COMPETITION DISTORTION AND
PROBLEMS OF DEVELOPMENTAL GROWTH:
The Case of the Russian Federation
It is essential for any ambitious policy of economic growth to establish firm rules of free and unhindered competition in the workings of its markets. The full development of market forces and the realization of all possible benefits of an open economy rely to a substantial extent upon the application of free competition practices. It is beyond ideological inflexibility and preconceived socio-economic dogma to assert that the benefit of consumers and the fulfillment of a viable and stable socioeconomic order can most certainly be achieved through the implementation of policies that encompass a really open and free competition regime.
The ultimate objective of all economic policies is the welfare of a country’s citizens. And this can be realized only by means of guaranteeing popular satisfaction with the condition of the economy, with the transparency of the state’s (and, consequently, the taxpayers’) finance, with hopeful prospects and expectations for a prosperous future.
Within the context of a modern economy, obliged to compete in an environment of an essentially globalized worldwide open market, there are several options to be followed for success to be ultimately attained. The economy has to be open. So that investment can flow in, new technologies attained, modern projects initiated and the market forces achieve a balanced level of activities. The private sector of the economy has to be enlarged thorough privatization and the reduction of state monopolies. This policy enhances the possibilities of more vigorous economic action, expands the state’s finances by means of extending the available tax basis and opens more possibilities for new initiatives, innovation and modern entrepreneurial practices which add dynamism and tremendous potentiality to the furthering of growth and economic development. Productivity levels finally have to be raised. So that the country should be able to compete efficiently on the international economic arena at almost every level of financial endeavor. High productivity is the measure on the basis of which countries achieve satisfactory levels of growth and attain rapid rhythms of development.
To attain however high productivity levels it is more than essential for an economic regime to establish free and open competition practices. Any disruption of competition rules and any violation of its root concepts and characteristics undermines the smooth working of the market and diminishes the prospects of high productivity results. It is therefore imperative that competition rules should be clear, all encompassing, universally – within the context of a national economy of course - applicable and with as few as possible exceptions tolerated. And by means of exceptions an overtly open and sincere competition concept should consider all state policies that undermine free marker procedures, offer protection to specific segments of the economy, allows for unwarranted state intrusions to the functions of the market and hinder unobstructed competition policies.
Practices of Competition Distortion
Within the above described context there are many government activities in the Russian economy that directly or indirectly impede the full application of an absolutely free competition environment. And thus contribute to the development of economic dysfunctions, growth impediments and difficulties for really antagonistic trade and business practices to emerge and flourish. As a result the final pursuit of rapid growth, not boosted by high oil prices*, remains illusive and unattainable and the society’s ills and miseries are not banished nor radically curtailed.
It is customary under similar circumstances, i.e when a limited share of economic activity is left to the market and there are serious obstacles to the application of genuine and free competition practices, the blame of the unsatisfactory end results to be attributes to the, so called, open economy. While it is exactly the obstacles imposed upon its functions by overt or covert state intervention procedures that contribute to the unwelcome outcome.
To formulate therefore an efficient competition policy concept we should at first attempt to specify existing market dysfunctions that today hinder the process of growth and are holding the economy back from a rapid expansion. Then we should address a number of policy initiatives that impose problems upon a really free competition regime. And finally, we will proceed to recommend a number of policy initiatives that will most probably encourage the full and unobtrusive application of real competition rules in the economy.
Without getting into specific details there can be acute observations that locate problems and deficiencies that badly influence free competition. In the case of the Russian Federation many decades of strict central control of the economy and a heavy legacy of state planning and non-existent free market mechanisms had left a heavy burden of competition distortion practices. Overlooking the problems imposed by such realities renders it almost impossible for a truly free competition regime to be installed. The main areas where such distortions of competition are observed are almost all of them related to the functioning of the state. Taxation avoidance or granted exceptions , direct or indirect subsidization, bureaucratic hustle, illegal imports, toleration of fake products, unfair procurement allocations and purposeful harassment by various state agencies are some of the most important cases that lead to serious competition distortion.
When government decides to subsidize some public, semi-private and private firms and not their competitors intervenes in the workings of the market and hampers competition. This usually happens on the justification of alleviating social problems which would endure if an enterprise – usually gigantic and dominating the economy of a region or a local community – is threatened with bankruptcy and closure. The spectre of local or regional unemployment forces government agencies to intervene and discover ways to
salvage the firm. Smaller healthy firms however cannot under similar circumstances efficiently compete and survive under pure market terms.
