In this paper I would like to examine Russian economic situation through the variable of Investment, and more precisely the Foreign Direct Investment (FDI). I would like to investigate whether the low of FDI in Russia, is due to a high level of Corruption, as it is one of the factors of the Investment Climate.
First of all I shall present the main variables involved, secondly investigate the existing studies on FDI and corruption and finally apply this theory to Russia in order to verify my hypothesis.
FDI has played an important role in development and increasing
productivity of other emerging economic powers such as China. In Russia however FDI has been relatively low. Since the recovery after the 1998 financial crisis – growth rates averaged at 7% of GDP in the period of 1997-2008, and it is forecasted to be 6%, or three times the GDP in most European countries.
The growth of Russia’s output is primarily driven by private consumption. It is provided by the use of the existing industrial capacity, rather than through new ones. The investment rate in Russia’s economy remained essentially stable, at 20-25% of GDP but the FDI stuttered at 1% of GDP. However, after Russia has received Moody’s Investment grade rating the investment has been growing faster and playing a bigger role in the economic growth. Indeed, FDI has been a substantial part of total investments in the country, in particular in some strategic sectors, like the hydrocarbon industry. Nevertheless FDI remains low in Russia due to its unattractive Investment Climate that consists of many variables such as Stability, Infrastructure, Labor cost, Market size, Transparency of legal system and Corruption. In this paper I would like to examine the significance of Corruption is as a factor for FDI.
1. Introduction
In this paper I would like to examine Russian economic situation through the variable of Investment, and more precisely the Foreign Direct Investment (FDI). I would like to investigate whether the low of FDI in Russia, is due to a high level of Corruption, as it is one of the factors of the Investment Climate. First of all I shall present the main variables involved, secondly investigate the existing studies on FDI and corruption and finally apply this theory to Russia in order to verify my hypothesis.
FDI has played an important role in development and increasing productivity of other emerging economic powers such as China. In Russia however FDI has been relatively low. Since the recovery after the 1998 financial crisis - growth rates averaged at 7% of GDP in the period of 1997-2008, and it is forecasted to be 6%, or three times the GDP in most European countries. The growth of Russia’s output is primarily driven by private consumption. It is provided by the use of the existing industrial capacity, rather than through new ones. The investment rate in Russia’s economy remained essentially stable, at 20-25% of GDP but the FDI stuttered at 1% of GDP. However, after Russia has received Moody’s Investment grade rating the investment has been growing faster and playing a bigger role in the economic growth. Indeed, FDI has been a substantial part of total investments in the country, in particular in some strategic sectors, like the hydrocarbon industry. Nevertheless FDI remains low in Russia due to its unattractive Investment Climate that consists of many variables such as Stability, Infrastructure, Labor cost, Market size, Transparency of legal system and Corruption. In this paper I would like to examine the significance of Corruption is as a factor for FDI.
A. Russian Economic Overview.
Russia is a vast country stretching across Europe and Asia, possessing a great wealth in the form of natural resources, technology, large skilled workforce, and nearly 150 million consumers with unfulfilled needs. Its GDP has reached $2,225 trillion in 2008(PPP).
After the breakdown of USSR the economy has been struggling for 8 years, the GDP has decrease enormously and the productivity was diminishing. In 1999 the recovery has begun, after more then a decade of almost constant decline, due to such factors as: the high world prices for Russia’s oil, gas, and other commodity exports; the import substitution effect that followed the devaluation of rubble in August 1998 (1998 Crisis); market-oriented restructuring of the plannified rotten economy; and solid fiscal and monetary policies. Russia’s average GDP growth has been around 7% from 1997-2007.
Due to the current global crisis, Russian economy is undergoing an evident recession; its GDP growth rate has fallen to around 6% in 2008. While Russia's strong short-term macroeconomic fundamentals such as: low debt and large international and fiscal reserves, assure the economy is well prepare to deal with the crisis, its obvious structural weaknesses such as: dependence on the price of oil make the effect of the crisis more explicit than expected.
