Natalia P. Drozdova
Natalia P. Drozdova
Associate Professor
Public Administration Department
Graduate School of Management
St. Petersburg State University
e-mail:
Irina G. Kormilitsyna
Ph.D. student
Graduate School of Management
St. Petersburg State University
e-mail:
Government Economic Policy and the Formation of Investment Climate:
The Experience of Russia in the Late Nineteenth — Early Twentieth Century
Introduction
The economic development is largely determined by quality of investment climate. A favorable investment climate is an important precondition for effective functioning of the economy. In this regard the issues of investment climate are paid a lot of attention in modern economic literature and especially in practical activity.
Virtually all studies recognize the important role of the government in creating a favorable investment climate. «For governments at all levels, a top priority should be to improve the investment climates of their societies. To do so, they need to understand how their policies and behaviors shape the opportunities and incentives facing firms of all types» [World Development Report 2005, p. 20]. The investment climate is largely determined by the government economic policies as a set of institutional arrangements designed to create optimal conditions for investment. “… [F]irms assess investment opportunities and related government policies and behaviors as part of a package” [World Development Report 2005, p. 2].
The issue of a favorable investment climate is given serious attention in present-day Russia. However, the problem of creating an appropriate environment for investment was of vital importance in the past as well. In particular, it was on the agenda in Russia in the late XIX — early XX century. The study of historical experience of how the government policies influenced the investment climate in the past was of interest both from the standpoint of economic history, and as a practical matter, since it allows tracking the effectiveness of various policy instruments for investment decisions.
No doubt, business environment and the characteristics of the business have changed significantly in comparison with XIX–XX century, but it seems that the entrepreneurial spirit and human nature have evolved not so radical.
The purpose of this study is to assess the impact of the government economic policy on the formation of investment climate in Russia in the late XIX — early XX century.
Following W. Smith and M. Hallward-Driemeier, under investment climate we imply «the set of location-specific factors shaping the opportunities and incentives for firms to invest productively, create jobs, and expand» [Smith, Hallward-Driemeier, 2005, p. 40].
Based on comparative analysis of different methodologies of assessing the investment climate (Moody’s, Standard & Poor’s, Euromoney etc.) the authors identified the most important factors and indicators for assessing the investment climate at the country level, which were then adapted to the task of the study.
Five hypotheses concerning the impact of the government economic policy on the investment climate in Russia in 1885-1913 were formulated. The hypotheses were tested by means of econometric analysis. The regression analysis results were interpreted taking into account the realities of the investigated period. The authors come to the conclusion that in total the economic policy, pursued during 1885-1913, contributed to the formation of a relatively favorable investment climate which was expressed in attracting domestic and foreign investment.
Contexts
In the late XIX — early XX century the Russian government took a number of measures to strengthen the role of Russia in the world economy, namely: stimulation of economic growth through industrial development, improvement of public finances, stabilization of the ruble by the introduction of the gold standard, protectionism, and expansion of transport infrastructure. This study assesses the impact of the above mentioned measures on the formation of investment climate in Russia in 1885–1913.
The years 1885–1913 are considered as an integral period from the point of view of the conducted economic policy, and, consequently, its impact on the investment climate. It should be noted that success in the development of Russia in the late XIX — early XX century is traditionally associated with the policies of Sergei Witte, who served as the Minister of Finance (1892–1903) and the Chairman of the Council of Ministers (1905–1906). Indeed, Witte worked out a coherent program for the economic development of Russia, known as «Witte’s System». However, the basis of the policy pursued by Witte was laid by Nikolaj Bunge, Minister of Finance (1881–1886). Bunge carried out the tax reform in 1885, started to prepare the reform of the monetary system and transition to the gold ruble, took a number of measures to reorganize the state budget, pursued a policy of protectionism, and furthered the expansion of the railways [Stepanov, 1998]. I. A. Vyshnegradsky as Minister of Finance (1888–1892) continued Bunge's policy.
Thus it can be argued that Witte continued the policy of his predecessors. The same point of view is held by such well-known experts as H. Barkai, P. Gregory, T. H. von Laue [Barkai, 1973; Gregory, Sailors, 1976; Laue, 1963]. Witte in a Secret Memorandum to Nicholas II wrote: «In taking over the ministry of finance in 1892, I felt obliged to make clear to myself the foundations of the commercial and industrial policy of my predecessors and to bend all efforts toward continuing and finishing what they had begun or had taken over from their predecessors. The necessity of such succession and continuity seemed to me so paramount that I relinquished my own personal views». «[T]he most harmful of all commercial and industrial systems is that which is inconstant and wavering» [Laue, 1954, p. 65]
As for the policy of the successors of Witte as the Minister of Finance, the views diverge here. H. Von Laue believed that with the resignation of Witte the policy he followed was interrupted. O. Crisp and P. Gregory are of opposing opinion [Crisp, 1964; Gregory, Sailors, 1976]. They presume that the policy lasted almost until 1914.
Thus the years 1885–1913 are considered as an integral period from the point of view of the conducted economic policy, and, consequently, its impact on the investment climate.
