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Stuck in the Middle: “Dutch Disease” and Energy-driven Diversification in Russia

Working paper by Olga Garanina/St Petersburg State University of Economics, 2013

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The aim of the present paper is to aliment the debate on the impact of resource richness on economic development through the analysis of the Russian case. The paper identifies the patterns of the “Dutch disease” and provides the foresight on energy-driven diversification. It argues that Russia does not clearly demonstrate all symptoms of the “Dutch disease”, but neither it seems to successfully put in place a strategy of energy-driven industrial modernization.

Olga GARANINA

St Petersburg State University of Economics


Date: 30.06.2013




Stuck in the Middle: “Dutch disease” and energy-driven diversification in Russia






Introduction


Russian economic history can be described as a sequence of periods of stagnation and economic leaps. As argued by Gershenkron (1962), economic backwardness may be overcome by a strong state capable of stimulating and coordinating agents’ strategies so as to promote modernization. State-driven development is exemplified in Russia of the late nineteenth - early twentieth century with a strong state providing guidelines and financial support to the capital-intensive heavy industry, mining and metallurgy.

Challenges of economic backwardness remain in the twenty-first century Russia with the issue of oil and gas rent use entering into debate. Based on the economic theory, one can advance a counter-intuitive hypothesis stating that resource richness hampers economic development. The “Dutch disease” model (Corden and Neary, 1982) describes a situation when a discovery of natural resources in a country or a boom in prices of such resources leads to negative consequences for other tradable sectors (in particular, for manufacturing sector). In fact, increased export revenues entail currency appreciation, therefore boosting competitiveness of imported goods on the domestic market and in this way provoking deindustrialization. Further on, a strand of literature on the “resource curse” emphasizes negative longer-term impacts of the “Dutch disease” on the country’s technical progress, mainly in manufacturing, caused by the diversion of financial resources from productive, growth-oriented use, due to rent-seeking behavior (UNCTAD 2012). Resource richness negatively affects economic growth, as demonstrated by Sachs and Warner (2001) who explored the linkages between the real GDP growth per capita and exports of natural resources as a per cent of Gross Domestic Product (GDP). Deceleration of growth can be explained by a variety of political factors including weak institutions, rent-seeking behavior of empowered sectors, strategies of state-owned enterprises of extracting sectors or policymakers’ shortsightedness (Ross 1999).

However, negative impact of resource richness for economic development is a matter of debates. First, several studies demonstrate lack of positive links between resource richness and economic development based on other econometric variables and applying different methodology. For example, Alexeev and Conrad (2009) focused on the levels of per capita GDP and showed that the effect of a large resource endowment on long-term economic growth of countries has been on balance positive. Stijns (2005) demonstrated that natural resources per se (measured by reserves or production) do not have significant influence on growth rates. Brunnschweiler (2008) argued that per capita “natural capital” contributed to economic growth in 1970-2000.

Second, several countries (like Australia, Botswana, Canada, Iceland, Norway, New Zealand and the United States) were able to turn the resource curse into a blessing thus denying the “resource curse” paradigm (UNCTAD 2012). It supports the idea that resource richness can contribute to economic development if the exporting sector is closely linked to other domestic industries. In this domain, the example of Norway, which succeeded to develop a competitive advantage in oil and gas equipment following the discovery of hydrocarbon fields in the country, is worth remembering. On the contrary, if such industrial linkages are lacking, a country gets into a trap of a raw materials exporter.

Finally, a short-term approach adopted in the “Dutch disease” literature, that is based on the analysis of instant price hikes for energy resources or one-fold discoveries of new fields is subject to criticism. Wright and Czelusta (2004) argue for adoption of a longer-term analytical perspective, so that to analyze the natural resource sector as a sector intensive in technologies and innovations. In turn, the resource dotation can be increased via introducing innovative exploration and production technologies.

The aim of the present paper is to aliment the debate on the impact of resource richness on economic development through the analysis of the Russian case. We keep aside the controversy on political and institutional implications of the public-private governance model in Putin’s Russia so as to focus on the evolutions taking place in real economy. In particular, we concentrate on identifying the patterns of the “Dutch disease” since the beginning on 2000s as well as on providing the foresight on energy-driven diversification, on the example of the development of Russian oil service industry. We argue that Russia does not clearly demonstrate all symptoms of the “Dutch disease”, but neither it seems to successfully put in place a strategy of energy-driven industrial modernization. In a longer perspective, this situation increases risks of the “resource curse” given lagging investment in human and technological capital and rent-seeking strategies of actors.

Section 1 discusses the peculiarities of the Russian case through the lens of Corden and Neary (1982) model and concludes on the limited character of deindustrialization taking place. Section 2 shows that the paradigm of energy-based diversification does not seem to be implemented therefore inducing a “resource curse” pattern in long term perspective.




