69760 THE WORLD BANK Russian Federation Export Diversification through Competition and Innovation: A Policy Agenda July, 2011 Final draft ii Foreword and Acknowledgments This study builds on three technical notes on the following topics: (i) “Analysis of Selected Trade Outcomes in the Russian Federation;� (ii) “Competition and Competition Policy in the Russian Federation;� (iii) “Commercializing Public Research in Russia: Scaling up the Emergence of Spinoff Companies,� and a background paper “Econometric Analysis of the Russian Investment Climate.� The study was co-funded by the Trust Fund Grant from the multi-donor Diagnostic Facility for Shared Growth (DFSG). Key findings of the study have been shared and discussed with the Russian Government in three Global Development Learning Network (GDLN) workshops focusing on each of the three technical notes. The study was prepared by a World Bank team led by Paulo Correa and Donato De Rosa, and included Guillermo Arenas, Carolina Austria, Sylvie Bossoutrot, Paul Conway, Jose Luis Guasch, Juan Julio Gutierrez, Mariana Iootty, Martha Licetti, Dragana Pajovic, Jorge Pena, Ljudmila Poznanskaya, Igor Pilipenko, Jose Guilherme Reis, Jose-Daniel Reyes, Alina Tourkova and Yana Ukhaneva. The note was prepared under the guidance of Pedro Alba (Country Director, ECCU1), Gerardo Corrochano (Director, ECSPF) and Sophie Sirtaine (Sector Manager, ECSF2). Frank Sader and David Rosenblatt (World Bank), Geoff Barnard (OECD) and Natalia Volchkova (CEFIR) were peer reviewers for the study. Valuable comments were provided by Zeljko Bogetic, Matthias Grueninger, William Liefert, Tatyana Ponomareva, Jean-Luis Racine, Natalya Shagaida and Stepan Titov. The team is also grateful for the input from the participants at the three GDLN workshops at the Ministry of Economic Development of the Russian Federation, in particular Mr. Alexandr Pirozhenko, Director, Department of Competition Promotion, and Ms. Natalia Larionova, Director, Department of SME Development. We would also like to thank the other participants during the workshops: Russian regional representatives, and participating speakers Elena Boutrimova, Miguel Camacho, Jorge Duarte de Oliveira, Carlos Gutierrez, Ann Penistan, Russell Pittman, Elizabete Serodio and Mariana Tavares. The GDLN activities were coordinated by Francois Nankobogo, with contributions from Mikhail Bunchuk. iii Table of Contents Executive Summary .....................................................................................................................................................1 I. Introduction ........................................................................................................................................................7 II. Trade Performance of the Russian Federation ................................................................................................ 9 III. „Binding Constraints‟ to Export Diversification – Firm-level Evidence ...................................................... 12 Investment Climate and Propensity to Export .................................................................................................... 13 Investment Climate and Total Factor Productivity ............................................................................................. 16 Investment Climate and Propensity to Invest in R&D ........................................................................................ 18 IV. Competition and Competition Policy .............................................................................................................. 19 V. Entrepreneurship, Innovation and Research Commercialization ................................................................ 24 VI. Policy Implications ........................................................................................................................................... 28 Trade policy in the Russian Federation .............................................................................................................. 32 Competition Policy in the Russian Federation .................................................................................................... 34 Innovation and Commercialization Policies in the Russian Federation .............................................................. 36 Annex I: The World Bank Enterprise Survey – Data and Methodology ............................................................ 41 Annex II: The Agricultural Sector in the Russian Federation .............................................................................. 43 List of Figures Figure 1: Decomposition of export growth 2000-2008 .................................................................................................9 Figure 2: Comparative advantage and the product space in the BRICs (2006-2008) .................................................. 10 Figure 3: Russia‟s unexplored markets ........................................................................................................................ 11 Figure 4: BRIC‟s export relationships ......................................................................................................................... 11 Figure 5: Exports relative to endowment, 1993 ........................................................................................................... 12 Figure 6: Exports relative to endowment, 2003 ........................................................................................................... 12 Figure 7: Contributions of measured variables to export propensity, % ...................................................................... 13 Figure 8: Percentage absolute contributions of TFP to the probability of exporting ................................................... 14 Figure 9: Contributions of measured variables to aggregate log-TFP, % .................................................................... 17 Figure 10: Contributions of measured variables to the propensity of investing in R&D, % ....................................... 19 Figure 11: Overall PMR indicators, Russia and comparator economies, 2008 ........................................................... 20 Figure 12: Sub-indicator - State Control, Russia and comparator economies, 2008 ................................................... 20 Figure 13: Distribution of observed PCM in manufacturing (Russia and selected ECA countries) ............................ 21 Figure 14: Concentration levels in selected Russian industries, by region – HHI ....................................................... 21 Figure 15: Total entrepreneurship activity, 2006 ......................................................................................................... 24 Figure 16: R&D/patents granted vs. GDP per capita, 2008 ......................................................................................... 25 Figure 17: Science and engineering journal articles per researcher in Russia ..................................................... 26 Figure 18: Characteristics of Russian Technology Transfer Offices ........................................................................... 28 Figure 19: Export diversification - A schematic approach .......................................................................................... 29 List of Tables Table 1: Age of researchers by educational attainment ............................................................................................... 26 List of Boxes Box 1: The investment climate and the intensity of exports ........................................................................................ 16 Box 2: Price controls and other Government interventions in the agricultural sector in Russia ................................. 23 Box 3: The case of soybean exports in Brazil.............................................................................................................. 31 Box 4: Competition policy in action: The Australian experience: What… and how? ................................................. 35 iv Executive Summary Trade performance in Russia is characterized by a narrow product base and untapped trade potential. 1. Russia‟s exports became further dominated by petroleum and natural gas over the last decade. The sector experienced double-digit annual export growth in the last decade and represented almost 65 percent of Russia‟s exports value in 2009 – a product of higher commodity prices and higher export volumes. Export growth rates of the non-oil and gas sector were also notable. Such industries as machinery, electronics, transportation equipment and chemicals reached a combined growth rate in export value of 10 percent in the last decade. This more positive comparison, however, hides relevant structural limitations in Russia‟s trade performance. 2. A closer look at Russia‟s trade composition indicates a narrow product base and lack of diversification towards new markets and products. Decomposition of export growth from 2000 to 2008 highlights how flows of existing products to old trading partners accounted for 88.4 percent of the growth in Russian exports. This was offset by declining exports to existing markets (-4.3 percent) and by the extinction of exports of existing products in existing markets (-3.2 percent). Exports of old products to new markets also increased over the decade (19.0 percent). In sum, analysis hints at Russia‟s deficiency to expand its export base to new markets and products. 3. Moreover, Russia‟s revealed comparative advantage seems concentrated in the “periphery� of the product-space map, which may limit the potential for export diversification.1 This includes industries such as raw materials (26 products) and forestry (11 products) out of a total of 97 identified products. (At the center of the product-space are industries such as metallurgy, vehicles, machinery, etc, in which Russia does not show comparative advantages). Such specialization is sometimes considered problematic because the capabilities developed in those sectors are not easily redeployed to other industries, hindering the process of economic diversification. Yet, several resource-rich countries have managed to expand their comparative advantages beyond the traditional, natural resource-intensive products. 4. Russian firms are, on average, larger than the average firm in the ECA region but too few firms export. It is a well documented fact that only a minority of firms in an economy export. Yet, according to the World Bank‟s Enterprise Survey, the share of exporting firms in Russia in 2009 (6.9 percent) is significantly lower than in India in 2006 (12.5), Brazil in 2009 (18.1) and China in 2003 (24.5). The comparison with Brazil and India is particularly striking because both are continental economies with only moderate trade integration. This low export participation ratio is observed across industries and still remains an issue when comparing Russia to more developed economies. 5. Exporters face difficulties not only entering but also sustaining their presence in foreign markets. Analysis of over 40,000 export relationships (country-product pairs with at least one year of exports valued at least USD 1,000) in the period 1999-2009 reveals that only 57 percent of export events in Russia survived for more than two years. In the case of China the export survival rate is over 70 1 The Product Space analysis is based on the tools pioneered by Hidalgo et al. (2007). The position of a product in the product space map determines the products to which companies in that economy may be able to produce related products, based on the existing set of capabilities available and the location of corresponding products on the map. The process of accumulating specific capabilities therefore results in diversification and economic development. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 1 percent, with also Brazil and India performing better than Russia (but worse than China). Some level of export “mortality� is common, but the comparatively low export survival rates in Russia provide further evidence of the lack of international competitiveness in the non-oil and gas sectors. 6. As a result, Russia is not fully tapping into its existing trade potential (i.e., trade opportunities given the country‟s current structural conditions). An analysis based on a “gravity model� including 130 of Russia‟s trading partners indicates that Russia under-trades with China and India, as well as with several G-8 countries including the U.S., Italy and Germany. More interestingly, the number of countries with which Russia seems to be under-trading rises when the oil and gas industries are excluded from the model. Indeed, despite the increase of China in global trade, the share of the country in Russia‟s total exports remained stagnant at around 4-5 percent in the 1998-08 period. 7. While macroeconomic variables such as the exchange rate play a central role in determining export performance, this report focuses on microeconomic firm level factors that are reducing the propensity of Russian firms to export. International experience shows that the entry of new exporters has been a driving force behind several export booms. In Chile, for instance, 64 percent of the increase in exports during 1990-2007 was accounted for by the entry of new exporters, rather than by an increase in exports by existing exporters (export intensity). Microeconomic factors related to the business environment affect firms‟ profitability and – given that firms differ in terms of productivity – their ability to export. This may be preventing Russia from expanding its export base and tapping into existing trade opportunities. Productivity, innovation and competition are core factors in explaining Russia‟s narrow export base and limited use of export potential. 8. Our exploratory study of Russia‟s investment climate finds (i) firms‟ productivity levels; (ii) firms‟ innovation performance and (iii) the level of domestic competition to be the main microeconomic determinants of Russia‟s export propensity. Interestingly, (total factor) productivity is a less important determinant of export intensity, whereas domestic competition and firm-level R&D continue to present significant contributions, along with red tape, corruption and labor skills. This is consistent with the notion that higher productivity levels are crucial to help firms cover fixed costs associated with entering new markets, but less so in the case of expanding existing export relationships. Preliminary findings from our trade analysis have in fact shown that fixed costs to export are on average higher in Russia than in comparator countries (and that, on the other hand, variable export costs are at the same level). 9. In addition to productivity, innovation and competition, other obstacles to higher export propensity should also be considered. For instance, firms experiencing a higher number of power outages per month or having higher shares of electricity coming from a generator are less likely to enter foreign markets. Businesses that are spending more time dealing with bureaucratic issues show lower export propensity, indicating the relevance of the regulatory environment. Moreover, firms that purchase a higher share of their input on credit (after delivery) – which we interpret as evidence of cash- constrained companies – have a lower probability of exporting. 10. The importance of productivity, innovation and competition to export propensity is not unique to Russia. Productivity is shown to be significant and relatively the most important positive Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 2 covariate for export propensity in a sample of 19 countries, including Brazil, South Africa and Turkey. A number of studies relate higher R&D expenditures and product innovation to higher export performance, as for instance in the case of small non-exporting firms in Germany and Spain. Finally, our results on the important contribution of competition are consistent with the argument that strong rivalry in domestic markets strengthens the capacity of local firms to compete abroad. This argument has been corroborated by the experience of a number of countries including Japan, Chile, Indonesia and India. In Russia, the combined (absolute) contribution of competition variables amounts to over 15 percent of the probability of exporting – with price increases in domestic markets (a sign of monopoly power) making firms less likely to export. Yet firms‟ productivity and innovative performance depend on the overall investment climate conditions. Productivity, in turn, is also affected by a larger number of investment climate factors including competition and innovation. 11. A larger number of investment climate factors are affecting the productivity levels of Russian firms, including technological capacity and entrepreneurship. There are about 20 different factors, as compared to 15 for the case of export propensity, that are relevant to firm productivity. Technological upgrades – the share of staff with access to a computer, import activity and quality certification (an indication of technical conformity) – appear among the most relevant investment climate factors. Consistent with the complementary relationship between skills and technology, the supply of training by firms appears as another key strategy to increasing business productivity. Of particular relevance, according to our results, is the experience of the manager, which we interpret as evidence of the role of business-related skills for firm productivity in Russia. Moreover, firms developing new products or services show higher productivity levels. 12. Intensity of domestic competition is another important element for productivity. Firms subject to informal competition (the grey market) show lower productivity levels. Public subsidies also seem to be associated with lower levels of productivity – an apparent contradiction, in principle, with the goals of state aid. All these factors tend to distort competition and have an adverse impact on productivity. In fact, the Olley and Pakes decomposition of Russia‟s productivity shows that the current contribution of the “allocative efficiency� component (how much of the output is commanded by the more productive firms) to aggregate productivity in the country (about 20 percent) corresponds to half the value for Brazil in the early 2000s. By creating a more level playing field, competition policy in Russia may contribute to increase productivity and thus export diversification. Russia‟s highly restrictive product market regulations are hampering productivity and export diversification. 13. State ownership is twice as large in Russia as in the EU-10 countries, with state-owned enterprises commanding about 17 percent of employment. Available data indicate that, with national, state, or provincial government controlling at least one firm in 16 (out of 19) sectors – a relatively high figure compared to OECD averages, where the typical member economy registers government participation in only 9 of the same sectors. The EBRD Transition Indicators also show that enterprise restructuring in Russia is lagging behind that of Poland, Turkey and the average of the ECA region. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 3 14. State aid seems to favor larger, less productive incumbent companies over smaller, more efficient firms. State aid (for example, in the form of loans, subsidies, and tax cuts) is often applied unevenly across regions, sectors, and firms. According to the World Bank Trade Restrictiveness Index, incumbent firms are more insulated from international competition, especially through non-tariff barriers in the form of technical regulations and quantitative restrictions, than in most comparable countries. Actions of regional governments also influence competition conditions in domestic markets. 15. The analysis of market structure within Russia at the geographic and product market level also reveals a high degree of concentration, with significant variations across regions and sectors. A related problem is market fragmentation: the 2009 World Bank Enterprise Survey shows that 50 percent of Russian firms considered local markets to be their main sales destination – a large number, even when compared to large economies such as Brazil (35 percent). Despite the size of the Russian economy, isolation from global markets may induce companies to choose less modern technology and operate at sub-optimal scales. 16. One implication of limited import competition in Russia is market dominance. Price cost margins (PCM) for inputs of exportable goods in Russia tend to be larger than those of their international peers, reducing the incentive of local exports. Russian firms register larger PCMs compared to the average of the region in every manufacturing sector except food, garments, and chemicals. A more detailed PCM analysis in selected sectors reveals that firms in sectors where Russia registers higher PCMs than regional counterparts, tend to be older and larger, are less likely to export and invest in R&D, and are more likely to operate in local markets. Lack of entrepreneurship and low commercialization of public research limits the emergence of new products with export potential. 17. Despite its importance to export propensity, business R&D has been declining in recent years. Russia‟s business R&D expenditures declined from a high of 0.88 percent of GDP in 2003 to 0.65 percent in 2008. Comparatively, OECD countries increased their average business expenditures on R&D in the same period, from 1.49 percent to 1.63 percent. As shown by our econometric results, the propensity of Russian firms engaging in R&D activities depends on a number of investment climate factors that are only partially affected by innovation policies. For instance, firm productivity levels, investments in information and communications technologies, skills as well as the experience of the manager – proxies for entrepreneurship and business knowledge – are all important factors. 