Tag: Russia

Russian Financial Markets, Pension Funds and ETFs

Posted on December 18, 2017 | Policy Brief

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In this brief, I consider problems arising from the virtual non-existence of index funds and/or Exchange Traded Funds (ETFs) in the Russian financial markets. While the Russian economy requires cheaper money for firms’ investments and better options for pensioners, there are almost no instruments that allow stocks for long-term value acquisition by the pension funds. I argue that more passive options and better representation of Russian stock indices may be beneficial for both the real economy and future pensioners.

Russian financial markets

In Russia, banks play a more important role in the economy than financial markets (see Danilov et al., 2017). Comparing the two, we observe bank assets to GDP ratio of about 100%, and financial markets to GDP of less than 45%. The current proportion of sources of corporate and household financing (2/3 of banks and 1/3 of financial markets), and the value of financial markets to GDP, is similar to Germany. However, the banking system in Russia is smaller and less stable. For example, it attracts passives that are very short-term, with average duration of less than 3 years.

One of the causes of the underdeveloped financial markets is the low amount of money in non-government pension funds, and the restrictive regulation that requires them to protect initial capital of future pensioners. This reduces the investment opportunity set of these pension funds, as volatile stocks are unattractive to them, and instead the funds mostly choose to invest in bonds. This is specific to the Russian market: for example, there are no such restrictions in the European approach (European Commission, 2017). However, both in developed countries and in emerging markets, stocks provide higher long-term returns than bonds. Thus, future pensioners in Russia lose on the upside, and the economy sticks to banks as the main source of investment.

The macro economy is also less effective due to the small financial markets. In the data (see Cournède et al., 2015), we see a positive correlation between the growth of outstanding stocks/bonds and the economic growth for low enough levels of total value of financial markets. While causality goes in both directions (higher GDP means need for more financial instruments), this is a compelling reason to develop financial markets.

Finally, people in Russia do not “believe” in stocks and bonds. If one compares the deposit rate in a bank with the yields of the same bank, the former is almost uniformly lower than the latter. Yet, even in the case of Sberbank, the largest bank in Russia, individuals prefer to keep their money in deposits or in foreign currency. This is a signal of low financial literacy, as well as of low income, or lack of trust; this is evident in many surveys (S&P, 2015).

Therefore, our research question is: what could be done to make the Russian market more attractive to domestic investors, and make them invest and save for pensions?

Indexing

There are many papers regarding diversification and investment opportunities of individual investors. As recent research shows (see Bessembinder, 2017), individual stocks are not good for investment even on US market. Namely, most stocks return less than Treasury bills at monthly horizons. Due to this property of financial markets, it is important that domestic investors have access to wide indices.

Moreover, Berk and Binsbergen (2015) demonstrate that active mutual funds generate as much of profits as they retain as fees. This means that individual investors are better off if they choose passive options, like index funds or Exchange Traded Funds (ETFs), as their main investment vehicle. Index funds and ETFs mostly invest in one index, say S&P500 of the 500 largest US stocks, and their explicit mandate is to stick to this index. Index funds can only be bought through a broker, while ETFs are traded on an exchange, like stocks. This makes them different in terms of possibility of active portfolio rebalancing. However, both are very passive by nature.

These arguments lead to the first conclusion: to improve investment opportunities of pension funds and individual investors, as well as the macroeconomic stability, the regulator might motivate institutional market participants to provide more passive, diversified, and stock-based portfolios.

ETFs and robo-advising in Russia

One way to increase the number of passive options is to allow more ETFs in Russian stock exchanges. As ETFs and their availability to investors have to be confirmed by the regulator (the Central Bank), one cannot immediately add new ETFs to the market. Index funds are another option. However, they have a long and sad history in the Russian market: most (about 95%) of the so-called “index funds” deviate from their benchmarks and do not follow indices. This has to do with the openness of the funds: while mutual funds and index funds have to report their stock/bond/cash holdings once a quarter, ETFs publish it daily. So one can check that ETFs follow their mandates with ease. Moreover, ETFs are usually cheaper and thus save returns for investors.

While existing ETFs on the Moscow Stock Exchange already cover a wide range of markets and even some sectors (including the Russian stock market, US S&P500, Europe and China), they are still too small in terms of assets under management (about $150 millions) and are issued by one company (FinEx). Currently, FinEx ETFs are almost the only option to invest passively, and to diversify, in the Russian market. At the same time, in most markets, index funds are marginally better saving/retirement/investment vehicle as they require less trading fees and thus save returns for low-income investors.

Regulators can facilitate the process of indexation in at least two following ways: (i) allow introduction of more index funds or ETFs in the market (requires regulator’s supervision and confirmation); and (ii) provide incentives to brokers and financial advisors to make them their first recommendation to individual investors and pension funds (as is done in the US, see BNY Mellon, 2016).

Another way to cater to low-income investors is robo-advising – an ongoing revolution in the financial markets. This tool allows investors to get wealth management advice for a small fee (about 0.15% in the best case), and it mostly invests in low-cost, passive ETFs that allow diversification of investments. While this is still new for Russia (and done by FinEx with partners from banks), it has become more widespread in developed markets. Assets under management with robo-advisors increase rapidly and now exceed $220 billions. This tool is useful for investors who are not financially literate, do not have economic or financial education, but still need good investment opportunities. In Russia, robo-advising may become a norm for so-called “non-qualified” investors – people with low enough savings and no educational certificates on financial markets. The regulator has not yet confirmed this, but we see many signs that it will go in this direction. One problem for this market is that it is still not official, and human financial advice is considered as a norm for non-qualified investors if they would like to expand their investment universe to say derivatives.

A big positive side of robo-advising is the reduction of human errors. As Richard Thaler, Nobel Prize winner of 2017, has persuasively shown in his research that humans make many judgement errors. These mistakes lead to lower returns on investment, too much trading that eats returns due to fees, and higher wealth inequality. Robo-advisers avoid all that and allow individual investors to save and invest more long-term.

The second conclusion is: regulators should help the financial industry to develop better robo-advising software that uses ETFs; use these robo-advisers as replacement for human advisers; and advertise this as the option for long-term investment, including pension funds.

Conclusion

Russian financial markets should provide more financial instruments to Russian firms and higher flexibility for investors. The Central Bank as the supervisor of financial markets, and the Ministry of Economic Development as the main government branch responsible for economic growth, may take additional steps to increase availability of passive investment options for Russian citizens. Reforms of incentives of brokerage firms might be needed, yet the ultimate goal is to improve well-being and pensions, and probably make good use of the money of long-term domestic investors. One possible option is to widen already existing ETFs market and allow individual investors to use robo-advising to invest in many instruments, even if these investors are not highly qualified or wealthy.

References

Highlights for Commemoration of the 1917 Russian Revolution – Hints for Further Study

Posted on December 11, 2017 | Policy Brief

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Professional historians in general have an ambivalent attitude towards anniversaries and commemorations of historical events, be they epochal or not. On the one hand, centennials and similar memorials may alleviate the funding of one’s research projects as the authorities likewise wish to highlight certain events. On the other hand, jubilee years can tend to divert historians from their ordinary research directions. Not for nothing would even frank scholars from Oxford, England complain in 2014 of the “tyranny of celebrations” and wish that nothing comparative to the centennial of the Great War 1914-1918 would appear soon.

In Russia, similar attitudes seem not to have appeared with respect to the centennial of the 1917 revolutions, the February and October revolution as traditionally called. In my April 2017 policy brief, I noted how universities all over Russia organized conferences devoted to various aspects of 1917. Many more publications have appeared as well as translations or new editions of classical works. Here I only hint at some accomplishments that may deserve to be studied for anyone who is genuinely interested in the historical debates in Russia.

This autumn, the leading institutes of the Academy of Sciences, the Institute for General History (IVI RAN) and the Institute for Russian History (IRI RAN) held their grand events with participation of leading scholars from the West, inter alia Hélène Carrère-d’Encausse and Alexander Rabinovich, to mention only a few. The IRI RAN presented its two-volume “The Russian revolution in 1917: The Power, Society, Culture” with the same emphasis as the main theme of the conference, i.e. how the historiography of the February and October revolution changed over time (see http://iriran.ru/?q=node/1699).

Western mass media and Russia observers in particular have during 2017, in my view, one-sidedly focused on how Kremlin would, or not, ‘celebrate’, ‘commemorate’, or even ‘want to forget’ the epochal events in Russia one hundred years ago. In contrast to other anniversaries, the 200th of Napoleon’s war on Russia or the 100th of the First World War, the highest political spheres have, as it seems for good reasons, left the information sphere quite free for the professional historians, film and TV producers, and others to commemorate at their own behest the 1917 revolution.

