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Moscow Times
July 4, 2008
Not All Regions Created Equal
By Alexander Osipovich
Editor's note: This is the fifth in a series of reports about the key challenges facing Russia today. Previous reports can be found at www.themoscowtimes.com.

PSKOV -- It was once the pride of Soviet telephone technology, producing the bulky phones that graced the desks of countless factory directors and Party officials.

Now, the Pskov ATS Factory has fallen into disrepair, unable to compete with slicker manufacturers like Samsung and Panasonic. Part of its premises has become a shopping center, and the factory's output has been reduced to a trickle, although a sign outside proudly states that its technology is used by the president and security ministries.

The collapse of the Soviet planned economy was not kind to the Pskov region, a stretch of northwestern Russia that was largely agricultural until the 1950s.

Though rich in history and full of scenic lakes and forests, the Pskov region has none of the commodities -- oil, gas and metals -- that have driven Russia's economic expansion during the past eight years.

Despite recent growth in construction and retail, which has brought shopping malls and high-end apartments to Pskov, the region as a whole lags behind Moscow or nearby St. Petersburg in terms of its job market and living standards.

"You can only have a normal life in the metropolises, in Moscow and St. Petersburg," said Alexander, a taxi driver. "In the villages, people are hungry. Believe me. And it's impossible to move to the towns because it's too expensive."

Evening out the huge disparities between Russia's regions is one of the main challenges facing policymakers today. It is a task that goes hand in hand with efforts to revamp the country's crumbling infrastructure and diversify its economy away from oil and gas.

Soaring oil prices have poured money into the federal budget and driven impressive growth rates, but they have also increased regional disparity. Measured in terms of GDP per capita, the country's wealthiest region, oil-rich Tyumen, was 44 times richer than the poorest region, Ingushetia, in 2006, the last year for which data is available from the State Statistics Service.

And Moscow, the country's financial and political heart, is like a different country by many economic measures. Living standards in the capital are comparable to those of Malta and the Czech Republic, while living standards in impoverished Ingushetia and Tuva are comparable to those of Mongolia, Guatemala and Tajikistan, according to a report released last year by the UN Development Program.

"The income gap between our citizens is still unacceptably wide," then-President Vladimir Putin said during his last annual state-of-the-nation address in April 2007.

In the same speech, Putin announced plans to spend billions of rubles on fixing roads and replacing dilapidated Khrushchev-era housing. The proposals were in the same vein as the so-called "national projects" -- a group of four much-publicized initiatives to improve housing, agriculture, education and healthcare throughout the country, overseen by Dmitry Medvedev, who became president this year.

More evidence that the Kremlin was serious about helping the regions emerged in September when Putin chose Dmitry Kozak, a longtime aide known as his favorite troubleshooter, to head the Regional Development Ministry. Putin then granted the ministry control of the multibillion-dollar Investment Fund for infrastructure projects. The moves raised the profile of a once-obscure ministry.

Since his appointment, Kozak has proposed a range of initiatives aimed at reforming the federal government's relationship with the regions and, ultimately, sparking development at the regional level.

Experts have praised the Kremlin's decision to pay attention to regional issues after what they described as many years of neglect.

"Russia has finally realized that having a regional growth policy is important," said Natalya Zubarevich, director for regional programs at the Independent Institute for Social Policy. "And this is thanks to Kozak."

But Zubarevich and other experts gave mixed reviews to Kozak's initiatives. The key question, they said, is whether the government -- armed with billions of dollars and a clear mandate from the Kremlin -- will revert to the familiar methods of Soviet-style state planning or whether it will serve the needs of a contemporary market economy.

Filling in Potholes

One thing experts and officials agree on -- along with perhaps every single driver in Russia -- is that something must be done about the dire state of the country's roads.

Alexander complained bitterly as he drove his taxi over a bumpy, recently patched-up country road in the Pskov region.

"All they've done is fill in the potholes," said Alexander, who asked that his last name not be published for fear of reprisals. "In a month and a half, it will be back to the way it was before."

The Pskov region is strategically located, with two major transportation corridors running through it -- the east-west Moscow-Riga highway and the north-south St. Petersburg-Kiev highway -- and borders with two EU countries, Latvia and Estonia, as well as Belarus. That brings the region about 20 percent of Russia's international trucking, according to the Pskov Chamber of Commerce.

But until its dismal roads are fixed, Pskov will not realize its potential as a logistics hub, said Lev Shlosberg, head of the regional branch of the liberal Yabloko party.

"The roads need to be improved dramatically," said Shlosberg, who also edits a local opposition newspaper, Pskovskaya Gubernia, and heads an NGO devoted to regional development. "Right now, they are in an utterly wrecked state. Cars simply fall apart from driving on them."

Improvements are also needed at the border crossings with Latvia and Estonia, where the lines waiting to cross can sometimes be 1,000 vehicles long, Shlosberg said.

To maximize the impact of its infrastructure projects, experts say the government should focus on improving the transportation corridors connecting Russia's main growth centers.

