Nataliya Smorodinskaya Kaliningrad: Baseline Tendencies of Social and Economic Development in the 2000-s International Workshop “Water Resources Management.

Nataliya SmorodinskayaNataliya Smorodinskaya

Kaliningrad: Baseline Kaliningrad: Baseline Tendencies of Social and Tendencies of Social and EconomicEconomic Development in Development in

the 2000-sthe 2000-s

International Workshop “Water Resources Management and Development for Economic Growth and Environmental Sustainability in Kaliningrad Oblast”. Org. by SIWI, Warsaw, 15-17 March, 2010

Institute of Economy, Russian Academy of Sciences

• Federal districtFederal district: : North-Western. North-Western. Border withBorder with: : Lithuania and PolandLithuania and Poland• Size:Size: 75th out of 83 regions in Russia in terms of area (15 100 km)75th out of 83 regions in Russia in terms of area (15 100 km)• Distances to some European capitalsDistances to some European capitals ( (km)km)::• Vilnius (350 )Vilnius (350 ) Riga (390), Warsaw (400 ), Berlin (600 ), Riga (390), Warsaw (400 ), Berlin (600 ), Stockholm (650 ),Stockholm (650 ),

Helsinki (660 ), Copenhagen (680), Oslo (850) and… Helsinki (660 ), Copenhagen (680), Oslo (850) and… Moscow (1200 )Moscow (1200 )• Inhabitants:Inhabitants: 937 400937 400• Largest townsLargest towns: : Kaliningrad 422 400, Sovetsk 42 700, Chernyahovsk Kaliningrad 422 400, Sovetsk 42 700, Chernyahovsk

41 100, Baltiysk 33 300. 41 100, Baltiysk 33 300. Share of urban populationShare of urban population: : 77%77%• Main industriesMain industries: f: food (fishing), fuel (oil), machine building, metallurgyood (fishing), fuel (oil), machine building, metallurgy• Natural resourcesNatural resources: : 90% of world’s amber reserves, oil, brown coal, peat, 90% of world’s amber reserves, oil, brown coal, peat,

rock salt, mineral water servicesrock salt, mineral water services

Kaliningrad: general facts

Key economic peculiarities:Key economic peculiarities:• since 1991, since 1991, special SEZ statusspecial SEZ status ( (free trade and free trade and other exclusive federal favours)other exclusive federal favours)• since 2004, since 2004, unique enclave positionunique enclave position within the EU within the EU

Kaliningrad as of the Russian Total:Kaliningrad as of the Russian Total:

• Area 0.1 %Area 0.1 %• Population 0.7 %Population 0.7 %• GDP 0.5 %GDP 0.5 %• Enterprises 1.0 %Enterprises 1.0 %• Industrial production 0.6 %Industrial production 0.6 %• Retail trade 0.5 %Retail trade 0.5 %• Exports Exports 0.5 % 0.5 %• Imports Imports 3.9 %3.9 %• FDI 0.6% FDI 0.6%

KD is much more than a regional case...KD is much more than a regional case...

As free-customs enclaveAs free-customs enclave KD is the most open economy in Russia. As enclaveAs enclave inside the EUinside the EU it is the most exposed locality to global competition

This unique combination makes KD an amplifier ofThis unique combination makes KD an amplifier of:• all-Russian economic trends

• all-Russian structural disbalances• all-Russian social illnesses

It is the best magnifying glass to observe all-Russian realitiesIt is the best magnifying glass to observe all-Russian realities

Federal Underlying Policy Priorities Federal Underlying Policy Priorities towards Kaliningradtowards Kaliningrad

Not to loose the levers of control over the territory in the enlarged EuropeNot to loose the levers of control over the territory in the enlarged Europe

1. 1. To bound KD’s To bound KD’s life-support systems centripetally to mainland Russialife-support systems centripetally to mainland Russia (infrastructure, power supply, communication(infrastructure, power supply, communication))

- - to provide free flow of traffic to local ports and military facilitiesto provide free flow of traffic to local ports and military facilities - to ensure easy terms of cargo, gas and energy transit deliveries to KD- to ensure easy terms of cargo, gas and energy transit deliveries to KD

2.2. To hold any extension of the Western economic presence in KD To hold any extension of the Western economic presence in KD - to narrow down the EU-Russian cooperation on KD to the- to narrow down the EU-Russian cooperation on KD to the

issues of its immediate life-support (issues of its immediate life-support (transit-pointstransit-points), while avoiding), while avoiding discussion of its fundamental modernization priorities discussion of its fundamental modernization priorities

