For innovation to succeed in Russia, state must cede control

By EBRD  Press Office
@ebrd

Failures in the education system, a shortage of skilled managers, as well as restrictive immigration policies and a poor business environment, all combine to hold back Russia’s efforts to create an innovative economy and lower the country’s dependence on commodity exports, which is deeper today than 15 years ago, an EBRD study says.

Even though Russia is exceptionally endowed in mineral riches, these resources are finite and its identified oil reserves are expected to start running out in 20 years should extraction continue at present rates. This is what gives urgency to the diversification agenda, making it Russia’s priority development challenge.

The Bank’s ‘Diversifying Russia’ report says that while the state clearly has an important role to play in changing the economic model, experience shows, top-down legislation is not enough. A state-led approach to innovation which does not engage with the private sector from the earliest stages runs a high risk of failure.

The EBRD says there is a broad consensus that the economy has failed to innovate and increase productivity and gives the Russian government credit for recognising the scale of the problem. Wrong government policies can hinder the development of an innovative economy even more than lack of funding, the report warns.

Although Israel is an outstanding example of an innovative economy emerging thanks to government initiative, the report said that for every Israel, there are too many examples of countries that have tried and failed to use public resources to promote innovation or diversification.

The report says the Russian state should stop taking centre stage in financing innovation. Rather than aim for majority control, the government should instead focus on buying minority stakes through which it can support the private sector.

It argues that one of the problems of state sponsoring of innovation is that it often ignores the need to ensure there is market demand for what is being produced.

If the state selects innovation priorities in advance, without taking market logic into account, Russia risks repeating the countless selection of failures that litter the history of vertically-driven industrial policy, the report says.

The Russian authorities’ innovation strategy suggests the country is aiming to develop cutting-edge technology with the aid of state funding, but the EBRD study stresses that for this to work, it is likely to require a business environment that differs greatly from what is described in the report.

The 88-page report incorporates the first published findings of the latest Business Environment and Enterprise Performance Survey (BEEPS) carried out jointly by the EBRD and the World Bank in 2011-12. The survey, the fifth of its kind, incorporates responses from 4,000 manufacturing and services firms in 37 of Russia’s 83 regions.

The survey found that the majority of respondents regarded, corruption, skilled labour shortages and access to funding as the main obstacles to doing business in Russia. However, for the innovative sector, additional priorities are customs and trade regulations, as well as finding skilled staff.

Russia’s shortage of skilled managers is a consequence of an education system that has fallen behind, the report says, suggesting that improvements in education could raise the country’s growth rate by as much as one per cent a year. A strong education system is essential and the sector requires reform urgently, the report says.

The report argues that because problems in the Russian business environment deter potential investors, the state is by far the biggest source of funding for Research and Development (R & D), while the private sector accounts for less than nine per cent.  

Multinationals, traditionally a major source of R & D and a driver of innovation, are under-represented in Russia. One of the reasons for this is the difficulty in finding qualified managers locally, a problem compounded by a restrictive immigration policy that strongly limits the hiring of highly skilled foreigners.

Other deterrents for multinationals include problems over enforcement of contracts and patent protection. Even though the relevant laws may exist by now, they are not always enforced. The report warns that weak protection of intellectual property rights not only discourages inventions in Russia but also encourages a Russian brain drain.

The relatively limited presence of multinationals thus means Russia is missing out on one of the most powerful sources of innovation, the report says.

Innovation also usually goes hand in hand with exports, which, together with research, often drive growth and diversification, but in 2008-2009, only three per cent of Russian firms exported. The equivalent figure for France over the same period was 15-17 per cent.

The report says that improvements to the business environment, particularly those that would encourage exports, must be at the heart of any diversification strategy.

Russia invests one per cent of its Gross Domestic Product (GDP) in R & D, a very low figure compared to the average for the Organisation for Economic Cooperation and Development (OECD), which Russia wants to join. However, despite the state’s support, current research yields virtually no commercially viable applications.   

The report says the problem lies with government and industry-level organisations that remain effectively unreformed, unproductive and immaterial to the creation of high-quality R & D. For that reason, both pure and applied research in Russia has underperformed and remains commercially irrelevant, according to the report.

‘Diversifying Russia’ spells out priorities for the next phase of Russia’s efforts to diversify its economy. The study is based on research carried out by a large team of Russian and international economists and is the result of a joint effort involving the EBRD, Russia’s Vnesheconombank and Moscow’s New Economic School.