Outside the oil province

Even the most problematic areas of non-raw-material sector are still capable of overcoming the crisis. But it can not be done without persistent industrial policy.

By Dmitry Grishankov, Dmitry Kabalinsky

So far oil-dollar anesthesia helps our economy to bear almost without flinching permanent crisis of entire branches of non-raw-material sector of industry, some of which were once subjects of national pride. Aircraft industry, ship-building, electronics, agricultural machinery, light industry — the list is not complete. These industries have long been in the state of profound depression. Slow development is no longer an issue - mere existence of the industries is now at stake. Prolonged crisis has been traditionally attributed to the large scope of accumulated problems. Mostly they are the same for the whole of non-raw-material sector: technology potential has been almost lost during 20 years of beggary existence, equipment is obsolete, stuff has degraded.

But, according to analysis of the future for non-raw-material industries, conducted by us together with Minpromenergo, regeneration is quite possible. The issue is not to find so called growing points – they should be developed purposefully. The most promising branch of industry may wither away without sustainable and efficient efforts by the state, without its notorious industrial policy. And, the other way around, creating favorable conditions may invigorate industries considered dead. Here are several examples (each one of them — over one billion dollars to add to GDP after several years).

Renovation of niches

Local aircraft and ship-builders have a lot in common. The both sectors played key roles in the USSR machine-building, having been engaged in manufacturing military equipment and civil craft and ships. But since the 90-ies both aircraft and ship-building industries have been submerged by a long ongoing crisis. True, Russian air fighters and battleships have been steadily demanded abroad. Current revenues of these branches are almost entirely based on export orders for military-industrial complex products, and the largest suppliers like Irkut, Sukhoi, Sevmash are present in the Rating of the largest Russian companies. As to civil products, no purchasers have been found both in Russia and abroad.

Loss of ground. Downfall of purchasing power on the side of shipping companies and air transport carriers in the first years of market reforms made aircraft and ship manufacturers drastically cut their operations. After improving their financial situation, consumers were not in a hurry to place their orders to Russian dockyards and aircraft plants. By that time mass production of ships and aircraft disappeared without a trace. Annual output of civil ships in the USSR amounted to 140 units, but recently our ship-builders put to service at best 5 or 6 ships. Statistics in the aircraft manufacturing are similar. Obviously, production of single batches of machinery can not be efficient; and, sure enough, there is a set of corresponding problems.

As a result domestic market of civil aircraft and commercial ships was totally lost for local manufacturers. Within the last decade our ship-builders received only 6% of orders from domestic shipping companies (diagram 1). Situation in the aircraft construction is only a tiny bit better. Since the 90-ies air transport carrier fleet has acquired 35 modern aircraft from domestic manufacturers, but imported over 90 planes. There are no large-scale export supplies, either. All traditional markets for Soviet aircrafts are at present controlled by leading world aircraft corporations. In ship-building domestic companies have to be content with orders for building hulls, which does not exceed 30% of the final cost of a ship.

Diagram 1. Domestic shipping companies and airlines prefer to use imported equipment

On the one hand there are ambitions of the world-scale aircraft and ship-building country. The ambitions are nourished by successfully (so far) exporting military-industrial complex products. On the other hand, the ambitions do not seem to have practical hopes for implementation. External markets are out of reach, domestic ones are underdeveloped. Few more years of inaction would cause irreversible degradation of domestic aircraft and ship-building in Russia.

Several years ago such statements made officials irritated – they were obstinate enough to lobby all sorts of the state programs to support the dying industries. At present the problem and the way to deal with it are quite clear.

There is one solution for the both industries. We need a project which will use our competitive advantages and occupy a worthy place at the international market. And the state should assist in practical implementation of the advantages.

Regional aircraft. Our advantages in aviation are technical schooling – so far alive (stuff, experience, industrial capacities etc.) – and enormous domestic transportation market.

Competing with Boeing and Airbus (combined annual output about one thousand planes) requires dozens of billion dollars and still guarantees no result. Today, regional aircraft seems to be the only possible solution. The project will enable to engage all the technological chain in the aircraft industry (from design to maintenance support). Besides, the plane will be demanded in Russia, which is very important at the initial stage of the project. Finally, so far economic situation for the international market of regional jet planes is favorable for Russia. According to Boeing, about 4000 planes of the category would be sold within the next 20 years to bring back 80 billion dollars. Today this segment of the market is almost entirely controlled by Brasilian Embraer and Canadian Bombardier. But expected annual 20% market increment will allow Russian manufacturers to find room in the niche.