18. More broadly, entrepreneurship in Russia is below the level that the country‟s stage of development would suggest. Limited entrepreneurship is closely related to poor governance and weak institutional regimes, as it affects the allocation of talent in the society which favors the allocation of talent to rent-seeking rather than productive activities. About a quarter of management time in Russia is spent on regulation requirements, compared to 7 percent in India, which illustrates how a deficient governance regime leads to misallocation of talent. Yet Russia‟s talent pool is large, as indicated by an internationally comparable level of graduates in engineering and science. 19. Meanwhile, the commercialization of public research – potentially another source of innovativeness – has been hampered by a number of factors. Researcher productivity has been declining historically and public measures to promote innovation have been focused on universities, even Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 4 though universities receive a much smaller share of public R&D investments than research institutes – limiting the research pool available from which patents can be obtained and licensed, and spinoff companies can be created. Funding allocation on a per headcount basis, as opposed to performance-based allocation, along with a declining number of middle-career researchers – who are more likely to publish and commercialize research – does not favor research productivity. Discoveries in the defense sector, which could potentially be a major source of civilian innovation, remain inaccessible to the private sector. 20. Overall conditions for large scale commercialization processes are gradually improving but important limitations remain. Despite recent advances in intellectual property legislation, loopholes and uncertainty relating to the full ownership of discoveries financed by public funding hinders private sector investments and the full development of the commercialization process. Licenses are mostly granted on a non-exclusivity basis which raises doubts about firms‟ capacity to raise capital and carry on necessary investments. A gap between the Foundation for Assistance to Small Innovative Enterprises (FASIE) programs and venture capital funding continues to threaten the survival of Russian start ups, despite recent initiatives to improve early stage financing in the country. A strategy for export diversification in Russia should incorporate the conditions for emergence of productive and innovative firms. 21. Our analyses suggest taking a broader view of the diversification challenge in Russia, incorporating the conditions for emergence of productive and innovative firms and for achieving a higher probability of firm survival in foreign markets. Raising the share of non-resource based exports in Russia has so far proved a difficult task, reflecting similar difficult experiences elsewhere. Experience also shows that there is no magic recipe to promote export diversification. Discovering a strategy that could induce export diversification within Russia‟s institutional and political economy constraints is therefore likely to be a gradual process involving recurrent assessments, government learning, consistency with the country‟s comparative advantages, and policy attention in each area (and awareness of interlinkages) – rather than a single-shot type of intervention. 22. Policy-makers can contribute to increases in the potential of export diversification in Russia by adopting selected innovation and competition policies in combination with productivity oriented reforms. Export diversification depends on a number of macro- and microeconomic conditions, including a competitive exchange rate and solid governance system. Yet, by affecting competition, improving innovation and facilitating trade, the government can enable economic renewal, and the ability and capacity of firms to enter international markets. This in turn could trigger a positive cycle of productivity, innovation and trade integration through existing feedback effects. Russia‟s competition policy should level the playing field, reducing rents in domestic markets and favoring the emergence of more efficient firms. 23. Leveling the playing field, facilitating entry of more efficient firms, and encouraging orderly exit of less efficient ones would contribute to higher productivity and export propensity. At its core, the policy should promote a reduction of state ownership; a more uniform, transparent, and result-oriented enforcement of state aid regulations; the simplification of the business environment in which firms operate; and the promotion of competition in service and network industries. As in the cases of Australia and the European Union, such a policy could help increase productivity and consolidate Russia‟s Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 5 domestic market, enabling domestic firms to benefit from additional gains from trade. Specific measures should include: (i) advancing government reforms of public enterprises, minimizing their distortive impact on the marketplace (ii) broadening the mandate on state aid regulation in order to diminish firm- and sector-specific state aid; (iii) aligning state aid regulation to international best practices; and (iv) eliminating preferential treatments for state or municipality-owned corporations. Sector specific policies in key service industries (such as transport, construction and professional services) would further increase competition, promote entry and reduce the prices of services. Continued reform of the innovation system will increase firm-level R&D and commercialization of public research, possibly unleashing entrepreneurship. 24. The Government‟s current initiatives to foster innovation could be strengthened through improvements in Russia‟s Innovation System; the country‟s human capital; and the intellectual property legal framework. More specific policy options include (i) results-based management of public research organizations; (ii) performance based career development; (iii) strengthened cooperation with Russian researchers based abroad; and (iv) transfer of ownership rights of intellectual property to research organizations. The funding gap should be addressed through provision of finances for early stage development of technologies, matching grants, and differentiated tax breaks for SMEs. More long term, the Government should (i) expand commercialization efforts to new areas with innovative potential, including the Russian Academy of Sciences, the defense sector, and agricultural research; (ii) continue to reform the investment climate, focusing on skills and technology adoption, favoring business investments in R&D; and (iii) continue to improve the governance of the overall economy to decrease incentives for rent-seeking and incentivize the allocation of talent, entrepreneurship and innovation. Reducing remaining anti-export bias of Russia‟s trade policy and aligning export promotion strategies to international best-practice will further enable export diversification. 25. Efforts to liberalize trade have been one of the highlights of Russia‟s economic reform for the past two decades. Parallel to making efforts in lowering tariffs, reducing quotas, and diminishing import subsidies, the country has also advanced the process of negotiating accession to the World Trade Organization (WTO), with bilateral market access negotiation completed with interested WTO members, including the U.S., and with accession expected to be near. Yet, some hurdles remain for Russia‟s full integration with the rules-based trading system, including increased tariff rates in several industries such as processed foods, light manufacturing, the automotive sectors, and some construction equipment in light of the economic crisis. Adopting a low and uniform tariff structure could bring benefits for an economy that seeks to enhance export diversification through innovation. Moreover, based on our findings of high fixed (sunk) costs to exports in Russia, reducing such costs could provide opportunities to encourage firm exports and to facilitate enterprises in establishing new export relationships. Advancement of the development of regional coordinating centers would in turn facilitate both the creation of new exports as well as help sustain current trade partnerships. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 6 Russian Federation Export Diversification through Competition and Innovation: A Policy Agenda2 I. Introduction 1. Economic modernization and export diversification are priorities in the Russian economic policy agenda, with several measures being undertaken in recent years to promote growth in the non-oil and gas sectors. Yet the reason why some firms succeed in breaking into foreign markets while others do not is far from fully understood. In this note, we try to identify the „binding constraints‟ to export diversification in Russia. Using firm-level data, we identify which investment climate factors are affecting Russian firms‟ propensity of engaging in export activities. Results show that lack of competition and entrepreneurial innovation are relevant obstacles to the emergence of new, potentially exportable products. We then discuss what enhanced trade, competition and innovation policy measures could contribute to export diversification. 2. Russia‟s export base has narrowed substantially in the past decade. Oil and natural gas comprised less than half of total exports in 2000. In ten years, this figure had grown to two-thirds of total exports, with an additional 15 percent coming from other extractive commodities and only 9 percent from high-tech exports, mainly in the defense industry. At the same time, and in contrast to the other BRIC countries, Russia currently exhibits revealed comparative advantage3 in only two sectors (extractive industries and iron and steel).4 While in part a result of higher commodity prices, this also indicates a loss of export competitiveness of Russia‟s non-resource sectors. 3. Lack of diversification cannot be pinned down to a single cause.5 In addition to the macroeconomic imbalances resulting from the alteration of relative prices between resource and non- resource sectors, poor governance, administrative complexity (red tape), inadequate labor and managerial skills, and difficult access to finance contribute to hindering the emergence of exporters in non-resource sectors. According to a 2009 enterprise survey, for instance, only 12 percent of Russian firms do not identify skills and education of the workforce as a constraint, compared to 40 percent in 2005. At the same time, a mere 30 percent of firms have access to a line of credit or a loan from financial institutions (compared, for example, to 65 percent in Brazil).6 2 This note was prepared by Paulo Correa, Lead Economist, Donato De Rosa, Senior Economist and Dragana Pajovic, Analyst, all Private and Financial Sector Development, ECA Region, The World Bank. 3 Revealed comparative advantage (RCA) is an empirical indicator of trade specialization. The index is used to calculate the relative advantage or disadvantage of a certain country in a certain class of goods or services as evidenced by trade flows. RCA of exports by sector in Russia and the BRICs is computed using the 2-digits HS classification system. Defining Xi and Mi as, respectively, exports and imports, RCA is computed, for each sector i, as:  Xi Mi  RCAi  100   X k  M k    4 Brazil, by comparison, shows comparative advantage in the same sectors with the addition of agricultural products and food and beverages. 5 Several recent studies examine the challenge of economic diversification from different perspectives. See, for example, World Bank (2009) Russian Federation: Regional Development and Growth Agglomerations; World Bank (2007) Energy Efficiency in Russia: Untapped Reserves; World Bank (2011a) Russian Economic Report No. 25: Securing Stability and Growth; World Bank (2011b) Russia: Reshaping Economic Geography; Bogetic et al. (2010) "Long-Term Fiscal Risks in an Oil-Rich Country: The Case of Russia;" OECD (2009) Economic Survey of the Russian Federation. 6 See www.emterprisesurveys.org for data of enterprise surveys conducted worldwide by the World Bank. The 2009 survey for the Europe and Central Asia Region - the Business Environment and Enterprise Performance Survey (BEEPS) has been conducted in cooperation with the EBRD and is used in this study. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 7 4. Competition and innovation are examined in this study as key drivers of export diversification. We propose an interpretation of the challenges of export diversification in Russia in which the lack of competition and entrepreneurial innovation are presented as relevant obstacles to the emergence of new, potentially exportable products, and thereby export diversification. This is done by complementing assessments of trade, competition and innovation in Russia with the analysis of firm level data from the 2009 Enterprise Survey, analyses which can be found in three technical notes and a background study on the Russian business environment. 5. Following our findings we identify some key trade policy measures which could help firms in entering foreign markets as well as sustaining current trade relationships. Preliminary findings from our trade analysis have shown that fixed costs are on average higher in Russia, while the minimum average productivity level required to export is higher than in most other comparator economies. Reducing such fixed export costs could provide opportunities to encourage firm exports and to facilitate enterprises in establishing new export relationships. Meanwhile, adopting a low and uniform tariff structure could bring benefits for an economy that seeks to enhance export diversification through lowered obstacles to innovation. Finally, there should be a continued effort to promote exports through the regional coordinating centers that support and promote export-oriented SMEs, serving as a single- window for trade and investment issues. 6. A comprehensive competition policy would in turn help establish a level playing field, facilitate entry of more efficient firms, and encourage orderly exit of less efficient firms, thereby contributing to increased productivity and export propensity. Specific measures should include: broadening the mandate on state aid regulation in order to diminish firm- and sector-specific state aid; creating an inventory of state aid; aligning state aid regulation to international best practices; and eliminating preferential treatments to state or municipality-owned corporations. Sector specific policies in key service industries (such as transport, construction and professional services) would further increase competition, incentives for entry and reduce prices of services. 7. The Government‟s current initiatives to foster innovation could be strengthened through a number of specific measures focusing on commercialization of public R&D and adequate research funding. More specific policy options include results-based management of public research organizations; performance based career development; transfer of IP rights to research organizations; provision of finances for early stage development of technologies; matching grants; and differentiated tax breaks for SMEs. The Russian Academy of Sciences, the defense sector, and agricultural research could meanwhile be explored as areas with innovation potential. 8. This study is organized as follows: Section II scrutinizes various dimensions of Russia‟s trade performance, including export diversification, sophistication and survival. A detailed analysis of the role of exports, innovation, productivity and competition on firm performance is presented in Section III. Section IV analyzes the competition environment in Russia, by presenting analyses of price cost margins, state ownership, and regional and sectoral characteristics of competition, whereas Section V provides an overview of Russia‟s innovation system and proposes measures to increase the impact of R&D on the economy. Section VI concludes and presents policy options. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 8 II. Trade Performance of the Russian Federation7 9. Decomposition of export growth shows that Russia has been struggling to diversify its export base to new markets and products. Decomposition of export growth into the margins of trade is informative to identify the source of export dynamism.8 When examining export growth in Russia from 2000 to 2008, flows of existing products to existing export destinations accounted for 88.4 percent of total export growth (Figure 1). This increase was offset by falling exports to existing markets (-4.3 percent) and by the extinction of exports of existing products in existing markets (-3.2 percent). The only significant variation at the extensive margin is the increase of old products in new markets (19.0 percent). While export growth of more developed countries is expected to be concentrated in the intensive margin, this analysis hints at Russia‟s deficiency to diversify its export base to new markets/products. Russia: Decomposition of Export Growth 2000-2008 Figure 1: Decomposition of export growth 2000-2008 140.0 Extensive Margin 120.0 100.0 88.4 80.0 Percentaje 60.0 40.0 19.0 20.0 -4.3 -3.2 0.0 0.0 0.0 Increase of old Fall of old Extinction of Increase of new Increase of new Increase of old -20.0 product in old product in old exports of products in new products in old products in new markets markets existing markets markets markets products to existing markets Components of Export Growth 10. Exports are concentrated in markets that are not growing strongly. How a country‟s industry is faring in international competition can be gauged by its share in strategic markets, such as those that are growing (and importing) rapidly. Generally, Russia‟s top export partners are not among those that have seen the highest rates of import growth between 2000 and 2008. In fact, Russia shows the lowest correlation between (log) product share and annual world import growth among BRIC countries. 11. Russia reveals a comparative advantage mainly in products that have few connections – or potential spillover effects – with other sectors. Computed at the 4-digit SITC level, Figure 2 shows the 7 This section is based on the technical note “Analysis of Selected Trade Outcomes in the Russian Federation,� prepared by Jose Guilherme Reis, José-Daniel Reyes and Guillermo Arenas, all International Trade Department, The World Bank. 8 Export growth can take place at the intensive margin (selling existing products to existing markets) or at the extensive margin (selling existing products to new markets, new products to new markets, and new products to existing markets). Growth along the intensive margin, of products with already established exports, is a source of export diversification if it is obtained through the increase of the share of non-traditional exports in total exports. There are multiple definitions of the intensive and extensive margins. In this note the concepts are invoked in the context of diversification as well as survival of exports. In the former, the attempt is to explore to what extent Russia has been able to add new products and new markets – that are economically significant – into its portfolio. When the two margins are discussed in the context of export survival, the attempt is to decompose export growth into constituents capturing growth of old products in old markets versus the rest. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 9 products in which Russia has revealed comparative advantage (RCA) in 2006-08 (black dots) on the product space map, compared to the other BRICs.9 Figure 2: Comparative advantage and the product space in the BRICs (2006-2008) Russia Brazil China India 12. The product space analysis of Russia‟s export basket reveals three points. First, Russia’s product space map has a relatively healthy number of products (97) in which the country has achieved RCA. Second, the products in which Russia has developed RCA are mostly in the periphery of the product space map, meaning that they have few connections to other sectors. This implies that gaining comparative advantage in other sectors is more difficult since the capabilities needed to produce the current export basket are not easily redeployed to other sectors. All other BRICs have, on the other hand, been somewhat successful in penetrating the core of the product space (especially China), implying that future structural transformation of the export basket could be easier. 9 The Product Space analysis is based on the tools pioneered by Hidalgo, Klinger, Barabasi, and Hausmann (2007). “The Product Space and its Consequences for Economic Growth,� Science 317; 482-487. The position of a product in the product space determines the products to which companies in that economy may be able to relate products, based on the existing set of capabilities available and the location of corresponding products on the map. The process of accumulating specific capabilities therefore results in diversification and economic development. Revealed comparative advantage of Russia‟s product space is here computed at the 4-digit SITC level. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 10 Third, new products in which Russia has developed RCA are in the same or very similar sectors as its ‘classic’ exports. These are mainly resource-based commodities like raw materials, forestry, cereals, and oil and gas, indicating that over the last fifteen years, Russia has been mainly stuck in the same export sectors (Figure 3). It is however worth mentioning that the country also developed comparative advantage in some non-resource based industries like capital intensive goods and chemicals. 