The Growth of Russia's Outsourcing Industry: Russian Economic Diversification - Literature review Example

Business Contents Introduction 3 Analysis and Evaluation 3 Political Factors 3 Economic Factors 4 Technological Factors 7 Outline of Future Strategy 8 Conclusions and Recommendations 10 Reference List 12 Introduction The birth of Russia is a rather a testimony of communist violence in contemporary times. In December 1991 the USSR was divided into 15 independent republics and Russia was a part of it. Ever since the birth of Russia as an independent republic the country had established a semi-authoritarian rule under the leadership of Putin and has made remarkable economic progress (CIA World Factbook, 2014). The success story of Russia is commendable because even after its post-Soviet political turmoil the country has emerged as a rapidly developing nation (BBC News, 2014). The economic structure of Russia has improved drastically over the past ten years and concerted efforts have been taken by the government to liberalize the economy driven by market forces. This move can be considered as a paradigm shift from the initial centrally planned economy of the country which had very low economic growth rates. From 1998-2007 the growth of the country had averaged to 7% (The World Bank, 2014). However, the global economic crisis of 2008 and fluctuations in the oil prices coupled with the fall in the FDI have severely affected the economical progress. The purpose of this paper is to focus on the factors that have led to the rapid development of the country in the past and suggest ways in which the country can continue to progress in the future by overcoming its present difficulties. Analysis and Evaluation Political Factors The political system in Russia under Putin had largely committed itself to increased integration with the world economy. The government of the country had taken measures to associate it with the global-club forums to socialize with the global economy. Ever since the post-Soviet break up the Russian government at the federal had set up special economic zones in the country to attract FDI for overall economic development. The government had particularly reframed the corporate tax laws of the country to create a uniform investment environment which will provide incentive to foreign companies to invest in the country (USA International Business Publications, 2007). The government of Russia had taken up privatization of the economy from 1993 as the state-owned enterprises of the economy were allocated to the property funds of the federal government of the country. The role of the regional government had also been formidable in this effort and local governments began to exercise their control on the trade and retail service sector. The federal government had cooperated with the regional governments to sell off ownership shares at a discount and this had particularly stimulated the growth of the economy. According to the research conducted by Boycko, Shlefier and Vishny (1995) it had been commented that the revenues that were earned from the privatization actually acted as a source of incentive for the regional governments to support the privatization measures. The profits made by the regional governments had influenced them to reframe their legislations to support the federal government. The Putin government had reframed the corporate rule of law, transparency requirements and property rights to encourage investors to invest in the country. Russia joined the WTO under the Putin government. This was considered as a bold attempt to liberalize the economy. 42 legislations had been passed by Russian government prior to the accession into the WTO. Though the government had taken attempts to liberalize the economy in the past there have been complaints regarding the fact that the government had exercised a heavy control on the key sectors of the economy preventing them to act freely. Despite the complaints regarding the role of the government in the past ten years the Russian government had created policies that provide ample opportunities for business growth. Liberalization of the capital account has also been a major determinant in the net inflows of foreign funds in the country since 2006. It has been estimated that the government policies had increased the net inflows in the economy and the estimated value was $82 billion in the pre-crisis period (Beck, Kamps and Mileva, 2007). Economic Factors The changing attitude of the government had a massive impact on the economic growth of Russia. Though the economic growth of the country has been impressive but there are huge regional imbalances. The following graph shows the economic growth of Russia from the time period of 2000-2012. Figure 1: GDP growth rate of Russia (Source: Trading Economics, 2014) It can be seen from the above graph that the rate of growth of Russian economy had shown three distinct phases. The first phase is roughly from 2000-07 when the economy had experienced an average growth of 7% before reaching the peak of 9% in 2007. The second phase is 2008-2010 when the country had recorded negative growth rate of -11.20 in 2009. Thereafter the economy had shown signs of recovery however the extent of growth has been considerably lower in 2010-2014. Three main reason behind the slowdown of the economy in the current times namely volatility in the foreign exchange market, slowdown in the banking and financial sector of the economy and loss in the confidence of investors owing to the uncertainty in the political scenario. The purpose of this section is to highlight the factors that have caused the rapid growth of the economy before the crisis. Ever since the liberalization of the economy the production paradigm had been altered in Russia and privatization had improved the overall efficiency which had contributed to the higher growth. The accession to the WTO had also provided a huge boost to the trading sector of the economy. In a recent research that had been conducted by Jensen, Rutherford and Tarr (2007) it was established that Russia’s gain was expected to increase from $53 billion to $177 billion per year. According to the researcher duo the main reason behind this growth was the inflow of the FDI into the country due to the liberal policies taken by the government. This period has also been characterized by the impressive performance of the stock market and the ratio of market capitalization to that of GDP was close to 117% only 3% lesser than the OECD