Brief history of “the turn to the East”
Russia’s “turn to the East” is already nearing 13 years in the making. The decision to make the development of the Far East a national priority came at the December 2006 Security Council meeting chaired by Vladimir Putin. A number of steps were taken in quick succession thereafter. In 2007 Putin suggested Vladivostok as a venue for the Asia-Pacific Economic Cooperation (APEC) summit in 2012, owing to which the city’s infrastructure was significantly modernized. In 2009 Putin endorsed a strategy for the development of the Far East, laying emphasis on mega projects in the power industry and transport infrastructure to be financed by the state and state-owned companies. The Ministry for the Development of the Russian Far East was established in 2012 and in 2013 the position of deputy prime minister responsible for this region was added to the cabinet. One of Putin’s most talented and energetic managers, Yury Trutnev, was appointed to the post, simultaneously becoming presidential envoy to the Far Eastern Federal District.
Trutnev’s team drafted a series of federal laws designed to make the Far East attractive to both domestic and foreign investors. Since 2014, Russia has adopted 39 federal laws and 167 government acts aimed at improving the economic climate in the region. First and foremost, special economic zones were established as “priority development territories” (PDT) and the Free Port of Vladivostok was set up. The Far Eastern Hectare program was adopted to allocate free land to residents of the Far East. The Eastern Economic Forum (EEF) became the main showcase of Russia’s Far Eastern policy. Since 2015 it has been held every year on Vladivostok’s Russky Island, hosting leaders from Japan, China, South Korea and Mongolia. The Indian and Malaysian prime ministers are expected to attend in September of 2019.
The Far East remains deserted
Moscow’s Far East policies are having some effect. In 2018, industrial production in the region increased by 4.4 percent which is 50 percent higher than the national average. However, the socioeconomic situation in the Far East fundamentally has not changed, evidenced by the continued depopulation of the region resulting from a combination of natural population decline (when deaths outnumber births) and outmigration, with the latter exceeding 30,000 people in 2018. People are leaving the region mostly for Moscow, St.Petersburg and the Krasnodar Territory. Living standards in the Far East, even in its capitals of Vladivostok and Khabarovsk are still meaningfully lower than in the European part of Russia. Many well-educated and ambitious young people go to Moscow, St. Petersburg or Shanghai in the hope of finding opportunities for career advancement and personal fulfillment, which they still do not see at home. The overwhelming majority of them do not come back. The election loss of the governors of Primorye and Khabarovsk territories last September demonstrated how a considerable part of the population feels about the status quo in these two key areas of the Far East. There is alarming data showing a decline in business activity. In Vladivostok, the capital of the Far East, for example, the number of registered companies fell 15 percent in a year.
The federal mega projects, such as the Eastern Siberia – Pacific Ocean oil pipeline, the Power of Siberia gas pipeline or the Vostochny Cosmodrome produce an increase in gross regional product (GRP) but have little effect on the living standards of the majority of Far Easterners. For instance, it is impossible to get an appointment with a surgeon or other specialists, even pediatricians, at an outpatient clinic in my native city of Bolshoi Kamen that has PDT status and in which construction of the Zvezda “super shipyard” is in full swing. The situation with medicine is only slightly better in Vladivostok. It is telling that residents of the Primorye Territory that are a bit better off prefer to seek medical treatment in serious cases in South Korea.
To meaningfully improve the quality of social infrastructure (medicine, education, roads etc.) in the Far East, it is necessary to invest trillions of rubles. Considering that these are not for-profit investments, such huge funds can only come from the government. And given the difficult state of the Russian economy and the existence of a host of other urgent budget priorities such as defense and security, it will be difficult to find such sums for the Far East.
Awaiting Asian investors
PDTs and other mechanisms intended for the Far East were largely invented to lower the Far East’s dependence on government funding and attract private investment, especially from abroad. According to officials, tens of billions of dollars, or trillions of rubles, in foreign investment in the Far East has been attracted. But on closer inspection, this refers to committed rather than real investment for the most part – letters of intent or discussions. Regrettably, for the time being, there are relatively few strong projects with foreign capital participation that have got off the ground. Oil and gas projects on Sakhalin account for the lion’s share of FDI. And these are not new investments either – they were made in the late 1990s-2000s, before the proclaimed “turn to the East.”
For all the hopes pinned on China, there is only something like four large projects with Chinese participation: the gambling zone near Vladivostok; the IRC that is mining iron ore in the Jewish Autonomous Republic; the development of the Klyuchevsky Gold Deposit in the Trans-Baikal Territory; and the mining of coal at the Zashulansky deposit in the same area. Chinese capital is not yet rushing into the Far East, in part because Chinese companies would like to mine natural resources there on similarly liberal terms as in Third World countries, such as Angola or Laos where they bring their own workforce and do not overly concern themselves with environmental regulations.
Investors from China and other Asian countries mostly keep their distance from the Russian Far East. The sale of two uncompleted five-star hotels in downtown Vladivostok illustrates their caution about purchasing assets in the Far East. Although the price of the hotels was reduced at auctions many times, no foreign company was interested in them. Oleg Deripaska’s subsidiaries ended up buying them for next to nothing.
