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Aleksandr Dynkin

President of the IMEMO, RAS Full Member, Chairman of the RIAC Scientific Council, RIAC Member.

Although the diversified risks and opportunities for Russian products to become more competitive in various regions are significant, collectively, as a factor, the success of Russia's integration into the global economy will chiefly be determined by domestic processes. In the absence of any real attack on corruption and excessive monopolization, the investment climate is unlikely to improve, at least where capital inflow into high-tech sectors is concerned. Future economic modernization hinges on a system of innovation that requires significant effort to develop dynamically.

With this article of Alexander Dynkin, a member of Russian Academy of Science, we begin a new series of forecasts and policy proposals from leading Russian experts on key aspects of Russian foreign policy up to 2020.

Risks and Opportunities to Develop International Competitiveness

A noticeable drop in the European Union's economic performance in 2012 [1] has revived discussions of the outlook for the global economy in the coming decade. These kinds of predictions are a complicated and often unrewarding area of academic inquiry. However, exposure to critical long-term trends, key determinants and possible turning points seems to be the only way to generate an adequate strategy for national development. In the modern policy-centric world, even a major state is not able to radically influence all these global trends. Hence, completing the post-socialist transformation and proving successful in the new task of economic modernization both require a comprehensible vision of global processes.

Working several decades in long-term forecasting, the Institute of World Economy and International Relations has developed an original methodology that often brings results better than key foreign predictions [2]. This method involves a statistical framework and integrated analysis of key development tendencies at national, regional and global levels. We do not adjust countertrends to the exposed tendencies, and instead of making two or three schematic alternative scenarios; we concentrate on the most likely global development path, while analyzing the conditions that could prevent full-scale implementation of the suggested future-scenario.

Global Recovery and Risks for Russia

During this period we do not expect to see any disruption that would drastically alter the current configuration of the global economy.

The latest global economic crisis should seriously affect both quantitative and qualitative parameters of global development in the coming decade. However, the reason for this lies less in the shock delivered to economic processes and more in the resulting acceleration of the structural shifts that had begun to surface in the early 2000s. Optimization and higher efficiency are taking on new importance in almost all sectors of the economy. Key economic sectors such as energy, construction and machine-building are seeing investments and restructuring rise. Science, education, healthcare and computer science are all showing rapid progress.

During this period we do not expect to see any disruption that would drastically alter the current configuration of the global economy. Even when the global crisis peaked, leading countries stopped short of sweeping protectionism that would have risked reversing these fundamental trends toward globalization. Mechanisms for financial regulation under discussion are also far from alarmist about an end to yet another round of internationalization. In the decade to come, all global economic centers are sure make further progress, despite the structural economic problems that result from the crisis, employment misbalances and failures in financial market regulation.

Consequently, Russia will be at a disadvantage in any strategy to maintain its global economic position if it fails to improve its international competitiveness on a new, innovative, basis.

As a result, the 2010s should retain high global growth rates, which means that through 2020 Russia's international standing will be defined by a harsh economic environment. Besides, the new power center, in particular China, will keep growing. Major developing countries are rapidly winning numerous commodity markets, including those that had traditionally been Russian, in a development that exacerbates Russia’s raw-materials export bias.

Global GDP growth seems likely to exceed pre-crisis level, topping 4 percent a year in line with the PPP calculations. On the one hand, according to the Institute's assessments gradually confirmed by the IMF and other international bodies, China’s GDP growth should only slightly slow down, whereas in India and other major developing countries the growth parameters will stabilize or even rise slightly. On the other hand, as a result of positive structural changes and successful reforms, key industrialized states should start to accelerate, although they are likely to remain below average global growth rates.

During the 2010s, innovation will remain important to global development; the technological basis should see qualitative improvement; and groundbreaking technologies may appear in the energy sector, biotechnology and medicine. At the same time, no restrictions will appear that have an impact on resources i.e. raw materials, workforce, capital and technologies [3].

