The low economic diversification in Russia is commonly blamed on the abundance of energy resources. This brief summarizes the results of our research that investigates the presence of Dutch disease effects across Russian regions. We compare manufacturing subsectors with different sensitivity to the availability of natural resources across Russian regions with varying natural resource endowments. We find no evidence of differential deindustrialization across subsectors, thereby offering no support for a Dutch disease. This finding suggests that the impact of energy resources on Russian manufacturing is more likely to go through the “institutional resource curse” channel. Thereby, we argue that more efficient policies to counteract the adverse effect of resources on the Russian economy should focus on improving the institutional environment.
Russian abundance in oil and gas, and the ways it could negatively affect long-term economic performance and institutional development is not a new debate. One of the key concerns is the influence of energy resources on Russian industrial structure. Energy resources are often blamed for the low diversification of the economy, with an extensive resource sector and the dominant oil and gas export share.
In a forthcoming chapter (Le Coq, Paltseva and Volchkova), we contribute to this debate by exploring the channels through which abundance in energy resources influences the industrial structure in Russia. Our main focus is on the deindustrialization due to the expansion of the natural resource sector, the so-called ‘Dutch disease’. Specifically, we explore the impact of energy resources on the growth of manufacturing subsectors in Russian regions. Adopting a regional perspective allows us to separate the Dutch disease mechanism from the main alternative channel of the institutional ‘resource curse’. This brief summarizes our findings.
Dutch disease vs. institutional resource curse
The Dutch disease and the institutional resource curse are, perhaps, the most discussed mechanisms proposed to explain the influence of natural resources on economic performance (see e.g., earlier FREE brief by Roine and Paltseva for a review). In an economy facing a Dutch disease, a resource boom and resulting high resource prices shift production factors from manufacturing industries towards resource and non-tradable sectors. As a result, a country experiencing a resource boom would end up with a slow-growing manufacturing and an under-diversified economic structure. Since the manufacturing sector is often the main driver of economic growth, the economic development may be delayed. If, instead, an economy is suffering from the institutional ‘resource curse’, it is the interplay of weak institutions and adverse incentives created by resource rents that leads to a slow growth of manufacturing and delayed development.
Importantly, offsetting the potential negative impact of these two channels requires different policy interventions. In the case of a Dutch disease, a state can rely on direct industrial policy mechanisms targeted towards increasing the competitiveness of the manufacturing sector and isolating it from the effect of booming resource prices. For example, it can use subsidies or targeted trade policy instruments, or channel money from increased resource prices out of the economy through reserve fund investments abroad.
In the case of an institutional resource curse, on the other hand, resource rents and weak institutions may undermine and disrupt the effect of such policies. In this case, state policies should be targeted, first and foremost, towards promoting good institutions such as securing accountability and the transparency of the state, and protecting property rights. This suggests that properly understanding the channels through which resource wealth impacts the economy is necessary for choosing appropriate remedial measures.
In our analysis, we address the differential impact of energy resources in Russian regions. This regional perspective allows us to single out the Dutch disease effect, and disregard the mechanisms of a political resource curse to the extent that the relevant institutions do not differ much across regions.
Resource reallocation effect vs. spending effect
The mechanism of a Dutch disease implies two channels through which a resource boom negatively affects the manufacturing sector. First, a resource boom implies the reallocation of production factors from other sectors of economy such as manufacturing or services to the resource sector, a so-called ‘resource reallocation effect’. Second, an additional income resulting from a boom in the resource sector leads to an increase in demand for all goods and services in the economy. This increase in demand will be accommodated differently by different sectors, depending on their openness to world markets. Namely, in non-tradable sectors, isolated from international competition, there will be an increase in prices and output. This, in turn, will increase the prices on domestic factor markets. For tradable manufacturing sectors the price is determined internationally and cannot be adjusted domestically. As a result, production factors will also reallocate away from manufacturing to non-tradable sectors, a so-called “spending effect”.
The strength of either effect is likely to be different across different subsectors of manufacturing depending on the sectoral specificities. In particular, subsectors with higher economies of scale are likely to be more affected by the outflow of factors towards the resource sector through the “resource reallocation effect”. Similarly, subsectors that are more open to international trade are likely to be affected by the “spending effect”.
