[Medvedev:] New dynamics in Russia’s socioeconomic development

Dmitri Medvedev file photo

(Government.ru/Rossiyskaya Gazeta – September 22, 2016)

Article by Prime Minister Dmitry Medvedev for the academic journal Voprosy Ekonomiki (Economic Issues)

Abridged version (published in Rossiyskaya Gazeta):

The Russian economy is undergoing a period of profound transformation. In the next few years Russia will have to fundamentally restructure its economic system in response to the challenges and changes of the world’s current socioeconomic order. The global crisis that started in 2008 and continues to this day is forming a new agenda for the world’s leading countries – advanced and developing alike.

Russia is no exception. We are faced with the task of forming a development model that enables Russia to play a prominent role in the modern world.

The current crisis has resulted in growing instability on world markets, which now operate in a way that is considerably different from the past few decades. The new global financial market is capable of transferring huge sums of money almost instantaneously but lacks an adequate global regulatory system.

The politicisation of the economy, especially at the international level, is becoming a major feature of the current stage of development (and the ongoing crisis). Markets are increasingly being subordinated to the laws of politics instead of the laws of economics. Political considerations are playing a larger and larger role in economic policy, sometimes to the point of replacing market competition. Sanctions of all kinds are merely a graphic illustration of this trend.

Russia’s economic development has been strongly influenced by external shocks since 2014. These include the changing price of oil and other Russian exports and sanctions (primarily financial and technological). Importantly, the problem is not just how much prices have fallen, which has happened periodically over the past few decades, but the speed of their decline. In 2015 oil prices fell by half in roughly half a year, which is unprecedented in modern economic history.

However, the main factor contributing to low economic development rates is still rooted in the structural problems of the Russian economy, which were aggravated by two overlapping factors – the global crisis and the exhaustion of the economic growth model of the 2000s. A substantial reduction in growth rates started long before oil prices declined and sanctions were imposed on Russia.

1. Economic crisis: Intermediate results

In late 2014 we were told that we were in for a disaster, with one prominent politician claiming that our economy would be “in tatters.” We were told that we would face a catastrophic scenario – an uncontrollable budget crisis, rampant inflation, the long-term weakening of the rouble, a protracted and deep decline in production and a spike in unemployment. This might have happened had we made the worst possible choice and opted for a nervous, populist response to the difficulties that befell us (by fixing the exchange rate, increasing budget spending and freezing prices).

Instead of implementing outwardly popular but irresponsible proposals, we worked consistently to simultaneously cushion the shocks and create the conditions for rejuvenating our economic system. The results beat out most predictions. We withstood the challenge because we managed to develop a system of anti-crisis measures to keep the situation from spinning out of control.

We preserved the foundation for ensuring macroeconomic stability. Our budget is coping – albeit not without losses – with difficult challenges in the foreign economic environment. The structure of budget revenues is changing. The share of non-oil and gas revenues amounts to almost 60 percent. This is a completely different economic model.

Timely decisions to switch to inflation targeting allowed Russia to preserve its foreign exchange reserves and ensure the stability of its monetary system. Inflation is steadily decreasing and will not exceed six percent this year. The goal of bringing it down to four percent, which seemed fantastical to many just recently, is becoming realistic.

Despite fluctuations in the currency rate, unlike in all previous crises this time depositors did not flee the banks, and roubles were not converted into foreign currency – the national currency prevailed in deposits of the population. In 2015 these deposits went up by a quarter, and Russia’s corporate accounts grew by 20 percent.

The banking system is undergoing a difficult cleansing process in which poorly performing banks are being shut down. The Central Bank closed 48 banks in the first half of 2016 and 93 banks in 2015. Importantly, these measures did not cause a bank panic in Russia. Its banking system is fairly stable.

Capital outflow has been considerably reduced. In 2015 it fell more than 2.5 times to $58.1 billion (as compared to $153 billion in 2014). In the first half of 2016 it amounted to $10.5 billion as compared to $51.5 billion in the first half of 2015. Russia’s aggregate external debt is also going down. It decreased from its maximum of $733 billion in mid-2014 by 30 percent (over $200 billion) to $516 billion.

