Economic Reforms in Russia:Progress and Challenges: Economic Reforms in Russia: Progress and Challenges Mikhail Dmitriev Research Director Center for Strategic Research Saint-Petersburg Leontief Readings 10th February 2005


Slide2: This report is focused mainly on economic reforms which are needed to complete the transition of Russia to market economy. The report does not consider longer-term economic policy issues beyond the transition agenda This report is not a product of an independent comparative study of market reforms in transition economies, and is based on CSR experts’ assessments and on international research data (World Bank, European Bank for Reconstruction and Development and others) Conclusions and assessments presented in the report are preliminary and will be used to set up a framework for a comprehensive research project on Russia’s economic policy


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


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


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


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


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


Slide8: ADOPTION OF LEGISLATION IN MOST CASES MAY BE REGARDED AS AN INTERMEDIATE RATHER THAN FINAL CRITERION OF REFORM SUCCESS THE REFORMS CAN BE CALLED EFFECTIVE ONLY WHEN THEY SUCCED TO AFFECT ECONOMIC BEHAVIOR IN DESIRED WAY


FACTORS WHICH INFLUENCE THE PROGRESS AND RESULTS OF REFORMS: FACTORS WHICH INFLUENCE THE PROGRESS AND RESULTS OF REFORMS Dynamics of political institutions Level of rent concentration Fiscal and monetary discipline Security of property rights Level of trust Effectiveness of public administration


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


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


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


DYNAMICS OF POLITICAL INSTITUTIONS: DYNAMICS OF POLITICAL INSTITUTIONS The level of political competitiveness and the “state capture” by special interest groups (1999) Source: The World Bank. Transition: The First Ten Years


Slide14: As of the year 2000, the level of “state capture” among transition economies was the highest in the group of countries with limited political competitiveness, which include Russia For Russia a considerable decrease or, alternatively, a considerable increase in political competitiveness in the coming years could bring the same outcome - a decrease of “state capture” levels.


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


LEVEL OF RENT CONCENTRATION: LEVEL OF RENT CONCENTRATION Comparative levels of rent concentration and the possible pace of reforms in certain areas (stylized data) Gas Customs administration Railroads Electric energy Oil Science Education Housing and communal services Healthcare Level of rent concentration Potential pace of reforms Expected pace of reforms Source: CSR expert assessments. Pace of reforms 1 0 0,1 0,5 0,5 0,9 0,3 0,3 0,4 1,0 0 Comparative level of rent concentration (in decreasing order)


FISCAL AND MONETARY DISCIPLINE: FISCAL AND MONETARY DISCIPLINE Overall, fiscal and monetary discipline has a positive influence on economic expectations and risk assessments, and can therefore improve the outcomes of reforms aimed at changing the behavior of market participants. Fiscal and monetary discipline can be weakened by increased political competitiveness*, and can be either high or low in noncompetitive political environment. * Alesina A., Roubini N., Cohen G.Political Cycles and the Macroeconomy/Cambridge.MA. 1997


INSECURITY OF PROPERTY RIGHTS IN TRANSITION ECONOMIES: INSECURITY OF PROPERTY RIGHTS IN TRANSITION ECONOMIES Source: The World Bank. Transition: The First Ten Years


Growth and property rights insecurity in 20 transition economies: Growth and property rights insecurity in 20 transition economies Index of insecurity of property and contract rights (BEEPS) GDP 2000/GDP 1989 R2 = 0.3452 80 70 60 50 40 30 20 1.4 1.2 1.0 .8 .6 .4 .2 BLR UKR ARM GEO AZE UZB RUSSIA KAZ KGZ LTU POL BGR ROM HRV EST CZE SVK HUN SVN MDA Source: “After the Big Bang: Obstacles to the Emergence of the Rule of Law in Post-Communist Societies”, Karla Hoff and Joseph E. Stiglitz, September 2003


EFFECTIVENESS OF BANKRUPTCY INSTITUTIONS: EFFECTIVENESS OF BANKRUPTCY INSTITUTIONS At the creditor’s request At the debtor’s request Source: EBRD Transition Report 2004


TRUST TOWARDS INSTITUTIONS: TRUST TOWARDS INSTITUTIONS Insufficient level of trust towards institutions is a common problem for the economies in transition, but in Russia this trend is more pronounced than in many other countries


IMPACT OF PRIVILEGES’ MONETIZATION: IMPACT OF PRIVILEGES’ MONETIZATION


EFFECTIVENESS OF PUBLIC ADMINISTRATION : EFFECTIVENESS OF PUBLIC ADMINISTRATION Decrease of political competitiveness facilitates Performance based management Elimination of redundant functions Reform of control and supervisory institutions Public administration reform at subfederal level Decrease of political competitiveness impedes Development of the civil society Introduction of participatory policymaking Increase in transparency Overcoming of corruption A decrease of political competitiveness can facilitate public administration reform in certain areas and impede it in other areas


Progress of Market Reforms in 2005-2007: Realistic Assessment: Progress of Market Reforms in 2005-2007: Realistic Assessment


AVERAGE ANNUAL GROWTH OF THE COMPOSITE REFORM RATING: AVERAGE ANNUAL GROWTH OF THE COMPOSITE REFORM RATING 2005-2007 rating growth according to declared intentions Possible 2005-2007 rating growth considering the obstacles to reforms progress Rating growth necessary to achieve the highest rating indicators among transition economies The maximum 2004 level of composite rating growth in transition economies


1989-2003 GDP growth in transition economies and the composite reforms rating as of 2004: 1989-2003 GDP growth in transition economies and the composite reforms rating as of 2004 Source: EBRD Transition Report 2004; CSR expert assessments; Uzbekistan, Turkmenistan and Belarus are excluded from the regression Russia Uzbekistan Turkmenistan Belarus


PROGRESS OF REFORMS AND ECONOMIC GROWTH: PROGRESS OF REFORMS AND ECONOMIC GROWTH A strong positive relationship between the market reforms and the pace of economic growth exists in transition economies. However, only part of the reform agenda may have a significant impact on economic growth in Russia in a medium-term perspective (2005-2007).


EXAMPLES: EXAMPLES Reforms that affect medium-term economic growth Reforms aimed at strengthening trust and developing institutions Reforms that are expected to have the highest progress Science Financial sector, judiciary and law-enforcement Labor law Accession to WTO Economic deregulation Education, healthcare, natural resources consumption The Kyoto Protocol


ECONOMIC GROWTH: ECONOMIC GROWTH Source: CIS Statistical Committee.


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


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


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


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