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. Last Updated: 07/27/2016

Tariffs Reflect a Stronger Ruble

There are lots of signs that creeping protectionism is taking over Russian trade policy: Finance Minister Vladimir Panskov announced import tariffs will rise 20 percent; officials have threatened to put quota restrictions on imports of everything from liquor to European floor coverings; and then the ban on imports of American chicken legs has shocked the poultry world.

It might seem that growing Russian xenophobia or an impending communist revanche is to blame for these moves, but the underlying cause is rooted in an objective economic reality: the huge real appreciation of the ruble over the past year.

Of course, in nominal terms, the ruble continued to fall last year, sliding from 4,000 to the dollar down to about 4,700.

But the real exchange rate is a much more crucial measure for trade since it assesses whether the ruble is rising or falling faster than other prices and wages in the economy. In fact, the real value of the ruble rose in value against the dollar by about 75 percent.

For example, the ruble may have fallen, but wages have risen much faster. At the start of 1995, the average Russian wage was 302,000 rubles a month, or about $75 at the current exchange rate. At the end of 1995, the average wage had risen to 710,000 rubles (about $150) a month.

This is all good news for the Russian macroeconomy in that it is a sign of growing confidence in the currency.

But the flip-side is that imports have become much cheaper relative to Russian-produced goods in a way that has never been seen before. A local Russian chicken that may once have cost the ruble-equivalent of $3 a kilo now costs $6. At the same time, its U.S. competitor is still selling for $3.

In fact, the "real value" of the ruble is now higher than at any time since the start of the reform. The result has been a growth in imports.

The official figures for imports jumped from $38.6 billion in 1994 to $46.4 billion in 1995. This leaves out another $11 billion in unofficial imports carried in by shuttle traders in suitcases that probably grew by a similar amount. It is not just frozen meat but cigarettes, alcohol and consumer goods.

A move to protectionism under these circumstances is unavoidable. For instance, the same thing occurred in the analogous situation in late 1993. Back then, Russia's real exchange rate increased dramatically (almost tripling) thanks to the efforts of former finance minister Boris Fyodorov.

Starting in early 1994, the Russian government responded by raising import tariffs marginally for food products and hysterically for a few key sectors, especially automobiles. Viktor Kadannikov, former director of AvtoVAZ, was of course the big winner.

It is hard to recommend protectionism, since it is always inefficient and costly to consumers. Moreover, restricting foreign competition removes the main incentive for Russian industry to restructure.

But equally, faced with this huge shock to its economy, Russia's move to protectionism is understandable. Most Western governments would have long ago introduced some trade barriers faced with the same situation. Russia is still not a high-tariff country.

In any case, restricting imports is certainly preferable to abandoning the ruble corridor, which some factory directors and President Boris Yeltsin have floated as an alternative. A rapid depreciation might protect local industry, but it would give all sorts of bad signals on macroeconomic policy.

If the government does give in to protectionist pressure, it could try to tread carefully and learn from past mistakes.

Import protection will raise domestic prices, hurting consumers. The government must balance this against the need to win support in the agrarian lobby. The political question is whether to do this before or after the presidential elections.

Moreover, the form and level of import protection is crucial. They should allow for some competition from imports. Tariff increases cannot, as in the car industry, make it impossible to import under any circumstances. The government must set tariffs at a level that gives the local industry the time to restructure, not the grounds for complacency.

The government must also avoid the fundamental mistake it made in 1994. Back then, as the Russian proverb goes, the strictness of laws was compensated by the fact that no one had to obey them.

The government slapped prohibitively high import taxes of 200 percent to 300 percent on vodka, cigarettes and cars. The result was that legal imports all but stopped, only to be replaced by a corresponding but mafia-controlled flood of illegal smuggled imports.

If the government wants to impose protectionist measures, it must make sure that the administrative apparatus exists to collect them. Otherwise, trade barriers are just an instrument for promoting corruption and inefficiency.

For instance, any attempt at quota rather than tariff restrictions on imports of liquor or food would quickly be turned into a joke. Russia's Foreign Trade Ministry and customs service are far too incompetent, understaffed and corrupt to have any hope of operating a complicated quota system. Similarly, the risk is that higher tariffs will just stimulate more smuggling and tax avoidance. The fine print of Panskov's announcement that tariffs will be raised shows some recognition of the problem of effective tax collection rather than simply high but meaningless tariff rates.

Not only will tariff rates be raised, but perhaps more importantly minimum tariffs denominated in European Currency Units will be set for most goods. The logic is that this prevents traders avoiding tariffs by understating invoices. That might be at least part of the solution.