These observations give raise to our empirical strategy: we access differences in growth of regional manufacturing subsectors with different sensitivity to the availability of energy resources, where sensitivity reflects economies of scale, for the first mechanism, and openness to the world market, for the second mechanism. In other words, we test whether manufacturing subsectors with higher economies of scale (or openness) grow slower than subsectors with lower economies of scale (or openness) in regions rich in energy resources, as compared to the regions poor in energy resources. Observing differential deindustrialization, depending on the industry’s exposure to the tested mechanism, would offer support to the presence of a Dutch disease.
Note that the validity of our empirical strategy relies on the fact that there is high variation in resource abundancy and structure of the manufacturing sectors across Russian regions (as illustrated by Figures 1 and 2).
Figure 1. Geographical distribution of fuel extractions relative to gross regional product; 2014, percent.
Figure 2. Regional diversity in manufacturing structure, 2014.
Data and results
Our empirical investigation covers the period 2006—2014. The data on manufacturing subsector growth and regional energy resource abundancy come from Rosstat, the sensitivity measures across different manufacturing sectors are approximated based on data from Diewert and Fox (2008) (economies of scale in US manufacturing), and OECD (sectoral openness to trade).
The results of our estimation show that the differences in growth rates of manufacturing subindustries across Russian regions with varying natural resource endowments cannot be explained by the sensitivity of these subindustries to the availability of energy resources. This can be seen from Table 1, where the coefficient of interest – the one of the interaction term between the measure of sectoral sensitivity if resource abundance and regional energy resource wealth – is not significantly different from zero, no matter how we measure the sensitivity: by the returns to scale or by openness to international trade.
Table 1. Estimation of Dutch disease effect with different sensitivity measures.
|Dependent variable: average annual growth index of sectoral output|
|Sensitivity measure: Economies of scale||Sensitivity measure: Openness|
|Subsector sensitivity * Size of the fuel extraction sector in the region
|Subsector fixed effect||YES||YES|
|Region fixed effect||YES||YES|
Source: Authors’ calculations.
These results hold true if we control for differences in regional taxes, labor market conditions, and other region-specific characteristics by including regional and sectoral dummy variables, if we consider alternative measures of energy resource wealth, and if we use other, non-parametric estimation methods.
In other words, our data robustly offers no support for the presence of a Dutch disease in Russian regions.
Conclusion and policy implications
Diversification is often mentioned by the Russian government, as one of the top economic policy priorities, and the need for ‘diversification’ has been used in the political debate as an argument for an active industrial policy.
However, the policy measures that are necessary to counter the effect of abundant energy resources on diversification and, more generally, on economic development may be highly dependent on the prevailing channel through which resources affect the economy. In particular, while active industrial policy may be justified as a remedy in the case of a Dutch disease, industrial policy may well be ineffective, or even harmful, in the presence of an institutional resource curse mechanism.
In our study, we find no support for the Dutch disease effect when looking at the impact of energy resources on the growth of regional manufacturing sectors. Thereby, to counterbalance the resource curse effect on the Russian economy, we argue that it may be more efficient to improve the institutional environment than to use active government policies affecting industrial structures.
- Diewert, W. E and Fox, K. J. (2008) ‘On the estimation of returns to scale, technical progress and monopolistic markups’, Journal of Econometrics, 145(1-2): 174-93.
- Le Coq, C., Paltseva E., and Volchkova N., forthcoming. “Regional impacts of the Russian energy sector”, in Perspectives on the Russian economy under Putin, eds. Becker and Oxenstierna, London, Routledge.
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
How does the removal of trade preferences influence the exports of the affected country? We study this question on the example of Belarus’ loss of trade preferences granted by the EU to developing countries. Our brief argues that trade preferences are most important for simple non-manufactured goods. As a result, removal of trade preferences should increase the manufactured goods in the export structure. Indeed, the overall complexity of Belarusian exports was not harmed by the removal of EU preferences and the manufactured exports increased relative to non-manufactured exports.
