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Strange bedfellows: How the politics-business nexus stifles innovation in Russia

It is no secret that innovation is responsible for as much as 80 per cent of economic growth. Not surprisingly, given the current situation in the global economy, especially the rising inequality in the developed world and the dysfunction of commodity-driven economic models in many developing countries, the next economic breakthroughs lie in innovation in fields such as biotechnology, genetic engineering, 3-D printing and robotics. The question of what it takes to be globally competitive really comes down to what it takes to be innovative. And the answer lies in politics.

November 24, 2016 - Dina Rosenberg - Articles and Commentary

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 The fact that the economic market depends on the political market is well-known. However, there are multiple channels of how politics can influence the economy that are yet to be discerned. According to Paul Krugman, the recent currency crisis in Russia is no stranger to the political economy of other countries, albeit with one important difference. Russia did not use borrowed money to pay for its imports and thus did not run trade deficits, but rather spent it on oligarchs, which is a textbook example of crony capitalism. This explains a large part of how the Russian economy works, but surely not all of it.

Another channel of influence, largely overlooked by experts and scientists, is the connection between political institutions and innovation, which is thus particularly relevant for a country’s global competitiveness in the modern world. Innovations are first and foremost a political rather than economic question because they change the balance of political power in the society. At first glance, this point of view can be easily rebuffed by saying that any economic redistribution alters the political configuration in the country, for instance by empowering certain economic agents over others. Yet there are important differences between innovative activities and any other economic activity, which make innovations much more susceptible to politics: they are expensive, risky, long-term and possess qualities of public goods – once an idea is in the air, anyone is free to use it. Radical, or disruptive, innovations render the existing products redundant (e.g. computers replaced typewriters), which makes the owners of the obsolete capital resist and prevent new economic agents from entering the market. This is done, for example, through reaching monopolistic agreements, erecting administrative barriers, as well as bribing and/or lobbying politicians for preferential treatment. Imagine now how much easier it is to resist and, more importantly, to win the battle if you are a state-backed monopoly. Of course, such a situation will discourage rational entrepreneurs and investors: they will either give up innovating or flee the country. Both trends are present in Russia.

Is Russia globally competitive?

According to the World Economic Forum (WEF), the most competitive (with higher productivity) countries consistently outperform the least competitive countries in terms of economic growth, especially during and after the 2008 global financial crisis. The global and interdependent nature of the modern world dictates its own definition of being globally competitive. The most comprehensive index of countries’ competitiveness produced by the WEF seems to reflect all of the components that are crucial for a country to successfully withstand global pressure and stay competitive. These include institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication and innovation.

Although invaluable for policy recommendations and comparative purposes, this index has its shortcomings that are common for almost all indexes. First, it is not clear how much each component should be weighted, and whether these weights are the same across different countries. Second, components might not be equal in terms of the effort/result ratio. For instance, market size is usually highly correlated with country size, which is for the most part an exogenous factor, whereas labor market efficiency and the macroeconomic environment require a good deal of effort on the part of many political and economic actors. Third, and what I dislike most about indexes: they mix up explanatory factors and outcomes. The resulting score is then of little help in exploring causal relationships between important political and economic variables. Also, it is not clear regarding how to escape double counting: what if protection of property rights explains the lion share of a country’s ability to innovate? Fourth, the survey methodology that is used to construct some indicators is always questionable. Thus, interpreting these scores should be theoretically warranted and country-specific, which I will demonstrate on the example of Russia below.

According to WEF’s annual global competitiveness reports, Russia has been steadily improving its score since 2012: from 67 in 2012-2013 to 43 in 2016-2017 among the 138 countries analysed (the lower the score, the better). But the devil is in the details. Deconstructing the indexes further illustrates the genuine driving forces behind Russia’s success: foreign market size index (5), government debt (10), tertiary education enrollment rate (13), mobile-cellular telephone subscriptions (13), quality of railroad infrastructure (25) and several others. It is self-evident that these components are either exogenously given (market size), represent the artifact of the Soviet system (education) or are simply a result of oil dollars. If we look at the factors that drag down Russia’s score, the picture will be more pessimistic: inflation (132), property rights (123), quality of roads (231), soundness of banks (121) and capacity for innovation (78). Russia’s institutional development is at the level of Gabon, macroeconomic development – Senegal, financial market development – Benin and business sophistication – Honduras. Ironically, according to Aleksashenko, it is exactly these institutional and macroeconomic components of the index that can lead to the salvation of the Russian economy. What do these close-to-failing scores tell us about the current and future situation of the Russian economy?

What is the real situation of the Russian economy today?

