Competitiveness of the Kaliningrad‘s Economy: Problems and Opportunities

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The favorable geographical position of Kaliningrad region with regard to the main trading partner of the Russian Federation – to the European Union – and the status of special economic zone create specific external conditions, in many respects distinct from conditions for economic activities in other Russian regions. Although the effects of the factors are not obvious and not only positive, in combination with such traditional factors of competitive advantages as relatively low cost of labour and development of the industrial and transport infrastructure, they have actually decisively influenced the formation of economic specialization of the Kaliningrad region at the present stage of development.

Let us briefly consider the factors, underlying the competitiveness of Kaliningrad’s economy at present.
Being the only subject of the Russian Federation geographically advanced to the West from the basic part of the country, the Kaliningrad region is isolated from the mainland of the country by territories of foreign states. These features of geopolitical position render both positive and negative influence on conditions and opportunities for conducting enterprise activities in the region, acting as external factors of Kaliningrad enterprises’ competitiveness.
The location of the region placed in the geographical centre of Europe, on the crossing of traditional trading routes, close to major Western and East-European markets, predetermines possible economic gains. Obvious and undisputable advantages of the geographical position of the region include the proximity of its territory to the markets of Western and Eastern Europe and availability of the only Russian ice-free port complex on the Baltic Sea in the territory of the region. Pan-European transport corridors 1A and 9D go through the territory of the region linking Kaliningrad to the vast European transport network, serving as additional tools for Kaliningrad’s development as they expand transport carrying capacities and provide an infrastructure basis conducive to the promotion of its trade links with the EU. Taking into account the importance of Russia as a natural bridge between Europe and Asia, and the intentions by Russia and the EU to further integrate their transport networks, as well as benefits granted by the SEZ regime in Kaliningrad, the region has yet another opportunity to become and international intermodal transport hub and be involved in servicing transit freight traffic of other countries.
These advantages, on the one hand, provide easy enough (and, hence, economically attractive) passage of western goods through the territory of the region onto the extensive Russian market. The proximity of the region to western markets significantly facilitates development of foreign economic relations for the Russian (Kaliningrad) enterprises. The influence of these factors creates favorable preconditions for the use of the territory of the region as an intermediate industrial platform – some kind of a link between foreign manufacturers of materials and accessories and consumers of finished goods, made of them in Russia, and serve as a competitive advantage in comparison with other Russian regions in the sphere of foreign trade and in business support activities.
Another feature of the geopolitical situation of the region is its exclave position with regard to the main part of Russia. The transit of cargoes by land between Kaliningrad and the mainland across the territories of foreign states is thus inevitable, which makes the Kaliningrad region’s trade with other Russian regions more complicated and expensive. In addition, considerable uncertainty is caused by the changing nature of legislation regulating the conditions of such transit.
This part of EU legislation does not take into account all specific aspects of Kaliningrad region’s position. In particular - that Kaliningrad region is a part of the Russian customs territory, separated from it by EU customs territory, and Kaliningrad cargo transit, as a matter of fact, represents moving goods within uniform Russian market, carried via EU customs space for only a limited time interval. As Russia has limited opportunities of influencing the contents of the EU customs legislation concerning transportation between two parts of the Russian territory, an essential element of unpredictability in the conditions for conducting economic activities in the territory of the Kaliningrad region is always high on the agenda.
As of today, delivery of cargoes from Kaliningrad region to the other part of Russia is a multistage procedure with each stage adding extra time and financial expenditures which are higher if compared to internal transportation within Russian territory. This is usually caused by stricter EU requirements to freight insurance and carrier’s liabilities, to veterinary and phyto-sanitary control, to transportation of dangerous products, to characteristics of motor vehicles and rolling stock. Moreover, as time goes by, these requirements (and, therefore, the time and financial losses of Kaliningrad companies and their Russian partners) tend to become even tougher.
Given that the basic transport link connecting the region with the other part of Russia is the railway, that renders direct influence on the inter-regional competitiveness of Kaliningrad companies, entailing specific additional transportation costs – the shipment of cargoes to the region costs much more than transportation of goods through similar distances within the basic part of the Russian Federation. As an example, the prices of the main kinds of energy carriers delivered by railway are 10-15% higher for Kaliningrad consumers compared with average prices for consumers in mainland Russia. The railway provides the overwhelming part of shipments to and from the region. Other modes of transport are not only less economically feasible, but are also physically unable to fully provide for the required volume of the trade flows between the region and other parts of Russia. In absence of real alternatives, this factor makes the Kaliningrad region quite vulnerable.