Belarus losing trade preferences
As a developing country, Belarus used to receive trade preferences from the US and EU. These preferences grant duty-free imports or provide a discount on the import tariff under the so-called Generalized System of Preferences (GSP). The preferences are provided on a unilateral basis to developing countries and can also be removed on a unilateral basis for various reasons. Their stated objective is to support the economic development of poorer countries (Ornelas 2016). In particular, the US removed Belarus’ preferences in 2000 for worker rights violations. Later, the EU removed the preferences in 2007 for similar reasons. It is a relevant question for policy to understand how the removal of trade preferences affected exports.
This brief discusses the effect of trade preferences removal on the value of Belarus’ exports to the EU and on the structure of exports. Utilization of trade preferences might not be uniform across sectors. In fact, a preference-receiving country should satisfy the Rules of Origin (ROO) requirements and demonstrate that a large enough share of the exported product was produced in the country. This requirement might be more difficult to satisfy for complex manufactured goods with many components from several countries (Hakobyan 2015). Exporters of such products might find satisfying the ROO more costly than what they could gain from receiving an import tariff preference. Exporters of simple or raw products, on the other hand, face a lower cost of demonstrating the origin.
The remainder of the brief develops the hypothesis of a differential impact of trade preferences removal on manufactured and non-manufactured goods; and makes an event study of Belarus’ loss of EU trade preferences in 2007. Our findings suggest that GSP withdrawal affected disproportionally non-manufactured exports, leading to an increase in the manufacturing exports share. This means that harm caused by losing trade preferences was, to some extent, reduced by higher incentives to export more complex manufactured exports.
The complexity of Belarusian exports
To understand the overall structure of Belarusian exports, we first look at the complexity of Belarusian exports over time. Figure 1 presents the economic complexity index (ECI), developed by Hausmann et al. (2014), of exports of Belarus relative to Russia from 1995 to 2014. The ECI measures the diversity and ubiquity of a country’s exports. It considers the number of products a country exports with revealed comparative advantages and how complex these products are. In turn, the complexity of the products is accessed by a so-called product complexity index, PCI. It is determined in an analogous fashion: if few countries are able to export a good and these countries have diversified exports, this product is complex. For example, fertilizers and oil (important exports of Belarus) have low complexity scores, as countries that export these products tend to not have diversified exports.
Figure 1 shows that the difference between the economic complexity of Belarus and Russia increased following the two incidents of Belarus losing trade preferences; first from the US and then from the EU. The incidents of removal of trade preferences are associated with an increase in economic complexity of Belarusian exports relative to Russia. That is, the export of more complex manufactured goods became more important in the export basket of Belarus when it lost the trade preferences. This is consistent with the hypothesis that trade preferences are more important for simpler goods, and following a preference removal their share will go down. Russia is chosen for comparison due to its similarity in economic perspective (economies in transition, similar complexity, GDP trends, dependence on oil and fertilizer prices) and because it also received trade preferences from both the US and EU throughout the considered period.
Figure 1. GSP withdrawal and Export Complexity in Belarus relative to Russia
Export structure of Belarus
To make a first pass at understanding how GSP withdrawal affects the composition of exports, we conduct an event study centered on the year of 2007, when the EU withdrew its GSP preferences for Belarus. We consider the three years before and after the revocation, and benchmark the share of manufacturing exports from Belarus to the EU with its share of manufacturing exports to the US. Since the US had already withdrawn its preferences earlier, its trade regime with Belarus stayed unchanged throughout the period. This makes the US a natural point of comparison to understand the effect of GSP withdrawal.
As Figure 2 shows, the average share of manufactured products in Belarusian exports to the EU increased slightly after the GSP withdrawal, increasing to 40.4% from its earlier level of 37.9%. At the same time, mineral and fuel exports, though falling slightly, remain the backbone of Belarusian exports accounting for 50% of total exports to Europe. Interestingly, the share of non-fuel exports to the EU remained approximately unchanged at 9%. In other words, the composition of exports to Europe did not drastically change after the GSP withdrawal, as had been anticipated by some ex-ante studies (e.g. BISS 2007).
This comparison alone does not address the question of what might have happened to Belarusian manufacturing exports had the GSP preference not been removed. One possible counterfactual is that the trends in the European export market would have been the same as in the US, where Belarusian manufacturing exports massively lost ground. Their share decreased from 53.4% to 19.3%. Hence, a difference-in-difference estimator would suggest that perhaps the withdrawal of the GSP reduced non-manufacturing export growth to Europe. In turn, the Belarusian manufacturing export share is estimated to be 36.5% higher than it might have been if the GSP had not been withdrawn (statistically significant at the 1% level). This estimate may be a result of trade diversion of non-manufactured goods from the EU to the US. To the extent that non-manufacturing products benefit more from the GSP preferences, these should be stronger affected by trade diversion and would therefore reduce the manufacturing share of Belarus’ exports to the US.