One important source of information about the commemoration of the 1917 Russian Revolution is the book published by AIRO-XXI, Association for the Study of Russian History in the 21th Century, led by the renowned historiographer Gennadyi Bordiugov. Just as for the anniversaries of the Victory in World War Two (in 2005 and 2015), Bordiugov and his colleagues in AIRO-XXI started a huge monitoring project in late 2016 in order to follow how various groups and centres all over Russia, as well as in major Western countries, were to commemorate the 1917 Russian revolution. The monitoring is by now complete and the result is the mighty book “Revolution-100. A Reconstruction of the Jubilee” (http://www.airo-xxi.ru/-2017-/2395–100-). This will for a long time serve as the best introduction to how Russia – in the broadest terms – comes to grips with the jubilee. The first articles give the background – how the October revolution was celebrated in the Soviet era and the major changes in the post-1991 Russia. Several contributions give the present-day context – how parallels are drawn between contemporary events in Russia and abroad, on the one hand, and the Russian revolution, on the other hand. The virtual sphere today, the Internet and blogosphere take up a much more important space for the younger generation than books and encyclopaedias; therefore the monitoring project also includes surveys of which aspects of the revolution are treated therein.

In contrast to what originally was set as leitmotiv for the commemoration – a reconciliation among groups and personalities with divided approaches to the Bolshevik takeover in particular and the Soviet experiment in general, most publications, exhibitions and meetings that the AIRO-XXI have monitored show that the epochal historical cataclysms one hundred years ago still are as divisive as before. The great contrast is that disputes are formalized and fact-based, that arguments from any side are given due consideration, and that most accept the device that “there is no final truth in history, merely arguments without end”.

The AIRO-XXI monitoring also treats the cinema, television and Internet series that were shown in connection with the jubilee. Much media interest was connected with the protests from the Orthodox Church against the film “Matilda” as it allegedly defamed the last tsar Nikolai II for showing his love affair in the 1890s with a prima ballerina. The artistic freedom finally triumphed and the debates only slightly influenced the mass of cinemagoers. We can also note that Russian television channels have sent pedagogical and dramatic series on some of the major figures of the revolution. One on the mythical Aleksandr Parvus (Helphand) with his views on revolutionizing Russia during the war, even with the help of the German General Staff; the other on Leo Trotskii as people’s commissar of war from 1918. These series and many others are vividly described in the AIRO-XXI volume by the philologist Boris Sokolov, who clearly presents where historical facts might have been twisted for the sake of art.

Mention should finally be made, for those who wish to follow how Russia’s leading professional historians analyse the revolution, that many lectures given at universities during 2017 are available at YouTube. Suffice it here to mention Vladimir Buldakov (for his books, see my previous policy brief), who since the 1980s researched the Russian revolutions and presented his main theses in “Krasnaya Smuta” (Red Troubled times). In 2017, he has lectured on this theme for various audiences (compare https://www.youtube.com/watch?v=SG9T3H55Hrk;https://www.youtube.com/watch?v=JnRXgCqGBrg; https://www.youtube.com/watch?v=9UPYYBnYow8)

To appreciate how an academic discussion on the ‘Great Russian Revolution ‘ – as many scholars today prefer to treat the events in 1917 – at its best can deepen our understanding, it is well worth pondering the arguments by renowned historians Aleksandr Shubin, Aleksandr Vatlin, Tatiana Nekrasova, Gennadii Bordiugov and Vladimir Pantin in the Kultura Channel program series “Chto delat?” (What is to be done) (https://www.youtube.com/watch?v=KQF0o8adIDw). Although each of the specialists had their own interpretations and various approaches, the mentor Vitalii Tretiakov, well-known journalist and formerly chief-editor of “Nezavisimaya Gazeta, managed to step-by-step highlight the issues that have divided historians in the past, as well as such matters that will call for renewed research.

In early 2017, some hoped that commemorative arrangements on the 1917 revolution would lead towards reconciliation between those opposing groups who still reason and argue as one or the other political parties of that era, between those who sympathized with the socialists in general and/or the Bolsheviks in particular, on the one hand, and those who ideologically has more affinity with the Liberal, Conservative or Monarchist groups, on the other hand. While such reconciliation is not yet in sight, the many articles in mass media, museum exhibitions and TV series have definitely heightened the older generations’ understanding of the very complex, intricate nature of the political, social and military forces that first led to the dissolution of tsarism, their fact-based knowledge of the tentative to establish a full democratic country even in the framework of the world war, and finally to a better grasp – than the standard Soviet orthodox narratives – of why and how the seemingly minuscular Bolshevik party could successfully grasp power in November 1917 and in the end also triumph in the devastating civil war.

It goes without saying that for school teachers all over Russia, the commemorative arrangements have provided a golden opportunity to engage their pupils and students in various forms of so-called living history, i.e. combining the state’s grand story with the localities’ and the families’ own histories.

On Economics of Innovation Subsidies in Russia

Posted on October 9, 2017 | Policy Brief

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Following the general agreement that innovation is a source of economic growth, the Russian government has provided various stimuli to foster domestic innovation. One of the mechanisms of innovation policy is research subsidies. This policy brief starts off with a discussion of the theoretical predictions and empirical evidence, which relates the economic incentives of research subsides to innovation and growth. We then address the potential adverse effects of focusing innovation subsidies mainly on large public companies in Russia. Finally, we attempt to establish a link between the innovation rate and market competition within Russian industries.

Overview

According to data from the Russian Statistical Agency, the R&D intensity – measured by R&D expenditure as percent of sales – increases with company size. Companies with 50 to 500 employees spend 1% of their sales on R&D, while the R&D intensity varies from 2 to 5% of sales for larger businesses (see Figure 1). The size non-neutrality of R&D in Russia contradicts the findings in the theoretical and empirical literature, which hold for companies in the developed countries (Cohen, 2010). An explanation may be the excessive government support to public companies in Russia, and in particular, to larger public corporations. A positive consequence of such policies is that public corporations come ahead of private companies, not only in R&D intensity, but also in innovation rates (see Figures 2–3).

However, government support towards innovation does not necessarily have a positive impact on overall economic activity. The purpose of this brief is to discuss the unwanted effects of the government policy in the form of research subsidies, both in theory and in an application to public companies and corporations in Russia. We base our analysis on the outcomes of the 2014–2017 micro surveys by the Analytical Center under the Government of the Russian Federation.

The role of government

Fighting under-provision of innovation

According to the seminal paradigm of the endogenous growth models with technological change, companies are engaged in quality competition, and their innovations are explained by a rational decision to raise profits through expanding the markets for existing products or entering markets for new products (Schumpeter, 1942; Romer, 1990; Grossman and Helpman, 1991; Kletter and Kortum, 2004). The innovation becomes one of the causes of economic growth, which is proved in empirical applications for developed countries, such as the U.S., Japan and the Netherlands (Akcigit and Kerr, 2010; Lentz and Mortensen, 2008; Grossman, 1990).

Figure 1. Innovation rate and R&D intensity by company size (number of employees)

Source: Indicators of Innovation in the Russian Federation: 2017. Tables 2.4, 2.16, Data for 2015. Innovative rate is % of companies involved in innovative activity.

However, the technological change is closely linked to knowledge disclosure, which means that new products become vulnerable to imitation, and that the non-rival character of knowledge causes an under-provision of innovation on the market (Arrow, 1962). The argument supports the cause for government policies through the system of intellectual property rights on the legal side, and research subsidies as an economic mechanism (Rockett, 2010; Hall and Lerner, 2010). Research subsidies are expected to have a positive effect on innovation rate, as is empirically shown for the U.S. in Acemoglu et al. (2016) and Wilson (2009). However, the impact on economic growth is ambiguous (Acemoglu et al., 2013; Grossman, 1990).

Figure 2. Innovation rate and R&D intensity by ownership

Source: Indicators of Innovation in the Russian Federation: 2017. Tables 2.6, 2.17, Data for 2015, public corporations are different from organizations by regional/federal government.

Figure 3. Share of public funds in R&D financing, % of company budget

Notes: Indicators of Innovation in the Russian Federation: 2017. Table 1.13; Innovation Development Programmes of Russian State-Owned Companies, Fig.4.

Unwanted effects of subsidies

Two concerns are associated with subsidization of innovation. First, while research subsidies may stimulate innovation among the targeted companies, the growth effect is likely to be heterogeneous across companies in the industry or economy, leading to a neutral or even negative overall effect. For instance, the increased innovation rate in subsidized large incumbents may curb entry of new (and more productive) firms, so the net outcome is deceleration of growth in the economy (Acemoglu et al., 2013). Research subsidies may even cause a shrinking of the high-tech sectors: if skilled labor moves from manufacturing to research labs, manufacturing may experience a shortage of labor, resulting in the net effect being a decrease in production (Grossman, 1990).

Another extreme of subsidizing entrants, in view of antitrust policies, occurs when former entrants change their market status to incumbents: now they face lower profits relative to newer entrants and hence, become less incentivized in their economic activity (Segal and Whinston, 2007).

Second, innovation policy (for instance, in the form of subsidies) may sometimes not even increase the innovation rate. Indeed, incumbents have no incentives to innovate in order to keep their market power or to prevent entry of higher quality firms in industries with non-perfect competition (Rockett, 2010; Qian, 2007).

Both mechanisms are likely to hold for Russian industries, where the protection of large public corporations has led to low competition, various forms of distortions on the market and hence, weak incentives to innovate.