1. “Dutch Disease” in Russia: peculiarities of the Russian model



A. The “Dutch disease” model (Corden & Neary, 1982)

The term “Dutch disease” was coined by the The Economist1 in the context of economic stagnation in the Netherlands following the discovery of the Groningen field. It got its theoretical justification with the seminal Corden and Neary (1982) article exploring the adjustments in real economy following the energy boom. Three sectors are distinguished within the “Dutch disease” model:

  • traditional tradables, mainly the manufacturing sector;

  • the boom sector, with new natural resources, such as energy;

  • non-tradables, mainly the services sector.

The model applies to a case of a small open economy. It means that the world market prices for tradables are set on the world market, the economy being a price taker. Further on, the argumentation is built on a number of assumptions which are: (i) full employment; (ii) no spending for capital accumulation; (iii) international capital immobility so that savings of windfalls abroad are excluded; (iv) external equilibrium (capital account and current account are in balance); (v) no inflation (only a one-off price increase in non-tradables is analyzed); (vi) labor demand depends on the real wage (neoclassical view). No government intervention is authorized, therefore the effects of monetary, exchange rate, fiscal and industrial policy are not envisaged.2

Finally, the Corden and Neary (1982) model analyzes a barter economy, where the price of tradables serves as numéraire. Although monetary variables per se are not included, the indication on real exchange rate is given by the ratio [price of non-tradables/price of traditional tradables]. In relation to the modeled case, a real appreciation corresponds to a situation where the nominal exchange rate remains constant despite the inflation observed in the domestic economy. Therefore, a real appreciation of the exchange rate means that the value of non-tradables rises compared to the price of tradables.

The “Dutch disease” propagates via two effects:

  • Resource movement effect. The boom in energy sector attracts mobile factor (labor) to the energy sector to the detriment of manufacturing and services.

  • Spending effect. Energy boom provides increased incomes of public and private sector that are to be translated into incremental spending (as no saving is authorized in the model). The latter provokes a price growth in services, as the price of services is determined by the play of the demand and supply on the internal market. The price of tradables remains constant despite increasing domestic demand because it is set by the world market. In result, mobile factor flows towards services. At the same time, real exchange rate appreciation (depicted by the growth of prices in services) contributes to crowding out of manufacturing.

Both effects lead to deindustrization of the economy, and this phenomenon is called the “Dutch disease”.

This approach can be nuanced by taking into account learning effects, as well as the effects of scale economies on competitiveness of manufacturing, and also the scope and duration of the energy boom (Van Wijnbergen, 1984; Krugman, 1987; Sachs and Warner, 1999). For example, in the situation where the manufacturing industries are protected by subsidies stimulating massive learning effects, and where the energy boom is not long-lasting, deindustrialization pattern could be avoided.

Next sub-sections analyze the symptoms of the “Dutch Disease” that Russian economy has been demonstrating since the recovery of the oil prices after 1999-2000.



B. Economic vulnerability, trade balance and exchange rate

Russian economy is extremely vulnerable to external shocks. As shown in fig. 1, the period of high economic growth in 1999-2008 (with the average annual growth rate close to 7%) coincided with skyrocketing oil revenues.3 Oil exports boosted from 19,6 to 241,0 billion US dollars, driven by a more than five-fold increase of oil prices (from 18 up to 97 doll/bar) during the same period.4 The growth of oil export revenues is mostly based on soaring oil prices. The growth of exported volumes is more moderate: oil exports passed from 179 million tons in 1999 to 360 million tons in 2008,5 which is about a two-fold increase.


Fig. 1. Russia’s oil revenues and GDP growth

Source: IMF World Economic Outlook Database, April 2013. Accessed 18.06.2013.


The decline of oil prices in 2008-2009 and global financial crisis led to a sharp economic decline registered in Russia in 2009 (-7,8% in 2009). The subsequent recovery did not allow the return of pre-crisis growth rates despite the return of oil prices to levels close to 100 doll/bar. The growth decelerated reaching 4,5% in 2010, 4,3% in 2011 and 3,4% in 2012. According to the International Monetary Fund (IMF) projections, the GDP growth rate is expected to range from 3,4 to 3,8% for the period 2013-2018.6 However, according to latest available data, Russia’s economic growth projections for 2013 have been downgraded by IMF from 3,4% to 2,5%, in this way coming closer to Russia’s Ministry of Economic Development expectations of a 2,4% growth in 2013.7

Russia has a strongly positive trade balance, with the trade surplus increased by a factor of about 2.5 during the decade of the 2000s. However, this surplus is mainly based on hydrocarbon exports, which provide more than 60% of Russia’s total exports. On the other side, Russia increases imports of manufactured products, with machinery and transport equipment providing about 40% of total imports.8

The unfavorable trade structure where natural resources are exchanged against final goods reveals a strong vulnerability of Russian trade balance despite its overall surplus (fig. 2). In particular, the balance calculated for manufactured goods9 is negative and it has been strongly deteriorating propelled by the imports growth in the context of high oil prices. In result, total imports of 2011 are comparable to pre-crisis levels of exports. Therefore the risks of trade balance reversal in case of external shocks are significant.