Figure 2. Share of Manufacturing Exports
Alternatively, one could consider the Belarusian manufacturing export share in relation to Russia, within the European market. For Russia, there is a pattern of declining manufacturing shares. Before 2007, manufacturing accounted for 17.7% of exports to the EU, but afterwards it declined to 14.2%, a 2.5% fall. If Belarus had experienced the same trend, its manufacturing share would have fallen from 37.9% to 34.4%. Instead, Belarusian manufacturing share grew from 37.9 to 40.4%, which suggests that due to the GSP removal, the Belarusian manufacturing export increased by 6%. Given the smaller effect size and the short sample period, this increase is not statistically significant. However, in economic terms, it would still be an important shift.
Although development is one of the main goals of the GSP, there is little evidence that the EU’s Generalized Scheme of Preferences supported the development of advanced industries in Belarus. To the contrary, after the GSP withdrawal the export complexity of Belarus increased relative to that of Russia. There is also some suggestive evidence that the GSP may have encouraged an export profile more focused on non-manufactured products, for which rules of origin are easier to satisfy in practice. More research is clearly needed, not least to analyze other cases of GSP withdrawal for external validity.
Our preliminary findings suggest that GSP in its current form might have created incentives for exporting relatively simple goods, thus creating a risk of “middle-income trap”. Policy implications are twofold: First, the goal of preference programmes like the GSP is development, i.e. more advanced economy with more complex production, and if the preferences in fact foster simple exports, it could create a barrier to development; Second, removal of preferences might have a large negative impact overall but the observation that it removes the previous incentive of producing simple non-manufacturing goods can be seen as positive and thus cushion the negative impact.
- Belarusian Institute for Strategic Studies (BISS), 2007. “Belarus exclusion from the GSP: possible economic repercussions”, at: http://www.belinstitute.eu.
- Hakobyan, Shushanik, 2015. “Accounting for underutilization of trade preference programs: The US generalized system of preferences.” Canadian Journal of Economics/Revue canadienne d’économique, 48.2, 408-436.
- Hausmann, Ricardo; Hidalgo, Cesar A., Bustos, Sebastian; Coscia, Michele, Simoes, Alexander, & Yildirim, Muhammed A. (2014). The atlas of economic complexity: Mapping paths to prosperity. Mit Press.
- Ornelas, Emanuell, 2016. “Special and differential treatment for developing countries.” Handbook of Commercial Policy 1, 369-432.ilable online, please hyperlink the title.
This policy brief discusses the economic mechanisms triggered by import substitution policies, associated losses and conditions that ensure positive economic effects. Numerical estimations of potential effects of Russian import substitution policies indicate a decline in GDP, decrease in output of unprotected sectors and consumers’ welfare losses. We conclude with a discussion of the role imports play in economic efficiency.
Import substitution: pro and contra
Two years after joining the WTO, in the new political reality, Russia began implementing a series of import substitution policies. Supported sectors range from agriculture and production of metal products, to computer equipment and special purpose vehicles. The potential economic effects of these policies are of substantial interest and importance both for researchers, policymakers and the general public. However, they have not yet been quantitatively assessed. This policy brief summarizes the results of a study of these effects conducted at CEFIR in 2016 (Volchkova and Turdyeva, 2016).
Import substitution can be implemented by a range of instruments aimed at creating preferential conditions for domestic producers of imported goods compared to foreign competitors. Barriers to trade are the most common and easily available policy tools. Trade barriers lead to price increase on domestic market relative to the world price of the good.
Domestic manufacturers in the protected industry enjoy higher prices on domestic market, thereby securing higher revenues at the same costs. The protected sector also is able to put into operation those capacities that were generating losses in the absence of protective measures. However, if the economy works at full employment in absence of import substitution, then in order to increase production in the protected sectors, factors should be reallocated there from the other sectors. As a result of the import-substituting policy, producers in unprotected sectors will decrease the scale of production, and some will exit the industry. That is, producers that were efficient enough before import substitution policies will be forced out by those that cannot compete at international prices. From the point of view of welfare economics, this maneuver is accompanied by a loss of economic efficiency.