The so-called fat 2000s of the Russian petrostate economy, boosted by soaring oil and gas prices, were replaced by stagnation that kicked in around eight years ago and according to the Ministry of Economic Development may last for another two decades. Most experts would agree that the consequent economic turmoil that hit the country in 2014 was largely triggered by plunging oil prices, questionable political decisions, such as the annexation of Crimea and Russian actions in eastern Ukraine, and the resulting Western economic sanctions. According to Konstantin Sonin, long-term stagnation is the most important and thus worrying signal of the state of the economy.

The pernicious economic consequences include the devaluation of the national currency, the sharp fall in real income for the first time in 16 years, a massive outflow of foreign capital and a palpable decrease in GDP. If in 2014 the devalued ruble helped to save national reserves, finances (including the state’s liability before its workers and pensioners) and even some industries due to much lower production costs, 2015 saw a continuing output contraction and decline in consumption, which reinforce each other in a vicious circle.

More recently, it has been claimed that the Russian economy is slowly making inroads in leaving the recession behind, showing an increase in the PMI index of business activity in the manufacturing sector a growing demand in the internal market, and decreasing inflation. However, as Rogov shrewdly notices, successes in the manufacturing sector during the summer of 2015 and 2016 follow periods of an appreciation of the rouble, which indicates weakness of the economy rather than successful import substitution: producers simply benefit more from a strong rouble that allows them to economise on imported parts for their products.

Strikingly, the lion’s share of such imported parts is cutting-edge technology that Russia simply does not produce on its own. The level of its dependence on imports is shocking: up to 80 per cent in the medical industry, around 90 per cent in heavy machinery, and almost 100 per cent in computer technologies, to name just a few. In 2015, Brazil produced nearly 80 per cent of its manufacturing equipment at home, which is undoubtedly an achievement of its democratic government since 1985, when the manufacturing sector accounted for only 27 per cent of the country’s GDP. Sanctions added to the commodity crisis, and imports fell drastically: for instance, by March 2016 imports of mechanical and electrical equipment fell by 46 per cent and 34 per cent over three years, respectively. Is import substitution a panacea? According to Mirkin, it is doomed to fail: the level of investment in Russia is 18.4 per cent of GDP (compared with 45 per cent in China) and investments in human capital still lag behind the levels of the developed world. The brain drain problem that was exacerbated by the recent economic hardship adds to this. So the only viable option for Russia to stay globally competitive is for politicians to “re-friend” the West. Will they? And more importantly, can they?

Where is Russia heading politically?

Even if politicians are nominally trying to restore their relationships with the West, do they really mean it? What the West wants from Russia, for better or worse, coincides with what it takes to be innovative today: political and economic reforms that will eventually lead to a politically competitive regime. Is the recent rhetoric in Russia pandering to the West and shrouding its real intentions? Current political events point to “yes”.

Russia is simultaneously strengthening all of its repressive organs and weakening the judicial system, including business courts that were arguably the most (the only?) efficient element of the system. Propaganda and machine politics prosper as opposed to free democratic elections and civic activism: both parliamentary and street opposition are nipped at the bud. State intervention in the economy is gaining momentum: gas and oil assets are being re-nationalised, which pushes out private investment. The guns-and-butter debate is slanted towards the former: the country intends to cut healthcare spending, which is already low by Western standards, by 33 per cent. The litany of facts and intentions may continue, but the overall tendency is obvious: Russia is building a dictatorship.

These trends bode inauspiciously for political competition that is already miniscule and will soon be ceased. The only alternative that such a regime might offer is a system of denouncements among bureaucrats reminiscent of the Soviet Union, which, as history teaches us, fails to generate long-term and innovation-led growth. As Krugman explains, “One can make a case that whereas old-fashioned heavy industry was susceptible to central planning, new technologies, especially in microelectronics, favor free-wheeling competition over centralized control”.

From this perspective, the often-mentioned shortcomings of the Russian innovative system – low R&D expenditures, an underdeveloped system of university-industry linkage, an inability to innovate despite the brilliant ability to invent, the state’s (as opposed to business’) immense role in funding research – are a mere manifestation of the bigger political problems described above. And if Russia is sliding back to the system in which the greatest inventors are not free to speak their minds, a failure to stay globally competitive is a foregone conclusion.

Dina Rosenberg is an assistant professor of Political Science at the Higher School of Economics, Moscow.  She a co-editor (with Ekim Arbatli) of the book Non-Western Social Movements and Participatory Democracy: Protest in the Age of Transnationalism (Springer, forthcoming, 2017), to which she has also contributed. 

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