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Module 18 Economic Geography and the Regions of Russia Masahisa Fujita, Kazuhiro Kumo and Natalia Zubarevich 1. Introduction

The aim of this module is to describe the effects of geographical factors on location patterns of economic activity. Economic integration processes must facilitate realization of the borderless economy; hence, we might have to take regions or cities as the analytical units rather than national economies.

Inter-city or interregional competition is one of the main topics in the field of economic geography. Thus, in this session, recent development in the so-called ‘new economic geography’, which would give some policy implications for regional governments under globalization, is reviewed in first. Then we discuss what kind of spatial dynamics could be expected in Russia, which has a vast territory and is characterized by uneven distribution of the industrial power and natural resources.

Geographical distribution of industrial activity in Russia was distorted by the former socialist government. The essence of ‘new economic geography’ will show what kind of structural changes in industrial location patterns can be realized because of economic integration and liberalization in the long-run. 2. New Economic Geography: Conceptual Outlines

Geographical factors must have critical effects on economic development. Especially in recent years, economic geography, which aims at explaining the geographical organization of economic activities in an economy, gained a renewed interest among an increasing number of economists. Their work is commonly called the ‘new economic geography’, which emphasizes agglomeration forces generated through the interaction of increasing returns and the effects of transport costs. The work on the ‘new economic geography’ has been fostered by the recent trends towards increasingly borderless world economy, including the integration of national economies within new trading blocks such as the European Union and the North American Free Trade Area. As market integration dissolves economic barriers between nations, national boundaries no longer provide the most natural unit of analysis. The most striking feature of today’s economic development patterns is the concentration of economic activities in cities. Given the recent progress towards a borderless economy, cities have been enhancing their importance as basic units of international economic systems, as well as of domestic systems. Regional or urban development patterns hinge increasingly more on economies of agglomeration than the location advantages due to first nature such as climate and mineral deposits. Recent economic growth of cities in advanced countries is fostered mainly by agglomeration effects generated from self-reinforcing advantages. Interactions of three basic factors, (1) variety or heterogeneity in goods and economic agents, (2) economies of scale and (3) transport costs (broadly defined), would yield dense trade and

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communication networks. Spatial agglomeration forces of economic activity will be derived from these linkages in a self-organizing manner. In the next subsection, such a mechanism of economic agglomeration will be explained more concretely. 2.1 Mechanism of Economic Agglomeration through the Variety of Products and Increasing Returns If a large number of firms exist in a city, a greater number of varieties would be produced there. This means that consumers in that city can enjoy more variety of goods in comparison with consumers in other places. It may be reasonable to assume that people would have tastes for variety. Thus, given the same nominal wage, the real income of the consumers in this city would be higher than those in other cities. This induces more consumers to migrate into this city. Then, the resulting increase in the number of consumers creates a greater demand for consumer goods than other regions, which therefore leads more firms to locate there. If economies of scale exist, there would be an incentive to concentrate the production activity in one city to reduce fixed costs per output. Additionally, because of the transport cost, it is more efficient to produce in the city with a large market and ship the products to others. This implies the availability of an even greater variety of consumer goods from the city. This argument is summarized in Figure 1, which describes the circular causation for the agglomeration of firms and consumers through forward linkages (the supply of greater variety of goods increases the consumers’ real income) and backward linkages (a greater number of consumers attracts more firms) (Fujita, 1996: Fujita & Krugman, 2004, p.145).

more consumers demand locate in the city effect

backward more firms locate higher real income forward linkage in the city from a given nominal wage linkage

greater variety of real income

consumer goods effect produced in the city

Figure 1. Circular causality in spatial agglomeration of firms (consumer-goods producers) and consumers (Fujita, 1996) This kind of circular causality can be applied not only to the interrelationship between consumer-goods producers and consumers. If many producer-service firms locate in the city, then a more variety of producer services would be supplied there. Because of complementarities in services, this can improve the productivity of final-goods producers in the city. Thus, more final-goods producers would locate there. This means that even more specialized producer-service firms can be supported in the city. In such a way as described above, both consumer-goods variety and intermediate-goods variety can lead to spatial agglomeration. In addition, variety of

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people can be regarded as one of the engines of agglomeration. A greater variety of people in a city results in more information or knowledge; hence, this would lead to close location of innovative firms, as can be imaged in the case of Silicon Valley. Needless to say, this kind of mechanism can result in further growth of existing economic agglomeration nodes. Recent trends in concentration of economic activity such as the banking sector in Moscow can be regarded as one of the supporting evidences of this agglomeration effect. 2.2 Positive and Negative Lock-in Effects of Agglomeration We have to mention next about positive and negative lock-in effects, the critical factors of the concentration process of economic activity. It offers an interesting viewpoint on the role of natural geography in geographical distribution of economic centers. Anyone who examines even casually the real geography of economic activity is struck by the important degree of arbitrariness or, at best, historicity involved: Silicon Valley exists because of the vision of one Stanford official two generations ago. Furthermore, rivers and ports surely do matter. One should remember that many large cities were once port cities. Once a new centre has become established, it grows through a process of self-reinforcement, and may thus attain a scale at which the initial advantages of the location become unimportant compared with the self-sustaining advantages of the agglomeration itself. In an odd way, natural geography can matter so much precisely because of the self-organizing character of the spatial economy (Fujita & Krugman, 2004, p.147). If some level of concentration of economic activity emerges in a city, the existence of agglomeration itself has lock-in effects and other economic agents will newly be attracted there. This can be regarded as positive lock-in effects. But in other cases one can think that agglomeration would impede the evolution of economic structure of a city in the long run. Some Russian regions specializing in manufacturing activity have been in heavy stagnation after the collapse of the Soviet Union. It is natural that a decline in demand for certain goods may stagnate regions specializing in producing those goods. In the early industrialization period, regional specialization could contribute to economic growth. The legacy of specialization policy during the Soviet era, however, may exert negative lock-in effects on Russian regions in some cases. 2.3 The Source of Regional Change: Decrease in Transport Costs Transport costs can be regarded as the main engine of regional economic change in the ‘new economic geography’. In this regard ‘transport costs’ are defined in a broad sense, including not only monetary costs but also other non-monetary burdens. International trade incurs other costs such as tariff, risks from unstable exchange rates, psychological costs, cultural gaps and so on. All of these are regarded as broadly- defined transport costs, and they have been continuously decreasing through the human history because of the progress in transport technology and communication networks. Especially in recent years, development of airway networks, advancement in