This process of subsidization can take various forms. It is not always necessary for public money to directly fill the coffers of the troubled enterprise. Not paying taxes without the consequences of direct state sanctions is an indirect way of financial support. The case of the confrontation between Rosneft and Nenets governor Alexei Barinov, over the state-owned oil major’s outright refusal to pay a 900 million ruble tax debt, is indicative of situations such as this. A similar case is the abrupt reduction of Yuganskneftegaz’s tax bill by a Moscow court in April 2006. Yuganskneftegaz is a production unit recently acquired by state owned Rosneft from troubled Yukos. The back taxes this company owed while belonging to Yukos were reaching $4.7 billion dollars. This tax bill was reduced, according to a statement from Rosneft, by the Russian court to about $700,000 !!
electrical company – usually controlled by the Local Government body. And bartering (for purchase of raw materials or settling electrical, water and gas bills) by means of unjustifiably overvalued goods produced by the local firm, still in some (rare) cases comprises a way of keeping an essentially bankrupt enterprise in business.
In a similar way competition is distorted when – usually – local and regional governments offer contracts to some enterprises and not to others. Competitors are driven out of the market and prices are formed in an unnatural way when costs are soaring and the state appears to believe that direct control of drilling and distributive activities will provide higher returns for the Russian economy than the ones envisaged from foreign investors now involved in the aforementioned projects (in Sakhalin-1 and Skahalin-2, predominantly). However, the Russian mastermind of the PSA concept, Mikhail Subbotin, who is currently the director of the CRP-Ekspertiza consulting company in Moscow, reiterated in an article at the economic newspaper Vedomosti (reproduced in Moscow Times, October 25, 2006) that similar arguments are at least absurd and contribute, in the final analysis, to “an unscrupulous approach to competition”.
Likewise, it is to the detriment of free competition when bureaucratic hurdles are raised to prohibit firms from achieving their goals while making life easier for their competitors. There is an unfair advantage for businesses that are facilitated in their way around red tape while their competitors are struck down by bureaucratic inefficiency or purposeful feet dragging. There can never be a regime of genuine competition unless the rules of the game are the same for all entrants, corruption is cut to a minimum and regulations (inspections, permits, certificates) are limited to a level where bureaucratic involvement is minimal.
A serious issue of competition violation is the toleration of lots of various legal or semi-legal commercial outlets. By avoiding the taxman and by sometimes providing customers with counterfeit, fake or unlicensed products these semi-clandestine operators undermine the ability of well-organized and legitimate competitors to survive profitably in the market. It is impossible, for example, for a serious food chain to compete in a market where hundreds of street or borough vendors operate outside the tax collecting system, without product quality control or health provisions and free of import duty obligations. The same is true in cases of publication copyright infringements or intellectual property violations when legitimate competitors have to function under conditions of strict adherence to the law. In all these circumstances competition is violently disregarded undermining overall productivity and creating an inefficient and demand then few resources are able to move to the private sector while bottlenecks and shortages are created in the public sector. Moving half way from a centrally controlled command economy – through partial and hesitant reform – to a proper market economy usually produces economic dysfunctions and sometimes leads to the collapse of output. dysfunctional market.
De-Politicization of the Economy
It is quite clear that all the above competition distortions are not related directly to the content and jurisdiction of the existing or under review competition legislation. They are merely byproducts or end results of existing political and social conditions. It is inevitable however that one must take these conditions under consideration when discussing competition issues in the Russian Federation. Politics is an essential ingredient for the functioning of all legislative regimes as well as for the character shown by national markets. Politicization of the economy (1), for example, is a common feature in situations in which competition is distorted and markets operate under conditions of unfairness and burdensome state involvement. It is inevitable, ie, that when public agencies set prices for the services rendered or products provided by state monopolies (or official prices between state firms) with little respect to market forces and consumer preferences few resources move to the private sector. And when they do bottlenecks are created and shortages appear in the public sector. When the transition from a centrally controlled command economy to open markets is hesitant and half hearted the final result is usually dysfunction and collapse of output.
The essential problem is to devise ways in which politicians can no longer influence the economy and are able to impose practices that favor their constituencies over the health of the economy as a whole. One step to this direction is rapid and widespread privatization. Limiting the role of the state in the owning of economic assets and playing a role in market behavior makes it much more expensive for politicians to influence firms. Privatization reduces the amount of inefficiency that firms accept to satisfy political desires but, nevertheless, it does not make by itself firms fully efficient.
