Regional Economic Associations: Competition for Integration, or the Way to a More Global World

Dear First Deputy PM Shuvalov! Dear Minister Khristenko! Distinguished panelists! Ladies and gentlemen!

It is a great pleasure and honor to be here today. And on a personal note, this is also a very special moment for me. It is my farewell to Russia. In a few days I will be completing my four-year mandate as Vice President of the Europe and Central Asia (ECA) region in the World Bank and moving to a new position as Vice President for South Asia.

The World Bank supports trade openness as a driver of countries’ integration into the global economy, economic growth, and development. Integration in the global economy has been a key driver of development throughout the world. No country in the past 50 years has sustained high growth and raised incomes without expanding trade. Trade allows economies to use their comparative advantages to create jobs, raise incomes, and reduce poverty.

By contrast, the World Bank does not have a position of principle in favor or against regional trade integration. In our view, this is an empirical question. It depends on whether a regional agreement increases or reduces trade openness. Regional trade agreements can increase trade openness by lowering trade barriers (tariffs, quotas), including those applied to non-members. They can also enhance trade by simplifying customs clearances or harmonizing product standards.

Today, I would like to focus my remarks on the preliminary findings of a new report that the World Bank has recently prepared jointly with the Eurasian Development Bank. This report, which is entitled "Diversified Development", looks at the benefits of diversification for the economies of Eurasia, including Russia. More pointedly, it looks at whether resource-rich countries in the Commonwealth of Independent States (CIS) should care about product and export diversification. And the answer is "not too much". There are more important things to worry about.

Let’s look at the facts. In the past two decades, resource-rich CIS economies have re-oriented more of their trade to non-CIS markets. For example, exports to other CIS countries accounted for only 15% of Russia’s exports in 2011, 14% of Kazakhstan’s exports, and 11% of Azerbaijan’s. ⁽¹⁾

At the same time, the export structure of resource-rich CIS economies has become less diversified and more dependent on natural resources. ⁽²⁾

But the dominance of resource-based exports has made resource-rich CIS economies more efficient. An efficient economy exports more of the things that require the means of production with which the country is well endowed. In this sense, resource-rich CIS economies have become more efficient since the end of central planning.

Natural resource wealth has brought clear economic gains to CIS countries. In the past decade, average per capita incomes in the CIS rose more than six times and about 100 million people in the region were lifted out of poverty. ⁽³⁾

CIS economies have also managed to increase productivity and employment. Unemployment came down in almost all countries. Furthermore, resource-rich countries have achieved large gains in labor productivity and employment. They have also done better than resource-poor CIS countries in reducing output volatility (variation in GDP growth).

Based on these facts, we find no compelling reason for CIS economies to diversify their product and export base to reduce their reliance on natural resources. There is nothing intrinsically worse about comparative advantage based on resource wealth compared to other factors (e.g. capital or labor).

Our research finds that there is no such thing as a resource curse. Reliance on natural resource exports has not prevented Australia, Canada or Norway from achieving sustained growth, high income status, and excellent results in human development indicators.

The main difference between resource-rich economies that achieve and sustain high-income status and those that do not is not diversification of products, but diversification of underlying assets: infrastructure, human capital, and institutions.

No country has achieved high-income status or high scores on the Human Development Index without diversifying its underlying assets. This is what successful resource-rich economies, such as Australia, Canada, and Norway have done. These countries have not diversified production, but they have still reached high-income status. Others, like Argentina and Brazil have diversified production through protectionism and/or industrial policies, but have not developed beyond middle-income levels.

Likewise, we find that industrial policy is neither necessary nor sufficient to diversify production. Some economies have diversified their production through selective support for specific sectors and achieved sustained growth. These countries, for example, Finland and Chile, have also invested in their underlying assets: infrastructure, human capital, and institutions. And they have been successful. However, others, which have pursued industrial policies in isolation, have failed to diversify both their underlying assets and production.

Industrial policy appears to work when it is consistent with a country’s endowments of natural resources, human and physical capital and institutions. What this means is that it is necessary to diversify endowments to diversify production and export structures. For most economists, this is not a surprising finding. For policy makers, this may not be a welcome message. Economic diversification will take time, because it takes time to build a balanced portfolio of assets. In the meantime, policy makers in search of quick results may be best off implementing industrial policies only in sectors for which the economy already has adequate endowments.

So CIS resource-rich economies need not worry too much about diversifying production, especially as they have managed the risks associated with natural resource wealth well.

They have for the most part contained the perils of Dutch disease ⁽⁴⁾ by pursuing sound macroeconomic policies, including through stabilization funds. We also see that productivity has increased in both the oil and non-oil sectors. On the other hand, we see some signs of "Gulf syndrome",   that is high public employment and weak job growth in the private sector, especially in Azerbaijan.

There is one thing that CIS countries should worry about much more: so far they have not done very well in transforming resource wealth into assets. According to the World Economic Forum ⁽⁵⁾, the quality of infrastructure, education and health in CIS countries lags behind OECD economies and many emerging markets.

So, what does this mean for CIS economies as we go forward?

First, resource-rich CIS countries should continue to invest in their extractive sectors to maintain their comparative advantage, especially in the face of new developments such as the commercial exploitation of shale gas.

Second, continued vigilance in macroeconomic policy is needed to guard against the risk of Dutch disease.

Third, despite some progress, resource-rich CIS countries should do much more on infrastructure, education, and health. Capital investment remains lower than in East Asia and the EU. So do learning outcomes, particularly in Azerbaijan and Kazakhstan. Investing in infrastructure, education and health creates capital, which is needed for diversification. To do so effectively, CIS countries need to undertake reforms to improve the efficiency and quality of public spending on infrastructure, education, and health.

Last but not least, although the quality of institutions has also improved in recent years ⁽⁶⁾, most CIS economies can do much better. The quality of the business regulatory framework in CIS economies lags behind the OECD and Central European countries ⁽⁷⁾. A better regulatory environment will help the private sector create more and better jobs. This means not only good regulations but also reliable and efficient enforcement of laws and regulations by the public administration, regulatory bodies, and the courts.

In short, my main message here today is that investments in infrastructure, education, and reforms to develop effective institutions are the strongest foundations of a prosperous future.

Thank you for your attention.

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¹⁾ In 1995, exports to the CIS were 54% of Kazakhstan’s total exports, 40% of Azerbaijan’s, and 19% of Russia’s total exports. By contrast, resource-poor CIS still send about 40% of their exports in the CIS.

²⁾ Natural resource products made up 94% of Azerbaijan’s exports in 2006-2010 [up from 21% in 1992], 85% of Kazakhstan’s [up from 44% in 1992], and 70% of Russia’s [up from 57% in 1992].

³⁾ In resource-rich countries, the poverty rate at $5 a day dropped to 26% in 2008 – from 68% in 2000. Life expectancy has risen, and health and education outcomes have improved throughout the CIS.

⁴⁾ Dutch disease: currency over-valuation leading to reduced productivity and competitiveness in non-resource sectors.

⁵⁾ World Economic Forum Global Competitiveness Index 2012-2013.

⁶⁾ For example, many CIS countries have improved business regulations and the enforcement of laws through the courts. Thanks to such reforms, the average ranking of CIS economies in the Doing Business report rose from 96th in 2008 [out of 178 economies] to 83th [out of 185 economies] in 2013. Resource-rich CIS did better: their average ranking in 2013 was 78th.

⁷⁾ The average ranking of CIS economies in 2013 was 83rd [78th for resource-rich CIS], compared to 29th for OECD economies and 60th for Central European countries.