Potential adverse effects in Russia

Large companies are likely to attract public attention owing to their obvious advantages in spreading fixed costs of innovations (Cohen,

2010). Russia is no exception to the phenomenon, so public corporations, which are commonly of a large size, received government subsidies. However, the subsidy is primarily used for acquiring new technologies and perfecting design, rather than conducting R&D (See Figure 4 with comparison available for communications and IT industry). The fact points to a possibility of a small effect of innovations on growth of public companies. Only if the research subsidy is spent on delegating the R&D research to specialized firms, with a subsequent acquiring of the resulting technology, the existing policy of supporting public corporations may induce their growth and/or growth of the corresponding industry.

Figure 4. Structure of spending the research subsidy in communications and IT in 2013, %

Notes: Indicators of Innovation in the Russian Federation: 2017. Table 1.134 Innovation Development Programmes of Russian State-Owned Companies, Fig.3.

In an attempt to formally assess the effect of innovation subsidies on company growth, we focus on the time profiles of the common proxies for company size: sales, profits and employment (Akcigit et al., 2017; Akcigit and Kerr, 2010; Acemoglu et al., 2013). The macroeconomic literature predicts that innovation becomes one of the channels for an increase of each of the three variables through a rise in quality. Motivated by this literature, the micro-data analysis “On the Interaction of the Elements of the Innovation Infrastructure”, conducted by the Analytical Center under the Government of the Russian Federation (2014), asked companies to assess their changes in sales, profits and employment in response to the innovation subsidy. As a result, the outcomes of the above analysis allow for a comparative assessment of the impact of the government’s innovation subsidy for public and private companies.

In particular, the results point to higher growth across private companies owing to research subsidies: the percent of private companies with new employees is higher than that of public companies. Similarly, the percentage of private companies that increased market share or raised profits/export due to subsidies exceed those of the public companies (see Figure 5). Here, we interpret new hires as employment growth and increase of market share as a potential indicator of sales growth.

Figure 5. Economic activity owing to research subsidies, % of companies

Source: Analytical Center under the Government of the Russian Federation, 2014. Fig.22

The innovation activity in private Russian companies lead to a higher prevalence of new products in comparison with public companies. The fact goes in line with a more important role of research and development in the innovative activity of private Russian companies (see Figure 4).

Finally, we attempt to establish a link between the innovation rate and market competition at the level of Russian industries. For this purpose, we use the results of the annual surveys “An assessment of the competitiveness in Russia”, conducted in 2015–2017 by the Analytical Center across 650–1500 companies from 84 Russian regions. The respondents were asked if they implemented R&D as a strategy for raising their competitiveness. We use the percentage of firms doing R&D as a proxy for the innovation rate. Competition in the industry was evaluated by respondents on a five-point scale (no competition, weak, median, high and very high), and we combine the prevalence of the two top categories as a proxy for competition in the industry.

Figure 6. Competition and R&D in Russian industries, % of firms

Source: Analytical Center under the Government of the Russian Federation, 2017, pp.8, 18.

The results show that innovative activity in the form of R&D or product modification is observed in industries with relatively high competition in Russia – for instance, in machinery and electric/electronic equipment (Figure 6). At the same time, industries where competition is not as high (e.g. woodworking, construction) show absence of either type of innovation. The findings go in line with the economic theory about market competition being a prerequisite for the rational choice of companies about innovation. Moreover, if the purpose of government subsidies is to foster innovation, the effective allocation of subsidies would imply the focus on Russian industries with high competition – here various forms of innovation do play a role in the company strategy on the market.

Conclusion

Our analysis outlines the theoretical foundations for the potential adverse effects of innovation policies in the form of research subsidies. The unwanted outcomes may relate to heterogeneity of companies and absence of the association between innovation activity and growth on non-competitive markets.

We offer the empirical evidence, which points to the undesired effects of subsidizing public companies in Russia. For instance, compared to the overall Russian sector of communications and IT, the innovative activity in public corporations has a weaker association with research and development. Additionally, compared to private companies, the innovations may result in smaller prevalence of increased exports, profits or new hires, as well as in a less frequent development of new products by public companies in Russia.

References

  • Acemoglu, D., Akcigit, U., Bloom, N., Kerr, W. R., 2013. “Innovation, reallocation and growth”, National Bureau of Economic Research Working paper, No. 18993.
  • Acemoglu, D., Akcigit, U., Hanley, D., Kerr, W. (2016). Transition to clean technology. Journal of Political Economy, Volume 124(1), pages 52-104.
  • Akcigit, U., Kerr, W. R., 2010. “Growth through heterogeneous innovations” National Bureau of Economic Research Working Paper, No. 16443.
  • Analytical Center under the Government of the Russian Federation, 2014. “On the Interaction of the Elements of the Innovation Infrastructure”, Analytical report, in Russian.
  • Analytical Center under the Government of the Russian Federation, 2015-2017. “An Assessment of the Competitiveness in Russia”, Analytical reports, in Russian.
  • Arrow, K., 1962. “Economic welfare and the allocation of resources for invention”, In The Rate and Direction of Inventive Activity: Economic and Ssocial Factors, Princeton University Press, pages 609-626.
  • Cohen, W. M., 2010. “Fifty years of empirical studies of innovative activity and performance”, Handbook of the Economics of Innovation, Volume 1, pages 129-213.
  • Grossman, G. M., Helpman, E., 1991. “Quality ladders in the theory of growth”, The Review of Economic Studies, Volume 58(1), pages 43-61.
  • Grossman, G.M., 1990. ”Explaining Japan’s innovation and trade”, BOJ Monetary and Economic Studies, Volume 8(2), pages 75-100.
  • Hall, B. H., Lerner, J., 2010. “The financing of R&D and innovation”, Handbook of the Economics of Innovation, Volume 1, pages 609-639.
  • Indicators of Innovation in the Russian Federation: 2017. N. Gorodnikova, L. Gokhberg, K. Ditkovskiy et al.; National Research University Higher School of Economics, in Russian.
  • Innovation Development Programmes of Russian State-Owned Companies: Interim Results and Priorities, 2015. M. Gershman, T. Zinina, M. Romanov et al.; L. Gokhberg, A. Klepach, P. Rudnik et al. (eds.), National Research University Higher School of Economics, in Russian.
  • Klette, T. J., Kortum, S., 2004. “Innovating firms and aggregate innovation”, Journal of Political Economy, Volume 112(5), pages 986-1018.
  • Lentz, R., Mortensen, D.T., 2008. “An empirical model of growth through product innovation”, Econometrica, Volume 76(6), pages 1317–1373.
  • Qian, Y., 2007. “Do national patent laws stimulate domestic innovation in a global patenting environment? A cross-country analysis of pharmaceutical patent protection, 1978–2002”, The Review of Economics and Statistics, Volume 89(3), pages 436-453.
  • Rockett, K., 2010. “Property rights and invention”, Handbook of the Economics of Innovation, Volume 1, pages 315-380.
  • Romer, P. M. (1990). Endogenous technological change. Journal of political Economy, 98(5, Part 2), S71-S102.
  • Segal, I., Whinston, M.D., 2007. “Antitrust in innovative industries”, American Economic Review, Volume 97(5), pages 1703-1730.
  • Schumpeter, J., 1942. “Creative destruction”, Capitalism, Socialism and Democracy, pages 82-83.
  • Wilson, D. J., 2009. Beggar thy neighbor? The in-state, out-of-state, and aggregate effects of R&D tax credits. The Review of Economics and Statistics, Volume 91(2), pages 431-436.

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Intergenerational Mobility of Russian Households

Posted on May 2, 2017 | Policy Brief

To understand the nature of income inequality one needs to know how persistent the inequality is across generations. The same inequality levels could conceal different intergenerational mobility. We utilize the Russian Longitudinal Monitoring Survey (RLMS-HSE) to find out how large intergenerational mobility in Russia is as measured by income, educational and occupational mobility. We find that although a sizeable upward intergenerational educational mobility, there is a pronounced occupational immobility and a low level of intergenerational income mobility. Indeed, the position of children in the income distribution is highly correlated with the income position of their parents, especially their mothers.

Sizeable and non-decreasing inequality in Russia poses a threat to social stability and long-term sustainability. Inequality in Russia has remained high throughout the transition period, and even slightly increased in the 2000s; the Gini inequality index rose from 0.397 in 2001 to 0.416 in 2014. The ratio of average incomes of the highest decile to those of the lowest decile also increased from 13.9 to 16 during this same period. This income gap is driven primarily by the gap between incomes of the top decile and all of the others: the top decile is estimated to have thirty percent of total monetary income in the economy. Furthermore, income inequality originates in earnings inequality: the top decile of wage earners gets thirty five percent of total wage earnings in the economy.

A key question is how persistent the inequality is, given that the same inequality levels could conceal different intergenerational mobility. In particular, social stability is challenged when income inequality is stable across generations, or put differently; there is little intergenerational mobility. Economic developments of the last 25 years seem to increase the risks of getting this problem in Russia.

Data and research methodology

We employ Russian Longitudinal Monitoring Survey (RLMS-HSE) to find out how large intergenerational mobility in Russia is as measured by income, educational and occupational mobility (Denisova and Kartseva, 2016). The RLMS-HSE questionnaires in 2006 and 2011 contain questions on dates of birth, education and occupation of the father and mother of the respondent when the respondent was 15 years old.