Economic literature discusses several cases when import substitution can be justified, such as a presence of positive external effects from protected sectors to the economy; learning-by-doing effects in protected sectors; and an infant industry argument. All of these cases imply market failures in the absence of government intervention, leading to lower than socially optimal output of the sector in question. Then, government interventions aiming to increase output – such as import substitution – might bring additional welfare improvement to the economy. If any of these effects do take place then the gain brought by protected sectors may compensate for the loss by the unprotected. To validate any of these cases one needs to perform a thorough and independent analysis of the economy based on very detailed information.
Estimates of static and dynamic effects of import substitution
In order to illustrate the potential effects of import substitution policies in the current Russian situation, we use a static CGE model of the Russian Federation constructed at CEFIR.
Based on publicly available documents (Russian Government’s Decrees №2744-Р 29.12.2015 and № 2781-р 31.12.2015), we identify the sectors that are targeted by the import substitution policy: agriculture and four manufacturing sectors (metal production; machinery and equipment; cars; sea crafts, airplanes and spaceships).
To model the effects of import substitution, we calculate an ad valorem tariff equivalent, which ensures a 10% decline of the volume of import in each of five industries. In order to simulate proposed policy measures, we conduct six experiments: increase in import tariffs in each of five industries individually, and a comprehensive policy change with an increase in all five tariffs simultaneously.
If import substitution policy is implemented not by trade policy instruments but only through producer support measures then it will be accompanied only by changes in relative prices for producers while consumer prices will not be affected and will be determined solely by international prices. In this case, our estimates will represent an upper bound of possible consumers’ losses. Since the distortion of relative prices for producers do not depend on a particular instrument chosen to implement import substitution policy then the consequences for other sectors and for efficiency of the overall production will be the same under trade or domestic policy interventions.
Table 1 shows the results of our calculations. Columns (1) – (5) present the estimates of the effects of the import-substitution measures in the relevant sectors. Column (6) reports the results of the comprehensive policy reform.
Table 1. Consequences of the decline in imports by 10% in the protected sector (s).
|Agriculture||Metals||Machinery, and equipment||Cars||Sea crafts, airplanes and space ships||Tariff change in all industries|
|Ad valorem tariff equivalent, %||2.9||3.9||6.1||6.7||5.6|
|Protected sectors’ output, %||0.7||2.5||9.8||10.3||8.3||3.8|
|All other production, %||-0.2||-0.4||-0.5||-0.2||-0.5||-2.3|
Source: Authors’ own estimation.
Our results illustrate the anticipated effect of import substitution policy in economy with full employment. The protected industries increase their output at the expense of other industries. An increase in economic inefficiency is reflected by a fall in GDP.
In order to capture dynamic effects of the proposed import substitution policy, we simulate an import tariff increase in a Solow-type growth model calibrated for the Russian economy. The proposed policies result in a deeper economic decline in 2016 than in the baseline scenario (-0.76% in the baseline scenario and -0.79% in the import substitution scenario), followed by somewhat faster growth in subsequent years due to a lower base. The aftermath of the import substitution policy is still visible in 2020: GDP growth in 2020 relative to 2015 in the baseline equals 2.4365%, while the import restriction in all targeted industries will reduce economic growth in a five-year term by 0.007 percentage points, to 2.4295%. The numbers correspond to the expected reduction in economic efficiency as a result of the import substitution measures.
While numbers in terms of GDP do not look particularly large, the annual losses in GDP in nominal figures correspond to $650 million in value added, which is roughly equivalent to 30,000 jobs lost in Russia due to import substitution. Besides, effect on growth adds to 5,000 more jobs lost over 5 years.
As we mentioned above these losses might potentially be justified by the positive external effect from an increased output of the protected industries on the rest of economy. To ensure this, the selection of industries for protection should have been done through independent expertise based on a thorough analysis of sectoral interaction over time. However, the way the economic policy is formulated in modern Russia, with heavy influence of lobbying groups and very little contribution from independent economic research, we can hardly expect that the industries targeted for import substitution satisfy the objective criteria of positive external effects.