13. There may be untapped potential to unexplored markets Figure 3: Russia‟sPredicted v Actual Exports increase exports within the existing product- 20 space. Analysis of Russia‟s total exports, based on a Log of Predicted Exports, 2006-2008 Log of Predicted Exports, 2006-2008 18 CHN DEU IND USA ITA gravity model of Russia and over 130 of its trading 16 JPN 15 partners indicates that Russia under-trades with BRA 14 India, China as well as with several G-8 countries including the U.S., Italy and Germany (located 12 10 above the 45-degree line in Figure 3).10 The number 10 of countries rises significantly when the oil and gas industries are excluded from the model. This result 8 5 suggests that there is scope for exploring other 8 10 12 14 16 18 8 Log of Actual Exports, 2006-2008 opportunities for export diversification in Russia. 14. Russia‟s exports also seem to suffer from Figure 4: BRIC‟s export relationships BRIC's Export Relationships premature “death.� The probability of Russian Survival Rate 1999-2008 1 export relationships surviving until the second year is about 0.57 (on a 0-1 scale), and of maintaining a .8 relationship for 5 years is 0.22 (Figure 4). In probability .6 comparison, the survival rates of the export .4 relationships of other BRICs are much higher, particularly in China, where the survival rate is .2 roughly 0.70 for the first two years. This result 0 suggests that export diversification strategies in 0 5 10 Analysis Time Russia should pay particular attention to the factors Russia Brazil affecting the survival of new exports (export China India discoveries). 15. This may provide indication of a mismatch between current exports and the country‟s factor endowments. To explain why a country‟s exports cannot be sustained, one of several areas to investigate is whether the exports that die represent attempts to produce goods that require a different mix of factor endowments than supported by the economy. With few exceptions, the most significant exports of Russia in 1993 were in line with the average factor endowment in upper-middle income countries, with some embodying capital greater than the average (Figure 5). By 2003, the endowment of both physical and human capital had increased slightly, and Russia produced many exports with higher factor requirements. The major exports, however, remained close to the endowment point, with one major output below (Figure 6). A majority of exports that existed in 1993, but not a decade later, required a relatively high level of physical and human capital. At the same time, a majority of “new� exports active 10 For a detailed discussion on the gravity model and the results of this exercise, see “Analysis of Selected Trade Outcomes in the Russian Federation,� technical note for this study, pp. 8. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 11 in 2003, but not a decade earlier, are also moderately capital-intensive. It can be hypothesized that, all else equal, ambitious ventures that defy a country’s comparative advantage have a higher rate of failure. Figure 5: Exports relative to endowment, 1993 Figure 6: Exports relative to endowment, 2003 Russia: Exports Relative to Endowment 1993 Russia: Exports Relative to Endowment 2003 15 15 Revealed Human Capital Index 10 10 5 5 0 0 0 50000 100000 150000 0 50000 100000 150000 200000 Revealed Physical Capital Index Revealed Physical Capital Index III. „Binding Constraints‟ to Export Diversification – Firm-level Evidence11 16. Empirical analysis of the investment climate factors and its‟ effects on firm performance help identify the „binding constraints‟ for non-resource exports in Russia. Based on more than 250 variables provided by the 2009 World Bank Enterprise Survey (2009 ES) and related to the Russian investment climate (IC). The topics covered in the survey include the obstacles to doing business, infrastructure, finance, labor, corruption and regulation, law and order, innovation and technology, trade, and firm productivity. Out of these numerous variables, we identify a smaller set of (about 20) variables that are statistically significant (at least at 5 percent) to explain each of the four aspects of firm performance: total factor productivity (TFP);12 the economy‟s export propensity and intensity (probability of exporting and the share of exports in total sales); and innovation ability. 17. We apply micro-econometric techniques in order to estimate the correlations between dependent and independent variables. In addition to the above mentioned dependent variables, the equations measure a number of independent (or explanatory) variables‟ impact on firm performance, including competition, a group of other investment climate variables, as well as other control variables (industry, region, firms size, among others). A system of equations is used to model the interrelations among the dependent and independent variables. A summary of the methodology used may be found in Annex I. While we interpret the results with a “grain of salt,� we believe they represent a good first screening of Russia‟s “binding constraints� for firm growth. The remainder of the section summarizes the results of Pena (2010) describing key investment climate factors affecting firm productivity (TFP), exports (propensity), and innovation.13 11 This section is based on the background paper “Econometric Analysis of the Russian Investment Climate,� prepared by Jorge Pena, Department of Economics, Universidad Carlos III de Madrid, Spain. 12 Total Factor Productivity (TFP) is the portion of output not explained by the amount of inputs used in production. As such, its level is determined by how efficiently and intensely the inputs are utilized in production. 13 More details on data and methodology can be found in Annex I Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 12 IC and Propensity to Export 18. The results of this analysis show that the main contributors to firm export propensity in Russia are the firm‟s productivity level, its innovation performance, and the competition environment it faces. Factors related to infrastructure, regulatory environment, and access to finance, although still playing a role in the propensity of Russian firms to export, exhibit lower (absolute) contributions. The relative contributions of individual variables to firms‟ export propensity (i.e. the effect that can be associated with the investment climate) are presented in Figure 7. Our primary focus on export propensity, in turn follows recent findings of research showing entry as the driving force behind several export booms. In Chile, for instance, 64 percent of the increase in exports during 1990-2007 came from new exporters, rather than from an increase (export intensity) in incumbent exporters. The contribution of the investment climate on Russian firms‟ export intensity is however also discussed in Box 1. 19. Productivity levels exhibit the largest contribution by far: A 1 percent increase in TFP is associated with an increase in export propensity of up to 11 percent. Also, evaluation of the importance of TFP, relative to other variables, in explaining the propensity of firms to export shows that TFP accounts for 42.1 percent of the determinants of exporting for firms in Russia (relative to other variables) (see Figure 8). Such importance of productivity levels to a firm‟s propensity to export is consistent with recent studies on trade with heterogeneous firms. These studies argue that high- productivity firms are more likely to export because they are able to pay the substantial sunk (fixed) costs incurred in entering foreign markets.14 Figure 7: Contributions of measured variables to export propensity, % TFP Innovation, quality & skills Competition Infrastructure Regulatory env. Finance Other 70 control variables 58.37 60 50 40 32.71 % Contributions 30 20 7.61 6.07 10 3.82 4.74 1.44 2.22 2.42 0 -0.27 -4.45 -3.76 -1.08 -10 -4.56 -5.29 1 2.1 2.2 2.3 3.1 3.2 3.3 3.4 4.1 4.2 5.1 5.2 5.3 6.1 7.1 1 TFP (log) 3.1 Domestic competition 5.1 Informal payments in tax inspections 2.1 Dummy for R&D 3.2 Dummy for informal competitors 5.2 Manager's time spent in bur. issues 2.2 Dummy for new product 3.3 Dummy for more than 5 competitors 5.3 Dummy for gifts to receive certificates 2.3 Dummy for quality certification 3.4 Dummy for increased prices 6.1 Purchases paid for after delivery 4.1 Power outages 7.1 Dummy for sales decreased 4.2 Electricity from own generator 14 Yet the role of productivity in shaping aggregate export responses should not be overstated, and most of the literature identifies exchange rates and foreign income growth as more important determinants (see for instance Bernard 2006). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 13 Figure 8: Percentage absolute contributions of TFP to the probability of exporting 50 40.7 42.1 42.9 40 30.3 30 24.1 24.2 24.4 25.1 20.7 21.7 22.0 18.2 19.6 19.6 20 14.0 15.7 15.7 9.0 9.1 10.6 10 0 Source: Staff calculations based on Pena (2010) and Escribano, Pena and Reis (2010) 20. The relevance of firm productivity to the probability of exporting is not unique to Russia. While significant in its own right, it is important to give a cross-country perspective, to understand to what extent the contribution of productivity to export propensity is specific to the Russian context. Figure 8 above shows the percentage relative contributions of TFP to the probability of exporting (exporting propensity) in 19 countries. Results show that, regardless of the country in focus, TFP is always significant and relatively the most important positive covariate for international engagement. However, the results also show that, together with Turkey and South Africa, Russia stands out as a country where this association between productivity and exporting is particularly strong. 21. The underlying costs to export may be higher in Russia than in other countries. The heterogeneous firm literature in international trade has established that export participation is mostly determined by variable export costs (such as transport costs and tariffs) and fixed export costs (such as market entry costs). This combination impacts firm profitability and – given that firms differ in terms of productivity – also affects their ability to engage in exports. As a result, the firms that are able to overcome the trade costs to export are usually the largest and most productive within a country. There is, therefore, a direct relationship between the level of trade costs and the minimum productivity threshold required to export. A simple way to infer about differences on exporting costs across countries is to look at some measure of the minimum productivity level required to export in each country. 15 Our results indicate that the minimum average productivity level required to export in Russia is higher than in almost all comparator economies.16 22. Further analysis suggests that fixed costs to export are the key impediment to Russian businesses. In order to gauge the impact of variable costs for exports, we look at the Market Access TTRI,17 which is below the average of the ECA region – indicating that variable export costs in Russia are slightly more favorable than for the countries in the comparator regions. This in turn suggests that the fixed costs of exporting are the key factor impeding export participation in Russia. These preliminary findings are in line with firm-level evidence provided by Volchkova (2010), where the author links firm- 15 We compute two measures of productivity in each country: The first one is the “Solow residual� estimated from an OLS regression of a log Cobb-Douglas production function. Specifically, we regress total sales on total employment, total stock of capital, and cost of materials (all in logs). The second one is the standard revenue-based labor productivity computed as the ratio of total sales over total employment at the establishment level 16 For a detailed discussion on these results, see “Analysis of Selected Trade Outcomes in the Russian Federation,� technical note for this study, pp. 29. 17 The Market Access tariff trade restrictiveness index (TTRI) calculates the equivalent uniform tariff of trading partners that would keep their level of imports constant. It is weighted by import values and import demand elasticities of trading partners. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 14 level information with customs data to find that Russian enterprises face a higher fixed exporting cost than French firms. This analysis could suggest that Russia faces unexploited trade potential in the form of firms that are willing yet unable to venture abroad because of too high fixed costs to export. 23. The tax code may further limit the willingness to export, especially for smaller firms.18 In Russia, exporting firms are entitled to receive a VAT refund which, according to anecdotal evidence, increases the probability of being inspected by tax officials. In this context, firms may prefer not to export at all over facing tough tax controls and potential charges. We investigate this issue using firm-level information from the Russia 2009 ES. Our preliminary findings indicate that the probability of being audited is around 20 percent higher for exporters than for non-exporters in Russia. 24. Firms introducing a new product and investing in research and development (R&D) and those facing competition from domestic firms are more likely to export. By encouraging innovation and enterprise R&D, innovation policies could, in principle, increase the probability of a firm to export and thus contribute to export diversification. This conclusion holds regardless of the sector of the firm performing R&D. Similarly, firms subject to strong domestic competition have a higher probability of exporting. Results are consistent with the argument that strong rivalry in domestic markets strengthens the capacity of local firms to compete abroad.19 By affecting the competition environment, the Russian government can affect the export propensity of domestic firms. 25. Another factor impeding the propensity of exporting is the red tape faced by Russian enterprises. Figure 7 above illustrated that firms where senior managers spend more time dealing with requirements of government regulations have a lower probability of exporting. Indeed, Enterprise Survey data shows that managers in Russian enterprises spend on average 19.9 percent of their time trying to meet regulatory requirements – a value higher than in many other emerging economies, such as Romania, Ukraine or Brazil (ranging from 9.2 to 18.7 percent) and significantly behind the OECD average of 1.2 percent. 26. Limitations in infrastructure as well as delays in payments are also impediments with adverse effects on firm‟s probability of exporting. Establishments that purchase a higher share of their input on credit (after delivery) seem to have a lower probability of exporting. Similarly, infrastructure seems to impose a strain on exporters. Businesses that are experiencing a higher number of power outages per month are less likely to enter foreign markets, as are firms with a higher share of electricity coming from a generator. 18 Tax rates are perceived by businesses in general as a major obstacle to growth (see Plekhanov and Isakova, 2011). 19 See for instance Porter and Sakakibara (2004) in reference to the Japanese experience. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 15 Box 1: The investment climate and the intensity of exports A secondary issue to export propensity is the intensity of exports – here, other investment climate conditions prove to be the main determinants, with domestic competition and innovation also playing a role. As a second step to export propensity, we try to say something on the determinants of the volume of exports, that is, once a firm self-selects into export markets, why do some firms export more than others? We construct a standard probit model for exports volume, measured as percentage of total annual sales, with the objective of getting consistent estimators of the effects of TFP, innovation, competition and investment climate variables on the exporting intensity of firms.20 Results show small relative contributions of domestic competition and innovation, both around 3 percent to higher export intensity. This can probably be explained with the low proportion of firms engaging in R&D and facing intense domestic competition. On the other hand, Absolute contributions of R&D, competition and control variables other investment climate variables as a to export intensity whole contribute with almost 50 percent to the mean of exporting intensity, while the remaining 43 percent is explained by other Regulatory environment control variables (industry, region, size 18.1% Finance effects, etc). Within the 50 percent Other inv. Other control 5.1% variables climate contribution of the investment climate the 43.3% variables Quality Labor skills 0.9% role of regulatory factors, labor skills and 12.1% other control variables (mainly number of Other (competition) competitors), as well as additional 13.3% Domestic competition variables (mainly facing more competition R&D investment 3.5% 3.2% than five competitors) stand out (right panel in the Figure). IC and Total Factor Productivity 27. Productivity is a multidimensional variable but investment climate factors are able to explain a significant part of it. Because productivity levels play a major role in the firm‟s decision to export and invest in R&D, we also investigated which investment climate factors are contributing more to the TFP levels of Russian firms. In fact, results indicate that the investment climate explains up to 36 percent of aggregate logTFP.21 Details on the role of the investment climate are presented in Figure 9, where the individual IC contributions to aggregate logTFP are included. There are a total of 20 statistically significant variables, out of which 17 are exclusively investment climate variables. 20 We here take into consideration a self-selection problem, as we only observe the volume of exports for those firms exporting. Thus the equation encounters an endogenous sample selection problem. In order to model the probability of firms exporting, we use probability of exporting equation estimated with a standard probit model. For more details on the methodology, see Pena (2010). 21 In addition to the investment climate, other factors explaining aggregate logTFP include the equation‟s explanatory variables (exports, FDI, innovation, employment) as well as industry/region/size effects and the constant technical efficiency (constant term of the TFP equation). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 16 Figure 9: Contributions of measured variables to aggregate log-TFP, % Trade & FDI Innovation, quality and skills Competition Infrastructure Reg. Finance and Other control 30 & logistics env. corporate governance variables 25.96 25 20 14.18 15 11.40 12.17 10.78 8.69 8.88 10 7.30 % contributions 5.59 6.10 2.45 3.39 5 1.34 0.55 0 -5 -1.22 -1.42 -0.54 -2.13 -3.68 -10 -9.79 -15 1.1 1.2 1.3 2.1 2.2 2.3 2.4 2.5 3.1 3.2 4.1 4.2 5.1 6.1 6.2 6.3 6.4 6.5 7.1 7.2 1.1 Dummy for FDI 1.2 Dummy for exports 3.1 Domestic competition 6.1 Dummy for loan 1.3 Dummy for imports 3.2 Dummy for informal competition 6.2 Sales paid after delivery 2.1 Dummy for new product 4.1 Shipment losses in exports 6.3 New fixed assets financed by internal funds 2.2 Dummy for quality certification 4.2 Days to clear customs in exports (interac.) 6.4 New fixed assets financed by equity 2.3 Staff with computer 6.5 Dummy for subsides 5.1 Dummy for gifts in tax inspections 2.4 Dummy for training 7.1 Dummy for incorporated company 2.5 Experience of the manager 7.2 Dummy for decreased sales 28. Results indicate that innovation, labor skills, exporting as well as importing activities, among others, are associated with higher TFP. Technological upgrades – defined as the share of staff with access to a computer, import activity and quality certification (an indication of technical conformity) – appear among the most relevant investment climate factors. Of particular relevance, according to our results, is the “experience of the manager.� The positive contribution of the dummy for incorporated companies, in turn, can be seen as evidence of the importance of strict corporate governance rules. 29. Firms subject to informal competition (grey market) and businesses receiving subsidies have lower productivity levels. Public subsidies seem associated with lower levels of productivity – in apparent contradiction, in principle, with the goals of state aid. All these factors tend to distort competition and have an adverse impact on productivity. In fact, the Olley and Pakes decomposition of Russia‟s productivity shows that the current contribution of the allocative component (how much of the output is commanded by the more productive firms) to aggregate productivity in the country (about 20 percent) corresponds to half the value for Brazil in the early 2000s. By creating a more level playing field, competition policy in Russia may contribute to increased productivity and thus export diversification. 30. Data supports the hypotheses of domestic competition spurring TFP and exports. In order to evaluate how competition is related to the endogenous variables of the system, four variables approximating four different measures of competition have been defined: domestic, foreign, customer and informal competition. Analysis suggests that the more competition a firm faces from domestic firms, the higher the TFP and probability of exporting. Meanwhile, facing informal competition exerts a statistically significant negative influence on TFP, employment and R&D investment. 