To study occupational and educational mobility, we use the subsample of respondents of 25-55 years old and utilize the information on education and occupation of the respondent and his/her parents. We then estimate whether the parental education level predicts the probability that children have a university degree, a secondary or a junior professional degree.

To study intergenerational occupational mobility, we estimate influence of parental occupation on the probability that the child works as a manager, a professional, a technician or professional associate, a clerk, a qualified worker or an unskilled worker.

To study the child-parent income correlation based on RLMS is trickier. There is a panel component in RLMS but it is not long enough to study intergenerational mobility directly since we for most cases are not able to observe both parents and children during their working ages. To overcome the problem we impute wages for parents. In particular, we choose respondents aged 25-35 (children) in 2006 (and 2011). We then identify respondents born in the period 1945-1961 (1945-1966 for children in 2001) (‘parents’) and use the labor market information for this group as of 1995 (2001 as robustness check) to impute parental wages. We estimate a wage equation (separately for males and females) on the sample of ‘parents’ and then use the estimated returns (coefficients) and the reported age and education of respondent’s mother and father to impute wages of respondent’s parents.

We follow Björklund and Jantti (1997) to estimate the child-parent correlation of earnings based on the equation:

delta= β0 + β1X+ β2 delta_father + β3 delta_mother + ε

where delta=log(wage/average wage in respective sample), X – age, education, settlement type, region. Standard errors are clustered on primary sampling unit.

Intergenerational educational mobility

Our analysis shows that the education of parents, high professional (university) and secondary professional in particular, is a major determinant of children’s education. Moreover, there are clear signs of upward educational mobility across generations for both males and females: the coefficients in the transition parent-child matrix are significantly higher above the diagonal (Table 1).

Table 1. Father-child education matrix

Source: Authors’ calculations based on RLMS

The probability to have a university degree is 2.4 percentage points higher if the mother’s education is at university level (as compared to secondary school), and 2.1 percentage points higher if the father’s degree is at university level (as compared to secondary school). A secondary professional degree of parents also increases the probability of a child getting a university degree by about 1 percentage point. The probability of having secondary professional degree decreases if the father or mother has a university degree.

Intergenerational correlation of occupations

There are signs of sizeable occupational rigidity between generations, especially for the top two occupational groups (managers and professionals). The probability that a child works in the same occupational group is the highest for parents-professionals: it is 40% for fathers-professionals and 35% for mothers-professionals. Surprisingly, it is also rather high for parents employed as skilled workers – about 20%. These patterns survive controlling for other variables.

Income mobility

The correlation of parent-child wages measured for 2006 data are presented in Table 2. The results point to the sizeable average intergenerational rigidity of relative wages: the wage elasticity of children’s wages with respect to parental wages is about 0.4. This is at the level of the intergenerational wage rigidity in the US (Solon 1999).

There is sizeable gender asymmetry in the rigidity: we observe a high and significant correlation of son-mother wages, but an insignificant correlation of son-father wages. There is no significant correlation of daughter-parents wages.

Table 2. Parent-child income correlations, 2006

Source: Authors’ calculations based on RLMS

Conclusion

Generational poverty stemming from low intergenerational income mobility is a threat for sustainable development in any country. The economic and social development in transition seems to increase the risks of having this problem in Russia. Our estimates show that although there is sizeable upward intergenerational educational mobility in Russia, there is a pronounced occupational immobility, and low level of intergenerational income mobility. Indeed, the position of children in the income distribution is highly correlated with the income position of their parents, especially mothers. These findings are worrisome signals important for the design of policies of sustainable development.

References

  • Björklund, Anders; and Markus Jantti, 1997. “Intergenerational Income Mobility in Sweden Compared to the United States,” American Economic Review, 87(5), 1009–18.
  • Denisova, Irina; and Marina Kartseva, 2016, “Intergenerational Mobility of Russian Households”, mimeo
  • Solon, Gary, 1999. “Intergenerational Mobility on the Labor Market,” Chapter 29 in Handbook of Labor Economics, Vol.3 edited by O.Ashenfelter and D.Card , 1761-1800.

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To Commemorate the 1917 Revolution in Russia – Occasions More for Reflections than for Celebrations

Posted on April 7, 2017 | Policy Brief

20170406 FREE Policy Brief by Lennart Samuelson Image

The centennial of the 1917 revolution in Russia provide opportunities for the public to refresh knowledge of the tumultuous events that dramatically changed the country’s history. Conferences, television series and debates, exhibitions at historical and art museums are some of the activities that will illuminate the February and October revolutions in 1917. The complex, intertwined and contradictory historical process and the following tragic Civil war 1918 – 1922 calls for careful, objective and dispassionate approaches and evaluations.

Over the last years, Russia has officially sponsored or encouraged great historical commemorations, e.g. the bicentennial of the war against Napoleon in 1812 and the centenary of the outbreak of the First World War. In contrast, this year’s commemoration of the 1917 revolution(s) in Russia – the first in February and the other in October (old style calendar) – pose a whole range of difficult questions. In the contemporary school curriculum in Russia, the most often used concept is ‘the Great 1917 Revolution in Russia’, thereby avoiding the previous, inappropriately counter posed February vs. October revolution. Instead, emphasis shifts to a continuous spectrum of revolutionary processes on different levels of the state and in various social groups throughout 1917. Likewise, this concept captures the multi-ethnic character of the revolution better than ‘the Russian revolution’.

In this brief, I outline the expected results from professional historians and archivists, by academic institutions and museums. In a forthcoming study of recent Russian historiographic debates (Samuelson, 2018), I intend to analyze also the changing official assessments of the 1917 revolutions.

In the Soviet era until the glasnost in the late 1980s, party-controlled historians described the ‘Great Socialist October revolution’ tendentiously, with many obfuscations and ‘white spots’. Not only were the opponents of the Bolsheviks depicted in caricature forms; also, the later oppositionists to Stalin’s party line were eliminated from the 1917 history, or mentioned merely for the alleged mistakes. In the West, on the other hand, there existed a plethora of interpretations of the Russian revolution, reflecting ideologies and worldviews of liberals, conservatives, as well as exiled Russian politicians (see e.g. Mazour, 1971 or Laqueur, 1967).

In the decades since the fall of the Soviet Union, Russian historians have profoundly enriched our knowledge of the 1917 revolutionary process as well as the ensuing Civil war. ‘Un-persons’ like Lev Trotsky, and hundreds of other who were expelled later from the Communist party, got back their due place in history. Works have been published of monarchists, liberals and socialists who led the Provisional governments during 1917. Historical studies by exiled scholars, as well as memoirs by politicians and diplomats that were once published in the West, have now been reprinted by Russian publishing companies (for the best survey, see Gennadyi Bordiugov, 2013 (1,520 pages!!)).

In today’s Russia, there co-exist an abundance of interpretations and assessments of the 1917 revolutions. The February strikes and uprising in Petrograd triggered the abdication of tsar Nikolay II, led to the founding of a republic and the formation of new government. The revolutionary changes outside the capital, throughout the whole empire, took quite different forms and only in recent years, regional scholars could describe them objectively.

Naturally, the fundamental changes in the political landscape in Russia after the return from exile of Vladimir Lenin in spring 1917 have attracted interest by scholars. Solid biographies of Lenin by Dmitrii Volgogonov (1994), Vladlen Loginov(2017), Anatolii Latyshev(1996) and Elena Kotelenets(2017), to mention only a few, give the Russian public a more nuanced figure than the more hagiographic works published in the Soviet epoch. The British historian Catherine Merridale (2016) gives a fascinating narrative of how Lenin’s return from exile in Switzerland would completely change the perspectives of the revolution. The renowned Russian specialist Vladimir Buldakov wrote profound reinterpretations of the ‘Red Troubled times’ (Krasnaya smuta) of 1917 in the first of a series of path-breaking research in the central and regional archives (Buldakov 2010, 2015).

As we approached the centennial of this decisive and deeply divisive year in Russia’s long history, many observers wondered how it was to be officially observed. Just like similar jubilee years, for example in 1989 of the French Revolution, it seemed obvious that this was not a time for triumphant celebrations as had been the case of the annual October Revolution holiday (on 7th November, new calendar) in the Soviet era. On the other hand, it would equally be unfortunate to pass over in silence this eventful revolutionary year. So by support from the Ministry of Culture, the Russian Historical Society (abbrev. RIO) set up a vast program of conferences, round tables, exhibitions and publications. Universities all over the Russian Federation will organize gatherings for historians and students. Central and regional archives arrange exhibitions, the explicit purpose of which is, not to give any definite value judgments, but to let the public form their own views on the personalities by pondering over original documents on Tsar Nikolai II and the tsarist family, the politicians of various parties, as well as on Lenin, Bolsheviks and others of the Left.

The call from the Russian political leaders has been to strive for a balanced, as dispassionate as possible, reassessment of the 1917 revolution in Russia. The ensuing civil war 1918–1922 created a generation-long, deep division among Russians, inside the country and in exile. Just as was the case in other countries, e.g. Finland and Spain, where civil wars scarred the national fabric in the 20th century, at present, the goal should be for reconciliation and mutual understanding of the historical actors on all sides of the political spectrum.

