Russia and the World Trade Organization

Myth 1. WTO membership means complete exposure of the economy to global competition, leading to the displacement of domestic industry followed by mass unemployment.

This myth rests on a number of assumptions:

Current tariffs protect Russia’s industry against competition.

WTO membership will lead to a drastic reduction in this tariff barrier.

WTO membership means that the government will lose the key instruments it uses to protect local industry.

Opening the economy as required by WTO membership amounts to a death sentence for domestic industry.

The truth is more complex:

Current tariff rates are low, some 7-15 percent at the two-digit industry level, too low to be very effective by international standards. Moreover, customs administration functions so poorly that only about half the tariffs are collected.

Joining the WTO will not necessarily lead to a reduction in tariffs. Tariff rates will be decided during accession negotiations, and some tariffs may even be raised. Because the rates are likely to be fixed once the accession agreement is signed, government and industry must think carefully about the levels of future tariffs.

The government will not lose its ability to protect domestic producers. Members of the WTO are permitted to implement temporary defensive measures. Also, keeping the real exchange rate low can help protect domestic producers.

Although it is true that exposure to international competition may be detrimental in the short run to some sectors of the Russian economy, such as the food and machine building industries, the long-term consequences of not joining and not restructuring are even more harmful.

Myth 2. WTO membership will open agricultural markets to cheap products from abroad, and domestic producers will be unable to compete successfully. The Russian agricultural sector will wither, and the country will become dependent on imported food products.

Almost every country in the world protects its agricultural sector. By world standards Russia’s agricultural tariffs and subsidies are not very high. Joining the WTO is unlikely to exacerbate the current situation if, during accession negotiations, Russia reaches agreement on a high and stable tariff system for agriculture. Moreover, WTO membership does not prohibit agricultural subsidies. It requires only that countries establish a subsidy ceiling, which may not be exceeded. Recently, Russia negotiated with the WTO a $16 billion ceiling for agricultural subsidies, well above what Russia now spends or plans to spend on agriculture.

The claim that the Russian agricultural sector will wither once the economy becomes more open is unfounded. Many of the sector’s problems will persist regardless of whether Russia joins the WTO. Many of the current problems cannot be called “development-inducing” by any definition-soft budget constraints, vague property rights, opportunistic behavior by managers, and difficulties obtaining credit. Institutional reforms, including land reform, founded on a new system of incentives and greater specialization can propel Russian agriculture to a prominent place in the global economy.

Myth 3. The Russian banking system, insurance industry, and pension funds are still too small to face foreign competition. WTO membership will lead to a devolution of Russian financial institutions while international bankers collect citizens’ savings and move them abroad.

The main problems for the Russian financial sector relate to the poor investment climate and weak protection of creditors’ rights, not WTO membership. Similarly, a lifting of the controls on capital flight, much discussed in Russia these days, will not be enough to improve Russia’s investment position without reforms in laws and regulations, accounting procedures, corporate governance, and financial regulation.

The monopolistic position of the Russian financial sector should be broken. After 10 years of isolation under infant industry protection, Russian banks are still unable to perform basic functions. WTO membership does not mean that Russian financial markets will immediately face foreign competition. Russian banks will have time to prepare themselves to operate in a more competitive environment.

Myth 4. Tariff reduction will boost imports at the expense of foreign direct investment.

Theoretically, in countries with poor investment climates and internal markets protected by tariffs, it is cheaper to build a factory inside the country than to import goods. If the markets are open, goods will be produced abroad and imported. However, the experience of countries that have joined the WTO demonstrates a different reality. WTO accession attracts foreign direct investment, both during the accession process and once a country becomes a member.

With WTO membership, export-oriented Russian producers will become more attractive for foreign investors. Guarantees to protect the rights of creditors, a part of WTO membership, will shield foreign investors from discrimination by regional authorities. Horizontal investments (those oriented toward the domestic market) will go to regions with greater concentrations of population, and vertical investments (oriented toward export) will move to border regions with concentrations of skilled labor. Again, improving the investment climate is a prerequisite for achieving long-term economic growth-whether Russia joins the WTO or not-since tariff rates are only a small part of the transaction costs motivating foreign investors.

Myth 5. WTO membership limits opportunities for corruption in the bureaucracy, diminishing the need for administrative reform.

This myth arises from a distrust of the government’s ability to reform itself. True, WTO membership provides foreign producers with tools to resolve conflicts with Russian authorities, so that in cases of discrimination, Russian exports will be subject to fines and levies in global markets. However, WTO membership does not preclude the pressuring of domestic businesses by the Russian authorities, which could continue. Administrative reform is thus a must. If the government does not reform itself, Russian business may lose rather than benefit from WTO membership.

Myth 6. Regional free trade agreements are becoming more important than the WTO. Membership in the WTO will not offer Russia any special advantages, and may even weaken its position if the Customs Union with the Commonwealth of Independent States is abandoned.

