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Analysis & Opinion
19.02.10 Russia Profile Weekly Experts Panel: Should Modernization Be Imposed?
Introduced by Vladimir Frolov

Contributors: Stephen Blank, Vladimir Belaeff, Ethan Burger, Vlad Ivanenko

Last week, President Dmitry Medvedev called on the leaders of big business to contribute to the modernization of the economy. Medvedev asked Russia’s business leaders to come up with a list of specific innovation projects involving cutting-edge technologies that would open new markets for Russian-made high-tech products. The list of such projects will be reviewed by the Kremlin’s Commission on Modernization in May, in order to determine which projects will receive state funding or a special tax regime. Will this approach to innovation succeed in Russia, where others did not? Can the state actually force private companies to innovate? What kind of incentives does the state have to encourage private investment in innovation?

Medvedev chaired a meeting of his commission to modernize the economy in Tomsk, where he met with the leaders of the business community, including RusAl Chairman Viktor Vekselberg, Onexim Group owner Mikhail Prokhorov, Rusnano Chief Anatoly Chubais and LUKoil CEO Vagit Alekperov. The president essentially acknowledged that private businesses should be forced to invest in innovation, since very little private investment in Russia is geared toward those objectives. It was an ultimatum, albeit a mild one. “I believe that all large private companies that have been established in our country in recent years have to make a major contribution to the modernization of Russia's economy and promote its growth,” Medvedev said, calling for significant growth in the innovation component in corporate investment programs.

He even went as far as to demand that the corporate social responsibility programs be redefined to move away from charity toward a practical focus on innovation and the companies’ effectiveness. Acknowledging that such demands amount to heavy government intervention, Medvedev reminded the oligarchs of their moral obligation to the state that bailed out their crumbling business empires at the peak of the financial crisis last year. “It is very important to remind ourselves that the government has shown itself to be a reliable partner during the crisis; it has not abandoned private companies to their fate. And today when we talk about the challenges of the innovative development of our economy, I hope that we can understand each other and formulate a plan of specific measures and long-term policy outlines,” Medvedev said.

Among innovative projects discussed at the meeting was Prokhorov's plan for a low-budget car, and Vekslberg’s Renova investment company plans to open a solar panel factory in Chuvashia by 2012. Prokhorov said that he plans to launch mass production of his car by the middle of 2012. The car will use liquefied natural gas as fuel and will fundamentally change the existing infrastructure of the automobile industry, he said. Both Vekselberg and Prokhorov are counting on state financing for their innovation projects.

Will this approach to innovation succeed in Russia, where others did not? Can the state actually force private companies to innovate? How can the state determine which private innovation projects need government support and which do not? What kind of incentives does the state have to encourage private investment in innovation? Why is Medvedev moving away from the recommendations of his think tank for less government interference in private business? Why is he adopting a sort of a statist approach to innovation? Will Medvedev’s efforts bear fruit?

Vlad Ivanenko, Ph.D. in economics, Ottawa, Canada:

It is laudable that president Medvedev proceeds with public consultations after having launched his modernization agenda in the article “Go Russia!” a few months ago. It indicates a certain structural break with the more familiar authoritarian approach exercised by the Kremlin up to now. However, a look at the list of projects proposed by big business makes me question the process by which the state selects the winners, and its transparency.

As part of my job responsibilities, I monitor the programs of modernization worldwide, particularly in the energy sector. It strikes me that projects that Frolov mentions – the production of liquefied natural gas-fuelled cars and solar panels – are borrowed from abroad. This is a disturbing development because the Russian proposals are not tailored to meet specific local objectives, unlike their foreign analogues. For example, the plan by American billionaire T. Boone Pickens to use natural gas in cars would eliminate the need for imported crude oil and, hence, reduce the U.S. trade imbalance – a major threat to the national financial stability. A similar project by Russian billionaire Michael Prohorov would be a boon to Gazprom, whose sales are in decline, but what else would it do for Russia?

Similarly, the EU support of solar power plants in Spain and possibly in Sahara is conditioned on their ability, among other things, to rid the union of its dependence on the import of Russian natural gas. Under the circumstances, the project by another Russian billionaire Victor Vekselberg to build a solar-panel factory is ill-thought out, unless it is somehow integrated in the EU plans. These observations suggest that for one reason or another, Russian big business is unwilling to synchronize its plans with the Russian state as much as its American and European peers do.

