Among the more important problems that haveto be addressed as a matter of priority, is the need for advanced and efficientmanagement and control mechanisms; domestic consolidation of themilitary-industrial complex stripping it of excessive structures; and moreeconomically efficient state holdings.
The above and some other problems must beaddressed through a well-substantiated program integrating themilitary-industrial complex in the market infrastructure and making it moreeconomically competitive. The complex can be made more efficient andcompetitive only through implementation of modern market instruments.
That was the aim of the new version of thegovernment policy formulated in the “Basic policies of Russia in itsdefense-industrial complex for the period to 2010 and in a longer term” and inthe government’sfederal targeted program of reform and development of the military-industrialcomplex in 2002 - 2006.
In accordance with the approved documents,the first target for the reform in the domestic defense industry should beconsolidation of the 1,700 current defense projects into up to 50 holdingsproducing military equipment and armaments. The consolidation of productionoperations could be structured round technological compatibility or historicalschemes of cooperation or regional factors. In other cases, integration will bemechanical merging similar product operations. At the second stage, thoseentities would be consolidated further in even larger civilian-militaryassociations. The consolidation will come together with the reduction in thenumber of enterprises charged with defense contracts, leaving approximatelyhalf of the more efficient businesses.
The issue of the efficient owner is stillpending. Back in 1996 a presidential decree established the Sukhoi aviationmilitary industrial complex. Despite the strong administrative support, itsoperations were heavily criticized, so a more recent decision was about settingup, on the basis of the complex, a publicly held joint-stock company Sukhoiaviation holding. As a result, they would incorporate state-held Novosibirskand Komsomolsk aircraft operations and contribute the controlling stakes inthose enterprises to the Sukhoi holding. Such a decision is believed to helpinvigorate and make for more efficient management of the businesses related tothe production of Sukhoi planes.
At the same time, low operability of themilitary-industrial complex may be unrelated to the variety of forms ofownership across its businesses.
The operation and legal protection ofintellectual property rights held by the state should be discussed separately.The plans are to license the right to develop and produce research-intensiveand high-tech products to the parent entity in the holding, which would grantsuch rights to the plants and thus help consolidate cash flows. This is theproposed solution to R&D funding.
However, the state does not have anyproper experience in the utilization of intellectual property in a marketenvironment. There should be a more transparent procedure for the statutorylicensing commercial businesses to develop and produce military equipment. Inaddition, intellectual property is a unique property difficult to sell forprofit. Part of the problem is the valuation of such intellectual property andidentification of its true owner. The legislation needs to be improved.
The government is to resolve the issue ofmobilization of capital for the military-industrial complex, including foreigncapital. Instances of international cooperation under joint defense-relatedprojects are no longer isolated. The Russian-Indian BraMos is ready to offer tothe international markets a unique multi-purpose rocket developed byRussia’s Research andProduction Machine-building Institute and India’s DRDO. There is an ongoing jointproject of Irkutsk aircraft factory and Indian HAL. Mutually beneficialRussian-Chinese defense projects are in the pipeline.
Going back to the restructuring of themilitary-industrial complex, note that it has been already exposed to sevenmajor reorganizations. It would be appropriate to analyze the effects of thechanges and all the consequences of the previous stages of restructuring in theindustry.
It all started in 1992 when the scope ofdefense orders for armaments and equipment plummeted a whole 400 percent. Then,the list of operations banned for privatization started to shrink. By 1997,about half of the enterprises belonging to the military-industrial complex wereincorporated to become part of the private sector.
Let us consider the economics of thoseevents. In 1992, the public was promised that a smaller defense industry and amore efficient owner replacing less efficient (government) would spawn growthin the civilian production. The indicators suggest that throughout the periodof intense reforms in the military-industrial complex up to 1998, resulted inthe declining production both at the defense and civilian projects (Table 51).
All these years, except the last two,owing to the destructive attitude of the government to defense enterprises, andmoreover, regular underfunding, their debts kept accumulating. Many were edgingto the brink of bankruptcy, others walked over the edge.