This spring, the Siberian branch of the Academy of Sciences in Novosibirsk organized a round-table on the 1917 revolution. Dozens of scholars presented their research findings and opinions on various events in the region; the protocol’s understatement that “the discussions had often a polemical character” indicate that the Russian revolution is still a subject of hot controversies, even in academic circles. On 29–31 March, the Moscow State University arranged the first of several grand international conferences planned this year. In twenty sessions, hundreds of scholars from all over Russia and from foreign countries gave papers on widely different aspects of the revolutionary processes. Likewise, universities in Samara, Volgograd, Cheliabinsk and other cities have announced their forthcoming conferences on the 1917 Revolution.

The main depository of political archives, RGASPI, in Moscow has contributed over 800 archival documents to a special exhibition, ‘1917. The Code of the Revolution’ at the Central Museum of Contemporary Political History. (https://www.sovrhistory.ru/events/exhibition/58becc2aa0e5981d9da515c4, accessed 31.03 2017). Two grand exhibitions projects with less-known archival documents attempt to give new perspectives, first, on Tsar Nikolai II, and, later this year, on Vladimir Lenin; both are of course well-known personalities, but the archivists and museums’ commissars hope to inspire visitors to renew their perspectives. In St. Petersburg, besides conferences, round-tables and exhibitions, there will be theatrical performances to reproduce dramatic events of 1917 and precisely on the streets and squares where they once upon a time took place. Russian Internet sites will provide pieces of contemporary news from 1917 for each day (https://project1917.com/).

Publishing houses have started new series devoted to the 1917 revolution in Russia, and the shelves in bookshops give abundant ‘food for thought’ for eager readers. Here one can find not only Trotsky’s own renowned History of the Russian Revolution written in his exile in the USSR. There are also memoirs by officers in the White Army during the Civil war, and a multitude of new popular-history works that reflect today’s ‘lessons of history’. The leading publishing company Rosspen will edit an archival documentary series, and compile an encyclopedia on the 1917 Revolution, thus hopefully summing up what has been accomplished in the former states of the USSR concerning the dramatic year of 1917 that was to profoundly change not only the country’s history, but even global history for many years ahead.

References

  • Dmitrii Volkogonov, Lenin: A New Biography, New York, 1994;
  • Vladlen Loginov, Lenin: How to become a leader, Glasgow 2017;
  • Anatolii Latyshev, Rassekrechennyi Lenin (The declassified Lenin), Moscow 1996;
  • Elena Kotelenets, Bitva za Lenina. Noveishie issledovaniia i diskussii (The Fight over Lenin: Recent research and discussions), Moscow 2017.
  • Catherine Merridale, Lenin on the train (Swedish edition Lenins resa: Vägen till revolutionen 1917), London 2016.
  • Vladimir Buldakov, Krasnaya smuta: Priroda i posledstviia revoljutsionnogo nasiliya (The Red Troubled Times: The nature and consequences of revolutionary violence), Moscow 2010;
  • Vladimir Buldakov, Voina, porodivshaia revoliutsiiu (The War that brought along the revolution), Moscow 2015.
  • Lennart Samuelson, Sovjetepoken i backspegeln.The Soviet Epoch in the Rear-view Mirror’, forthcoming in 2018
  • Anatole G. Mazour, The Writing of History in the Soviet Union, Stanford: Hoover University Press, 1971;
  • Walter Laqueur, The Fate of the Revolution: Interpretations of Soviet History from 1917 to the Present, London: Macmillan, 1967.
  • Gennadyi Bordiugov (ed.), Mezhdu kanunami: Istoricheskie issledovaniia v Rossii za poslednie 25 let, Moscow: AIRO-XXI, 2013

The photograph to this policy brief shows Bolshevik leader Vladimir Lenin and other Russian exiles in Stockholm, 13 April 1917, on their way from Switzerland, to change the course of the Russian Revolution and world history of the 20th century. Social democrat Ture Nerman is talking with Lenin (4th from right, with umbrella).; behind them – mayor Carl Lindhagen and Aleksandra Kollontay, radical feminist who spent World War One here and in the 1930s to return to Stockholm as ambassador of the USSR.

Note: This Swedish photograph is in the public domain in Sweden because one of the following applies: (i) The work is non-artistic (journalistic, etc.) and has been created before 1969, (ii) The photographer is not known, and cannot be traced, and the work has been created before 1944.

 

Too High or Too Low? The Pros and Cons of Regulating the Reserve Price in Public Procurement in Russia

Posted on March 13, 2017 | Policy Brief

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In theory, an optimally set reserve price leads to an optimal outcome in all standard auctions. In reality, however, it is difficult to identify the optimal reserve price. In public procurement auctions, a higher reserve price may lead to a higher competition for the contract, because more suppliers will find the contract profitable. Thereby a higher reserve price may lead to lower prices. But on the other hand, if competition in the market is already quite low or the risk of collusion is high, a higher reserve price will just lead to higher contract prices. The controlling bodies in Russia become suspicious when the reserve price in public procurement auctions is too low because they are afraid it is a sign of collusion between the procurer and the seller. Indeed it may be the case that the reserve price is set low to exclude other sellers from competing, thus acting against efficiency. Using data on public procurement of gasoline in 11 Russian regions in 2011-2013, we show that a higher reserve price did not lead to lower contract prices, and that low competition in the private market was a major obstacle to efficiency.

Why is the reserve price important?

The reserve price is widely discussed in the auction and procurement literature. Standard auction theory says that an optimally set public reserve price results in the optimal outcome in all standard forms of auctions with risk-neutral agents and independent private values (Myerson, 1981). But practice is far from pure theory. The procurer does not have all information to set the optimal price and this leads to losses in social welfare (Klemperer, 2004; Dimitri et al, 2006).

There are several concerns for a practitioner here. First, there is the question of whether the reserve price should be known to everybody in advance (Dimitri et al, 2006; Brisset et al, 2015; Eklof&Lunander, 2003). Second, the reserve price influences the entry decision and competition for the contract (Klemperer, 2004; Krishna, 2009; Wang, 2016). Generally, a higher reserve price may lead to higher competition for the contract, because more suppliers will find that contract profitable, which may in turn lead to lower prices. But on the other hand, if there is a high probability of collusion in the market, a higher reserve price will just lead to higher contract prices due to coordinated behavior of the potential sellers (Wang, 2016). The procurer could use lower reserve prices to decrease gains from collusion (Krishna, 2009), but in a corrupt environment a lower reserve price is treated as an instrument to restrict entry for the favor of preferred bidders in exchange for bribe (Guide to Combating Corruption & Fraud in Development Projects).

Hence, there are various arguments for and against setting the reserve price in public procurement auctions higher rather than lower. We are interested in showing which of them hold true in practice, or in other words, do higher reserve prices lead to lower contract prices in public procurement auctions?

In Russian public procurement, the reserve price in an auction is set by the procurer and is visible to everybody. Moreover, before April 2011, procurers were free to set the reserve price, and they could easily set it unreasonably high, and then share the surplus with a seller. Starting from April 2011, procurers are obliged to prove that the reserve price is set at a reasonable level. In the explanations to the Law from Ministries of Economy and Finance, there are recommendations to set the reserve price higher rather than lower. Regulators are much more afraid of corruption than a high price of the contract.

Using data on public procurement of gasoline in 11 Russian regions in 2011-2013, we show that a higher reserve price did not lead to lower contract prices, and that low competition in the private market was a major obstacle to efficiency.

How does public procurement of gasoline work in Russia?

To make it clear how auctions in Russia are held, we will now present some details on Russian public procurement of gasoline.

First, the public procurement law is the same for all Russian regions. Second, the detailed information on public procurements – including calls for bids, chosen procedure, auction protocols, and supporting technical documentation – is published online at a unified website. If the reserve price is below 500000 rubles, public buyers of gasoline may choose between sealed-bid “paper” auctions and open-bid electronic auctions. If the reserve price is above 500000 rubles, they should use open electronic auctions.

To set the reserve price, a procurer may ask a few firms to provide estimates of an expected price of the contract at which they would agree to sign the contract. Alternatively, procurers may search for price information on the Internet or in other open sources on prices of goods and services (some gasoline stations publish its prices online, e.g.). The reserve price may then be calculated on the basis of these prices.

The procedures start when a procurer publishes the call for bids, stating basic characteristics of the contract and the reserve price. In sealed-bid auctions the bidders send their price quotations and the supporting documents. The bids are opened simultaneously, and the lowest bid (or the earliest bid in case where two or more equal prices are announced) wins. Open-bid auctions are conducted in two stages. By the first deadline all perspective bidders should provide a statement of interest, including the supporting documents and in some cases monetary deposits. Procurer may assess the statements of interest and exclude the firms that do not meet the basic requirements at the bidding stage. At the second stage, the preselected bidders show up at the auction and make descending open bids. The lowest bid wins the contract.