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telecommunication technology and liberalization of international trade and other institutional reforms have been decreasing transport costs drastically. Although the role which transport costs play in industrial location patterns is complex one, a simple explanation will be helpful for understanding. If transport costs were very high and the market demands (people) were dispersed, small industrial nodes should be constructed across territories to avoid shipping costs of final goods. Then if transport costs decreased gradually, however, some of the neighboring markets could work as a unified one because of their contiguity. In this unified market agglomeration forces will be strengthened. The circular causation described in Figure 1 would start working and cities would be formed. The larger agglomeration would supply more variety of goods and a core-periphery type spatial system might be formed. Thus, if transport costs decreases further, at least at the initial stage more people and firms would be gravitated towards a larger city (see Appendix I and II for details).

Broadly-defined transport costs include institutional costs, troubles in the business routine, and transaction costs and so on. The effects of transport costs described above would, however, be realized in the long-term spatial processes. Transport costs themselves have been decreasing historically. WTO accession implies the decrease of cross-border transport costs. In addition, each region must not apply its own trade policy, and this may lead to decrease of interregional transaction costs. The theoretical insight above provides an implication on what changes will be expected in location patterns of economic activity in Russia. 3. Economic Geography and the Regions of Russia

All vast countries including Russia are internally heterogeneous and their regions differ substantially in terms of social and economic development. There is a multitude of differentiating factors including climatic conditions, availability of resources, demographic trends, history of population spread, and economic development. In the past, Soviet economic geographers paid most attention to location of natural resources and climatic conditions. The role of these factors remains important for Russia where rich natural resources and accumulated industrial capital helped survive the transition at less social and political costs. The transfer of an economic system to a market economy, however, has made it obvious that regional development is also dependent on other historically inherited factors leading to negative outcomes.

The ‘new economic geography’ provides essential insights to the Russian regional economy. In this section, we discuss three specific issues: (1) possible changes in the urban system, (2) negative lock-in effects of industrial specialization and (3) possible concentration processes of economic activity in Russia. We can expect concentration processes of economic activity into European parts of the Russian Federation, considering such factors as described in the previous section. Realized regional economic transformation patterns may give us some kind of supporting evidences for regional clustering.

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3.1 Migration Dynamics and Urban Systems in Russia 3.1.1 Urban systems The recent work by the Russian Country Economic Memorandum (CEM) pointed out that Russian cities did not follow the ‘rank-size rule’. The size distribution of cities in many industrialized countries appears to approximately follow the rank size rule. The number of cities will be larger the smaller the size of the city is. Although it is not confirmed by theoretical frameworks, a plot of the logarithm of city sizes against the logarithm of their ranks (with the largest having a rank equal to one) generally follows a straight line; hence, this empirical pattern is called the rank-size rule (See Figure 2A and 2B). (This could be implied by the hierarchical urban system described in Appendix II.) According to this rule, one would expect to see several Russian cites in the 2-6 million range, but there are none (Figure 2C).

US cities > 50,000slope = –0.71

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A. The size distribution of United States cities in 2000

French cities > 40,000slope = –0.65

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B. The size distribution of French cities in 2000

Russian cities > 40,000slope = –0.98

y = -0.9845x + 16.5

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C. The size distribution of Russian cities in 2000

Figure 2. The Size Distribution of Cities in Selected Countries. Source: CEM, 2003, p.10 and p.12.

The two largest cities, Moscow and St Petersburg, which have both served as Russia’s capital in the last 100 years, are both “too small” in the sense that the rank-size rule would predict population figures of about 13 and 7 million. All other major cities with a population exceeding 1 million people are also off the line. While there are an excessive number of cities with a population of 500,000 to 1,500,000 people, larger cities with a population of 1.5 million to 4 million are few. As a rule this is due to administratively imposed limitations on the growth of major cities which was characteristic of the Soviet era. Scarcity of major urban agglomerations creates

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difficulties for spatial development as the country lacks powerful centers organizing territories around them1.

Cities serve as development centers for adjacent territories therefore their accessibility and density of spatial distribution are extremely important. The European part of Russia accounts for 77% of the nation's cities with the average distance between any two cities of 70+ kilometers. In eastern regions of Russia, average distance between any two cities is in excess of 225 kilometers. Small numbers of towns and cities have become a negative factor under the transition to a market economy. Territorial mobility of population has decreased and shuttle migration within urban agglomerations are underdeveloped (with the exception of the Moscow agglomeration), therefore the population cannot not find better employment and make full use of its potential. New economic geography gives us important implications in understanding urban systems in Russia. Russia’s (and the Former Soviet Union’s) distinctive characteristic is its vast territories and scarce transport networks. Combining these factors, the policy maker, who was requested to realize ‘optimum location patterns’, was forced to locate small cities (production centers) across territories to meet the demand scattered in the country. Remember that concentration of economic activity could be realized only if economies of agglomeration compensate the transport cost to ship manufactured goods from the industrial center to peripheral regions. Not only socialist policy implemented during the Soviet era but also natural geographical factors critically affect the realized size distribution of cities in Russia. The size distribution of cities, however, can be changed in the long-run, especially after economic liberalization. 3.1.2 New Directions of Migration and Changes in Population Distribution

For many decades Russia served as a migration donor for other republics within the USSR but since mid-1970s the vector of migration has changed. One of the reasons for inward migration of Russians from Trans-Caucasia and Central Asia is a rapid growth of autochthon population resulting in a higher demand for jobs leading to demographic substitution of Russians. After disintegration of the USSR a sharp increase of net migration inflows was observed in the Russian Federation. Net migration inflow in 1991-2000 was 4.5 million people (this official statistics clearly falls short of the real immigration figures due to inadequate registration practices). By the year 2001 however annual immigration reduced to 124,000 people and stabilized at a low level. It is becoming ever more obvious that the wave of reverse migrations is coming to an end.

