As we saw in Chapter 1, the economic linkages which existed under the centrally-planned economy have been disrupted throughout Russia, and the various regions are confronting structural problems. It is argued, in fact, that half of the decline in industrial production since the reforms has been due to the collapse of such economic linkages (Zaitsev [1996]). Large economic problems of this kind have been apparent in the Russian Far East as well. In this chapter, we will examine the situation in this region as an example of the common problem of structural adjustment in industry and regional economies which is occurring throughout Russia, and also based on its geographical characteristics, examine the direction of the region's development, placing emphasis on linkages with the Asia-Pacific region.
The structural characteristics of the Russian Far East economy are, as will be seen below: a low population density; an industrial structure with a few varieties; obstacles, including high transportation costs, to price competitiveness; and a fiscal structure which is highly dependent on the federal government.
When forming economic linkages with the Asia-Pacific region, it is important for the Russian Far East to develop an international division of labor based on its comparative advantage and its complementarity with other economies. The debate should focus on what industries the region should develop.
If we look at the question of what commodities this region can provide, we find, as we saw in the first section, that its main industries include non-ferrous metals, marine products and other processed foods, machinery and lumber.
For processed foods and timber, there is room to increase international competitiveness in terms of both price and quality by upgrading the antiquated equipment and processing technology. As far as machinery is concerned, the problem remains the delay in changing the mainly military-oriented production to civilian use. In terms of energy, production of coal already accounts for 10% or so of total Russian production, and it is being exported, but there has been virtually no development or production of the abundant reserves of petroleum and natural gas.
We begin from the question of how well demand in the Asia-Pacific region matches the supply structure of the Russian Far East.
In the mid-term, energy demand looks promising. It will expand rapidly if the current high growth in the Asia-Pacific region continues into the future. For instance, energy demand for the big ten APEC Asian economies (excepting Japan) is projected to grow by 2010 to more than 2.3 times the figure for 1992, but energy supply will only grow by 1.9 times, meaning that the rate of dependence on energy from outside the region is projected to grow from 6.1% to 24.1%. In particular, projections are that reliance on sources outside the region for supplies of natural gas, which is being promoted as an effective environmental policy, will grow from 9.0% in 1992 to 26.6% in 2010, and it appears that the countries of the region are now being confronted with the need to consider whether to import from the Middle East, where political instability leaves doubts over whether a stable supply can be maintained, or to develop new natural gas fields within the region. Some countries within the fast-growing Asia region are still heavily dependent on coal, and if countermeasures are not taken against the precipitation of sulfur oxide, which is one of the causes of acid rain, there is a possibility that by the beginning of the 21st century the levels of acid rain in the region will exceed those of Europe (National Land Council Planning Committee [1995]). Given this situation, it is projected that there will be an increase in demand in the region for natural gas, which emits practically no sulfur oxide and 60% lower carbon dioxide than coal. There are thus hopes that the abundant natural gas resources of the Russian Far East can be developed and a pipeline built to transport it to the Asia-Pacific region.
Given what we have seen above, we can well conceive that in the medium to long term the Russian Far East will be able to develop an industrial structure on the basis of its comparative advantage, principally its abundant natural resources.
If this case, the strategy will have to center on natural resource-based industries such as forestry, non-ferrous metals, and fishing and processing of marine products while it awaits the development of the energy sector, including the completion of projects that are currently underway in Sakhalin oblast. It is conceivable that it will be able to upgrade its industrial structure gradually, by carrying out high value-added processing for these export commodities while taking into consideration the market needs of the Asia-Pacific region. In order to do this, it will have to remove antiquated equipment and processing technology, which will require the promotion of investment. On the other hand, in areas such as grains, vegetables and light industries, where it is at a comparative disadvantage given environmental factors and the competition of neighboring countries, it should promote imports from its neighbors, and through abundant, low cost imports of food and daily necessities it will be able to begin a process of increasing real wages.
There is thus a need to begin, in a positive way, to transform the industrial structure of the Russian Far East, and the key to doing this will be the promotion of investment. In particular, three areas, namely, a) large-scale investment for natural resource development, b) investment in processing of natural resources, and c) investment for conversion from military to civilian production, will be very important for this process.
Given the basic directions set out in the previous section, as with Russia as a whole, the encouragement of investment and structural change in industry will be required, but so too will policies which deal with the future of the economy in the context of the Asia-Pacific region. Further, it will be necessary to pursue comprehensive policies which include the whole of the Russian Far East. In this regard, it is desirable that the Far East Long Term Development Program which is currently being prepared by the Russian Federal Government, be developed from such a standpoint and that it be systematically implemented.
