Economic Reforms in Russia: Progress and Challenges

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Economic Reforms in RussiaProgress and
Challenges

• Mikhail Dmitriev
• Research Director
• Center for Strategic Research
• Saint-Petersburg
• Leontief Readings
• 10th February 2005

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This report is focused mainly on economic
reforms which are needed to complete the
transition of Russia to market economy. The
report does not consider longer-term economic
policy issues beyond the transition agenda This
report is not a product of an independent
comparative study of market reforms in transition
economies, and is based on CSR experts
assessments and on international research data
(World Bank, European Bank for Reconstruction and
Development and others) Conclusions and
assessments presented in the report are
preliminary and will be used to set up a
framework for a comprehensive research project on
Russias economic policy
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THE NEW VERSION OF REPORT

• Original version of this report was presented on
  10 December 2004 at a 5-year Anniversary
  Conference of the Center for Strategic Research
• Since that presentation policy environment in
  Russia was transformed so dramatically that we
  had to reconsider the initial assessment of
  reform process
• The new version of report reflects most recent
  developments including policy impact of privilege
  monetization.

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Progress of market reforms in the Russian
Federation
Privatization Corporate governance and
restructuring Trade and forex system Competition
policy Banking reform Stock markets and non-bank
financial institutions Infrastructure Real estate
and land markets Natural resources
consumption Science and innovation Social
reforms Fiscal system Government
administration Justice and law-enforcement system
Russia The maximum level in transition
economies The average level in developed countries
Sources EBRD Transition Report 2004, CSR expert
assessments.
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PROGRESS OF REFORMS

• During the last year progress of reforms,
  enlisted in the surveys of the European Bank for
  Reconstruction and Development, was relatively
  slow
• There was only one area where progress of
  reforms in Russia could be observed (reform of
  the railway system)
• In seven other transition economies there was
  progress in 2 or 3 areas
• In one country (Romania), there was progress in
  4 areas
• Russias EBRD composite reform progress rating
  for the last year is among the lowest compared to
  other transition countries (0.035 compared to
  0.11 for the leading group)

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2005-2007 Outlook for economic reforms in the
Russian Federation(estimates on the basis of
formal political intentions)
Rating growth according to declared
intentions Rating growth necessary to achieve the
highest existing levels among transition
economies
Privatization Corporate governance and
restructuring Trade and forex system Competition
policy Banking reform Stock markets and non-bank
financial institutions Infrastructure Real estate
and land markets Natural resources
consumption Science and innovation Social
reforms Fiscal system Government
administration Justice and law-enforcement system
Source CSR expert assessments.
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Possible obstacles to reforms

• At the policy development stage
• special interests
• insufficient effectiveness of the policy
  development process
• insufficient political prioritization of certain
  areas of reforms
• At the implementation stage
• ineffective design (one of the reasons being the
  compromises at the policy development stage)
• ineffective law-implementation by the executive
  and judiciary system
• systemic risks and expectations of economic
  agents (lack of trust)
• limited administrative capacity
• political mechanisms

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ADOPTION OF LEGISLATION IN MOST CASES MAY BE
REGARDED AS AN INTERMEDIATE RATHER THAN FINAL
CRITERION OF REFORM SUCCESS THE REFORMS CAN BE
CALLED EFFECTIVE ONLY WHEN THEY SUCCED TO AFFECT
ECONOMIC BEHAVIOR IN DESIRED WAY
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FACTORS WHICH INFLUENCE THE PROGRESS AND RESULTS
OF REFORMS

• Dynamics of political institutions
• Level of rent concentration
• Fiscal and monetary discipline
• Security of property rights
• Level of trust
• Effectiveness of public administration

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DYNAMICS OF POLITICAL INTITUTIONS
The level of political competitiveness and the
progress of reforms (1999)
Source The World Bank. Transition The First Ten
Years
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DYNAMICS OF POLITICAL INSTITUTIONS AND PROGRESS
OF REFORMS