Substantial changes are taking place in the real economy. For a long time we complained about the Dutch disease – a stronger national currency resulting in declining efficiency and competitiveness of domestic production. Now the Dutch disease is less pronounced. As a result, some industries have increased production and become more competitive. This applies to metallurgy, the chemical industry, production of mass consumer goods (food products, clothes and shoes), agriculture, some branches of machine-building and the pharmaceutical industry. In 2015 the food industry grew by two percent, chemical production by 6.3 percent and oil production by 0.3 percent. The production of medicines has increased by 26 percent. Agriculture is demonstrating steady growth: by 3.7 percent in 2014, three percent in 2015 and 3.2 percent in the first seven months of 2016.

On the contrary, the industries that used to be in the best shape because of the growth of rental income (primarily construction and services) have been hit the hardest.

We talk a lot about import substitution. What’s most important is to understand the two significant ways in which it differs today from common import substitution models of the 20th century. First, import substitution is not designed primarily to oust imported goods but rather to encourage the emergence of competitive producers on the global market. Second, genuine import substitution is based not on currency manipulation or administrative props for Russian companies but on creating conditions that are conducive to the emergence and growth of Russian companies that can conquer the global market. In other words, import substitution is part of our strategy rather than “the slogan of the day.” We can already see some of the results of import substitution.

The effect in the car making industry is the most pronounced. Owing to the formation of joint ventures with foreign companies, the average annual share of imports fell by 22.5 percentage points in 2015. There has also been a reduction of 4.5 percentage points in the production of metals and metal ores, 7.8 percentage points in the manufacture of textiles and small wares, and 4.1 percentage points in food production.

A number of companies and industries have improved their position markedly. Companies increased their profits by 53.7 percent in 2015. This was far above the inflation level. Russian companies have over 21 trillion roubles in their accounts, including more than 12 trillion roubles in deposits (an increase of 40 percent in the past two years). This creates a foundation for boosting investments.

The willingness of the population to invest in housing is an important indicator of economic development. Anti-crisis measures invigorated mortgage lending in 2016. In the first half of this year mortgages amounted to 665 billion roubles (an increase of 44 percent).

However, all of these stabilisation measures are so far unable to compensate for the main consequence of the crisis – a decline in the wellbeing of people in Russia. Although we managed to prevent a spike in unemployment – both compared with the 1990s and 2009 when it exceeded nine percent, compared to the current six percent – people in Russia have become poorer in the past two years. Disposable incomes and real wages have gone down.

We have substantially expanded social assistance. Social spending grew faster than most other expenses. On the whole, in 2015 budget spending on social policy increased by 0.4 percent in real terms (adjusted for inflation); spending on pensions went up by 1.3 percent whereas the aggregate spending of the consolidated budget in real terms decreased by 5.1 percent. The Government will always focus on social assistance although we do understand that steady economic growth is the best way to ensure greater prosperity.

Political stability is an indispensable part of achieving this. We have just held elections. It is very important for the new State Duma to provide a legislative platform for responding to the economic challenges facing this country.

2. Economic growth: Challenges, risks and limitations

Economic growth cannot be restored automatically after a recession. At least, this holds true for developed economies. In the past, crises often led to the contraction of the economy, but once balance was restored, economic growth resumed almost automatically. Now the situation is changing. A good example is Japan, which has experienced growth rates bordering on stagnation for the past quarter-century, and the situation does not seem to be improved by any macroeconomic experiments. For the past five years, a similar pattern has been observed in the euro area. This new reality, which has emerged in recent years, calls for new solutions to revive economic growth. Russia is facing similar problems, although the specific solutions to jumpstart growth cannot be identical to those that would help Japan or the euro area. So what is needed to achieve sustained economic growth? Primarily investment – public and private, domestic and foreign. Investment must now be the driver, and it is more important than boosting consumption and export demand. To put Russia on the path of sustainable growth requires a substantial increase in the scale of investment, from the current 20 percent to 22-24 percent of GDP.

Domestic private investment certainly tops the list of priorities. It is necessary to develop measures that would not only incentivise savings, but also encourage their transformation into investment.

Interest rates are obviously not the problem. In Europe, they are even negative, while investment still tends to hover around zero. The problem lies in the high level of uncertainty, although it can manifest itself in different ways in different countries and regions. For some countries, the problem is that businesses don’t understand the prospects for demand. Other businesses are inhibited by geopolitical uncertainty and a lack of clear priorities in the actions of national governments. What we call deficiencies in the business climate – poor protection of property rights, inconsistent rules of the game, and other things – also play a role.

