Dmitry Medvedev’s article: The time of simple solutions is past

(Government.ru –  Dmitry Medvedev – September 27, 2013)

[English translation of commentary published in Vedomosti, September 27, 2013]

1. The beginning

Five years ago it became obvious that a global economic catastrophe was beginning. I remember very well the first G20 anti-crisis summit meeting in Washington and the views which I and the majority of my colleagues expressed there.

From a speech at the G20 summit in Washington on November 15th, 2008: “All of the speakers have tried to establish a diagnosis of this crisis. This is a question that requires deep and thorough study. I want to say that comparisons with past crises do not hold up. What we face now is not the Great Depression of the 1930s, and not the crises of the 1970s-1980s. This is a twenty-first century global crisis. “In my view, it shows that a number of the principles underpinning the post-war economic world order no longer work today. We see that many of the international institutions and organisations (including security organisations) established at that time are no longer able to cope with today’s demands. This is why we need new ideas for today, ideas just as powerful as those put forward decades before to address the challenges of the post-war period.”

Most of these conclusions proved to be true. But at the time when they were made no one could gauge the depth or length of the crisis. Experts discussed what letter the course of the global economic process would look like ­ W, V or L. The most attractive option was V and the least attractive was W, with alternating periods of recession and growth. Today we see that it looks very much like the square root symbol. The initial plunge gave way to recuperative growth and then the developed countries almost levelled off.

The debt burden remains excruciatingly high in most G8 countries, excluding Russia, also because attempts to reduce it rapidly will likely provoke a long stagnation period. The European economy is balancing on the edge of a recession, and growth in all BRICS countries has slowed down. The US economy has not yet found a fail-safe solution to the problem of sweeping unemployment, and many Americans have barely started to repay their debts. Russia’s economic growth has also slowed considerably. Its stock indexes are now as low as in early August 2008.

We have been forced to review our anti-crisis policies. Let me remind you what the Russian leadership has done to reverse the economic slowdown.

The Bank of Russia was lowering the rouble exchange rate very moderately, at the same time increasing the number of instruments for refinancing commercial banks. This helped to maintain public trust in the rouble and to prevent a landslide withdrawal of bank deposits. The Government has overhauled the structure of budget revenues and increased funding for the priority spheres which are vital for economic revival and for preventing a dramatic decrease in domestic demand. Large companies were given additional loans and guarantees and so could restructure their debts, stretching them out over a longer period and thereby preventing mass bankruptcies. Active employment and small business support programmes were implemented, including in single-industry cities.

These anti-crisis policies were implemented concurrently with the implementation of national priority projects. We started modernising the education system and emergency and high-tech medicine, and we also indexed maternity capital, which allowed us to maintain the birth rate and to prevent depopulation.

Russia joined the WTO after 20 years of talks, accepting the common rules which it now can not only use, but also influence. We created the Customs Union with Kazakhstan and Belarus and strengthened coordination within the framework of the SCO and BRICS. We are learning to use the benefits of international cooperation to the advantage of national interests but without infringing on our partners’ interests.

Overall, the crisis has taught us many things. We now know what to do in an economic downturn, and we are ready to honour our commitments to our people, who have given us a huge credit of trust. The outcome of elections has confirmed that we are doing the right thing: unlike in the majority of developed countries, the ruling political force has not been replaced in Russia. This is the advance payment, and we will have to work hard to prove that we are worthy of this trust.

Changes (%) in 2011 compared to 2008:
GDP ­ up 0.5%
Industrial production ­ up 2.7%
Personal income ­ up 9.7%
Unemployment ­ down 3% (as of December 2011)
Birth rate ­ up 4.8%
Mortality rate ­ down 6.9%

This work continued as soon as the new Government was formed in May last year. I put forth seven key tasks for the year: budget planning based on a strict budgetary rule, adoption of the main Government programmes, fulfilment of social development tasks formulated in the presidential executive orders, step by step privatisation of surplus state-owned assets, comprehensive implementation of the National Business Initiative roadmaps, accelerating the reform of the civil service and launching Open Government mechanisms. We have fulfilled all of these tasks, and we are proceeding according to plan regarding medium-term goals. However, once we started working, it became clear that the global economy, and consequently also the Russian economy, was improving slower than we expected.

2. The Steps

According to our former forecasts, GDP growth rates should have exceeded 3%, and we hoped for a revival of the economy in Europe (the EU accounts for half of Russia’s foreign trade). But the depth of the debt crisis and a plunge in competitiveness in many European countries have proved so significant that, judging by all appearances, we will have to wait several more years for real and stable growth in Europe. As prominent US economist Kenneth Rogoff said not so long ago, growth is an illusion in periods of very high public debt…

I will name several areas where we have managed to achieve headway.