countries. Russian multinational companies were soaring during this period. The strongest impulse to the growth came from the non-manufacturing sector especially the financial and the communications sector. Construction sector had shown the highest growth of 14% and oil production had expanded by 3%. Economists had concentrated on the role of the oil sector of the economy and its role in the growth. Favourable prices of the oil and its exports had supported the growth of the economy. Some researchers have claimed that the unplanned devaluation of the currency combined with the institutional reforms also contributed to the growth. Some of the researchers have highlighted the role of the domestic consumer demand particularly in the consumer goods in the Russian growth. The household consumption had also remained stable around 50% and the investment prior to 2008 was close to 50%. There has also been evidence that the growth of the economy has actually reduced the level of unemployment in the economy from 12% in 2000 to 6% in 2008. A marked reduction was also noticed in the poverty rate of the country which fell from 29% in 2000 to 13% just prior to the economic crisis. Figure 2: Unemployment Rate of Russia (Source: Trading Economics, 2014) The research conducted by Guriev and Zhuravskaya (2010) had shown that the income and the well being of the poorest segment of the population had significantly improved during this period. In another research that was conducted by Gorodnichenko, Sabirianova Peter and Stolyarov (2010) it was noted that the overall inequality in Russia had actually decreased during this time. Technological Factors The technological progress that has been made by Russia in the past decade has also been remarkable. The rising instance of trade of Russia with the Western partners has actually helped the country to imbibe superior technology from the foreign country. Technological transfer and growth of nations has emerged recurrently surfaced in the works of maximum researchers. The research conducted by Brynjolfsson and Kahin (2000) had shown that the role of information technology in the development of a nation is crucial as it helps in the expansion of products and services. Improvement in IT sector of a country had been found to be positively correlated with the capital investment in an economy which further causes economic growth. In a research that has been conducted by Gryczka (2010) the role of technology in the BRICS countries were studied in details. According to the observation made by him international trade in high-tech products have greatly contributed to the economic growth of these countries and Russia is no exception to this rule. In case of the Russian economy it can be said that the role of the multinational companies in the economic growth is unquestionable. The favourable policies created by the government regarding foreign trade had caused a large number of Western companies to expand their operations in Russia. According to the research conducted by Lloyd (1996) it can be confirmed that multinational companies helps in diffusion of technology into three ways namely transferring of technology through joint ventures, spill-over effects they create and the investment in research and development that they make. Researchers like Veloso and Soto (2001) reflects a similar sentiment and had confirmed that FDI can truly act as machinery for the development of a country mainly. Absorptive technologies have been found to improve the productivity of the local workforce and overall productivity of the economy increases as a result of this. Furthermore, the research of Eberhardt, Helmers and Yu (2011) had established that industrialization driven by foreign technology mainly improves innovation of the local economy through the absorption of this technology. The development of the information technology sector has been incredible in Russia. The government have realized that high dependence on the natural resources of the country cannot be a sufficient for sustainable growth. High-tech industries are now being developed in Russia to sustain the growth. Ever since the new millennium the Russian government has invested a considerable amount of money in the development of its IT sector and the productivity of the IT sector have improved four times compared to the other sectors of the economy. The government has invested money on large scale infrastructure and other long-term development projects to enhance the economic growth (The Institute of Contemporary Development, 2014). Strategy for the Development of Russia’s Information Society, a regulatory body responsible for the growth of the IT sector prioritizes the areas for investment for the economic development. Presently, three areas have been highlighted regarding development the national information system and communication services and securing the IT services that are affordable. It has been widely reported that the outsourcing the IT industry acts as a major source of integration of the Russian service sector in the global economy. Software development represents the largest market in IT and had a value of $1 billion by 2005 (Dresen, 2014). Outline of Future Strategy From the present research it appears that the current state of the Russian economy is quite unstable as the economic growth of the country is at record low. The state of political issues and the government actions in the country can be largely blamed for the recent economic slowdown. The policies of the government post financial crisis have been criticized by a number of authors. Researchers have pointed out that maintaining the exchange rate of the country above the market average has been problematic. Weakening of the ruble 1% per week by the Central Bank had been particularly criticized. Economists state that the bailout policy followed by the Russian government by depreciation was a rather weak move and direct transfers would have been more beneficial. Apart from the problems in the past the Russian government is currently in a cold war with the U.S. and the relations between the two have deteriorated and this casts a long shadow on the future prospects of the country. It has been found that both the U.S. and the European Union have imposed sanctions against certain multinational companies and senior officials of the government on account of the military invasions on Crimea. At present 14 companies associated with national defence, 4 companies from the service sector and 6 major nationalized banks