Another event that took place in Russia last week highlights a possible mismatch between the idea of public consultations floated by president Medvedev and a more opaque way to support modernization plans emphasized by Prime Minister Vladimir Putin. It concerns the ?2.1 billion loan that the government is offering for a joint venture between the Russian automaker Sollers and the Italian car giant Fiat. The loan is questionable on two counts.

Firstly, Putin does not explain the merits of this particular project relative to its alternatives. Secondly, the logic of singling out the car-making industry for state subsidies instead of other economic sectors is unclear. It is true that road vehicles constitute one of the largest items in the structure of Russian import, but import substitution should not be a national priority for a country that runs persistent trade surpluses. If the Kremlin decides to substitute a part of the imports, it is better advised to look at the development of the national petroleum services industry – the idea suggested in Tomsk by Lukoil’s president Vagit Alekperov – given Russia’s unique conditions under which its oil and gas industry operates.

In general, I find that the relationship between the state and business in Russia is currently deformed. On the one hand, the state doubts private interests as the latter has shown proclivity to misuse public support. On the other hand, big business is careful not to put all of its eggs in the Russia basket, mindful of Yukos’ fate. The resulting mutual distrust can be gradually healed if the two sides continue the dialogue that Medvedev seems to be determined to maintain, possibly with the help of independent mediators.

Ethan S. Burger, Adjunct Professor, Georgetown University Law Center, Washington, DC:

In the near future, the European Court of Human Rights will turn its attention to the cases of Mikhail Khodorkovsky and Yukos. The Russian government’s handling of this matter over the years has become a prism through which the country is judged by many business and political leaders. In 2002, then-president Putin’s actions toward the oligarchs can be summed up as “stay out of politics, behave patriotically, and I will let you keep the wealth you accumulated during the Boris Yeltsin years.”

Medvedev’s approach to Russia’s existing oligarchs seems more sophisticated than that of Putin. He has apparently said, through words and actions, “I am not so concerned with what you can do for me, and don’t ask what your government can do for you. Instead, tell me what you can do for our country.” President Medvedev’s success and future will ultimately depend on the health of the Russian economy. While human connections remain important, it seems as if Medvedev believes that policies must be based on well-designed programs and respect for the law/private property.

President Medvedev aims to implement industrial policies that rely primarily on market principles, rather than with some new form of a command economy (in the Putin as opposed to the Soviet sense). Medvedev is well aware of the fact that state-run enterprises tend not to operate efficiently. Fear of outright or creeping expropriation is unlikely to motivate domestic business leaders to invest in Russia as such policies are far more likely to make them think of the best way to transfer their wealth abroad, which will not strengthen the Russian economy.

Governments have plenty of tools to encourage businesses to pursue particular goals, particularly by altering tax policies. Giving favorable treatment for research and development as well as investment in human capital, increasing government procurement of products and services and providing incentives to create jobs in areas of high unemployment can be effective mechanisms for achieving policy goals. Creating tax disincentives for investing abroad can lead to positive economic outcomes. It is also reasonable for the state to pick out sectors to support. Taxing clean jobs at a lower rate (e.g. ones where recycled materials are used or generate less pollution than existing factories) is good public policy as well as good politics.

The oligarchs should not be coerced to undertake particular policies. At the same time, where the oligarchs see opportunities to adopt policies that are consistent with the state-created incentive system, they should not be excluded from participating if they do so lawfully. A statist industrial policy and government intervention in the economy are important when the market fails (as they have in many parts of the world), but Adam Smith did not blindly believe in laissez-faire economics. He had considerable faith in the invisible hand, but not in unregulated capitalism or excessive political interference in economic activity.

Vladimir Belaeff, President, Global Society Institute, San Francisco, CA:

Medvedev’s appeal to Russian business – to become more involved in economic and technological modernization – is neither surprising nor exotic. The proposal is contrary to deeply seated habits (vices) of corporate egotism, short-term planning and greed for the “quick buck.” In our present global crisis the pursuit of obscene short-term profits at the expense of society and reckless disregard for the long term are no longer seen as legitimate, quaint or endearing. Democratic governments serve the interests of large societies; when these are forced to rescue commercial corporations from the consequences of their folly and greed – the beneficiaries are required to reciprocate. So there is nothing wrong with Medvedev’s reasoning.

