European Affairs

Moscow and the WTO: A Unique Chance to Modernize Russia     Print Email
Bob Vastine and Vladimir Gololobov

Russia's bid to join the World Trade Organization (WTO) presents a unique opportunity for the country's leaders to modernize the Russian economy, mainly by developing the crucial services sector.

If Russia enters the WTO on terms that require true market reforms, transparency and legal protection for investments, foreign investors can help invigorate Russia's services sector through increased participation in the economy. This would be an essential factor in securing Russia's prosperity and its better integration into the global market.

Unfortunately, however, Russia is still far from offering the concessions necessary to gain WTO membership, and its leaders have not yet dared to confront the vested interests that are resisting the required reforms. If Russia does not seize this opportunity, it will consign itself to second-class economic and political status.

The Russian services sector is ripe for further development. The sector emerged relatively unscathed from the economic turmoil of the 1990s, and small business services have been growing much faster than manufacturing or agriculture. The share of services in Russian gross domestic product rose from about 39 percent in 1990 to 62 percent in 1998.

Most of these services, however, are personal services like retailing, wholesaling and transportation. Russia must now encourage growth in its knowledge-based services, such as telecommunications and financial services, and can only do so through vastly increased inflows of foreign direct investment.

Most foreign direct investment in Russia is in the energy and extraction industries, but the level of overall investment remains extremely low and the annual inflow is declining.

Foreign direct investment fell from $3.3 billion in 1999 to $2.5 billion ($17.51 per capita) in 2001, a figure that represented only 0.03 percent of global foreign direct investment. Russia's aggregate foreign direct investment is far below that of China ($36.48 per capita) and Brazil ($129.59 per capita).

Service industries are now the main recipient of worldwide foreign direct investment. But Russian services are not receiving sufficiently strong foreign support to build the essential service infrastructures required by modern economies.

Russia's reliance on inherently unstable fuel exports, which comprised 59 percent of all its exports in 2000, is potentially devastating for its overall economy and for its federal budget. Plummeting oil prices were the root of the deterioration of the terms of trade in the 1980s and 1990s.

The creation of an attractive environment for foreign direct investment in services should be the key priority for the Russian government if it wishes to secure a resilient, globally viable economy. WTO accession offers Moscow its best chance of achieving these goals.

There are a number of reasons for the low level of foreign direct investment in Russia's services:

Regulatory barriers in services. Russia puts significant restrictions on the commercial presence of foreign firms, including limits on the form of establishment and percentage of ownership. These barriers are a powerful deterrent to investing in services and they are especially stiff in the financial and telecommunications sectors.

The slow pace of privatization. Structural reforms that began in the 1990s have stalled. Although investors were able to buy a 25 percent share of the state telecommunications monopoly, further privatization has been delayed indefinitely. Even less progress has been made in privatizing the financial services sector.

Lack of regulatory transparency. There is currently no obligation to secure private sector participation in the rule-making process, for example, by giving advance notice of new regulatory proposals and providing adequate opportunity for public comment. There is no provision for non-discriminatory enforcement of the rules.

Licensing and certification requirements remain complicated and burdensome, and licensing decisions are not transparent. Contributing to the licensing difficulty is the confused legal structure of Russian regulations, which often fail to identify the regulatory authority.

Even when such responsibilities are clear, implementation of regulations at the regional and national levels may be inconsistent. There is a serious lack of independent regulators, for example for telecommunications and financial services.

Unpredictable sectoral policy. Foreign investments and rights are not sufficiently protected under the law. It will also be important to ensure that service providers already established in the Russian market do not lose acquired rights or market access under the terms negotiated for Russia's WTO entry.

Foreign direct investment in Russian services is likely to rise by four to 4.5 percent a year in the first two years after Russia joins the WTO, according to ING Bank estimates. To implement ambitious projects in telecommunications, and promote overall industrial modernization, Russia will have to ensure a steady inflow of foreign capital.

Specifically, foreign capital will be needed to fulfill Russia's aim of matching European levels of telecommunications development, a project estimated to require $33 billion in total investments.

A significant liberalization of the Russian services sector as a result of WTO entry would also lead to greater efficiency and productivity in other areas, such as agriculture, and thus improve overall living standards.

Russia's negotiations with the WTO have proceeded extremely slowly since they began more than nine years ago. It is not surprising that such complex negotiations should take time, just as they did in the case of China, which finally joined the WTO in 2001.

Some observers of the negotiations have found fault with the slow processes of the WTO. But the main cause of the delay is not a failure of process but of will. Russian negotiators have had to educate themselves - or be educated by members of the WTO accession working party - on the extensive obligations that WTO membership entails.

Meeting these obligations, as other WTO applicants have found, will require very substantial modifications in domestic law. They require that Russia's highest leadership decide to modify the country's protectionist policies, laws and regulations - a decision that has not yet been made.

The secondary cause of delay is the complexity of the schedules of commitments used in the General Agreement on Trade in Services, which has presented a steep learning curve for the Russian negotiators.