Fig. 2. Russian trade balance

Source: Unctadstat. Accessed 20.05.2013.


Being differentiated in the past given the heritage of planned economy (economic relationships between countries being administered by a central planner) or geo-economical constraints (absence of pipelines towards China), Russian trade pattern tends to align towards unfavorable model of a raw material exporter with regard to all trade partners. According to the analysis in Garanina (2009a), Russia is globally disadvantaged in manufactures trade vis-a`-vis the EU and China, while managing to expand its manufactured exports on the post-soviet space. However, it was shown that Russia was gradually losing its role of main supplier of capital goods in the post-Soviet space.

Unfavorable trade structure is accompanied by the appreciation of the ruble real exchange rate (fig. 3). Since the 1998 crisis, ruble has been constantly appreciating, with the only exception observed in the end 2008 – beginning 2009 following the fall of oil prices and global financial crisis.


Fig. 3. Ruble real effective exchange rate and oil prices

Source: Bank for International Settlements statistics http://www.bis.org/statistics/eer/ Accessed 19.06.2013; EIA. US Energy Information Administration http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=rbrte&f=m Accessed 22.06.2013.


In theory, currency appreciation can be explained not only by trade surplus but also by the Balassa-Samuelson effect. The latter states that countries with higher levels of productivity growth experience increase of real wages and therefore an appreciation of the real exchange rate.

However, it seems that Balassa-Samuelson effect is relatively irrelevant for Russia. According to the report by CMASF (2013, p. 115), almost a half of the economic sectors in Russia registered a more than 3% annual labor productivity growth in 2007-2012. However, this productivity improvement is partly due to a contraction of employment in crisis context. In absolute terms, the productivity levels in Russia remain very low reaching about a half of the levels of Eastern European countries, and 5-7 times lower as compared to the core EU economies. As for the future, availability of qualified labor force puts strong constraints on productivity improvement in a long-term perspective (CMASF, 2013 p.30).10

At the same time, the growth of real wages in Russia is overpassing the productivity growth therefore hampering the cost competitiveness of Russian manufacturing. For example, in 2012, the ratio between real wages growth and productivity growth constituted about 3:1. In medium and long term, the gap between productivity growth and real wages growth could be offset by decelerating wages growth or by reducing employment. However in a Keynesian perspective this policy would lead to stagnation of revenues therefore slowing down investment activity (CMASF, 2013 p.30-32).

As of June 2013, the devaluation of ruble nominal exchange rate was in the focus of economic policy debates. However, its rationale being to enhance export competitiveness, the expected results are questionable. Russian trade structure has been deteriorating during the past years, with the industrial competitiveness being concentrated in production of iron, steel and fertilizers, with the other sectors globally disadvantaged in the international trade. Therefore the gains from currency devaluation can be only limited. On the contrary, domestic sectors that use imported machinery would suffer from depreciation of the ruble. Hence monetary policy should be accompanied by active industrial policy in order to improve factor productivity.



C. Industrial structure

As discussed above, the “Dutch disease” provokes deceleration in manufactures (tradable sector) via the spending effect and the effect of resource movement. As for services (non-tradable sector), the impact of the spending effect is positive, while the impact of the resource movement effect is negative.

It can be argued that for Russia the resource movement effect (based on the movements of workforce) is limited or irrelevant due to the very small part of the energy sector in the employment structure (Covi 2013). According to Rosstat data, mining sector attracted 1,8% of the employed population in 2005 and 2% in 2012.11 Therefore, the share of hydrocarbons in the employment structure is even smaller, and the resource movement effect is almost negligible. Further on, rigidities of the labor market constrain the mobility of the resources. For example, data on wage differentials testify of lack of intersectoral mobility of resources. According to Rosstat, the average wage was 51588 rubles in energy sector against 21781 rubles in manufacturing in 2011.12

Negligible resource movement effect allows suggesting a strongly positive dynamics in services (non-tradables) driven by the spending effect. In fact, sectorial growth rates data confirms this hypothesis. As demonstrated in Table 1, the past decade demonstrated concentration of economic growth in services (financial activity, trade, construction etc.) with the annual growth rates reaching two-digit levels.


