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21.06.07
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Waiting For WTO
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By Felix Goryunov
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While WTO Accession is a Good Thing, It May Initially Bring More Problems than Benefits
Among the many heated East-West exchanges of political rhetoric in recent weeks, Polish President Lech Kaczynski’s suggestion that the European Union reconsider its approval of Russia’s accession to the World Trade Organization stands out. Although it is unlikely that Brussels will respond favorably to Warsaw’s suggestion and Russia will probably become a full-fledged WTO member, this development may prove to be extremely detrimental for Russia’s economy. As a matter of fact, Russia’s approaching WTO membership is a clear example of a strategic blunder caused by disregard of economic realities in pursuit of political goals.
Economic warfare depends on a well-chosen strategy, as well as proper knowledge of the battlefield. While Soviet representatives took part in the UN Conference on Trade and Employment in Havana in 1947 – the conference that initiated the package of trade rules that gave life to the WTO’s predecessor, the General Agreement on Tariffs and Trade (GATT) – Stalin’s stubborn refusal to join specialized UN agencies prevented the Soviet Union from becoming a founding father of the organization. The Soviet leadership decided to join the GATT only in 1984; Russia officially applied for WTO membership in 1993, and consultations on accession began in 1995.
Considering the dire state of the Russian economy in the early 1990s, the accession negotiations did not gather momentum until after 2000. Seven years of active negotiating is not much time to achieve a final resolution, but the Russian negotiators lost no time in securing agreements with the country’s major trading partners. Government officials also had to educate the Russian business community about the regulation of international trade by multilateral agreements. Indeed, the work of the Ministry of Economic Development and Trade in informing businesspeople about the WTO, its rules and procedures is a rare and encouraging example of fruitful partnership between government and business in Russia. Hundreds of conferences, seminars, roundtable discussions were organized by the ministry in cooperation with regional administrations and business associations in all of Russia’s regions in order to alert businesses to the challenges they will face after WTO accession is acheived. These discussions, and the feedback from them, helped negotiators formulate Russia’s position during the talks.
After these long, difficult negotiations, the problems with Russia’s accession to the WTO are not the result of the terms of entry; rather, the problems lie in the state of the national economy. Neither Russia’s relatively deep integration into the world market, nor its high growth rates and favorable external balances can conceal the fact that the country’s under-reformed and underdeveloped market economy is not yet in a position to meet WTO commitments.
Comparative Disadvantages
Although Russia is still outside the WTO, it belongs to the global market. The country is open to free flows of capital, merchandise, services and labor. The ruble is a convertible currency whose float, as in any developed country, is corrected by a central bank. Russia possesses expanding currency, equity and debt markets, which are sensitive to bullish or bearish trends in centers of world finance. Total accumulated foreign investment into Russia of $150 billion almost equals Russian investment abroad of $140 billion. Domestic and foreign businesses equally enjoy a comparatively favorable tax regime. Russia’s business legislation was not only adapted to international standards but, by recognition of many western businessmen, is now more liberal than that of a few European countries.
These points make Russia fully worthy to be a member of the WTO, but it must also be realized that joining this organization exposes Russia to the whims of international markets and makes the country more dependent on the economic and financial policies of its major trading partners.
The recent massive inflow of foreign capital into Russia seems like a clear indication of the country’s improving economic performance. This inflow has resulted in an increase in hard currency reserves to over $400 billion and in a substantial surge in liquidity. But at the same time, both results pushed up the ruble exchange rate and created problems in cutting inflation to the planned 8 percent for this year. Consequently, the Central Bank of Russia cannot risk lowering its refunding rate from the current 10 percent, which means that lending rates in Russia will remain twice as high as those in Europe and the United States and three times higher than those in China, thereby putting domestic businesses at a financial disadvantage. While appreciation of the ruble is favorable for the handful of Russian companies planning to buy new machinery and equipment, it creates price restraints for most businesses facing foreign competition at home and abroad.
Finance Minister Alexei Kudrin said recently that the total foreign capital inflow this year could exceed $70 billion, since by June it already totalled $60 billion. But only about $10 billion of this money was recognized by the Russian Statistical Committee as foreign direct investment (FDI), since a prevailing share of the investment was attracted by appreciation of the ruble and high profit margins – making it short-term speculative inflow. Looking at the share of FDI by sector, it becomes apparent that 78 percent of the money was invested in extraction industries, 7 percent in manufacturing and only 0.2 percent in agriculture, while shares of FDI for 2006 were 33.1 percent, 19 percent and 1.4 percent, respectively. Still more telling are the statistics for fixed capital investment in manufacturing: In 2006, machine building accounted for only 0.7 percent while the food industry received 3 percent and metallurgy and metal products, 4.3 percent. Though incomplete, the statistics convincingly point to the fact that both FDI and all fixed investment in Russian industry are also motivated by current opportunities to make money fast without substantial long-term commitment. Additionally, they are not leading to a diversification of the economy, but rather serve to strengthen its resources-based structure.