• In December 2004 Freedom House rated Russian
  Federation as as not free, i.e. as a
  non-competitive political system
• Progress of reforms in competitive democracies is
  usually higher than in countries with limited
  political competitiveness, which include Russia
• A decrease in political competitiveness will not
  necessarily be accompanied by a slow-down in
  reforms, because we can see cases of both fast
  (Kazakhstan) and slow reforming countries with
  noncompetitive political systems
• However, as political competitiveness decreases,
  pro-reform influence of institutional factors
  (e.g. mass media and civil society) can also
  decrease, whereas the process of reforms
  increasingly vests upon personal preferences of
  top political leaders

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POLITICAL INSTITUTIONS AND REFORM PROCESS

• Democratization in the countries with well
  established rule of law tends to facilitates
  economic reforms and accelerate economic growth
• There is some empirical evidence, however, that
  in the countries with weak rule of law
  democratization may negatively affect
  institutional progress and economic growth.
• Alesina A. and Rodrik, D. (1994), Distributive
  Politics and Economic Growth
• Polterovich V. and Popov V. (2004), Democracy
  and Growth Reconsidered Why Economic Performance
  of New Democracies is not Encouraging.

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DYNAMICS OF POLITICAL INSTITUTIONS
The level of political competitiveness and the
state capture by special interest groups (1999)
Source The World Bank. Transition The First Ten
Years
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• As of the year 2000, the level of state capture
  among transition economies was the highest in the
  group of countries with limited political
  competitiveness, which include Russia
• For Russia a considerable decrease or,
  alternatively, a considerable increase in
  political competitiveness in the coming years
  could bring the same outcome - a decrease of
  state capture levels.

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RENT CONCENTRATION AND PROGRESS OF REFORMS

• Decrease of political competitiveness in Russia
  can facilitate reforms in those sectors, where
  state capture previously blocked the reform
  process
• The scale of state capture is closely related
  to the concentration of rent extracted as a
  consequence of non-level playing fields
• The most active resistance to reforms in
  transition economies will come from the areas
  with high concentration of rent
• Such conclusion comes in line with the
  expectations that in the following years, the
  most active progress of reforms in Russia will
  take place in the areas with the lowest
  concentration of rent, whereas reforms in the
  areas with maximum concentration of rent are
  unlikely

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LEVEL OF RENT CONCENTRATION
Comparative levels of rent concentration and the
possible pace of reforms in certain areas
(stylized data)
Level of rent concentration
Potential pace of reforms
1
1,0
0,9
Pace of reforms
Expected pace of reforms
0,5
0,5
0,3
0,3
0,4
0,1
0
Customs administration
Railroads
Oil
Science
Education
Housing and communal services
Healthcare
0
Electric energy
Gas
Comparative level of rent concentration (in
decreasing order)
Source CSR expert assessments.
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FISCAL AND MONETARY DISCIPLINE
Overall, fiscal and monetary discipline has a
positive influence on economic expectations and
risk assessments, and can therefore improve the
outcomes of reforms aimed at changing the
behavior of market participants. Fiscal and
monetary discipline can be weakened by increased
political competitiveness, and can be either
high or low in noncompetitive political
environment.
Alesina A., Roubini N., Cohen G.Political
Cycles and the Macroeconomy/Cambridge.MA. 1997
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INSECURITY OF PROPERTY RIGHTS IN TRANSITION
ECONOMIES
Source The World Bank. Transition The First Ten
Years
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Growth and property rights insecurity in 20
transition economies
1.4
POL
1.2
SVN
HUN
SVK
UZB
CZE
1.0
GDP 2000/GDP 1989
BLR
EST
HRV
.8
ROM
KAZ
KGZ
BGR
LTU
RUSSIA
.6
ARM
AZE
UKR
R2 0.3452
.4
GEO
MDA
.2
80
70
60
50
40
30
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Index of insecurity of property and contract
rights (BEEPS)
Source After the Big Bang Obstacles to the
Emergence of the Rule of Lawin Post-Communist
Societies, Karla Hoff and Joseph E. Stiglitz,
September 2003
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EFFECTIVENESS OF BANKRUPTCY INSTITUTIONS
At the creditors request
At the debtors request
Source EBRD Transition Report 2004
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TRUST TOWARDS INSTITUTIONS
Insufficient level of trust towards institutions
is a common problem for the economies in
transition, but in Russia this trend is more
pronounced than in many other countries
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IMPACT OF PRIVILEGES MONETIZATION

