The Forum Travel Guide
If the program of the Forum reflects the structure of Russian authorities' thinking, then, thanks gods, this thinking is changing along with ongoing events.
One year before the first Forum day was dedicated to global problems and second to Russian ones, in a way underlining that the world is in crisis, and Russia is a safe heaven although with problems of its own kind. In contract this year Russia is in the same boat with the world, and thus the first Forum day is about economy and the second — about finance.
Economic day
Global crisis
An ability to change behavior adjusting to changing environment is a key skill for species survival. Next evolutionary stage is an ability to forecast changes, let us hope our government will reach it one day too. But it is hardly reached so far. The words of President Medvedev on the opening of the last forum are symptomatic: "... Development of financial and house sectors in our country is on the early stage so far, so there are simply no such large-scale risks as in the other countries".
At the same time risks in Russian financial sector were openly mounting. The outstanding credit rose minimum 40% during 2005-2007, external private debt reached $500 bln in summer of 2008 and almost matched reserves of Central Bank of Russia. In the first quarter of 2008 outflow of residents' capital increased dramatically and inflow of foreign capital slowed down. During the first quarter industrial production was falling even after subtracting seasonality. Oil prices were so high that it was hard to believe they will stay so for long. To those looking at the figures it was the question of not if there will be something bad, but how soon it will be. And the answer was — soon. And here other words of the President would be appropriate: "At the same time it does not exempt us from learning the right lessons, so that there will be no such shake-ups in Russia any more". Possibly we will hear those lessons from the President on the Forum plenary meeting this year. But what are the right lessons?
Here is how president of Center for Strategic Research, Mikhail Dmitriev, formulated his lessons from the crisis: "First, the key priority during the crisis should be not fighting it, because government policies can not overcome the crisis of such scale, but creation of conditions for successful after-crisis development. And second, the strategy for growth based on external borrowing by Russian companies showed its vulnerability. After the crisis attracting FDI including those to natural resources sectors, should be a priority."
The price of oil
It is very hard to forecast oil market behavior, and there are fundamental reasons for this. In April of this year Eyal Dvir from Boston College and Kenneth S. Rogoff from Harvard published an article called "Three epochs of oil". Using statistical and historical analyses of real oil prices in US from 1861 to 2007, they showed that it is possible to divide the history of oil for three major periods: from 1861 to 1877 (average price — $51 per barrel in 2007 USD, minimum — $10, maximum — $110), from 1878 to 1872 (average price — $17, minimum — $10, maximum — $50), and from 1973 to now (average price — $44, minimum — $20, maximum — $140). Periods differ in structure of supply and demand. In the first and third period prices were higher and more volatile thanks to restricted — by railways in the first period and OPEC in the third — supply of oil from one side and strong demand shocks from the other. In the first period USA were going through rapid industrialization and in the third — the same were happening in South-East Asia and most recently and notably in China. Restricted supply together with growing demand gives higher price and volatility in the first and third periods, while in the second supply was flexibly absorbing demand shocks through active spreading of pipelines before 1930s and after discovery of oil in Texas in 1930 — through USA government extraction quotas supposed to stabilize prices. In 1971 oil production in Texas reached its maximum, and USA have lost ability to increase supply in response to demand or supply shocks. Since then the world saw the rise of OPEC.
It is quite obvious why restriction of supply increases the price, but why volatility? Authors explain it this way. An increase in demand leads to higher increase in price than if supply was responding. And because oil can be stored, traders expecting further price growth start to hoard oil making the price go even higher inflating the price bubble. And vise versa, when the price starts to fall, traders sell their reserves driving the price into the ground. Moreover, now traders can buy and sell oil on futures and options markets without caring of storing it or having it in stock to be able to sell in the first place. Thus to forecast oil price one needs to forecast bubbles behavior which is so stochastic that to make a right guess about the price even plus minus $10 in the next six months is the same as winning a lottery many times in a row.
Theoretically US might return itself an ability to increase supply at their will. In the last Forum Jeroen Van der Veer, Chief Executive Officer of Royal Dutch Shell, reminded to audience that 80% of their continental shelf is closed for prospecting and developing oil fields. In 2005 George Bush administration started a program aimed at increasing oil production around Alaska, Obama administration pushed the program further, but in this April it was frozen by Washington court until more detailed research of possible environmental damage from increase in oil production in the region. By the way US have common interests with China on the oil market, and China is building reserves which might be used in future together with American to stabilize the market.