By creating product market competition corporate governance is improved and political control is almost entirely diminished. When, for example, private firms continue to receive subsidies in exchange for sustaining employment they are pursuing political and not profit enhancing objectives. With product market competition de-politicization evolves rapidly. When firms face efficient rivals they either have to become efficient themselves or face the prospect of bankruptcy. Because, to keep an inefficient private firm afloat by means of state subsidies is much more expensive than sustaining by means of state aids an inefficient monopoly that can waste large monopoly rents and assets before it begins to lose money heavily.
However, political notables realize that product market competition raises the cost of exerting influence in the economy and they directly or indirectly intervene to restrict competition by political action. The most common way of political intervention to restrict competition is through the justification of protecting national, and long established, firms from domestic and foreign competition. This extends frequently to bankruptcy procedures which become politicized leading to the “rehabilitation” of incompetent enterprises rather than being allowed to “go under”.
(1) For a further analysis of the de-politicization concept, see Andrei Shleifer, A Normal Country: Russia After Communism. New York: Harvard University Press, 2005
Great strides towards the complete de-politicization of the economy can be achieved by means of opening up the market to a genuine competition regime. This can be achieved by encouraging domestic competition at every level of economic activity and by opening up the economy to the winds of international trade.
Excessive Concentration of Economic Strength Under the State
Within the context of serious distortions to the competition policy pivotal role is played of course by any steps taken to enlarge the involvement of the state in controlling significant segments of the economy. De-politicization cannot really be effected nor state intervention in the market can be minimized when huge business concerns fall back in the hands of the government. The state instead of being rolled back from getting involved in the economy there are signs that extends its implication in the market place. There are of course defensible political justifications for such political initiatives. The restoration of the power of a crumbling state machine, the strengthening of a weakened public image and the re-concentration in the hands of the public sector of the control of the most important national resources.
Nevertheless, from the view point of enhancing productivity and achieving rapid rates of economic growth such policies do not contribute to the desired final goal. The exclusion of foreign involvement in segments of the market, the maintenance of semi-private or public monopolies in vital sectors of the economy and the designing of entrepreneurial schemes that lead to the concentration under the control of the state of crucial heavy industries in the fields of energy, gas and metallurgy have serious negative effects. Such policies have the undesirable result to stifle competition, impair the flow of foreign investment and to undermine the future competitive efficiency of the concerned firms.
There are many cases that prove the above point. The giant monopoly gas company Gazprom has been suggested that may face serious shortages in its production output in the not so far future. According to the views of the executive director of the International Energy Agency Gazprom may be unable to meet its supply commitments by the end of the decade because of a lack of investment. Based on the IEA data its leadership maintains that “in the coming years Gazprom will not have enough gas to supply even their existing customers and existing contracts”. And this is because, “Gazprom is not investing enough”. Former Russian deputy energy minister Vladimir Milov has also insisted that there exists inefficiency in the company which would lead Russia to be short of about 100 billion cubic meters of gas by 2010. The problem for Russia is that new projects such as the Shtokman field in the Arctic has been repeatedly delayed, Milov said, and Gazprom’s policy to lock in extra supplies from Central Asia is impossible to cover the emerging gap. As a result, the maintenance of strict state monopoly over gas leads to reduced investment, inefficient productivity performance and, finally, to serious production drawbacks. Even Gazprom’s own think tank NIIGazekonomika (Research Institute for the Economics of the Gas Industry), has recently warned, in a study concluded at the end of 2005, that in a few years the volumes of gas consumed by Russia itself will so much multiply that deposits available for export will be minimal (2). Gazprom’s european clients will thus be forced to look to
(2) Even at cabinet level there was a debate about Gazprom’s ability to supply gas after 2011. See “Cabinet Disagrees on Gas Production”, Moscow Times, March 5, 2007
other energy sources, namely in Central Asia. For Russia, the study insists, the main problem will be a huge loss of needed foreign currency reserves. It is therefore imperative, the NIIgazekonomika study recommends, to encourage the exploration of new gas fields so that production will not stall**.