Hypothesis
The aim of this study is to assess the impact of the government economic policy, namely: stimulation of economic growth through industrial development, improvement of public finances, introduction of the gold ruble, protectionism, and expansion of transport infrastructure, on the formation of investment climate in Russia in the late XIX — early XX century.
Five hypotheses were formulated.
The economic growth is usually considered as an indicator of economic stability and the country's ability to depreciate shocks with positive effect on the investment climate.
W. Rostow believed that at the end of XIX — early XX century Russia has entered a stage of take-off with self-sustained growth [Rostow, 1990, p. xviii]. According to P. Gregory during 1885-1913 the growth rate accounted for 3.25% per year, and per capita — 1.75% per year [Gregory, 1982, p. 192]. In comparison with the developed countries of the time Russia was one of the fastest growing economies. Industrial growth rates were significantly higher than the average for the national economy and for the years of industrial expansion (1885–1913) reached 5.72%, and in 1890-ies — even 8.03%. During the period the average annual growth rate of industrial production in the U.S. amounted to 5.26%, in the UK — 2.11%, in Germany — 4.49%, in Sweden — 6.17% [Gerschenkron, 1947, p. 156]. Thus at the turn of the XIX–XX century Russia held one of the first places in the world for the pace of industrial development.
Taking into account the above mentioned facts the first hypothesis was formulated as follows:
H1. The economic growth positively influenced the investment climate in Russia in 1885–1913.
Government financial strength is one of the most important factors shaping country’s investment climate. Experts consider deterioration in government financial strength to be a serious negative factor affecting the investment climate.
The task of improving government financial strength was very important in 1885–1913. Bunge as the Minister of Finance paid great attention to the soundness of state budget, trying to reduce expenditures and increase revenues. To this end he held the tax reform in 1885. Vyshnegradsky managed to cut budget deficits and even produced surpluses. He converted Russian gold-based debts, which resulted in the reduction of the average nominal rate of interest to 4%. Witte resumed the conversions of the public debt, and almost completely transformed it into 4%. Achieving a balanced budget was the central objective of Witte and his successors. To increase revenues wine monopoly was introduced in 1894. Since 1899 ordinary budget was in excess of revenues over expenditures and the debt was accurately served.
Based on the above observations, we can formulate the following hypothesis:
H2. The increase of government financial strength positively influenced the investment climate in Russia in 1885–1913.
When assessing the investment climate leading agencies (Fitch, ICRG, Euromoney) take into account the stability of national currency. In 1885–1913 the stabilization of the ruble was the focus of Russian economic policy. In 1881 the government stopped the emission of credit rubles and covered budget deficit by domestic and foreign borrowings. Indeed those and some other measures contributed to the stabilization of the ruble. Finally Russia acceded to the decision of the Paris Conference held in 1867. In 1895–1897 Witte executed monetary reform and introduced the gold standard. Thus, we put forward the following hypothesis:
H3. The stabilization of the ruble positively influenced the investment climate in Russia in 1885–1913.
It is generally accepted that the tariff policy should create incentives and conditions to attract capital into production. In 1885–1913 Russia pursued protectionist policy aimed at industrialization. Witte repeatedly stressed that the protective tariff of 1891 was the original reason of the commercial-industrial system. After industrial development had become the main objective of the government economic policy in 1890-s, Witte articulated new priorities. He put it as follows: «What are the tasks of the protectionist system? …The creation of our own national industry — that is the profound task, both economic and political, from which our protectionist system arises» [Laue, 1954, p. 66]. The protectionist system would contribute to the creation of national industries and as a consequence to the economic and political independence of Russia. «Popular welfare and state finance will find firm support not only in agriculture but also in industry and will gain considerably greater steadfastness and strength thereby. Such are the great tasks of the protectionist system, which was steadily applied to Russia, beginning with the reign of Alexander III» [Laue, 1954, p. 67].
A. Kahan also believed that the introduction of protectionism in Russia had a positive effect: “No one would deny that the Russian tariff had a number of stimulating effects upon the growth of domestic industrial output, employment, and incomes. This is indisputable” [Kahan, 1967, p. 471].
In this regard, the fourth hypothesis was formulated:
H4. The policy of protectionism positively influenced the investment climate in Russia in 1885–1913.
Nowadays many experts suggest that the development of transport infrastructure is a serious measure to improve the investment climate. The issue of transport infrastructure was a hot topic in the period under consideration when the expansion of railroads started to occupy a prominent place in the country’s development policy. The construction of railways in Russia went extremely fast. By 1861 the length of railways was about 1.5 thousand verst, and by 1915 — already 70.3 thousand verst[1].
J. Metzer found that the Russian railroads contributed to aggregate economic activity about 5.6% of GNP in 1907. He admitted that «this order of magnitude seems to be quite modest both absolutely and comparatively» [Metzer, 1976, p. 86]. However one should not forget about the indirect effects. Railroads were a major growth accelerator at the time and served as a multiplier, the impetus for the development of many industries, especially heavy industry and metallurgy. In his other paper Metzer demonstrated that railroad construction promoted market integration, particularly in agricultural markets [Metzer, 1974]. He came to the conclusion that «the rural sector in the late Tsarist Russia was indeed responsive to economic opportunities, and behaved rationally, economically speaking. …The importance of the findings lies not only in the empirical verification of the process of market integration cum railroad construction, as such, but also (and perhaps more so) in the light they shed on the economic response to the new opportunities opened by the improvements in interregional links» [Metzer, 1974, p. 549]. We believe that the same was true for the industrial sector.