The reduction in investment in the Far East since the reforms has been greater than the average for Russia as a whole and dependence on the federal and regional government budgets, which was already large, has become even larger. Consequently, investment by corporations is now less than 50% of total investment (Figure 29). On the other hand, the savings of the Russian Far East amount to 3% of total Russian savings and corporate settlement funds and savings to 5.5% of the total for Russia. Of the 2,571 commercial banks in Russia, 134 are active in the Far East and Vladivostok, which already has a stock market and an exchange market, is gradually being developed as a financial center. While continuing with these developments, structures to absorb and utilize the profits and foreign exchange gained from natural resources to promote investment in the Far East should also be explored in the future.
The introduction of foreign capital is indispensable if the Far East is to build the kind of economic linkages with the Asia-Pacific region set out in Section 2. But, first of all, conditions must be put in place to attract and promote investment by foreign companies. In particular, the companies of the major investor countries, America, Japan and Korea, compare the Russian Far East to other possible investments in the Asian region and look at the total picture including profit, cost, risk, and investment environment when they decide whether to invest or not. As the scale of investment needed for resource development projects in the future increases, investment decisions have to be medium to long term and will only be taken after serious consideration so the creation of an attractive investment environment and the minimization of risk will be of increasing importance. In such situations, the provision of accurate and highly transparent information about local companies will be a great advantage. Similarly, the establishment of complaints handling organization to deal with trade and investment matters will also be important in overcoming any lack of transparency in systems and procedures.
Moreover, in order for the local government - several thousand kilometers from Moscow and with a time difference of 6~9 hours - to have flexibility in the execution of policy, it is necessary to consider the partial delegation of the powers of the federal government within the limits that do not interfere with the economic management of Russia as a whole.
Unfortunately, the conversion from a military to a civilian based economy has been slower than expected and, because of the lack of civilian demand, there is a trend towards increasing military production again. Since these products are being exported cheaply to neighboring countries, the result is inevitably increased instability in the security and defense of the Asian region. A much higher level of support is needed from the advanced Western countries, including Japan, to assist the conversion from military to civilian production.
In terms of macroeconomic indicators, including the reduction in inflation and the bottoming out of the decline in production, there are signs that the Russian economy is achieving stabilization which was the objective of the first stage of the reforms directed towards creating a market economy. The economy is now entering a new phase, the second stage of the reforms.
In this report, we make several proposals about policy directions to deal with the new problems associated with the second stage of the conversion to a market economy and their solution.
(Sustained Growth through Exploitation of the Market Mechanism)
The Russian economy as it enters the second stage of the reforms is at a turning point - either it will achieve sustained growth or sink into the stagnation trap.
In other words, as indicated by the continuing decline in investment, the deregulation of the economy and macroeconomic stabilization achieved so far have not translated directly into autonomous and vigorous economic activity on the part of corporations and households acting on a medium to long term perspective. In this report, we called the current state of the Russian economy the stagnation trap. This is a vicious circle in which, on the one hand, corporations and households pursue immediate profit and rely on the government to bail them out or look for short term profits by continuing to use customary practices, and on the other, faced with the magnitude of the social cost and the confusion into which the whole economy is likely to be plunged as a result of such activities, in the end, the government steps in to save the situation.
The question is how should the policies which are necessary to move the Russian economy onto a sustained growth path - that is, encouragement of investment and structural change in industry and regional economies - be implemented. We consider that it will not be achieved by a simple method such as the government directly intervening in the distribution of resources. Rather, even though it may be a difficult task, it can only be achieved by removing the factors which create the stagnation trap and by stimulating the autonomous economic activities of corporations and households in accordance with the principles of a market economy. It is only through the formation of such a growth foundation that the objectives of the second stage of the transition to a market economy - that is, the transition to a sustained growth path by means of the market mechanism and the integration of the Russian economy into the world economy - can be achieved. From this point of view, the basic thrust of this report can be summarized in the following three points:
(Economic Development of the Russian Far East through to the twenty-first Century)
In the second chapter of the report, we discussed the future development of the Russian Far East. This was not only because of a geographic interest in the area because of its proximity to Japan. The Russian Far East - the eastern extremity - was included in the artificial and uneconomic distribution of industry under the former system. Consequently, it is one of the regions in which the economic problems following the transition to a market economy and the collapse of former economic linkages have shown up most starkly. The economic revival of the Russian Far East is one of the most challenging examples of the need for structural reform in industry and regional economies and at the same time, is a prime example of what the objective of the second stage of the reforms - integration into the world economy - means in practical terms (our attempt here represents only the first step in this direction).