Immigrants from the CIS have been settling in "Russian" regions of the Northern Caucasus, along the lower Volga and central regions of Russia. Since mid-1990s, migration from Kazakhstan to the South of West Siberia has been on the rise. Those were "stress" migrations and immigrants settled in regions close to national borders and wherever housing was cheaper but not in the regions where social and 1 The real gap is not so large because the definition of cities differs. Population of U.S. cities was defined by metropolitan areas but that of Russian cities was measured by official city boundaries only. The effects of in-migration restriction imposed on large cities during the Soviet era were, however, evident from the huge population inflows into Moscow after the 1990s.

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economic situation was better. On the contrary, migration of CIS labor that has been growing since mid-1990s possesses of an economic nature and is directed towards major cities and regions where production of natural resources for export is concentrated and consequently labor market is more developed and wages are higher.

Internal migration has radically changed and the inward movement of population to eastern and northern regions of Russia that has been in place for many years was replaced by migration outflows as wages paid in these areas no longer compensated for increasing costs of living and many industries have proven ineffective. Over 1989-2001 the population of northern regions has reduced from 9.7 million to 8.8 million. The largest net migration outflow was witnessed in northern regions of the Far East where in 1990-2002 two-thirds of the population have left the Chukot Autonomous District, and 50% have migrated from the Magadan Oblast. Those migrating were the younger and the better educated population. Figure 3 shows clear contrast in migration patterns before and after the collapse of the Soviet Union. People flow into comparatively warm south-west regions of Russia during the transitional period. In a long term gradual geographical evolution caused by decrease in transport costs will make urban systems in Russia something like other advanced countries. The vast territories and a severe climate, however, must be the obstacles of these processes.

Figure 3 Net Migration Rate (0/00) in Each Region in 1985 and in 2000. Source: Kumo (2003b)

In the 1990s net inward migration was marked in the regions with more favorable climatic conditions and a higher density of population with the exception of oil and gas producing autonomous districts in the Tyumen Oblast. Therefore the transition to a market economy has restored concentration of population in more favorable southwestern and central regions of Russia. Migrations have become to reflect the dynamics of economic situation more precisely as net outward migration commenced in the poorer outlying Oblasts in central Russia and increased in underdeveloped republics in the Northern Caucasus: this movement of population was directed towards major urban agglomerations. The northern Autonomous District where oil production was on the rise has become more attractive for migrants.

Nefedova and Travish (1998) demonstrated that during the transition relative prosperity was to be found in the cities with a still larger population (over 250,000 people). This group includes administrative centers of subjects of the Russian

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Federation (with the exception of autonomous districts) and major industrial cities. In this regard, we may be able to expect that industrial activity will be concentrated in existing agglomeration nodes, and the hierarchical structure of urban systems will be intensified in the future. 3.2 Geographical Distribution of Industry: What Changes and What Remains Unchanged

During the transition, inherited factors of spatial development have been complimented by the impact of new market institutions and Russia's inclusion in global economy. Influenced by this combination of factors, not only dynamics of regional development but also the spatial structure of economy have changed and new trends for concentration and polarization have emerged. These trends and structural transformations that have taken shape during transition are quite sustainable and will affect regional development even following Russia's admission to the WTO. 3.2.1 Manufacturing Industry: Growth of Resource-Mining Regions

In the 20th century, central and northwestern regions of Russia have been the heart of national industry where major manufacturing industries have been concentrated. During transition the spatial structure of Russian industry has changed under the influence of varying dynamics of separate industries. The crisis of 1990s has had the strongest impact in the least developed regions. In industrialized regions in central and northwestern Russia production fell three-fold. In major cities, industrial decline was similarly sharp (down to 29..32% of previous output) but industrial crisis was ameliorated by development of tertiary sector.

In raw material-exporting industries the decline was not as sharp as in manufacturing industries. Since 1994, the situation began to stabilize in new exporting regions specializing in metallurgy and petrochemical industry. The products of these regions have entered foreign markets. Varying rates of decline in industries have caused the following structural changes: monoindustrial specialization has increased in exporting regions; specialization of machine-building and textile-producing regions has become less pronounced; the process of de-industrialization of underdeveloped regions and capital cities has commenced; while in capital cities it was compensated by the growth of tertiary sector, in underdeveloped regions the structure of economy was re-orientated towards agriculture.

The growth wave, which started in 1999, swept over machine-building regions of the Center and North-West of Russia and the Urals where large orders from exporting companies have been received. The most stable growth was marked in Oblasts surrounding federal cities (Moscow and Leningrad) as their convenient geographic locations ensured an inflow of investments. Since the year 2000, growth has been accelerating especially in oil-producing regions which is due to mounting oil prices in the world market. Subsequent waves have been related to growth of real income of the population and increasing demand for the products of food industry in southern regions and major urban agglomerations, as well as improved situation in metallurgy.

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In spite of positive dynamics, vast majority of regions achieved smaller volumes of industrial output in 2002 than in 1990. The exporting regions (Tatar and Yakut Republics, Tyumen and Astrakhan Oblasts, Krasnoyarsk Territory) were faster to restore production than outsiders where the industrial decline hit its lowest in the first half of 1990s. Those are republics and autonomous districts with underdeveloped industry, regions specializing in machine-building and textile-producing (Voronezh, Pskov, Penza and Ivanovo Oblasts). In Moscow, industrial production is replaced with services and of remaining industries thanks to a huge demand in the market. Russian Far East has had the lowest growth rate due to a multitude of problems typical of this most remote and underdeveloped part of the country.