31. In summary, analyses indicate a strong correlation between productivity, innovation and domestic competition with firms‟ propensity to export. The analysis shows that innovation related variables (investing in R&D, introducing a new product and holding a quality certification) contribute to roughly 46 percent of the total effect of investment climate variables on firms‟ export propensity. Results also indicate significant differences in productivity levels – firms facing domestic competition have an Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 17 estimated 19 percent higher productivity level compared to firms that do not face domestic competition. At the same time, firms are 8 percent more likely to export when facing domestic competition. There are also large productivity gains to be expected from a hypothetical increase in the level of domestic competition in Russia to the levels of the top performer of the ECA region. These results support our emphasis on domestic competition and innovation as two crucial axes to promote the emergence of internationally competitive exports. 32. Yet, as the analysis has illustrated, these are not the only variables relevant to export propensity. In addition to the discussed strong contribution of productivity, innovation and competition, several other key investment climate factors are contributing to higher propensity to export by Russian firms, including bureaucracy, finance, and infrastructure, among others. Several of these issues have already been studied extensively by the Bank and other international and Russian organizations, providing a menu of policy options. The following sections therefore focus on competition and innovation – topics that have received comparatively less attention but where there is a strong demand from the Russian Government for Bank support – and how these areas could contribute to increased export diversification. IC and Propensity to Invest in R&D 33. To better understand the factors affecting a firm‟s R&D decision, we studied the effects of the investment climate on the probability of R&D investments by Russian firms – with results indicating that firms with higher TFP levels are more likely to invest in R&D. 22 Higher productivity levels may enable investments in R&D by increasing the amount of internal funds available to the firm. Internal funding is often preferred as a source of innovation financing because of lower costs or simple unavailability of credit (rationing). 34. Results indicate the importance of information and communications technologies, tertiary education, and training as well as the experience of the manager – proxies for entrepreneurship and business knowledge. Being a limited liability company also increases the probability of a firm‟s investment in R&D. By reducing monitoring costs and downside risks for shareholders, limited liability companies enable managers to undertake riskier investments that hold out a promise of greater returns and potentially represent an overall more productive investment strategy for the firm. 35. Firms introducing a new product are more likely to invest in R&D. Our analysis indicates a positive effect of introducing a new product, pointing to synergies between R&D investment and new products. One way to interpret this result is that R&D and technological modernization are complementary inputs to the innovation process, as technologically outdated firms are less likely to spend on research and development. However, it seems that firms are more likely to invest in R&D when capacity use is lower. This latter result, although apparently puzzling, follows the less conventional view that business R&D may be countercyclical (that is, increases during downturns). Meanwhile, the result of outsourcing is interpreted as evidence of gains from specialization – productivity enhancements derived from division of labor, which, in turn, is limited by the size of the market. By affecting the size of the market through product market regulations, governments may affect firms’ specialization and thus productivity levels. 22 Firms were asked what amount they spent in fiscal year 2007 on R&D activities, either in-house or contracted with other companies (outsourced). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 18 Figure 10: Contributions of measured variables to the propensity of investing in R&D, % TFP Trade Comp. Innovation, quality & skills Infras. Regulatory Other control variables 30 27.62 environment 27.83 25 20 15 12.79 7.37 8.13 10 5.92 5.63 4.93 4.44 % Contributions 4.28 4.35 5 1.42 0.80 0.44 0 -5 -0.86 -2.76 -10 -10.32 -15 1 2 3 4.1 4.2 4.3 4.4 4.5 4.6 4.7 5 6.1 6.2 6.3 7.1 7.2 7.3 4.1 Dummy for new product 6.1 Manager's time spent in bur. issues 1 TFP (log) 4.2 Dummy for outsourcing 6.2 Dummy for gifts to get construction permits 4.3 Dummy for webpage 6.3 Dummy for external auditory 2 Dummy for exports 4.4 Staff - skilled workers 4.5 Staff - university education 7.1 Dummy for incorporated company 3 Dummy for informal competitors 4.6 Dummy for training 7.2 Dummy for limited company 4.7 Experience of the manager 7.3 Capacity utilization 5 Dummy for own generator IV. Competition and Competition Policy23 36. Effective competition and competition policies can play a key role in fostering economic diversification. The entry conditions faced by new (innovative) firms and the exit of obsolete ones, which in turn would raise the productivity of surviving firms, is the main process through which growth prospects of the firms in the non-extractive industries would be strengthened. In particular, regulations that promote competition may increase the incentive – and lower the cost – to invest and innovate by incorporating new technologies into the production process, thus stimulating productivity growth. Olley and Pakes decomposition of Russia‟s productivity also shows that the current contribution of the allocative component (how much of the output is commanded by the more efficient firms) to aggregate productivity in the country (about 20 percent) corresponds to half the value for Brazil in the early 2000s. A similar point has been raised by a McKinsey 2009 Report: “(…) This paradox (that the presence of struggling productive players despite relatively high competition is primarily explained by the fact that the government, through unequal regulations and/or enforcement, is distorting the playing field) is the main explanation for the lack of productivity and investment growth in eight out of the ten selected sectors (…).� 37. Asymmetric application of existing regulations or access to state aid favor larger, less productive incumbent companies to the detriment of smaller and more efficient firms and potential entrants. These market distortions are sector specific and take many different forms. For example, cheap energy is provided to nonviable steel and cement plants and wholesale markets are subject to eight times fewer tax liabilities than new forms of retail organizations (e.g. hypermarkets and discount stores). This asymmetry is particularly acute at regional level and a source of regional variability in the broad 23 This section is based on the technical note “Competition and Competition Policy in the Russian Federation,� prepared by Martha Martinez Licetti, Strategy & Analysis Unit, The World Bank and Mariana Iootty, Private and Financial Sector Development, ECA Region, The World Bank. Carolina Austria, Alina Tourkova, Yana Ukhaneva provided research assistance. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 19 competition regime. In procurement rules, for example, municipal and regional authorities have adopted different approaches in respect to the use of single source procurement bids and of practices that may facilitate collusion, even though a legal framework has been established at the Federal level (a factor that normally has an important effect on the construction sector).24 According to the same McKinsey study, “(…) in nine out of the ten selected sectors, the non-level playing field is the key explanation for the lack of restructuring of the old assets and/or investments by best practice companies (…).� 38. Contrary to the experience of earlier reformers in Eastern Europe, firm dynamics (entry and exit) in Russia have not significantly contributed to productivity growth. Most of the country‟s productivity gains in the last decade have come from utilization of excess capacity, while specialization and technological updates were the main factors of productivity gains by the earlier reformers of Eastern Europe. Entry rates were particularly low in Russia25 – even though entrants showed labor productivity rates 10 percent higher on average in the entry year than incumbents. In addition, exit rates, although difficult to estimate, are probably much lower than in most transition economies, if one considers that enterprise restructuring in Russia lags behind Poland, Turkey and the average of countries in the Europe and Central Asia region. Moreover, Russia has one of the most pervasive product market regulations among developed economies (Figure 11), with particularly poor results in Russia presenting particularly poor results in the sub-indicator Barriers to Trade and Investment and State Control (Figure 12). Figure 11: Overall PMR indicator, Russia and Figure 12: Sub-indicator - State Control, Russia comparator economies, 2008 and comparator economies, 2008 3.5 6 3.0 Russia (3.09) 5 Russia (4.64) 2.5 4 2.0 3 1.5 2 1.0 1 0.5 0 0.0 Note: Strictness of regulations on a 0-6 scale; higher values more restrictive policies towards competition. Source: OECD PMR 2009. 39. The sweeping scope of the public enterprise sector and extent to which the state directly controls strategic decisions of public enterprises is a strong factor in Russia‟s comparatively poor performance. Indeed, as the EBRD Transition Indicators show, enterprise restructuring in Russia is lagging behind those of Poland, Turkey and the average of countries in the Europe and Central Asia region. The lack of enterprise restructuring is especially challenging for the competitiveness and growth of Russia's so-called "monotowns" (the 460 company towns that depend mostly on single industries). 40. Russian incumbent firms seem more isolated from international competition than their counterparts in countries with similar development levels, and with variations in firm qualities in sectors with higher price-cost-margin. According to the World Bank Trade Restrictiveness Index, 24 The Certificate of Independent Bid Determination (CIBD) has been discussed as a mechanism to deter collusive behavior, but has not been implemented since it will require changes in the procurement law. It is expected that the launch of electronic bids will increase competition and outcomes in this area. 25 World Bank (2008) Unleashing Prosperity: Productivity Growth in Eastern Europe and Former Soviet Union. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 20 international trade policy – especially non-tariff barriers in the format of technical regulations and quantitative restrictions – seems more protectionistic in Russia than in several OECD countries. The level of overall trade restrictiveness in Russia is 16 percent, compared to 6-10 percent in the U.S., Japan and China. One implication of limited import competition is market dominance: price cost margins (PCM) for inputs of exportable goods tend to be larger than those of their international peers (figure 13), reducing the incentive for local exports.26 Moreover, Russian firms register larger PCMs compared to the average of the region in every manufacturing sector except for food, garments and chemicals. A more detailed PCM analysis in selected sectors reveals that firms Figure 13: Distribution of observed PCM in in sectors where Russia registers higher PCMs than manufacturing (Russia and selected ECA countries) regional counterparts, tend to be (i) older; (ii) have 1.5 more employees; (iii) are less likely to export and invest in R&D; (iv) are more likely to operate in 1 Density local markets; and (v) in some cases, are less likely to operate in a competitive market structure. The .5 analysis of market structure within Russia at the geographic and product market level also reveals a 0 0 .2 .4 .6 .8 1 high degree of concentration, with significant pcm2 0 1 variations across regions and sectors, as illustrated Russia=1, Selected ECA countries=0 in Figure 14. Figure 14: Concentration levels in selected Russian industries, by region – HHI Textiles Electronics Plastic and Rubber Karelia Irkutsk oblast Karelia Tomsk oblast Tatarstan Tatarstan Moderately Irkutsk oblast Highly Highly concentrated: concentr Tver oblast Rostov oblast Tatarstan concentrate 1500-2500 ated : Tomsk oblast d : 1500- Voronezh oblast Voronezh oblast Perm Krai Tver oblast Rostov oblast Moderately concentrated: Tomsk oblast Perm Krai Voronezh oblast Moderately concentrated: 1500-2500 Irkutsk oblast Tver oblast Rostov oblast 1500-2500 Unconcentrated: Perm Krai Saint-Petersburg Unconcentrated: Saint-Petersburg <1500 Saint-Petersburg <1500 Unconcentrated: <1500 Moscow Moscow Moscow 0 2000 4000 6000 8000 10000 0 2000 4000 6000 8000 10000 0 2000 4000 6000 8000 10000 Source: SPARK Database 41. A related problem is market fragmentation: the 2009 World Bank Enterprise Survey shows that 50 percent of Russian firms considered local markets their main sales destination – a large number, even when compared to large economies such as Brazil (about 35 percent). Despite the size of the Russian economy, such isolation from global markets may induce companies to choose less modern technology and operate at sub-optimal scales. In the particular case of Russia, two factors could potentially explain market fragmentation and less competitive markets: (1) transportation costs (related to limited transport infrastructure and long distances) and (2) barriers created by the interventions of regional governments that hinder the entry of outside-the-region firms. 42. Enforcement of regulations and anticompetitive actions of regional authorities differ extensively in several policy areas contributing to the level of market fragmentation. Analysis 26 According to the World Economic Forum, for instance, market dominance in Russia is much higher than in the EU and the average OECD country. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 21 suggests that the application of state aid regimes in Russia, enforcement of competition rules related to tendering and specific anticompetitive practices, as well as actions conducted by government distort the level playing field, with the use of aid by regional authorities varying widely across Russian regions. In addition, the level of tax arrears as share of total tax revenues fluctuates broadly across regions, with 68 of totally 83 regions presenting tax arrears of 30 percent or more. Recent research in fact suggests that regional authorities were the most active providers of state support in the period 2007-08.27 Meanwhile, market dynamics and the level of government involvement differ significantly across key economic sectors. The stage of development of competition and regulation of infrastructure, manufacturing and service sectors vary substantially among industries. 43. Even though privatization of state-run companies is on the government‟s agenda, the state still controls the largest producers in many key sectors, including electricity, banking, oil and railways. State ownership in Russia appears to be twice as large as in the EU-10 countries and state- owned enterprises command about 17 percent of employment. These companies usually occupy dominant market positions in their areas of activity, with scope for private sector participation – including by foreign investors – tightly controlled (the share of foreign participation in the average Russian company corresponded to 2.7 percent in 2007 as compared to 7.5 percent in the EU-10 countries). Tariffs have progressively replaced non-tariff barriers as the principal instrument for regulating foreign trade, but average tariff rates and tariff dispersion were still higher in Russia than in all OECD countries by the mid- 2000s, providing some degree of isolation from international competition. 44. Entry regulations are still pervasive, with access to land being of particular concern, especially in terms of its regional variability. 2011 Doing Business (DB) data indicates that it takes 42 days to register property in Russia, compared to a 38-day average for the ECA region. DB also ranks Russia as 182 out of 183 measured economies in “dealing with construction permits.� It takes 540 days to build a warehouse, compared to 250 days on average in ECA (the corresponding cost is 4,141 percent of Russia‟s income per capita). A sub-regional DB analysis from 2009 showed that Moscow imposes the largest difficulties in dealing with construction permits, whereas in the Rostov-on-Don region firms have least problems complying with construction formalities.28 Looking instead at bankruptcy procedures, it takes on average 3.8 years to close a business, with Russia ranking 103rd out of 183 measured countries. The Government has also established a number of state corporations that have the special legal status of a non-commercial organization and are not subject to the Bankruptcy Law. 45. The stages of development of competition as well as regulation of infrastructure and service sectors vary substantially among industries in Russia. ∙ Within the transport sector, a state-owned enterprise dominates the railway market and road freight intermodal competition is extremely limited. Regional laws govern the road transport sector (freight and passenger) within a region while interregional truck transportation is governed by federal laws. Trucks and new vehicles are subject to high import duties which discourage entry, and regional and municipal authorities often provide preferential treatment to municipally owned enterprises, particularly in passenger services. 27 Kuznetsov et al (2010). “Russian Manufacturing Revisited: Industrial Enterprises at the Start of the Crisis,� Center for Comparative Economics 28 The sub-national DB Report on Russia is available through www.doingbusiness.org. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 22 ∙ Government also holds substantial ownership of firms in the banking sector, with an active role in the market via the state owned commercial banks and the state investment vehicle Vneshekombank (VEB), while contestability of the financial sector is obstructed by differences in supervisory practices across institutions and an unclear and not entirely credible exit process. ∙ Competition constraints have also been identified in the Russian construction market, in particular related to the lack of level playing field between incumbents and new entrants. Construction markets have characteristics prone to collusive and cartel behavior, at the same time as licensing schemes for the operation in each segment of the supply chain remains cumbersome. ∙ In telecommunications, fixed operators are dominant but there are a significant number of players in the mobile sector, even at the regional level. Some regulations to improve or simulate competition (e.g. mobile termination charges) are not yet in place. ∙ Meanwhile, the government recently introduced various export restrictions and price controls in the agricultural sector (Box 2). Such measures create a disincentive in the industry, distorting market signals and lowering production; with higher prices and a lack in long-term investments and productive capacity development as a result. Not surprisingly, arable land in Russia is underutilized, while the agricultural productivity gap remains significant.29 Box 2: Price controls and other Government interventions in the agricultural sector in Russia Since its transition to an open economy in the early 1990s, Russia has emerged as a major agricultural exporter of grains (mainly wheat and barley).1 The Russian Government has notably increased investment in the agricultural sector in the past five years, with the State Program for Development of Agriculture 2008-2012 designated budget mainly aimed at financial stability in the agricultural sector through interest rate subsidies. Several other active measures have been taken by the Russian Government as a response to the high inflation rates in 2007-2008: - Price freezes: The Government reached a voluntary price restraint agreement with major food producers and retailers to control retail prices on “socially important� food products, including bread, eggs, milk and sunflower oil. The agreement lasted from October 2007 to April 2008. - Direct input subsidies: In order to mitigate higher energy prices, farms are provided subsidies for fuel costs arising from sowing. They also receive subsidies for mineral fertilizer, chemicals and high quality seeds purchases, as well as for transporting seeds. Pig meat and poultry farmers receive per ton subsidies. - Grain commodity interventions were implemented in the period October 2007 – June 2008, through large releases of grains (nearly 85 percent of total intervention stock), mainly in industrial centers and regions with high grain imports. This pattern was reversed as a result of a large grain harvest in 2008 and the Government initiated grain purchase interventions in late 2008. As prices started to rise in the summer of 2010, the Government again started to sell grain from the state intervention fund. - Trade-oriented measures: Temporary reductions of import duties on key foodstuffs took place in order to combat high inflation, including tariff cuts for dairy products, vegetables and vegetable oil as well as lifted duties on poultry and eggs imported for breeding. Export restricting measures were also imposed in late 2007 through duties on wheat, meslin and barley exports. As a way to prevent wheat and meslin outflows through the Customs Union (duty-free zone), exports of these grains were also temporarily banned to Belarus and Kazakhstan. These duties were lifted in mid-2008, in response to large grain crops. However, as a result of severe drought and wildfires in the summer of 2010, the Government has imposed bans on grain exports expected to last until end of 2011. Sources: Liefert (2009); OECD (2009); USDA (2010); Bloomberg 29 For more detailed information on the agricultural industry in the Russian Federation, see Annex II. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 23 V. Entrepreneurship, Innovation and Research Commercialization30 46. Our empirical analysis provides support to the importance of firm-level innovation in export propensity and productivity levels of Russian businesses. As discussed in Section III, investing in R&D and, even more so, engaging in product development increases the probability of Russian firms‟ entering foreign markets, thus potentially contributing to export diversification. The analysis showed that innovation variables in total contribute to 46 percent of the investment climate effect on firms‟ export propensity. In addition, several innovation and labor skills variables are positively (and significantly) associated with higher firm productivity. 47. Private R&D investments in Russia are average relative to the level of development, but a declining trend in recent years is worrisome. Russia‟s business R&D expenditures declined from a high of 0.88 percent of GDP in 2003 to 0.65 percent in 2008. Comparatively, OECD countries increased their average business expenditures on R&D in the same period, from 1.49 percent to 1.63 percent. In addition, other advanced emerging economies such as Mexico and China, with lower or similar GDP per capita than Russia, had higher business R&D expenditures as a share of GDP (1.8 and 1.1 percent of GDP respectively), compared to 0.65 percent in Russia, while other advanced Eastern European economies, such as the Czech Republic and Slovenia are also ahead (0.91 and 1.07 percent respectively). In summary, it seems that there is room for improvement in R&D spending for the Russian business sector. 48. The R&D activities of foreign firms in Russia have also decreased in the last decade. The changing landscape of global R&D can be observed in the growth of R&D sourced from abroad (through private business, public institutions or international organizations). These sources are quite important in the funding of business R&D. In most countries, the financing of business enterprise R&D from abroad primarily comes from other business enterprises, notably multinational enterprises (MNEs). The share business R&D financed from abroad in Russia decreased, from a relatively high level in 1998 (11 percent) to 7.2 percent of business R&D expenditure in 2008. In the EU-27 this share represented on average of around 9 percent of total business R&D in 2007. Among emerging economies, Slovakia and Hungary reported the largest increases during 1998-2008 (17 and 6 percentage points respectively), while the share in for instance Sweden grew by over 7 percentage points. 49. More broadly, entrepreneurship in Figure 15: Total entrepreneurship activity, 2006 Russia is lower than the country‟s development level would suggest. Data indicate that the total amount of entrepreneurial activity declines with development levels (measured by per capita income) up to a point, after which a positive relationship seems to take place (Figure 15). This may be interpreted as evidence that Russia entrepreneurship could present declining returns – as the catch-up process evolves – possibly Source: Global Entrepreneurship Monitor & World Bank reflecting declining opportunities for imitation, Note: 2006 is latest available data 30 This section is based on the technical note “Commercializing Public Research in Russia: Scaling up the Emergence of Spinoff Companies,� prepared by Paulo Correa and Juan Julio Gutierrez, Private and Financial Sector Development, ECA Region, The World Bank, with inputs from Jose Luis Guasch (LCSPF), Donato De Rosa, Dragana Pajovic and Alina Tourkova (ECSPF). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 24 learning by doing, etc. The subsequent ascending section of the graph may reflect, in turn, that innovation becomes a more active entrepreneurial factor, as richer countries tend to focus more on R&D-related activities. 50. Limited entrepreneurship is closely related to poor governance and weak institutional regimes, as it affects the allocation of talent in the society. Poor governance and institutional regimes are likely to favor the allocation of talent to rent-seeking rather than productive activities. In Russia, the number of firms considering corruption to be a top obstacle for business (11 percent) is about five times larger than in Brazil (2 percent), according to a World Bank 2009 Enterprise Survey (ES). About a quarter of management time in Russia is spent on regulation requirements, compared to 7 percent in India, which illustrates how a deficient governance regime leads to misallocation of talent. Foreign and domestic investors in Russia face potentially hazardous conditions, since the regulatory framework provides only limited protection from the risk of expropriation, as indicated by a weak scoring in the World Bank Doing Business Protecting Investors indicator (5.0 index points on a scale of 0-10). 51. Meanwhile, the commercialization of public research – potentially another source of innovativeness – has only recently become a focus of government innovation policy. According to the Ministry of Education and Science (MOES), more than 950 start ups have been created to date. The great majority of these new firms (97 percent) have stemmed from university research and only 3 percent from research institutes. This corresponds to an average of 5.1 firms per university and 1.2 firms per institute, even though the institutes concentrate a majority of both capital and human resources in R&D. In addition, the number of patents granted to Russian researchers – often seen as a first step to commercialization of research – remains stagnant. Patents granted as a share of patent applications to the U.S. Patent and Trademark Office decreased significantly in the past decade, from 71 percent in 1998 to 32 percent in 2008. Russia has in recent Figure 16: R&D/patents granted vs. GDP per capita, 2008 years been surpassed by Poland and 8.5 Log GERD/Patents granted in the U.S. China in the number of patents granted Romania Turkey Russia Portugal by the USPTO. The aggregate effect is a 8.0 Czech Rep. China relatively inefficient innovation system Poland Slovenia Slovakia Spain that requires much more investment in 7.5 Croatia Hungary R&D per patent than countries with Luxembourg Norway Austria Ireland Iceland similar levels of R&D: while Russia and 7.0 Italy Belgium France Denmark Sweden UK Finland Germany Israel Hungary spend similar shares of GDP Netherlands Canada Korea Switzerland U.S. on R&D (about 1 percent of GDP in 6.5 Japan 2008), Hungary is generating nearly -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 twice as many patents per unit of R&D Log GERD/GDP spent than Russia (Figure 16). Sources: OECD, UNESCO, USPTO, WDI Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 25 52. This persistently negative trend in scientific performance undermines Russia‟s research pool, limiting the options for commercialization. Scientific production in Russia has always been low compared to other countries, which is partly Figure 17: Science and engineering journal articles related to the performance of R&D in government per researcher in Russia research institutions rather than in universities. 0.035 Worryingly, academic productivity has further 0.034 decreased in recent years, despite the higher R&D 0.033 investments as a proportion of R&D (Figure 17). 0.032 At the same time, the number of researchers in 0.031 Russia decreased by 15 percent in the period 0.030 1996-2008, resulting in fewer researchers as a 0.029 share of employment, compared to the averages 0.028 for the EU-15, EU-27 and the OECD – an area in which Russia had outperformed its industrialized Source: Staff elaboration based on WDI 2011 neighbors only a decade ago. 53. One of the reasons for declining research productivity in Russia is the way public funding is distributed. Currently the government allocates a budget to public research organizations and higher education institutions in amounts deemed sufficient to cover anticipated costs, regardless of the performance of the institute or the researcher. A small proportion of research institutions‟ budget is allocated competitively (about 15 percent in 2009, as compared to roughly 30 percent in Israel), a mechanism that as a norm results in a better link between research funding and scientific output. Most of the budget for research institutions, including universities, is allocated based on personnel headcount, again without any link with the performance of the research organization. In addition to low scientific outputs, this budget allocation on a per-headcount basis creates a system that inflates costs, as research organizations have the incentive to keep the number of researchers high. 54. Another obstacle for a more efficient R&D system is the declining number of middle-career researchers. Middle-career researchers (between 30 and 49 years old) tend to publish more and are also more likely to commercialize research results. In Table 1: Age of researchers by educational attainment Russia, this group has been decreasing Year Age Category 2002 2004 2006 dramatically in the past years, to 32 percent of Researchers 70 and older 3.8 4.6 5.9 total researchers in 2006 (Table 1). This is at 50-69 y.o. 44.9 45.2 45 least in part caused by the limited renovation of 30-49 yo. 37.7 34.9 32.1 under 29 y.o. 13.5 15.4 17 the research pool, as indicated by the large share 70 and older 20.3 22.2 24.7 of science and engineering graduates studying oversees and not returning (by 2007, less than PhDs 50-69 y.o. 64.2 63.7 62.3 30-49 yo. 15.5 13.9 13.1 under 29 y.o. 0.2 0.1 0.1 one quarter of science and engineering graduates 70 and older 5.9 7.4 9.7 receiving PhDs in the U.S. in 2002 had returned Candidates of science 50-69 y.o. 54.9 54 52.8 to Russia). Limited opportunities for career 30-49 yo. 35.6 34.4 33.1 development in Russia, compounded with wages under 29 y.o. 3.5 4.1 4.5 Source: Indicators of Science (2009) - Ministry of Education and Science, that are not internationally competitive are the ROSTTAT and the Higher School of Economics basis for this negative development. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 26 55. Although the legal framework for intellectual property has improved, there is still uncertainty, discouraging both patenting and licensing. Two major pieces of legislation govern intellectual property (IP) in Russia: (i) Part IV of the Civil Code (2008) provides a foundation to treat the IP generated with public funding (63 percent of total R&D expenditure); whereas (ii) Federal Law 217 (2009) deals exclusively with the use of IP generated from public funds for the purpose of start-up companies by universities and Russian Academy of Sciences research institutes. However the start-ups do not own the patent that supports the company, with IP rights not being granted to companies on an exclusivity basis. In addition, while discoveries in the defense sector could potentially be a major source of civilian innovation, their use remains limited since on the one hand, most of the discoveries of defense R&D remain inaccessible to the private sector and, on the other hand, much of the technology developed falls in to the category of know-how as opposed to patents, making commercialization difficult. Finally, the absence of a patent court implies that a lack of jurisprudence makes it difficult to arbitrage disputes, while the issue of assigning IP to discoveries made before the Civil Code (2008) remains unresolved. 56. Several initiatives to overcome the financial gap have been put in place in recent years, yet there seems to be a lack of funding instruments for specific firm segments. Most interviewed innovators during the identification mission mentioned the lack of funding for the innovation cycle between the third round of investment from the Foundation for Assistance to Small Innovative Enterprises (FASIE) and venture capital funding – often referred to as a “valley of death.� This gap is not even being addressed by the recently created seed capital fund of the Russian Venture Company. RVC was established by the Russian government with the objectives to stimulate creation of a venture investment industry, increase the funds of such venture foundations, and move Russian science-intensive technological products and services to the world markets. However, most Russian venture capital continues to be attracted to mature companies operating in mature markets rather than the early stage financing of Russian firms. Essentially, there seems to be a lack of investment projects that fit venture capital investment criteria. 57. A large number of technology transfer offices (TTOs) in Russia have been created by the Ministry of Education and Science. International experience lends some support to the notion that TTOs, as organizations specialized in the management of intellectual property, can play a central role in accelerating the commercialization of public research. A World Bank/MOES survey of 112 TTOs conducted in January and May 2011 indicates that Russian TTOs share most of the characteristics of similar institutions in the U.S. and Europe, including in terms of number of employees and formal background, the use of pay-scale and incentives/bonuses/success fees and the engagement in a broader scope of innovation related activities that goes beyond simple technology transfer, as shown in Figure 18. Yet, the existence per se of TTOs will not lead to a massive process of research commercialization if the appropriate incentive regime for disclosure of discoveries is not in place. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 27 Figure 18: Characteristics of Russian Technology Transfer Offices a. Sources of TTO income 2010 b. TTO personnel payment c. Additional services provided by system 2010 TTO or parent institution 8% 20.4 21% 39.5 20% 13% 51% 18.4 54% 18% 15% 0.4 9.9 7.3 0.5 3.6 from parent institution univ. pay scale and bonus incubator and prototyping services licenses royalties in 2010 equity in new companies only univ. pay scale only incubator ss broker for research rent of space only bonus only prototyping ss rent of equipment consulting fees none additional ss other payment system other Source: TTO Survey – Joint MoES-WB Study 2011 VI. Policy Implications 58. We argue that improving the investment climate factors that contribute most to explaining firms‟ export propensity – relaxing some of the “binding constraints� – would enable more firms to break into new foreign markets and contribute to export diversification. In Russia this essentially implies (i) raising productivity levels, (ii) promoting innovation and R&D and (iii) strengthening competition. Enhancing managerial and technical skills and accelerating technology adoption would further contribute to increased productivity as would improvements in the access to better trade logistics. In a nutshell, by reforming the investment climate, Russia‟s policymakers could contribute to a more bottom-up approach to export diversification. 59. Competition and innovation are sources of economic renewal which in turn are at the core of the long-term development process. Reforms to “relax� critical binding constraints would also contribute to raised productivity and a greater propensity to export among Russian firms. Over the long- term, the interplay of competition, innovation and higher productivity would expand the number of exported products and thus raise the “density� of Russia‟s product space. These “bottom up� initiatives could then complement the currently mostly top-down approaches to export diversification. A stable macroeconomic framework and a governance regime that rewards productive investments over rent- seeking are also among the underlying factors of critical importance. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 28 60. Yet traditional export diversification strategies often involve government interventions that increase economic returns on investments in specific industries (industrial policy). Industrial policies aim to shift economic resources towards industries producing sophisticated, high-tech products. The rationale is to provide temporary conditions for firms to learn-by-doing and eventually reach international levels of competitiveness. The goal is to achieve faster growth by rapid productivity increase and/or expansion of global demand for those products. In addition, measures have often been used to help productive firms to overcome market and policy Figure 19: Export diversification - A schematic approach failures specific to the export cycle – often related to uncertainties in undertaking new activities in foreign markets (especially with regard to costs) and sunk-entry costs – and exploit export opportunities (export promotion policy) (Newfarmer et al. 2009). Export promotion policies encompass a variety of soft measures – for instance commercial diplomacy, intelligence about foreign markets, etc. In a simplified way, one could map industrial policy and export promotion through two stages of the “production-exporting cycle:� creating new products and breaking into new markets; but not enabling the emergence of productive firms or the survival of new exporters. Source: Staff elaboration 61. The contribution of industrial policies to the successful examples of export diversification is difficult to assess. The popular view that industrial policies have driven export diversification in East Asian countries becomes controversial when other factors affecting export diversification are taken into account. South Korea and Taiwan, for instance, had large rates of physical and human capital accumulation that shifted their comparative advantage towards capital-intensive goods during the period 1960-80, making it hard to isolate the effect of industrial policies at that time. In the late 1980s, for example, Korean business expenditures in R&D reached 80 percent of total R&D expenditure. In that period, students with internationally acquired, government-funded PhDs were required to return to Korea and encouraged to work in emerging enterprises. In addition, the adoption of measures to neutralize the anti-export bias of industrial policies enabled firms to break into foreign markets, achieve efficient sizes and adopt modern technologies – mitigating any anti-export bias inherent in other measures. 62. Targeting high-tech sectors has typically had a limited benefit for export diversification. Learning-by-doing in these sectors is much more challenging, given the rapid technological change compared to that of mature industries with more stable technologies. Developing countries often succeed in mastering the technology of “mature� products in the high-tech sector, breaking into markets for technological commodities – e.g., standard computer chips. But keeping up with the frontier is less often achieved. The magnitude of the spill-over effects of high-tech production is often overestimated. As the U.S. experience of the last two decades suggests, productivity gains are driven mostly by the use of information and communication technologies (ICT) in the service sector – not by the expansion of output of ICT industries. ICT and other R&D-intensive sectors generated spillovers and contributed to the U.S. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 29 technological leadership in that period, but it is the diffusion of ICT use in the service sectors – e.g., retail – that explains most of the productivity gains of the 1990s. 63. Often cited instances of new products breaking into foreign markets have limited value as viable models. Internationally competitive high-tech sectors will inevitably command a small share of output and employment in developing countries, given the limited and expensive supply of inputs. Therefore, the likelihood of generating relevant spillover benefits or significantly improving the country‟s labor productivity is bound to be small. For example, the share of the output of, and employment from, mid-range Embraer jet manufacturers in total output and employment in Brazil is less than 1 percent; as the country develops, the share of services in both output and employment inevitably grows. Other experiences in export diversification, perhaps more relevant to the purpose of this note – such as the cultivation of asparagus in Peru, clothing manufacture in Mauritius and cut-flower cultivation in Kenya – failed to generate a continuous, dynamic process of export diversification. Generating a process of permanent product upgrading, productivity growth and innovation is important. However, the emergence of exportable goods and firm survival in foreign markets are two elements in the “production-exporting� cycle that are often overlooked by traditional export diversification strategies. 