Launching regional aircraft for 95 persons (Sukhoi Superjet, formerly RRJ) to serial production is to become the main trump of the Russian aircraft industry in the near future. The project is really a novelty for our aircraft industry. First, the new plane has been initially designed considering the market demand. For the first time domestic aircraft manufacturers would offer to a consumer exactly what he needs, and not something they manage to manufacture. Second, for the first time the plane in Russia has been built in close cooperation with leading foreign manufacturers. Engineering and marketing support was provided by Boeing, which, by the way, has no planes of the similar class. Engines were developed by Saturn together with French Snecma Moteurs. Involvement of the world renowned aircraft companies promises to the Superjet real world market demand.

According to forecasts demand for the plane for the next 20 years is to be 630 units. Average cost of one plane being 20 million dollars, the project may earn for the Russian aircraft industry about 12.6 billion dollars.

How can the state be of help? The first step has already been made — the priorities were set. Now the point is to secure political support for the project. For instance, in the relations with the West: are you interested in selling to us long-distance liners? You are welcome, so far it is not our strong point. But, instead, permit our regional jets to enter your markets.

Ship-building. In this sector the idea of breakthrough has not yet reached popular masses. Unfortunately, numerous interviews with consignors of goods, shipping companies and ship-builders provided no clear answer to the main question: how to restore life in the sector? One hears regular set of maxims: Russian ship-building means poor quality and high prices, we can not manufacture big ships, international markets are out of reach. We have to be content with manufacturing river and coasting ships, plus ice-breakers and some other trifle stuff. But the market for river and coasting ships would not exceed 300-400 million dollars per year. Not too much for a ship-building country.

Let’s return to competitive advantages. Next to moribund but still powerful technical school we have another ace in the hole – offshore hydrocarbon deposits. Actually, oil cluster is the main hope for ship-builders. Arctic shelf development till 2020 would demand 30-40 new operation platforms with approximate cost of each in the range between 100 million dollars and 1 billion dollars. According to different assessments, requirements for this type of equipment would amount to 3-4 billion dollars. And shelves, as is widely known, exist outside Arctic Zone, too.

Head-shakers immediately bring about the issue of tough competition. As a matter of fact, almost all the countries, involved in shelf operations, (from USA and Norway to African countries) set rigorous and graceless regulations as to who may manufacture ships and platforms for offshore development. Strangely enough, the issue has been left unattended in Russia.

But offshore development is not the only point of interest. Oil and gas cluster gives a good chance to edge one’s way into the international division of labor. Leading oil and gas companies plan to build liquefied natural gas (LNG) plants in Russia. Thus, one of them is to be built within the frameworks of Sakhalin-2 project. LNG transporting requires special gas carriers. True, so far Russian ship-builders have never built such ships. In 2005 three St.-Petersburg shipyards competed to get the Sovkomflot order to build liquefied gas tankers (deadweight 150 000 tons) for Gazprom export programs. According to expert assessment, Sovkomflot requires at least 20 LNG tankers. International market price of such a tanker amounts to 190 million dollars, so the whole order might be assessed in the neighborhood of 4 billion dollars. But in the end of the day the order was not placed in Russia.

Obviously, for the order of such magnitude one needs investments. Market players say: manufacturing of large capacity tankers in Russia requires building from scratch a big dockyard at the south of Russia or at the Pacific, employing about 10 000 qualified personnel and making the yard work at full capacity. The cost of such a dockyard would total about 1.5 billion dollars with annual output of 5-6 tankers. Return on investment may be expected after putting into service 25 tankers.

Still, the game is worth the candle. Being hydrocarbon global market player, Russia can easily lobby interests of national manufacturers (being cynical, we are in control of gas supply). And talks about lack of experience in building LNG carriers are quite invalid. LNG plants would reach full capacity in about 10 years, which is enough to build a new shipyard and LNG tankers. It would not be difficult to find investments. The thing is to formulate the problem and get the state preference guarantees (for instance, as in case of offshore development, obligate to transport LNG by domestic tankers).

Forming demand

No developed economy can exist without modern electronic industry. Russia is no exception. But domestic electronic industry, contributing at least something to the GDP, corresponding to demands of developed cooperation, having its own modern science base – does not exist in Russia. At present 90% to 95% of electronic components in the innovative Russian equipment, including military area, has been manufactured abroad. Unfortunately, it is not a surprise.