This dependence sometimes reveals itself in Russia’s relations with the European Union in general, as well as its bilateral relations with Lithuania and Poland. The recent example is the discussion on the possibility of temporary closure of the Lithuanian section of the train route “for repairs” voiced by high-ranking Lithuanian officials as a reaction to oil pipeline closure by Russia. Leaving aside the essence of this ongoing dispute, it is obvious that such rows cause a significant negative effect on the image of the region and may have far-reaching implications for its investment attractiveness.
Another important aspect of Kaliningrad’s competitiveness is its Special Economic Zone status, which was first introduced in the region in 1991. Since 1996, the principal document regulating economic activities in the Kaliningrad region is the Federal Law "About the Special Economic Zone in the Kaliningrad region". In economic terms this law was designed primarily to compensate the additional costs caused by the detachedness of the region from the basic territory of Russia, as well as to create favorable investment environment and to facilitate accelerated social and economic development of the region.
The SEZ regime envisaged special, preferential treatment of entrepreneurship, investment and foreign trade activities. However it was limited to creation and functioning of a free customs zone in the territory of the region, and that became the basic feature of economic and legal conditions for doing business in the Kaliningrad region compared with other regions of the Russian Federation.
Customs privileges were the key component of the SEZ mechanism, serving as a powerful incentive for business development and, primarily for foreign trade activities in the region. However, the old version of the law has produced rather one-sided effects. Under that law the region's economy has become distinctly specialized in providing an alternative way for penetration of foreign goods (exempt from regular customs procedures) to the Russian market. As a rule, Kaliningrad import-substituting enterprises are assembly lines specialized in final, technologically simple operations for production of consumer goods out of imported materials and components. As the result, several new industries evolved, such as food processing, assembly lines for household appliances and consumer electronics, and furniture, all targeting the Russian market. The SEZ regime, working at expense of the federal budget and the competitors in other Russian regions, became vital for the regional economy.
The new law on the Special Economic Zone has taken force in April this year, establishing a regime based on tax preferences for big investors combined with the duty-free imports. This design corresponds to the normal SEZ design practiced throughout the world. Contrary to the old law, the new legislation shall not pose any WTO-related legal issues. At the same time, the new regime would co-exist with the old one during the transition period of ten year when the SEZ residents would be able to choose either one.

Opinions on the future impact of the new Law vary, although a large number of experts specializing in this field believe that it will be insufficient to significantly increase the inflow of investment and speed up the region’s economic development. The reasons for these are manifold.

With the adoption of the new law, the situation may develop where special conditions for large investors – with regard to obtaining necessary approvals for implementation of their investment projects – would make their position on the market even stronger, and actually divide them into two groups: a small privileged group, provided with ‘first-class’ service and all other enterprises. The law actually neglects small and average businesses as SEZ participants, and accordingly, does not target them as beneficiaries of the new law, which does not at all correspond to modern world trends, where enterprises of small and medium-sized business in many countries already have become the basic driving force of economic development. In this situation, there is a risk of a dramatic decline in the motivation for establishing of new businesses, as well as in the region’s export figures.
The new law does not envisage a powerful system of incentives for economic growth of the region. It is not focused on the development of the R&D activities, or high-tech industries, or services to business, etc. Their potential in the region is certainly not very high, but even that is underused. Scientific and industrial parks and business centers could become efficient tools for its development, but this requires more focused incentives, not always and not only privileges.
Another reason is that this is a “frame” law, which is rather general and leaves a lot of scope for the authorities to interpret it in many different ways, adding to the uncertainty in the eyes of investors. This was one of the failing of the previous SEZ regime, where over twenty new regulatory documents have been adopted (basically presidential decrees and government orders) in addition to the law, either enacting or canceling some privileges, thus changing the SEZ regulatory framework.
