Russia’s Innovation Gap

Itzhak Goldberg and Raj M. Desai

This article was originally published in Russian in Kommersant as “The Accumulated Lag”

Russian manufacturing remains uncompetitive in global markets

The Russian economy has been growing at a rate of 6 percent over the last five years. But the growing dependence of the Russian economy on oil and primary-goods exports, combined with lagging productivity levels relative to rising wages in the manufacturing sector, has generated concerns that Russia is following a path of unsustainable economic growth. According to a study of 1,000 large and medium size Russian enterprises in 49 regions conducted by the World Bank in 2005-2006, Russia should focus on enhancing the competitiveness of its manufacturing sector in global markets.

Expensive and unproductive

Although productivity in the manufacturing sector has been rising, it has not kept pace with rising real wages in recent years, limiting the international competitiveness of the Russian manufacturing sector. Real wages in manufacturing in Russia (deflated by the producer price index) has increased 72 percent since 1999. The monthly manufacturing wage in 2005 was approximately $300, an increase of 65 percent in just two years, and a 369 percent increase over the 1999 level of $64 per month. Under these conditions, international competition with countries whose labor costs are cheaper may be increasingly difficult for Russian manufacturers. Russian manufacturing productivity is now about 40 percent of Brazil’s and only one-third of South Africa’s. Productivity in Poland is twice as high as in Russia. Although labor productivity in Russia is slightly higher than that of India and China, Chinese wages in manufacturing are 30 percent lower than in Russia. And low labor costs in these two countries give Russia a competitive disadvantage: for each dollar of wages, a Russian worker produces about half the output of an Indian or Chinese worker.

Disintegrated knowledge

The Russian Federation devotes considerable resources and manpower to research and development (R&D), yet the Russian economy lags behind other large OECD and middle-income economies in terms of R&D-based outputs. Based on the number of researchers, Russia’s productivity should be among the highest—on par with Germany and South Korea. Despite the large overall size of the R&D effort in terms of expenditures and personnel, Russia’s manufacturing productivity has not benefited.

Relative to other countries, moreover, Russian manufacturing firms have benefited less from increased integration into the global economy. Russian firms’ trade in parts and components for electrical machinery—a standard measure of the integration in global production-sharing networks—remains significantly lower relative not only to Germany, but also to Poland, China, India, South Africa, and Brazil. As a result, Russian scientists and inventors tend to apply only for Russian patents, avoiding patent registration abroad.

Russian government is developing a venture capital program aimed at promoting innovation. However, some caution is warranted with regard to the Russian Government’s initiative to establish venture capital funds companies with 100 percent state participation. In the most successful cases worldwide, governments typically “seeded” the venture capital industry by investing in privately managed funds.

According to international standards, the Russian workforce is highly educated. The average Russian citizen (25 and older), dedicates 10.5 years of his/her life to schooling. This is among the highest indicators in the world, ahead of Brazil, India, China, South Africa, other transition countries, as well as Germany, Japan, and the United Kingdom. Russia also had one of the highest shares of population with tertiary education (over 50 percent).

In spite of this, the Russian workforce lacks the requisite skills for firms to compete on the global market. More than a third of all managers reported deterioration in the quality of their work force between 1996 and 2005. Almost half of the firms hired workers with lower quality skills, while only 10 percent of firms improved workforce quality by hiring more skilled workers.

The investment climate

The Russian investment climate—while much improved in the last few years—is still characterized by unpredictability. A tendency to punish most dynamic and innovative firms is evident: firms holding monopoly positions on the market or those that have political connections receive tax breaks, investment credits, subsidies, and guaranteed loans. As a result, they experience fewer investment climate obstacles.

Corruption remains a serious problem. While there has been some improvement over the past few years, more firms complain of bribe payments to acquire business licenses, to inspectors, to tax collectors, and in dealings with courts in 2005 than in 2002. During the same period, this problem has become less acute in the Commonwealth of Independent States (CIS) and in Central Europe and the Baltic region.

There are, additionally, problems with real estate transactions and land privatization, as they are neither transparent nor fair. Over one third of the firms trying to purchase premises had to spend over half a year on that procedure; about 90 percent of the firms trying to purchase land failed to finish the procedure in half a year.

With regard to innovation, the intellectual property rights (IPRs) regime remains one of the primary weaknesses. First, the assignment of IPRs remains unclear, specifically if they should belong to the inventor, the inventor’s employer, or to the state that may have paid R&D costs. These uncertainties complicate collaboration between private firms and public institutes, inhibit technology transfer, and impair the development of spin-off companies into independent and growing businesses. Second, registered IPRs are weakly protected due to inability of public authorities to police producers or importers of pirated goods.

Finally, unpredictability of economic policy is an acute problem. As indicated in the survey findings, it remains one of the main problems in Russia. According to a new report by the World Economic Forum, Russia ranked 75th out of 117 countries surveyed in terms of regulatory unpredictability (China ranked 48th, India – 50th, and Brazil – 65th). This unpredictability is often caused by inconsistent and selective application of regulations; moreover, it has an increasingly deterring effect on investment.