It is indicative that EU energy officials have urged the Russian government to break up Gazprom’s gas export monopoly and to ratify the Energy Charter. If this happens third party access to Russian gas export routes will be allowed and thus new investment will flow into the country while genuine competition will pertain in this field of business activity. However, the prospects for something like this happening are very dim. Gazprom CEO Aleksei Miller told the World Gas Congress in Amsterdam recently that his company has no intention of ending its monopoly over Russia's pipeline system, as the EU has demanded, the daily "Kommersant" reported on June 7 of this year. According to the same newspaper’s March 3 issue, energy paragons close to Russian President Vladimir Putin were pressing for the creation of a single, state-owned pipeline company, which would include both oil and gas pipelines and which would be under their control. Analysts have suggested that the immediate goal could be the merger of Transneft with Transnefteprodukt, the state-owned oil-products pipeline company, and SG-Trans, the state-owned Liquid Natural Gas transport company, along with a 24 percent stake in the Caspian Pipeline Consortium, a private pipeline that transports oil from Kazakhstan to the Black Sea. The result would be a single state-owned pipeline company.
To add further validity to the above speculation on October 19, 2006, the economic newspaper Kommersant reported that The Federal Energy Agency has proposed an increase in state control over the Chevron-led oil pipeline from Kazakhstan to the Black Sea (CPC) so that the state can get revenues from the project sooner (3). Such a move would mean that the fees it charges oil firms using the pipeline would be set by the Federal Tariffs Service. Up to now the fees have been set by private shareholders, which also include BP, Royal Dutch Shell, LUKoil and Rosneft. Kommersant said if Russia were to declare the pipeline a monopoly, long litigation would follow, as CPC believes its agreement with Russia precludes such a move. Officials argue the agreement was never ratified by the parliament. So it appears that further difficulties loom in the future for another privately run energy project.
As a result of this climate of opinion it came as no surprise that the Russian President Vladimir Putin signed, a day almost after the G8 meeting in St. Petersburgh where voices urging Russia to end Gazprom’ monopoly over gas pipelines were raised, a law voted by the State Duma safeguarding the giant gas company’s monopoly rights. It appears however that even Russian companies, and not only competition practices and sound economics, face problems with this latest stipulation. Thus, on August 31st it became known that energy majors (even state-owned ones!) petitioned in writing the Prime Minister to revoke the law and exempt from Gazprom’s transport monopoly the gas produced in oil fields and is carried to markets in condensed form. It was quite a welcome surprise that among the companies addressing the PM (Lukoil, Rosneft, Surgutneftegas, TNK-BP, Russneft and Tatneft) was Gazprom’s own oil subsidiary Gazprom Neft!! The fact that the formal heads of all these companies signed the letter
(3) It is no coincidence that the Moscow prosecutor general has hitherto brought charges against CPC, for the purpose of revoking its license, while officials claim the pipeline should be a state monopoly. See “Agency Suggests Making CPC a Monopoly”, Moscow Times, October 20, 2006 and “Prosecution as a Weapon against Foreign-Controlled Energy Projects”, in a Stratfor report, December 2006.
appears to signify that a change in the approved bill is quite likely.
This event however brought into the forefront another issue of competition possible distortion. When Gazprom acquired oil conglomerate Sibneft the anti-monopoly authority (FAS) approved immediately, without any thorough investigation, the transaction on the basis that it did not relate to the same market sector. It appears however, after the oil majors’ reaction to the gas transportation exclusive monopoly, that oil fields produce gas as well. It is questionable therefore to what extent, and if, Sibneft’s acquisition by Gazprom had a considerable, and obviously overlooked, market effect…
Similar initiatives can be observed in the fields of oil and electricity. Despite its huge reserves and giant companies there have been serious disturbances in the Russian oil market. Important mergers and acquisitions have happened with the end result the private sector to lose a substantial share of the market. Until 1996 the by and large state – owned oil corporations had halved Russia’s oil output. This was due mainly to mismanagement, lack of market competition and averse to risk investment initiatives. Shortly after important oil majors Lukoil and Surgut were privatized followed shortly with the transfer to private concerns of most other oil companies. In all, by 1999, 90% of the companies dealing with oil were in private hands. Production rose rapidly averaging to about 8.5 percent annually for the next five years while new technologies were introduced and foreign experts were employed to work on old oilfields and help exploit the new difficult plateaus.