• Privileges monetization revealed severe
  bottlenecks in administrative capacity of the
  central government and reduced political support
  for economic reforms
• Public administration reform will only address
  the capacity constraint beyond mid-term horizon
• In the mid-term a number of simultaneous
  comprehensive structural reforms will have to be
  reduced to less than 6
• Unpopular reforms are no longer possible

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EFFECTIVENESS OF PUBLIC ADMINISTRATION
A decrease of political competitiveness can
facilitate public administration reform in
certain areas and impede it in other areas

• Decrease of political competitiveness facilitates
  
• Performance based management
• Elimination of redundant functions
• Reform of control and supervisory institutions
• Public administration reform at subfederal level

• Decrease of political competitiveness impedes
• Development of the civil society
• Introduction of participatory policymaking
• Increase in transparency
• Overcoming of corruption

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Progress of Market Reforms in 2005-2007
Realistic Assessment
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AVERAGE ANNUAL GROWTH OF THE COMPOSITE REFORM
RATING
2005-2007 rating growth according to declared
intentions
Possible 2005-2007 rating growth considering the
obstacles to reforms progress
Rating growth necessary to achieve the highest
rating indicators among transition economies
The maximum 2004 level of composite rating growth
in transition economies
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1989-2003 GDP growth in transition economies and
the composite reforms rating as of 2004
Russia
Uzbekistan
Turkmenistan
Belarus

• Source EBRD Transition Report 2004 CSR expert
  assessments
• Uzbekistan, Turkmenistan and Belarus are excluded
  from the regression

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PROGRESS OF REFORMS AND ECONOMIC GROWTH
A strong positive relationship between the
market reforms and the pace of economic growth
exists in transition economies. However, only
part of the reform agenda may have a significant
impact on economic growth in Russia in a
medium-term perspective (2005-2007).
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EXAMPLES
Financial sector, judiciary and law-enforcement
Science
Labor law
Reforms aimed at strengthening trust and
developing institutions
Reforms that affect medium-term economic growth
Reforms that are expected to have the highest
progress
Economic deregulation
Education, healthcare, natural resources
consumption
Accession to WTO
The Kyoto Protocol
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ECONOMIC GROWTH

• Source CIS Statistical Committee.

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ECONOMIC GROWTH

• Economic growth in Russia is slowing down
• In 2004 GDP growth in Russia was the lowest in
  the CIS
• In 2005 further slowdown is expected
• From an engine of economic growth in CIS
  Russian economy may evolve into brakes to
  regional growth

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CONCLUSIONS

• During tha last two years the progress of reforms
  in Russia was relatively slow compared to the
  transition countries with top reforms progress
  indicators
• Considering the close relationship between the
  progress of reforms and the economic growth, a
  slow-down in reforms can have a negative impact
  on economic growth
• The declared pace of reforms for 2005-2007 is
  overambitious it exceeds the growth rate of
  composite ratings of reform leaders in 2004
• Political environment may favor reforms in the
  areas with low and median levels of rent
  concentration
• The combined impact of impediments to reforms,
  will most probably result in much slower pace of
  reforms compared to the declared one

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CONCLUSIONS

• In 2005-2007, just as in 2004, the progress of
  reforms in Russia may remain slow in comparison
  with majority of transition economies
• The number of comprehensive reforms, carried out
  simultaneously during 2005-2007, is unlikely to
  exceed 5 or 6 in the most optimistic scenario
• Unpopular reforms are no longer possible
• The reform process and outcomes are increasingly
  dependent on the preferences of political
  leadership, while the influence of pro-reform
  institutional factors becomes weaker
• Slowdown of economic reforms could cause further
  slowdown of economic growth

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The above conclusions are preliminary and can be
only considered as hypotheses for subsequent
analysis of economic policy process in Russia