Our current industrial technological level is 0.8 micron (minimum size of a transistor - a microchip the most important parameter). The technology of the 1980-ies is sometimes still on demand but forbids to reach the new technological level. The mass world market is 0.18 micron, products containing such elements would be demanded for at least another 5-7 years. Besides, Intel in 2005 started replacing 0.09 micron with 0.065 micron and actively developing 0.032 micron technology. Implementation of these technologies in 2001-2005 cost the corporation about 22 billion dollars.

Small and fragmented manufacturers of domestic electronic equipment can not even dream of such investments. Zelenograd, our main electronic center, houses about 35-40 enterprises with over 100 stuff in each, plus about 3000 small companies. The only relatively successful group in the industry is Sitronics concern (Sistema affiliate structure). But Sitronics revenues mostly come from household appliances, manufactured on the basis of import components.

Situation in sectoral science is similar. For the last 15-20 years supply of new equipment for fundamental R&D has been minimized. Therefore the level of modern experiments is almost out of reach for our scientists. In the area of applied science Russia may boast only two centers engaged in micro-electronics: Angstrem and Micron.

Absence of notable domestic demand constitutes main hurdle to the domestic electronics development. As to Russian share in electronic production (per capita), we are 90 times behind the USA, 80 times behind Japan, 40 times behind Europe. We sell less electronic equipment at our domestic market than Poland, Hungary and Mexico, taken separately, this indicator places us number 30 out of 52 countries with significant consumption volumes. The current domestic Russian market of electronic components is estimated to be below 1 billion euro, and more conservative assessments show a range of 500-800 million euro. Rate of growth is 15-20% per year. More than half of the market is constituted by processors and computer memory modules. The "weight" of other segments is 40-50 million euro. The conclusion is that our domestic market is ridiculously small to make investments into large microelectronic projects. Imagine the impossible: all the import share of ready electronic equipment is substituted by one domestic gigantic manufacturer – the giant at best will find itself in the end of the first dozen of the world rating in electronics.

So in this case neither preferences, nor state investments would produce any effect, but contribute to further theft and corruption. There seems to be only one way out: the state should play an unusual role of a market-builder. Stimulation of demand based on domestic product would encourage business investments and create conditions for establishing full-scale micro-electronic industry in Russia.

According to business enterprises in the sector, there are two spheres that look perspective and easy to implement to develop civil microelectronics. First (and easy to realize) — mass production of chip-cards (sim-cards, credit and social cards, passports, drivers license, transportation cards). Even now, before taking corresponding development steps, it is about 200 million dollars per year. But the demand is almost 100% satisfied by imported goods. At the same time all the leading countries, engaged in introducing bio-passports and other ID papers (USA, China, European Union, Japan), do it with the stress on local manufacturers, considering such programs as part of national security activities.

Second — all-round support of power electronics, used for energy production and engine control. Total supply of power electronics to the Russian market is estimated to be 150-200 million dollars, of which imported share constitutes 95%. Since energy and railroads belong to the sphere of state-owned (fully or partially) companies, it is possible to accelerate demand on domestic power electronics. According to the market players, costs to build modern production of power electronics would amount to 150 million dollars. Considering the above-mentioned market volume and possible orders from state-owned companies, investments to such a plant would have minimum level of profitability. Additional income may be gained in the frameworks of national programs and projects.

Measures of technical regulation in the framework of "Energy saving economy" program may seriously extend the demand for power electronics. Energy consumption of engines may be cut down approximately one and a half times, by way of connecting to each engine a frequency regulator unit, securing slow start, slow stop and fine control of different regimes. Introducing special measures in the state project "Accessible housing" may become a separate element to support power electronics; the point is to provide state investments only to projects designed to use energy-saving technology in the end of the day to upkeep dwelling stock.

Increased demand due to the state support even in these two market segments would seriously encourage private investments, required to build our own Russian "factory" for manufacturing modern super-large integrated circuits. Such a factory would present totally new opportunities to manufacture microelectronics and develop modern industry – it would also set an example of the new production culture and become an intellectual center of attracting all high technologies.

Cooperation with large international players should not be neglected, too. Russian companies, as we have already said, are technologically equipped to manufacture microcircuit chips with topological size of transistors exceeding 0.5 micron. Obviously, it is not sufficient to manufacture modern PC (the segment leaders, Intel and AMD, actively use 0.13 and 0.09 micron technologies, and advanced research operates with 0.045 micron and even less), but good enough to satisfy demands of household appliances manufacturers. Potential consumers of such products, manufactured by Russian microelectronic specialists, dwell mostly in Asia-Pacific region, countries from the area being main consumers of Russian-made exported electronic goods. It is mostly semi-products (silicon slabs) and integrated crystal microcircuits.