64. A broader view of export diversification gives weight to the emergence of productive firms as well as entry and survival in foreign markets. The emergence of productive firms is closely related to the strength of the process of firm entry and exit. Healthy firm dynamics shift output towards more efficient plants, raising average productivity and increasing the likelihood of productive firms introducing incremental innovations (better products and lower costs).31 Strong business R&D and the massive commercialization of public research are an important source of new ideas to be introduced in the market by entrepreneurial researchers or businessmen – when the existing governance regime does not shift talent away from productive activities.32 By lowering costs, improving quality and creating new goods, firms are more likely to break into new markets and sustain their exports for longer. But exports are unlikely to survive and grow if the supply of internationally competitive inputs (the backbone services for exports) is not sufficiently elastic to accommodate eventual demand pressures and unforeseen changes in the business environment – unpredictable delays in customs, unanticipated power outages and rent-seeking from government officials. 65. Open markets and business-oriented technology policies are often ingredients common to the most successful cases of diversification. Chile managed to diversify away from its copper-intensive industry to wine, salmon and fruits by combining unilateral trade liberalization and business-oriented technology policies. Brazil provides another example. The country transformed from being highly dependent on coffee exports to becoming a diversified exporter – including the world‟s largest food exporter – in the space of roughly one generation. Brazil‟s success in the soybean market, for instance was due to determined trade orientation, entrepreneurship, business-friendly technology policies, and, in this case, a workable land market (Box 3). In addition, a large privatization program helped to transform moribund state-owned companies, Compania Vale do Rio Doce (iron ore and other metals) and Compania Siderurgica Nacional (steel), into global players whose products add to the diversification of Brazilian 31 See for instance Nickell (1996); Blundell et al. (1999); Aghion et al. (2005); and Aghion et al. (2008). 32 The importance of the scientific community to entrepreneurship has been increasingly documented by a growing body of economic research. See for instance, Rosenberg (2009) in Acs et al. (2009). The entrepreneurial pool of a society may engage in productive, unproductive and destructive activities, depending on the relative pay-offs embedded in the society‟s governance regime. Poor governance and weak institutional regimes shift talent away from productive activities – innovation, productivity and start-up of new firms – towards rent-seeking, property rights expropriation and crime. See Baumol (1990). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 30 exports. Worth noting in both cases is how consistency in policy regarding latent comparative advantages enabled Brazilian and Chilean exporters not only to break into foreign markets but also – thanks to the availability of inputs at competitive prices – to sustain and eventually expand their export volumes.33 Box 3: The case of soybean exports in Brazil Trade orientation, entrepreneurship and technology policy were the key factors in Brazil‟s transformation from a net importer into the world‟s second-largest export of soybeans in the space of about 30 years. In the early 1970s, the Brazilian government encouraged the cultivation of soybeans in the Southern region of the country, where a temperate climate and fertile soil seemed to provide adequate conditions. By the mid-1980s, however, fertile land in that area had become scarce and rental prices had risen. Agricultural entrepreneurs began looking for alternatives in the then-cheap and virtually unexplored “Cerrado� – the Brazilian prairies – an area about the size of France but with completely different soil and climatic conditions. At that time, Embrapa, a government agricultural research institute, was instrumental in rebalancing soil acidity and cultivating crops suited to the country‟s tropical climate, thereby expanding the area effectively available for cultivation for soybeans. Embrapa now grows more than 200 varieties of soybeans to suit the country‟s diverse soil and climatic conditions. High agricultural productivity rates and the effective utilization of land enabled entrepreneurs to explore new export opportunities. Access to better and cheaper agricultural inputs, stemming from broad trade liberalization, were also pivotal in raising agricultural productivity, and soybean exports in particular, after the 1990s. 66. No magic bullet, but some lessons and a menu of approaches. Experience of the last fifty years demonstrates that there is no magic recipe to promote export diversification; tailoring strategy to the country‟s characteristics is therefore essential. Export diversification strategies seem more likely to generate broad, sustainable results when they: ∙ Take account of all stages of the production-export cycle – in particular, conditions for the emergence of productive and innovative firms and firm survival in foreign markets; ∙ Are consistent with the country‟s comparative advantages (i.e., relatively abundant supply of inputs) and allow successful new entrants to foreign markets sustain and grow their exports; ∙ Adopt industrial policy strategies aimed at increasing the share of international trade in GDP, strengthening firm dynamism and fostering innovation;34 and ∙ Do not distort incentives to talent-attraction through unproductive activities such as rent-seeking. 67. As a result, there is no universal cookbook for diversification, just some policy lessons and examples of international experience. This implies that a successful policy framework for diversification will inevitably be broad, employing a menu of approaches. This does not mean that everything will need to be done at once or at the same speed but that a single approach is unlikely to be successful and policy attention in each area (and awareness of interlinkages) will be needed for long term success. In the following sections, we propose a menu of policy options in the specific topics of trade, competition and innovation, with the specific recommendations summarized in the matrix at the end of the section. To capture the importance of sequencing, the various actions are also grouped into short and medium term priorities. 33 See, for instance, Chandra, V. (2006). 34 See, for instance, Harrison, A. and Rodríguez-Clare A. (2009). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 31 Trade policy in the Russian Federation 68. Efforts to liberalize trade have been one of the highlights of Russia‟s economic reform for the past two decades. Russian authorities have to a large extent adopted the view that growth would be spurred on with greater integration with the world marketplace and, as a result, tariffs have been lowered, quotas reduced, and import subsidies diminished. At the same time, the country began the process of negotiating accession to the World Trade Organization (WTO) in the early 1990s, with bilateral market access negotiation completed with interested WTO members, including the U.S., and with accession expected to be near. 69. Yet, some hurdles remain for Russia‟s full integration with the rules-based trading system. The latest economic crisis had an impact on the pace of trade liberalization and the finalization of Russia‟s WTO accession process. Although Russia did reduce tariffs in 2007 and 2008, the prevailing trend in 2009 was to increase tariff rates in medium tech products in response to the global economic crisis. The Russian government increased tariffs on processed foods, light manufacturing, the automotive sectors, and some construction equipment, and has indicated that it will continue to review its tariff policy in light of overall economic conditions. Tariff data does show that Russia uses a relatively limited number of tariff policy measures to restrain import competition. Nonetheless, compared to other BRICs, the Overall Trade Restrictiveness Index in Russia is higher than India and China and only slightly lower than in Brazil. 70. Meanwhile, there is no single entity in charge of export promotion in Russia. At the federal level, the function of export support and promotion is divided between the Ministry of Industry and Trade and the Ministry of Economic Development (MoED), with the Ministry of Agriculture dealing with export promotion of agricultural products. At the regional level every ministry/department that deals with economic development and enterprise support has a section that deals with export promotion. Internationally, the private sector also supports related activities, as illustrated by the case of the Moscow Investment and Export Promotion Agency. Recent evidence suggests that on average, export promotion agencies (EPAs) have a significant positive effect on exports, however with decreasing returns to scale in resources devoted to export promotion (Lederman, 2010). EPAs with larger shares of private sector representation but with more public funding are associated with larger national export. Yet, although the matter of funding is a crucial issue for firms when deciding whether to export, many other factors, as international practices have shown, play important parts in creating successful EPAs, such as strong leadership, skilled agency staff and strong international market presence. 71. In order to encourage the participation of SMEs in exports, the Government has adopted a resolution with additional measures to support SMEs engaged in exports of industrial products. The program initiated in October 2010 and totaling USD 2 billion will provide funds to subsidize the costs associated with the payment of interest on loans, subsidize the cost of SME-related payments of certification, firm registration or other forms of conformity assessment, exhibitions and fairs abroad, etc. The program will support the creation and/or maintenance of regional coordinating centers to support export-oriented small and medium enterprises. A key principle for the organization and operation of these centers is that they should carry out their activities in close cooperation with MoED, Russian trade missions to foreign countries and other relevant authorities of the Russian Federation. There will also be a need for qualified personnel capable of implementing the basic functions of export and investment Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 32 promotion in order to support exports and attract investment in the region. The idea is for these centers to act as a "single window" for export-oriented small and medium enterprises and to attract investments. 72. Our analysis has shown that licensing policies and country-specific tariff rate quotas are limiting the ability of Russian firms to benefit from competition, in turn creating obstacles to the innovation process. For instance, import licenses are necessary for the importation of certain products, including alcoholic beverages, pharmaceuticals, hazardous wastes and some food products. These licensing policies along with tariff rate quotas are the most binding non-tariff measures limiting the ability of Russian firms to benefit from competition, creating obstacles to the innovation process. Adopting a low and uniform tariff structure could bring benefits for an economy that seeks to enhance export diversification through innovation. Recent literature has in fact shown that lower tariffs levels are associated with quality upgrading for products close to the world quality frontier,35 while discouraging quality upgrading for products distant from the frontier. Tarr (2000) has provided a compelling case for Russia to favor tariff uniformity over differentiated tariff protection, based on political economy considerations, administrative convenience, and reduction of smuggling and corruption in customs. 73. Findings further support the notion that the fixed costs to export are comparatively higher in Russia than in some peer countries. We explore this issue by examining the role of the current tax code on the probability of being tax audited – as one source of fixed costs for exporters. Preliminary analysis suggests that the probability of being audited is around 20 percent higher for exporters than for non-exporters in Russia. This finding is in line with the explanation that the VAT refund may encourage tax inspections, but this issue deserves to be explored further. Nonetheless, reducing such fixed export costs could provide opportunities to encourage firm exports and to facilitate enterprises in establishing new export relationships. Based on these findings, we summarize the policy options in the area of trade policy and diversifications as follows: Short-term policy options ∙ Develop further the initiated program for regional coordinating centers that support and promote export-oriented SMEs, serving as “one-stop-shops,� while ensuring private sector involvement and access to qualified, skilled personnel. ∙ Commit to a long-term process involving monitoring and evaluation, government learning, and policy adjustment. ∙ Work towards meeting remaining requirements for completion of WTO accession negotiations. Medium-term policy options ∙ Create a low and uniform tariff structure, thus encouraging innovation close to the world quality frontier. ∙ Encourage firms to enter new markets by lowering fixed (“sunk�) costs to exports, e.g. facing tax audits when exporting vs. operating in the local market. 35 See for instance Amiti and Khandelwal (2009). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 33 Competition Policy in the Russian Federation 74. A comprehensive competition policy would establish a level-playing field, facilitate entry and encourage orderly exit of less efficient firms, contributing to increased productivity and export propensity. The creation of a European single market is an example where the establishment of an active competition policy went beyond business behavior and covered control of state aid. This policy helped ensure fair competition for all and contributed to the convergence of Europe to U.S. productivity levels, and higher competitiveness, both for the region as a whole, as well as for the individual member economies. Another example of an economy that successfully transformed its national competition policy is Australia and its National Competition Policy (NCP). The country opened up its market to international competition, eliminated barriers to trade among its states, and managed to become a world leader in pro- competitive product market regulation in more recent years. The new competition policy was implemented through an incentive scheme in which the national government financially rewarded (punished) achievements of negotiated milestones (Box 4). 75. Development of a comprehensive competition policy in Russia would need to address issues remaining from the transition agenda and new challenges related to introducing pro-competitive regulations in product markets. Main issues are: (a) state ownership, price control, and trade policy; (b) regulation of entry and exit; (c) asymmetric application of existing rules and access to state aid; and (d) the regulation of service sectors (including infrastructure). Several of these factors may have significant regional variance and may contribute to mitigating (or accentuating) geographic factors such as lack of infrastructure, thereby generating unequal opportunities for growth among existing regions. 76. A series of policy interventions fostering competition in Russia could level the playing field and facilitate entry of new businesses. Such policies could help increase productivity and consolidate Russia‟s domestic market, enabling domestic firms to benefit from additional gains from trade: Short-term policy options ∙ Advance government reforms of public enterprises, ensuring alignment with market forces. ∙ Broaden the mandate on state aid regulation in order to diminish sector- and firm- specific state aid. ∙ Align state aid regulation and enforcement with international best practice (focus on horizontal objectives, include balancing test and effects on competition). ∙ Introduce Certificates of Independent Bidding Determination and prohibitions to contract and participate in public procurement if a firm has participated in a cartel. ∙ Create an inventory of state aid by beneficiary and evaluate distortions of competition of state aid (including tax arrears). ∙ In transport: eliminate price controls and government involvement. ∙ In construction: provide a unified database of land plots with complete information about ownership and usage status in the construction industry. ∙ In professional services: provide specific prohibitions towards self-regulations that facilitate price- fixing and limit entry. Medium-term policy options ∙ Eliminate preferential treatments to state or municipality-owned corporations. ∙ In transport: reduce direct participation of the state in the provision of goods. ∙ In construction: streamline the processes for registration, construction permits, and licensing schemes. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 34 Box 4: Competition policy in action: The Australian experience: What… and how? The extensive competition policy reforms in Australia gained broad consensus at highest political levels, through preparation of the parliamentary Hilmer Report in the early 1990s, as well as through the key role held by the parliament in monitoring the implementation of the main policy recommendations. After continuing pressure from business sectors exposed to international competition, such as agriculture and large enterprises, to reform nationwide infrastructure (energy, ports), and after recognizing the importance of national competition to productivity growth and increased living standards, policy makers in Australia reached consensus and agreed in 1992 to the development of a national competition policy, and a ten-year reform agenda. The establishment of a formal Council of Australian Governments and continuous meetings with representatives of federal, state and local governments in special Premiers‟ Conferences led to the creation of a formal institutional setting for cooperation on the reform agenda. Subsequently, an Inquiry Committee, chaired by Prof. Frederick Hilmer was set up to undertake an independent inquiry into a National Competition Policy (NCP), resulting in a report presented to the Council in August 1993 with the outcome that the broad scope of the Hilmer proposals were endorsed. Australia‟s competition-oriented reforms happened in three waves, first though increased exposure to international markets in the early 1990s; followed by the development and implementation of the NCP in the mid 1990s and with regular updates in the late 1990s and onwards. Comprehensive reforms coordinated across all levels of government aimed to (i) reform all legislation that restrict competition; (ii) implement a culture of “continuous improvement� in regulatory quality; (iii) implement competitive neutrality for all public businesses; and (iv) provide third-party access to significant infrastructure facilities. The NCP was implemented through an incentive scheme in which the national government financially rewarded (or punished) achievements of negotiated milestones. A system of “competition payments,� defined as the state‟s share of additional revenue arising from the NCP, was introduced – with payments made from federal to state governments that implemented specific reforms, while pecuniary penalties were imposed on slow reformers, in the form of reduced or delayed budget transfers from the central government. Although a majority of reform goals in competition policy were met on time in the ten-year period, some cases of pecuniary penalties for slow reformers exist. For instance, Western Australia‟s uncompleted plans for water systems led to a 5% suspension penalty of its 2005–2006 competition payments. When reform goals were finally met in 2007, suspended payments were then disbursed. Similarly Queensland‟s failure to address anticompetitive restrictions in liquor licensing resulted in a 5% permanent deduction penalty of the state‟s 2003-2004 competition payments, (see Table). The Australian experience is considered to be one of the most successful examples in recent years. The NCP helped make Australia one of the top performing OECD economies, and has enhanced economic flexibility and adaptability to change, showing the quickest recovery from the global crisis among OECD countries. The reforms have reduced barriers to entry and exit and improved competition, estimated to have increased GDP by 2.5% (not including dynamic effects). National Competition Payments 2002-03 to 2005-06, A$ million Sources: Corden (2009); Kain (1995); Hilmer (1993) Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 35 Innovation and Commercialization Policies in the Russian Federation 77. The main challenge for the commercialization of public research is how to balance the interests of researchers and research organizations vis-à-vis this objective. The process of commercialization often requires an additional engagement from the researcher that is not consistent with his career objectives. Universities also do not have a natural incentive for managing intellectual property that may emerge from publicly funded research – costs are high and to a large extent “sunk� and transaction costs are abundant. Returns, on the other hand, are often uncertain. In the U.S., for instance, the insignificant commercialization of research by universities motivated the adoption of the Bayh-Dole Act in 1980. The Act transfers to the universities the IP rights resulting from publicly funded research, establishes a minimum amount of royalties to be shared with the researcher and simplifies substantially the process of IP management (which was before subject to more than 20 different pieces of legislation). These changes enabled more universities to afford the investments required for effective monitoring, protecting and marketing of IP, and encouraged academic researchers to engage in the related activities. Similar versions of this act have so far been adopted in approximately 20 OECD countries. 