First. Budgeting obeys the budget rule. Let me be frank: it is not easy to work under these stringent budget restrictions. Next year we will have to cut our planned budget spending by 5%. But having a balanced budget and avoiding sharp fluctuations is more important.

Second. We have linked every area-specific programme both with other programmes and the main budget policy parameters. As a result, the Government has a balanced action strategy for several years ahead, and this strategy is reflected in several dozen state programmes.

Third.  All the key measures of the National Entrepreneurial Initiative have been implemented. It is of fundamental importance for the Government to carry out what we agreed with the business community. This is about tax and customs administration, access to engineering infrastructure and competition, government procurement, construction market regulation, and a number of other economic spheres.

Fourth. Our domestic business support system is being reformed in line with Russia’s WTO commitments. This was particularly difficult in agriculture, which has emerged as a driver of economic growth in recent years. But we have managed to bring into play so-called green box subsidies and they work fairly well.

Fifth. We have approved tax and customs benefits for investment projects in far-off regions. A case in point are the investment projects in the Russian Far East and Kaliningrad and mining on Russia’s continental shelf and in other hard-of-access localities. Hopefully this will considerably increase the amount of investment in new businesses.

And, sixth, (although we have done much more than this list suggests) a number of major infrastructure projects are underway that help unite the country and secure its stable long-term development. New railways, motorways, airports and seaports are being built, some of which as part of public-private partnerships.

3. Crossroads

Most of the measures I have mentioned will yield a substantial effect only in the mid-term. The current Russian economic situation is determined by an unfavourable external environment and also by the burden of unsolved problems.

Economic development forecasts are quite pessimistic. This year, it appears that GDP growth rates will not exceed 2%. I would like to note that it is for the first time since 2009 that growth rates are lower than in the global economy. Increased outlays of entrepreneurial activity (prices for the products and services of natural infrastructure monopolies, salaries and interest rates) make it unprofitable to continue the production process at a considerable number of old facilities and to implement serious investment projects.

August 2013 on 2007: Gas prices (without taking population into account) + 115%
Electricity prices (without taking population into account) + 71%
Actual salaries + 74%
Real effective exchange rate of the rouble + 16%

Production continues to expand almost solely through the implementation of major investment projects involving the state and state-controlled companies, by raising the incomes of public-sector employees, by issuing additional subsidies to the agricultural sector and some other sectors against the backdrop of high crude oil prices. But this source of development remains limited because it depends on the favourable oil-price situation. A rigid budget regulation is needed in order to guarantee the fulfillment of all social obligations of the state. But, in the future, this makes it impossible to rely on state demand alone. Therefore efforts to ensure stable sources of sustained economic growth in the non-public economic sector are becoming critically important.

OECD economists noted in their “Russia: Modernising the Economy” report that “Russia still has a long way to go to reach the living standards of the most advanced market-oriented countries, despite clear improvements in the past decade. To narrow the gap, Russia needs to modernise its economy, reduce its dependence on revenues from natural resource extraction and ensure more sustainable and broad-based growth. By making it more attractive to live, study, work, innovate and invest in Russia, the country can free the great potential of its people and ensure growth well beyond its natural resource endowment.”

I believe that the protection of private property and competition remains our unconditional political priority. The Russian economy still posts low investment levels, and this is not only caused by specific arithmetic calculations of potential capital-efficiency volumes. Investors still harbour irrational fears of working in an incomprehensible and sometimes unpredictable Russia. Add to this the absolutely explainable distrust of public institutions, including the judicial system and law-enforcement agencies. This is something which is very sad. As Fyodor Dostoyevsky wrote, capital likes external and domestic stability, otherwise it hides.

Among other things, this situation is caused by the fact that many officials, judges and police officers (although, of course, not all of them) still believe that state property, and therefore state companies, have the right to better protection, and that these rights are infinitely greater than those of individuals. They also believe that the latter pursue exclusively personal interests and are therefore suspicious and must be rigidly controlled.

The situation in the national banking system is an illustrative example of this. On the one hand, the banking system has proved its stability during serious crises, and it has preserved private savings in cooperation with the state. And this is, certainly, good. On the other hand, its structure can hardly be called optimal. The five largest banks, which are directly or indirectly controlled by the state, account for 56% of private deposits and for 53% of the entire economic credit portfolio. These banks receive obvious privileges from the state, including state companies, and they enjoy virtually unlimited state support. At the same time, almost 1,000 banks are unable to effectively integrate themselves into the state-assistance system. This impairs competition on the financial market, and there are no major regional banks either. Moreover, sky-high interest rates hamper entrepreneurial and investment activity.

This is only one example which highlights the overall situation concerning competition and the correlation between the public and private sectors. Not a single country with an advanced legal and political system finds itself in such a situation, and we must end this state of affairs if we want to become a competitive country with a developed economy. The obvious key aspects of our work are as follows: improvement of the entrepreneurial climate, enhanced activity of the national capital and increased foreign investment, technological retooling of the economy and a new policy regarding the labour market.