Besides Moscow and St. Petersburg, this includes cities like Samara, Yekaterinburg and Krasnodar, which have enjoyed high growth rates in recent years, said Zubarevich of the Independent Institute for Social Policy.

"Development is driven by large cities, by agglomerations," Zubarevich said.

"You need to stimulate the growth of agglomerations, and you need to invest a lot of money in infrastructure projects to connect major growth centers and shorten the economic distance between them," she said. "Then traffic and logistics become simpler, which is very convenient for business."

Officials have announced big plans to improve the country's road, rail, air and port networks. On May 20, in one of his first moves as prime minister, Putin approved a seven-year, $570 billion program to overhaul the country's transportation infrastructure -- Russia's largest spending project since the collapse of the Soviet Union.

Investors have also been closely watching the Investment Fund, which was started in 2005 to finance infrastructure projects through public-private partnerships, and which is now overseen by Kozak's Regional Development Ministry.

So far, about $14 billion from the fund has been allocated to 20 projects, ranging from a seaport in St. Petersburg to a hydropower plant on the Angara River in Siberia.

Some of those projects have been sharply criticized by experts, who say Investment Fund spending decisions are driven by the lobbying efforts of governors and big business interests, rather than a coherent development strategy.

Alexei Sidorenko, a regional analyst at the Carnegie Moscow Center, singled out the Ural Polyarny railroad as an example of bad policy. Partly financed by the Investment Fund, the railroad will connect several regions along the northern part of the Ural Mountains that are sparsely populated but rich in oil, gas and minerals.

"They choose projects like this over badly needed road repairs," Sidorenko said.

"Such investment projects might be effective in making money in the short run," he said. "But in terms of long-term strategy, they will actually thwart innovation and economic development."

A spokesman for the Regional Development Ministry declined immediate comment and asked that questions be submitted by e-mail. As of Thursday, the ministry had not responded to the e-mailed request sent June 4.

Zubarevich said the government should focus on the more populated European part of Russia, instead of trying to conquer the vast stretches of Siberia and the Far East. "Infrastructure in the east is important, but when infrastructure is falling apart in the European part of Russia, the east cannot be a priority," she said. "There will never be enough money for it."

'Upside-Down' System

It was perhaps a bit silly when, speaking on national television in 2005, then-President Putin promised a Stavropol region pensioner that the government would build water pipes to her village so she wouldn't have to walk 300 meters to the nearest well.

But the promise, which Putin made during his annual televised call-in show, was emblematic of the political system he had created.

Following the turmoil of the 1990s, Putin sought to restore the Kremlin's authority by strengthening the so-called power vertical. Once-powerful regional leaders were brought into line and many of their powers shifted to the federal government. In the wake of the Beslan hostage crisis of 2004, Putin canceled the election of governors and made them effectively Kremlin-appointed figures.

The idea was to clean up governance in the regions, widely seen as ineffective and corrupt, by making governors report directly to the president.

But some believe that centralization went too far. Critics argue that federal officials cannot possibly grasp the specific issues facing each region and that governors and mayors are now largely powerless to help their constituents.

By some estimates, only 30 percent of taxes collected in the regions remain in regional budgets, while the rest go to the federal government. This means that many governors spend their time lobbying Moscow for funds instead of trying to raise their tax base.

"Why should they bother with economic development?" said Shlosberg, the Yabloko leader in Pskov. "If they can only keep 30 percent of income taxes, why should they try to stimulate business and create jobs? Their main activity is lobbying for budgetary transfers from above. The system is totally upside-down."

Kozak has called for a range of reforms that would give more powers to regional and municipal governments.

"We in the federal government should not fall into illusion," Kozak said at an April meeting with regional leaders of Delovaya Rossia, a lobbying group for small and medium-size businesses. "We should not fantasize that we can come up with the right answers for each of 86 regions and 24,000 municipalities."

Giving governors real authority to set regional investment policies -- along with the funds necessary to carry them out -- is the best way to come up with policies appropriate for each region, Kozak said.

"They shouldn't be here in Moscow running around the State Duma or the Finance Ministry," he said. "They should be working in their regions, trying to develop their potential tax base."

It is unclear, however, whether Kozak can succeed in pushing through his proposals.

Kozak had a mixed track record while working in Putin's presidential administration, where he drew up a pair of complex reforms -- one aimed at the judicial system, the other at the country's notorious bureaucracy -- that both foundered after encountering fierce resistance.

He also proposed a self-governance reform designed to make local government more accountable. The reform, which has many similarities to Kozak's current proposals, became law in 2003, but the State Duma later voted to push back its implementation to 2009 amid fears that local governments were not ready to take on additional responsibilities.

Federal officials appear reluctant to give power to regional and local governments because they do not want to lose control over how money is spent.

"[Federal officials] say money gets stolen at the local level," Shlosberg said. "They say governors steal money, mayors steal money, district bosses steal money. What, so people in Moscow never steal anything?"

