Peter N. Loukianoff, 09.22.09, 05:00 AM EDT
Russia needs to diversify by tapping into its other natural resource--technology, says one investor.
Between 2000 and 2008, Russia experienced rapid economic growth catalyzed by strong energy prices and prudent fiscal policies. However, the global recession starkly exposed a disproportionate reliance on oil and gas revenues – a dependence that risked becoming an economic opiate. Call it Potemkin profits.
By all accounts, it was a strikingly quick ascent. Influenced by the effects of a devalued ruble following the 1998 financial crisis, the recovery was initially driven organically by growth of domestic firms who benefited from import substitution. Subsequently, soaring commodity prices helped drive the economy to new heights.
Some critics of Russia's public policies attributed its economic success to simple luck. However, a more sober and objective assessment would acknowledge that Russia's conservative fiscal policies had created fertile ground for sustainable growth.
Following the tumultuous 1990's, reforms such as the revision of the value-added-tax, introduction of a significantly lower and simpler 13% flat tax on personal income, and reductions in capital gains taxes encouraged entrepreneurship and drove government revenues to all-time highs.
The success of these policies allowed the Russian government to extinguish its Paris Club debt, create a rainy day fund, and build-up the third highest foreign currency reserves behind only China and Japan. By establishing a strong economic foundation, Russia has been able to weather the current economic storm.
With the recent rebound in oil prices, some in Russia have actually lamented the potential brevity of the recession; hypothesizing that a longer, deeper and more painful contraction would be necessary for substantive structural change.
A reasonable, flat individual tax and capital gains tax advantages helped the economy and increased revenues? Who could have predicted that?
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But diversification is essential to Russia's future as a prospering economy. And in order to diversify, Russia will need to tap its other natural resource -- technology.
To compete for global investment capital and sustain its economic development, Russia will need to continuously improve its investment environment and promote its achievements, especially in the areas of infrastructure, legal reform, reduction of pervasive corruption, shareholder rights, education and support for R&D. Two examples of progress: the Russian government recently reduced its corporate tax rate from 24% to 20%; and established landmark legislation on insider trading -- a vitally important step toward full-fledged financial transparency and market legitimacy.
Now, Russia needs to diversify, and the cornerstone should be a historically powerful asset -- its creative technological minds.
Russia is famous for producing highly educated, world-class engineers and scientists. However, during the Soviet regime, the other ingredients necessary to enable the emergence of an entrepreneurial culture in the private sector were repressed. Nevertheless, technological innovation was consistently promoted in state research institutes and universities.
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Specifically, scientists were encouraged to spend a certain percentage of their time pursuing unique projects in non-core areas of study. This was out-of-the-box thinking at its most basic, and – most productive. Ironically, or maybe not, these techniques are presently being used to maintain the innovative culture in companies such as Google ( GOOG - news - people ).
It is time for Russia to bring this mindset full circle.
During the 1990's, many Russians with technical educational backgrounds left science and technology for traditional industries – where they could more easily earn a living and establish their careers. In fact, many of the country's oligarchs brought their engineering and mathematical skills to the business world and created some of Russia's largest industrial companies. However, in recent years, this trend has shown signs of reversing.
Catalyzed in part by increasing competition in non-technology sectors of the economy, a new generation of market-oriented entrepreneurs and managers with deep technical training is entering the high-tech industry in pursuit of its objectively higher profit margins. They are inspired by startup pioneers, like Sergey Brin, co-founder of Google, Max Levchin of PayPal, and Serguei Beloussov, co-founder of Parallels and Acronis, who have shown that it is possible to generate faster and better returns in technology markets.
Many in this new generation of tech entrepreneurs gained experience in product development and management while working for leading western companies based in Russia, such as Adobe ( ADBE - news - people ), Cisco ( CSCO - news - people ), HP, Intel ( INTC - news - people ) and Microsoft ( MSFT - news - people ). Others are returning expats, who left to complete their education in U.S. or European graduate programs and business schools, and now see a growing opportunity at home.
Today, Russian entrepreneurs start software and Internet services companies in Moscow, St. Petersburg and Novosibirsk as easily as any MBA in Silicon Valley. Several start-ups have accessed the Internet for initial sales, expanded outside Russia's borders while utilizing foreign managerial talent, and subsequently built companies with over $100 million in revenue. Many early stage companies are poised to achieve similar growth. However, the development of a middle manager class is essential -- a challenge currently being addressed by emerging Russian business schools.
Together, these factors are contributing to the emergence of technology entrepreneurship in Russia. But to effectively diversify the economy, these sparks of innovation must be encouraged and nurtured. As Potemkin readily knew, one wall does not a house make. So for Russia, the current global financial crisis presents an opportunity -- one that must not be lost -- to achieve true structural change through its othernatural resource -- technology.