In developing economic policies, it is important to articulate not only what needs to be done, but also what the government should avoid. I see two things that should be excluded from any policy of structural reform and economic growth: one is populism, and the other is implementing reforms at the expense of the people. The first one is dangerous and, ultimately, leads to the second problem, because people always pay a price for populism. Meanwhile, the nature of the necessary structural reforms today does not require high social spending, as opposed to the 1990s.

We cannot allow populism either in our discourse or, more importantly, in our budget policy. We will not follow the path of printing more money and deregulating the economy, as this leads to disastrous consequences that people always pay for. If the government does not have enough money, we will not opt to print more to cover the missing revenue. Everyone understands that printing money is nothing but printing paper, which would fuel inflation and devalue people’s incomes, salaries and pensions.

Proposals to introduce very strict regulation of the economy, to return to the Soviet planning system, are equally unacceptable in the current circumstances. The rigidity of the Soviet model led to its collapse in the face of a modern, post-industrial society. There is a number of other ideas, as seemingly simple as they are dangerous, such as transitioning to a mobilisation economy, nationalising large companies and even selling off all state property.

However, real work – in contrast to propaganda – involves deep structural reforms that are aimed, at their core, at increasing the efficiency of the public (government-financed) and private sectors. These problems and difficulties are different than the mass closure of businesses, loss of revenue, and degradation of the social sector we saw in the early 1990s.

In this case, the pace of reforms is no less important than the purpose. The Government has to carefully analyse all the consequences of the steps it takes and to assume a more thought-out, even a more conservative stance on these issues.

3. The contours and priorities of economic policy for the near future

In this article, I would like to focus on key areas that are absolutely essential for long-term development.

An effective budgetary policy is a prerequisite for adapting to new economic realities.

An important task in the public sector is striking a balance between the need to live within our means and the need for fiscal stimuli to boost growth.

We will continue to optimise the budget, cutting less effective spending and focusing on more effective types that contribute to the improved performance of the Russian economy, to the extent the revenues allow. The most important is investing in human capital (which is investment rather than expenditure). The second component is investing in transport infrastructure.

In recent years, regional budgets have deteriorated, with a rapid increase in debt – especially expensive commercial debt. We have succeeded in curbing the growth of the debt burden on the regions. Now we need to increase the sustainability of regional and local budgets: to enhance their stability and the accountability of the different levels of government to each other and, most importantly, to the people.

Structural reforms will create a more competitive economy. This will involve a package of measures, including both general and targeted measures.

We are counting on effective implementation of the new measures stipulated in the Industrial Policy Law, including the special investment contract tool, which guarantees a predictable business environment for the next 10 years. We have great hopes for the Industry Development Fund, which recently began operating and has posted good results. We plan to introduce other financial support measures for growing businesses, including grants and state guarantees, co-financing of research and development, and policies to stimulate demand (also through public procurement).

Small business should play an important role in the diversification of the economy. The SME Development Corporation is up and running. The total amount of guarantees and sureties issued as part of the national SMEs guarantee system has already reached 45 billion roubles, which means that the total volume of lending to SMEs has reached 90 billion roubles. Interest rates on these programmes are 10-11 percent, and we plan to cut them further. The Corporation will support not only companies that operate on the domestic market, but also firms with export potential. These support instruments will help to at least double the share of SMEs in Russia’s exports.

The ability to export non-oil and gas products should become one of the main criteria for providing state support to a project or enterprise. Recently established export support institutions, including EXIAR and the Russian Export Centre (REC), also emphasise this. At the same time, all state support instruments should be cancelled in the absence of clear performance indicators and a timeframe for elevating the products to an internationally competitive level.

We will need to rethink existing approaches to foreign trade, including the concept of protecting domestic businesses. In the modern world, domestic producers should be part of global value chains. The most efficient and competitive products include components (and equipment) manufactured in different countries. In this way, artificial restrictions on imports often restrict exports.

Despite the geopolitical issues, Russia is going to move towards economic openness and free trade areas with individual countries and groups of countries, and will sign preferential trade agreements. We see huge opportunities offered by the liberalisation of international trade on the basis of equality. Naturally, the Eurasian Economic Union will be the focus of our integration agenda.