After 2003 however the state started to expand its presence and controlling interest in the energy sector. State owned oil company Rosneft, after initially acquiring the small oil company Severnaya Neft for the exuberant sum of $600 million (it had been privatized for only $7 million a few years earlier), has acquired a 20% share of Gazprom’s total ownership while it added to its portfolio the former Yukos crown jewel Yuganskneftegaz. Building upon its government connections Rosneft proceeded to acquire in the summer of 2006 operational control of TNK-BP's Udmurtneft subsidiary. The key to this deal is that Udmurtneft was purchased by the Chinese state oil firm Sinopec Corp. which then transferred control to Rosneft which has now its hands (even indirectly) on another 115,000 barrels per day of output. Likewise, Gazprom bought, with the acquiescence of the anti-monopoly authorities, as we described above, another large Siberian oil conglomerate, Sibneft. The sum it paid to Sibneft’s major shareholder Roman Abramovich was $13 billion for his controlling stake. The end result of all these initiatives has been a fall in overall production of oil. It was not only Yukos’ output that naturally plummeted but also Sibneft had a drop in its production levels (some attribute this to the prolonged period of its sale procedures) while Rosneft failed to proceed with new investment in its main line of work, ie production of oil, because it spent major amounts of money in the acquisition of other companies.
Similar concerns have surfaced about recent developments in the Sakhalin region. It appears that the Ministry of National Resources has decided to restrict foreign access to energy projects in the area. As a result the responsible government department appeared, as of May 2006, ready to issue a recommendation aiming at slashing foreign oil companies’ stakes in the Sakhalin – 1 and Sakhalin – 2 energy consortiums. Eversince that time the situation has worsened, The government is determined to revoke the Production Sharing Agreements governing the Sakhalin ventures. This move would lead to giving Russian oil majors, by and large state owned, majority stakes in the aforementioned projects. The intended revision plans to give Russian companies a 51% overall majority stake**.
The prospects however of the - to a large extent state controlled - oil industry does not appear particularly rosy. It was the middle of 2005 that the first cracks appeared. BP announced its first production decline at its key Russian oil and gas fields since its merger with Russia’s TNK. Although BP blamed the harsh weather there were wider concerns about slowing growth in the Russian energy sector. Capacity in Russian pipelines is restricted and winter conditions necessarily limit tanker movements. Possible depletion of reserves was held responsible by experts for the year’s production decline. To acquire more assets however TNK-BP has to overcome the government’s reluctance to allow foreign companies to participate in auctions for acquisition of new acreage.
It appears that the still private conglomerates, like Lukoil, Surgut and TNK-BP, within this climate of insecurity opted to reduce production levels as well by lowering their investment in introducing new technologies and exploring new fields. According to an analysis by the senior fellow at the Institute for International Economics Anders Aslund, “in 2005, the increase in oil output growth dropped to 2.7 %, with all of the growth coming from the three big private companies. This year, …after four months output has risen by an annual rate of only 1.7%, and stagnation appears to be approaching”.
In short, with the withering away of oil major Yukos, the state controls now a significant chunk of Russia’s oil production (there is also talk of state owned Rosneft to plan the purchase of still private oil company Surgut) while, through Gazprom, can exercise full monopoly over the production and export of gas. And it is well recorder that both business fields face serious long term problems in their production capabilities and business efficiency.
Near the end of last year Igor Bashmakov, the executive director of the Russian Center for Energy Efficiency, was quite outspoken. He maintained that unless energy efficiency is increased Russia will stop exporting energy sources because the domestic market will absorb them all. The vice president of the Russian Gas Society, Oleg Zhilin, believes that only price liberalization (ie competing market conditions for the formation of prices) will lead to a considerable decrease in gas consumption in Russia.
Upon the same line of argument, the head of the Russian Union of Oil and Gas Producers, Yuri Shafranik, said that Russia by the end of last year had reached its maximum level of production. He insisted that Russia’s oil production and subsequent exports will be inevitably limited in two years’ time. Oil production in Russia, said Shafranik, will continue to grow for another two to three years, then the volumes of production will stabilize at a certain level, and then will begin to fall. The lack of direct investment is the main cause. There are many unexplored oil deposits in the country. But they remain out of reach for producers and explorers. There is not adequate investment in the geological exploration of new deposits. And it is quite obvious that this is due to the limitations imposed upon the entry to the oil market of international investors as foreign oil companies and drilling firms. The limits on competition have negative effects upon production and overall market efficiency.
In the field of electricity a similar story unfolds. The fact that Russia has lots of generation plants does not mean that all this capacity is available to meet demand. Most Russian plants were built in the 1950s and 1960s. Many are worn out and, therefore, frequently out of service for repair or maintenance. On average, 10 percent of installed capacity is out of service at any one time. In some months, the figure can be much higher.
The existing park of generation plants was constructed in Soviet times to meet Soviet demand. Following the collapse of the Soviet Union, the shape of the Russian economy and the shape of Russian society have changed. Electricity demand patterns have changed -- but the location of the generation plants has not. The result is that there are now regions of capacity scarcity and regions of capacity excess, but the transmission infrastructure to correct these mismatches does not exist.