Alongside with the external geopolitical, as well as economic and legal conditions, the formation of the principal direction of Kaliningrad regional economic development was also influenced by such factors of competitive advantages as availability of relatively cheap and skilled labour, and relatively well developed technological and transport infrastructure (Kaliningrad ranks 3rd in Russia after Moscow and Saint-Petersburg in terms of infrastructural potential). At the initial stage of economic transformations, those traditional factors in a combination with external favorable conditions, have in many respects determined the current specialization of Kaliningrad regional economy. The level of wages in most industrial sectors in the Kaliningrad region is much lower than that in the neighbouring countries. However, one can assume that this serves as a compensation for the low labour productivity at Kaliningrad enterprises, thus supporting their competitiveness.
Labour quality issues are at the top of the agenda of Kaliningrad personnel managers, as the majority of the companies (especially those with industrial sites outside the regional centre) experience difficulties with staff recruitment. Employers experience problems in selecting managers and skilled workers of various trades. While there is no shortage of supply on the labour market in the region as a whole, most candidates are not adequately skilled and have very high expectations with regard to wages. Many experts believe that the difficulties in selection of skilled workers are explained by their shortage on Kaliningrad labour market and misbalanced systems of vocational training.
The government is making attempts to reverse the situation. The recently announced initiatives in the field of migration policy are designed to increase the population of the region by some 400-500 thousand people over the next few years. This is line with the new migration policy of the federal authorities, which envisages resettlement to several Russian regions of a large number of Russians currently residing abroad. According to Kaliningrad government officials, the resettlement program will target the labour force that is vitally demanded by the Kaliningrad’s economy.
Having certain advantages over foreign companies in terms of involved labour cost, Kaliningrad companies considerably yield to them in technological equipment. The consequence of it is much lower labour productivity of Kaliningrad enterprises. Low technological equipment can be considered one of the reasons of non-competitiveness of Kaliningrad enterprises, compared to their western counterparts. The most obvious way to overcome this drawback can be the accelerated innovative technological development of Kaliningrad industries. The regional economic policy should envisage special measures to stimulate introduction of new equipment and technologies, probably, with the use of international technical assistance.
The integrated assessment of competitiveness of Kaliningrad companies from the point of view of use of microeconomic factors can focus on the following three basic areas: organisation of business activities and administrative technologies; innovative potential and innovative activity; and provision of information to business.
Elaborate organisation of production and competent planning in the enterprise are major elements of competitiveness. On the one hand, a well organized control system allows providing an increase of efficiency of use of industrial resources available to the company. On the other hand, it creates necessary administrative and organisational preconditions for successful application of new equipment and technologies and for ensuring steady and long-term productivity growth. Although it is traditionally considered, that not enough attention is given to innovations in the sphere of management of Russian enterprises’ activities, Kaliningrad businessmen already have realized the importance of these issues. As a rule, business plans are developed by the enterprises themselves, without involvement of foreign experts, which testifies of high administrative potential of Kaliningrad companies.
One of the major tasks for supporting the competitiveness of the majority of Kaliningrad export-oriented companies is introduction of international standards of quality management and environment protection management systems – ISO 9000 and ISO 14000. At present, there are only a few companies having international certificates in the Kaliningrad region – basically, they are the largest enterprises in the region. While, according to the International Standardization Organisation (ISO), the share of certificated firms in Germany in 2002 was 2 % of the total number of companies, out of which about 2/3 are small and medium-size enterprises.
In modern market economy innovations are one of the major factors of companies’ competitiveness. Without continuous updating of the equipment, technologies, and improvement of manufactured products, it is impossible for a company to provide a stable market position. At the same time, in the course of several years, innovative activity of Kaliningrad companies remains at a very low level, even by Russian standards. Thus, even according to the considerably overestimated official data, the share of innovative companies in Kaliningrad region does not exceed 0.01 % of the total number of registered enterprises. For comparison, in ‘old’ EU countries this parameter makes at least 50%, and in Poland and Lithuania 15-17% of the total number of enterprises. This accounts for the poor current state of Kaliningrad’s innovative potential – 54th place among Russian regions in 2004.
The provision of information for business activity, alongside with administrative and innovative and technological potential, is another important factor of companies’ competitiveness. However the level of access of Kaliningrad enterprises to information resources remains unsatisfactory. As a rule, the principal underlying causes of this is the lack of systematized information in widely accessible information resources in the region, and low solvency of Kaliningrad companies, which makes qualitative information and services inaccessible to them.