If Russia joins the WTO, it will be able to acquire all the advantages of that organization. As for the Customs Union, all of its functions may be preserved through bilateral agreements or the establishment of a formal regional free trade association.

Myth 7. Because of Russia’s geographic position, WTO membership will not improve the investment climate in any significant way.

David Ricardo long ago refuted the old argument of the irrationality of trade in the context of high production costs for all products by demonstrating that comparative advantage is more important than absolute advantage. True, a colder climate increases transaction costs. But cold is not a decisive factor in the current development of the Russian economy. In growth regressions, the geographic variable loses its significance when bureaucratic corruption, an index of economic openness, and the quality of laws are controlled for.

Myth 8. The problem of the Russian economy lies in the “Russian character.” Although the market economy may work elsewhere, peculiar features of the Russian culture that emphasize collectivism preclude markets from functioning well in the country.

Markets function in Russia as they do anywhere else. The problem is that some parts of the Russian economy are still not functioning under market conditions. Many sectors remain unexposed to competition, so that growth of total factor productivity is slow in those sectors. However, Russian managers have demonstrated their ability to survive under adverse conditions. Russians are highly educated, with a proven ability to adjust and compete. Reducing trade restrictions would tap more of the vast potential of the stock of Russia’s human capital.

Resolving many vital problems in Russia does not depend on WTO membership. The challenges of structural unemployment, a negative investment climate, and implementation of structural reforms will remain whether Russia joins the WTO or not. However, the opportunities for success may turn out to be greater, and the social costs lower, if Russia decides to become a member. To take advantage of these opportunities, the country needs to improve factor mobility across enterprises, sectors, and regions. So the question is: “What should Russia do once it joins the WTO?”

Competitiveness in the world economy depends on:

Labor mobility, both geographic and professional.

Corporate mobility, the ability of a firm to innovate and change its administrative structure.

Capital mobility.

Information mobility, a precondition for lowering transaction costs.

Geographic mobility: WTO membership will allow Russia to restructure its economy faster, encouraging people to move to more productive sectors. Deregulation alone will not do it for sectors and regions with depressed demand and high unemployment. The key measures for improving geographic mobility are lowering administrative barriers, opening centers for support and retraining of migrants, getting informational support from the mass media, and developing credit markets. Greater geographic mobility will increase regional competition for qualified labor. Regional governments will be forced to do more to keep labor and capital in the region.

Professional mobility: The Russian labor force is one of the most educated in the world. To take advantage of this factor of production, the state needs to do more to improve the professional mobility of labor. But an educated labor force is not enough. Also needed is a willingness to learn and adjust to the new realities of changing technologies and markets. For Russia this may be even more of a problem than geographic mobility, because unlike the system of secondary and higher education, centers for retraining workers are not well developed. Education should be regulated as a value added sector, through a clear tax system and quality monitoring and implementation of contemporary structures of corporate governance in nonstate institutions of higher learning.

Corporate mobility: The solution to corporate mobility is to improve the professional education of managers. The country needs people who can move firms away from the hierarchical system of governance to the contemporary, network-based system. Changes in organizational structures need to be supplemented by development of professional consulting and accounting. WTO membership and exposure to international competition will provide positive stimuli for Russian firms to restructure.

Capital mobility: One way to smooth the transition to WTO rules is to allow greater capital mobility from depressed to more successful sectors of the economy. For that to happen, transaction costs in capital markets need to be lowered. The state can deal with this if it takes action in four areas: tax policy, deregulation, capital market development, and corporate governance. Lowering the tax burden, in particular, could stimulate investment. Capital gains need to be made tax free, at least temporarily. Reform of the judicial system would curb bureaucratic corruption and strengthen protection of property rights.

Information mobility: Russia needs to take advantage of new information technologies. Greater access to the World Wide Web will improve information mobility and aid the transfer of capital and labor to more productive economic sectors. Although the Internet is a public infrastructure good (like a highway system), the private sector should share the cost of its financing.

In sum, without greater mobility, Russia risks becoming trapped in a vicious (closed) cycle of survival without modernization, with moderate growth, at best, during years of high oil prices and stagnation or even depression during years of low prices for natural resources. With greater mobility-horizontal, vertical, and information mobility of capital and labor into the most promising sectors-Russia can be successful in the global economy. Investing in the more progressive areas of the economy helps improves the quality of education and contributes to higher mobility of the factors of production.

The quality of human capital remains Russia’s biggest comparative advantage. Human capital will be the driving force for investment in new sectors of the economy if Russia joins the WTO. If Russia waits too long, however, the potential of this factor could be wasted, and the chance to break the vicious cycle missed.

Thus the sooner Russia joins the WTO, the easier it will be to adjust to the new realities of the world economy. WTO membership means more than lower tariffs. It also implies deep structural changes in the economy as a whole. Such structural reforms are essential for Russia to benefit from WTO accession.