Russia might also increase oil production, but Kremlin prefers playing on OPEC side and even initiated foundation of "natural gas OPEC". Of course, supply restrictions increase the oil price exported from Russia, but it also increase oil price volatility, which makes it harder to stabilize ruble exchange rate without high inflation, high inflation make long-term credit too expensive and Russian companies borrow heavily abroad. Moreover, instable macroeconomic conditions hamper investments in all sectors including non-extracting. It turns out, that to overcome natural resource curse the best way is to liberalize the production and distribution of all natural resources including oil and gas. This will lower the prices for exports in the first time, but will make Russian economy much more stable and less focused on natural resources. It is hard to imagine someone in Kremlin daring to think about this choice, especially, while the one who controls oil and gas is the one who sits in Kremlin. Unexpectedly development of modern industry in Russia demands civilized democracy. It is interesting, that this logic seems to be intuitively grasped by RF finance minister Alexey Kudrin, who in his speech on the last Forum noticed: "I would be very careful with such institutions like OPEC. Cartels are not those institutions which might decrease risks on the markets, including oil market... I would also be very careful about natural gas cartels."
Another way of bringing end to the third oil epoch is technology. New ideas might free energy companies from dependence on sovereign countries deposits of oil and gas. For example, extraction beyond the shelf or alternative energy, such as solar, wind, even nuclear and so on. But new technologies in extraction come slowly. It is hard to believe but average age of engineers in oil industry is about 50 years, according to Andrew Gould, chairman and chief executive officer of Schlumberger Limited. He noticed that in his speech on the previous Forum. Alternative sources might influence the market in future (see the box), but so far they are either too expensive or even more restricted like for example nuclear power.
Moreover, it is possible, that demand for oil became less elastic. Thierry Desmarest Chairman of Total's Board of Directors on the previous Forum said that decline in oil consumption in developed nations was much lower than at the same price in the beginning of 1980s. It is possible, that is because people became richer, or may be they became more dependent on personal transportation. In any case in the coming decades, most likely, we will see very different and on average high oil price.
Anti-crisis programs
Soon crisis will celebrate its second birthday. In different countries it came in different times, but we already have two contracting ideologies of tackling the trouble: US along with UK suffering from deleveraging print money, restart credit markets, improve capital of banks and laying ground for reforms on financial markets. On the other side is China suffering from exports collapse increases government spending on infrastructure, buys commodities, orders state banks to issue more credit and state companies to keep employment and invest in new equipment. Of course, it is too early to compare results as China just started to slow down, but so far the score is 6,1% in favor of China, its GDP rose on this number in the first quarter and US one on the same number slid down.
Mikhail Dmitriev thinks that the best way to fight the crisis for Russia is depreciation of ruble, increase of unemployment benefits, restriction on inspections and other administrative burden for business, increase in government purchases and loan guaranties. He also believes that nationalization of banks to increase the credit to economy will lead to aggravation of bad loans problem. 70% of available for anti-crisis programs money Mikhail would spend on support of business and only 30% would go to households.
Boris Mintz supports lees fundamental changes: decrease in taxes and credit interest rates, increase in money supply including by increase in government purchases. He would spend only 25% of money available for anti-criris programs on support for business and the rest — for households.
PROSPECTS FOR THE EVOLUTION OF POLITICAL SYSTEMS
Potentially in this session one may see more debates than in others. This is because political science just several decades ago started to use statistics and math to test hypotheses and theories. So many researches still are mostly verbal, and it is hard to understand what is going on with political preferences of people in reality, not in researcher's mind. But let us hope that some modern researchers will make reports on the session, because preferences look change dramatically. In USA afro-american becomes a president, in Thailand premier-minister is forced to resign under accusations in election fraud, in Greece young people clash with police, interior minister ask for resignation, but it is not accepted.
Is it possible that information technology make mistakes and tricks of those in power more and more evident and known to ordinary people? Is it possible, that growing level of education and concentration of educated people in cities shift preferences of the median voter to more ethical leadership?
