#3 - JRL 7248
Moscow Times
July 15, 2003
Structural Reform vs. Growth
By Yevgeny Yasin
Yevgeny Yasin, former economics minister, is academic director of the Higher School of Economics. He contributed this comment to The Moscow Times.

At the Higher School of Economics, we recently completed work on a report on the "non-market" sector of the Russian economy. The study focuses on the crucial trade-off between structural reforms and economic growth.

As has been widely reported, President Vladimir Putin, in his state of the nation address to the Federal Assembly earlier in the year, set the objective of doubling GDP in 10 years and also stated that we do not need reform for reform's sake. I fully agree with the latter point. However, our report, which brings together the results of three years of research, leads to the conclusion that structural reforms are urgently needed, and that during their implementation there may be a temporary drop in the rate of growth.

When we talk about structural reforms, we are talking about reform of natural monopolies -- primarily Unified Energy Systems and Gazprom -- as well as housing reform and related measures in the area of social security.

Prices for gas, electricity and housing services in this country are low and regulated by the state. I would like to emphasize that domestic gas prices are not low because they are subsidized by high export prices, as is often held to be the case in the West. Even with low domestic prices, the gas industry is still profitable for the most part (losses are no more than 1 percent of turnover on the domestic market).

However, low domestic prices -- and they are about four to five times lower than export prices -- lead to the irrational use of extremely valuable resources. Cheap gas makes it possible to maintain low rates for electricity (gas makes up 62 percent of the fuel used in Russian power stations) and together they make it possible to keep prices for housing services low. This in turn is justified by reference to the low income levels of the majority of the population.

In fact, low incomes themselves are a product of the fact that we have preserved the Soviet tradition of maintaining services at an artificially cheap level and handing out all kinds of benefits. The population now pays only 50 percent of the cost of the housing services it receives. The rest comes from the budget, cross subsidization and running down infrastructure and capital stock. In 2001, combined this amounted to approximately 90 billion rubles.

Together, these branches comprise the heart of the non-market sector of the economy. They employ about 5 million people. This enclave of the Soviet economy, not dismantled to this day, in our opinion is a major obstacle to the healthy development of the country.

Low gas and energy prices, together with low salaries, are not in fact conducive to the development of manufacturing industries, as they destroy incentives to save energy and raise productivity -- although initially, of course, the increased price of inputs would lead to higher costs and lower profits.

And this is the crux of the matter: Either you raise costs and freeze growth for two to three years but get rid of the non-market sector, expand competition and create conditions for the inflow of capital into those sectors; or, for the sake of growth today, as fast as possible, you go slow on structural reforms and listen to all those industrialists incapable of functioning in a competitive environment and calling for electricity prices to be reduced even further.

Our conclusion is that structural reforms are the only way forward.

We propose gradually increasing electricity rates over a three-year period (2004-07) to 3.5 to 4 cents per kilowatt hour; and gas prices to $40 to $50 per 1,000 cubic meters. Rent on gas between $20 and $25 per 1,000 cubic meters should be earmarked for raising salaries for state employees and pensions so that the population would be able to afford the higher prices for housing and communal services.

Calculations based on 2001 conditions show that it would be sufficient to raise state employees' wages by 600 rubles per month and pensions by 300 rubles per month, while preserve housing subsidies and slightly increase child benefits, in order to compensate for 80 percent of the increase in household expenses. Moreover, less well-off families would receive full compensation.

As far as industry is concerned, costs would grow by approximately 13 percent including salaries, but predominantly in those sectors that have considerable export revenues (gas, ferrous and non-ferrous metals, chemicals and petrochemicals) and capable of mobilizing their resources to reduce costs in other areas, among other things by investing in new technology.

Under this scenario, we calculate that between 2005 and 2007 growth rates would slow to 2 percent to 3 percent per year. However, from 2008 to 2010, we calculate growth rates would rise to 5 percent to 6 percent, and possibly even more depending on how well structural reforms are implemented.

This approach differs from more generally accepted approaches. However, at least it forces us to look at our problems from a new perspective and to look for non-standard solutions, when hackneyed measures are very unlikely to result in success.