While analyzing Kaliningrad’s competitiveness, it is also worthwhile having a look at Kaliningrad’s immediate neighbours – Poland and Lithuania – in terms of their economic development. The fact that the state of Kaliningrad economic development should be measured against corresponding indicators of these two countries has long been acknowledged by Russian authorities, and the attainment of comparable standard of living is declared one of Kaliningrad strategic objectives.
Once embarked on the course for accession to the European Union, these countries focused attention on competitiveness of their enterprises. Particular emphasis was made on attraction of foreign direct investments, which became one of the major factors of their national competitiveness growth. The arrival of large transnational corporations has facilitated their access to financial, material and intellectual resources and accelerated the introduction of technological, organisational, and managerial innovations. Most of the largest private companies’ assets in Poland and Lithuania partly or completely belong to foreign – West-European - .capital. And it’s those companies that demonstrate the highest profitability indicators, investment activity, share of exported products – including high-tech commodities, and so forth. Foreign direct investments have played an important role in the creation of a modern market infrastructure (telecommunications, banking and insurance services, trading). In Poland and Lithuania those sectors took up to 40-45 % of the total amount of direct foreign investments, i.e. approximately as much, as the manufacturing industry. The accession to the European Union in 2004 gave an extra impetus to the enhancement of their national competitiveness. On the one hand, the last technical barriers and restrictions on access to EU markets were removed. On the other hand, opportunities of financing of competitiveness enhancement programmes, including those on the micro-level, were extended.
As an example, one of such programmes in Poland is “Enhancement of enterprises’ competitiveness for the years 2004-2006”, one of the seven so-called sectoral operative programmes, focused on implementation of the goals of the National development plan for the years 2003 – 2006. The program stipulates the purposes, priorities and actions of policy in the sphere of business and innovations. At the same time, special attention is given to small and medium-size enterprises. The funding from the European Regional Development Fund exceeds 1 billion euro, while national sources makes up additional 440 million euro of investment. The goal of the Program consists in enhancement of enterprises’ competitiveness, operating in the territory of Poland in the context of the common European market. The achievement of this purpose is called to reduce economic, social and technological backlog of Poland from the most advanced EU countries.
Similar initiatives are ongoing in Lithuania.
Given that the FDI stock per capita in Lithuania, and Poland is 5 times that of Kaliningrad’s, and that the gap is widening, the scale of investment required to make Kaliningrad able to compete with it’s neighbours is enormous.

All in all, Kaliningrad clearly has numerous advantages and opportunities if compared to other Russian regions, which include a relatively well-developed infrastructure, low labour costs and privileges provided by the Special Economic Zone regime, the opportunities stemming from its unique geopolitical position etc. As of today, however, Kaliningrad didn’t manage to fully utilize these opportunities, and the advantages don’t seem to be able to offset the worries of potential investors. As the result, the region accounts for mere 0.2 per cent of the foreign investment stock of the Russian Federation, which indicates that the region does not perform as well as the country as a whole in attracting foreign investment, and its investment potential remains low.
In order to reverse this situation the federal and regional authorities should intensify the implementation of activities designed to support accelerated infrastructure development and enhancement of border regime efficiency. It would also be expedient to consider the possibility of visa-free travel for the EU citizens to Kaliningrad with the purpose of facilitating international business contacts and boosting the tourist flow in the region. The authorities should continue making efforts to assist companies in upgrading of employees’ skills, introduction of innovations and quality management systems, implementation of technological modernization, and marketing activities in Russia and abroad (stimulation of exports). All these activities should be of systematic nature, similar to the mentioned programmes implemented in Poland and Lithuania. The new Government of the Kaliningrad region is currently elaborating the long-term strategy of the region’s development, and hopefully the said support measures will be taken into account.
However, in terms of investment attractiveness and competitiveness, the consistency of legal framework and political stability are probably even more important for Kaliningrad. From that stance, it is vital that Russia and the EU will finally bring their long-declared intentions of using Kaliningrad as a pilot region of co-operation to a new level, where a certain strategic agreement will be signed, ensuring that Kaliningrad will no longer be hostage of economic or diplomatic rows, and setting the frame for the region’s dynamic development in the years to come.