Jeremy R. Azrael and D. J. Peterson

While Russia’s leadership has identified the potential benefits of information technologies and participation in the information revolution, a great distance must be covered to overcome the impediments to reaching the goal of an “E-Russia.”
Most fundamentally, in the areas of IT development, diffusion, and application, Russia still remains far behind those nations with which Russian elites like to compare their country:

• In 2000, Russia had 22 telephone lines per 100 inhabitants, compared with 61 in Germany and 70 in the United States (see Table 1). Russia’s 5 percent rate of growth in international telephone traffic (measured as outgoing calls) between 1995 and 1998 lagged far behind the 9.5 percent average growth registered worldwide.

• The stock of personal computers in Russia in 2000 was lower than that in Brazil and Mexico. Three-quarters of Russians polled in a January 2001 survey had never even used a PC.
• Development of the Russian portion of the Internet (dubbed “Runet”) lags behind that of the West and many major developing nations, such as Malaysia.
• According to a June 2001 State Council report, Russia’s schools have just one computer for every 500 students, and just one in 50 schools has Internet access. For comparison, almost all elementary and secondary schools in the United States had Internet access by 2001.
• Russia also does not have any major firms or facilities engaged in the production of such IT hardware as PCs. In a RAND survey of trends in the global information revolution, Russia was not even identified as a visible actor in technology development or application.
• In 2001, the Economist Intelligence Unit ranked Russia 42nd of 60 countries evaluated for e-business readiness - behind Peru and Egypt (see Table 2).

Russia’s long-term IT innovation capabilities are also open to question. In 1990, 1.6 million people were reported to be employed in the science sector. Ten years later, that number had fallen by one-half. Since the mid-1980s, basic research in Russia has been hobbled by a lack of steady funding. In an August 2000 speech to the Russian Academy of Sciences, President Putin reported that 30,000 Russian scientists had moved to work abroad. After the United States and Germany sharply increased the number of long-term work visas available to information technology specialists in 2000, Communications Minister Leonid Reyman warned that Russia faced a wave of “computer brain drain”.
Such indicators suggest that Russia risks being caught on the wrong side of the global digital divide. The leader of the RAND survey mentioned above concluded: “It’s not just a question of Russia catching up with other nations that are advanced today insofar as the information revolution is concerned; it’s also a question of Russia catching upwith nations that are also moving ahead faster – often much faster - than is Russia”. The chief executive of one of Russia’s largest oil companies noted that Russia’s window of opportunity for jumping on the IT bandwagon was closing fast. “The rest of the world is moving on,” he said.

