International comparisons

If productivity levels are poor and wage costs are high, firms will find it difficult to compete with rival companies who are more efficient. Firms with higher productivity and lower costs will be able to sell their products at lower prices and increase market share.

If foreign firms are more competitive than Russian companies, consumers in Russia will tend to buy cheaper imported goods. Also, Russian companies will find it difficult to sell their products overseas. Falling demand for Russian products at home and overseas will cause rising unemployment.

It is, therefore, important to examine levels and changes in productivity and labour unit costs over time in Russia’s main overseas competitors.

2.2. Government Action to Improve Competitiveness

Government economic objectives

The government’s overall economic objective is to promote sustained economic growth in the total output by establishing a stable economic environment for business, based on low and stable price inflation. The government argues that without this, uncertainty will stifle business and employment opportunities, and businesses will be discouraged from investing for the future and developing the products on which Russia’s prosperity depends.

It is argued that high and volatile price inflation of the kind experienced during the 1990s destroyed jobs, stifled economic growth, and increased the demand for imports from countries with lower price inflation than Russia, thereby causing a balance of payments deficit.

Inflation may be defined as a general and sustained rise in the prices of goods and services. It is measured by calculating the percentage increase in the price level over successive time periods – per month, or per year. The Retail Price Index (RPI) is the main ‘headline’ measure of price inflation. It expresses the percentage change in the average level of prices of a ‘basket’ of some 600 different goods and services, in terms of movement in a single number series. The goods and services in the ‘basket’ are selected as representative of those purchased by the ‘average’ household, based on a sample of 7,000 households. Approximately 150,000 price quotations are recorded each month by government statisticians from a large number of retail outlets across the country.

In the base year, the average price of the RPI basket is assigned the number 100. If, on average, the price of the basket increased by 10% the following year, the RPI will be calculated as 110. If, over the next year, the average price of the basket rises by 12%, the RPI will be recorded as 123.2.

The Producer Price Index (PPI) is calculated from the price movements of approximately 11,000 materials and products purchased and manufactured by industry. Increases in material prices paid by producers are likely to feed through to retail prices after a time lag.

The government argues that low inflation – and the confidence that it will be kept low – is essential for better economic performance and improved competitiveness. This is because:

Inflation distorts the price signals in markets on which firms base their decisions about what goods and services to produce. Changes in relative prices become confused by general inflation. Even with general price inflation of only 5% per year, prices double every 14 years.

High inflation creates uncertainty, which leads to reduced business investment in new plant and machinery – the engine of future economic growth. If firms are unsure about future prices and levels of inflation, they will be less willing to take risks and invest in long-term projects.

High inflation relative to other countries reduces demand for Russia’s exports, but increases the demand for cheaper overseas imports in Russia, thereby destroying jobs at home.

High inflation erodes the purchasing power of money. People are able to buy fewer goods and services than they did before, and so demand for goods and services tends to fall. As the purchasing power of money falls, lenders of money push up interest rates to compensate. Savers will also demand higher interest rates to protect the value of their savings. As interest rates rise, borrowing becomes more expensive for consumers and firms. 

Government policy and inflation

Government policy for reducing inflation recognises the following possible causes of rising price inflation:

Demand-pull inflation occurs when the total demand for goods and services in the economy exceeds the total output or supply. As a result, prices will be forced up.

Cost-push inflation occurs when rising production costs are passed on to consumers in the form of higher prices. Production costs can rise either because workers push for wage increases above increases in productivity, or if the prices of materials and components rise.

Imported inflation is said to occur as the result of a fall in value of Russian rubble on the foreign exchange market. This will increase the price paid for materials, semi-finished, and finished manufactures, and services purchased from overseas.

Given these possible causes of inflationary pressure in the Russian economy, the following government policy measures to control inflation have been developed:

• Fiscal policy to control rapid increases in demand for goods and services by raising taxes and/or lowering government spending

• Using interest rates to stabilise the Russian rubble exchange rate to encourage exports and to reduce imported inflation

• Supply-side policies to improve the ability of Russian industry to expand output to meet demand and to reduce business costs and prices. These include:

• Reducing the size of government in terms of reducing the burden of taxation on consumers and producers and cutting government spending

• Competition policy to encourage price competition between Russian firms

• Privatisation: allowing private sector firms to produce goods and services formerly provided by central and local government

• Deregulation to remove out of date restrictions on competition and business

• Promoting skills through investment in education and training

• Support for innovation and new technology

• Removing barriers to international trade

• Encouraging inward investment

Fiscal policy has been used to control the level of total demand for goods and services in the economy. When demand was rising too fast causing prices to rise, governments would raise taxes and lower government spending to reduce the incomes of consumers and business. For example, corporation tax on company profits could be increased to reduce the money they had available to pay to shareholders and to use to invest in new machinery. Incomes taxes could be raised to reduce the amount of income consumers had to spend, and VAT could be increased to increase the price of some goods and services so that consumers could not afford to buy so many of them.

Fiscal policy is still used today to control the level of aggregate demand in the economy. However, some governments dislike trying to use fiscal policy to manage short run changes in the level of demand in the economy and instead place more emphasis on reducing the size of government over the long term.

The present government is committed to reducing the ‘size of government’ in terms of the amount of total tax it takes from the national income and the proportion of total expenditure accounted for by public spending. As part of this process, it is encouraging private-sector firms to run activities formerly operated by the government.

Ultimately the commitment to reduce government is linked to an aim to achieve a long-term balance between government spending and revenues and thereby reduce the need for government borrowing. It is argued that too much government borrowing ‘crowds out’ private-sector borrowing by firms, because the increased demand for borrowed funds by government forces up interest rates. As the cost of borrowing rises, firms tend to cut back their own investment plans.