in the country has been sanctioned (Naudé, Szirmai and Lavopa, 2013). Though there are certain debates regarding the effectiveness of sanctions in changing the behaviour of the target country there is no denying the fact it inevitably results in the loss of welfare of the citizens. The present situation is Russia as the commercial banks finds it very difficult to finance their operations. This is particularly constraining for the economic development as countries cannot progress without sufficient investment (BBC News, 2014). In order to return to its previous level of growth it has become important for the Russian government to change its current political attitude. This is because hostility cannot improve the state of any nation and evidences show that Russian companies are already making losses as they cannot raise finance for their expansion. The government needs to develop a friendly relation with the western countries to continue unfettered growth. It is anticipated that the growing dispute between countries can harm the investments in the energy sector of the country which can hamper future growth (Yurgens, 2014). Therefore, the government needs to improve its diplomatic relations with the Western countries. The Russian economy is profoundly dependent on oil sector. This is particularly the reason for which the economic growth of the country had stagnated particularly when the oil prices began to plummet. There is a growing consensus among researchers that the Russian economy has reached a point where it must reduce its dependence on the natural oil and gases for growth (Aslund, 2012). It has been found the Russia has the lowest GDP per capita compared to other developing countries like Brazil, China, India and South Africa. Figure 3: GDP per capita comparison of developing countries (Source: OECD, 2013) It can be suggested that the growth of Russia can be sustained only if the government tries to diversify its economic portfolio growth can be made sustainable. The government should try to promote its non-energy sectors like construction, service and tourism to expand its revenue stream. According to researchers it has been suggested that Russia must make a few changes in its macroeconomic policy framework in order to improve its prospects of sustainable for growth. Economists are favouring gradual consolidation of fiscal framework in order to protect the economy from the uncertainties of oil price fluctuations (Guriev and Tsyvinski, 2010). It has also been advised that the Russian government must improve the competitiveness of the business environment mainly by reducing its control on the business society. Tax law administration and inconsistent institutional reform has been blamed as the main reasons for which investors are considering to back out from the economy (J.J. Wild and K.L. Wild, 2014). Transparency in the role of the government and greater cooperation with the multinational companies is required to create higher confidence among investors. Russia also needs to remodel its fiscal policies to take into consideration about the volatility in commodity prices and exchange rate (Peng and Meyer, 2011). Some researchers are of the view that the role of the financial sector will also be crucial in the future in order to sustain the growth of the economy (Ahrend, 2006). The structure of the banking system needs to be deregulated as high stake of the government in the state banks and limited foreign ownership has hindered the development of the financial system (Rugman and Collinson, 2012). Russia will have to improve the corporate governance of its banks, regulatory and supervision standards needs to be improved to improve the competitiveness. Conclusions and Recommendations It has been seen that the growth of the Russian economy is rather mixed success. Though the country had made significant progress in the past but its future is likely to be jinxed if few policies are not modified. Three key areas have been identified in the research which needs improvement for the further development of the Russian economy: Firstly, the government will have to improve its diplomatic relations with the European and American countries in order to improve the current impasse. This is quintessential for smooth progress of the country by channelizing inflow of foreign funds. Secondly, the Russian government needs to take a transparent stand regarding the management of the overall business and financial sector of the economy. It has been found that the taxation and the legal systems in the current scenario are less than perfect and improvements can be achieved by shifting taxes from labour income to indirect forms of taxation. Thirdly, the government should show higher commitment to remodel its fiscal framework and take more prudent monetary policy. It had already been observed that the monetary policy taken by the government after the financial crisis has not been conductive to the economy as devaluation of the domestic currency. Improvement in the monetary policy is also expected to improve the performance of the non-resource sectors. Finally, the development of the financial sector will be of important. The financial sector acts as a source of engine of growth by allocating resources in an optimal manner (Deutsche Bank Research, 2007). Consolidation of investor portfolio and diversification can also improve the functioning of this sector. Reference List Ahrend, R., 2006. 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Is the dragon learning to fly? An analysis of the Chinese patent explosion. [pdf] The Economist. Available at: [Accessed 12 December 2014]. Gorodnichenko, Y., Sabirianova Peter, K. and Stolyarov, D., 2010. Inequality and volatility moderation in Russia: Evidence from micro-level panel data on consumption and income. Review of Economic Dynamics, 13(1), pp.209-237. Guriev, S. and Tsyvinski, A., 2010. Challenges facing the Russian economy after the crisis. Russia after the global economic crisis. [pdf] Peterson Institute of International Economics. Available at: [Accessed 12 December 2014]. Guriev, S. and Zhuravskaya, E., 2010. Why Russia is not South Korea. Journal of International Affairs, 63(2), pp.125-139. Jensen, J., Rutherford, T. and Tarr, D., 2007. The impact of liberalizing barriers to foreign direct investment in services: the case of Russian accession to the World Trade Organization. Review of Development Economics, 11(3), pp.482-506. Lloyd, P.J., 1996. 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