After a week of writing about the Russian economy, I put together the pieces of its growth diagnostics. The conclusion follows.
- Getting Started
- Introduction to Russia
- Infrastructure and Human Capital
- Taxes and Laws
- Market Structure and Competition
I picked Russia’s industrial policy as the top issue. Economists rightfully reach for their revolvers when they hear this. Local barons use “industrial policy” to justify protection for their industries. Usually it ends badly, even backed by good historical examples. The United States, Germany, and South Korea protected their “infant industries” at some point of time. But the isolated impact of protectionism is unclear in these cases. It may have any sign. Besides, protection for the 19th-century manufacturing sectors says a little about what a country should promote now.
So what should a country promote with industrial policies? In Russia, less protection for losers and more benefits for winners. This rule is hard to follow when the government appoints losers and winners. The market just supports those who get government protection. It must be the other way around! Government may support companies that do well in competitive, often international, markets. Usually, it’s not about handpicking specific firms, but about simple rules for entire sectors. A good industrial policy for Russia would imply less discretion in industrial policy making.
Since this series concerns only diagnostics, I’m not commenting on actions that can make sense in this case. However, I hope this series shows well that for upper-middle income countries, like Russia, the HRV framework must go much deeper because constraints become less obvious as economic complexity increases.
Appendix: What deserves attention
Industrial policy is important, but overall I took four issues from the previous posts in the series. The table below ranks each of them on a scale from 1 to 5 according to:
- How large is the possible impact of changes in this constraint on economic growth?
- How far is the current situation from the optimal one?
- How many evidences are available (or potentially available) for managing changes in this direction?
- Confidence in normative recommendations that economics can offer here
- Clarity of recommendations and their quantitative substance
- The “distortion potential” for stakeholders in cherry picking or changing recommendations in their favor
- Are there stakeholders who lose from changes in this direction?
- Do these stakeholders have policy making power?
- Are there stakeholders who win and can support changes in policies?
This is my arbitrary scale, and you may have your own. Now back to the list. The four constraints belong to “Taxes and Laws” (formal taxes, formal regulations) and “Market Structure and Competition” (industrial organization, industrial policy):
(More here means more potential for growth. The scale is for ranking only and doesn’t reflect the size of the gap between constraints.)
Formal taxes. As mentioned in the post, Russia combines its own idiosyncratic taxes with the same taxes that disincentivize accumulation of human capital in developed countries. Changing this situation could be technically easy because taxes are specific and quantitatively transparent mechanisms. However, taxes are vulnerable to politics (partly because of their transparency) and changes here are likely to face much opposition.
Formal regulations. Regulations constrain growth through two channels. First, they are direct and often not justifiable costs that always end in prices. So the citizen pays for them. Second, regulations grant power to corrupt officials. Corruption discredits both good and bad regulations, with more negative consequences for law enforcement and state capacity. That’s a quite conventional simplification, and the key nontrivial question is how large the distortions are (see rough estimates in this post). As for confidence, the burden of proof for regulations must be on the regulator and lawmakers. This is an idealistic picture for any country, but the point here is that many proofs don’t fit well what economics already knows.
Industrial organization. I put de-facto competition above de-jure regulations because competitive firms actually find ways to optimize regulatory costs, minimize corruption, and somehow do this without breaking the law. I would exemplify this with multinationals, which are more productive than domestic firms even in bad environments. For the entire range of issues that arise here, see the previous post.
Industrial policy. Like regulations, the policy of keeping weak firms afloat is paid by citizens, including workers who suffer poor management and lower wages. This part of low-performing firms can’t live without subsidies of some sort, but these subsidies are a bad form of job security. The key policy problem is how to relocate capital and labor to the best firms without unemployment and loss of physical capital. It’s technically difficult and economic knowledge here is limited. Why did I mark it as the most feasible then? Certain cases could have many winners, including powerful decision makers, and this is more important than administrative complexities.
This doesn’t say how much exactly the Russian economy could get from solving problems in these areas. The impact depends on the changes in question. But the exercise in growth diagnostics just organizes many issues in a single framework, which should ideally direct attention to more specific issues.