Imports as drivers of competitiveness
Classical trade theory shows that imports are a major cause of gains from trade integration. Modern trade theory complements the classical mechanism by selection effects among heterogeneous firms when only the most productive firms are able to sell in foreign markets (Melitz , 2003).
Keeping in mind that a substantial part of manufacturing trade flows consists of intermediate products that are used as inputs in subsequent production (in the case of Russia, the share of intermediates in imports is more than 60%) then the above reasoning implies that the competitiveness of domestic production is determined, among other things, by the availability of cheap imports.
Numerous empirical studies for many countries confirmed that industries with a higher share of imported intermediate goods are more productive than industries with a lower share (Feenstra, Markusen, and Zeile, 1992). Recent studies, analyzing data at the level of individual firms (Bernard at al., 2012; Castro, Fernandes, and Farolec, 2015; Feng, Li, and Swenson, 2016), confirm that the effect takes place at firm level: firms importing more intermediate goods have higher productivity than firms importing less, other things being equal, which suggests that imports of intermediate goods is an important source for the growth of firms’ competitiveness.
A study conducted for Russian firms showed that labor productivity in Russian companies which import intermediate goods is 20% higher compared to similar firms not importing intermediates (Volchkova, 2016).
On this basis, we have every reason to believe that import is one of the sources of economic competitiveness that enhances effectiveness of the economy. Thus import substitution policies in the absence of objective information and a profound selection procedure for protected sectors, are harmful to the economy. In an open economy, the effect of the firms’ selection and the availability of cheap imports ensure growth of sectoral productivity, but productivity declines in “protected” sectors. That is, while our estimates above assess the direct negative impact on Russian economic output and welfare from inefficient reallocation of factors of production, the implementation of import substitution policies also puts the Russian economy in a disadvantaged position relative to more liberal economies on the international markets due to forgone competitiveness. This creates additional obstacles for Russia on its way to export diversification and sustainable growth.
- Feenstra, Robert C, James R Markusen, and William Zeile. 1992. “Accounting for Growth with New Inputs: Theory and Evidence.” The American Economic Review 82 (2). American Economic Association: 415–21. http://www.jstor.org/stable/2117437.
- Feng, Ling, Zhiyuan Li, and Deborah L. Swenson. 2016. “The Connection between Imported Intermediate Inputs and Exports: Evidence from Chinese Firms.” Journal of International Economics 101: 86–101. doi:10.1016/j.jinteco.2016.03.004.
- Melitz, Marc J. 2003. “The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity.” Econometrica 71 (6). Blackwell Publishing Ltd: 1695–1725. doi:10.1111/1468-0262.004
- Pierola Castro, Martha D., Ana Margarida Fernandes, and Thomas Farolec. 2015. “The Role of Imports for Exporter Performance in Peru.”
- Volchkova, Natalya A. 2016. “Prospects of the export diversification:” Dutch Disease “or the failures of economic policy?” in “Seven lean years: the Russian economy on the verge of structural changes: the round table materials” / ed. Rogov. -Moscow: Foundation “Liberal Mission” (in Russian)
- Volchkova, Natalya A., and Natalia A. Turdyeva 2016, “Microeconomics of Russian import substitution”, Journal of New Economic Association, forthcoming (in Russian)
Political turnover is a normal, even desirable, feature of competitive politics, yet turnover in a context of weak institutions can create policy uncertainty, disrupt political connections, and threaten the security of property rights. What is the impact of political turnover on economic performance in such an environment? We examine the behavior of over 7,000 enterprises before and after Ukraine’s Orange Revolution—a moment of largely unanticipated political turnover in a country with profoundly weak institutions. We find that the productivity of firms in regions that supported Viktor Yushchenko increased after the Orange Revolution, relative to that of firms in regions that supported Viktor Yanukovych. Our results illustrate that the efficiency consequences of turnover can be large when institutions are weak.
Politics in much of the world is a winner-take-all contest. When Viktor Yanukovych fled Kyiv in February 2014, for example, he was joined by a close group of associates overwhelmingly drawn from the country’s Russian-speaking East, including Yanukovych’s home region of Donetsk. The governors who ran Ukraine’s regions under Yanukovych fared no better. Oleksandr Turchynov, who served as acting president from February to June of that year, did what all Ukrainian presidents do: he fired the existing governors and replaced them with figures friendly to the new regime.