Experts disagree about perspectives of Russian political development. "I expect that in our country political and social values will converge with the values of developed countries", — says Mikhail Medvedev.
"Speaking about political preferences over authoritarianism versus democracy, I believe in Russia people are traditionally prefer the former. For now the country is very far away from shifting to competitive model of government", — replies Boris Mintz.
Training future world leaders
"The academic school lags behind practical needs... How to bridge the gap between academic education and realities of life?" — is offered as session description by authors of the official Forum program. I am afraid, such statements will puzzle people from western education system. Some professors and scientists might lag behind practical needs, but the whole academic school! "What to do if we have such system in Russia?" — some locals may ask. "How do we know?" — foreigners will reply. "We never let our academia fall so much and thus we have never fixed it on such scale", — they would add.
Short personal experience in private American and state Russian universities makes me feel that actually it is not so much needs to do: fix university management, make regular real quality audit, increase scientific level of programs, enhance recruitment of students and professors, increase salaries for the latter and provide grants for research which should become necessary for success, help students going abroad for MAs and PhDs and return afterwards. Everybody knows this, but somehow few are doing.
But Boris Mintz is sure, that during this crisis a fundamental gap between practice and academia became evident. "Economics in US is regarded as the most advanced, but to be honest it could not only predict and offer preventive measures for the current crisis, but also did not demonstrate understanding of the ongoing events when the crisis was already flaring up". Although, Boris correct himself, that it is not only about scientists, but also about politicians who often are deaf to the former. "Science might be able to explain reality and give recommendations. But if politicians will not show demand for research, nothing will happen. Thus it is not economics will lag practice, but reactionary thinking of politicians will lag scientific achievements".
I remember when I was a student and took a course in public economics from one American professor. After he proved for us a long formula for calculation of an optimal tax I asked him, if it is being used for real tax rates calculation. He said that he straggles to explain it to students, what to say about politicians.
Retrospective of the world crises
Studying history always helps to understand better what might be waiting for us in the future. During the last 100 years the world saw many crises, and huge literature was written about them. Credit crises are probably the most interesting for present time. Great Depression which was thoroughly studied by Ben Bernanke working in academia is the most notable example. Also Northern countries (Finland, Sweden, Norway) crisis during the end of 1980s and beginning of 1990s. It is there first banks for toxic assets were created. Also Japanese "lost decade" of 1990s, when government and business were waiting for better times and postponing painful restructuring of bad loans in the banking sector.
"It is impossible to avoid crises. But we can mitigated them by countercyclical monetary and fiscal policies, as well as effective regulatory system for financial sector", — Mikhail Dmitriev believes.
Financial day
The post-crisis financial architecture
The global financial order will be reformed without doubts. It is because almost all countries including USA are interested in reforming it. The goal is also common — to decrease the risks in financial system through rise in transparency and control. But in reality it is more complicated. New financial products are very complicated for regulators to assess their systemic risks adequately, even inventors of those products failed to do it many times. If regulator can not assess the risk, he most likely will freeze the production until complete study, as it is done with drugs, for example. This will increase the costs of innovations, and companies will prefer to start them up outside such regulation. In order to keep innovations home US and Europe will push all more or less financially significant countries to implement the same regulation. Most of those countries have suffered from the crisis and they are interested in reducing the risk if the burden will be shred equally.
And those will of countries created Financial Stability Board in this April, which now includes 21 major countries and EC. FSB will start with monitoring of large hedge-funds and proceed with all other systematically important financial institutions and instruments. Among other things, FSB will assess contingency plans of those companies developed for cases of market distress or even bankruptcy.
Russian banking sector soon will probably need stronger medicine than monitoring and advice. Delinquencies are growing together with reserves covering them causing banks profit plunge.
Even after Central Bank of Russia eased definition of bad loans by increasing period of acceptable payment delay on 30 days from January 1st of 2009, share of loans with overdue payments in the bank system is about 10--30% by an estimate of Alexey Ulukaev, CBR chairman deputy. During the 1998 crisis IMF estimated that share in 40%.