Russia’s government is now identifying one of the objectives of social responsibility for big businesses operating in Russia. Is this “force?” Every government everywhere has coercive power – this is the definition of government. In what way is the demand that businesses engage in innovation different from taxation, central bank interest rate policies, anti-trust regulation and many other aspects of economic governance?

It is the function of governments to define and implement national goals for a variety of purposes (the U.S. Great Society program is an example.) Part of the implementation of such programs is a suite of tools to incentivize and to coerce business when appropriate – to perform alignment with the greater goals. This is the interaction of the state with the private sector, ongoing everywhere in the world, even in this instant, and since time immemorial.

More fundamentally, the reported dichotomy between “state” and “private” sectors – in the economy of any country – is fictitious. The state and the private sectors are distinct, but they are in a symbiotic relationship and must collaborate to survive. Proponents of a divergence between the private and state sectors, or those who advocate the absorption of one sector by the other (socialists – 100 percent absorption by the state; liberals and libertarians – 100 percent absorption by the private sectors) are demonstrably utopists.

The history of innovation demonstrates that the state is very often the main sponsor and initiator of economic and technological modernization. This was true in the days when the inventions of Archimedes were sponsored by the city of Syracuse; in the Great Modernization by Russia’s Alexander II; in the era of the U.S. Apollo program, as well as the National Ignition Facility at the Lawrence Livermore Laboratories today. These programs are prime drivers of very diverse innovation. Nobody complains about statism when American military programs generate lucrative contracts for the vast American defense industry – so cross permeated with the rest of the economy that practically every major U.S. corporation has a Department of Defense subdivision.

Generally, established business is not strongly innovation-oriented. Technical innovation is most active in entrepreneurial start-ups, university labs and think tanks and in some (but not all) engineering firms. So it is not surprising that a special invocation was addressed to leaders of Russia’s extractive industries. Whether the head of RossNano was a target or only a witness of the recommendation depends on how one measures his effectiveness as head of one of the “premier” innovation resources of Russia.

Will Medvedev succeed in his appeal? That depends on his audience. The fact that Medvedev had to speak out is indicative; but he has other options – for example, to impose surtax on large business revenues and direct the funds toward venture financing, and to support academic research and development in basic and applied sciences. Would this approach “force” innovation on the private sector? Or would it simply be a method to direct tax revenue into socially-beneficial projects – like other tax revenue streams?

Professor Stephen Blank, the U.S. Army War College, Carlyle Barracks, PA:

It is so Russian to believe that the state can force private business to innovate and that it, rather than business, knows what to innovate and where to go for exports. And it is equally Russian that this gambit will fall flat on its face as it always has in the past. If insanity consists of doing the same thing over and over again and expecting a different result, then Russian policy is insane.

If indeed Medvedev has opted for a statist approach (and nothing I'd seen suggested opting for a truly liberal approach), then it is because he has signally failed to modernize his domestic political and economic structures along the paths he wants, so maybe he will try more coercion and/or go along with Putin's preferred course, which is to rely on import substitution, the energy and defense industries.

These strategies have long been discredited and the resort to them merely indicates the bankruptcy of the current course which, however, has a lot of muscle and vested interests behind it. Russia's oligarchs, in any case, are not technological modernizers whatever other skills they possess, so this is not the audience for such sermons.
But then there is no truly independent business class in Russia, as property rights are not secured and entrepreneurial ambitions are distorted into short-term actions or corruption, or stunted by government regulations. Even those who are true entrepreneurs cannot reach their full potential in such a system.

While there are incentives that the regime can offer in terms of tax breaks, subsidies, etc., they don't get at the basic problems of this oligopolistic system. The main incentive he could give is the security to do as you will, with property rights under law and a truly free or at least freer market, but nobody should hold his breadth.

Medvedev is no Mikhail Gorbachev, nor even an Alexander II, just another bureaucratic reformer in a long line of such who inevitably fall short before the accumulated obstacles of vested interests, autocracy, despotism, and the absence of the rule of law.
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