INTERNATIONAL
What Russia must do to reap an investment bonanza
Summer 2006
If Russia embraces tough reforms and doesn’t squander its booming oil and gas revenues, it could within a decade be a prosperous pillar of the international economy. Antony Burgmans and Peter Sutherland assess Russia’s potential through the lens of the European Round Table of Industrialists (ERT)
Russia is much on EU policymakers’ minds these days, and for very good reason. It is also on the minds of Europe’s industrialists, again with good reason as EU-Russia relations have enormous economic potential. The mutual advantages to be gained from closer cooperation have so far been greatly underestimated.
The companies whose leaders are grouped in the European Round Table of Industrialists (ERT) together account for investments in Russia worth over €32bn, employing about 150,000 people. We think that Russia now has an unprecedented opportunity to become a global economic powerhouse, and that we in the European Union could benefit substantially from increased economic integration with our largest neighbour and one of our best customers. More trade and investment on both sides would be in the interest of consumers and companies everywhere.
The foundations are already in place. Trade and investment relations have been strengthening rapidly over the last 15 years, and in May of last year the EU and Russia agreed on detailed frameworks for intensifying cooperation in four “spaces”, including a common economic space. It’s an approach that should enable us to work together more closely than ever.
So how might Russia develop over the coming ten years? Providing that Russia’s own policy choices are consistent, we could see even greater changes in the next decade than in the last. Favourable commodity prices would enable the country to make crucial new investments in its transport infrastructure in the health and social security system, in schools and universities and in public administration. A determined drive to restructure Russian industry could greatly improve its efficiency and therefore its international competitiveness. And if that is paralleled by a track record of successful anti-trust and merger regulation in Russia, the fostering of business competition will certainly benefit Russian consumers.
Russia’s investment climate for domestic as well as foreign investors, could be further improved once the tax system is simplified and applied consistently, and once property rights become reliable and the judicial system independent. Russia’s membership of the World Trade Organisation (WTO) will in any case lead to its being integrated more firmly into the world economy, both as an attractive location for new industrial plants and as the home of globally-renowned Russian corporate brands. Increasing the ease of doing business there will encourage the development of a healthy base of small and medium sized companies, but that also means Russia will have to address the barriers created by corruption and bureaucracy.
This 10-year vision we’ve outlined is ambitious, and Russia could all too easily take other paths in the way it develops. Transforming this scenario into reality will depend on coordinating and implementing a complete programme of structural reforms. But all the leading economic forecasts suggest that tough structural reforms could deliver a hugely strengthened Russian economy within a decade. Assuming that there is policy continuity, these forecasts say that in terms of per capita GDP Russia could catch up with Italy in 12 years, with France in 16, with the UK in 21 and Germany in 22. Meanwhile, the inflow of foreign investment remains far below its full potential, so the further rewards to be won from pushing ahead with reform are strikingly clear.
In principle at any rate, reform should be made easier by the favourable economic situation in Russia today, with real GDP growth much higher than in the EU, a balanced government budget and government debt forecast to fall further to around 13% of GDP. Its buoyant revenue situation gives Russia the sort of flexibility it needs to cushion the impact of these reforms while still building up its long-term financial reserves.
But history warns us that over-reliance on revenues from oil and gas exports could reduce the pressure for reform, while the accompanying exchange rate adjustments can place Russia’s non-hydrocarbon industries at a competitive disadvantage. The main challenge facing Russian policymakers in the foreseeable future is to avoid the country becoming a victim of this sort of “Dutch Disease” by maintaining responsible fiscal, monetary and economic policies and continuing structural reforms in all key areas of the economy.
The closer exchange of ideas and experience between Russia and the European Union could provide constructive support to this process. Political agreement already exists on the various measures in the common economic space, so now the major challenge is to implement them. The first step is to prioritise them, and we would suggest that the following measures have the greatest potential.
1) Improvement of the investment climate should be the overarching objective of all actions in the context of the common economic space. This would boost business activity, create more jobs and generate wealth. The goods and services on offer to Russia’s citizens would increase, and so would the government’s tax revenues. Long-term investment in the oil and gas sector would also be attracted. What investors look for is the strict and non-discriminatory enforcement of applicable law, and the roadmap on the common economic space rightly highlights transparency, non-discrimination, predictability and simplification of regulation. It also provides for close dialogue with industry, and we see that as essential to identifying the most important areas for policy action.
2) The enforcement of intellectual, industrial and commercial property rights. Investor confidence largely hinges on the degree to which these property rights are enforced, so progress on the strengthening of the relevant legislative and law enforcement systems would greatly increase investment flows. The investment climate could also be improved through the approximation of the EU and Russian regulatory systems in line with best international practice. This, too, is one of the roadmap’s objectives.
3) Measures to boost EU-Russia trade and investment. Joining the WTO is a major step towards improving Russia’s international trading relationships, and the common economic space offers yet more mechanisms for facilitating trade and customs procedures. Research carried out by ERT shows that companies look more favourably on investing in countries where substantial improvements are under way in trade administration, especially when information technology speeds up the processing of imports and exports. Closer EU-Russia cooperation on this would also fight fraud, smuggling and other trade distortions, in line with the aims of the roadmap. Better cooperation on standards, technical regulations and conformity assessment procedures would also help stimulate trade.
4) A strong and permanent policy dialogue is needed on economic reform and enterprise policy issues. Both private and public sector actors in the EU and Russia have much to contribute to an ongoing exchange of views on the reform process and other measures to improve the trade and investment climate.
5) The consistent application of international accounting and auditing standards is the best guarantor of a fair and predictable corporate taxation system, and reliable rules in both areas are indispensable to attracting investors.
We and our colleagues in ERT – all of them top business leaders at the head of some of Europe’s largest companies – are in no doubt that the roadmap of the EU-Russia common economic space offers a solid basis for strengthening economic relations, so we strongly support its implementation. Most of the issues we’ve touched on here have to be addressed by government officials and politicians, but we nevertheless believe that companies in all sectors are ready to contribute operational, investment and marketing expertise to the wider process of policy formulation. Russia’s policymakers should themselves be in no doubt that bold economic reforms will be recognised and responded to by businesses around the world.