In industrial production, the role of regions specializing in extraction and primary processing of natural resources for export increased; the contribution of most manufacturing regions grew smaller and that of underdeveloped regions with uncompetitive industries became practically negligible. Spatial concentration of Russian industry is extremely high and still growing: the top 15 industrialized subjects of the Russian Federation accounted for two-thirds of production in 2002 (Table 1). Among leaders, regions specializing in raw materials export are predominant. Only two manufacturing regions (St. Petersburg and Moscow Oblast) have increased their respective shares in national industrial production compared to pre-default figures.

Table 1. Shares of major regions in industrial production (percentages)

Region Share in industrial production in 2002

Region Share in industrial production in 1997

1. Tyumen Oblast 13.3 1. Tyumen Oblast 9.1 2. Moscow City 6.9 2. Moscow City 6.9 3. Sverdlovsk Oblast 4.8 3. Sverdlovsk Oblast 4.6 4. Samara Oblast 4.7 4. Samara Oblast 4.0 5. Moscow Oblast 4.5 5. Chelyabinsk Oblast 3.8 6. Tatar Republic 4.3 6. Bashkir Republic 3.7 7. St. Petersburg 4.0 7. Tatar Republic 3.5 8. Krasnoyarsk Territory 3.8 8. Krasnoyarsk Territory 3.5 9. Chelyabinsk Oblast 3.8 9. Nizhny Novgorod Oblast 2.9 10. Bashkir Republic 3.2 10. Kemerovo Oblast 2.9 Subtotal for 10 RF subjects 53.3 Subtotal for 10 RF subjects 44.9 11. Nizhny Novgorod Oblast 2.8 11. Moscow Oblast 2.9 12. Kemerovo Oblast 2.8 12. Perm Oblast 2.7 13. Perm Oblast 2.8 13. City of St. Petersburg 2.7 14. Irkutsk Oblast 2.3 14. Irkutsk Oblast 2.2 15. Vologda Oblast 2.0 15. Vologda Oblast 1.8 Subtotal for 15 RF subjects 66.0 Subtotal for 15 RF subjects 57.2

* does not include additional estimates to reflect informal activities

Changes in spatial structure of industry in favor of regions specializing in extraction of natural resources for export have become permanent. While population is leaving northern parts of Russia migrating to warmer regions, Russian industry on the contrary is becoming "colder" because of natural resource location patterns. Employment dynamics is in line with the trend for concentration of national industry in

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the export-oriented and raw materials-oriented regions of the Urals and Siberia. At the same time, de-industrialization of employment in southern regions and post-industrial transformation of major cities continues. 3.2.2 Transformation of the Service Sector: Concentration into the Federal Cities

Lack of major agglomerations due to restrictions imposed on urban growth in the Soviet era has become one of the barriers inhibiting real "tertialization" of employment in Russia's peripheral regions. In the south of Russia and Oblasts in the Central European Russia the growth of employment in the services sector has been following the contingency model thus far with employment in retail trade prevailing. Other federal districts demonstrate similar dynamics, albeit the change is slower. The more important is the role of exporting industries for the economy of a region, the slower is structural transformation of the services sector and employment in it.

Globalization of the world economy promotes fast service sector development. In 1990s the share of service sector reached 49-52% of Russia's GDP2 due to a substantial decline in industrial and agricultural sectors of economy. Real structural transition to post-industrial development is most evident in the federal cities with concentration of population, growth of income, higher demand for industrial and consumer services. Moscow has seen a substantial increase of employment in finance, insurance and banking. Moscow was the first to achieve maximal employment in the services sector. In major exporting regions industry is prevalent and the services sector is underdeveloped (accounting for 15-39% of GRP). Entrance of these raw material-producing and exporting regions to global market helped mitigate the decline caused by the crisis but this was achieved at the cost of a disproportionably large share of manufacturing industry in GRP and slow modernization of economy.

Similar tendencies were typical of oil-producing countries of the Gulf and Latin America in the 1970s and 1980s where the majority of governments eventually failed to overcome structural disproportions and achieve outstripping growth of their respective services sectors. These phenomena could be regarded as some examples of negative lock-in effects. This aspect will be discussed later in this section. 3.2.3 Agricultural Activity: the North-South Dualism

In agriculture, spatial concentration of agricultural productivity commenced much later while in the 1990s de-concentration trends caused by a range of factors were prevalent. The most important factor was bigger productivity decline in regions with more intensive agriculture that suffered more from an abrupt decrease in supplies of machinery and equipment, fertilizers and productivity of labor. The second factor was growing isolation of regional food markets. Regional barriers, restrictions on inter-regional exports, and poorly developed market infrastructure resulted in isolation of producers within the boundaries of regional markets and de-concentration of

2 World Bank research shows that official data is overstated (World Bank CEM-2004)

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agricultural production: while in 1991 ten leading regions accounted for 30% of agricultural production, by 1997 their share has reduced to 27%.

As the market developed and institutional barriers lowered, the situation began to improve. Regions with a more favorable climate for agriculture were faster to restore productivity since the late 1990s. In the years 2001-2002 ten leading regions accounted for more than 34% of Russia's agricultural production. Agricultural production followed population movement to concentrate in areas with a more favorable climate.

Since the late 1990s market transformation of the agricultural sector accelerates in areas adjacent to cities and the southern area of commercial grain production, while remote peripheral regions and areas with unfavorable climatic conditions suffer from aggravating degradation of the sector and marginalization of rural population. In the Southern and Central Federal Districts employment has grown by 7-8% in 1995-2001 while in Central Russia most growth was accounted for by the more agrarian Oblasts in the black soil area. In areas with marginal agricultural production, employment has reduced most in the Far East and in the Northwestern Federal District. Therefore agrarian production and agricultural workers concentrate in the area with most favorable natural and climatic conditions. Growing numbers of agricultural workers in southern areas of European Russia however does not stimulate productivity of labor. 3.2.4 Regional Specialization: Its Negative Lock-in Effects When trying to explain why some regions specializing in manufacturing industry are in stagnation and why the growth of tertiary sector in resource-mining regions is hampered, we should take the lock-in effect of economic activity in certain regions into consideration. One of the main principles of Soviet industrialization was regional specialization. Technical factors in administration of the socialist economy contributed to this policy, but it resulted in construction of many one-firm cities. The problem is that economic transition causes changes in industrial structure from manufacture-based one to service-oriented. This can lead to deterioration of one-firm cities, most of which specialize in the manufacturing sector. Soviet economic policy had historically given priorities to heavy industry and built up many machine-building cores. Although it contributed to a rapid growth of newly constructed cities in the early Soviet period, now in the transition processes some Russian cities are in serious stagnation.