The implementation of structural reforms will also require improving the business climate and the quality of public administration.

Stimulating entrepreneurship. First of all, we will need to change the negative expectations of businesses and reduce their economic, political, and legal risks.

The ability of the authorities to meet their obligations will help increase predictability and mitigate negative expectations. Predictability is especially needed in tax policy.

It is equally important to streamline and ensure transparency in oversight, and to introduce a risk-management approach to the implementation of relevant activities. The roadmaps of the National Business Initiative have helped us streamline the entire system of barriers, some of which have survived from the Soviet era. We have simplified procedures in construction, registration of property rights, connection to power grids, and tax and customs administration.

One of the most sensitive issues for the business community is the protection of private property and protection from pressure on their businesses, which sometimes leads to their liquidation. In this regard, I would like to list some of the steps taken to reduce excessive oversight and illegal, forceful pressure on businesses, some of which are still in the works. Since the beginning of 2016, small businesses have been granted a three-year grace period for routine inspections by state and municipal supervisory authorities. We are discussing measures to ensure that law enforcement agencies be made accountable and even liable to criminal prosecution for illegal actions that impede entrepreneurship and disrupt business. A working group has been established by the President to resolve conflicts between law enforcement agencies and business, primarily thanks to the recommendations to improve legislation.

Finally, an integral part of a healthy business environment is fostering competition. We still have a lot to do here. First of all, it is necessary to deal with the administrative monopoly and the monopoly of large corporations, while sparing smaller businesses that have achieved dominance on local markets because they are effective.

We need to improve the efficiency of the state and municipal procurement system, and state-owned companies. We have almost completed the formation of the main institutions of the federal contract system, which in 2015 saved over 300 billion roubles. With the expanded involvement of small enterprises in the public procurement system, their total participation has reached 700 billion roubles, and should exceed one trillion roubles next year.

Experience shows that the willingness to invest primarily depends on the regions, which is where the foundation of trust is laid between the Government and business. For its part, the Government is creating additional opportunities and institutions to improve the investment appeal of the regions, including priority development areas, special economic zones, technology and industrial parks. The Government will closely monitor the effectiveness of these institutions and take decisions to rapidly close those that are ineffective or to form new mechanisms where regional administrations are doing effective work.

The quality of public administration

We are making progress on streamlining and simplifying the apparatus of the state. The 10 percent reduction of federal and regional civil servants in 2016 was a painful but relatively simple step in this direction.

Another important step is creating a single mechanism to administer tax, customs and other fiscal charges, and consolidating certain executive functions. This work will continue. We expect it to be extended to the regional level.

The next major step will be to appoint special project teams to ensure the achievement of priority goals. Without that, it would be difficult to achieve a qualitative change in society. We already have positive experience with priority national projects. Based on that, we can raise the operation of public administration institutions to a qualitatively new level. This work is coordinated by the Presidential Council for Strategic Development and Priority Projects.

Effective social development

Economic policy is important not for its own sake but to provide rising living standards. This is the focus of President Vladimir Putin’s May 2012 executive orders.

Despite all of the recent difficulties, we have scored important achievements, which lay the groundwork for further growth. First, for the past three years in a row the Russian population has grown – for the first time since the late 1980s. Second, the share of families with more than one child is increasing. Third, life expectancy has reached 71 years, and although it is not very high for a developed nation, it is a record in Russia’s centuries-old history.

The main task for the country’s social policy is to provide assistance to those who need it (above all pensioners, children and people with disabilities) and make it possible to earn a living for those who are willing and able to work.

We will tirelessly support families with children. Maternity capital has become an important tool of social policy. The Government has expanded the scope and duration of eligibility. Monthly allowances to families with three or more children, including for housing and utilities subsidies, will continue. Within the next three years, the waiting list for land plots for large families will be eliminated or housing will be provided to them.

It is necessary to develop a comprehensive assistance programme for senior citizens. This will make it possible to provide adequate medical care and help them maintain an active lifestyle to the greatest extent possible.

The labour market needs to be made more efficient. We must not be lulled by the country’s relatively low unemployment. The continuing decline in the number of working-age people requires more proactive measures to utilise available labour resources and concentrate them in economic growth areas.

