Finland can benefit from the Northwest Russia phenomenon

Press release 30 March 2004 Advantage Northwest Russia – A New Growth Centre for Europe? Grigory Dudarev – Sergey Boltramovich – Pavel Filippov – Hannu Hernesniemi A major joint Finnish-Russian research study has charted the opportunities for development in Northwest Russia. The most outstanding clusters in this region, which extends from the Finnish border to the Urals, are in the fields of energy, metallurgy, forestry, and information and communications. Northwest Russia has an abundance of raw material resources for these clusters together with a cheap pool of skilled labour and access to the rapidly growing Russian markets. The Russia phenomenon offers an outstanding opportunity to Finnish industry, an opportunity that will be realised when companies transfer their production to Russia. With growing investment the export of technology will also increase. The next stage is for small and medium-sized Finnish enterprises to invest in Russia and industrial cross-border networks. The Russian economy has grown in six years at a rate three times as fast as that of the EU countries. In the years 1999-2003 Russia’s GDP grew by an average of 6.1 per cent while the annual rate in the EU it was only two per cent and in Finland three per cent. The growth rate in Northwest Russia corresponds to the rate for the whole of Russia. In the future the logistically advantageous geographical position of the region between the key markets of Russia and Europe will increase its potential. Of the EU countries Finland can benefit most from Russian growth by reason of its proximity and economic synergy gains. Russia is growing in imports and exports to make it Finland’s leading trading partner alongside Germany. Finland has become an important channel and logistical centre for high-value goods to Russia. Thirty-seven per cent of Russia’s imports pass through Finland. Direct investment by Finland in Russia is in the starting line. By Northwest Russia is meant the region bounded in the west by Norway, Finland and the Baltic countries. In the east it is bounded by the industrial region of the Urals and in the south Central Russia, centring on Moscow with its strong purchasing power. Northwest Russia includes the city of St Petersburg and the surrounding region of Leningrad, the republics of Karelia and Komi, the regions of Murmansk, Archangel, Vologda, Pskov and Novgorod together with Kaliningrad, which as a result of enlargement will become an enclave within the EU. In area Northwest Russia is five times larger than Finland with a population of 14.7 million. The mainstay of the economy – energy, forest and metals The most promising cluster in Northwest Russia is the energy cluster. Komi, Nenetsia and the nearby Yamal-Nenetsia and Hanti-Mantsi regions produce both oil and coal. The Barents and Kara Seas hold Russia’s largest unexploited reserves of natural gas. Because of the strong growth of the region’s own manufacturing and transit haulage the transport of goods via the Baltic Sea is expected to increase greatly. A new pipeline to Murmansk would reduce the ecological risks and open up a channel to the US market. Developing the production of electricity and heat requires that the present monopolies and administrative price systems be dismantled. International companies could provide help in developing this field. The forestry cluster is growing to become the second largest cluster in the region, overtaking metallurgy. The forest reserves of Northwest Russia are approximately four times those of Finland but felling is only 60 per cent of the corresponding figure for Finland, and a considerable proportion of that is exported to Finland. At the moment the industry manufactures only low-refined products. The Svetogorsk paper mills (now owned by International Paper) and Syktyvkari pulp and paper mill (Neusiedler) have begun new development. Together they manufacture the majority of Russia’s needs for copying paper and are strongly oriented to-wards exporting. Developing the forestry industry requires long-term investment in forest and timber management, infrastructure, technology and environmental care. The fact that they are the only factories in the communities where they operate constitutes a problem since it means that the communities are dependent on them, which in turn makes it difficult to institute rationalisation measures in production. A second important problem is to obtain sufficiently long-term felling rights but attempts are being made to solve this problem with forest legislation. Developing the forest industry will make it possible to raise the standard of living in North-west Russia. The metal industry in Northwest Russia is based on the ore deposits in Karelia and the Kola Peninsula and the coal resources in the Komi region. Non-ferrous metals are refined in the Murmansk region and St Petersburg. The non-ferrous metals giant Norilsk Nikkel is a major operator. The processing of iron and steel is in the hands of Severstal in the Vologda region; it is the largest single enterprise in the whole of Northwest Russia. The most promising field for metal reining, however, the production of aluminium, for which Northwest Russia has both the raw materials and cheap energy. The collapse of the Soviet system revolutionised the metal industry. Domestic markets crashed and the industry had to concentrate on manufacturing basic products and on exporting, where it has succeeded well. Now domestic demand is on the increase as a result of the improved economy. The problems of the industry include the increasing costs of the mines. The mines, refineries and smelting furnaces are serious polluters of the environment compared with their western counterparts. Information