

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