We suggested that the direction of economic growth in the Russian Far East should be towards becoming dynamically involved in the international division of labor, with an emphasis on linkages with the Asia-Pacific region. This is not only because Asia-Pacific, especially the Asian region including China, is experiencing remarkable development and becoming the hub of the world economic growth. It is also because the threat to the global environment presented by the consumption of vast amounts on energy as a result of the rapid growth in the Asia-Pacific region is before our eyes. The Russian Far East can play an important role in the solution of these problems. The problems of the Russian economy and particularly the Russian Far East should not be treated as problems peculiar to countries in transition to a market economy, but in the context of a globalizing world economy and from a long term perspective looking through into the Twenty-First century.
(Towards Greater Sharing of Knowledge)
The first stage of the reforms saw the confusion which followed the transition to a market economy brought under control, and the stabilization of the macroeconomy, particularly the amelioration of hyperinflation. Then followed the creation of the actors in a market economy through the privatization of government enterprises and so on and the establishment of laws and systems which provide the basis and rules for market activities. In this process, the issues faced by all of the transition economies in Central and Eastern Europe and the former Soviet Union had much in common. The establishment of transitional economics was a response to these developments. In contrast, once the economy has been stabilized and moves towards the second stage of reform toward expansion and growth, the distinctive features of each of the economies become increasingly important factors and the problems increasingly varied and complex. From another point of view, this represents the fruits of reform - that is, a wider range of choices becomes available with respect to the direction each economy should aim for. However, differences and peculiarities should not be over-emphasized. "This country is different, professor. You don't understand."(21) If these words represent a rejection of mutual understanding, then they will have a negative effect not only on the transition to a market economy but also on cooperative development in the world economy as a whole. What is needed is a common language to explain the differences and peculiarities of individual economies and to make the effort to take advantage of the accumulated wisdom of the past. In this sense, our report is neither a novel or startling idea nor a cure-all for the present problems. Rather we hope it will make a contribution, however small, to the sharing of knowledge and to the deepening of mutual understanding.
NOTE (21): In the Foreword of Pierre-Richard Agenor and Peter J. Monteil (1996), Rudiger Dornbusch warns that this report is repeated all too often in relation to developing or transition economies and results in the rejection of a vast body of knowledge and experience which could be directed to solving these countries' problems.
In terms of game theory, the stagnation trap can be described as the prisoner's dilemma
First each company considers whether it will adopt policies (investment) to increase productivity. If it does undertake investment, the company will incur costs but at the end of the period, it will be able to obtain a larger income than if it had not invested. However, the size of the income which is gained as a result of investment is influenced by the following two factors. First the behavior of other companies. Generally speaking, it would be reasonable to assume that, if other companies also undertake similar investment activity, because of competition the returns to a particular company will be smaller than if they had not. But in the case of the Russian economy, because of the present large inefficiencies, if a large number of companies invest and raise their productivity, it is not unrealistic to assume that externalities will come into play and the returns to a particular company will actually increase.
The second factor is the government's behavior. In principle, the government should not interfere in private economic activity, but if large numbers of companies fail to invest and as a result, the government is faced with a serious problem of declining incomes, then it has to provide subsidies to rescue the situation (increase in the money supply). In this case, the burden is born by all economic agents in the form of an inflation tax. In turn, the real earning rate of the company which invested is undermined by inflation. In other words, a part of the earnings which should have been obtained is squeezed by companies which did not invest because of the government's intervention.
The game based on these assumptions is as follows.
| Own Company's Strategy | |||
|---|---|---|---|
| Invest | Do not Invest | ||
| Other Companies' Strategy | Invest | a,a | e,b |
| Do not Invest | b,e | c,c | |
The Bankruptcy Law came into effect in March, 1993. However, the provisions of that law make the procedures of going through the Arbitration Court complex and time-consuming so that, in a situation of high inflation, the real value of credit is lost in the course of the lengthy legal procedures. Moreover, the fact that external creditors don't expect to get much out of bankruptcy proceedings because priority is given to the payment of wages and other interests of insiders means that there is very little incentive for creditors to institute bankruptcy proceedings at court. In order to overcome these problems and speed up bankruptcy procedures, a new process was introduced by Presidential Order (effective mid-1994). This involved the establishment of a new Federal Bankruptcy Agency (FBA) and a system by which, in the case of companies in which the State holds 25% or more of the shares, the State can commence bankruptcy proceedings on its own initiative even if the creditors do not make any application.