Because of the inability to stockpile electricity, it is not average demand that dictates how much generation capacity is needed, but peak demand. While average national demand in Russia has not yet recovered to the highs of Soviet times, peak demand has spiraled. While the government's most optimistic economic growth scenario produced a "high-growth" peak electricity demand figure of 150 gigawatts for 2009, peak demand in January 2006 had already climbed to over 150 gigawatts.
With electric pumps used for traditional district heating systems and consumers buying more and more plug-in electric heaters as a backup, cold weather produces additional loads in electricity grids that were never foreseen by Soviet planners. The main culprit is below-cost electricity tariffs. Successive governments have used their tariff-setting powers to provide cheap electricity to the national economy. The hidden subsidies have been funded by power sector companies, and it is no surprise that investment by these companies is negligible. Since the business of electricity supply is loss-making, there is no cash to invest and -- at least from the long-suffering shareholders' point of view -- no reason to invest.
There has been persistent opposition to any initiatives for sector reform. Siberian smelters, for example, seemed to be under threat from the prospect that power sector reform would bring to an end the special arrangements under which the smelters paid some of the world's lowest prices for their electricity. This reaction, however, was overcome when Unified Energy Systems (UES) agreed that selected energy-intensive industries will be protected from the realities of market pricing by locking in cheap power with long-term power purchase agreements.
Government ministers acknowledged by speaking frankly that holding down tariffs in the cause of containing inflation could actually damage economic growth by killing investment in an essential infrastructure sector. Addressing the Soviet legacy of mispriced energy now, said Finance Minister Alexei Kudrin, could Russia avoid a repetition of the 1998 financial crisis. Privatization, however, and markets have not as yet taken hold in the electricity sector. Competition is not working and efficiency remains doubtful…
Very recently the government appeared ready to proceed with reforms in the electricity sector. Regulated tariffs would be replaced by market pricing. UES would be broken up and replaced by a series of competitive companies whose running would be left entirely to private shareholders. Electricity prices would be freed, investors would get fair returns, and Russian consumers would get secure supplies of heat and light. Even on that level however there have already been some drawbacks. It has been decided that the government will increase its share in the grid company and the dispatching units to 75% plus one share. But instead of swapping assets with private investors in UES as it was initially suggested, the state is posed to buy additional shares in the grid and dispatching units which would lead to a massive subsidy for the electricity sector. And maintenance of government control, of course…
Metals and Raw Materials
The business landscape in the raw materials and natural resources sector of the Russian economy appears to touch upon a heavier state involvement and direct or indirect control. The government does not hide its intentions to bring under Moscow control most of the activities expressed in the exploration, discovery, manufacturing and trading of raw materials found in the Russian mining terrain. On the one hand the government encourages the merger of pivotal Russian companies like steel giant Severstal with the Luxembourg based Arcelor. With the prospect within five years the Russian owners of the new company to be in total control of the combined metal mega enterprise the state aspires to indirectly influence one of the biggest steel manufacturers in the world. Almost simultaneously regional governor and business tycoon Roman Abramovich became known that he was prepared to purchase a controlling stake in the massive and largest Russian steel maker Evraz. A possible future aim of this deal would be the formation of a new Russian steel champion. This can happen if Evraz, strengthened by the capital induced by the Abramovich purchase, will proceed to merge with Magnitogorosk and Novolipetsk. These are the other two strong Russian steel companies. If this deal is concluded there will be a consolidation of the steel sector and Evraz, along with the combined powers of Arcelor and Severstal, will create a tremendous force in the steel industry with world wide implications. The Arcelor and Severstal deal finally was not concluded. Due mainly to shareholders reaction on the part of the Luxembourg company. This of course does not nullify the intentions expressed and the long term strategies unfolded.
No matter how grandiose the political considerations of such deals can be, from a purely economic efficiency point of view they appear rather disappointing. Especially if speculation concerning the ultimate objective of the Evraz deal – to be sold, like Sibneft, along with the new mergers to the state – come to materialize. Competition considerations will obviously be overlooked while productivity and business efficiency will most probably decline.
Similar, however, as the above negative phenomena are observed in other areas of natural resources business management. In uranium extraction nuclear fuel monopoly TVEL plans to issue new shares of the country's largest uranium miner, Priargunsk, and the Chepetsk uranium enrichment plant. This move could most probably dilute private ownership in the industry. State controlled TVEL's board, chaired by Kremlin chief of staff Sergei Sobyanin, has already voted for the share issues. An analyst at Alfa Bank was quoted by the press in late May as saying that the issue would obviously dilute private investors' stakes. "If they wanted to finance higher production, they'd sell the new shares on the market and earn much more," the analyst said..