Thus the last of the hypotheses put forward is formulated as follows:
H5. The development of transport infrastructure positively influenced the investment climate in Russia in 1885–1913.
Measures
To build a regression model we have to select the explained variable that reflects the state of the investment climate in the period under review, and explanatory variables that reflect the implications of government economic policies in terms of there impact on the investment climate.
Explained variable
The explained variable should reflect the response of entrepreneurs to the state of investment climate. In this regard, as a potential explained variable we considered: 1) the number of established joint-stock companies (both Russian and foreign), 2) the number of companies (both Russian and foreign), that actually started their activities within a calendar year, 3) the number of industrial enterprises (zavedeniy) in the manufacturing industry, and 4) the number of workers employed in the manufacturing industry.
The indicators seem to describe the process and the results of investment activities quite accurately. In accordance with the adopted definition of investment climate, a good investment climate results in productive investments, job creation and expansion of firms in the area [Smith, Hallward-Driemeier, 2005, p. 40]. In World Development Report 2005 it is emphasized that «a good investment climate fosters productive private investment» [World Development Report 2005, p. 19]. It is also important that appropriate statistics is available for all the selected indicators.
In this study, the choice was made in favor of joint stock companies (both Russian and foreign) that actually started their activities within a calendar year. In our view, this indicator can serve as a good approximation to characterize the real investment activities of entrepreneurs-investors, i.e. their reaction to the state of investment climate. First, in the late XIX — early XX century namely joint stock companies were seen as the main engine of economic development. In particular, Witte in his Secret Memorandum to Nicholas II, describing the amount of attracted foreign capital into Russia, operates with annual number «of newly established joint-stock companies» [Laue, 1954, p. 70]. In Russian industry corporations became the dominant form of organization of large enterprises in the second half of the 1890-s. As a result in the early twentieth century corporatization covered all the main Russian industries. In 1900 the share of fixed capital of industry in the whole mass of productive capital amounted to 68.9%, and in 1913 — 73.0% (calculated on the base: [Lyaschenko, 1948, p. 412]).
Second, the statistical data on joint-stock companies are very reliable. The statistics on Russian and foreign joint-stock companies that started their activities within a calendar year, were taken from L. E. Shepelev [Shepelev, 2006, p. 117, 118, 170, 271, 278]. The data includes trade, industrial and loan companies (without railway companies). The division of companies into Russian and foreign was conducted on a formal legal basis. A joint stock company was considered to be foreign if its charter was approved in a foreign country. As Shepelev noted, in order to bypass the restrictions of Russian legislation, some «foreign» companies sometimes were established by Russian subjects and using Russian capital. However, much more legally Russian companies actually operated by foreign capital in one way or another [Shepelev, 2006, p. 169].
We use the absolute increase in the number of joint stock companies started their activities within a calendar year as the explained variable[2]. The number of foreign joint stock companies was included in the explained variable multiplied by 1.5. This is due to the fact that during the period under consideration the amount of capital per one foreign company was on average 1.5 times more than the amount of capital of a Russian company.
Time series “the absolute increase in joint stock companies started their activities within a calendar year” was tested for the presence of break points or structural changes across time. There are three potential break points. The first could be due to the monetary reform of 1895–1897. The second could coincide with the beginning of economic crisis in 1900. Figure 1 also gives us a reason to suspect structural break in 1900. The third potential break point is the dismissal of Witte in 1903. As it was mentioned earlier some scholars suggested that with the Witte's resignation from his post as the Minister of Finance his economic policy was interrupted.
Figure 1 - The number of joint stock companies
started their activities within a calendar year
We performed the Chow test to check for structural changes across time. The results of the test show that there are not structural breaks in 1897, 1900 and 1903, and therefore it is possible to build a single regression model with the chosen explained variable.
Explanatory variables
Explanatory variables were supposed to meet the following conditions: firstly, they should reflect the economic policies pursued during 1885–1913, secondly, they should have analogs in the methodologies of assessing the investment climate, and thirdly, relevant statistics should be available.
As potential variables that characterize the economic growth we tested: net national product (NNP) and NNP per capita (the measures are commonly used in the methods of assessing the investment climate), total amount of wholesale and retail sales (commodity turnover), and personal consumption per capita (one can find some analogs in the methodologies of assessing the investment climate, e.g. consumer spending per capita, rate of growth in consumer spending, poverty).
When selecting variables reflecting government financial strength we preferred those that included both public debt and public revenues, namely: public debt/ public revenues ratio and interest payments on external debt/ public revenues ratio. Those variables seem to reflect the opportunities of the government to meet its debt repayment obligations. Note that like nowadays, in the period under review the burden of public debt was assessed by comparing it with the federal budget [Witte, 1997 (1912), p. 486].