The globalization trend in R&D should continue and GDP will be channeled m ore intensively into science in more countries, with the prospects for economic development directly dependent on the emergence of new designs and roll-out of innovations, the establishment of new sectors and the modernization of less advanced industries and services. Against a backdrop of the optimization of states’ priority-orientated technology policies, we can expect to see stronger differentiation between the strategies implemented by big business, primarily in transnational corporations (TNCs).

Top Western TNCs will strive for concentration on the most profitable market segments and innovation stages, enhancing intellectual property rights’ protection, whereas TNCs from developing countries will move from replicating foreign technologies and integrating them into the simplest chains with the goal of generating added value to creating their own innovation cycles.

In the coming decade, deeper R&D internationalization will be accompanied by further developments in value-added-chains and outsourcing. The transformation of corporate research will continue, with growing research personnel mobility and extensive dissemination of geographically dispersed teams that develop products and technologies. At the same time, despite the clear emphasis on internationalization, TNCs should retain close links with the countries and regions in which they are headquartered, both because of the various innovational, institutional and other competitive advantages that these countries offer and because of their close relationship with national governments. Hence, the mobility of skilled personnel will largely express itself as a brain drain out of those countries that cannot offer their middle classes comfortable employment and living standards, including modern public institutions, functioning political system and high environmental standards.

We predict that the energy sector, alongside healthcare, is to become the nucleus of the technological base from the 2010s to the first half of the 2020s.

Consequently, Russia will be at a disadvantage in any strategy to maintain its global economic position if it fails to improve its international competitiveness on a new, innovative, basis. However, innovation has a direct impact on the interests of the national energy and commodities oligarchy, which is resisting the redistribution of profits from raw materials exports to the knowledge economy. The balance between the interests of major business groups and long-term national goals is an indisputably political issue. A great deal of potential seems to lie in higher demand for innovation from high-tech sectors of the fuel and energy complex.

The 2008 economic crisis has already exacerbated problems relating to Russia's position in the global economy. One consequence is the de facto discontinuation of the diversification process in Russia’s economy. The three main export items (crude oil, oil products and natural gas) once again account for two-thirds of the country’s total export volume. At the same time, the global energy sector has undergone revolutionary changes, driven by the commercial production of shale gas and rapid progress in energy-saving and alternative electricity production. It is a different matter that certain trends are remain diffuse, in part due to major differences between energy market actors, and investment restrictions caused by the incomplete economic recovery of the EU, the alternative energy market leader [4].

Photo: REUTERS/Kacper Pempel
The Markowola-1 shale gas well was drilled
50 miles south of Warsaw, on behalf of Polish
state petroleum company PGNiG

The U.S. shale revolution is dramatically changing the geography of transborder LPG supplies, weakening the EU’s dependence on Russian hydrocarbon pipeline deliveries. This change stimulates the transition from long-term contracts to spot pricing. Besides, the EU, the main consumer of Russian hydrocarbons, is making rapid advances in wind and solar energy generation, underpinning the need for a liberalization of the gas and electric power markets in Europe. Energy markets are fast becoming buyer's markets, while Germany and certain other EU countries are focused on decarbonization, which will deliver a tangible blow to Gazprom [5].

We predict that the energy sector, alongside healthcare, is to become the nucleus of the technological base from the 2010s to the first half of the 2020s. Alternative energy will advance in step with increasingly effective and ecologically advanced traditional, hydrocarbon-based, heat and electricity generation technologies. It is not yet clear whether or not the Fukushima disaster heralds the decline of nuclear power, as Germany and other countries seem more inclined to turn their backs on nuclear power.

In the decade to come, the energy sector could be critically influenced by the smart grid technologies that seem set to optimize power production and consumption depending on demand, and raise energy services’ quality (supply stability, voltage and amperage). Unfortunately, Russia still underestimates the potential for modernizing electric power and boosting the quality of power grid services, especially where it comes to stimulating demand for modern electrical and electronic products for industrial and consumer use.