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Figure 1: Real GDP growth in %; Inflation in %. (1997-2007)
- If we follow the GDP breakdown trends we can notice that agriculture is decreasing even further (4.1%), Industry is climbing (41.1%), and services have fallen slightly (54.8%). Agriculture is primarily grain, sugar beeds, sunflower seeds, vegetables and fruits. Industry includes a wide range of range of mining and extractive industries producing coal, oil, gas, chemicals, and metals; all forms of machine building; defense industries; advanced electronic components; transportation equipment; medical and scientific instruments; consumer durables, textiles, foodstuffs, handicrafts. Services include advertising, education consulting etc.
- I nflation is still very high 13%, ensuring Russia to be the 20th worst country inflation in the world.
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Figure 2: Inflation rate (1992-2006).
- Investment is a rather low percentage of GDP: only 24%.
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Figure 3: Investment rate in various countries.
- Russian labor force is around 76 million and the unemployment is quite reasonable at 6% in 2008 (before the crisis).
- Russian Current Account balance is relatively high of $ 97,6 billion in 2008 (the 5th in the world, following China, Germany, Japan and Saudi Arabia). Main exports are petroleum products, natural gas, wood products, metals, chemicals, and a wide variety of civilian and military manufactures. Major imports include vehicles, machinery and equipment, plastics, medicines, iron and steel and consumer goods.
Overall we can conclude that Russian economy is in a transitional phase, with some stable growth but some underlying obvious problems.
B. Foreign Direct Investment in Russia.
Foreign direct investment is an investment of foreign assets into domestic economy: structures, equipment, and organizations. It does not include foreign investment into the stock markets. Foreign direct investment is considered to be more useful to a country than equity investments because those are potentially "hot money" which can leave rapidly after the first profits.
Foreign direct investment brings host countries capital, productive facilities, and technology transfers as well as employment, new job skills, and management expertise. These are important in the Russian Federation, where incentives for competition are limited and incentives of becoming efficient are slowed down by interregional barriers to trade, weak creditor rights, and administrative barriers to new entrants.
In the first ten years since USSR breakdown, FDI levels have remained very low. However a more recent trend (since 2002) is growth: by almost 8.3 times, reaching around EUR 44 billion in 2008, or over 3% of GDP, which is comparable to the FDI share in China. Correspondingly, the share of Russia in total FDI in the CIS, which had been falling during most of the 1990s, jumped from 40% in 2002 to almost 70% in 2006 (which is, however, still below Russia’s current share of the CIS aggregate GDP, at around 76%). See below the Graph of the Total FDI in Russia for the past decade.
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Figure 4: Total FDI in Russia and Share ofRussia in total FDI in the CIS (1994-2006)
The following graph presents total FDI inflows in different countries that could be compared to Russia due to its historical similarities. As we can see initially Russia received less inflows than the Czech Republic despite the huge population difference.
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Figure 5: FDI in various countries (1995-2002)
From this section we can conclude that Russian FDI experience can be divided into two separate periods: 1994-2002 very weak increase; 2002-2008 rapid growths.
C. Corruption in Russia.
Corruption is a frequent occurrence for the international investors present all over the world. A World Bank study of 1999 has shown that almost 90% of sampled multinational firms deal with corruption “always” or “mostly” when working with public sector. Nevertheless, corruption is very hard to measure due to its nature. There are several available measures of Corruption. First of all there are indexes based on the surveys of individual “experts” for instance the Business International (BI) Index, used by Wei in 1997 and 2000; studies or International Country Risk Group (ICRG). The second measure type is an index based on the survey of the firms for example Global Competitiveness Report (GCR) index by the World Economic Forum or the World Development Report (WDR) index by the World Bank. The third type of measure is an average of several existing indexes the most recognised of which is the Transparency International (TI) by an international non-governmental organisation aimed at fighting corruption. Unfortunately some of these indexed do not cover Russia; nevertheless we shall look at the ones that do to capture the trend.