Specialization itself has some positive effects on regional development. However, it can not sustain long-run growth because of demand constraints. One-firm city can not be a metropolis because its growth depends on the automobile market only. A decline in market demand for certain goods may stagnate regions specializing in production of those goods. Pursuing economies of scale and difficulties in administrating diversified industry stimulated regional specialization policy during the Soviet era. However, this has now become one of the obstacles to regional development. This phenomenon is an example of negative lock-in effects of economic agglomeration. The Soviet administration intended to build specialized cities to realize economies of scale and to control the industrial sector easily. The aim itself cannot be treated as meaningless one, but the industrial sector was insufficiently competitive and

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lost its market even domestically after the 1990s. In the region where only one large firm locates, there would be no other sources for capital accumulation; hence, the existence of large specialized firms has become the obstacle for reconstruction. This kind of problems will be discussed further in module 19. 3.2.5 The Issue of Cold: Legacy of the Soviet Union

Another outstanding characteristic of industrial location patterns in the former Soviet Union was that people flowed into colder regions from warmer ones and many big cities locate in very cold spots. According to mean January temperature, Russian cities occupy nine of the world 10 coldest cities with over one million people (Hill and Gaddy, 2003). Russia is a northern country in terms of its geographic location, spatial distribution of population and localization of industry. In most countries of the world population and industries have gradually concentrated in areas with a more favorable climate while in the 19th and 20th centuries Russia was developing eastern and northern regions with harsh climate but rich in mineral resources necessary for the national economy. Overall in Soviet times the population of the Far East has grown five-fold and of East Siberia, three-fold.

From the point of view of market economy, this situation resulted in a growth of economic costs but it should be kept in mind that in the 20th century, the "cost of the cold" issue was being ignored during the development of new regions with unfavorable climate. Long years of population movement to the North and East are ascribed to factors of military and strategic nature. In a geopolitically safe country such strategy could not be an option, while for the then Russia it was the only possibility. Inertial drive towards North and East survived in the 1960s through 1980s as Soviet economy remained heavily militarized and encapsulated and needed new resources.

As a result, Russia became a colder country than in the early 20th century. In Siberia, production costs are three to four times higher than in European Russia. The economy of Siberian cities and towns in the oil and gas producing regions is fairly effective, while in the cities where there is a substantial share of manufacturing industries especially defense industries, the economy demonstrates zero or even negative profitability. Introducing the principle of uniform distribution of production assets during the transition to a market economy has gravely affected these cities and towns, and high costs of production and remoteness of markets have manifested themselves. Therefore inefficient location of material and labor resources inherited from Soviet military and mobilization industrialization has become an obstacle to Russia's development during the transition period. Northern areas accounting for 80% of natural resource deposits and oil and gas production and over 60% of Russian export potential need a more effective development strategy.

Of course it is natural that mining industries locate in the Far North regions of Russia because industrial location could be critically affected by immobile factors such as natural resources. At the same time it is obvious that the development policy implemented during the Soviet era was inefficient due to the glut of labor supply in the Far North regions caused by policy-induced migration inflows (Kumo, 2003b). Not a

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few cities developed in the Far North regions during the Soviet era can be regarded as impediments because they give negative lock-in effects to regional economies. 4. Integration into the World Economy and the Russian Regions Economic system transition has resulted in noticeable concentration processes of economic activity into the federal city, Moscow, and rapid growth of resource-mining industries especially in West-Siberia regions. The effects of agglomeration economies described in section 2 may suggest that the process will head to increasing concentration in European areas. This may be confusing, but it is very natural that the existence of natural resources in Siberia gives positive effects on regional growth. To see more clearly how the location dynamics in Russia changes from dispersion to concentration under globalization, it may be better to examine the international economic relation of regions and the geographical distribution of high-tech based industry. Major forms of globalization are trans-boundary flow of capital (foreign investment), increasing openness of economy (foreign trade), development of global communications and information networks (Internet) and development of global cities, i.e. finance and economic centers influencing the entire world economy. Russian regions and cities demonstrate these forms of globalization in widely varying degrees and shows concentration processes of economic activity. 4.1 Foreign Direct Investment and Foreign Trade: Regional Polarization

Figure 4 Percentage shares of Russian Federation subject in FDI in 1996-2002

The volume of FDI has been small so far but its distribution within Russia is

highly graphical (see Figure 4). Over 1996-2002, nearly 50% of foreign direct investment went to the city of Moscow and Moscow Oblast; prior to default of 1998 Russia's capital city accounted for more than 60% of FDI. Concentration of investment in Moscow resulted in outstripping growth of new services (business and financial services) and modern consumer services; and stimulated change of consumption structure and way of life due to growing income of population. Since late 1990s, investment has been increasing in conveniently located regions (Leningrad Oblast and Krasnodar Territory) and among raw material producing regions, only in Sakhalin

39.1%

9.4% 9.2% 8.7%

4.1% 3.6% 2.6% 2.3% 2.2%

18.8% City of Moscow Moscow Oblast Sakhalin Island Krasnodar Territory City of St. Petersburg Leningrad Oblast Tyumen Oblast Samara Oblast Novosibirsk Oblast Other regions

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Oblast where PSA projects in oil production have been launched. Regional statistics of Russia's foreign trade is not quite adequate as a certain

part of exports is not recorded by region of production but by location of major producers' headquarters. Therefore the share of Moscow City in the structure of Russian exports is unusually high (25% in the year 2002) while the oil-producing Tyumen Oblast accounts for a mere 18%. Prevalence of raw materials increased spatial concentration of exports and nearly two-thirds of Russian exports is accounted for by 10 subjects of the Russian Federation.