Russia's Innovative Modernization – Geographical Partner Choice

Photo: telegraph.co.uk
Europe is one of the least dynamic regions of
the world, and will face severe problems during
recovery

To a great extent, it is domestic factors that will shape the success of Russia's innovative modernization, although it seems unrealistic without the involvement of foreign investors possessing breakthrough technologies and the subsequent expansion of the new product sales in both Russian and foreign markets. Opportunities for the development of Russia's competitiveness abroad greatly differ with the geography. According to data from 2011, the EU accounts for 48 percent of Russia’s commodity trade, but it is this vector that shows the greatest structural disbalances [6]. The EU is also quite visible in Russia's investment relationships. APEC now accounts for 24 percent of Russia’s trade, and this figure keeps rising, led by China, followed by Japan, South Korea and the United States. However, Russia’s foreign trade potential, especially in view of reciprocal investment in East Asian and North American countries, remains underused.

The CIS still occupies a special niche in Russia's investment pattern. But in 2011, CIS countries accounted for just 15 percent of Russia's foreign trade, 4 percent of Russia’s total exported direct investments (less investment through offshore entities), and less than 1 percent of direct investment into Russia [7]. Customs Union member-states remain the key candidates for the development of deeper integration formats due to their territorial, ethnocultural and historical proximity. However, these countries’ low technological level prevents them from playing a key cooperative role in Russia's modernization processes. Therefore the integration cooperation mechanisms, which carry great political value, must also be economically viable, providing markets for Russian high-tech and innovative products.

Fluctuations in the political dialog, as well as powerful interest groups – which are either not ready or not interested in taking the relationship to a new level – have no impact on the bilateral economic relationship, preventing a buildup of U.S. direct investment and the removal of trade barriers to Russian goods.

Integration in the post-Soviet space, through deeper relations beyond the Russia-Belarus-Kazakhstan Customs Union, could prove productive for Russia. This could be achieved on the basis of the de facto two-pronged economic strategy, under which European Russia is oriented predominantly toward the EU and Asian Russia is economically geared toward Pacific Asia. Since this concept may spark fears of the country breaking up and thus trigger considerable opposition, there is a need to convincingly remove the misgivings by political means. One approach could involve engaging Japan, South Korea and the United States in developing East Siberia and the Far East against the backdrop of competition with China, which would mean that the Russians perceive their country both as a European and Pacific power [8].

However rapidly the geography of Russia's foreign economic relations diversifies in the years to 2020, the EU will remain its main trade partner and investor. Technology transfers with Western Europe and strategic alliances between Russian companies and European TNCs, and European market opportunities will act as powerful drivers for Russian producers to become more competitive. To this end, the long-term goal is Russia-EU integration within an FTA Plus format working alongside the existing systems in place under the Customs Union and Unified Economic Space of Russia, Belarus and Kazakhstan to build an integrated market that covers the entire northern part of Eurasia [9].

At the same time, excessive reliance on the EU would have several negative consequences. First, Europe is one of the least dynamic regions of the world, and will face severe problems during recovery. This unfortunate economic situation will be aggravated by adverse social processes, primarily due to growing unemployment [10]. As a result, EU markets will be unable to dynamically expand their demand for Russian exports, particularly when it comes to energy, due to greater energy efficiency and diversification of supplies.

Integration in the post-Soviet space, through deeper relations beyond the Russia-Belarus-Kazakhstan Customs Union, could prove productive for Russia.

Besides, this Russia-EU foreign trade interdependence is heavily lopsided, as for most European countries Russia means much less than the EU means for Russia [11]. This makes Russia vulnerable to pressure in critical areas of cooperation. In fact, Russia's mounting positive balance in energy trade to a great extent derives from the absence of any alternative to the European buyers, whereas in all other major product groups (machines, chemical, and foods) Russia is deep in the red.