78. A number of policy measures have been launched in recent years to foster innovation in Russia – with particular emphasis on emulating the experience of Silicon Valley, as illustrated for example by the development of Rusnano (a state-owned a fund of funds for venture capital financing) and Skolkovo (planned as a “science city�). In addition, Russia has recently succeeded in creating more than 950 companies based on publicly funded research discoveries, which show how Russian innovation policy, if scaled up, could raise the productivity of small- and medium-size companies and contribute to a more diversified economy. This success is a consequence of the Russian Government‟s efforts in providing sound innovation policies, improving the legal frameworks and creating supporting services for innovation. Yet a larger scale process of spin-offs would not necessarily emerge from the current conditions, since current innovation policies still need fine tuning and improvements. Challenges include (i) increasing the volume of high-quality research; (ii) improved management of intellectual property emerging from public research; (iii) increasing the availability of public funding in all operational stages; (iv) improving governance and reducing the fragmentation of public R&D programs; and (v) targeting availability of support organizations (technology transfer offices, incubation services and science-parks) beyond supply of physical infrastructure. 79. Despite the Government‟s strengthened focus on increasing competitiveness of Russian enterprises through modernization and improved innovation capacity, the country still lags in the commercialization of its research base. We suggest a number of policy measures in the areas of Russia‟s Innovation System; the country‟s human capital; and the intellectual property legal framework that could help further foster this process: Short-term policy options ∙ Strengthen the results-based management of public research organizations, with allocation of public funding based on scientific output and acknowledgment of commercialization efforts. ∙ Develop performance-based career development for researchers, with support for young scientists set as a priority. ∙ Facilitate research collaboration with Russian researchers based abroad. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 36 ∙ Transfer full ownership (not only use) of the intellectual property to public research organizations through amendments to Civil Code Section IV and Federal Law 217. ∙ Provide funds for early stage development of technologies to address the financial gap between the FASIE program and the venture capital funding that includes early stage matching grants. ∙ Enhance the supply of financing for innovative startups through early stage matching grants; differentiated tax breaks for SMEs; and integration of business development services in one agency. Medium-term policy options ∙ Expand commercialization efforts to include areas with potential for new ideas: e.g. the Russian Academy of Sciences; the defense sector; agricultural research. ∙ Continue to reform the investment climate, focusing on skills and technology adoption, favoring business investments in R&D ∙ Continue to improve the governance of the overall economy to decrease incentives for rent-seeking and incentivize the allocation of talent, entrepreneurship and innovation. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 37 Policy Options Matrix Strategic Goal: To broaden Russia‟s export base through enhanced competition and innovation policies. Objective Short-term policy options Medium-term policy options ∙ Develop further the initiated program for regional ∙ Create a low and uniform tariff structure, thus coordinating centers to support and promote export- encouraging innovation close to the world quality oriented SMEs, serving as “one-stop-shops,� while frontier. Facilitate ensuring private sector involvement and access to and qualified, skilled personnel. ∙ Encourage firms to enter new markets by promote ∙ Commit to a long-term process involving monitoring and lowering fixed (“sunk�) costs to exports, e.g. trade facing tax audits when exporting vs. operating in evaluation, government learning, and policy adjustment. ∙ Work towards meeting remaining requirements for the local market. completion of WTO accession negotiations ∙ Advance government reforms of public enterprises, ∙ Eliminate preferential treatments for state or ensuring alignment with market forces. municipality-owned corporations. ∙ Broaden the mandate on state aid regulation in order to ∙ In the transport sector reduce direct participation diminish state aid to particular firms and sectors. of the state in the provision of goods ∙ Align state aid regulation and enforcement towards ∙ In the construction industry streamline the international best practice (focus on horizontal objectives, processes for registration, construction permits, include balancing test and effects on competition). and licensing schemes for each segment of the ∙ Introduce Certificates of Independent Bidding supply chain. Determination and prohibitions to contract and participate Enhance in public procurement if a firm has participated in a cartel. competition ∙ Create an inventory of state aid by beneficiary and evaluate distortions of competition of state aid (including tax arrears). In the transport sector eliminate price controls and government involvement ∙ In the construction industry provide a unified database of land plots with complete information about ownership and usage status in the construction industry ∙ In professional services provide specific prohibitions towards self-regulations that facilitate price-fixing and limit entry. ∙ Strengthen the results-based management of public ∙ Expand commercialization efforts to include areas research organizations, with allocation of public funding with potential for new ideas: e.g. the Russian based on scientific output and acknowledgment of Academy of Sciences; the defense sector; commercialization efforts. agricultural research. ∙ Develop performance-based career development for ∙ Continue to reform the investment climate, researchers, with support for young scientists set as a focusing on skills and technology adoption, priority. favoring business investments in R&D ∙ Facilitate research collaboration with Russian researchers ∙ Continue to improve the governance of the overall based abroad. economy to decrease incentives for rent-seeking Accelerate ∙ Transfer full ownership (not only use) to public research and incentivize the allocation of talent, innovation organizations through amendments of Civil Code Section entrepreneurship and innovation. IV and the Federal Law 217. ∙ Provide funds for early stage development of technologies to address the financial gap between the FASIE program and the venture capital funding that includes early stage matching grants. ∙ Enhance the supply of financing for innovative startups through early stage matching grants; differentiated tax breaks for SMEs; and integration of business development services in a single agency. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 38 References Aghion, P., Bloom, N., Blundell, R., Griffith, R., and Howitt, P. (2005) “Competition and Innovation: An Inverted- U Relationship,� Quarterly Journal of Economics, 120(2), 701-728 Aghion, P., Braun, M., and Johannes Fedderke, J. (2008) “Competition and Productivity Growth in South Africa,� Economics of Transition, 16(4), 741-768 Amiti, M. and Khandelwal, A. K. (2009) “Import Competition and Quality Upgrading,� NBER Working Paper Series, Vol. w15503 Baumol, W. 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Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 40 Annex I: The World Bank Enterprise Survey – Data and Methodology For the identification of the statistically significant investment climate (IC) effects on economic performance, the analysis uses a simultaneous equations system that relates the interactions between the IC with productivity, demand for labor, exports, FDI inflows and innovation (product development). Estimation always controls for firms‟ size, region and sector and yields elasticities and semi-elasticities of investment climate variables with respect to productivity, employment, wages, export propensity and FDI propensity. The IC elasticities and semi-elasticities provide a measure of the sensitiveness of outcome variables when the IC changes marginally. The sensitivity checks of the estimation results help present results robust to different estimations procedures, TFP measures, corrections for endogeneity, and so on. The data used for firm level analysis are derived from the World Bank Business Environment and Enterprise Performance Survey (Enterprise Survey, ES), carried out in Russia and other ECA countries during 2008/2009, with financial and balance sheet data referring to fiscal year 2007. The final dataset used is based on a stratified random sample of manufacturing firms, with stratification variables being size, industry and region. In order to ensure a large enough number of large establishments in the sample, a sampling approach which oversampled large firms was applied. The result in Russia is a sample with 777 manufacturing establishments. As a consequence of the particular sampling structure, using proper weighting to correct for oversampling of large firms when doing descriptive analysis is a requisite. However, for regression analysis we use un-weighted estimations given that we control for that by adding firm size, region and industry dummies in the estimation and the stratification is not based on the dependent variable of the regression. To the extent that we want to perform a number of international comparisons of investment climate conditions, we also use ES data for 27 other ECA countries. A system of equations is used to model the interrelations among the dependent and independent variables. This allows us to evaluate the relative importance of each variable on the sample means of the dependent variable: TFP, exports, FDI, employment and innovation (proxied by product development) (see equations and table below). Methodologically, robust micro-econometric techniques have been applied based on Escribano and Guasch (2005 and 2008), Escribano de Orte and Pena (2010) and Escribano and Pena (2010). Concretely, we have used an instrumental variables (IV) estimator to alleviate the endogeneity coming from simultaneous casualty bias, controlling for observable fixed effects, with the information contained in the ES dataset. log TFP  � TFP  � Exp yiExp  � FDI yiFDI  � RD yiRD  � IC  ICiTFP  � D  Di  uiTFP i TFP TFP TFP TFP TFP ∙ logTFP - total factor productivity ∙ logL - employment log Li  � L  �TFP log Wi  �TFP log TFPi  � Exp yiExp  � FDI yiFDI  � RD yiRD  � IC ICiTFP  � D Di  uiL W L L L L L L ∙ logW - real wage all in logs ∙ yExp - binary variable selecting those firms that export more than 10% of sales yiExp  � Expi  �TFP log TFP  � FDI yiFDI  � RD yiRD  � IC  ICiExp  � D  D  uiExp Exp Exp Exp Exp Exp i ∙ yFDI - binary variable indicating those firms that are receiving FDI (at least 1% of firms‟ share is foreign) yiFDI  � FDI  �TFP log TFP  � Exp yiExp  � RD yiRD  � IC  ICiFDI  � D  Di  uiFDI FDI i FDI FDI FDI FDI ∙ yRD - binary random variable taking value one for those firms developing new products or services yiRD  � RDi  �TFP log TFP  � FDI yiFDI  � Exp yiExp  � IC  ICiRD  � D  D  uiRD RD i RD RD RD RD ∙ D - vector of industry, region and firm size variables Table I-1: Structure of equations system Dependent Explanatory variables variables FDI R&D Product Competition Equation 1 TFP Exports Other IC variables inflows investment development variables FDI R&D Product Competition Equation 2 Employment TFP Exports Other IC variables inflows investment development variables Probability of FDI R&D Product Competition Equation 3 TFP Other IC variables exporting inflows investment development variables Probability of R&D Product Competition Equation 4 TFP Exports Other IC variables receiving FDI investment development variables Probability of FDI R&D Competition Equation 5 developing TFP Exports Other IC variables inflows investment variables new products Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 41 Table I-2: Contribution of the investment climate (explanatory variables) to the dependent variables of the equation Explanatory variables Innovation, Regulatory Infrastructure Finance & Other Competition Dependent quality & skills environment & logistics corporate governance control variables variables Exports ∙ Dummy for R&D ∙ Domestic competition (+) ∙ Manager‟s time spent in ∙ Power outages (-) ∙ Purchases paid after delivery ∙ Dummy for decreased investments (+) ∙ Dummy for informal bureaucratic issues (-) ∙ Electricity from own (-) sales (-) ∙ Dummy for new products (+) competitors (+) ∙ Informal payments in tax generator (-) ∙ Dummy for quality ∙ Dummy for more than 5 inspections (+) certification (+) competitors (+) ∙ Dummy for gifts to receive ∙ Dummy for increased certificates (+) prices (-) R&D ∙ Dummy for new product (+) ∙ Dummy for informal ∙ Manager‟s time spent in ∙ Dummy for own generator ∙ Dummy for incorporated ∙ Dummy for outsourcing (+) competitors (-) bureaucratic issues (-) (+) company (+) ∙ Dummy for own website (+) ∙ Dummy for gifts to get ∙ Dummy for limited ∙ Staff – skilled workers (+) construction permits (+) company (+) ∙ Staff – univ. education (+) ∙ Dummy for external audit ∙ Capacity utilization (-) ∙ Dummy for training (+) (+) ∙ Experience of manager (+) TFP ∙ Dummy for new product (+) ∙ Domestic competition (+) ∙ Dummy for gifts in tax ∙ Shipment losses in exports ∙ Dummy for loan or line of ∙ Dummy for incorporated ∙ Dummy for quality ∙ Dummy for informal inspection (+) (-) credit (+) company (+) certification (+) competitors (-) ∙ Days to clear customs in ∙ Sales paid after delivery (+) ∙ Dummy for decreased ∙ Staff with computer (+) exports (interac.) (-) ∙ New fixed assets financed by sales (-) ∙ Dummy for training (+) internal funds (+) ∙ Experience of manager (+) ∙ New fixed assets financed by equity (-) ∙ Dummy for subsidies (-) FDI ∙ Dummy for use of foreign ∙ Dummy for gifts to obtain ∙ New fixed assets financed by ∙ Capacity utilization (+) technology (+) construction permit (-) equity (+) ∙ Dummy for decreased ∙ Training of production ∙ Dummy for payments to ∙ Dummy for overdraft facility prices (-) workers obtain a contract with the (+) government (-) ∙ Dummy for checking or savings account (+) ∙ Dummy for external audit (+) Employment ∙ Dummy for quality ∙ Dummy for informal ∙ Dummy for security ∙ New fixed assets financed by ∙ Capacity utilization (+) certification (+) competitors (-) expenses (+) internal funds (+) ∙ Dummy for incorporated ∙ Dummy for website (+) ∙ New fixed assets financed by company (+) ∙ Staff with computer (-) trade credit (+) ∙ Dummy for training (+) ∙ Dummy for loan (+) ∙ Dummy for external audit (+) ∙ Dummy for subsidies (+) Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 42 Annex II: The Agricultural Sector in the Russian Federation 1. Russia‟s total land area is 1.7 billion hectares, with roughly one-quarter of this being intended for agriculture (402 million ha in 2009). 49 percent of the land intended for agriculture is actual agricultural area (196 million ha). Figure 1 shows that by the end of 2009, only 59% percent of the agricultural land was actually used for temporary or permanent cultivation. Land under cultivation in Russia has decreased by 38 percent in the past three decades, as depicted in Table 1, although there has been an upward trend since 2007. For instance, the grain area in production has fallen considerably in the past two decades, from 63.1 million ha in 1990 to 47.6 million ha in 2009, mainly turning into fallow land. However, as a rise in food and grain prices in 2006-2008 brought regained interest to returning the fallow land into production, the area used for Figure 1. Structure of agricultural land in 2009, grain crops increased, from 75 million ha in 2007 to 78 million % of total ha in 2009. Out of the total area under cultivation in 2009, 61 percent was used for cereal grains and pulses, an increase of 7 Arable land points since the turn of the decade. The second largest group 28.9% Fallow land was feed crops, amounting to 24 percent. Nonetheless, as a Permanent crops result of the Soviet regime pushing grain production onto 58.9% 9.5% Hayfield marginal land in remote areas, production costs are often very high, and investments in physical and commercial 0.6% Permanent meadows 2.1% infrastructure for storing, transporting and exporting grains are, more often than not, inadequate (Liefert et al. 2009). Source: ROSSTAT Table 1. Area under crops in Russia 1980 1990 2000 2007 2008 2009 Total area sown, mln ha 124.8 117.7 84.7 74.8 76.9 77.8 Cereals and pulses 60.5% 53.6% 53.8% 59.2% 60.8% 61.1% Industrial (technical) crops 5.0% 5.2% 7.6% 10.9% 11.3% 11.5% Potatoes, vegetables, melons and gourds 3.8% 3.4% 4.4% 3.6% 3.7% 3.8% Forage (feed) crops 30.8% 37.9% 34.1% 26.1% 24.1% 23.5% Source: Russian Federation Federal State Statistics Service (ROSSTAT) Figure 2. Land resources internationally, 2008 2. International comparisons show that 100 103.05 120 in 2008, cultivation in Russia (measured in the (ha per agricultural population) % of agricultural area 80 100 amount of arable and permanent crops) was 80 ahead of other comparable economies, such as Agrcultural land 60 60 Brazil and China. This is however still notably 40 17.99 40 lower than in for instance India and Canada. In 11.80 20 20 addition, the agricultural area in the Russian 0.31 0.63 0 0 Federation amounts to roughly 18 hectares per India Canada Russia Brazil China agricultural population, compared to only 0.6 Arable land and permanent crops Agricultural land hectares in China and 0.3 hectares in India. Source: FAO Productivity and profitability of the agricultural sector 3. Value added by the agricultural sector in Russia accounted for 4.7 percent of GDP in 2009, a strong decrease from the 16.6 percent share in 1990. There has been a similar pattern in employment in the sector, from 14 percent 1990 to 7.8 percent in 2008 (ROSSTAT). Meanwhile, both value added and employment in the services sector has increased notably (Figures 3 and 4). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 43 Figure 3. Sectoral composition of value added, % of GDP Figure 4. Employment distribution, % of total 70 70 60 60 % of total employment 50 50 % of GDP 40 40 30 30 20 20 10 10 0 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Agriculture Industry Services Agriculture Industry Services Source: World Bank WDI 4. The main agricultural products in Russia are Figure 5. Total crops produced, mln tons cereal grains (mainly wheat, barley, sunflower and rye) as 120 3 well as dairy, sugar beet, potatoes and vegetables. Exports Agro exports/total merch exports, % Total cereals produced (mln tons) are also highly concentrated in grains (both in quantity and 100 2.5 value) (Tables 2 and 3). Crop production in Russia has 80 2 been recovering in the past decade from a slump in the 60 1.5 1990s. Looking at cereals (the major crop output, on the left axis of Figure 5), production has increased from a 45 40 1 million tons low in 1998 to 106 million tons in 2008, the 20 0.5 same level as in the early 1990s. Similarly, exports of agricultural products increased from 0.8 percent of total 0 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 merchandize exports in 1999 to peaking in 2007 (2.2 percent). Wheat is the main contributor to agricultural Source: FAO exports, with 11.7 million tons exported in 2008. Table 2. Top-10 production (1,000 tons), 2008 Brazil Canada China India Russia Sugar cane 645,300 Wheat 28,611 Rice, paddy 193,354 Sugar cane 348,188 Wheat 63,765 Soybeans 59,242 Rapeseed 12,643 Maize 166,032 Rice, paddy 148,260 Cow milk 32,100 Maize 58,933 Maize 10,592 Vegetables 147,869 Wheat 78,570 Sugar beet 28,995 Cow milk 27,579 Cow milk 8,140 Sugar cane 124,918 Buffalo milk 60,900 Potatoes 28,874 Cassava 26,703 Potatoes 4,724 Wheat 112,463 Cow milk 44,100 Barley 23,148 Oranges 18,538 Peas, dry 3,571 Sweetpotatoes 80,523 Potatoes 34,658 Sunfl. seed 7,350 Rice, paddy 12,061 Soybeans 3,336 Potatoes 68,760 Vegetables 31,402 Rye 4,505 Ind. Ch. M. 10,244 Ind. Pigmeat 2,838 Watermelons 67,203 Bananas 26,217 Cabbages 3,170 Ind. Cattle 9,054 Ind. Cattle 1,280 Ind. Pigmeat 47,178 Maize 19,730 Vegetables 2,221 Bananas 6,998 Lentils 4,043 Cabbages 37,073 Mango, guava 13,649 Hen eggs 2,119 Table 3. Top-10 exports (1,000 tons), 2008 Brazil Canada China India Russia Soybeans 24,500 Maize 2,702 Garlic 1,536 Cake of Soyb. 5,146 Wheat 11,720 Sugar Raw 13,625 Cake of soyb 1,375 Fruit Prp Nes 1,182 Maize 3,537 Barley 1,496 Soybean c. 12,288 Sugar Raw 1,334 Apples 1,153 Rice Milled 2,474 Sunfl. cake 608 Maize 6,433 Brew dregs 772 Food Prep nes 1,051 Sugar Refined 1,875 Sunfl. oil 490 Ref. Sugar 5,848 Food prep 588 Beans, dry 960 Onions, dry 1,671 Wheat flour 453 Chicken m. 3,268 Bev. Non-Al 504 Preserv. Veg. 903 Raw sugar 1,455 Beer of Barl. 346 Soybean oil 2,316 Bananas 477 Tomato paste 817 Rapes. Cake 1,119 Food Prep 207 Coffee 1,567 Soybeans 370 Rice Milled 809 Buffalo meat 460 Bev. Non-Al 118 Or. juice 1,275 Wine 320 Veg. Frozen 767 Cotton lint 440 Bev.Dist.Alc 102 Meat-Cattle 1,018 Beer of Barl. 314 Waters, Ice 754 Oilseeds Cake 385 Pastry 91 Source: FAO Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 44 5. Several factors have contributed to the emergence of Russia as a major grain exporter. The overall contraction of the livestock sector has played a part in Russia‟s shift from importing grain and producing meat to exporting grain and importing meat.36 Rather than facing strong domestic demand for grain to feed a large livestock industry, Russia is today instead exporting grain produced at home. At the same time, growth in grain production has contributed to increasing exports. While, as earlier mentioned, the area under cultivation for grain is considerably smaller today than two decades ago, grain production has been rising since the 2000s, as a result of growing yields. Russia‟s grain yields grew from a low of 1.3 million ton per ha in 1998 to 2.3 million ton per ha in 2009. In addition, favorable weather for most of the 2000s has allowed grain production to prosper (Liefert et al. 2009). 