Table 1. GDP growth structure

 

GDP (market prices), % growth

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

107,3

107,2

106,4

108,2

108,5

105,2

92,2

104,5

104,3

103,4

Agriculture, hunting and forestry

98,2

101,0

100,3

102,7

101,3

106,4

101,5

87,9

114,8

96,2

Fishing and fish farms

101,7

102,5

89,1

104,0

99,1

94,2

105,6

90,9

104,1

101,5

Mining and quarrying

110,8

113,3

101,5

97,1

97,8

101,0

97,6

106,6

102,9

101,0

Manufacturing

108,8

108,1

104,4

106,6

107,5

97,9

85,4

108,6

105,3

103,3

Electricity, gas and water production and supply

100,9

107,9

100,9

104,5

96,6

100,7

95,3

104,0

100,5

100,1

Construction

112,7

109,9

110,2

112,8

113,0

111,1

85,3

104,4

104,5

102,0

Wholesale and retail trade; repair of motor vehicles, motorcycles and personal and household goods

113,3

110,2

109,1

114,1

111,7

109,9

94,2

105,8

103,3

106,5

Hotels and restaurants

101,6

105,7

109,3

107,9

113,6

110,1

85,1

106,5

103,6

104,8

Transport and communication

107,2

105,9

105,9

109,7

104,8

105,2

91,4

105,5

106,6

102,6

Financial activity

129,0

114,7

129,2

125,4

129,1

113,5

101,5

100,3

103,6

114,3

Real estate, renting and service rendering

102,8

96,4

112,0

110,0

120,8

110,9

95,5

106,0

105,5

104,7

Public administration and defence; compulsory social security

101,3

104,6

94,6

102,5

103,9

103,0

99,9

99,7

96,7

99,3

Education

101,2

100,3

100,3

100,5

101,1

99,9

98,6

98,2

99,1

100,1

Public health and social work

96,8

101,0

101,7

101,4

101,1

100,9

99,8

100,3

101,4

102,9

Other community, social and personal service activity

100,8

106,3

102,9

107,5

108,6

101,4

80,0

102,2

100,1

100,0

Source: Russian Federation Federal State Statistics Service, accessed 15.05.2013.


However, the evolutions observed in Russian industrial structures only partly match the trends described within the “Dutch disease” theory. The most important is the fact the manufacturing has been demonstrating positive growth rates (with the exception of the period 2008-2009).

However, the global crisis revealed vulnerability of industrial growth. Manufacturing registered a 15% contraction in 2009, and since 2011 it shows signs of deceleration. Employment statistics confirms the outflow of labor from manufacturing. According to Rosstat13, the share of manufacturing in the employment structure declined from 18,2% in 2005 to 15,0% in 2012, while the share of agriculture contracted from 10,1% to 7,3% respectively.



D. Stabilization Fund

Stabilization Fund has been established in Russia on January 1, 2004, in order to attenuate inflation and real appreciation of the ruble as well as to contribute to budget equilibrium in case of oil shocks. The cumulated reserves amounted to 156 billion doll, or 11,7% of the GDP as of January 2008 (fig. 4).

In February 2008, the Fund has been split into two separate funds:

  • Reserve Fund, dedicated to provide for public spending in case of budget deficits in the periods of low oil prices. It is invested in low-risk low-yield securities in foreign currencies and limited to 10% of the GDP;

  • National Welfare Fund, dedicated to fill the Pension Fund. It invests in riskier assets in foreign currencies and in rubles.






Fig. 4. Stabilization Fund

4% GDP

Straight Arrow Connector 6


Source: Russian Ministry of Finance data, accessed 25.05.2013.



Although having contributed to limit the real appreciation of the ruble, the Stabilization Fund can be criticized for the following reasons:

The volume of the Funds. Accumulated funds amounted to about 12% of Russia’s GDP in 2008 and 8% of GDP in the end 2012. For example, Norwegian Government Pension Fund – Global constitutes about 150% of the GDP of Norway in the end 2012.14 As shown in the graph, global economic crisis led to significant exhaustion of the accumulated funds due to implementation of anti-crisis measures. Therefore, the security margin provided by the Fund is relatively limited.

Savings versus investments. The Stabilization Fund has been instituted in a monetarist logic aimed to save the oil super-profits abroad so as to limit the pressure on the exchange rate and to prevent the inflation growth. However the saving abroad option seems to be the most adequate for developed countries with small population. As for less developed countries, as argued by Sachs (2007), “Dutch Disease” can be turned into a blessing if the rents are invested in public goods (including physical infrastructure, level of education). Such investments contribute to improve productivity in both tradable and non tradable sectors, therefore increasing the competitiveness of the domestic tradable sector. In the opposite case, lack of public funding entails lack of public goods therefore discouraging private investments. In this way, a vicious underinvestment circle is launched and the country gets into a poverty trap. Therefore, a rational strategy should presumably proceed by a mix of spending and saving abroad approaches.

