Powering Russia’s Post-COVID-19 Recovery: Do Global Value Chains Hold the Key?

Authors: Apurva Sanghi, Ian Gillson, Deborah Winkler

Compounding the human and health costs, the COVID-19 pandemic has hit Russia’s economy hard, with the economy expected to contract by 4 percent in 2020 before returning to growth between 2 and 3 percent in the following two years. The entire country has felt the impact, with unemployment increasing in all regions since the start of the pandemic. Effects of the crisis have been most concentrated in sectors least able to adapt to social distancing requirements (such as services and manufacturing), and in mineral resource extraction on the back of OPEC+ agreement.

The government responded quickly to the crisis with a range of fiscal, monetary, regulatory, and social policies that have helped contain the crisis’s worst impacts. Encouragingly, as we discuss in our latest semi-annual report “Russia’s economy loses momentum amidst COVID-19 resurgence; awaits relief from vaccine”, Russia has some fiscal headroom to pursue necessary measures to further manage the crisis. The immediate recovery will depend on a safe and effective vaccine. But Russia’s longer-term recovery depends on boosting its potential growth.

In this context, one debatable question is, to what extent can — and should — Russia integrate with the rest of the world? After years of sanctions, Russia is more insular and less integrated globally than its closest competitors. In a companion World Bank study, “Russia Integrates”, we conclude that Russia has much more to gain than to lose through greater global integration. Global value chains (GVCs), where production is broken into activities and tasks carried out in different countries, offer a particularly important opportunity for Russia to take advantage of its skilled and talented workforce and vast natural resources. Canada and Australia offer aspirational examples of large commodity exporters who have benefitted from deep integration into GVCs.

We propose that deeper integration of Russia into GVCs would require reforms in three areas: trade policy, services and foreign direct investment (FDI).

On trade policy, it is worth remembering that Russia’s economic successes have resulted from embracing greater openness, including becoming a member of the WTO in 2012. Indeed, import tariffs on manufactured and primary products have fallen sharply in Russia since then. However, while such tariffs are lower than in India and China, they are still twice as high compared to those imposed in the EU, the United States, and especially Turkey. Trade liberalization – including reducing non-tariff barriers – would improve access to high-quality inputs and promote participation and upgrading in GVCs.

Russia needs to be cautious of policies that discriminate against foreign imports – the so-called import substitution policies – which it has been expanding since 2014 to reduce its dependency on imports, especially from Western countries. The results have been mixed. For instance, while there have been some areas of modest growth, notably in agricultural exports, these come at the cost of higher food prices for Russian consumers.

Services trade is an area where Russia is well placed to compete in global markets, but it is currently held back by restrictive policies. Reducing these barriers is especially important for Russia to integrate in more complex GVCs that rely on imported services. Digitalization is one area that provides an opportunity to speed up Russia’s recovery from the current crisis. According to the OCED’s ranking of 45 economies, while Russia has made good progress in digital transformation, it remains among the top three most restrictive economies in digital services such as computing.

In computer services, there are relatively high restrictions on foreign entry as well as cumbersome regulations for the hiring of foreign professionals, including intra-corporate transferees and independent and contractual service suppliers.  While many of these restrictions currently in place were designed to help Russia compete with foreign suppliers, the actual result has been the opposite. Even the most dynamic Russian firms struggle to bring in foreign expertise that could transfer skills to their Russian counterparts. This leaves them less able to compete against firms in the U.S., EU, or India. 

Increasing FDI is another way for Russia to take advantage of GVCs. Currently, Russia’s FDI is largely driven by its natural resource endowments and originates more from tax havens. Sanctions have led to a low FDI trajectory. However, despite the negative impact of sanctions on FDI, there are measures that Russia can undertake to boost FDI. One example is Russia’s complex legal framework, which includes the Foreign Investment Law, the Strategic Investment Law, and the New Investment Law. A consolidated investment law that clarifies the institutional framework, investment entry, and protection rules would be simpler and clearer for investors.

Russia also has a high number of investor-state disputes, 26 publicly known ones. The most frequently alleged breach by investors is expropriation. However, foreign investors have limited dispute resolution options, and Russia becoming a full Contracting State to International Centre for Settlement of Investment Disputes (ICSID) would help this situation.

While our analysis portrays Russia in a post-sanctions environment – distinctly less connected to global markets, less innovative, and with an unlevel playing field between the public and private sector that hinders competition – the country has untapped potential to integrate further into GVCs, trade, and the global FDI network. The COVID-19 pandemic is reinforcing and accelerating changes in GVCs – such as reshoring and digitalization – that were already underway before its onset. And herein lies an opportunity for Russia to strategically position itself in the post-COVID world, and in doing so, help it move towards its 2030 National Goals.

First published in Kommersant.ru  via World Bank