Despite these shortfalls, Russia does have basic resources available to move the economy, government, and society toward the vision of an E-Russia, and it has already made notable progress on these fronts—especially when we consider where the country was in Soviet times.
A little over a decade ago, business and government (outside of national security agencies) could not rely on information technologies. The telecommunications industry was a government monopoly and its poor service was legendary. Intercity (and often local) messages were sent by telegram. The abacus was used for accounting. The few Soviet computers that were in use at that time were mainframe systems, considered obsolescent by international standards.
Today faxes, mobile phones, and personal computers are common. These, together with computer networks, are improving the efficiency of the economy by enhancing the level of detail of information available as well as its geographic reach - critical improvements in thin, dispersed markets. Among the first commercial users of the Internet in Russia, in the early 1990s, were wholesalers who used e-mail to post their prices for everything from computers to catsup. Now, business information and retail and wholesale markets are moving onto the Web at sites such as Interfax, Rambler, and Allshops.
A number of Russian “Old Economy” firms have invested in IT to improve financial controls and supply chain management and to oversee their rapidly growing business empires. An executive at one of Russia’s largest oil companies noted that his firm was investing in IT to “centralize” accounting and inventory management and to put these operations under the control of top-level executives. Better accounting tools are critical to firm restructuring in a country where intra-enterprise corruption and worker theft are widespread phenomena.
IT is helping Russian entrepreneurs and firms overcome their country’s historic isolation from international markets. Today, financial analysts and traders in Moscow monitor international markets in real time and watch for the latest developments at the U.S. Treasury and the Federal Reserve. As manufacturing and retail enterprises around the world develop global supply chains and move their purchasing to e-commerce platforms, firms in Russia are using the Internet to compete directly with their Western counterparts. To this end, a British-Russian consortium in 2000 opened Europe-Steel.com, a trading exchange to promote Russian metals sales on international markets. Other exchanges have been developed for mining, oil, and drilling services.
Information and communications technologies have also been used to improve public-sector performance. For instance, to bring Russia’s antiquated banking sector into the modern era, the Russian Central Bank has invested heavily in IT, including proprietary communications satellites, allowing it to quickly implement an electronic payments clearing system across half of the country’s 79 banking regions, thus eliminating the use of paper checks for payrolls and other tasks. Auctions of the assets of failed commercial banks by the Agency for Reconstruction of Credit Organization are conducted on-line.
A small but dynamic New Economy sector based on the integration of Western technologies emerged in the 1990s to meet the demand for information and communications technologies and services. International Business Systems was founded in 1992 and has grown to be Russia’s largest IT integration, retailing, and e-commerce firm, earning over $193 million in sales in 1999 and employing a staff of 1,500. At the end of 2000, Russia counted some 400 Internet service providers. Relcom (Reliable Communications), one of Russia’s largest Internet providers, emerged in the early 1990s from Moscow’s Kurchatov Institute of Atomic Energy. Independent installers helped boost the number of main telephone lines by 30 percent—from 23.4 million in 1990 to 31.8 million in 2000. At the same time, several wireless firms emerged to develop mobile phone networks in most major Russian cities. By the end of 2000, there were over 2.8 million subscribers, and that number was doubling every year.
As Russian specialists have become adept at integrating Western technologies, they have proven themselves skilled innovators and developers in their own right - especially in the field of software development. Thanks to the end of Cold War competition and cuts in government funding of science and technology, Russia possesses a sizable number of underemployed high-tech specialists including experienced software designers and programmers with a broad and deep knowledge of mathematics and engineering. Russian institutions of higher education and advanced training, despite cutbacks in public funding, still produce almost 100,000 programmers every year. In addition, Russia’s education system is particularly well set up to identify and promote the most talented students in such fields as math and physics. Judging by the winning performances of students in international competitions over the past several years, these schools have retained their world-class caliber. Such talent can cost one-fifth of what such labor costs in the United States, even considering the added expense of managing an offshore operation.
Contrary to Russia’s gangster image, Russia’s New Economy ventures are run by talented, forward-thinking entrepreneurs intent on building serious, world-class businesses. Esther Dyson, a U.S.-based IT investor and industry leader, argues that because Russia’s IT capabilities and firms are being built from scratch and are oriented toward Western technologies, its New Economy enjoys a culture that is refreshing in its transparency, spirit of competition, and cohesion. Not surprisingly, in a 1999 survey of the Russian economy, the McKinsey Global Institute found that Russia’s software development industry had the highest productivity of ten sectors examined and was thus its most internationally competitive industry.
The sector’s international orientation and price competitiveness is reflected in a number of successful offshore software development ventures. An illustrative case is the Boeing Company, which has hired over 200 programmers in Russia through partnerships with Illyushin, Tupelev, and International Business Systems. An Intel Development Lab was opened in Nizhnii Novgorod in 2000, and the company plans to expand into St. Petersburg. Such investments indicate that the firm is “very serious about developing long term business in Russia.” For over ten years, Sun Microsystems has contracted systems software and customized implementation work to a team of 250 engineers working in Moscow, Novosibirsk, and other locations. Jason Horowitz, the Russian project team manager, notes that Russian programmers are “very serious engineers” and, in comparison with their counterparts in other countries, they tend to be “stronger at tasks that require a deeper mathematical background.” Sun has teams around the world working on similar projects - in countries such as Ireland, India, Israel, and the Czech Republic - but programmers in such countries typically “don’t have anywhere near the talent as the Russians.” For this, they have gained the esteem of Sun’s engineers at the company’s headquarters in Silicon Valley.
In 2000, Russia’s offshore programming revenues were estimated at $60–100 million and were estimated to be growing 40–60 percent annually. An estimated 5,000–8,000 programmers were employed in the industry, but because such ventures do not follow traditional patterns of foreign investment and business development, they are less visible and not well studied. Nevertheless, they represent promising solutions for overcoming Russia’s inhospitable business climate.