6. A recent report by the OECD and FAO estimates that Russian exports of wheat could surge by more than 60 percent, and is expected to reach an exported quantity as high as 26 million tons by 2019. This projection indicates that Russia could in fact surpass the U.S. by 2019, currently the world‟s largest wheat exporter (Figure 6). Figure 6. Main wheat exporters Figure 7. Wheat production and price USA EU Canada Australia Russia Total exports 70 250 160 140 60 200 Production, mln tons 120 50 Milion tons Price, $/ton 100 40 150 80 30 100 60 20 40 50 20 10 0 0 0 Source: OECD FAO Agricultural Outlook 2010-2019. Note: Forecast for 2010-2019 Source: FAO 7. The increasing wheat production has Figure 8. Cost and output of wheat, Russia and Canada been accompanied by strongly increasing 1200 30,000 Producer price index for wheat, wheat prices, as shown in Figure 7. Price per 1000 25,000 Annual yeald (hg/Ha) ton has increased from USD 49 in 1993 to a 800 20,000 high of USD 205 in 2008. A notable decrease 1992=100 in prices over the last two years has come as 600 15,000 the result of a large grain crop in 2008. 400 10,000 Compared to Canada however, another major 200 5,000 exporter of wheat, price volatility in Russia has 0 0 been significantly more prominent. At the same 1992 1994 1996 1998 2000 2002 2004 2006 2008 time, output of wheat has almost consistently Yeald Russia Yield Canada been higher in Canada than in Russia over the Producer Price Russia Producer Price Canada past two decades (Figure 8). Source: FAO 36 Since the opening of markets and privatization of agricultural land in the early 1990s, Russia‟s earlier high meat production has decreased considerably, being replaced with high meat imports. From 10.1 billion tons of produced meat in 1990, production has averaged 4.8 million tons per annum in the period 1996-2005. In recent years, as a result of government initiatives to increase self-sufficiency, this value has increased, to 6.7 million tons of produced meat in 2009. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 45 Structure of the agricultural sector & land ownership 8. Privatization and the reorganization of land in the 1990s led to the surfacing of several legal forms of private agricultural enterprises and significant reductions in state ownership. Large farms – so called agricultural organizations – dominate the agricultural sector in Russia, accounting for 75 percent of sown land. However, these farms produce however only 45 percent of the output (Table 4). Private household plots have increased their share in output, on the other hand (47 percent in 2009), while operating on roughly 4 percent of land and producing mainly for own consumption. In addition to the large farms and private households, there exist peasant farmers (including individual entrepreneurs). As the agricultural organizations, they are commercially-oriented; they account for 7.5 percent of output in 2009 and operate on one-fifth of the land. These peasant farmers emerged as a result of active public policies in the early 1990s aiming to build up individual family-type farming in Russia. Table 4. Structure of agricultural output, current prices, Land area sown, % of total % of total 1970 1980 1990 1995 2007 2008 2009 2009 Agricultural Organizations 68.6 71 73.7 50.2 47.6 48.1 45.4 75.3 Private household plots 31.4 29 26.3 47.9 44.3 43.4 47.1 4.4 Peasant farmers - - - 1.9 8.1 8.5 7.5 20.3 Source: Russian Statistical Yearbook 2010 (ROSSTAT) 9. Agricultural organizations were responsible for 78 percent of total grain output in 2008. This is however a decreasing share (from 91 percent in 2000), as peasant farms are stepping up their grain production, from 8.4 percent in 2000 to 21 percent in 2009. Other key outputs by agricultural organizations include sugar beets, sunflower seeds, and eggs (71-89 percent of total production). Private household plots produce only a fraction of the grain output, but instead dominate in potatoes, vegetables and fruit production (71-84 percent). Peasant farmers, although still not a major producer group, have been the most dynamic of the farm groups, steadily increasing their production share, particularly in sunflower grains, wool and sunflower seeds (21-29 percent of total production in 2008). 10. The initial privatization process, which began in 1991, was based on the redistribution of land held by collective and state farms in the form of land shares to individuals (equal shares to each farm worker, pensioner or employee of social services in agriculture), creating “joint share companies.� These shares could in turn be withdrawn from the collective for establishing own farms or kept as shares in joint cultivation (Shagaida and Lerman, 2008). As a result, agricultural organizations today acquire land through lease contracts with individual shareholders or leasing of land plots from individuals who have already withdrawn their land shares. Transfer of land ownership through leasing or purchase of shares from the original shareholders to legal entities is becoming more common. Although, as mentioned, a majority of agricultural land has been privatized, most of this land is represented by land shares and not by ownership of actual plots (only 6 percent of agricultural land in 2003). Seeing as only a land plot and owned land can be used as collateral, this type of land structure, along with high technical barriers to meeting basic requirements when mortgaging land, limits the effective control of land, along with much of the farmer‟s incentive for future investment (Shagaida and Lerman, 2008). In addition, a World Bank report on the agricultural and rural sectors in Russia notes that a sizable – albeit diminishing – group of unprofitable and inefficient enterprises are being sustained through state support for political and social reasons (World Bank, 2006). 11. Another trend is the emergence of agro-holdings – complex institutional arrangements involving take-over of insolvent farms‟ assets by outside investors whose core business is outside of the agricultural sector. Agro- holdings are commercially oriented (as opposed to production for own consumption), have a multi-farm structure and consist of a consolidation of agricultural organizations, processing, and independent services units, with controlling stock belonging to one common holder (Rylko et al. 2008). They are mainly operating in grain production, as this sector represents the largest export opportunities. In addition, these companies are today the main Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 46 investors in upgraded machinery, farm equipment and modernization of primary agriculture, bringing new investments and technology to the industry (Liefert et al. 2009). 12. The legal structure of agricultural land in Russia is quite complex and is regulated by several acts, covering property registration, peasant farmers, cadastral legislation and tax regulations. Although the legal reforms were underway already in the early 1990s, the issue of land ownership was not regulated until 2003, with the introduction of the Federal Law on Agricultural Transactions. A key component of this act is the issue of land sales, giving the local government preferential rights to buy land, with the seller of land being required to formally notify the local government of his intent to sell the land. Similarly, an individual share-holder who wishes to either sell his land share or convert it into an actual land plot must inform the other share-holders as well as the local government. Moreover, the law stipulates that agricultural land is to be kept solely for agricultural use, with possibilities for regional governments to impose limits on the physical concentration of land by a single owner and with some restrictions on sales of agricultural land to foreigners (only leasing being permitted). There have however been numerous changes to this law and it continues to be amended. Public agricultural policies and support programs37 13. In addition to increased interest rates, as a response to the high inflation rates in 2007-2008, there have been several other active measures taken by the Russian Government to reduce inflation in food prices: - Price freezes: The Government reached a voluntary price restraint agreement with major food producers and retailers to control retail prices on “socially important� food products, including bread, eggs, milk and sunflower oil. The agreement lasted from October 2007 to April 2008. - Direct input subsidies: In order to mitigate higher energy prices, farms are provided subsidies for fuel costs arising from sowing. They also receive subsidies for mineral fertilizer, chemicals and high quality seeds purchases, as well as for transporting seeds. Pig meat and poultry farmers receive per ton subsidies. - Grain commodity interventions were implemented in the period October 2007 – June 2008, through large releases of grains (nearly 85 percent of total intervention stock), mainly in industrial centers and regions with high grain imports. This pattern was reversed as a result of large grain harvest in 2008 and the Government initiated grain purchase interventions in late 2008. - Trade-oriented measures: Temporary reductions of import duties on key foodstuffs took place in order to combat high inflation, including tariff cuts for dairy products, vegetables and vegetable oil as well as lifted duties on poultry and eggs imported for breeding. Export restricting measures were also imposed in late 2007 through duties on wheat, meslin and barley exports. As a way to prevent wheat and meslin outflows through the Customs Union (duty-free zone), exports of these grains to Belarus and Kazakhstan were also temporarily banned. These duties were lifted in mid-2008, in response to large grain crops. However, as a result of severe drought and wildfires in the summer of 2010, the Government has imposed bans on grain exports expected to last until mid-2011. 14. Russia‟s trade deficit in the agricultural sector reached USD 13.2 billion in 2009 and is mainly the result of large meat imports. The Government has introduced a strategy to support investments in the meat industry in order to increase meat self-sufficiency, with beef, pork and poultry being subject to tariff rate quotas, allocated to countries on an historical import basis (Box 1). 37 Key sources of information on support programs and federal budgets are OECD (2009) and USDA (2010). Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 47 Box 1. Evolution of Russia Tariffs Quotas (TRQ‟s) for meat Russian meat production declined rapidly following the collapse of the Soviet Union. As a result, meat imports increased rapidly to sustain domestic demand. In 2002, Russia implemented meat TRQ‟s for beef, pig meat and poultry. The life span of the initial TRQs expired by the end of 2009, with amendments made starting in 2006. However, in order to promote domestic production, by restricting over quota imports, the Russian government introduced prohibitive out-of- quota tariffs for pig meat and poultry. In December 2009 the Russian government approved a decree that will regulate meat imports to Russia in 2010-12. According to the law, the quota on poultry imports will almost be halved – from 952 kt in 2009, the quota for pork will gradually decline, while for beef it will rise. These TRQs have been developed taking into consideration the different trend of the various meat sectors. For poultry the TRQ has significantly been reduced to reflect the desire of the Russian government to promote the development of the industry which has grown, in the recent past, by 10% to 15% per year. It is expected with the current level of protection that Russian producers will be able to mostly meet domestic demand for poultry products after 2015. In the case of pig meat, the reduction in the quota reflects the slower growth in demand combined with an inadequate supply level from the domestic market. Nevertheless, it is not expected that Russian producers will catch up on the current gap between supply and demand. Finally, for beef an increase in imports is expected to occur as beef production in the Russian Federation is closely linked to the dairy herd. It is likely that the dairy herd will continue its long term decline leading to a reduction of domestic slaughtering. In accordance with the new trade regulations for 2010 to 2012, new tariffs have been adopted for all meat products. The allocation of quotas among countries has been worked out by the Russian authorities. Source: OECD-FAO (2010) 15. The Russian Government has notably increased investment in the agricultural sector in the past five years, by initiating a comprehensive policy framework focusing on sustainable rural development, sustainable use of agricultural land, and an increase in Russia‟s share of world agricultural production. In a short time period, several strategic policy programs have emerged, focusing on both mid- and long-term development goals. Key documents focused on agricultural development are presented below. - The Federal Law on Development of Agriculture (2006) sets out six broad objectives: i) improved competitiveness and quality of agricultural products; ii) sustainable rural development and improved living standards of the rural population; iii) conservation of natural resources used in agriculture; iv) development of an efficient agricultural market and improvement of market infrastructure; v) improvement of the investment climate in the agro-food sector; and vi) agricultural input-output price parity support. - The State Program for Development of Agriculture 2008- Table 5. Financial sustainability support under the 2012 succeeded the National Project for Development of State Program, aggregate spending, 2008-12 the Agro-Industrial Complex 2006-2007 in setting out % of total agricultural support measures. With a planned budget of Capitalization of Rosselkhozbank 3.31 RUB 551 billion over the set five-year period, the Capitalization of Rosagroleasing 2.05 Program is laid out in accordance with the 2006 Reduction of agricultural production risks 10.80 Agriculture Law. Major shares of this budget are aimed Interest rate subsidies 83.84 towards financial sustainability of agriculture (53 percent Agricultural organizations 59.15 of total funding) and sustainable rural development (20 Smallholder farms 11.67 percent). The three other components are the creation of Technological modernization 13.02 basic conditions for agricultural production (13 percent); Source: OECD (2009) development of priority agricultural sectors (12 percent); and regulation of agricultural markets (1 percent). The financial support is planned to increase by 30 percent in 2010 (compared to 2009 allocation), with interest rate subsidies as the major tool (Table 4). Subsidies will continue to support already initiated projects as well as new investments in dairy, livestock breeding, primary processing of meat and milk, among others. Major shares of subsidies will be allocated to agricultural organizations and household farms. Other investment support Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 48 implemented under the State Program include programs for state leasing of agricultural machinery and pedigree livestock (Rosagroleasing); capital grants for farm construction and land improvements (Rosselkozbank). - Other major public programs include the Program on Social Development of Rural Areas and the Federal Program for Soil Fertility Enhancement and Rehabilitation of Agro-landscapes as Russia‟s National Heritage, both initiated in 2002 and extended until 2012. The latter program provided RUB 41 billion in funding in the 2008-10 period, mainly through subsidies and capital investments (Russian Grain Union, 2010). - Measures to return agricultural land into cultivation are being taken by individual regions, for instance through subsidized costs of physical delimitation and registration of land ownership rights; land allocation to owners of land shares; and regulatory simplifications in agricultural land transaction (OECD, 2009). - The state-owned United Grain Company was established in 2009, with the role of domestic grain market regulator and investor in grain market infrastructure (transport, storage, ports). United Grain aims to invest an estimated RUB 52 billion by 2015 in order to reduce handling costs for grain exports, thus achieving higher competitiveness for the Russian grain industry. Over the next three years, United Grain will receive RUB 3 billion in government funding and plans to raise at least RUB 10 billion from private investors. A recent key development is that the Government, as part of the 2011-2013 Russian Privatization Plan, plans to sell 100 percent of its shares in the company by 2012 (Businessweek). - The Russian Academy of Agricultural Sciences is the institution responsible for providing support for research in the agricultural sector. The main functions of the Academy include developing and financing research programs; supporting and providing training to scientists from higher education and research institutions in the agricultural sector; and improving international cooperation, among other things. Nonetheless research institutes in the Russian agricultural sector are lacking overall capacity in delivering the technical and managerial innovation skills needed to enhance the industry‟s competitiveness – an area that remains largely neglected. - One outcome of the broader agricultural support program has been more clearly defined responsibilities of federal and regional governments in agricultural policies. The federal government – mainly through the Ministry of Agriculture – is responsible for formulating broad policy objectives, market interventions as well as the development and financing of nation-wide support programs in agriculture. Regions are however responsible in locally executing the federal programs. As of 2009, it has been envisaged that federal funds will be distributed to regions on the basis of matching funds. This has however proven to be difficult as numerous regions have not been able to co-finance projects, something that has resulted in planned decreases in the required share of co-funding from 50 percent in 2009 to 35 percent in 2010. The Ministry of Agriculture also plans to better select projects qualified for funding and to tighten control over their implementation. This will be done through selection of eligible projects by a special commission with representatives from banks, unions and relevant ministries, based among others on compliance of socio-economic development targets; economic viability and pay-off period of the project; as well as preservation or increase of jobs (USDA, 2010). 16. Given that the current and planned support measures continue as anticipated, the OECD-FAO Agricultural Outlook 2010-2019 estimates that the Russian agricultural sector could experience 26 percent growth by 2019, compared to the 2007-09 base period. Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 49 Annex II List of References Bloomberg Businessweek - “Russia‟s United Grain Seeks to Lower Export Costs by $20 a Ton.� June 08, 2010 http://www.businessweek.com/news/2010-06-08/russia-s-united-grain-seeks-to-lower-export-costs-by-20-a- ton.html - “United Grain Co. Plans to Raise $421 Million for 2-Year Program.� December 13, 2010 http://www.businessweek.com/news/2010-12-13/united-grain-co-plans-to-raise-421-million-for-2-year- program.html - “United Grain Company OJSC.� December 13, 2010 http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=99331238 Liefert, W., O. Liefert, E. Serova. 2009. “Russia‟s Transition to Major Player in World Agricultural Markets.� Choices, Agricultural & Applied Economics Association. Vol. 24, No. 2 OECD. 2009. Agricultural Policies in Emerging Economies: Monitoring and Evaluation. ISBN 978-92-64-05927-6 OECD and FAO. 2010. Agricultural Outlook 2010-2019. ISBN 978-92-64-08376-9 Russian Grain Union. 2010. “Agricultural Production in Russia - Challenges and Opportunities.� Presentation at the 3rd Forum for the Future of Agriculture, March 16, 2010, Brussels Rylko, D., I. Khramova, V. Uzun, R. Jolly. 2008. “Agroholdings: Russia‟s New Agricultural Operators.� in Lerman, Z. Russia’s Agriculture in Transition: Factor Markets and Constraints on Growth. Lexington Books, 2008 Shagaida, N. and Z. Lerman. 2008. “Land Reform and Development of Land Markets.� in Lerman, Z. Russia’s Agriculture in Transition: Factor Markets and Constraints on Growth. Lexington Books, 2008 World Bank. 2006. Enhancing the Impact of Public Support to Agriculture and Rural Sectors. Report no. 39213 USDA Foreign Agricultural Service. 2010. “Russian Federation Agricultural Budget in 2010.� Prepared by Yelena Vassilieva. Report Number RS1012 http://gain.fas.usda.gov/Recent%20GAIN%20Publications/Agricultural%20Budget%20in%202010_Moscow_Russi an%20Federation_3-9-2010.pdf Data sources OECD.Stat ROSSTAT. Russian Statistical Yearbooks 2009 and 2010, www.gks.ru World Bank World Development Indicators Russian Federation – Export Diversification through Competition and Innovation: A Policy Agenda 50