Kozak and other officials have discussed ways to crack down on regional corruption by tightening Moscow's control over how governors spend money and dismissing the ones found to be corrupt.

But the experts interviewed for this report agreed unanimously that there was only one sure-fire way to make governors act responsibly: to bring back gubernatorial elections, making them accountable to their voters.

"As we learned from experience, gubernatorial elections did bring some unfortunate candidates to power," said Sidorenko of the Carnegie Moscow Center. "But people learn from their mistakes and eventually elect responsible people. And the governors themselves feel more responsible."

Corruption is a key factor holding back regional development, experts said. One issue, for example, is that companies with close ties to regional governments often have monopolies in their regions, crushing competition and preventing innovation.

"One of the main problems for regional development is the presence of monopolies at the regional level," said Yaroslav Lissovolik, chief economist for Deutsche Bank Russia. "Activating competition and fighting monopolies is very important here."

Some of the worst regions in this respect are the ethnic republics of the North Caucasus, which are also among the poorest, most undeveloped parts of Russia, Zubarevich said.

"Business is not going there because institutions there are very weak," she said. "They have feudalism, and laws serve the people in power."

Moreover, experts stress that no reform plan -- no matter how well-intentioned -- can succeed unless corruption is reined in.

For instance, one often-discussed idea is the creation of special economic zones where businesses get tax breaks and other incentives for setting up shop. Such zones have helped stimulate growth from Ireland to India to China, prompting Russian officials to draw up plans for Bangalore-style technoparks and Dubai-style seaports.

But the zones would not do much good if corruption and favoritism is allowed to fester. "A special economic zone, if it is in a country full of bad institutions, will not be very helpful," Zubarevich said.

Workers Wanted

Heiner Berr is one of the few foreign investors in the Pskov region. In 2002, he and two other Germans started a resort on the shores of Chudskoye Lake, a large body of water that straddles the Russian-Estonian border. The resort, called Chudskoye Podvorye, now has 43 cabins, a restaurant, a masseuse and a petting zoo.

Today, Berr's biggest problem is finding qualified staff to serve visitors and maintain the facilities, he said in an interview. "We used to only have problems with bureaucrats," Berr said. "Now we only have problems with staff."

A shortage of labor is one of the biggest problems facing companies in the region, said Alexander Staroselsky, vice president of the Pskov Chamber of Commerce.

"There is a dire shortage of skilled workers," Staroselsky said.

"Our region has too few workers, and it gets especially bad in the case of skilled personnel, like builders, engineers and IT specialists," he said, adding that many qualified graduates leave for nearby St. Petersburg.

Any attempts to stimulate regional development will bump up against the problem of depopulation, experts say. But the most obvious solution -- attracting immigrants from abroad -- is also the most improbable, given the widespread animosity toward migrants among politicians and the public.

"Our country does not have enough people," Zubarevich said. "We need to attract migrants. But at the same time, Russia is a frighteningly xenophobic country."

The government should also encourage internal migration, helping Russians move from unproductive regions to places that need labor, Zubarevich said.

"There are many barriers to moving," she said. "First, there are administrative barriers, like the registration system. Then there is the housing market. Housing prices are insane in the places where there are jobs, and people can't afford to live there."

Pskov has benefited from a program to relocate people from remote northern regions, Staroselsky said, but he conceded that depopulation remained a problem.

Last year, the Pskov regional government announced plans to build an $800 million oil refinery in Velikiye Luki, the region's second-largest city, and a 1 billion euro ($1.6 billion) pulp-and-paper plant backed by Estonian, Norwegian and Austrian investors, which it said would create 2,000 new jobs.

Pskov Governor Mikhail Kuznetsov has called the projects "locomotives" designed to boost the regional economy.

Some have criticized the projects, however, questioning their feasibility and saying it would be better to focus on small business, which represents a small fraction of Russia's economy compared with the economies of Western nations.

"If you look at the Russian economy, all you see are big monsters, and there's no room left for small business," Shlosberg said. "The state doesn't like to pick at tiny grains. It wants to scoop out big spoonfuls from the barrel, and nothing else interests it."

Sergei Yermolayev, a spokesman for the Pskov regional government, acknowledged that small business was underdeveloped in the region but defended the two big projects.

"There is a clearly thought-out business plan," he said in an e-mail, pointing out that Western investors stood behind the pulp-and-paper plant and that construction on the plant had already begun.

But poorly conceived "megaprojects" are all too common in Russia, experts say, calling them a legacy of the Soviet system.

"Since most officials are not actually very well qualified, they make many decisions on the basis of whether something will make an impression or not," Sidorenko said. "Thus we get a lot of loud, extremely difficult to implement projects like, for instance, an ecotourism village in Khakassia that needs several billion dollars just to start working."

Zubarevich agreed, arguing that an "imperial syndrome" stood in the way of making sensible regional development policies.

"We don't know how to do ordinary work," she said. "We know how to come up with a slogan, make a lot of noise for a month or so, and then forget everything."