Even given the progress that is under way, none of the goals proclaimed for the creation of an E-Russia will be easily or quickly accomplished. Many of the policies that are being advocated or adopted are unlikely to achieve their goals or could even be counterproductive.
The E-Russia program calls for federal spending of $1.3 billion, to be matched by another $750 million from regional governments. Will the resources be available? The federal government has an established history of not funding its numerous “Presidential Priority Programs” in science and technology, so they accomplish little in reality. In July 2001, the Ministry of Education already had threatened 12 regions that the federal government would not provide computers for public schools if the regions did not cover their half of the program’s cost. In any case, an ambitious program may not be warranted: Experiments with e-government in Europe and North America suggest that demonstrating successes with smaller initiatives in specific programs or agencies having the appropriate entrepreneurial climate may be the best way to start out.
Second, it is not clear that focusing on IT should be a priority at this time for Russian government or industry. After decades of massive IT investment in the West, the United States appears to be the only country to have registered measurable productivity benefits from the information revolution - and these finally started to appear only in the late 1990s. In a discussion of IT trends in Russian business, a Russian executive commented that Russian firms do not have a strong incentive to invest in IT: He, for example, was achieving enormous productivity increases at his heavy industrial operations just by firing excess workers, and he had a long way still to go before he would need computers to replace laid-off workers. According to Yukos Chief Executive Officer Mikhail Khodorkovsky, information technologies were expected to save his oil company just $30 million over three years while gross revenues would be over $7 billion. In short, improving the performance of business and government need not depend on making significant investments in IT capabilities at this time.
Third, as business and government in the United States and elsewhere have learned over the past 25 years, spending on IT hardware must be matched with appropriate investments in “knowledge management” and other organizational transformations (i.e., investment in people) to ensure that the large volume of information that is being generated is actually used. Efforts by the Soviet government in the late 1980s to develop a unified database to improve central planning and management of the economy failed in part because the government agencies involved refused to share information. In Russia today, many business managers continue to believe that controlling business information is “a major tool of power,” observed a portfolio manager, adding that despite investments
in IT, “artificial constraints on information flows” are still an issue of concern. Similarly, e-commerce may not go very far in Russia because the generation of electronic records of business transactions is inimical to tax evasion. Speaking more broadly about Russia’s IT challenge, an American business leader in the media and information sector argued that IT alone does not promote openness in society or stronger ties between its individuals in the society. Rather, the key issue is to what ends people choose to use these technologies. In sum, for Russia to realize many of the benefits of the information revolution will require decentralizing government and business institutions and encouraging the free flow of information—dramatic changes for a culture that has equated power with control over information.
Fourth, there is no proven policy recipe to promote technology development. Efforts around the world to create technology clusters that mimic Silicon Valley have had mixed results. Moreover, government efforts to pick “winning” technologies as part of an official industrial policy typically do not result in the most productive use of government resources. In Russia, the government has sponsored numerous strategic research programs, but the priority-setting process typically has not been guided by merit. Such efforts as creating tax-free zones or technoparks, Sun Microsystems’ Horowitz notes, “in the Russian context become goals in themselves.” These endeavors are especially problematic in the IT sector, given the rapid pace of technological change. Government funds may be more effectively spent to improve Russia’s telecommunications infrastructure, thus ensuring that more people and businesses have reliable access. Horowitz suggests a policy of “benign neglect.”
Fifth, one may ask: Does Russia have a sufficient comparative advantage to enable it to become a major IT innovator and developer? Russia’s IT research, development, and export aspirations place it in competition with many other countries - India, Ireland, and Israel are the main competitors in the global outsourcing market - that have already been investing billions in their efforts to jump on the IT “development train.” A foreign investor with a broad international experience in technology development argues that Russian firms trying by themselves to break into the international software markets are handicapped because they are too small, do not have a good understanding of the notion of value creation, and lack sufficient business-building capacity. Speaking of Russia’s need to boost its IT profile, Dmitry Loschinin, managing director of Luxoft, a leading Russian IT outsourcer, observed, “We thought all we had to do was be good and people would recognize us.” Although the Putin administration has targeted IT as an export sector for growth, Russia’s large trade surpluses, created by massive exports of energy, minerals, and other commodities (another administration priority), have bolstered the exchange rate of the ruble. A strong ruble makes IT imports relatively cheaper and Russian IT exports less competitive internationally.
Finally, the pace at which Russia moves forward in the years to come - both in the integration of IT and as an IT innovator and developer - will be decisively determined by the direction and rate of change in the overall economy and its business climate. As with the development of the Russian economy in general, IT integration and innovation are hampered by bureaucratic red tape, the absence of credit and equity markets, poor protection of property rights, official corruption, and burdensome taxes. Unlike Russia’s Old Economy oligarchs, the country’s New Economy entrepreneurs lack political clout and are especially vulnerable to the bureaucratic and structural impediments to business development in Russia.
On these points, Russia’s repeatedly ranks at or near the bottom of the charts for business environment (see Table 2). An undue preoccupation with IT development programs and complex e-commerce, encryption, and antipiracy legislation would only distract Russian decisionmakers from more fundamental policy needs, such as ensuring that existing laws governing contracts and property rights are enforced in a consistent and transparent manner. In short, to develop a dynamic and internationally competitive IT sector, Russia first needs to develop a dynamic and internationally competitive economy.
To summarize, concerns about Russia being trapped behind the digital divide may be overwrought. As we have already seen in the 1990s, Russia need not be an IT innovator to become a large-scale acquirer, adept user, and beneficiary of the latest information and communication technologies from abroad. Policies to promote IT deployment, use, and development in Russia can provide additional payoffs, especially if they are made in tandem with other necessary reforms. But IT is not, for the immediate future, a critical force that, by itself, will radically improve the performance of government, business, or the economy in Russia.