33. . To avoid both the growing social contrast and the too rapid convergence To avoid both the growing social contrast and the too rapid convergence of KD with the EU neighboursof KD with the EU neighbours

– for the sake of preventing a rise in local separatismfor the sake of preventing a rise in local separatism

Kaliningrad’s specialization as the SEZ :Kaliningrad’s specialization as the SEZ : not an exporter to EU but just an intermediary for not an exporter to EU but just an intermediary for pushing duty-free consumer imports to Russiapushing duty-free consumer imports to Russia

Imports were sky-rocketing far above GRP and all trade flows

Sales to RF in RUR just followed imports…Exports proper werealmost flat

KD’s import-led pattern of growth in theKD’s import-led pattern of growth in thebooming 2000-s:booming 2000-s: ImportsImports reached unrivalled levels of reached unrivalled levels of 30-50% above GRP30-50% above GRP. . Exports Exports kept kept 60-65% below GRP60-65% below GRP (and started (and started

to grow only after 2004, due to Russian oil transit flows)to grow only after 2004, due to Russian oil transit flows)

GRP, rate of growth, %

Exports proper (cleared from transit oil) = max 30%

Manufacturing exports (excl. local oil) = max 11%

This was incomparable with 130-150% for imports, also mostly manufacturing

Kaliningrad GRP growth rates as compared Kaliningrad GRP growth rates as compared to Russia and Baltic statesto Russia and Baltic states

For many years KD has been operating under a hidden For many years KD has been operating under a hidden state of defaultstate of default, , with the growing trade and fiscal deficits with the growing trade and fiscal deficits covered from the federal budgetcovered from the federal budget. . The higher were the The higher were the GRP growth rates, the larger were the shortagesGRP growth rates, the larger were the shortages

By 2006, KD’s actual deficit (as cleared from transit flows) amounted to US$ 4bn, or By 2006, KD’s actual deficit (as cleared from transit flows) amounted to US$ 4bn, or 92 % of GRP. If not growing oil exports, it would have exceeded GRP by a quarter92 % of GRP. If not growing oil exports, it would have exceeded GRP by a quarter

Deliveries from SEZ to Russia (Deliveries from SEZ to Russia (cars, TV, etccars, TV, etc.) are formed .) are formed for 70-85%for 70-85% by byimported components, but statistically registered in value imported components, but statistically registered in value as KD industrialas KD industrialoutputoutput

KD KD macro-pathologies may enter the Guinness Book of Recordsmacro-pathologies may enter the Guinness Book of Records: • To be competitive at remote Russian markets, import-processingTo be competitive at remote Russian markets, import-processing firms firms (...% of (...% of

industrial output) industrial output) regularly avoid or evade taxesregularly avoid or evade taxes• KD runs a second economy in the shadow (KD runs a second economy in the shadow (95% of GRP)95% of GRP)• Official economy grows under decreasing level of private investment and tax Official economy grows under decreasing level of private investment and tax

collectioncollection• budget rests on oil industry as the largest taxpayer budget rests on oil industry as the largest taxpayer ((it makes only 9-11% of it makes only 9-11% of

industrial output, but 70-80% of net KD’s revenue)industrial output, but 70-80% of net KD’s revenue)• KD faces a dope dependence of business on state money, and of public sector, KD faces a dope dependence of business on state money, and of public sector,

on external aid on external aid Vicious Circle of Economic Growth:Vicious Circle of Economic Growth:

““Shortages - federal subsidies – higher growth – more shortages – Shortages - federal subsidies – higher growth – more shortages – - more federal assistance”- more federal assistance”

Kaliningrad’s import-led industrial growth is purely statistical…

• Rich natural landscape, advantageous geographical location in the centre Rich natural landscape, advantageous geographical location in the centre of Europe, and of Europe, and unique cultural and historical heritageunique cultural and historical heritage

• DynamicDynamic neighbourhood neighbourhood of rapidly growing Baltic states, geographical of rapidly growing Baltic states, geographical proximity to Scandinavian countries (technological leaders of the EU), and a proximity to Scandinavian countries (technological leaders of the EU), and a natural chance to get linked to numerous infrastructural and communication natural chance to get linked to numerous infrastructural and communication networks in the BSRnetworks in the BSR