Data, empirical strategy, and results

To figure out whether higher reserve prices lead to lower contract prices in public procurement auctions, we used data on public procurement procedures available at a unified official public procurement website. In particular, we collected data on all public purchases of gasoline with octane number 92 at the regional level in 2011-2013 in 11 regions of Russia (1559 observations).

Among the characteristics of the procurement procedures, the most important are the number of bidders, the type of the procurement procedure (sealed-bid or open), and the characteristics of the contract (the volume and duration). We also take into account the number of price quotations the procurer uses to calculate the reserve price and some other characteristics of the purchase: the number of procurers in centralized purchase, the number of purchases of gasoline this procurer made in 2011-2013, and whether the procurer requested some special conditions from the seller (e.g., that the seller should have a network of gasoline stations).

The information allowed identifying:

  • Procurements with only one bidder;
  • Procurements with no or a very small price decrease as a result of the auction;
  • Procurements with a reserve price higher than the market price;
  • Procurements with a reserve price higher than the maximum of the price quotations.

Using these new variables, we test whether the probability that there is only one bidder (which is not what a regulating body would wish to see) correlates with auction characteristics and the fact that the reserve price is higher than the maximum of the price quotations (implying it is unreasonably and probably inefficiently high).

Table 1 Regression results

Probabilty Probabilty
VARIABLES One bidder Discount = 0
one bidder 1.074***
(0.115)
open auction 0.749*** -0.191*
(0.0973) (0.115)
volume 8.62e-06*** -3.03e-06
(2.51e-06) (1.96e-06)
duration 0.000828* 0.00209***
(0.000454) (0.000610)
number of price quotations -0.126*** 0.386***
(0.0436) (0.0539)
reserve price is higher than max of quotations -0.469*** 0.560***
(0.108) (0.136)
Constant -0.264** -0.694***
(0.126) (0.160)
Observations 931 932

Standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1

We also test whether the probability that there is no price decrease during the auction (discount equals zero) correlates with the auction characteristics and the fact that the reserve price was higher than the maximum of the price quotations or just higher than the market price.

Table 1 shows that a higher reserve price does not lead to a higher competition, but leads to higher probability of the situation that there will be no price decrease at all. Hence, there is no evidence that setting the reserve price at a higher level will attract more bidders and result in lower contract prices.

Conclusion

Auctions are viewed as one of the best ways to achieve lower prices. But in reality there are many factors that make this questionable. In this policy brief, we focus on the regulation of the reserve prices in public procurement. Is it reasonable to recommend procurers to set high reserve prices? We look at a specific market with high entry barriers, and a relatively low number of suppliers active on the public procurement market. Such markets face high collusion risk.  We show that high prices do not attract more bidders and auctions with reserve prices set higher than all quotations end up with no price decreases during the auction. A big share of auctions (46% in our data set) in Russia is inconsistent (only one bidder comes to bid), and in such an environment high reserve prices can only increase government spending. It is more reasonable to follow the ideas mentioned by Krishna (2009) and use low reserve prices to decrease contract prices and, thus, gains of suppliers from colluding behavior, even if it happens. Our study shows that general recommendations that do not take into account market specifics could not help procurers achieve efficient results.

References

  • Krishna, Vijay. Auction theory. Academic press, 2009, ch.11.
  • Klemperer, Paul. “Auctions: Theory and Practice.” Princeton University Press, 2004, ch.1,3,4.
  • Dimitri, Nicola, Gustavo Piga, and Giancarlo Spagnolo, eds. Handbook of procurement. Cambridge University Press, 2006, ch.11.
  • Myerson, Roger B. “Optimal auction design.” Mathematics of operations research 6.1 (1981): 58-73.
  • Brisset, Karine, François Cochard, and Julie Le Gallo. “Secret versus public reserve price in an “outcry” English procurement auction: Experimental results.” International Journal of Production Economics 169 (2015): 285-298.
  • Eklöf, Matias, and Anders Lunander. “Open outcry auctions with secret reserve prices: an empirical application to executive auctions of tenant owner’s apartments in Sweden.” Journal of Econometrics 114.2 (2003): 243-260.
  • Wang, Hong. “Information Acquisition Versus Information Manipulation in Multi-period Procurement Markets.” Information Economics and Policy (2016).
  • Guide to Combating Corruption & Fraud in Development Projects, http://guide.iacrc.org/

The Economics of Russian Import Substitution

Posted on December 5, 2016 | Policy Brief

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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
(1) (2) (3) (4) (5) (6)
Ad valorem tariff equivalent, % 2.9 3.9 6.1 6.7 5.6
Change in
CPI, % 0.04 0.09 0.39 0.3 0.3 1.0
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
GDP, % -0.002 -0.011 -0.023 -0.005 -0.018 -0.049
Welfare, % -0.015 -0.020 -0.074 -0.041 -0.080 -0.215

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.

References

  • 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)

Russia and Oil — Out of Control

Posted on October 31, 2016 | Policy Brief

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Russia’s dependence on oil and other natural resources is well known, but what does it actually mean for policy makers’ ability to control the economic fate of the country? This brief provides a more precise analysis of the depth of Russia’s oil dependence. This is based on a careful statistical analysis of the immediate correlation between international oil prices — that Russia does not control — and Russian GDP, which policy makers would like to control. I then look at how IMF’s forecast errors in oil prices spillover to forecast errors of Russian GDP. These numerical exercises are striking; over the last 25 years oil price changes explain on average two thirds of the variation in Russian GDP growth and in the last 15 years up to 80 percent of the one-year ahead forecast errors. Instead of controlling the economic fate of the country, the best policy makers can hope for is to dampen the short-run impact of oil price shocks. A flexible exchange rate and fiscal reserves are key volatility dampers, but not sufficient to protect long-term growth. The latter will always require serious structural reforms and the question is what needs to happen for policy makers to take action to get control over the long-term fate of the economy.

In a recent working paper (Becker, 2016), I take a careful look at the statistical relationship between Russian GDP and international oil prices. This brief summarizes this analysis and its policy conclusions.

Russia and oil, the basics

Although Russia’s oil dependence is discussed every time international oil prices drop, it is not uncommon to hear that oil is not really so important for the Russian economy. The argument is that the oil and natural resource sector only accounts for some 10 percent of Russian production. This is indeed consistent with the official sectoral breakdown of GDP that is shown in Figure 1 where the minerals sector indeed only has a 10 percent share.

Figure 1. Structure of GDP in 2015

slide1Source: Federal State Statistics Service, 2016

However, this static picture of production shares does not translate into a dynamic macro economic model that allows us to understand what is driving Russian growth. Instead a careful analysis of the time series of Russian GDP is required to understand how important oil is for growth.

Russian GDP can be measured in many different ways: nominal rubles, real rubles, U.S. dollars, or in purchasing power parity (PPP) terms to mention the most common. Here we focus on GDP measured in real rubles and U.S. dollars since we want to get rid of Russian inflation, which has been quite high for most of the studied time period. The PPP measure generates figures and numerical estimates that are in between the real ruble and U.S. dollar measures and are not included here to conserve space.

The first evidence of the importance of international oil prices as a major determinant of Russian income at the macro level is presented in Figures 2 and 3 where the first figure shows dollar income and the second real ruble income. In both cases it is obvious that there is a strong correlation and that the correlation is higher for income measured in dollars.

Figure 2. U.S. dollar GDP and the oil price

slide2Source: IMF, 2016

Figure 3. Real ruble GDP and the oil price

slide3Source: IMF, 2016

However, it is also clear that all the time series have some type of trends or in econometric language, are non-stationary. This means that simple correlations of the time series shown in Figure 2 and 3 may not be statistically valid (or “spurious” as it is called in the literature). This is not a critical issue but can be handled by regular econometric methods.

Russia and oil, the econometrics

When time series are non-stationary they need to be transformed to some stationary form before we can do regular regressions (in Becker, 2016 I also address the issue of using a framework that allows for co-integration).

Two transformations that make the variables stationary are to use first differences or percent growth rates. Both are used before we run simple regressions of growth or first differences of GDP on growth or first difference in international oil prices. The full sample starts in 1993, but since the early years of transition were subject to many different shocks at the same time, a shorter sample starting in 2000 is also used.

A number of observations come from the estimates that are presented in Table 1: Oil prices are always statistically significant; the adjusted R-squared is higher for dollar income than real rubles (with one exception due to a large outlier in 1993); overall the explanatory power of these simple regressions are very high (42-92 percent) and the explanatory power increases in all specifications when going from the full sample (1993-2015) to the more recent sample (2000-2015). Note that the latter sample perfectly overlaps with the current political leadership so contrary to some wishes; the oil dependence has not been reduced under Putin/Medvedev.

Table 1. Russian macro “models”

slide4Source: Becker 2016

Russia and oil, the forecasts

The strong correlation between international oil prices and Russian GDP provides a very simple econometric model for explaining past variations in Russian GDP. Unfortunately it does not imply that it is easy to forecast Russian GDP since international oil prices are very hard to predict. There are many models that have been used to forecast oil prices, but the IMF and many others now use the market for oil futures to generate its central forecast of oil prices.