The discrepancy between high growth and investors’ unwillingness to commit funds to sectors other than oil, gas and metals either reflect suspicions about the sustainability of growth or about the Russian government’s economic policies. It can also be assumed that economic policymakers in Moscow are still unclear themselves what and where they must diversify.
Russia also suffers from unclear industrial policies. Speaking to a session of the State Duma in January 2004, German Gref, the Minister of Economic Development and Trade, said that the only sensible way to diversify the economy is to raise competitiveness of the economy as a whole rather than focusing on specific industries or companies. Recent actions, however, seem to indicate that the plans for improving the economy have been moving in a different direction. President Vladimir Putin and his two first deputy prime ministers have recently been focusing on policies to realize key development objectives. These include not only social programs such as affordable housing or higher pensions, but also improving infrastructure and transportation systems, reviving the aviation industry and increasing innovation in the economy through fast development of nanotechnologies.
Invisible Hands and Open Pockets
Russia can only belong to the global market if it has an open economy based on enterprise, allowing a free play of market forces driven by competition. Called the invisible hand of the market by Adam Smith, competition does play a crucial role in Russia. Although the country’s economy suffered a painful blow when the government defaulted on its sovereign debt in August 1998, a beneficial impact of the default followed: The fourfold devaluation of the ruble revived uncompetitive Russia manufacturing and agriculture along with other sectors and ensured continuous growth in the economy for the next four years. A rise in world oil prices picked up the growth to become the economy’s next driving force.
The windfall of revenue from oil and gas exports affords the Russian government the luxury to pour billions into any fancy technology it may choose, but as in other policy issues, Russia stumbles over constraints of mentality derived either from obsolete Soviet perceptions or based on more recent ideas of its role as a major global provider of raw energy resources. Because of these mental constraints, Russia wastes time pursuing policies that contradict the best world practices – trends that also raise a question mark over the country’s ability to be fully committed to the WTO disciplines.
The contradictory policy in question is the strengthening of the so-called power vertical, creating lavishly funded state development agencies and banks for heavy investment in federal or regional R&D projects. The massive buyouts of private assets in the strategic industries, including in the oil and gas sector, by state-owned corporations are also raising eyebrows. All these tendencies signify nothing else but the desire of the government to be a decisive player in the market or control major financial flows. In other words, we are witnessing a return of a supposedly market-oriented government to some form of centralized control. Whether this turn in institutional policy is dictated by considerations of national security, by a desire to govern the most profitable assets or just by rent-seeking of government executives remains to be seen, but the initial reasons are not so important in comparison with the shudders these polices send throughout the economy.
These developments have already raised concern among Russia’s major trading partners, but much more importantly is that they bode ill to the country’s economic development as they become a pretense for indulging another invisible hand in the Russian market – corruption. In recent years, corruption has actually become endemic and turned out to be the most forceful and dangerous constraint to creating a functioning economy. In some spheres of economic and social life, the invisible hand of corruption overwhelms that of competition.
Strange as it may seem, largely due to corruptive practices, Russia has no single market in such sectors as soft drinks and beverages, meat and dairy products, vegetables, construction as well as other industries with a fast return on investment. Regional or municipal bureaucrats in league with local businessmen just don’t allow “alien” Russian products to be sold in local markets.
And there are too many pockets open to bribes. By some estimates, the Russian Federation now employs about 1.5 million public servants – four times more than the Soviet Union. Their total spoil is rumored to be equal to Russia’s annual federal budget. The transparency of regional and local budgets leaves much to be desired and local coffers are prone to embezzlement and fraud. But even when a public servant is caught pocketing the spoils, he may well escape time behind bars since law enforcement officers and judiciary are also ready to oblige at a price. Many businessmen complain that although the taxation and customs regulations have been noticeably liberalized in recent years, the relevant officials tend to seek every unclear reading of the law for arbitrary decisions and extortion.
A Very Big Deal
The issue of Russia’s accession to the WTO attracts international attention, since it is the only big national economy remaining outside the multilateral negotiating process. Speaking at the recent St. Petersburg Economic Forum, WTO Director-General Pascal Lami said that without Russia, the organization cannot be considered multilateral. Thus, it is no wonder that many economics scholars have attempted to assess Russia’s potential gains and losses from entry. Most of the studies, however, come to conclusions derived more from common economic sense than from field studies of the Russian economy. The key gains and losses the WTO accession will bring to Russia are described as follows:
1. In the medium term, the Russian economy will gain about 8 percent of its value in domestic consumption and a rise in wages with more potential gains in the future.
2. Liberalization of barriers to FDI in services will help Russian businesses receive additional funding to develop telecommunications, banking, insurance and transportation services and thus cut costs and increase profits.
3. Tariff reductions will improve resource allocation. Due to better exposure to world market prices, especially for new technologies, Russian businesses will shift resources to production of higher value goods from less profitable industry sectors thus increasing overall productivity.
4. Enhanced antidumping and countervailing duty rights and improved market access for domestic exporters will supplement the most-favored nation (MFN) bilateral agreements concluded by Russia with its major trading partners.