Foreign investors believe the risks of doing business in the Russian Far East do not justify the expected profits. They have always been primarily interested in the region as a supplier of raw materials. However, the resources it possesses are by no means unique, probably with the exception of Yakutian diamonds. They can be imported from many other countries: coal from Australia, iron ore from Brazil, copper from Chile and wood from New Zealand, all the more so since the costs of maritime shipping are relatively low today. The region’s extreme natural and climatic conditions and insufficient transport infrastructure considerably increase the costs of such projects and put them at a disadvantage to projects offered by our competitors in Africa, South America or Southeast Asia.
Importantly, Japan with its declining population and upgraded energy efficiency technology, has already passed the peak of its raw materials consumption and is steadily reducing imports of minerals and energy. Hence, the Japanese are much less interested in the Russian Far East than they were 20 or 30 years ago. South Korea is also reducing raw materials consumption and China will follow suit in the near future.
Another factor that limits foreign investment, especially by Chinese companies, is the reluctance of the Russian authorities to let them take control of so-called strategic facilities, for instance, ports. This is one of the reasons why Chinese companies are not rushing to invest in the Primorye-1 and Primorye-2 transport corridors although they could give northeast China direct access to the Sea of Japan. Unlike Greece that sold its main port of Piraeus to China, Russia is not ready to let foreigners control its transport infrastructure, including in the Far East. Russia holds onto its sovereignty and China its money.
No doubt, many potential investors are scared off by US sanctions on Russia. South Korea, for example, refused to fund construction of the Nakhodka Mineral Fertilizer Plant at a price tag of over $6 billion. Never mind South Korea and Japan, even Chinese banks often refuse to deal with Russian clients for fear of coming under US sanctions.
There has been a lot of discussion recently about the agricultural export potential of the Far East. But the Far East is not Argentina or even Kuban. It does not have many lands suitable for growing high-margin agricultural products, primarily soy that enjoysenormous demand in the Chinese market. There are some prospects for meat exports to China. Large pig farms are being built in the Primorye Territory for this purpose but currently the Chinese market is shut to red meat from Russia and it is unclear when Beijing will lift these restrictions.
Tourists and students flock to Vladivostok
So far, tourism has benefited most from Russia’s “turn to Asia”, with Vladivostok in particular enjoying a tourist boom. Most visitors come from South Korea, China and Japan. It is third after Moscow and St. Petersburg in the number of foreign tourists. In 2018 the Primorye Territory was visited by a record 780,000 foreign guests, and even more are expected to come in 2019. Vladivostok is reaping the benefits of investments in infrastructure made before the 2012 APEC summit, visa-free travel with South Korea and the e-visa system in the Free Port. A tourism industry emerged in the city in literally just a few years. It is geared to Asian visitors and is made up mostly of small and medium companies.
The cosmopolitan spirit of Vladivostok is particularly pronounced on Russky Island that hosts the campus of Far Eastern Federal University (FEFU), built in 2012. FEFU has 3,500 students from 74 countries. This is probably Moscow’s best investment in the Far East because it is an investment in human capital. The steady growth of the number of foreign students there shows that exporting education may become one of major non-energy industries in the Far East.
Unfortunately, Russia’s “turn to Asia” and the development of the Far East face several serious impediments. The head winds have been stronger than the tail winds so far.
First, it is hardly possible to hope for the dynamic development of the region as long as the Russian economy as a whole demonstrates anemic growth and teeters on the brink of recession. Moreover, low growth is reducing federal resources to fund social infrastructure in the Far East, without which it is impossible to preserve and build up the human capital that it so badly needs.
Second, Russia’s confrontation with the US and other Western countries is scaring many potential foreign investors away from the Far East. Geopolitical tensions are also making defense and security spending a priority, leaving less money for other needs, including the development of the Far East.
Third, the demand for the region’s main exports – minerals and energy resources – has its limits. Japan is already reducing its consumption of raw materials. South Korea and probably China, which is clearly in an economic slowdown, will soon follow suit. China’s northeastern provinces, the main partners of the Russian Far East, have been in an economic depression for several years now. Non-energy high-technology exports that were declared one of the main goals of PDTs still look more like a dream. The region practically has no companies that can offer competitive high-tech goods or services on the world market, and developing them requires time and considerable investment.
Fourth, the Russian Far East has not yet built an effective model for cooperation with China. For all the importance of other Asian partners like Japan, South Korea or India, it is China that is the main market and potential investor for the Far East. But this potential still remains untapped. For the time being, Chinese money keeps away from the region.
It is possible to assume that China’s interest in the Russian Far East will increase as its geopolitical confrontation with the US escalates. This antagonism may compel China to stop buying raw materials from the US and its allies, such as Australia and Canada. Moreover, if the conflict exacerbates, the US and its allies may even block maritime routes used to import vital resources to China. To minimize such risks Beijing should reduce its dependence on maritime supplies and build up mainland exports of resources from Eurasian countries along its border, including the Russian Far East. The two recently built bridges across the Amur River obviously could be of help in this respect.
Despite expectations of potential dividends from the US-China confrontation, Russia should take additional measures to enhance the appeal of its Far East for Chinese business. For example, the time is past due to remove the visa barrier and sign an agreement on visa-free tourist and business travel with China. Russia did this a long time ago with South Korea and Mongolia. It should also be possible to show more flexibility on the sale of controlling stakes to Chinese investors. China’s control over one or two ports in the Far East is unlikely to undermine Russia’s national security.