International Workshop “Water Resources Management and Development

Nataliya SmorodinskayaKaliningrad: Baseline Tendencies of Social and EconomicDevelopment in the 2000-s International Workshop “Water Resources Management and Development for Economic Growth and Environmental Sustainability in Kaliningrad Oblast”. Org. by SIWI, Warsaw, 15-17 March, 2010 Institute of Economy, Russian Academy of Sciences

Kaliningrad: general facts • Federal district: North-Western. Border with: Lithuania and Poland • Size:75th out of 83 regions in Russia in terms of area (15 100 km) • Distances to some European capitals (km): • Vilnius (350 ) Riga (390), Warsaw (400 ), Berlin (600 ), Stockholm (650 ), Helsinki (660 ), Copenhagen (680), Oslo (850) and… Moscow (1200 ) • Inhabitants:937 400 • Largest towns: Kaliningrad 422 400, Sovetsk 42 700, Chernyahovsk 41 100, Baltiysk 33 300. Share of urban population: 77% • Main industries: food (fishing), fuel (oil), machine building, metallurgy • Natural resources: 90% of world’s amber reserves, oil, brown coal, peat, rock salt, mineral water services • Key economic peculiarities: • since 1991, special SEZ status (free trade and other exclusive federal favours) • since 2004, unique enclave position within the EU

Kaliningrad as of the Russian Total: • Area 0.1 % • Population 0.7 % • GDP 0.5 % • Enterprises 1.0 % • Industrial production 0.6 % • Retail trade 0.5 % • Exports 0.5 % • Imports 3.9 % • FDI 0.6%

KD is much more than a regional case... It is the best magnifying glass to observe all-Russian realities • As free-customs enclaveKD is the most open economy in Russia. As enclaveinside the EUit is the most exposed locality to global competition • This unique combination makes KD an amplifier of: • all-Russian economic trends • all-Russian structural disbalances • all-Russian social illnesses

Federal Underlying Policy Priorities towards Kaliningrad Not to loose the levers of control over the territory in the enlarged Europe 1. To bound KD’s life-support systems centripetally to mainland Russia(infrastructure, power supply, communication) - to provide free flow of traffic to local ports and military facilities - to ensure easy terms of cargo, gas and energy transit deliveries to KD • To hold any extension of the Western economic presence in KD - to narrow down the EU-Russian cooperation on KD to the issues of its immediate life-support (transit-points), while avoiding discussion of its fundamental modernization priorities 3. To avoid both the growing social contrast and the too rapid convergence of KD with the EU neighbours • for the sake of preventing a rise in local separatism

Kaliningrad’s specialization as the SEZ :not an exporter to EU but just an intermediary for pushing duty-free consumer imports to Russia Imports were sky-rocketing far above GRP and all trade flows Sales to RF in RUR just followed imports… Exports proper were almost flat

KD’s import-led pattern of growth in the booming 2000-s:Importsreached unrivalled levels of 30-50% above GRP. Exports kept 60-65% below GRP (and started to grow only after 2004, due to Russian oil transit flows) Exports proper (cleared from transit oil) = max 30% Manufacturing exports (excl. local oil) = max 11% This was incomparable with 130-150% for imports, also mostly manufacturing GRP, rate of growth, %

Kaliningrad GRP growth rates as compared to Russia and Baltic states

For many years KD has been operating under a hidden state of default, with the growing trade and fiscal deficits covered from the federal budget. The higher were the GRP growth rates, the larger were the shortages By 2006, KD’s actual deficit (as cleared from transit flows) amounted to US$ 4bn, or 92 % of GRP. If not growing oil exports, it would have exceeded GRP by a quarter

Deliveries from SEZ to Russia (cars, TV, etc.) are formed for 70-85% by imported components, but statistically registered in value as KD industrial output KD macro-pathologies may enter the Guinness Book of Records: To be competitive at remote Russian markets, import-processing firms (...% of industrial output) regularly avoid or evade taxes KD runs a second economy in the shadow (95% of GRP) Official economy grows under decreasing level of private investment and tax collection budget rests on oil industry as the largest taxpayer (it makes only 9-11% of industrial output, but 70-80% of net KD’s revenue) KD faces a dope dependence of business on state money, and of public sector, on external aid Vicious Circle of Economic Growth: “Shortages - federal subsidies – higher growth – more shortages – - more federal assistance” Kaliningrad’s import-led industrial growth is purely statistical…

Rich natural landscape, advantageous geographical location in the centre of Europe, and unique cultural and historical heritage Dynamic neighbourhood of rapidly growing Baltic states, geographical proximity to Scandinavian countries (technological leaders of the EU), and a natural chance to get linked to numerous infrastructural and communication networks in the BSR High market adaptability of the local population due to its wide-range engagement in the small-business and individual entrepreneurial activities under years of the SEZ regime. Today, this experience could be renewed and substantiated through developing flexible and innovative forms of economic activity Currently these assets have either a negative value or no value at all. But they will get their natural investment attractiveness once KD’s economy starts moving towards integration into Europe To make an economic advance, KD should rely on three basic assets:

Amending federal incentives for Kaliningrad: ideology of the 2006 Law on SEZ Three main federal motives to revise the old Law on SEZ: • to stop shadow leakage of federal money into local private pockets and reorient KD to European export markets • to prevent KD from rapid lagging behind its neighbours as new EU-members • to bring the SEZ in compliance with international standards applied in WTO In late 2005, Boos was appointed the governor just to clear out KD. But the new Law appeared to be a compromise between rational economic reasons and alarmist security concerns. The Law prioritized: • Russian investment inflow to KD instead of foreign • Big Russian newcomers to KD (to become “locomotives of new industrial clusters”) instead of local SME • Building large industrial plants instead of stimulating new economy