Moscow City also accounts for the largest share of imports (35%) and sales of imported goods in Russian regions. In the year 2002 the federal cities (Moscow and Saint-Petersburg) accounted for nearly 50% of Russia's imports, and the top ten subjects of the Russian Federation including regions on the national border having a developed transport infrastructure, for more than 70% of imports.

Such superconcentration of trade and financial functions resulted in outstripping growth of employment in tertiary sector and incomes of Moscow City residents. Compared to Russia's capital, exporting regions offer few advantages as the growth of population incomes is confined to smaller groups of those employed in exporting industries and modernizing impact of globalization is less pronounced. 4.2 Information Technology: Dense Communication Networks in Large Cities

Information globalization in Russia is developing in the form of innovations' diffusion spreading through an urban hierarchy from major cities to smaller cities. According to Perfilyev (2003), prior to 1998 Internet users were largely concentrated in the cities of Moscow and St. Petersburg. Since 1999 Internet usage was spreading massively in major cities with a population of over 1 million people, and since late 2000, Internet access became common in cities with 500,000+ residents. Residents of the largest cities with a population of 1,000,000+ people and of major cities in exporting and foreign trade-oriented regions are the fastest in joining information globalization thanks to their higher incomes and outstripping modernization of their ways of life.

Central-peripheral hierarchy also manifests itself in distribution of mobile communications. According to Jason & Partners, in the year 2000 Moscow agglomeration accounted for 60% of mobile phone users and the city of St. Petersburg with Leningrad Oblast, for 11%. By mid-2003 the aggregate share of these two major urban agglomerations has reduced to 48% while the share of regional subscribers has increased from 29% to 52%. Coverage area has included regional capitals and cities with export-oriented industries where residents' incomes are higher. Despite the high rate of diffusion, development of global information and communication networks in Russian regions encounters real barriers in the form of low incomes and non-modernized ways of life of population. Residents of medium-sized and small cities and towns together with rural population have dropped out from the global information space and the gap between the central and peripheral regions is widening.

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4.3 Trends in Regional Disparities Economic liberalization resulted in the expansion of regional differentials in

Russia. The national economy is more concentrated than population: while ten most populated subjects of the Russian Federation account for approximately one-third of Russia's population, the ten subjects leading in economic terms jointly account for nearly 54% of aggregate Russian GRP (see Table 2). Over 1994-2001 the share of ten economic leaders has grown by nearly one-third but this increase is owing to Moscow City and Tyumen Oblast alone. Unlike major industrial regions, economic leaders are biased towards the European part Russia and Siberia is represented only by Tyumen Oblast and Krasnoyarsk Territory. Small in terms of population and poorly developed republics of Northern Caucasus and southern Siberia, and northern Oblasts in the Far East are nearly invisible in the economic map: the ten economic outsiders (excluding sparsely populated autonomous districts) account for a meager 1.2% of aggregate GRP.

Table 2. Percentage shares of major Russian regions in national GDP

2001 1994 1. City of Moscow 20.7 1. City of Moscow 10.2 2. Tyumen Oblast 10.4 2. Tyumen Oblast 6.3 3. City of St. Petersburg 3.5 3. Sverdlovsk Oblast 3.8 4. Moscow Oblast 3.4 4. Moscow Oblast 3.6 5. Krasnoyarsk Territory 3.0 5. City of St. Petersburg 3.2 6. Tatar Republic 2.8 6. Samara Oblast 3.2 7. Sverdlovsk Oblast 2.7 7. Krasnoyarsk Territory 3.0 8. Samara Oblast 2.6 8. Nizhny Novgorod Oblast 2.8 9. Bashkir Republic 2.4 9. Bashkir Republic 2.7 10. Krasnodar Territory 2.4 10. Chelyabinsk Oblast 2.7 Total for 10 regions 53.9 Total for 10 regions 41.5

In the year 2001, only 16 relatively prosperous subjects of the Russian

Federation have had a per capita GRP exceeding average national level (adjusted for cost of living in a given region). Leaders included federal cities and "open" export-oriented regions accounting for more than 25% of Russia's population. Most Russian regions demonstrate per capita GRP that is below average national level. Some 20 subjects have proven clear outsiders with less than 50% of average national per capita GRP: those are underdeveloped republics and districts, and imports substitution regions not included in global economic ties.

Per capita GRP allows comparison of regional economies but does not reflect real household consumption as a substantial percentage of regional product is re-distributed by the state. A better comparison is offered by the share of GRP consumed by the population of a given region. Actual final consumption of households in the national accounts system provides a less differentiated picture of regional disparities: adjusted for cost of living, the disparity between the "richest" and "poorest" subjects of the Russian Federation in the year 2001 amounted to 370% while this disparity expressed through GRP was 610%.

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4.4 Geographical Re-organization of Economic Activity in Russia As examined in previous sections, we can see concentration processes of economic activity into the European parts of Russia, especially in the federal city, Moscow. If we consider about export-oriented or resource-mining regions, the situation may seem to be confusing, as seen in section 3.2.1. The meaning of the first nature such as the location pattern of natural resources may, however, lose its importance in the long run in determining geographical distribution of industrial nodes; rather, we should consider such factors as agglomeration economies or circular causality of industrial location, which could be called as the second nature, when examining a possible spatial dynamics of economic structure in the future. Growth of the tertiary industry must reinforce concentration of economic activity. Regions specializing in import-substitution industry in peripheral areas would be stagnated because of their inferior transport conditions. As for exporting industries, they cannot be concentrated because natural resource location patterns affect critically on regional growth patterns. The main leading agglomeration center will be, needless to say, the Moscow city since we have no human recourses for other centers’ growth because of huge depopulation since the collapse of the Soviet Union. Moscow agglomeration will be the leading growing area at least for the decade of 2000-2010 due to migration from Russia’s regions and CIS countries.