We have virtually reached a crossroads. Russia can continue to move ahead very slowly and to show close-to-zero economic growth rates, or it can take a major step forwards. The second option is fraught with risks. But, if we choose the first scenario, which supposedly may make it possible to preserve current prosperity, then this would be even more dangerous. This route leads to losses, to an abyss.

4. Strategy

How does the Government see the way to encourage growth amid low global demand and strong competition?

There are three underlying principles.

First, we need to give businesses the widest possible opportunities for action and initiative. Government support needs to be rechanneled into creating modern effective jobs in innovation based value chains (from theoretical science to commercial production). Second, we need to start using the existing resources much more efficiently than we are doing now, including to raise labour productivity. Third, we need to ensure high-quality state administration, people’s security, protection of property rights, and the required social and physical infrastructure.

Russia has found itself in a unique position compared with other countries with a similar growth pace. We have the lowest unemployment; moreover, the Russian economy will likely struggle with a shrinking workforce over the next few years, which entails a heavier tax burden as a result of the growing medical and social security spending on an aging population and from the shortcomings of the pay-as-you-go pension system. Employers will likely have problems finding personnel, with uneven regional labour markets.

Therefore, what we need is a new approach to the regions’ economic development. Regional diversity gives Russia an edge, so we need to identify points of potential  growth and provide targeted support. Interestingly, over the last few years, regional growth rates have become quite independent from their mineral reserves. Growth is driven by the regional leaders’ and local elites’ ability to promote their regions ­ not just to sit there waiting for government support but to work to have their initiatives backed by the people and included in federal stimulation programmes.

By combining our efforts, we will be able to abandon our former policy of supporting employment at all costs, regardless of important economic factors ­ a policy characteristic for periods of recession and often justified amid crises. Such policies should be applied with caution; to achieve social stability we need to create conditions for professional growth, not to try and maintain something that has already had its day. Maintaining social stability and modernising the economy are interrelated, not mutually exclusive processes.

We need to reduce conscription further, while manning the armed forces and law enforcement agencies with people serving on a contract basis. Other policies should be aimed at stimulating more effective work at government-financed companies and services and later retirement of highly-qualified workers.

Free entrepreneurship and a sound competitive environment are compulsory conditions for modernisation and innovation- based development. Russia was one of the developed economies for the bigger part of the 20th century, despite many dramatic developments, and was the uncontested leader in some industries. I am confident that Russia is capable of regaining that position by focusing on human resources ­ their intellectual and creative potential ­ the trailblazers of growth. Yet it would be wrong to just copy recipes invented in the past. The world has progressed a long way from that time, and we need to use new methods.

I think it is critically important to elevate fundamental and applied science to a higher level and to return national education to a leading position and eliminate the digital divide. I am sure that the Government will continue playing a leading role in addressing these issues. But we need to do this the sooner the better, including by attracting private investment.

We need to build a system for the reproduction of commercially justified innovative technology which would help increase labour productivity, improve environmental security, and ensure consumer convenience. The main obstacle here is the poor quality of our regulatory environment. We will complete the work on an improved legal framework within the next few months.

We have only limited access to advanced international technology for many reasons such as politics, customs formalities and other regulations. The costs of importing technology into Russia are higher than in other countries. I think it would be expedient to cancel import duties on materials and research equipment, and expand the practice of issuing government grants and subsidies for the import of equipment, components and materials needed for research.

We will continue developing the Skolkovo Innovation Centre as well as other innovative projects and technology parks. Large companies and investors should invest more in research and establish their own universities. It would be good if Gazprom, LUKoil, Rusal and Rosneft were to have their own universities, or at least departments, and the Government should think how we could encourage such investments ­ possibly with tax incentives.

These investments should yield good profits. At present, unfortunately, nearly every project faces a recruitment problem ­ who will work there? Is the average Russian ready to meet modern labour market requirements? We know the answer, and that answer is more often “no” than “yes”.

Given the slowdown of growth, we do not want the Government to play an unjustifiably big role in the economy, and we do not want state officials to create excessive barriers for doing business.

I am confident that government agencies need to concentrate on performing their core functions and outsource or divest other functions, and to continue increasing transparency and accountability. The establishment of public oversight institutions, public discussion and the adoption of state programmes and the federal contract system are important steps toward these goals.

Our long-term goal is to build a smaller, decentralised and more efficient public sector of the economy. A situation where its productivity and return on investment are far lower than in the comparable segments of the private sector is unacceptable.  It is impossible to raise effectiveness without additional investment in fixed capital and personnel training. It is also important to keep operating expenses efficient too, first of all in the procurement of goods and services, and in some cases it would be wise to stop spending taxpayers’ money on certain projects and agencies if they are ineffective.