The 2006 Law on SEZ in Kaliningrad:benefits for Old SEZ Residents «Old» SEZ residents based on customs favours granted by the 1996 Law on SEZ • firms registered in KD before April 2006, may use their customs benefits • imported foreign goods are exempted from customs duties and taxes • goods delivered to other RF regions are exempted from customs duties if: - commodity classification code has changed at the level of first four digits - share of the added value has reached at least 30 % Favours for “old” residents will be in force till the end of March 2016 (for 10 years)

The 2006 Law on SEZ in Kaliningrad: benefits for New SEZ Residents New SEZ residents based on tax favours introduced by the 2006 Law on SEZ • New firms conducting a capital investment at least 150 mn RUR (USD 5.3 mn) in the region’s industrial sector over 3 years may use the tax benefits Tax benefits offered for an investor: • corporate income tax and property tax are 0 % for the first 6 years and reduced by 50 % for the 7-12 years after the investment The 2006 Law will be in force till the end of March 2031 (for 25 years)

The new Law on SEZ hasn’t changed KD’s pattern of growth but rather enhanced its ability to generate negative value added • no large capital came to KD, rather local firms re-registered as new SEZ residents (56 as by 2009) • a bulk of small firms were deprived of any SEZ favours and had ruined • no new export facilities, rather assembling firms established daughters to make double use of both customs and tax favours • KD economic “achievements” by 2007-2008: • Imports rise by €1bn a year, to reach €6.6 bn in 2008. KD hasthe largest in RF imports per capita and per unit of GDP, with China as the largest supplier. • VA of imported goods is more than twice as high as VA of exported.In 2008, • trade deficit ( €5.8 bn) was 30% above GRP (€4.4 bn) • skyrocketing growth in import-processing (food, cars, TV sets) and, therefore, in • manufacturing output(a 2.6 fold increase y-o-y) under miserable investment of • assembling firms(0.7% of the total)

Now the crisis (globalization) has started to wash awayKaliningrad’s pattern of growth… In the booming 2000-s: • 2000– 16%(RF -10) • 2002 – 10% (RF – 5) • 2005 - 13%(RF – 6) During crisis years: • 2008 - 9.1 %(finalized) • 2009 - 13.9 % (RF = - 7.9% ) GDP growth rates in KD and Russia

KD’s industrial production as compared to St-Petersburg and Russia as a whole Until the start of the crisis assembly industries were making KD the leader but in 2008 KD sharply slowed (2.5%) and in 2009, went down (- 11.8%, and -- 18% for manufacturing) due to a fall in consumer demand in mainland Russia.

Kaliningrad inflation rate (%) For reference , 2008: Lithuania – 10.9%, Poland – 4.2%, Estonia – 10.4% In 2009, CPI in KD reached16.3% by official local estimation

Kaliningrad calamities as of 2009 … - 14.8% for index of industrial production , - 13.9% for rate of GRP Construction has fallen by 64% Like in Russia as a whole, a sharp rise of tariffs in HC services (production and distribution of electricity, gas and water) Small business swept away by major firms Unemployment rate – 11.6% (RF- 8.2%). Each third-forth is dismissed or under the risk of dismission Good news: the import-processing firms have started to look out for export markets beyond Russia… But they have too littlel to offer.

General Tendencies accompanying the economic crisis in Russia(since autumn 2008) 1. The crisis has so far reinforced existing tendencies: • state control over the economy • oil-oriented structure of the economy, • the ruling elite's economic expansion at the expense of private businesses, • the preservation of political power and status-quo 2. In 2010, social protests in Russia are becoming increasingly political Protests staged in Kaliningrad (10,000-12,000 people) were followed in February 2010 by similar demonstrations in Angarsk, Irkutsk (4000) and Samara (4000). 3. Further monopolization of the Russian economy A new wave of accelerated redistribution of assets in key sectors. A section of the political elite which using the crisis to take over selected strategic assets in their private interests. 4. Macroeconomic trap – how to secure social stability under falling federal finance

Key concerns of Mr. Boos as a governor show that Kaliningrad is a mirror of Russia 1. Economic concerns: • How to ensure the local major businesses (Avtotor the first) a sufficient volume of federal favours for the future, to successfully get round the crisis challenges (the growing unemployment is not the last problem )? • How to save the budget? Under the existing set of federal guidelines and incentives for KD, the local community is objectively unable to improve KD’s economic structure and social situation. Just like his predecessors, Boosisdoomed to go on seeking additional rents, money and benefits from the federal centre 2. Political concerns: • to strictly follow Moscow guidelines and to preserve the existing level of administrative power • to keep KD under control through authoritarian style of ruling and toughening verticals of power even more than on the federal level. By 2009, local Duma has become completely subordinated to Boos. MPs have lost any independent say on Governor’s activities and the question of state-property redistribution.

Risks and limitations of the Project for reforming KD water system management 1. Full dependence of the regional authorities upon Moscow 2. Communities of remote regions are just a tool in Moscow’s strategic games and commercially beneficial foreign contracts 3. For Moscow, ecology issues are a third-rate priority as compared to good bargains or social stability at separate enterprises 4. General moods of political and business elites, both federal and regional, to preserve the status-quo as long as possible (instead of speeding modernization) 5. Macroeconomic trap in Russia and its regions, growing fiscal deficits However, this discouraging situation looks …encouraging for searching a non-traditional, creative approaches to the Project in a post-modern style

To becontinued… Thank you for attention!

International Workshop “Water Resources Management and Development