The latest event observed in the natural resources sector of the economy is the decision by the head of the aluminium giant RusAl, Oleg Deripaska, to purchase a controlling stake and thus merge with the second Russian aluminium behemoth SUAL. In forming a new company in which RusAl, SUAL and the Swiss alumina commodity trader Glencore (which will also be acquired) will all participate with 64.5%, 21.5% and 14% respectively, then there will emerge a $30billion company. This will be, in the words of media reports, “the worlds’ leading caster of aluminium and the world’s second largest producer of alumina, the raw material from which the metal is made”. The deal, which was unofficially announced in Aug. 31 of this year, warrants obviously close inspection by the anti-monopoly authorities. The kind of inspection however that aims to uphold competition principles and not to fall prey to visions of creating world national business champions.
Positive signs, nevertheless, do still exist. The proposed merger of RusAl and SUAL, to create the world's largest aluminum producer, will not be completed without scrutiny by the anti-monopoly authorities. "The process will not be a fast one," Igor Artemyev, head of the Federal Anti-Monopoly Service, told reporters in September 19, 2006. "An application will be examined in accordance with the new law." The new law on the protection of competition, which extends the watchdog's powers and sets tougher anti-monopoly regulation rules, became effective on October 20, 2006. And it appears that the anti-monopoly authority’s leadership is determined to apply its provisions at every direction. To the benefit of the Russian economy and the average consumer, of course.
Other Business Sectors
In banking there have also been substantial changes that ended up in strengthening also the role of the state. Essentially, a small number of state controlled banks, five in all, are appropriating most of their private sector antagonists. One can notice that apart of pure business tactics for the state – owned institutions to achieve their ends there have been smear campaigns, bank runs and accusations of money laundering. As a consequence, the banking sector is still by and large under the state’s control with the uninspiring result (according again to Anders Aslund’s formerly quoted study) that “the ratio of the broad money supply to GDP is about 10 percentage points lower than in less-developed Ukraine, where private banks dominate and flourish”.
Heavy machinery companies, especially Uralmash, have done quite well, albeit the government intervened in this sector as well. Last year, and without any explanation that pertains to reasons related to economics, Uralmash’s mother company, OMZ, was sold to Gazprom. And a relatively efficient not state – owned private company, Siloviye Mashiny, was similarly sold to government controlled Unified Energy Systems. Without having the slightest relations with the latter’s main business activities and objectives.
The automotive sector in Russia could have been the most successful business field in the country. Higher incomes warrant more or less the purchase of new private vehicles. Unfortunately, in Russia this is not happening. Mainly, because there has not been any new major investment in the filed and no foreign companies have been encouraged to enter the market either independently or in cohort with Russian enterprises. There have been publicized intentions but it appears that all plans have been thwarted either by common bureaucratic hurdles or because the presence of powerful private companies in this business sector was not welcome. On the contrary, Rosoboronexport, a state-owned major arms manufacturer and trader, took control last year of AvtoVAZ, the country's largest carmaker (the car LADA). For this endeavour to have any chance of success the government will have to infuse large amounts of subsidies to the auto making company. Although during the August 2006 Auto show in Moscow the Avto VAZ head Vladimir Artyakov retraced his previous statements, about the need of heavy public subsidies, and stressed that there will be now no need for state help, he did not explain where the “absolutely needed help” will come from. These movements that involve the flow of state funds to the industry undoubtedly create problems. Because they imperil competition and prohibit this business sector from any chance of healthy, and independent from the state, economic growth. Rosoboronexport is allegedly negotiating the acquisition now of a majority stake in VSMPO-Avisma, the world's largest titanium maker, and St. Petersburg's two military shipyards. Again the state expands in business sectors best left in private hands if competition, efficiency and high economic returns are anticipated.
The Russian aircraft industry is also a field in relative trouble. There have been up to now a number of small private enterprises managing to survive under difficult odds and an all suspecting and doubtful about their intentions state bureaucracy. Finally, the state decided to make its move. A big merge will take place placing all independent private companies (in Ulyanovsk, Voronezh, Samara, Komsomolsk-on-Amur, Kazan) under the auspices – and ownership of course – of the main and immense state–owned AiRUnion corporation (to be called United Aircraft Building Company). The fate of all the hitherto private companies remains doubtful since the state bureaucracy will flood the field with public funds (the initial estimation of starting funds reaches $1 billion) to support the ailing and by and large inefficient smaller public corporations.