"I would estimate the share of overdue loans in the banking system on the level of 15%. Share of completely hopeless loans, of course, is significantly lower. But it is not only loans. Among toxic assets there are bonds with technical or even complete default. In the beginning of May there were more than 175 bln RUR and $640 mln of such assets", — says Boris Mintz.
There are several ways of solving the problem of toxic assets. It is possible to ease reserve requirements for banks and let them accumulate bad loans in the hope of after-crisis rise when banks profit will allow writing them off or companies will repay at least some of them. In such hope Japan lived through its lost decade. It is also possible to create state funds for toxic assets as it was done in Northern countries, or state-private funds as in US. It is possible to stimulate M&A processes and capitalize banks from treasury. In any case the problem of bad loans will have to be solved in Russia, possibly, in a combination of those ways.
The future of reserve currencies
On the previous Forum there was a question for Herman Gref if Russia would be a part of Eurozone in the next 20 years. "It is a good question. Russia will use Euro or Eurozone will use ruble? I think chances are 50/50. And even more chances that we all will use Renminbi", — he smiled.
For the last 10 years we saw the rise of Euro as a competitor for dollar. As Caio Koch-Weser, Vice Chairman of the Deutsche Bank Group, put it last year on the Forum, there are more cash and coins in Euro than in USD already. In 2007 almost 50% of bonds in the world were nominated in Euro and only 35% in USD; 40 countries directly or indirectly pegged their currencies to Euro and 60 — to USD; 26,5% of the world central banks reserves were nominated in EUR and 64% — in USD, but Euro share is growing, for example, in 2003 it was only 19,7%.
Menzie Chinn from University of Wisconsin and Jeffrey Frankel from Harvard using data for more than 20 years assessed the impact of different factors on currency share in the world reserves. It turned out that GDP of issuing country, inflation lower than average oven developed countries, appreciation of the currency and low volatility increase that share and vise versa. Central banks appear to behave like portfolio holders. But there is big inertia in those portfolios — half-life of deviation from equilibrium is 12-17 years, but authors admit that there should be some bifurcation points, when changes are almost sudden, like it happened with USD replacing UK pound just in several decades.
If this model is close to reality, then Eurozone enlargement along with inflation in US after crisis is over will give Euro a chance to at least become equal to dollar in the world reserves. GDP of Eurozone is already almost equal to US one, and if Sweden, Denmark and especially Britain with its financial sector would adopt Euro, there will be no question who is number one. Nor Japan, neither China in the nearest future will be able to reach US. China GDP is 3 times smaller and it will take at least 25 years to reach US if the difference between their growth rates stays at 5%. But for Renminbi to become major reserve currency along with EUR and USD, China will have to limit inflation, keep currency rate and budget balance stable, and develop a major financial center, larger than in Japan. So far there are not so many reasons to believe that Chinese are not able to make it in 20-30 years.
Ruble perspectives according to this model are rather modest. Russian GDP is almost 10 times smaller than American, inflation is beyond CBR control, economy is based on extraction of natural resources and poor property rights hamper development of financial market. By the way there will be separate session on financial centers.
"To become a reserve currency ruble lacks stability. It is obvious, that a country which has just depreciated its currency and possibly will do it again in the nearest future, can not count on other countries keeping its currency in reserves. It is also hard to count on that because of double digit inflation. And besides one should do something if he wants his currency to become a reserve one, not only declare intentions. For example China supplies its currency through swap agreements. Comparing to China Russia has only one advantage — it has no limits on capital operations. If China does the same then chances for ruble to become a regional reserve currency might weaken substantially", — says Boris Mintz.
The future of cities: preparing for economic growth
Edward Glaeser from Harvard, famous urban economist, has recently published an article "The Wealth of Cities: Agglomeration Economies and Spatial Equilibrium in the United States". Using a theoretical model and empirical results he showed what instruments may make a city grow. Those are either cheap housing or increase in productivity. Of course, status of national capital adds a lot, but those two things are the only major drivers. Productivity may grow because of climate, geography, natural resources, or because of business climate and agglomeration itself. Studies show that in cities people faster accumulate human capital and produce more innovations. For example, it was discovered by Glaeser that city migrants' incomes grow not immediately after arrival, but simply faster than outside of cities, probably, because people inside cities accumulate human capital faster.