This phenomenon partially means an adjustment process of inefficient regional economic policy implemented during the Soviet era. The cost of adjustment will, however, not be large. Rather we could gain from more efficient industrial location patterns. Problems will be localized in textile and machinery building one-firm cities and few machinery building regions. Benefits will be localized in the big urban agglomerations, exporting regions and seaport/boundary regions. As for the Russia as a whole the cost of adjustment is connected with the objective process of regional polarization started in the beginning of the 1990s. WTO accession seems to add slight polarizing effect only comparing with the objective process.

Open trade policy will affect all types of advanced regions and cities, and it is the main positive impact of WTO accession. Russian spatial development is getting more and more similar to all developing countries. The strongest are getting stronger, the weakest continue to stay backward (for details, see Module 19). Several specialized areas will show extraordinary economic growth. We can expect that the boundary seaport areas will jump up (Leningrad oblast, Krasnodar region etc). This process has already started from the end of the 1990s.

A clustering of activities in European Russia will be observed in the near future. Concentration of population in European Russia is going on. Spatial trends of economic activities are more complicated. In Russia economic activities depend on world market price on mineral recourses. As a results oil, gas and metal producing Siberian regions are growing faster after the end of the 1990s. The other growing regions are boundary seaport regions and big agglomerations located in European Russia.

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5. Concluding Remarks and Policy Implication The impacts of WTO accession vary from region to region. Geographical

factors play critical roles in characterizing regional economies. The federal cities, Moscow and Saint-Petersburg, are growing with tertialization, owing to their large market. People would vote with their feet which region is more desirable in a market economy. The meaning of exporting industry in each region would be magnified under the integration processes into the world economy. Regions which have such industries as those receiving large orders from exporting companies are in favorable situations. Natural resource mining centers also work well. Without some kind of policy implementation, peripheral regions without any natural resources and export industries must be stagnated and concentration of economic activity may be unavoidable. Regional diversity has been growing since the collapse of the Former Soviet Union. Open trade policy, which would be required after WTO accession, must reinforce these tendencies. Thus, each regional government should enforce measures for promoting certain industrial activities in its territory to avoid social tensions.

Implications for active policies are derived. For survival of Russian regions, division of functions by region is required and the adequate policy implementation is needed. Mining cities in the Far North regions should be supported and the assistance for introducing labor-saving technology would be desired. Because the living costs in cold regions are very high, it may be suitable for the federal government to promote people to migrate from northern regions to the warmer ones. Although developing transport networks will contribute to the realization of agglomeration economies, it must cost too much because of Russia’s vast territories. Thus, so far as millions of people live in remote cities, desired industrial composition should be examined to avoid high transport costs incurred when shipping goods from a city to the others. The scale of out-migration from the Far North regions is not small and in some cases it has been regarded as a problematic phenomenon in previous studies (Mikheeva, 2001). The emergence of out-migration from these northern areas should be regarded, however, as an outgrowth of the distortion accumulated during the Soviet era and as an inevitable event. The Far North regions without any natural resources did not have any foundation for supporting inhabitants, and the out-migration from there seemed to be quite natural.

Regional disparities are conditioned by objective factors and therefore possess of a stable nature. As a result, reducing these disparities requires redistribution of financial resources on a massive scale. The experience of 1990s has demonstrated that government's inability to reduce regional disparities leads to growing social and political tensions. Early in the 21st century the volume of interregional redistribution has increased with a bias towards "outsiders" i.e. under-urbanized and economically "closed" republics and autonomous districts most of which are located in the southern and eastern areas of Russia. The new policy however has several negative outcomes. First, redistribution does not encourage regional development based on region's resources. Second, economic growth of most advanced regions and the entire country is impeded. The search of most adequate level and instruments of redistribution constitutes

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a highly complex economic and management task that remains to be resolved by the Russian Federation. References

Country Economic Memorandum (CEM) for the Russian Federation (2004), From Transition To Development, the Document of the World Bank. (Draft)

Fujita, M. (1996), On the Self-Organization and Evolution of Economic Geography, Japanese Economic Review, vol.47, no.1, pp.34-61.

Fujita, M., P. Krugman and T. Mori (1999), On the Evolution of Hierarchical Urban Systems, European Economic Review, vol.43, no.1, pp.209-251.

Fujita, M., P. Krugman and A.J. Venables (1999), The Spatial Economy: Cities, Regions and International Trade, MIT Press, Cambridge MA.

Fujita, M. (2002), Land, Infrastructure and Transport Policy from a Viewpoint of the Spatial Economics, Institute of Land, Infrastructure and Transport, Tokyo.

Fujita, M. and P. Krugman (2004), The New Economic Geography: Past, Present and the Future, Papers in Regional Science, vol.83, pp.139-164.

Fujita, M., (2004), Industrial Clustering Policies from a Viewpoint of the Spatial Economics, in Ishikura, Y., M. Fujita, N. Maeda, H.Kanei and A.Yamazaki, Industrial Clustering Strategy in Japan, Yu-hikaku, Tokyo, Chapter 6.

Hill, F. and C. Gaddy (2003), The Siberian Curse, The Brookings Institution, Washington D.C.

Kumo, K. (2003a), Migration and Regional Development in the Soviet Union and Russia: A Geographical Approach, Beck Publishers Russia, Moscow.

Kumo, K. (2003b), Migration and Regional Economies in Russia: Recent Trends and Their Backgrounds, Far Eastern Studies, vol.2, pp.1-14.

Mikheeva, N.N. (2001), Dokhody Naseleniya Dal’nevostochnykh Regionov: Sovremennye Tendentsii, Comprehensive Analysis on the Russian Far East, Russo- Japanese Far Eastern Academic Forum, pp.133-141.

Nefedova T.G. and A.I. Travish. "Strong" and "weak" cities of Russia, Growth poles and centers in regional development, Edited by Yu.G. Lipets., Moscow, IG RAN publishers, 1998, pp. 136-143.

Perfilyev Yu. Russian Internet Space: Development and Structure. Moscow, Gardariki publishers, 2003.

Travish A.I.. Geography of Russian crises, Izvestia RAN. Geography series, 1999. vol.2, pp. 7-16

Vardomsky L.V.. Issues of regional development in Russia under globalization , Russian regions and the Center: co-operation in economic space, Edited by Yu.G. Lipets, Moscow, IG RAN publishers, 2000, pp. 13-17.