• High market adaptability of the local populationHigh market adaptability of the local population due to its wide-range due to its wide-range engagement in the small-business and individual entrepreneurial activities engagement in the small-business and individual entrepreneurial activities under years of the SEZ regime. Today, this experience could be renewed and under years of the SEZ regime. Today, this experience could be renewed and substantiated through developing flexible and innovative forms of economic substantiated through developing flexible and innovative forms of economic activityactivity

Currently these assets have either a negative value or no value at allCurrently these assets have either a negative value or no value at all.. But they will get their natural investment attractiveness once KD’s But they will get their natural investment attractiveness once KD’s

economy starts moving towards integration into Europeeconomy starts moving towards integration into Europe

To make an economic advance, To make an economic advance, KD should rely on three basic assets:KD should rely on three basic assets:

Amending federal incentives for Kaliningrad: Amending federal incentives for Kaliningrad: ideology of the 2006 Law on SEZideology of the 2006 Law on SEZ

Three main federal motives to revise the old Law on SEZ:Three main federal motives to revise the old Law on SEZ:• to stop shadow leakage of federal money into local private pockets and reorient KD to stop shadow leakage of federal money into local private pockets and reorient KD

to European export marketsto European export markets • to prevent KD from rapid lagging behind its neighbours as new EU-membersto prevent KD from rapid lagging behind its neighbours as new EU-members• to bring the SEZ in compliance with international standards applied in WTO to bring the SEZ in compliance with international standards applied in WTO In late 2005, Boos was appointed the governor just to clear out KD. In late 2005, Boos was appointed the governor just to clear out KD. But the new But the new

Law appeared to be Law appeared to be a compromise between rational economic reasons and a compromise between rational economic reasons and alarmist security concernsalarmist security concerns..

The Law The Law prioritized:prioritized:• Russian investment inflow to KD instead of foreignRussian investment inflow to KD instead of foreign• Big Russian newcomers to KD (Big Russian newcomers to KD (to become “locomotives of new industrial clusters”)to become “locomotives of new industrial clusters”)

instead of local SMEinstead of local SME• Building large industrial plants instead of stimulating new economyBuilding large industrial plants instead of stimulating new economy

The 2006 Law on SEZ in Kaliningrad:The 2006 Law on SEZ in Kaliningrad: benefits for Old SEZ Residentsbenefits for Old SEZ Residents««OldOld»» SEZ residents based on customs favours granted SEZ residents based on customs favours granted

by the 1996 Law on SEZby the 1996 Law on SEZ• firms registered in KD before April 2006, may use their firms registered in KD before April 2006, may use their

customs benefitscustoms benefits• imported foreign goods are exempted from customs duties imported foreign goods are exempted from customs duties

and taxesand taxes• goods delivered to other RF regions are exempted from goods delivered to other RF regions are exempted from

customs duties if:customs duties if: - - commodity classification code has changed at the level of first commodity classification code has changed at the level of first four digitsfour digits - share of the added value has reached at least 30 %- share of the added value has reached at least 30 % Favours for “old” residents will be in force till the end of March 2016 Favours for “old” residents will be in force till the end of March 2016

((for 10 yearsfor 10 years))

The 2006 Law on SEZ in Kaliningrad: The 2006 Law on SEZ in Kaliningrad: benefits for New SEZ Residentsbenefits for New SEZ Residents

New SEZ residents based on tax favours introduced by New SEZ residents based on tax favours introduced by the 2006 Law on SEZthe 2006 Law on SEZ

• New firms conducting a capital investment at least 150 mn New firms conducting a capital investment at least 150 mn RUR (USD 5.3 mn) in the region’s industrial sector over 3 RUR (USD 5.3 mn) in the region’s industrial sector over 3 years may use the tax benefitsyears may use the tax benefits

Tax benefits offered for an investorTax benefits offered for an investor: : • corporate income tax and property tax are 0 % for the first 6 corporate income tax and property tax are 0 % for the first 6

years and reduced by 50 % for the 7-12 years after the years and reduced by 50 % for the 7-12 years after the investment investment

The 2006 Law will be in force till the end of March 2031 The 2006 Law will be in force till the end of March 2031 ((for 25 yearsfor 25 years))