and communications represent new fields of business in the region. This cluster is concentrated to St Petersburg. Northwest GSM, which is now a part of the nationwide Mega-phone, is a pioneer in the field of mobile telephones in Russia. Six and a half million mobile telephones are sold each year at the moment in Russia but the country has no production of its own. A second growth area within information and communications is software development, a field where the region could follow the pattern of India and Israel. It is based on entrepreneurial interest and a strong university education. Of the three Russian centres in this field – Moscow, St Petersburg and Novosibirsk – St Petersburg is most oriented towards exporting. The centre of Russia’s electronics industry is to be found in St Petersburg and the surrounding area. Only the shell remains of the information and communications technology giants but within this shell there have emerged manufacturers of niche products. An important new form of production is manufacture under licence, which requires a network of sub-contractors to support it. However, regulations controlling the import and export of components need to be liberalised. Russia needs an industrial policy It became obvious in the course of the study that industry in Russia lacks almost completely any guidelines by industrial branch or political region. There is also practically no development activity. Hitherto the central administration has concentrated on reforms that will contribute to more efficient markets. At the same time in many branches, such as energy production, transport and fixed-line telephone communications, the old monopolies still exist. A factor that hinders investment in capital-intensive enterprise such as the forest industry, metallurgy and energy production is the high wealth tax, 2.2 per cent. This “extra” demand set on returns by the state is too high. It has, however, encouraged leasing finance since the capital assets acquired in this way are free of tax. The Russian state is endeavouring to guarantee its own sources of revenue by retaining many key industries as state monopolies. These include, for example, rail transport, gas production, pipeline transport of oil and the fixed-line telephone network. If these branches were opened up to competition, it would result in marked economic growth and a wave of investment. At the same time administrative prices for gas and electricity, for example, would have to be freed from restrictions. The government is putting reforms of this nature into practice but relatively slowly. A characteristic feature of Russian industry is the predominance of massive, large-scale companies and the lack of small and medium-sized enterprises. Such companies were not established during the Soviet era nor have they emerged during the succeeding period of just over ten years as they have in trade and services. This creates problems for large foreign investors, for example, since to set up a network of sub-contractors is a laborious task. Russian factories also find it difficult to outsource their operations since there is nobody to whom they can outsource. Russia needs an SME policy. Another structural problem is the lack of a corporate R&D policy and the paucity of R&D activity. During Soviet times the research and development work for new products and production processes was done in research institutes while companies were merely production units. Now the research institutes are encountering difficulties but companies have not as yet developed their own R&D activities. No venture-capital system exists to develop new techno-logy and bring it on stream. The most pressing matter at present is to get investment moving. Now would be the time for both the state and the different regions to invest in the infrastructure of promising industrial communities, transport channels and information networks. At the same time other decisions favouring investment need to be taken so that the costs and risks of investing are reduced. The fact that foreign investment per capita is considerably lower in Russia than elsewhere in Eastern Europe is a reflection of the present poor investment environment. Opportunities for attracting investment would seem to be reasonable because of the availability of raw materials, the advantageous transport costs and rapidly expanding domestic markets. Foreign investment is needed to help develop new products and technology, to make available know-how for corporate management, financing and marketing and to open up marketing channels to international markets. Background During the years 2001-2003 Sitra has funded a cluster study of Northwest Russia. The study has been conducted as a joint project by Finnish and Russian companies and research institutes. The Centre for Strategic Research in Moscow, Solid Invest, a research body and consultancy in St Petersburg, ETLA (Research Institute of the Finnish Economy), the Finnish Ministry of Trade and Industry and twenty leading Finnish companies have been involved in the project. The study has now produced an assessment of the present and future competitiveness of companies in Northwest Russia and the clusters that they form together with the business policies needed for their development. The results of the study will benefit Finnish companies when they consider sub-contracting to and investing in Northwest Russia. The results also provide a basis for developing the concrete contents of a policy for the northern dimension of the European Union. Further details Grigory Dudarev, Solid Invest, tel. +358-50-465 4085 Sergey Boltramovich, Solid Invest, tel. +7-812-118 62 34 Pavel Filippov, Solid Invest, tel. +7-812-112 6234 Hannu Hernesniemi, Etlatieto Oy, +358-50-574 1801