After the 1998 financial and economiccrisis, not only there was no further slump in the output, but on the contrary,there was a certain growth in the output of both military and civilianproducts. It must have been a combination of two factors: firstly, activeimport substitution as a result of ruble devaluation which made many domesticproducts competitive and stimulated output growth at civilian and defenseenterprises (increased output of civilian products); secondly, increased worldoil prices and, as a consequence, bigger revenues for the Russian budget and apossibility to finance defense orders (increased output of defenseproducts).
Production dynamics in themilitary-industrial complex
Changes in the aggregate output of marketableproducts, in % to the previous period
Changes in the output of militaryproducts, in % to the previous period
Changes in the output of civilianproducts, in % to the previous period
Integral change in the output of allmarketable products, in % to 1991
Integral change in the output ofmilitary products, in % to 1991
Integral change in the output of civilianproducts, in percent to 1991
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* Forecasts ofthe Russian Ministry of industry, science and technologies, and estimates ofthe Institute of Transition Economies.
Proper structural changes must have beenprompted by a competitive selection of the more important projects and theirefficient performers, and not by bureaucratic inventions. In fact, over thelast 2 – 3 yearsdefense projects have been consolidating with the resulting voluntaryrestructuring, instead of the one imposed from the top. The merged businessesmanaged to locate additional sources of financing, established additionalcontacts, some outside the military-industrial complex, and thus raised bothcivilian and military output, and in such way are saving high-technologyindustries in Russia.
Reform is costly. It is difficult toexpect that the restructuring of the defense industries to help them grow wouldconcern private investors as well as the government. But state investment inthe defense industries could help set up production, to be followed by leasing,of aircraft needed by our airlines. Another example –the funds assigned to defenseindustries reform could be invested to set up a mass serial production ofRussian cruise missiles, similar to U.S. Tomahawk, which are requireddomestically and could be offered to the world market of armaments (see oursurveys for the previous years). There could be other options. Such projectspromising good returns and long-term partnership of private capital and thestate could easily find an investor.
Later, a tender could help select the mostpreferable contractors. This would be the natural way to segregate the coredefense industries which would not be imposed from above but instead based onspecific models of armaments, their key elements and technologies, specificgoals of defense planning, and specific circumstances in the area of technicalmilitary cooperation.
If, despite the budging economic growth,the government that has a major stake in the defense operations is stilluncertain about the efficiency of the industry, a comprehensive analysis of thecause is needed. This prompts the need to make public the following:
– a listof businesses and institutions of the military-industrial complex, and acomplete list of their owners;
– costs(borne by the government and other owners) to operate and help develop defenseprojects;
–revenues generated by defense projects and their distribution amongowners;
–non-financial results from the operations of the military-industrialcomplex;
– avaluation by independent experts of the economic and functional efficiency ofall owners;
– reasonsfor which the industry needs the reform.
With this analysis done, a tender shouldbe opened up for the best project of the industry’s reform. The best project wouldthen serve as a basis for the reforms in the industry.
The most favorable effect on themilitary-industrial complex could be had from proper funding of the statedefense order. According to the commentary by the Russian Deputy DefenseMinister for armaments, published in RossiiskayaGazeta, the 2001 state defense order was fullyfunded. A State Armaments Program was approved, complete with resources andfunding, allowing defense projects to embark on a long-term planning for theiroperations. Another good impact could come from the repayment of the debt thatgovernment owed to the military-industrial complex over the past years. Notethat under RF Government Resolution No 1020 of 29.12.2000, full repayment ofthe outstanding debt should be completed by 1 January 2003. The repayment iscurrently on time. Those positive changes bode well for the defense economy.
1 This section has been prepared on the basis of the results ofsurveys involving the managers of industrial enterprises that have beenconducted monthly by the IET since September 1992 and covered the wholeterritory of the Russian Federation. The panel includes 1400 enterprises withover 20% of the total of the workers employed in industry. The panel is biasedtoward large enterprises by each of the 61 specified sub-branches. This isconsistent with the international practice and ensures highly representativeresults on the whole, on the branch and sub-branch levels. The questionnairereturn rate is about 70%.
2 Kawasaki, S. and Zimmermann, K.F. (1986), Testing the Rationalityof Price Expectations for Manufacturing Firms, Applied Economics 18,1335-47
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