5. There would be increased economic growth and higher employment in industry sectors most affected by international trade – ferrous and non-ferrous metals, chemicals, gas and telecommunications. But Russian industry sectors, which are more protected by tariffs and are not competitive enough to increase exports, will face a contraction in production and employment. The most affected among these will be manufacturing industries – production of machinery and equipment, construction materials, food and light industries.
But more important than gains or losses will be the assurance that Russia will not turn back from its market economy. According to the World Bank: “WTO accession can be a force for galvanizing Russian support for reform.” This galvanization, also known as a lock-in effect, is perceived to be a vital point on the Russian political agenda by Alexander Shohin, president of the Russian Union of Industrialists and Entrepreneurs. In St. Petersburg, he called on Western investors to facilitate their governments’ negotiations on the accession. He believes that the sooner Russia is in the WTO, the less danger that its business legislation will be politicized.
How do these assessments of potential gains and losses correlate with realities of Russia’s current economic development? In a situation described by Ruchir Sharma, Morgan Stanley’s investment manager for emerging markets, as “one of the most powerful domestic-demand booms in the emerging-market universe,” a mere 8 percent medium-term increase in the value of consumption after WTO accession looks rather modest. Also not very tempting is the benefit of easier access to international funds for development of service industries. The speed of development in this sector is already higher than of the economy as a whole, partially thanks to recent heavy borrowings abroad of Russian telecommunications, banking and insurance companies.
A relatively limited positive impact can also be expected from waiving of antidumping and similar protectionist measures against Russian exporters of steel, chemicals and other semi-finished products, and they will certainly not affect the commodities sectors, which account for an overwhelming share of Russian exports. As to potential gains from lower import tariffs for business equipment, these would fully materialize only when diversification of the Russian economy gains momentum. So far, domestic and foreign investors are too happy with huge, fast revenues from extraction industries to consider massive funding of high-end manufacturing products and introduction of new technologies.
No More Shock Therapy
After WTO accession, Russia will inevitably have to deal with some painful transition issues. There will be a period for adaptation of customs protection measures and changes in trade legislation as well as the introduction of structural reforms. And, of course, Russian businesses will have to adapt to changes in business practices in the face of new competition in order to meet new challenges. Russia has already come through a difficult transition, which started 15 years ago and some economists claim is not yet complete. However, there are differences between the WTO transition, which is promised to be smooth, and Russia’s transition to a market economy.
The first difference is that the most crucial market reforms of the government of Yegor Gaidar were decreed within a couple of months – which is basically the equivalent of overnight for radical economic changes. Generally unaware that these reforms were changing their whole way of life, Russians felt the pains only a year or so later when skyrocketing inflation robbed them of their savings. Then, state enterprises, which lost even their operating capital in inflation, had to sack workers as the cutting of budget expenditures increased unemployment in the public sector.
The meltdown of the Russian economy can best be judged by the following figures. By 1994, Russia’s GDP had decreased to 52 percent of its 1990 level, industrial production contracted by 55 percent, while consumer price inflation increased 2,850 times. The agricultural sector suffered most severely. A sizable reduction of import tariffs helped to fill Russian grocery stores, emptied by Gorbachev’s abortive perestroika, but the flood of heavily subsidized food imports literally ruined local farmers, weakened by price hikes for feed and fuel. By the mid-1990s, Russia had lost about half of its livestock. The aftereffects of these changes are still felt, for instance, in Russia’s northwestern dairy provinces, where farm unemployment is three times higher than the national average.
In contrast to Russia’s transition to a market economy, the adjustment to WTO membership should take 2 -3 years, therefore, Russian businesses are expected to be effectively protected by existing tariffs from price competition and will have time to become cost efficient. Another difference is that supposedly easier access to foreign capital will help Russian companies to finance restructuring and use new technologies. But the main difference between the WTO transition and Gaidar’s shock therapy will be the direct involvement of major WTO contracting parties through the lock-in mechanism of Russia’s commitments to the WTO rules-based disciplines.
So, the major question remaining in the accession is how the WTO lock-in will affect the current state of Russia’s economy. Its openness to imports of merchandise, services and to FDI has proved that these flows can contribute to the development of most profitable market sectors where domestic businesses are short of funds or know-how and technologies. However, foreign companies at large are not yet committed to the Russian market for the long term. This means that the Russian government and business community must solve the most crucial national problems without outside assistance, including the diversification of the economy from dependence on extraction industries, equipping manufacturing and agriculture with new technologies, developing infrastructure and leveling the uneven development of the regions. In this case, China is a vivid example. Its accession to the WTO in 2002 and the corresponding influx of FDI contributed to the further development of the country’s industrialized coastal regions, but brought little changes to poor western parts of the country, which are fraught with social unrest.
Whether Russia joins the WTO or continues to weigh the pros and cons of accession will not largely affect Russia’s economic performance. It remains predominantly dependent on government economic and social polices and domestic business. To use a famous Soviet phrase, “the saving of the drowning man rests with the drowning man.” |
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