Of the approximately 4,000 companies to which this system applies, by July, 1995, 2,018 had been declared insolvent by the FBA, but the proportion that has actually gone into bankruptcy or been reorganized is extremely small. Usually all that happens is that State sells its share-holding and the company is required to reorganize itself through the process of privatization and so on. There are various reasons for this failure to deal effectively with insolvent companies. Large companies, particularly those in regional areas, frequently provide social services such as housing and medical care. Therefore, one important factor is the opposition to the loss of social services that would result from the winding up of the company. When a company goes into liquidation, the local government is required to take over the social services but many local governments take a very negative attitude to doing so on the grounds of financial difficulty.
Decisions of the FBA(Number of companies)
| Type of Decision | Jan.,1995 | Apr.,1995 | July,1995 | ||||
|---|---|---|---|---|---|---|---|
| Sale of State Holding | 47 | 113 | 50 | 163 | 183 | 85 | 268 |
| Liquidation | 14 | 26 | 23 | 49 | 51 | 30 | 81 |
| Privatization | 38 | 111 | 69 | 180 | 244 | 122 | 366 |
| Application to the Arbitration Court | 8 | 26 | 15 | 41 | 38 | 21 | 59 |
| Request for Shareholders Meeting | 2 | 2 | 0 | 2 | 4 | 0 | 4 |
| Recoverd* | 41 | 78 | 28 | 106 | 142 | 41 | 183 |
| Other | 33 | 1 | 123 | 275 | 1 | 276 | |
| Total | 183 | 122 | 186 | 664 | 937 | 300 | 1237 |
Source:FBA
Government of the Russian Federation
"Russian Economic Trends 1995 Vol.4 No.2"
It is a principle of the market economy that when a company which is carrying a large amount of bad debts becomes insolvent, it is dealt with by bankruptcy or reorganization but when a majority of companies is in this situation, in practice, it becomes impossible to deal with the problem by the bankruptcy process alone. Moreover, if the process becomes lengthy, the social cost increases enormously. In Japan after the Second World War, because wartime debts became bad debts, most companies were in an extremely precarious financial position. In order to solve this problem, the Japanese government implemented the following policies. Policy provided for two separate schemes; one for dealing with the debts of financial institutions and another for the debt of non-financial, private corporations, although the basic framework was the same for both. The example of a non-financial institution is explained simply below.
NOTE (22): For the original argument, see Toshihiro Kodama, 'Industrial Policy and the Transition to a Market Economy in the Central and East European Countries - the Relevance of Japanese Experience' MITI Research Review, No. 4, and Takeo Hoshi, "Cleaning up the Balance Sheets: Japanese Experience in the Postwar Reconstruction Period" in Aoki and Kim
Separation of Old and New Accounts
───────────────────────────────────────
Old Accounts Assets Liabilities
───────────────────────────────────────
Old Accounts (A1) All assets other than (L1) All liabilities
the below (a1)
(A2) Claims against new accounts (L2) Capital
───────────────────────────────────────
New Accounts (a1)Assets considered necessary (l1) Debts against old
for the continuation of accounts
normal operations
───────────────────────────────────────
A financial and industrial group is a group consisting of one or more financial institution (bank) and a number of non-financial corporations. There are those which arise spontaneously between a bank and a number of companies and which do not have any government involvement and others which are registered under the government system and receive special treatment as discussed below. The formation of financial and industrial groups was adopted as government policy by Yeltsin in 1994. The first group registered was Ural Factories and by February, 1996, 32 groups had been registered (Afansiev, 1996). On the one hand, groups that are formed spontaneously by private companies are created in a number of ways. A bank or its holding company form a group under its control by acquiring shares in those companies. Alternatively, upstream and downstream processors in a particular industry or companies in related industry sectors may get together to form a group. Reportedly, many of these spontaneously formed groups are showing a strong interest in becoming registered groups in order to obtain special treatment.
The methods by which groups are formed under government direction include joint investment by members of the group to create a new company; one particular company in the group holding the shares of all the other companies; or entrusting the crossholdings of shares by the group companies to one particular company. The special treatment available to special registered companies includes placing the government's share holding in trust with the group; the government supplying part of the investment capital; giving a government guarantee to group investment; and in cases where the group includes companies from the CIS countries, giving special treatment to those companies for the repayment of debt to Russia. In order to obtain registration, the government must be satisfied that the group's business is of strategic importance to the country and that the group is making sufficient effort towards rationalization but the criteria of judgment are not transparent.
The primary object of the financial and industrial groups is to promote investment by joining finance and industry but a variety of other benefits can also be expected. These include improved external capital raising ability because of increased credit-worthiness resulting from the formation of the group; efficient utilization of resources within the group (joint marketing, materials acquisition, logistics, and so on); preventing the accumulation of debt between corporations(simplifying the canceling out of debts and credits); mutual assistance among companies of the group (bankruptcy prevention); and improved economic relations with the CIS countries.