The IMF also provides confidence intervals around the central forecast, and the uncertainty surrounding the forecast is substantial: In the latest forecast the 68 percent confidence interval goes from around 20 dollars per barrel to 60 one year ahead, while the 98 percent interval ranges from 10 dollar per barrel to around 85. With oil currently around 45 dollars per barrel, these variations imply that oil prices could either halve or double in the next year, not a very precise prediction to base economic policy on for Russia since the estimates for real ruble growth in the later sample in Table 1 imply that Russian GDP growth in real ruble terms could be anywhere from minus 5 to plus 10 percent, or a fifteen percentage point difference!

If we look at past IMF forecasts of oil prices and Russian GDP and see how much they deviate from actual values a year later we can compute one year ahead forecast errors. We can do this calculation for the last 16 years for which the IMF data is available. Figures 4 and 5 show how the forecast errors in oil prices correlate with the forecast errors for dollar income and real ruble income, respectively. Similar to the regressions presented in Table 1, the correlations are very high for both measures of GDP: 82 percent for dollar GDP, and 65 percent for real ruble GDP.

In other words, a very large share of the uncertainty surrounding Russian GDP forecasts can be directly attributed to variations in international oil prices, a variable that (again) Russia does not control. The fact that the variations in oil prices explain somewhat more of the variation in dollar income compared to real ruble income is a result of a policy change that in later years allowed the exchange rate to depreciate much more rapidly when oil prices fall.

Figure 4. Forecast errors

slide5Source: Becker 2016

Figure 5. Forecast errors

slide6Source: Becker 2016

Policy conclusions

The depth of Russia’s oil dependence is much greater than what casual observers of the mineral sectors share of GDP would suggest. At the macro level, variations in international oil prices explain at least two thirds of actual Russian growth and even more of the one-year ahead forecasts errors.

The experience of the 2008/09 global financial crisis provided an important lesson to Russian policy makers, which is that exchange rate flexibility is required to dampen the real impact of falling oil prices and to protect both international reserves and the fiscal position. In the more recent years, the currency has been allowed to depreciate in tandem with falling oil prices and the drop in real ruble income was therefore less severe in 2015 than in 2009. Income in dollar terms, instead, took a greater hit, but this was a necessary corollary to protecting reserves and the budget. A flexible exchange rate and gradual move to inflation targeting in combination with accumulating fiscal reserves in times of high oil prices are key to Russia’s macro economic stability.

Nevertheless, these policies are not sufficient to remove the long-run impact that low or declining oil prices will have on growth, measured both in real ruble terms or dollar terms. It is nice to have fire insurance when your house burns down, but when you rebuild the house you may want to consider not building another straw house. For Russia to build a strong economy that is not completely hostage to variations in international oil prices, fundamental reforms that encourage the development of alternative, internationally competitive, companies are needed. This includes reforms that initially will reduce policy makers control over the economy and legal system, but over time it will provide the much needed diversification away from exporting oil that puts the fate of the Russian economy squarely in the hands of international oil traders. Losing some control today may provide a lot more control in the future for the country as a whole, but perhaps at the expense of less control for the ruling elite.

References

Russia’s State Armament Plan of 2010 – The Macro View in mid-2016

Posted on September 26, 2016 | Policy Brief

FREE Policy Brief Torbjorn Becker

Russian defense spending has increased significantly in recent years and reached over 4 percent of GDP in 2015 according to estimates. If the Russian state armament program for 2011-2020 is fulfilled, further large investments will be made in the years to come to modernize the military forces. However, the macro economic realties have change dramatically since the original plans were drawn up in 2010. This brief provides an analysis of what the new macro economic reality means for the armament plans that were made in 2010. In short, the major issue is not that spending as a share of GDP has increased dramatically but rather that the nominal ruble amounts that make up the plan amount to significantly less real purchasing power both in real ruble and dollar terms according to the most recent forecasts. In other words, it is not necessarily the trade off between different government spending areas that will be the main issue in this new macro economic environment, but rather what the priorities will be regarding different types of military equipment within the existing plan.

A 2016 study by Julian Cooper details Russia’s state armament plans for 2011 to 2020, “GPV-2020” (in Russian, State armament program is Gosudarstvennaia Programma Vooruzheniia), to the extent that is possible by using open source information. He makes a special point of discussing the non-transparent structure of Russian defense spending, which makes more precise calculations and statements regarding this expenditure area difficult or even impossible. Nevertheless, he provides broad numbers for the state armament plans that are publically available and this is used in this brief.

The plans of 2010

The state armament plans for 2011-2020 that were made in 2010 were stated in nominal ruble terms. The full path of the plan has not been announced but a total of 19 trillion rubles has been mentioned.

Figure 1. Armament and defense spending

slide1Source: Author’s calculations based on Cooper (2016)

Cooper’s study details amount until 2015 and in Figure 1, the remaining years have been guesstimated by a smooth trend that delivers a cumulative plan of 19 trillion rubles.

The armament plans were very ambitious and it is noteworthy that they were almost fully implemented during the years for which we have actual numbers from Cooper’s study (the blue and red lines almost overlap perfectly). The other rather remarkable feature is how high these spending are compared to the national defense spending reported in his report, with the GPV plan peaking at 70 percent of defense spending.

Changing macro environment

The armament plans were not made in a vacuum but decided based on the economic outlook at the time, i.e., what policy makers projected in 2010.

Figure 2. IMF forecasts and actual GDP

slide2Source: Author’s calculations based on IMF (2010, 2016). Note: The IMF’s 2010 forecast only goes to 2015 and for the remaining years a constant growth rate based on the last year is used.

Figure 2 shows what the IMF’s growth forecasts back in 2010 implied for the development of nominal GDP (dotted blue line); what actually happened until 2015 (solid red line); and what is projected to happen between 2016 and 2020 according to the latest IMF World Economic Outlook forecast of April 2016 (dotted red line). As is pointed out in Becker (2016), international oil prices are key for Russia’s growth performance and any forecast of it is no better than the forecast of oil prices. This implies that also the IMF’s April 2016 projection is highly uncertain, but this is true for any other forecast of Russian GDP as well.

There are two important observations that follow from Figure 2; first, nominal GDP at the start of the program was underestimated; and second, the growth rate was overestimated. As coincidence some times has it, two wrongs make close to a right for 2016; i.e., the forecast of 2010 almost perfectly coincides with what is expected to be the nominal GDP level in 2016 and 2017 in the latest IMF forecast. However, since the slowdown in expected growth is rather significant, in later years the IMF now expects nominal GDP to be less than what it thought it would be in 2010.

Implications for the GPV

The fact that nominal GDP in 2016 and 2017 is almost exactly the same as projected in 2010 implies that the GPV plan as a share of GDP based on the 2010 forecast compared with the 2016 forecast is almost the same in 2016 and 2017. This may be viewed as a peculiar circumstance but it can also have real implications. If the plan in 2010 was developed with a greater view of priorities in different government spending areas, the fact that the plan is still not absorbing more as a share of GDP suggest that the plan may not necessarily be a contentious issue at the level of the government.

However, this is expected to change after 2017 when nominal GDP will be lower than originally thought, and therefore the GPV share of GDP would be higher as seen in Figure 3.

Figure 3. GPV plan as share of GDP

slide3Source: Author’s calculations based on Cooper (2016) and IMF (2010, 2016)

A more immediate concern would be what the nominal spending plan from 2010 actually buys in real terms in 2016. This is a more fundamental issue than changes in nominal GDP that will affect how quickly the armed forces can modernize their equipment. Figure 4 compares how the real purchasing power of the plan has changed from the 2010 to the 2016 forecasts, both in terms of constant (or real) ruble terms (green and purple lines) and in nominal U.S. dollar terms (red and blue lines).

Figure 4. The real spending power of GPV

slide4Source: Author’s calculations based on Cooper (2016) and IMF (2010, 2016)

It is clear that there has been a significant reduction in real purchasing power both in real ruble and dollar terms. The cumulative change in real ruble terms is a loss of 12 percent in purchasing power, while the loss in dollar terms is 45 percent. Since most of the loss in spending powers is from 2014 forward, the impact in the remaining years is even higher than what these cumulative numbers indicate.

The actual impact on the spending plan will crucially depend on how much of what is planned needs to be imported but it is nevertheless clear that there has been a significant reduction in purchasing power if the initial plan in nominal ruble is implemented. This is without any consideration of the impact of sanctions or reallocating government resources to other spending areas that may be considered and would affect this calculation.

Policy conclusions

Although the precision of the discussion in this brief is no better than the accuracy of the available numbers, the general trends and qualitative conclusions made here are most likely still relevant. And without any claim of being able to assess the quality of military equipment or the ability Russia’s military industrial complex to make the right priorities (see instead Rosefielde, 2016 for such discussion), it is clear from a pure economics standpoint that the changing macro environment will have serious real implications for how quickly the modernization process of equipment can go.

It is also highly likely that the worsening of the economic outlook in 2016 compared with 2010 will lead to more general discussions of government spending priorities. Spending on producing arms by the military industrial complex could in principle be a Keynesian type of demand injection that can raise growth in the short run if there are idle resources that are put to use and generate income to workers that in turn spend more of consumption. However, it is not likely that the resources required to build sophisticated new military equipment is idle even in an economic downturn, so this effect is likely not very significant. Instead, more spending in areas that are already in short supply will generate inflation or put pressure on the exchange rate depending on how much is produced domestically and how much is imported of the demanded goods and services.