In Russia, creation of the development institutions dates back to the end 2007, that is, just before the global crisis and the consequent exhaustion of available funds.15 Nowadays, the debate on using oil revenues for building infrastructures returns to the agenda, exemplified by a proposal of V. Putin to invest 450 billion rubles (about 14 billion doll) in transport infrastructures announced at the St Petersburg International Economic Forum in June 2013.

Management of the Fund. Russian oil funds provide very low levels of profitability. In particular, the profitability of the Reserve Fund and of the National Welfare Fund constituted 0,74% for 2012 for each Fund. The profitability of the Reserve Fund, for the period since its creation in 2008 and up to the end 2012, is measured at 2,28% on the annual basis.16 In this way, results of the saving strategy reveal negative in real terms.



D. Peculiarities of the Russian case

Nevertheless, attributing the “Dutch disease” diagnosis to Russian economy can be objected for the following reasons.

  • Exhaustion of extensive growth in energy. Traditional oil and gas production zones in Western Siberia put in production in Soviet times are being gradually depleted. Shifting production zones towards the North and the East, expected in ES-2030, and the consequent development of new infrastructures necessitates substantial financial as well as technological investments therefore bringing the possibility of numerous spillover effects for connected industries (in particular, for oil and gas services and energy machinery).

  • Positive economic growth in manufacturing. Continued growth in most sectors up to 2008 contradicts the deindustrialization model. Nevertheless this argument is losing strength as the latest data covered demonstrate signs of economic slowdown. Several growth projections have been recently revised downwards (see above).

  • Structural changes in a transition economy. Crisis in certain industries can be explained by weak competitiveness inherited from administered economy. At the same time new competitive sectors demonstrate high growth rates. In the same way, increased growth of services can be partially explained by adjustment of production structures in the frames of economic transition of the post-soviet states.

Peculiarities of the Russian case can be explained by several reasons. First, Russia has a diversified economy with a high internal market potential. Therefore, the impact of external shocks is attenuated, especially for inland regions distanced from major transport hubs. Second, Corden and Neary (2012) model is built on a number of restrictive assumptions, which are not met in practice. As discussed above, inter-sectoral mobility of factors is limited therefore constraining the presumed adjustments to changes of relative prices. While the model is based on the hypothesis of full employment, in situation of unemployment, increased labor demand in energy and service sectors can be satisfied by hiring unemployed population. Third, the model does not analyze the role of Stabilization fund or tariff protection for limiting the propagation of the “Dutch disease”.

Finally, it is equally important to distinguish between price effects and volume effects of the energy booms. “Dutch disease” risks are higher if the energy boom is based on a price shock. If the energy boom is based on production growth, development of the energy sector could be translated into an energy-driven modernization starting from oil services and energy machinery. In the case of Russia, development of new production areas necessitates developing unique technological equipment and building new infrastructures therefore allowing for substantial positive spillovers.



2. Towards industrial diversification based on energy sector?


A. Energy Strategy of Russia and economic development

According to the Energy Strategy of Russia for the period up to 2030 (ES-2030),17 energy complex is perceived as a driving force of modernization and diversification of the national economy. ES-2030 is prepared in relation to the “Concept for the Long-Term Social and Economic Development of the Russian Federation for the Period till 2020”18, the latter providing the guidelines for the transition of Russian economy to the innovative path of development. In particular, ES-2030 specifies the role of the energy sector within the process of transition towards innovative development. In particular, the development of the energy sector contributes to modernization via creating demand for energy machine building and pipe manufacturing, as well as via promoting innovations in energy. According to ES-2030, the share of energy sector in GDP is expected to decrease from 30% as of 2008 to 18% at the perspective of 2030, and the share of energy resources in total exports will pass from 64% to 34% respectively.

ES-2030 supports import replacement: in perspective to 2030, the needs of the energy complex are to be satisfied by Russian equipment.19 The share of imports in purchases of equipment should not overpass 12% by 2013-2015, 8% by 2020 - 2022, and 3% - 5% by 2030.20

Nevertheless, the declared long-term objectives are not supported by the elaboration of the corresponding policy measures neither by an exhaustive monitoring system; both are not elaborated in an extensive way in ES-2030. The latter fact exposes difficulties of applying strategic macroeconomic planning within the market context.



