Import substitution alone can’t fix Russia’s economy
Import substitution has always been important for Russia as it seeks to reindustrialize, but it gradually became a key national policy as a response to economic and geopolitical crises.
First, the financial crisis led to the collapse of energy prices and a large devaluation of the ruble. This combination made import prices skyrocket, so consumers shifted to more affordable domestic products. Second, after the Ukraine crisis, Russia set strong barriers against Western imports as retaliation for Western sanctions on Russia. That created space for domestic products on the Russian market.
The Russian government established the Commission on Import Substitution in August 2015, underscoring its importance for the Kremlin. The policy has already achieved substantial results.
In manufacturing, in April 2017 Prime Minister Dmitry Medvedev revealed in a government report that production of agricultural machinery had increased 50 percent in 2016. In agriculture, Russia is now the world’s largest wheat exporter.
The military industry concerns national security, and Russia developed it early on. In June 2014, when Ukraine announced sanctions against Russia, an import substitution plan was announced immediately to stop relying on Ukrainian military products by 2018.
Import substitution also affects the services sector -- for example, the domestic tourism industry. Russian President Vladimir Putin also has referred many times to the need to establish a domestic payments system. Visa and MasterCard have a combined 90 percent share of the Russian market, and Putin finds that unacceptable.
Import substitution is a reasonable policy, but it has been hotly debated in Russia, with many academics warning that it is no silver bullet for Russia’s economic problems. Import substitution can help infant industries avoid competing too soon with strong foreign rivals. In Russia’s case there is also a sound geopolitical reasoning, as Western sanctions have made it impossible for Russia to buy some foreign products.
But import substitution is a flawed policy in many ways. It sacrifices the interests of domestic consumers to protect producers, who can become complacent due to lack of competition. This is why Putin himself has emphasized many times that import substitution is not “replacing foreign products with domestic products that are worse and more expensive.” Russia could become isolated from the global industrial sector and lose its ability to participate again in the international division of labor, so any import substitution plans must be adjusted once foreign currency reserves grow and industrialization reaches a sustained pace. On the 6th Gaidar Forum held at Moscow in January 2015, Medvedev also said that import substitution could continue for several years, but it could not be a longterm economic development strategy.
Russia’s import substitution policies also rely mostly on state investment and policy advantages, but the scale and effect of those are limited. The recipients of most investment are large state-owned enterprises (SOEs) but the low efficiency of SOEs is a factor dragging down the Russian economy. Small and medium-sized enterprises (SMEs) are the drivers of innovation in today’s economy, but SMEs in Russia are only 5 percent of GDP, and an SOE-centered import substitution plan could starve them of needed resources.
Import substitution also won’t help the high-technology industry, which the Kremlin strongly wants to develop. Western sanctions make it hard for Russia to obtain new technology, and core technologies require long-term cumulative work and investment. Lastminute efforts, no matter how large, do not work in the high-technology field. Russia should also be selective in the sectors it wants to develop. Laborintensive industries, for example, make no sense for Russia with its declining population.
If imports are stopped for just a while, domestic products might fill the demand, but the Russian domestic producers will have to compete with imports when the imports come back.
Russia might seek import substitution for military and oil equipment for national security reasons, no matter what the cost, but making everything on one’s own does not fit the trend of economic globalization. Subsidies to Russian companies are also not fair to other countries in the Eurasian economic union. For example, if subsidies to Russian agricultural machinery makers hit Belarus’ exports of machinery, that could create conflict inside the union.
If imports are stopped for just a while, domestic products might fill the demand, but the Russian domestic producers will have to compete with imports when the imports come back.