The new Law on SEZ hasn’t changed KD’s The new Law on SEZ hasn’t changed KD’s pattern of growth but rather enhanced its pattern of growth but rather enhanced its ability to generate negative value addedability to generate negative value added• no large capital came to KD, rather local firms re-registered as new SEZ no large capital came to KD, rather local firms re-registered as new SEZ residents (residents (56 as by 200956 as by 2009))• a bulk of small firms were deprived of any SEZ favours and had ruineda bulk of small firms were deprived of any SEZ favours and had ruined• no new export facilities, rather assembling firms established daughters to no new export facilities, rather assembling firms established daughters to make double use of both customs and tax favoursmake double use of both customs and tax favours

KD economic “achievements” by 2007-2008:KD economic “achievements” by 2007-2008:• Imports rise by €Imports rise by € 1bn a year, to reach1bn a year, to reach €6.6 bn in 2008in 2008. KD hasKD has the largest in RF the largest in RF imports per capita and per unit of GDP, with China as the largest supplierimports per capita and per unit of GDP, with China as the largest supplier . • VA of imported goods is more than twice as high as VA of exported.VA of imported goods is more than twice as high as VA of exported. In 2008, In 2008, trade deficit (trade deficit ( €5.8 bn) €5.8 bn) was 30% above GRPwas 30% above GRP (€4.4 bn) (€4.4 bn)• skyrocketing growth in import-processingskyrocketing growth in import-processing (food, cars, TV sets) andand, therefore, in therefore, in manufacturing outputmanufacturing output (a 2.6 fold increase y-o-ya 2.6 fold increase y-o-y) under miserable investment of under miserable investment of assembling firmsassembling firms (0.7% of the total)

Now the crisis (globalization) has started to Now the crisis (globalization) has started to wash awaywash away Kaliningrad’s pattern of growth…Kaliningrad’s pattern of growth…

In the booming 2000-sIn the booming 2000-s::• 20002000 – – 16%16% (RF -10)(RF -10)• 20022002 – – 1010 % % (RF – 5)(RF – 5)• 20052005 - - 13%13% (RF – 6)(RF – 6)

During crisis years:During crisis years:• 2008 2008 - 9.1 %- 9.1 % (finalized(finalized) ) • 2009 2009 - 13.9 %- 13.9 %

((RF = - 7.9% )RF = - 7.9% )

GDP growth ratesGDP growth rates in KD and Russia KD and Russia

KD’s industrial production as compared to St-KD’s industrial production as compared to St-Petersburg and Russia as a wholePetersburg and Russia as a whole

Until the start of the crisis assembly industries were making KD the leader but Until the start of the crisis assembly industries were making KD the leader but in 2008in 2008 KD sharply slowed ( KD sharply slowed (2.5%)2.5%) and and in 2009in 2009, went down, went down (- 11.8%, and -- (- 11.8%, and -- 18% for18% for manufacturing) due to a fall in consumer demand in mainland manufacturing) due to a fall in consumer demand in mainland Russia. Russia.

Kaliningrad inflation rate (%)Kaliningrad inflation rate (%)20002000 20022002 20042004 20062006 20072007 20082008

Producer prices in KD 27.7 23.8 8.8 0.5 -2.0 -2.0

Consumer prices in KD 17.5 9.8 11.7 7.9 11.211.2 15.215.2

Consumer prices in RF 20.2 15.1 11.7 9.7 9.0 14.0

For reference , 2008: Lithuania – 10.9%, Poland – 4.2%, Estonia – 10.4% In 2009, CPI in KD reached 16.3%16.3% by official local estimation

Kaliningrad calamities as of 2009 …Kaliningrad calamities as of 2009 …

• - - 14.8% for index of industrial production , - 13.9% for rate of GRP 14.8% for index of industrial production , - 13.9% for rate of GRP • Construction has fallen by 64% Construction has fallen by 64% • Like in Russia as a whole, a sharp rise of tariffs in HC servicesLike in Russia as a whole, a sharp rise of tariffs in HC services ((production and distribution of electricity, gas and waterproduction and distribution of electricity, gas and water) ) • Small business swept away by major firmsSmall business swept away by major firms• Unemployment rate – 11.6% (RF- 8.2%). Each third-forth is dismissed Unemployment rate – 11.6% (RF- 8.2%). Each third-forth is dismissed

or under the risk of dismissionor under the risk of dismission

Good news: Good news: the import-processing firms have started to look out for the import-processing firms have started to look out for export markets beyond Russia… But they have too littlel to offer. export markets beyond Russia… But they have too littlel to offer.