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Figure 6: Corruption Perception Index in Russia (2001-2008)
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Figure 7: CPI trend in Russia (2001-2008)
The trend captured from the TI data is also supported by the report from the Poverty Reduction and Economic Management Unit, Europe and Central Asia of World Bank on “Russian Federation Administrative and Regulatory reform in Russia. Addressing the Potential Sources of corruption.” According to this report, published in 2006, corruption levels are remaining high in some cases the situation is worsening. More precisely the quality of regulation is declining and the uncertainty about the regulatory reforms is very real. This report claims that the biggest obstacle in fighting corruption lies with the ineffective implementation mechanisms, bureaucracy and the lack of transparency of the legal system. The final recommendation of this report is to improve the efficiency and transparency of governmental institutions.
To conclude we can state that the corruption level in Russia is rather instable with a lot of fluctuations but a general trend of slight increase.
Overall from this first Introduction part we have established several main dynamics: economic growth, FDI increase and Corruption slight increase.
2. Existing Theory
A. Overview
There are two strands of literature related to this paper. The first one is the literature on foreign direct investment, too vast to be comprehensively referenced here (Caves, 1982, and Froot, 1993). The second literature relevant for this paper analyzes the consequences and causes of corruption in a cross section of countries, including Mauro (1995), Ades and Ti Della (1999), Kaufmann and Wei (1999) and others. Most of these papers do not deal with foreign direct investment.
Wheeler and Mody (1992), Hines (1995), and Wei (2000) were the first three papers to examine the effect of corruption on foreign direct investment. However these papers have reached different results and still don’t have a consensus on the effect of corruption on FDI. The results vary as following:
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Frequently asked questions
What is the main topic of this paper?
This paper examines the Russian economic situation through the lens of Foreign Direct Investment (FDI) and investigates whether low FDI levels are linked to high levels of corruption.
What role has FDI played in other emerging economies?
FDI has been crucial in the development and productivity growth of other emerging economies, like China.
How has FDI performed in Russia compared to other nations?
Despite Russia's economic growth, FDI has been relatively low compared to other emerging economies.
What factors contribute to Russia's unattractive investment climate?
The unattractive investment climate is influenced by factors like stability, infrastructure, labor costs, market size, transparency of the legal system, and corruption.
What are Russia's economic strengths?
Russia possesses vast natural resources, technology, a large skilled workforce, and a significant consumer base.
What characterized Russia's economic recovery after the 1998 financial crisis?
The recovery was driven by high world prices for Russia’s exports, import substitution, market-oriented restructuring, and solid fiscal and monetary policies.
What are the primary drivers of Russia's output growth?
The growth is primarily fueled by private consumption utilizing existing industrial capacity.
What impact has the global crisis had on Russia's economy?
The global crisis has led to a recession, decreasing GDP growth, although Russia's strong macroeconomic fundamentals provide some resilience.
What are Russia's main economic challenges?
Structural weaknesses, such as dependence on oil prices, contribute to economic vulnerability.
What are the main sectors of the Russian economy?
The Russian economy includes agriculture, industry (mining, manufacturing, defense), and services.
What is the significance of FDI for Russia?
FDI brings capital, productive facilities, technology transfers, employment, and management expertise, important for promoting competition and efficiency.
How has FDI in Russia evolved over time?
FDI levels were very low in the initial years following the USSR breakdown, but experienced significant growth after 2002.
How is corruption measured in this context?
Corruption is measured through indexes based on expert surveys, firm surveys, and averages of existing indexes, such as the Transparency International (TI) index.
What is the general trend of corruption in Russia?
Corruption levels in Russia are considered unstable, with fluctuations but a general trend of slight increase.
What contributes to the high corruption levels in Russia?
Ineffective implementation mechanisms, bureaucracy, and a lack of transparency in the legal system contribute to high corruption levels.
What are the two main areas of literature relevant to this paper?
Literature on foreign direct investment and literature analyzing the causes and consequences of corruption in various countries.
Which studies have examined the relationship between corruption and FDI?
Studies by Wheeler and Mody (1992), Hines (1995), and Wei (2000) have investigated the effect of corruption on FDI, but results have varied.
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- Maria Golushko (Author), 2009, Corruption as a factor of FDI levels in Russia, Munich, GRIN Verlag, https://www.grin.com/document/166332