B. Energy driven diversification or technological dependency? The case of oil service industry

As stated above, resource abundance can be used as a basis for developing competitive energy complex including the oil service industry. However, the transition crisis led to negative consequences for Russia’s energy sector. The ES-2030 describes number of internal factors provoking threats to provision of energy security.21 One can find first and foremost a high degree of fixed assets depreciation in the fuel and energy complex that reaches almost 60% in power and gas industries and 80% in the oil refining industry. The problem of underinvestment has not been resolved during the plenteous 2000s. During 2004-2009, investments in the fuel and energy complex amounted to approximately 60% of the volume specified in the precedent Energy Strategy of Russia (adopted in 2003 for the period up to 2020).

Further on, underinvestment touches the development of the reserve base itself. Insufficient investments in exploration led to a decrease of Russia’s share in world hydrocarbon reserves. In the same time, the nature of reserves evolves towards increasing share of difficult and hard to extract reserves. During the period 1998-2012, Russia’s share in world proved oil reserves declined from 5,8% to 5,2%, while its share in the proved natural gas reserves passed from 23,4% tо 17,6%.22 It is worth noting that in the last issue of BP Statistical Review of World Energy published in June 2013, Russian gas reserves have been downgraded by 10% (from 44,6 Tcm to 32,9 Tcm). It translated into the fact that Russia lost its first place in the ranking of gas reserves to the benefit of Iran who has been granted the leadership with 18% of the world proved gas reserves (its reserves have been slightly reviewed upwards from 33,1 Tcm to 33,6 Tcm).23 At the same time, the US outdistances Russia as the first gas producer due to the shale gas boom.

According to existing estimates, Russia occupies the second place in the world according to its park of drilling equipment after the US.24 At the same time Russian drilling equipment park is characterized by a very strong deterioration rate that constitutes over 80%.25 According to other estimates, about 35% of Russian drilling equipment park has been in exploitation since more than 20 years.26 Therefore, investing in developing the production base including technologies for hydrocarbon exploration and production becomes a crucial issue for Russia in order to keep the leading role on the world energy markets in the long run.27

Despite the expressed concerns, elaboration of the strategic guidelines for the oil service industry does not find any substantial place within the ES-2030. In such a way, the implementation of positive spillovers between the extractive activities and connected manufacturing sectors is left to free market forces.

Analysis of the current market context demonstrates unfavorable trends for domestic firms. Up to the present, major players on the Russian market are Russian entities (fig. 5). The total share of international giants Schlumberger, Weatherford, Halliburton and Baker Hughes constitutes about 15%. However, during the past decade, the share of occidental companies on the oil services market increased by 6 times, while the share of Russian companies declined by a factor of 2,5.28 Large international companies dispose of strong advantages like developed technological and innovation base, as well as broader financial capacities that constitute strong advantages in comparison to Russian firms.


Fig. 5. Key Players in the Russian oilfield services market in 2012 (by revenue)



Source: Integra group presentation. – May 2013. http://www.integra.ru/eng/investors/presentations/, accessed 26.05.2013.


The tendency towards increasing place of foreign companies in the sector goes in parallel with the increasing imports of foreign equipment used in the oil service industry (see fig.6). Insufficient technological competencies of Russian companies are also revealed by Russia’s openness to international cooperation while developing large-scale offshore projects, in particular in the Arctic Seas.

According to the 2010 data, despite the fact that major part of the equipment park of Russian drilling companies is produced domestically, Russian equipment producers are loosing their market share. In the structure of drilling equipment purchases, the share of imported equipment overpassed 70% in 2010, to compare to 40% in 2006.29

Increasing imports from China that reached significant levels by 2007-2008 were of special concerns. Starting from January 1st, 2012, a 10% import duty for drilling equipment (but not less than 2,5 per kilo) is imposed.30 Such decision is related to the lobbying of Russian producers in context of increasing competition from China.


Fig. 6. Imports of drilling equipment

Data: UN Comtrade database, HS 8430. Accessed 10.05.2013.


However, the effectiveness of trade protection measures can be questioned for several reasons.