Long-term growth can also be affected if the GPV plan crowd out resources from other spending areas. The effect will of course depend on what the spending alternatives are and how this is linked to future growth; if military spending does not generate growth by itself while reducing spending on education, research and health care that we think promote long-term growth, prioritizing military spending will have an additional price in terms of reduced future growth. There could be cases where spillovers from military production are significant and spur new businesses and thus generate economic growth, but this does not seem to have been the case in the past in Russia.

In short, it will be hard for policy makers to avoid making tough decisions on what spending areas to prioritize given the new macro outlook for Russia. And even if the spending in nominal rubles in the GPV-2020 plan does not change, there will be new trade-offs to be made within the plan given how higher inflation and a depreciated currency has reduced the purchasing power of the original 2010 plan.

References

  • Becker, T, 2016, “Russia’s oil dependence and the EU”, SITE Working paper 38, August.
  • Rosefielde, S., 2016, “Russia’s Military Industrial Resurgence: Evidence and Potential”, Paper prepared for the conference on The Russian Military in Contemporary Perspective Organized by the American Foreign Policy Council, Washington DC, May 9-10, 2016.
  • Cooper, J., 2016, “Russia’s state armament programme to 2020: a quantitative assessment of implementation 2011-2015”, FOI report, FOI-R-4239-SE.
  • IMF, 2010, World Economic Outlook, October 2010 data, http://www.imf.org/external/pubs/ft/weo/2010/02/weodata/index.aspx
  • IMF, 2016, World Economic Outlook, April 2016 data, http://www.imf.org/external/pubs/ft/weo/2016/01/weodata/index.aspx

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Effects of Trade Wars on Belarus

Posted on June 20, 2016 | Policy Brief

20160620 FREE Policy Brief

The trade wars following the 2014 events in Ukraine affected not only the directly involved participants, but also countries like Belarus that were affected through international trade linkages. According to my estimations based on a model outlined in Ossa (2014), these trade wars led to an increase in the trade flow through Belarus and thereby an increase of its tariff revenue. At the same time, because of a ban on imports in the sectors of meat and dairy products, the tariff revenue of Russia declined. As a member of the Eurasian Customs Union (EACU), Belarus can only claim a fixed portion of its total tariff revenue. Since the decline in the tariff revenue of Russia led to a decline in the total tariff revenue of the EACU, there was a decrease in the after-redistribution tariff revenue of Belarus. As a result, Belarusian welfare decreased. To avoid further welfare declines, Belarus should argue for a modification of the redistribution schedule. Alternatively, Belarus could increase its welfare during trade wars by shifting from being a part of the EACU to only being a part of the CIS Free Trade Area (FTA). If Belarus was only part of the CIS FTA, the optimal tariffs during trade wars should be higher than the optimal tariffs without trade wars. The optimal response to the increased trade flow through Belarus is higher tariffs.

Following the political protests in 2014, Ukraine terminated its membership in the CIS Free Trade Area (FTA) and moved towards becoming a part of the EU. The political protests evolved into an armed conflict and a partial loss of Ukrainian territory. These events led to Western countries introducing sanctions against some Russian citizens and enterprises. In response, Russia introduced a ban on imports from EU countries, Australia, Norway, and USA in the sectors of meat products, dairy products, and vegetables, fruits and nut products. In addition, both Ukraine and Russia increased the tariffs on imports from each other in the above-mentioned sectors.

Clearly, the trade wars affected directly involved participants such as the EU countries, Russia, and Ukraine. At the same time, countries like Belarus that were not directly involved in the trade wars, were also affected because of international trade linkages. It is important to understand the influence of trade wars on none-participating countries. To address this question, a framework with many countries and international trade linkages will be utilized and I will in this policy brief present some of my key findings.

Framework and Data

To evaluate the effects of the trade wars, I use the methodology outlined in Ossa (2014). This framework is based on the monopolistic competition market structure that was introduced into international trade by Krugman (1979, 1981). The framework in Ossa (2014) allows for many countries and sectors, and for a prediction of the outcome if one or several countries changes their tariffs. Perroni and Whallye (2000) and Caliendo and Parro (2012) present alternative frameworks with many countries that can also be used to estimate the welfare effects of tariff changes. The important advantage of the framework introduced in Ossa (2014) is that only data on trade flows, domestic production, and tariffs are needed to evaluate the outcomes of a change in tariffs, though the model itself contains other variables like transportation costs, the number of firms, and productivities.

It should also be pointed out that the framework in Ossa (2014) is not an example of a CGE model as it does not contain features such as investment, savings, and taxes. Since the framework in Ossa (2014) is simpler than CGE models, the effects of a tariff change can more easily be tracked and interpreted. On the other hand, this framework does not take into account spillover effects of tariff changes on for example capital formation and trade in assets.

The data on trade flows and domestic production come from the seventh version of the Global Trade Analysis Project database (GTAP 7). The data on tariffs come from the Trade Analysis Information System Data Base (TRAINS). The estimation of the model is done for 47 countries/regions and the sectors of meat and dairy products.

Results

According to my estimations, because of the ban on imports by Russia, the trade flow through Belarus increased. Belarusian imports of meat products are estimated to have increased by 28%, and imports of dairy products by 47%. Such increases in imports mean an increase in the tariff revenue of Belarus. It should be pointed out, however, that the model only tracks the effects of the ban on imports in the sectors of meat and dairy products. An alternative way would be to construct an econometric model that takes into account different factors influencing the trade between the countries. The effects of the decrease in the price of oil and the introduced ban on imports, which happened close in time, could then have been evaluated.

The estimated model further predicts that, because of the ban on imports, the tariff revenue collected by Russia in these two sectors has decreased by 53%. This means that since Belarus can only claim a fixed portion (4.55%) of the total tariff revenue of the EACU, its after-redistribution tariff revenue collected in the meat and dairy product sectors declined by 44.86%, in spite of its increase in before-redistribution tariff revenue by 35%. The decline in Belarus’ after-redistribution tariff revenue is thus estimated to have led to a decrease in welfare by 0.03%. To prevent such a decrease in the future, Belarus should argue for an increase in its share of the total tariff revenue of the EACU.

Furthermore, in addition to the decrease in the tariff revenue, the estimated model predicts that the real wage in Russia decreased by 0.39%, and its welfare by 0.49%.

The introduced ban on imports also affected the European countries that used to export to Russia. The model predicts that the welfare of Latvia declined by 0.38% and that the welfare of Lithuania declined by 0.27%. A substantial portion of the decline in welfare of these countries can be explained by a decrease in their terms of trade. The introduced ban on imports by Russia led to a decline in prices in the countries that exported meat and dairy products to Russia. Lower prices led to a decrease in the proceeds from exports collected by EU countries, and lower proceeds from exports buy less import, implying a decrease in their welfare.

In spite of the increase in tariffs between Russia and Ukraine, the model predicts an increase in the welfare of Ukraine by 0.23% following the formation of the EU-Ukraine Deep and Comprehensive Free Trade Area (DCFTA). An increase in real wages by 0.34% is the main factor contributing to this welfare increase. This is because it is associated with a redirection of Ukrainian exports from Russia towards the EU. The predicted increase in real wages in Ukraine have not materialized so far, presumably because of the ongoing military conflict and because time is needed to redirect the trade flows in response to the changes in the tariffs.

While bearing in mind that the analysis is only based on the sectors of meat and dairy products, Belarus could have increased its welfare during the trade wars if it had shifted from EACU status back to CIS FTA status with tariffs set at before-EACU levels. In this case, Belarus would not have needed to share its tariff revenue with other countries, and would then have increased its tariff revenue by 47.93% instead of the now predicted decline by 44.86%. Similarly, the welfare during trade wars could then have increased by 0.05%, instead of the now predicted decline by 0.03%. Another advantage of moving to CIS FTA status during trade wars is that the real wage could have increased by 0.04% instead of the 0.003% in the case of continued EACU status. Belarus could further have benefitted from moving to CIS FTA status by choosing optimal tariffs. This study suggests that the optimal tariffs of Belarus under CIS FTA status with trade wars are higher than the optimal tariffs under CIS FTA status without trade wars. Higher tariffs is the optimal response to the increased trade flows through Belarus resulting from trade wars.

Conclusion

Although it is optimal to move to CIS FTA status during trade wars, it is optimal to move back to EACU status after the trade wars are over. Therefore, such a policy should be adopted with caution, since the shift back to EACU status will likely not be possible. If it is expected that the trade wars will continue for a long period of time, or if the other members of the EACU will often deviate from the common tariffs, a transition to CIS FTA should be adopted. At the same time, asking for an increase in its share of total tariff revenue of EACU is a feasible strategy for Belarus to follow.

While estimating the effect of a transition from EACU status to CIS FTA status for Belarus during trade wars, the evaluation was done using two sectors affected by counter-sanctions. To evaluate the full welfare effect of this transition, its effect on the other sectors of Belarus should also be estimated, which is a question for the further research.