Moreover Glaeser shows that city growth in our times very weakly depends on natural amenities themselves, those like warm climate. And this in spite of active growth of population in southern cities of US during the past 50 years. Detailed analysis shows that the reason is not warm climate demand for which supposedly rose among Americans getting richer, but growth in productivity and construction policy of those cities.
Of course, large metropolitan areas will most likely grow further. For example, in US the highest growth during the last 80 years was observed in eight major agglomerations: Boston-Washington corridor, Los Angeles, San Francisco and so on. This growth will continue because personal communication enhances a lot innovation and trust, and distant means of communication can not replace it so far. Studies show that new patents more often refer to patents registered in the same area, and people more often call by phone those who live nearby.
But this growth is not guaranteed. If a city will limit construction and stick to the current economy structure pressing out innovation and productivity growth, it will see decline. For example, in Detroit and Cleveland manufacturing still dominates labor market and gives jobs to 20 and 16% of employed respectively. Detroit for the last 30 years lost 22% and Cleveland — 8% of their population. At the same time San Francisco grew on 17% and Chicago — on 14%. In the former manufacturing is not even in the fifth major industries: 23% of employed work in finance and insurance, 21% in professional, scientific and technical services and so on. In Chicago manufacturing gives only 11% of jobs, and just in 1977 it was dominant industry in almost all major US cities: Chicago — 36%, Detroit — 55%, Cleveland — 44.
OPINION
Alternative energy
Jyrki Koskelo, director of department of financial markets, IFC:
"The economic potential of renewable energy (excluding large hydro power plants) is estimated to be 30% of the country's total actual primary energy supply (270 million tons of coal equivalent). These are untapped resources, which, if fully enabled, would allow Russia to export a greater proportion of its energy supply — it is estimated that more than 40% of the electricity fuel mix is gas fired. In addition to this, domestic energy demand will continue to increase (1.4% increase annually through 2030), more so as rates of economic development improve. Energy and specifically electricity supply, has the potential to be a bottle neck to Russian economic development, especially as aging generation assets are slated for retirement and replacement capital costs are many orders of magnitude higher than they were, more than 35 years ago when the majority of Russian power plants were built — renewable energy technologies are scalable, and can replace obsolete generation capacity. In 2003, independent experts estimated that the electricity sector will need between $20-50 billion in order to avoid nationwide electricity shortages — today those numbers are estimated to be nearly 6 times higher. In addition, many regions throughout Russia are power-stranded, and import fossil fuels from other regions - locally available renewable energy resources can improve the local economics, reduce dependency on these fuel movements and reduce transportation costs. According to IEA, Kamchatka, Republic Tyva and Republic Altai spend more than half their budgets on importing fuel. In 2003, approximately 10 million people in Russia were not connected to the electricity grid, served by stand-alone generation systems using diesel or gasoline, often interrupted by fuel delivery problems or high fuel costs. Russia has a massive potential for renewable energy, which is currently vastly untapped — less than 0,5% of current energy is generated from renewable energy, again excluding hydro plants.
State regulated natural gas prices as well as electricity tariffs that are subsidized and kept artificially low, prevent new entrants to the power generation market — namely renewable energy. The primary level to enabling the development of renewable energy in Russia is through the introduction of a market based pricing structure which will allow it to successfully compete with other subsidized sources of electricity. Additional improvements in general investment climate reliability, reduced bureaucracy and delays in permitting processes for such front loaded and capital intensive projects will also help to promote more investment in alternative energy".
Petr Bezukladnikov, general director of Group E4:
"Speaking about the need for alternative energy in Russia, I am sure the need will be significant, but in 5-10 years from now. Taking in account our fossil fuels reserves, including uranium ones, alternative energy is not a necessity. Most likely we will have to start with PR and advertising policies. Because alternative energy will start to replace fossil fuels only when Russian society will be ready to pay higher price for preserving environment, as it is in Western Europe, USA and Japan."
OPINION
Power of innovations
Bernard Lukey, general director of internet-shop OZON.ru:
"Internet is very important factor increasing communication speed and volume and contributing by this to innovation break-through. Among innovation directions I would mark out legalization of electronic document exchange system in the legal field (including tax and court fields). Implementation of such system would speed up business processes, decrease costs and save forests."