  • First, a 10% duty can be insufficient to protect domestic suppliers. According to 2011 data, the cost of Chinese drilling rigs was 35%-40% lower compared to Russian analogues. Therefore duties would presumably constrain purchases of equipment from occidental producers, while reinforcing the competition between Russian and Chinese firms;31

  • Second, the effectiveness of import duties should be analyzed in comparison to subsidizing domestic producers (as it was proposed by the Ministry of Energy before the WTO accession but had not been implemented);32

  • Third, import duties can be by-passed by Foreign Direct Investments (FDI). For example, in March 2013 an agreement was concluded between Uralvagonzavod (Russian machine building plant), VTB Leasing and Honghua Group Limited on creating on Russian territory joint Russian-Chinese enterprise for producing drilling equipment;33

  • Finally, in the context of Russia’s accession to the WTO import duties will be reduced by 2014-2016. Final binding tariff rates are fixed at the level about twice lower than that before the accession.34

In the longer perspective, improving competitiveness of Russian firms in the domain of oil and gas technologies can hardly be expected. Unfavorable dynamics can be confirmed by the fact that Russia is lagging in terms of investments in research and development (R&D) in the domain. While public investments in R&D decreased in the transition period, private companies did not take the lead. While annual expenses in R&D of Russian oil companies and Gazprom amount to around 250 million dollars, the expenses of Shell taken alone, in 2009, that is during the crisis, overpassed 1 billion US dollar (Shmal 2013). According to other data, the share of R&D costs per ton of oil equivalent (toe), produced by Russian energy companies, constitutes about 0,2/toe, that is much lower compared to 0,8 – 3,44 doll/toe spent for R&D by international energy companies.35

In total, the case of the oil service industry demonstrates insufficient degree of implementation of the positive spillovers while developing the energy sector.



C. A “resource curse” in the longer run?

Theoretically, while in the short run the “Dutch disease” can be avoided via creating reserve funds and promoting industrial productivity, in the longer term, if the energy boom is lasting in time, the risks of the resource curse (understood as negative growth effects provoked by unproductive use of capital and rent-seeking behaviour) increase. This seems to be in place in Russia facing the challenges of improving investment climate and fighting corruption. For example, according to the Global Competitiveness Report 2012-2013 of the World Economic Forum, Russia is ranked 133 out of 144 for the quality of institutions.

Russian developmentalist policies have been traditionally dominated by a strong state approach. The arrival of V. Putin to power marked a return of the state control in the energy sector with the intention to redistribute hydrocarbon rent for developing strategic economic sectors like aircraft, shipbuilding, nanotechnologies, by creating semi-state corporations (Garanina 2009b). However, the example of the oil service industry shows the failure of the strong state approach focused on direct public support provided to strategic industries. This kind of “picking the winners” approach left the oil services as a fragile player if not a “looser” on competitive markets.

As argued by Krugman (1987), the effects of the energy booms depend on their size and duration. If the energy boom is limited in its scale, its effects would be limited by wages growth. However, if significant in size, energy boom will result in a shift of some industries from home country to abroad, and if the expansion of energy sector lasts in time, these industries will not return to the home country after the end of the energy boom.

In view of this argument, almost fifteen years of high oil prices should lead to a lasting thus irreversible deindustrialization in Russia. The fact that the “Dutch disease” was preceded by a 50% industrial decline of the transition period of the 1990s renders the re-industrialization even more difficult. At the same time, widespread corruption and weak institutions puzzle further on the economic modernization trajectory.







Conclusion

It has been shown that Russian economy demonstrates symptoms of the “Dutch disease”, notably a strong exposure to external shocks and appreciation of the ruble real exchange rate. Nevertheless, while the development of non-tradable services corroborates the model of the “Dutch disease”, the manufacturing sector demonstrates positive growth rates with the exception of the 2008-2009 period. However, the argument of absence of deindustrialization is loosing ground given the recent slowdown of economic growth. At the same time, Russia does not appear to successfully put in place a strategy of energy-driven industrial modernization as shown on the example of the oil service industry development. In total, turning the analysis to a longer perspective as the times goes by, we conclude that risks of the “resource curse” become stronger as the growth dynamics is systematically constrained by lagging productive investments and rent-seeking behavior.








References



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Annex



Russian foreign trade structure

Trade structure (%)

Russian exports

Russian imports

2000

2005

2010

2000

2005

2010

Agricultural products

7,1

5,9

5,2

20,7

15,3

14,8

.Food

3,6

3,0

2,9

18,6

14,3

13,8

Fuels and mining products

66,7

70,5

70,4

8,6

4,0

5,3

.Fuels

50,3

60,8

63,3

3,7

1,3

2,3

Manufactures

23,5

21,7

20,2

69,8

79,8

75,7

.Iron and steel

6,8

7,8

5,8

3,4

3,3

3,6

.Chemicals

6,7

5,4

6,1

11,0

10,8

12,6

..Pharmaceuticals

0,1

0,1

0,1

2,8

3,0

4,6

.Machinery and transport equipment

4,7

4,2

3,7

28,9

40,6

38,9

..Office and telecom equipment

0,3

0,2

0,4

6,7

10,0

8,2

Electronic data processing and office equipment

0,1

0,0

0,0

3,0

3,4

3,0

Telecommunications equipment

0,1

0,1

0,3

3,3

5,9

4,9

Integrated circuits and electronic components

0,1

0,1

0,1

0,4

0,6

0,3

Automotive products

0,9

1,0

0,6

5,3

9,7

10,5

.Textiles

0,4

0,2

0,1

2,9

2,3

1,5

.Clothing

0,4

0,1

0,0

6,0

6,3

2,9

Total (billion US dollars)

105,6

243,8

400,1

44,7

125,4

248,7

Source: WTO Statistics database, accessed 26.01.2012.