As of now, Russian offers are far less significant than the commitments made by China to gain WTO membership. In addition to a strong general commitment to introduce transparency and guarantee acquired rights, Russia should make the following specific undertakings:

In banking and insurance, foreign financial institutions should be allowed to choose a form of commercial presence, including the opening of branches, that best suits their business objectives.

Russia should eliminate limitations on foreign investment in the financial sector. As a matter of principle, it should remove the caps on overall foreign participation in insurance (15 percent) and in banking (12 percent). It should also drop limits on foreign investment in particular insurance activities.

Russia should liberalize its mandatory insurance sectors. The barring of foreign firms from offering mandatory insurance, particularly third party auto liability insurance, which becomes mandatory by July 1, 2003, will hurt Russia in the long term. Mandatory insurance accounts for the largest volume of Russian insurance premiums.

A liberalized insurance sector would offer better security for businesses and provide more capital for investment. A more open insurance market would lead to improved loss prevention practices and guarantee compensation for personal injury and property losses that are currently drains on public and individual resources. Limitations on property and casualty insurance are both damaging to future market growth and counterproductive for the entire Russian economy.

In telecommunications, Russia should make substantial commitments with regard to cable, satellite and other enhanced services. Providers of value-added services, including data and internet-based services, and private leased circuit services, should be granted full market access and national treatment.

Russia should also accelerate its pace of structural reform, and shorten phase-in periods for implementing its commitments in long distance and international call services. In conformity with WTO practices, exclusive rights in telecommunications should be applied only to basic services.

The Russian government should guarantee that local authorities apply sectoral regulations in a non-discriminatory manner. Additionally, licensed providers should be able to offer all the services that they are authorized to provide upon WTO accession. An independent regulator should be established.

Russia should rescind its decision to set a foreign ownership cap of 49 percent in telecommunications. This could actually result in less foreign participation in this sector. Backtracking on previous commitments alarms foreign investors.

In computer and related services, Russia should guarantee full market access and national treatment for data processing, software implementation and database services.

In express delivery, full market access and national treatment in multi-modal courier services should be secured. Russia should state that specific commitments in courier services apply to both public and private sectors to ensure that all like services are treated equally.

In accounting, Moscow should drop its requirement that CEOs of foreign firms be Russian nationals. Other countries do not impose this requirement, which impairs the ability of companies to appoint skilled and experienced managers. The active participation of foreign executives of international accounting firms will help Russia switch to international accounting standards by January 2004, as planned.

In audiovisual services, Russia should make meaningful commitments in motion picture, home entertainment, radio, TV production and sound recording services. Upon accession, Russia should also commit to implementing the WTO agreement protecting intellectual property (TRIPS). Valuation of digital products for customs purposes should be based on the carrier medium.

In energy services, Russia should provide full market access and national treatment in oil and natural gas exploration and development, electricity and natural gas marketing and energy related services. Through pending legislation on electricity liberalization, Russia has an opportunity to create favorable regulatory conditions for market pricing and allow open access to electricity generation and supply.

In environmental services, Russia should make full market-opening commitments in all modes of supply, specifically in systems for environmental clean-up, remediation, prevention and monitoring. Russia should allow temporary duty-free import of tools and equipment essential for such services.

To ensure a competitive economic environment, Russia should eliminate cross-subsidies, including those in telecommunications and courier services. Cross-subsidization prevents new entrants from entering the market and providing competitive high quality services.

Russian interest groups, however, continue to urge their negotiators to ensure "infant industry" protection for a significant part of Russia's service sector, especially for financial services. This tactic is politically shortsighted and economically harmful, since Russia's services will surely fall even further behind the rest of the world if it is adopted. Such a policy would be especially damaging for Russia's services sector, given its reliance on technological innovation.

The United States does not expect an instantaneous opening of Russia's services markets, and will accept phased-in liberalization as long as the phase-in period is reasonable - three to five years at most. Russian interest groups are pushing for much longer periods.

For example, executives at Sberbank, a state owned bank and the largest provider of retail banking services, are calling for a transition period of ten to 12 years in banking. Rostelecom, the state owned telecommunications monopoly, would like Russia to open long distance and international call services eight years after accession.

Such terms of accession are not acceptable to foreign investors, and would guarantee Russia's backwardness in these sectors. The Russian offers are not nearly good enough to gain acceptance by the United States or the European Union, which are in broad agreement on the steps Moscow must take, in services and in other sectors.

Russia thus faces another important turning point on the rough road to constitutional stability and economic reform. Its leaders can seize the opportunity offered by WTO accession to force through the internal reforms that are absolutely essential if Russia is to obtain the external financing it needs to modernize its critical service sectors. Surely Russia's leaders understand that they must confront the powerful vested interests that are denying Russia its main chance to break the bonds of economic stagnation.

 Bob Vastine is President of the Coalition of Service Industries (CSI). He previously was President of the Congressional Economic Leadership Institute, and has held positions on Capitol Hill, in the Executive Branch and in private industry. Vladimir Gololobov, an associate at CSI, is handling its Russian WTO accession project. He holds an M.A. from the School of Commercial Diplomacy of the Monterey Institute of International Studies.


This article was published in European Affairs: Volume number IV, Issue number I in the Winter of 2003.