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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 Policy implications
55 Reerences
06 Skills and migration
58 Introduction
58 Russian education in context
61 Migration
63 Policy implications
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
76 Policy implications
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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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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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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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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7Diversiying Russia/ Overview
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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8Overview / Diversiying Russia
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
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9Diversiying Russia/ Overview
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.
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10Overview / Diversiying Russia
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.
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11Diversiying Russia/ Overview
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.
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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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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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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
%
Diversiying Russia/chapter 01
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
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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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10,000 20,000 30,000 40,000 50,000 60,000 ,0
Herfindahl index of export concentration
GDP per capita (US$)
Sources: Feenstra et al. (2005), IMF and authors calculations.
Note: Based on data for 2000 for 156 countries. Dat a on GDP per capita are provided at purchasing
power parity on the basis of 2005 prices.
Chart 1.7
Specialisation and income per capita
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Iran
Lybia
Oman
Gabon
Bahamas
Iceland Kuwait
Qatar
Norway
United Arab Emirates
Saudi Arabia
Diversiying Russia/chapter 01
10Both the general pattern and the income threshold at which specialisation begins to dominate are robust
across time periods, country samples and industry breakdowns; see Hesse (2008).11See, or example, Auty (1993).
There are many potental explanatons or ths pattern. At
earler stages o a countrys development, dverscaton provdes
nsurance aganst dosyncratc economc shocks, matches
dverscaton n consumpton patterns as peoples ncome rses,
and helps n the development o a broad sklls base, leadng
to stronger productvty growth. At the technologcal ronter,
however, the cost o copyng technologes becomes hgh, and
progress requres the nvestment o large amounts o physcal
and human resources n specc areas. As a result, resources
become concentrated n certan sectors, leadng to constant or
ncreasng levels o specalsaton. Indeed, specalsaton and
the queston o how to specalse eectvely s a key ssue
or advanced economes and eatures promnently n ther
polcy consderatons.
The emprcal threshold where dverscaton ends andspecalsaton begns s somewhat above Russas current per
capta ncome o around US$ 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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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
Diversiying Russia/chapter 02
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