According to informal assessments, annual export volume of such products from Russia totals about 100 million dollars, three enterprises in the sector being in the lead at the post-Soviet space: concern Sitronics (former Science center) with NIIME and Micron in Zelenograd and VZPP-Micron in Voronezh, science and production association Integral (center in Minsk) and Angstrem in Zelenograd.

Local electronic specialists have reached certain success abroad. Thus, Micron share in certain types of bipolar circuits constitutes 12-17% of the world market, Micron clients being such gigantic companies as Ericsson, Samsung, IXYS. Minsk Integral supplies micro-sensors and microchip-drivers for printers, ordered by Seiko, and certain Siemens cellular phones are equipped with Integral transistors. Russia and Belarus also execute foundry-outsourcing orders (manufacturing chips for outside clients). Foundry-orders share for 0.8-2.0 micron technology constitutes about 14% in total volume of Micron production, in case of Integral foundry-services share in integrated microchip supplies grew up from 10% in 2001 to 15-20% in 2003-2004.

Protecting markets

According to liberal textbooks global competition is good. And sometimes it really works well. Let’s take food industry. Desperate attempts to protect one’s niches from waves of imported stuff finally resulted in a big cluster of efficient national food companies, equipped with most modern machinery and technologies. But words by Nietzsche "what does not kill us, makes us stronger" should be applied to economy with caution. Because you may get killed, after all.

Let us admit the obvious: actually, light industry in Russia is no more. Within the last 15 years the light industry share in economy dwindled by over 8 times: from 11.9% to 1.4%. Total turnover of 14 000 enterprises in the industry in 2005 officially amounted to 135.7 billion rubles – less than annual revenues of Magnitogorsk iron-and-steel works (twentieth in our Rating).

Analyzing possible competitive edges we singled out the main factor – enormous dynamically growing domestic demand. Today it is equal to 40 billion dollars (diagram 2). True, development of production capacities inside Russia is hindered by moral and physical obsolescence of main types of machinery, low ability of local manufacturers to pay, almost total absence of own raw material base. Still, the main reason for poor dynamics lies elsewhere.

Domestic light industry has been mostly destroyed by domination of shadow import (smuggling, putting it bluntly) and clandestine home manufacture of light industry goods. Total scope of counterfeited and smuggled light industry goods at the Russian market in 2005 was assessed to be almost 22 billion dollars, being twice as much as the level of legal production and import (diagram 3). Besides, the shadow sector tends to grow: within 2004-2005 illegal production and import of light industry goods went up by 68.5%.

Cheap clothing and footgear are most characteristic areas of illegal production and shadow import. As a result Russian manufacturers are almost totally pushed out of the market segment, and only few of them are capable of operating at higher priced segments. Altogether the share of domestic light industry enterprises at the local market in 2003-2005 averaged 15%-17%.

Good nutritional medium for "shadow light industry" is secured by underdevelopment of distribution networks. Light industry products are mostly sold at goods marketplaces – more than half of all clothing and footwear is estimated to be sold there. Light industry products significantly surpass majority of other consumer goods, as far as this indicator is concerned. Altogether more than 42% of all goods, sold at markets, are light industry products, foodstuff included.

Clearly, light industry can not develop seriously without liquidating openly criminal sector of the market. Putting things at the market to order (directly as well) — is a must for the state. No need to be ashamed of direct police measures, they are unavoidable. Even the first steps in this direction produce pretty considerable results. This year at last the authorities took some action. More than 100 criminal and 200 administrative cases were raised in relation to illegal movement of goods to the Russian custom zone. Partly because of this certain revival took place in the industry. Manufacturing of garments and fabrics grew by 10.8%, footwear by 12.3% in the first half of 2006.

System of custom tariffs should be modified, too. Current differentiation of import dues for different light industry products permits unscrupulous importers to make manipulations and diminish custom value of goods. Flat rates of import dues for the industry products may save the situation.

Fighting counterfeiting and smuggling is a necessary, but insufficient condition to restore light industry. The state should also encourage technical restructuring of the industry enterprises. To do it you have to "set to nil" import dues, at least, for the equipment which is not manufactured in Russia. Actually, almost everything "is not manufactured", so there is no need to worry over possible abuse in the area. Optimization of raw material supply for light industry is also an issue — Russia nowadays has to buy abroad wool, cotton and silk. Supply chains, set due to existing norms, sometimes amaze you with their inefficiency. Suffice it to say, that in the recent past a Baltic state was the largest supplier of cotton to Russia.