1 26 November1977, “The Dutch Disease”.

2 See discussion in UNCTAD (2012).

3 Here we concentrate on oil prices and revenues. The value of Russian gas exports stands for about 35% of Russia’s oil exports (as of 2011), with natural gas prices being indexed on oil prices. See Russian Federation Federal State Statistics Service, http://www.gks.ru/free_doc/new_site/vnesh-t/exp-to.htm, accessed 27.06.2013.

4 In current dollars.

5 BP Statistical Review of World Energy June 2013. Accessed 18.06.2013.

6 IMF World Economic Outlook Database, April 2013. Accessed 18.06.2013.

7 Kommersant-FM, 19.06.2013.

8 See Russia’s foreign trade structure in the Annex.

9 [Exports of manufactures – imports of manufactures]. Manufactured goods are defined according to SITC classification (SITC 5 to 8 less 667 and 68).

10 See for example the interview of D. Shulman, the executive director of Russian oil service company Integra, on the lack of qualified labor force in the oil service industry (http://angi.ru/news.shtml?oid=2786867, published 26.03.2012, accessed on 27.06.2013), or the opinion expressed by Vice Prime Minister D. Rogozin, during the St Petersburg International Economic Forum in June 2013, on the need to attract foreign qualified engineers-constructors in shipbuilding industry (http://www.fontanka.ru/2013/06/20/078/, accessed on 27.06.2013).

11 Russian Federation Federal State Statistics Service, http://www.gks.ru/wps/wcm/connect/rosstat_main/rosstat/ru/statistics/wages/labour_force/#, accessed 20.06.2013.

12Russian Federation Federal State Statistics Service, http://www.gks.ru/wps/wcm/connect/rosstat_main/rosstat/ru/statistics/wages/labour_costs/#, accessed 20.06.2013.

13 Russian Federation Federal State Statistics Service, http://www.gks.ru/wps/wcm/connect/rosstat_main/rosstat/ru/statistics/wages/labour_force/#, accessed 20.06.2013

15 In the end 2007 about 8,4 billion euros has been assigned for funding development institutions (including Vneshekonombank, Russian corporation of nanotechnologies and Investment fund). According to Russian Ministry of Finance, http://www.minfin.ru/ru/official/index.php?pg4=41&id4=3229, accessed 11.2008.

16 Russian Ministry of Finance data, http://minfin.ru/ru/official/index.php?id4=18585/, accessed 14.06.2013.

17 Energy Strategy of Russia for the period up to 2030. Approved by decree N° 1715-r of the Government of the Russian Federation dated 13 November 2009. Part V.1.

18 Concept for the Long-Term Social and Economic Development of the Russian Federation for the Period till 2020. Approved by the Regulation of the Government of the Russian Federation No. 1662-r of November 17, 2008.

19 ES-2030. Part II.2.

20 ES-2030. Part VII.2.

21 ES-2030. Part V.2.

22 BP Statistical Review of World Energy June 2013.

23 Le Monde 13.06.213.

24 Agibalov et al. (2010), p. 14.

25 Agibalov et al. (2010), p. 14.

26 Burovye ustanovki: vyzov vremeni [Drilling rigs: the challenge of our times]. Neftegaz.ru. – 6. 2012. - p.24. http://magazine.neftegaz.ru/index.php?option=com_magazine&func=e-magazine&id=37, accessed 13.05.2013.

27 See Shmal (2013).

28 Rossiyskaya Biznes-gazeta, 31.07.2012.

29 Burovye ustanovki: vyzov vremeni [Drilling rigs: the challenge of our times]. Neftegaz.ru. – 6. 2012. - p.25. http://magazine.neftegaz.ru/index.php?option=com_magazine&func=e-magazine&id=37, accessed 13.05.2013.

30 Decision of the Commission of the Customs Union of 16 August 2011 No.739.

31 Tamojennye novosti [Customs news]. 12 (157), 2011. P. 18.

32 Idem.

33 Data from Uralvagonzavod, www.uvz.ru/news/2/297, accessed 13.05.2013.

34 According to the Tariff concession list, accessible at http://www.wto.ru/documents.asp?f=docs&t=14, accessed 13.05.2013.

35 Tulenev (2011), p.14.

19



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