5. Solutions

In view of increased competition, reducing costs is the key condition for ensuring the competitiveness of Russian companies. The infrastructure monopolies’ rates are a major factor and a very complex issue. However, few people still doubt that high rates are a major hindrance for the majority of Russian businesses and that they slow economic growth.

We will begin by adopting long-term pricing principles and place the largest monopolies’ budgets under public supervision. As for the near future, the Government has decided to freeze the rates of the basic infrastructure monopolies in 2014 and to peg them to inflation in the subsequent two years. However, this must not affect substantiated investment programmes, or more precisely, this must not infringe on the rights of infrastructure monopolies’ clients.

The prices of most other infrastructure companies in the utilities, communications and passenger transport industries will be adjusted in the next few years in accordance with the “inflation minus” pricing formula. The parameters may vary, depending on the initial situation and certain structural decisions, for example, minimisation of cross-subsidising in power generation, gradual liberalisation of the gas market and introduction of differentiated baselines in some commercial services, as well as modernisation of the postal service.

The removal of non-competitive enterprises should be accompanied by the establishment of new businesses that can create effective jobs. This is the essence of economic modernisation. At the same time, the focus will be on supporting small and medium-sized businesses.

First, we have reviewed the decision on a considerable and immediate increase of insurance payments: the rates will be increased step by step. I’d like to emphasise that we are not talking about increasing the tax burden, but about ensuring a proper level of insurance for small companies’ personnel, who must have the same rights as the personnel of any organisation.

Second, small businesses will be offered more incentives in the sphere of information technology. Starting in 2014, they will be available to companies which employ at least seven people (down from at least 30 before).

Third, I believe it would be expedient to give the regions and local authorities the right to introduce tax breaks for small start-up businesses in some sectors, primarily in production. This method has been used in many countries. Of course, there is a risk that unscrupulous people will try to evade taxes. But I believe that proper oversight measures can minimise this risk.

Fourth, we will increase financial assistance to small and medium-sized businesses. Vnesheconombank will use the National Wealth Fund money it holds to issue investment loans to small and medium-sized companies, while the Central Bank of Russia will refinance these securitised loans. In addition, we will greatly increase state guarantees for small companies, including by creating a federal guarantee fund and by broadly using regional guarantee funds.

Fifth, we should use positive foreign experience to approve quotas for the purchase of goods and services from small and medium-sized enterprises (SMEs) within the framework of the state and municipal procurement systems, as well as for purchases by large state-owned companies.

And lastly, it is highly important to implement SME support programmes in single-industry cities. We must again review the performance of special programmes approved for such cities and create mechanisms for their financial and organisational support if and where necessary.

Taken together, the Government has approved the allocation of over 100 billion roubles for these purposes in the draft of its three-year budget.

But government support for business is not enough. The issue of cheap long-term loans is even more important. The Government and the financial mega-regulator established on the basis of the Central Bank are drafting measures to protect pension accruals and to expand the spheres of their investment. Last spring the Government made public a package of tax measures aimed at stimulating retail investors’ long-term investment and promoting the evolution of the national financing industry. I hope the State Duma will discuss a draft law to this effect this autumn.

We will work to ensure macroeconomic stability, promote the evolution of our financial market and the development of Moscow into an international financial centre. We will continue working to create a favourable environment for long-term foreign investment. The Central Bank’s policy of inflation targeting and floating exchange rate will help us tackle the above issues, in particular, ensure the issue of really long-term loans.

6. The Future

The world is not sitting on its hands, and global competition will become increasingly tough. This could be Russia’s opportunity to change its role in the international division of labour. Compared to other countries, Russia has a relatively small debt and very large reserves.

But the time of simple solutions is past, and we must not underestimate the current economic challenges. There is a difficult path ahead. We must proceed to a post-industrial economy and a smart state whose main value is the individual, amid difficult conditions that can be defined as a crisis. We must reach the trajectory of sustainable development without losing the achievements of the past few years in reducing poverty and supporting the most vulnerable groups of people and regions.

But the Government alone cannot create such as state. It must rally the assistance of socially responsible individuals who will be its equitable partners in this difficult project. Moreover, awareness of this responsibility has nothing to do with social status, because workers, freshmen, academicians, businesspeople and officials alike ought to feel this.

The state should only change together with people.  Over the past year, the Government widely used feedback from civil society and business when taking important economic policy decisions. We welcome constructive public initiatives and consult business and experts when coordinating the majority of our decisions. The operation of its departments has become more open to public control, and Open Government has become a fact of life. We will continue to improve this format, and the same must be done at the regional and municipal levels.

We must work together to take the next major step towards implementing our plans, to weather the global economic downturn and ultimately to create a strong Russia with a high quality of life.