What is the impact of such political turnover on economic performance? In principle, replacement of political elites can have profound consequences for enterprise owners and managers, who rely on the support of patrons in government for government contracts, direct and indirect subsidies, the security of property rights, and permits to do business. In a system without effective checks and balances, economic policy can also swing widely as power passes from one group to another. Yet little is known about the impact of such changes on firm productivity, a major driver of economic welfare.
We examine the impact of political turnover on productivity and other aspects of firm performance in “The Productivity Consequences of Political Turnover: Firm-Level Evidence from Ukraine’s Orange Revolution” (Earle and Gehlbach, 2015). Our main finding is that the productivity of firms in regions that supported Yushchenko, the eventual winner of the 2004 presidential election, increased after the Orange Revolution, relative to that of firms in regions that supported Yanukovych, the chosen successor of incumbent President Leonid Kuchma. These results demonstrate that political turnover in a context of weak institutions can have major efficiency consequences as measured by differences in firm productivity.
Ukraine in 2004
Three factors make Ukraine in 2004 an appropriate setting for identifying the effect of political turnover on economic performance. First, Ukraine under Kuchma was a paradigmatic case of “patronal presidentialism,” in which the president “wields not only the powers formally invested in the office but also the ability to selectively direct vast sources of material wealth and power outside of formal institutional channels” (Hale 2005, p. 138). Who won the presidential contest had enormous implications for economic activity.
Second, economic and political power was regionally concentrated in Ukraine’s Russian-speaking East—Yanukovych himself was closely affiliated with oligarchs in Donetsk—while the political opposition represented by Yushchenko had its base in the ethnically Ukrainian and less industrialized West. Voting in Ukraine’s 2004 presidential election reflected this regional divide.
Third, few gave Yushchenko much chance of winning the presidency until the presidential campaign was well underway. In the end, it took not only a highly contested election, but also sustained street protests to wrest power from the existing elite.
Together, these considerations imply not only that political turnover in Ukraine could have an impact on firm performance, but also that any such effect could be observed by comparing the performance of enterprises in regions supportive of the two candidates before and after Yushchenko’s unexpected election victory.
The Orange Revolution and Firm Performance
To analyze the impact of political turnover, we use data on over 7,000 manufacturing enterprises that we track over many years, both before and after the Orange Revolution. We compare the evolution of productivity across firms in regions by vote in the 2004 election that was won by Yushchenko, while controlling for any shocks to particular industries in any year, for constant differences across firms in the level or trend of their productivity, and for regional differences in industrial structure. This design avoids many of the other influences on firm-level productivity that might have coincided with the Orange Revolution.
Our primary finding is that the productivity of firms in regions that supported Yushchenko in 2004 increased after Yushchenko took power, relative to the productivity of firms in regions that supported Yanukovych (and, implicitly, his patron Kuchma, whom Yushchenko succeeded as president). This effect is most pronounced among firms that had the most to gain or lose from presidential turnover: firms in sectors that rely on government contracts; private enterprises, given Ukraine’s weak property rights; and large enterprises. Other measures of economic performance suggest that these results are driven by favorable treatment of particular firms, either before or after the Orange Revolution, rather than by broad changes in economic policy.
Political turnover is often desirable. Nonetheless, our results suggest that the distributional consequences can be profound when institutions are weak, that is, when access to those in power is the primary guarantee of market access, contract enforcement, and property-rights protection. Oscillation of privilege from one region or sector to another is inefficient, as firms initiate or postpone restructuring based on who is in power. The optimal solution, of course, is not to restrict turnover, but to make turnover safe for economic activity. This requires that institutions be reformed to guarantee equal treatment for all economic actors—a difficult process that has proceeded with fits and starts in post-Yanukovych Ukraine.
- Earle, John S.; and Scott Gehlbach, 2015. “The Productivity Consequences of Political Turnover,” American Journal of Political Science, 59(3), 708–723.
- Hale, Henry E, 2005. “Regime Cycles: Democracy, Autocracy, and Revolution in Post-Soviet Eurasia,” World Politics, 58(1), 133–65.