Analysis of the way in which these groups are managed remains an issue for future study but there is one study available, a study of the Ural Factories by Tselichtchev (1995). In the case of Ural Factories, the highest governing body is, of course, the General Meeting of shareholders but, below this, an Auditing Committee (the equivalent of the Board of Directors) has been established and constitutes the headquarters of the group. The Auditing Committee consists of a number of CEOs, among whom functional responsibilities for administration, finance, procurement, sales, research and development and so on are divided. The Committee also determines management strategy for the group as a whole and adjusts and coordinates activities within the group.
The government is promoting the formation of financial and industrial groups. In his Annual Address, President Yeltsin, while expressing great hope in the formation of such groups in the base metals, chemicals, petrochemicals and military demand sectors, also indicated that there would be positive moves to establish such groups not only in the manufacturing sector but also in the international finance sector.
National Land Development Council, Planning Committee. 1995. (in Japanese)
"Grand Design for Land Planning in the 21st Century - A New Approach
to Comprehensive, Nation - Wide Development Planning" (in Japanese)
Kodama, Toshihiro. 1994. "Industry Policy and the Transition to a market
economy in the Central and East European Countries - the Relevance
of Japanese Experience." MITI Research Review, No. 4 (in Japanese)
Advisory Committee for Energy, International Energy Committee. 1995. Interim
Report (in Japanese)
Tselichtchev, Ivan. 1995. "What happens in the Russian Economy" Nikkei (in
Japanese)
Fujime, Kazuya. 1995. "Outlook for Long - term Energy Demand and Supply in the
APEC Countries" Journal of Energy Economy Vol. 21 No. 12 (in Japanese)
Miyabe, Junichiro and Hanada,Tomoko.1994." Russian Manufacturing Industry in
the Transition Period - the Emergency of Private Industry" Zaikai
Kansoku" August, Nomura Research Institute (in Japanese)
Murakami, Takashi. 1996. "The Economy of the Russian Far East and the Asia-
Pacific Region" Papers for the International Symposium on Russian
Economic Reform, Economic Planning Agency (in Japanese)
Hoshino Committee on Economic Reform in Russia. 1995. "The Present State of
the Russian Economy and Issues for the Future" Joint Research Report
on Intellectual Support for Russia, Japan Research Institute. June (in
Japanese and in Russian)
Afanasiev, Mstislav. 1996. "Promotion of Investment in Russia" Paper for the
International Symposium on the Russian Economic Reform, Economic
Planning Agency
Agenor, Pierre-Richard and Peter J. Montiel. 1996. Development Macroeconomics.
Princeton
Aoki, Masahiko and Hyung-Ki Kim eds.1995. Corporate Governance in Transitional
Economies. World Bank
Gavrilenkov, Evgeny. 1996. "Macroeconomic Performance and Macroeconomic Policy
in Russia" Paper for the International Symposium on the Russian
Economic Reform, Economic Planning Agency
Government of the Russian Federation. 1995. Russian Economic Trends. London:
Whurr Publishers
Krugman, Paul. 1994. "The Myth of Asia's Miracle" Foreign Affairs 73(6): 62-78
Lehmann, Harmut. 1995. "Active Labor Market Policies in the OECD and in
Selected Transition Economies" World Bank Policy Research Working
Paper 1502
Leitzel, Jim. 1995. Russian Economic Reform. London and New York: Routledge
Levintal, A. B. 1996. "Development of Far Eastern Russian Economy: Trade,
Investment and Development Policy" Paper for the International
Symposium on the Russian Economic Reform, Economic Planning Agency
Maddison, Angus. 1987. "Growth and Slowdown in Advanced Capitalist Economies"
Journal of Economic Literature 25: 649-698
OECD. 1995. OECD Economic Survey the Russian Federation 1995
OECD/IEA. 1995. Energy Policies of the Russian Federation. OECD
Sakurai, Makoto. 1996. "Investment Promotion Policies in the Russian Economy
"Paper for the International Symposium on the Russian Economic
Reform, Economic Planning Agency
Tselichtchev, Ivan. 1996. "Macroeconomic Stabilization in Russia: Progress and
Problems" Paper for the International Symposium on the Russian
Economic Reform, Economic Planning Agency
World Bank. 1995. Russian Federation towards Medium-Term Viability. Report No.
14472-RU. World Bank
Zaitsev, Valery. 1996. "Economic Reform in the Russian Far East: Trade
Investment and Development Policy" Paper for the International
Symposium on the Russian Economic Reform, Economic Planning Agency