We can expect to see more “bumps in the road” for Russia-EU relations as their companies’ interests collide in the post-Soviet space. EU decisions are highly politicized due to the Eurozone crisis and long-term problems related to development conditions for the EU’s peripheral members (mainly in South Europe), creating additional hurdles to deeper EU-Russia integration. The prospects for creating a visa-free regime remain vague, even though it is an essential precondition for the development of a Common Space of Research and Education. This has a broad cultural remit, and the two sides signed off on the roadmap for it back in 2005. The time and format of the new Partnership and Cooperation Agreement are also yet to be decided. In an environment like this, Russia would serve its interests best by being insistent and remaining open to tactical compromises.

Developing cooperation with the Asia Pacific region is the key vector for the geographical diversification of Russia's foreign trade through 2020. For Russia’s eastern regions, one key reason lies in how transportation costs are structured, as areas east of the Urals naturally gravitate toward China and other Asia Pacific countries.

Russia’s eastward exports are constrained by the fuel and energy infrastructure’s bias to Europe and growing competition with Asian countries in ferrous metallurgy, mineral fertilizers and other basic industries. In addition, there are political barriers, such as the unresolved territorial dispute with Japan, the region’s leader in technology, which hinders a breakthrough in bilateral relations.

Photo: Russian Railways

Regrettably, Russia is failing to fully employ potential levers to alleviate its commodity bias. National transportation lines do not provide a logistics bridge between the EU and Asia Pacific. Russian companies participate too hesitantly in transcontinental added-value chains, for example those related to specimen products they have developed for European markets which are later mass produced in China and countries in Southeast Asia.

Special attention should be paid to the advancement of economic relations between Russia and the United States. Fluctuations in the political dialog, as well as powerful interest groups – which are either not ready or not interested in taking the relationship to a new level – have no impact on the bilateral economic relationship, preventing a buildup of U.S. direct investment and the removal of trade barriers to Russian goods.

Although the diversified risks and opportunities for Russian products to become more competitive in various regions are significant, collectively, as a factor, the success of Russia's integration into the global economy will chiefly be determined by domestic processes. In the absence of any real attack on corruption and excessive monopolization, the investment climate is unlikely to improve, at least where capital inflow into high-tech sectors is concerned. Future economic modernization hinges on a system of innovation that requires significant effort to develop dynamically.

Notes

1. According to the European Commission spring forecast, in 2012 this Eurozone drop will equal 0.3 percent (see: European Economic Forecast. Spring 2012. P. 10).

2. See: Global Strategic Forecast 2030/ РАН; RAS Institute of World Economy and International Relations. Edited by Dynkin, A.A. Moscow: Magistr Publishers, 2011. Pp. 17–24.

3. For details see: Global Strategic Forecast 2030/ РАН; RAS Institute of World Economy and International Relations. Edited by Dynkin, A.A. Moscow: Magistr Publishers, 2011. Pp. 99–114, 461.

4. See: Telegina, E.A. Globalization of Gas Markets — New Challenges // World Economy and International Relations. 2012. № 4. Pp 36–39.

5. See: Ziesing H.-J. The German and EU Modernization Project: Decarbonising the Economy // Papers of international conference " Germany/EU – Russia: from Carbon Economy to partnership for Modernization held by RAS Institute of World Economy and International Relations and SWP Germany. April 17, 2012.

6. See: Russian Federation's Foreign Trade by Key Countries and Groups of Countries

7. See: Statistical Tables on Direct Investment, Central Bank of Russian Federation

8. See: Global Strategic Forecast 2030/ РАН; RAS Institute of World Economy and International Relations. Edited by Dynkin, A.A. Moscow: Magistr Publishers, 2011. Pp. 444, 449.

9. See: Russian International Posture: Economic Guidelines // Strategy 2020: A New Growth Model – A New Social Policy. Pp. 814–815.

10. See: Russia and the World: 2012. Annual Forecast / Project Masters: A.A. Dynkin, V.G. Baranovsky. RAS Institute of World Economy and International Relations, 2011. Pp. 56-57.

11. Although Russia is the EU's third largest trade partner after the United States and China, it has just a 7 percent share in EU27 goods exports, and 12 percent in imports. (See: Strong recovery of trade in goods between EU27 and Russia in 2011 // Eurostat Newsrelease. 2012. No 12. June 1).

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