General Tendencies accompanying the General Tendencies accompanying the economic crisis in Russiaeconomic crisis in Russia ((since autumn 2008since autumn 2008))

1. 1. The crisis has so far reinforced existing tendenciesThe crisis has so far reinforced existing tendencies::• state control over the economystate control over the economy• oil-oriented structure of the economy, oil-oriented structure of the economy, • the ruling elite's economic expansion at the expense of private businesses, the ruling elite's economic expansion at the expense of private businesses, • the preservation of political power and status-quothe preservation of political power and status-quo

2. In 2010, social protests in Russia are becoming increasingly political 2. In 2010, social protests in Russia are becoming increasingly political Protests staged in Kaliningrad (10,000-12,000 people) were followed in February 2010 by similar demonstrations in Protests staged in Kaliningrad (10,000-12,000 people) were followed in February 2010 by similar demonstrations in

Angarsk, Irkutsk (4000) and Samara (4000). Angarsk, Irkutsk (4000) and Samara (4000).

33. . Further monopolization of the Russian economyFurther monopolization of the Russian economy AA new wave of new wave of accelerated redistribution of assets in accelerated redistribution of assets in key sectors. A section of the political elite which key sectors. A section of the political elite which

using the crisis to take over selected strategic assets in their private interestsusing the crisis to take over selected strategic assets in their private interests..

4. 4. Macroeconomic trap Macroeconomic trap – – how to secure social stability under falling federal finance how to secure social stability under falling federal finance

Key concerns of Mr. Boos as a governor show Key concerns of Mr. Boos as a governor show that Kaliningrad is a mirror of Russiathat Kaliningrad is a mirror of Russia

1. 1. Economic concerns:Economic concerns: • How to ensure the local major businessesHow to ensure the local major businesses ( (Avtotor the firsAvtotor the first) a sufficient t) a sufficient

volume of federal favours for the future, volume of federal favours for the future, to successfully get round the to successfully get round the crisis challenges (crisis challenges (the growing unemployment is not the last problemthe growing unemployment is not the last problem )? )?

• How to save the budget?How to save the budget? Under the existing set of federal guidelines and Under the existing set of federal guidelines and incentives for KD, the local community is objectively unable to improve KD’s incentives for KD, the local community is objectively unable to improve KD’s economic structure and social situation. Just like his predecessorseconomic structure and social situation. Just like his predecessors, Boos, Boos isis doomed to go on seeking additional rents, money and benefits from the doomed to go on seeking additional rents, money and benefits from the federal centrefederal centre

2. 2. Political concernsPolitical concerns::• to strictly to strictly follow Moscow guidelinesfollow Moscow guidelines and to preserve the existing level of and to preserve the existing level of

administrative poweradministrative power • to keep KD under control through authoritarian style of ruling and to keep KD under control through authoritarian style of ruling and

toughening verticals of powertoughening verticals of power even more than on the federal level. even more than on the federal level. By 2009, local Duma has become completely subordinated to Boos. MPs have lost anyBy 2009, local Duma has become completely subordinated to Boos. MPs have lost anyindependent say on Governor’s activities and the question of state-property redistribution. independent say on Governor’s activities and the question of state-property redistribution.

Risks and limitations of the Project for Risks and limitations of the Project for reforming KD water system managementreforming KD water system management 1. Full dependence of the regional authorities upon Moscow1. Full dependence of the regional authorities upon Moscow2. Communities of remote regions are just a tool in Moscow’s 2. Communities of remote regions are just a tool in Moscow’s

strategic games and commercially beneficial foreign contracts strategic games and commercially beneficial foreign contracts 3. For Moscow, ecology issues are a third-rate priority as compared 3. For Moscow, ecology issues are a third-rate priority as compared

to good bargains or social stability at separate enterprisesto good bargains or social stability at separate enterprises 4. General moods of political and business elites, both federal and 4. General moods of political and business elites, both federal and

regional, to preserve the status-quo as long as possible regional, to preserve the status-quo as long as possible ((instead of speeding modernization) instead of speeding modernization)

5. 5. Macroeconomic trap in Russia and its regions, growing fiscal Macroeconomic trap in Russia and its regions, growing fiscal deficitsdeficits

However, this discouraging situation looks …encouraging for However, this discouraging situation looks …encouraging for searching a non-traditional, creative approaches to the Project in searching a non-traditional, creative approaches to the Project in a post-modern style a post-modern style

To beTo be continued…continued…

Thank you for attention!Thank you for attention!