The government has argued that high income tax rates are a disincentive to greater effort by workers. High corporation tax rates on profits also discourage firms from investing, because any additional profits generated are swallowed up in tax. The government is therefore committed to reducing the burden of direct taxation on the incomes of employees and industry.

Fears of higher price inflation tend to place downward pressure on the rubble exchange rate. This is because overseas investors, anticipating a fall in the purchasing power of their money held in Russia, will withdraw their investments and sell Russian roubles in return for other currencies. As with any other good or service, an increased supply of Russian roubles on the world currency market will push down their price. A fall in the value of rubble will raise import prices, and the cost of many raw materials and finished goods will rise also.

Interest rates can be used to stabilise the value of the Russian currency on world currency markets. Raising interest rates will attract foreign investment to Russia. As foreign currencies are exchanged for Russian roubles, the increased demand causes the value of rubble to rise. 

Supply-side policies

The aim of government supply-side policies is to free individual markets of imperfections, so as to allow producers to operate and expand more effectively. 

Competition policy concerns the removal of restrictions to free competition which in turn inhibit market supply, output, and employment. Anti-competitive behaviour in Russian markets, such as price-fixing agreements by dominant firms, can be investigated by the Anti-monopolistic Committee, who can also recommend corrective measures.

Privatisation involves the transfer of public-sector activities provided by the government to the private sector. Supporters of privatisation argue that many public-sector concerns were often overmanned and inefficient because they faced no competition and did not have to return a profit. Competition to supply the services for profit therefore improves quality and efficiency. Others argue that privatisation has created private monopolies that have increased their profits by exploiting consumers. 

The process of removing government restrictions on business and free competition is known as deregulation. Deregulation aims to remove some statutory regulations on business, ranging from restrictions on opening hours and the sale of ethylated spirits, to the licensing of employment agencies. The removal of these restrictions should reduce business costs.

Support for innovation in new technology. The government recognises the need for research and development (R&D) and implementation of new technologies in Russian industry to keep pace with that of our main competitors. New technology can improve the speed, accuracy, and quality of production, and hence release resources that can be used productively elsewhere and reduce costs.

However, the cost of R&D and the implementation of new technology can be high, and the payback in terms of lower costs and increased revenues slow to materialise. In the meantime, uncertainty about the economy, particularly price inflation and exchange rate and interest rate stability, can reduce firms’ incentive to invest in new products, equipment and methods.

The government is able to encourage firms to invest in R&D and new technologies by providing a stable economic environment, and through a number of other measures:

• Enabling capital expenditure on research and new technology to be offset against corporation tax on company profits.

• Providing funding for skills training in new technologies

• Funding R&D by the science and engineering base (i.e. universities and research establishments), and research commissioned by government departments

• Providing advice, networking between support organisations at a local and national level, and access to international research programs, new insights, practices, and technology developed overseas

• Improving education and training. In order to compete successfully in international markets, it is essential to have a highly trained and skilled workforce. Skill needs in industry are rising as competition and the pace of change in technology increase.

A well-trained workforce can have the following benefits for business:

• Increased productivity and profitability. Training can help employees achieve maximum efficiency.

• A flexible and multi-skilled workforce. Well-trained personnel will be able to adapt more easily to new products, technology, and production processes.

• Improved fob satisfaction. Training motivates staff and enables them to derive greater satisfaction from their work. This will help firms retain staff with skills appropriate to their future needs.

• Reduced accidents and injuries. Workers who are properly trained in health and safety procedures and able to operate machinery and materials correctly are less likely to be absent from work due to illness or injury.

• Improved company image – and therefore, enhanced recruitment potential.

The government has taken a number of steps to improve productivity and labour force flexibility through skills training for those in work and the unemployed. Without government intervention, there would be no market for training people without a job, unless they could afford to pay for it. 

Investment is defined as the act of buying new and often improved plant and machinery by private and public sector business organisations. Investment spending is, therefore, a source of demand and revenue for producers of business premises, machinery and other man-made resources. Investment spending is also known as gross domestic fixed capital formation.

Some investment expenditure will be to buy new assets to replace man-made resources – premises, machinery and other equipment - which are old, worn out and no longer productive. Simply replacing old equipment does not add to the ability of firms to increase their output. However, investment in new and additional premises, machinery and other equipment will expand productive capacity.

New investment by business is, therefore, essential if the productive capability of Russia’s economy is to grow. Investment in new technologies can also mean faster, more efficient production, less wasteful and better quality production. This can lower the cost of producing each unit of a good or service and, therefore, improve the competitiveness of Russian industry.

It is often argued that Russian firms are reluctant to invest compared to other countries because business owners are often uncertain about the profits they will earn from new investment. For example, in 1993 Japan industry invested around 31% of the total value of its output of all goods and services and Germany invested 22%. This suggests that these other countries are devoting a large proportion of their total national outputs to investment in new plant and machinery. However, these figures do not tell us how much of that spending is to replace old and worn out equipment or to increase productive capacity.

The government policy is to encourage both inward and outward investment. Inward investment refers to the setting up of foreign-owned multinational companies in Russia. By far the biggest foreign investors in Russia are German companies. Outward investment refers to Russian investment overseas. The setting up of Russian companies abroad provides access to foreign consumers, allowing Russia-owned business to sell more goods overseas and improve the balance of international payments.

The government suggests inward investment has the following benefits: «Inward investment brings world-class production techniques, technical innovation and managerial skills, which can be transferred to local companies. It has revived the international competitiveness of some sectors of Russian industry».