Venables, A. and Limao, N., Geographical disadvantage: a Heckscher–Ohlin–von Thunen model of international specialisation, Journal of International Economics, vol.58, 2002, pp.239-263.

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Appendix 1 Transport Costs: The Source of Regional Change

The effects of transport costs on spatial economy are rather complex. For

simplicity we assume that transport costs among cities are extremely high. If some activities such as agricultural production and their workers (demands) were tied in a certain area and fixed at the initial location, other economic activities (manufacturing, services etc.) should also be dispersed in accordance with the demand of land-intensive activity; hence, agglomeration forces are not realized. When transport costs decreased gradually, however, the circular causation described in Figure 1 would start working and cities would be formed. The larger agglomeration would supply more variety of goods and a core-periphery type spatial system might be formed. Thus, if transport costs decreases further, more people and firms would be gravitated towards a larger city. More decreases in transport costs attract more people to the larger city. However, if transport costs further decrease, other factors must be considered: in a large agglomeration center, wage rates and land rent would become high. That is, congestion costs should be taken into account. Therefore manufacturing activity might start relocating to peripheral areas in the country. The effects of decrease in transport costs on economic activity vary from industry to industry. It depends on the relative transport cost intensity across industries; that is, if transport costs were low enough, some relatively footloose industries could relocate their factories to remote regions or overseas in order to avoid congestion costs incurred (Venables and Limao, 2002).

This could imply, for example, the importance of the liberalization of services and telecommunications for the welfare of remote regions. Small information- technology oriented industries are now growing in Moscow and in Saint-Petersburg as subcontractors of high-tech industries in Japan, the European Union and the United States. In the future, Akademgorodok in Novosibirsk or other Siberian cities might have a bright future by specializing in such I.T.-oriented industries.

One may think that during the Soviet period the transport costs were low and in the 90s they jumped up. But artificially low freight rates in the former Soviet Union did not contribute to concentration processes of economic activity in the USSR because they were artificially high in other cases, as seen in restrictions policy on population inflows into large cities.

The effects of transport costs described above would, however, be realized in the long-term spatial processes. Transport costs themselves have been decreasing historically. WTO accession implies the decrease of cross-border transport costs. In addition, each region must not apply its own trade policy, and this may lead to decrease of interregional transaction costs.

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Appendix II The Market Potential Curve: Urban Systems and the Core-periphery Structure

Decrease in transport costs implies also the widening of market areas of industries. Again, transport costs have been decreasing throughout the human history, and we have to point out that the economic integration process itself means decreases in transport costs in a broad sense.

market potential = relative profitability

A B C 0 1

2 .3

1: dairy necessities; 2: differentiated goods; 3: highly differentiated goods Figure A2. The Potential Curve (Fujita, 2002)

What will happen if the market area of an industry widens? A useful concept is ‘the market potential curve’ utilized in the new economic geography. The potential curve of an industry represents the relative profitability of each location for firms in that industry. If the value is less than unity at a location, no firm will locate at that location. An example is presented in Figure 2. A megalopolis is supposed to exist at location A. There also exist inhabitants on the horizontal line, but not densely. Let us assume that there are three goods in this world. Good 1 is one of daily necessities (bread), good 2 is comparatively differentiated one (high price clothing), and good 3 is a highly differentiated good (international banking services). The potential curve of good 1 in Figure A2 means as follows: in city A there already exist many bakeries. If a new bakery tries to enter the market, and if it does not choose location A in order to avoid competition, the new bakery will choose a location far from city A because a limited but certain size of the market exists in the hinterland.

That is, city A is a densely-populated mega city, and the accessibility to this big market diminishes rapidly if the firm moves away from city A. Therefore the market potential curve of good 1 drawn from the city A to the right side shows a downward slope at the initial stage. However, in the area far enough from city A, consumers have a poor accessibility to the bakeries in city A. Thus, people living far away from city A prefer to get bread from adjacent bakeries; hence, the market potential in such an area will be improved for the bakery which tries newly to enter the market. Thus, the potential curve of good 1, which initially has a downward slope, shows an upturn. In particular, at the location B or city B, it is possible for new firms to survive. The shape of the potential curves is different from goods to goods according to their characteristics. Shops dealing with non-differentiated goods such as bread have

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only small market areas. Even consumers who buy bread at the nearest bakery, however, would be willing to go to a distant department store to buy high-price clothing. The market area of such differentiated goods is larger than that of daily necessities. If another department store tries to enter and survive, it has to locate sufficiently apart from city A, much far away from the new bakery at city B. Thus, the potential curve of the differentiated good 2 shows an upward slope at a greater distance from city A than that of good 1, and it reaches the zero-profit level only at city C. Highly differentiated goods (for example, international banking services) would attract even those people who live far away from city A. Hence, the potential curve of such goods is monotonously diminishing, and the industry can locate only at the core, the city A. If the transport cost decreases because of improved transport networks and transport technologies, the market area of firms providing good 1 in city A would become larger. Improvement in accessibility enables consumers locating far from city A to buy good 1 at city A. Then a bakery which tries to enter the market has to locate at an outer point of city B in order to avoid competition with firms in city A. This means that some business functions of city B are absorbed by city A, and small cities near the core city may decline. Figure A2 also suggests that cities in an economy tend to form a hierarchical system in a self-organizing manner. The core city has most critical functions of the economy, providing all types of goods, while the second-order city provides good 1 and good 2, and the third-order city provides only good 1. In other words, this self-organization process of a hierarchical urban system will lead to a core-periphery pattern of industrial location (Fujita, Krugman and Mori, 1999).

The theoretical insight above provides an explanation to the concentration of economic activities in Moscow and its surrounding areas, and to underdevelopment in Central Asian states or Siberia. Moscow, the most populated city, can be regarded as the core and other regions far away from Moscow as peripheral areas. The same core-periphery patterns exist on the regional level, the biggest cities – regional centers concentrate economic activities and smaller ones are peripheral areas.