As economic growth picks up, employment opportunities will expand. However, this is not a reason for complacency if we are seeking a new quality of growth. We face the challenge of creating millions of highly productive jobs. This calls for a massive modernisation of production facilities, as well as the closure, stoppage or reconstruction of enterprises, which always involves cuts or retraining or the need to change jobs. Therefore, labour market standards will be raised. Yes, for demographic reasons, fewer new employees are currently entering the market, which can ease the employment problems associated with economic modernisation. However, this equation is too simple for real life. The professions, specialities and regions that are in-demand will not always overlap.

The state and prospects of the pension system are among the most urgent socioeconomic problems. This goes beyond the retirement age issue, which can only be addressed through a balanced and inclusive public and expert discussion, in the course of which various proposals for the development of the pension system are put forward, including the abolition of mandatory pension savings, the transition to a state-stimulated voluntary savings system, and so on.

Selecting a specific pension model is both an extremely important and extremely challenging task. It is difficult even to identify the most successful model that would be recognised as such throughout the world or at least in developed economies with a higher life expectancy. However, with any model, the distribution of the pension system’s resources should be based on the prioritisation of support to people in older pension age brackets.

Healthcare and education were among the priority national projects in the 2000s and they remain our priority still. They are on the list of strategic projects for years to come.

Quality education is a major source of a country’s competitiveness, which predetermines its position in the world for decades ahead. Today, we need to focus on making quality school education more accessible. Schools lay the groundwork for the country’s intellectual and technological successes. For all the importance of universities, they hone professional skills that are largely predetermined by the quality of school education. In a decade, the number of school students will grow by 3.5 million, and they will need to study at modern educational institutions.

Vocational education is also a priority. The key tasks here include offering opportunities for retraining throughout one’s career. Education for adults and older generations – retraining, acquiring a second speciality and computer literacy – is becoming increasingly important. Continuing education needs to be made more accessible. Educational institutions that run continuing education programmes for different categories of people should be incentivised to expand such programmes.

In assessing the costs and efforts required to develop education, it is important to remember that this involves a highly competitive sphere. There is fierce competition for human resources in the global economy. In today’s world, people are able to choose where to study and then work. We cannot afford to lose this competition.

The quality of the healthcare system is crucial for the quality of human life. The tasks that we are facing in this sphere are far more challenging than those we have addressed to date. For example, the scale of the capital investment that has been made in modern medical equipment over recent years exceeds everything that has been done previously. However, even more important is efficient utilisation – the effect that we need to get from this.

Any reform in such a sensitive sphere as healthcare must define clearly and comprehensibly state guarantees for the provision of free medical care.

The priorities here include the development of the primary medical care system, telemedicine and the introduction of integrated electronic medical records for patients. The top priority is to ensure the availability and quality of medications, including for low-income patients, the unrelenting suppression of counterfeit products in the retail sector, and strengthening inspections of the quality of medications. Oversight of the quality of medications, medical preparations and medical equipment produced is all the more relevant in a situation where the important process of import substitution has begun in these areas. People must be confident about the quality of domestic products.

In the coming years, Russia will be confronted with competition and rivalry between countries for markets, investment and human capital, as well as continuing trade and financial restrictions, and a relative decline in the value of its traditional exports. It is pointless to expect the return of favourable conditions on commodities market. This strategy would doom our country to backwardness and falling living standards, and would close off prospects for reaching advanced positions in the economic and social spheres. It is equally futile to expect that economic development issues can be resolved predominantly with state funds. The state’s priority is security, investment in human development, assistance to the most vulnerable sections of society, and infrastructure. The Russian budget should be structured accordingly.

Under these circumstances, it is of critical importance not simply to resume economic growth but also to ensure long-term and sustained growth rates. The new economic growth model must, above all, increase private investment by fostering a favourable business climate and encouraging entrepreneurial initiative. We should make Russia attractive to business.

The complexity of the tasks that we are facing and the scale of the challenges that we need to meet, especially given our limited resources, require us to act very accurately. Only in this case will we be able to see not just the contours of a new economic structure in the near future but also tangible results.

Results that will be seen above all by the people. Results that will enable Russia to play a leading role in the global economy. Results that we all will be proud of.

The full version of the article is published in the academic journal Voprosy Ekonomiki (Economic Issues), issue No.10 for 2016.