It is quite apparent that all these initiatives do not aim at the strengthening of the economy. They are rather related to efforts of central control of major sectors of the economy. They impede however heavily competition practices and undermine efforts to raise productivity in the economy as a whole. It is not therefore a matter of legalistic adherence to the wording of certain documents. The issue is primarily related to actual political initiatives and the pursuit of objectives that have as their target the overall functioning of the economy. A competition policy project cannot overlook these realities. They constitute the essence of the functioning of the market. And they characterize the future prospects of the economy of the Russian Federation.
It goes without saying that the government aims to control a major chunk of the natural resources business sector. And by means of the power thus acquired it may spread the state’s influence to other sectors of the economy as well. Gazprom portrays the hazards of such a perspective. As it stands now the giant gas company, including its subsidiaries, has 38 % of its assets outside the energy sector, including holdings in construction, banking, media, agriculture and other sectors. In the media field only Gazprom has $700 million worth of assets. Even the recent sale of the successful economic newspaper Kommersant to tycoon Alisher Usmanov, who is a senior manager of Gazprom and works closely on various serious projects with the company, some observers believe that it will end up in the gas giant’s embrace.
The three main categories of strategic industries that the government has shown a strong interest to participate in and, if possible, to control are high-profit natural resources; key infrastructure such as banks, pipelines, and electricity generation; and sectors of perceived strategic advantage, such as nuclear power, technology and aviation.
The state's increasingly assertive control over the perceived most important ‘strategic sectors’ -- the natural resources sector foremost among them, but also metals, automotive, aviation and other industries -- has rattled foreign investors and unsettled the prospect of an open free market regime. Many observers insist that state control brings inefficiency and corruption. It is beyond doubt that enhances difficulties in product output, bureaucratic and risk aversion management and fundamentally undermines competition.
One can observe that the planned industrial policy of the government relates directly to the exploitation of energy funds to putting together strategic industries. The overall aim is to put together financial and administrative resources to support economic growth. It seems that the government is persuaded that effectiveness or strategy is set by the state and efficiency is up to private companies and the market to figure out. The stable development of the Russian economy in the coming years it is thus presumed that needs to be based on the planned growth of its component parts, including above all mineral resources. But events do not unfold usually in this optimistically perceived way. The objective allegedly pursued by the state is without doubt righteous. The final result however is almost never positive.
The pursuit and final implementation of a fairly functioning competition regime is a basic means for achieving business efficiency, high competitiveness for the economy and rapid rates of growth. This objective however is seriously burdened by the policies that were above exhibited. A competition policy concept therefore, above and beyond the legislative framework of the government apparatus, should take seriously under consideration the promotion of alternatives that remedy the existing dysfunctions. The removal of competition distortion practices, the promotion of policies that de-politicize the economy and finally a sincere effort to cut back in the state’ s attempts to control major shares of the natural resources business sector are primarily the objectives for the establishment of a really free competition economic environment.
*It is indicative that even First Deputy Prime Minister Dmitry Medvedev, in an interview published in Moskovsky Komsomolets in September 2006, suggested
that oil prices, which are fueling economic growth, would not always remain high. According to his remarks, it is also the view of expert economists that this growth can only be sustained through considerable investment in industry and infrastructure. Which of course, under conditions of competition distortion, are not forthcoming.
** Equally disturbing is the fact that government officials admit that in the near future gas prices will increase without however any previous steps to be taken to prepare consumers for the emerging new reality. On October 23, 2006, pe, was reported that Industry and Energy Minister Viktor Khristenko said that natural gas prices in Russia will reach for industrial consumers European levels by 2015.
***Contrary to the above mentioned policies, clearly hostile to foreign investment initiatives, the Minister of Economic Development and Trade German Gref maintained, at the 2006 St. Petersburg International Economic Forum, that a new law would limit foreign ownership in 39 so-called strategic sectors of the economy, up from an initially planned 17. He said the bill, still being drawn up by government officials to become law by the end of the year, “should not significantly impede foreign investment”. And he added a startling joke. Asked if telecoms would be named a strategic sector, Gref noted that it was one of the most competitive areas of the economy. "As soon as we call it strategic, that will be the end of it, and we'll all be left without mobile phones," he said, to laughter from the audience.