30 September, 2015
IBS Group President Anatoly Karachinsky describes why Russia needs to increase high-tech exports, and how it should be done
Author – IBS Group President
The ‘Technological Renaissance’ series is a joint initiative with the online newspaper Vedomosti.
We need to fulfill one strategic objective: increasing our exports of products to the global IT market, and proportionately reducing our export of intellect, or “brain drain.” This would set off a new wave of Russian IT giants marketing their products in the global arena. We begin with the obvious: Russia must see itself as a country competing with many others to attract high-tech exporters.
Today we are experiencing a true technological revolution. Three decades ago, Microsoft had a monopoly on the IT market. Now two more companies, Apple and Google, are building their own systems. We used to live with client-server architecture. These days, computing power, data storage, and services are gradually becoming cloud-based. We used to have personal computers, and now we have mobile devices: phones, tablets, and watches. We use maps and navigation systems installed right in our cars. Computers are increasingly fulfilling the functions of TVs and many other electronics. We already communicate with them in a common language, and we are witnessing the appearance of artificial intelligence. Robots are no longer characters in sci-fi fantasy novels – they’re sold in stores. All of these rapid advances have one thing in common: software development in unprecedented leaps and bounds. Moreover, the use of clouds instead of servers, and of mobile devices instead of computers, means that the majority of software developed over the last 20 years needs to be rewritten. In the current market, some countries will build huge multi-billion-dollar IT companies, while others will simply provide them with programmers.
For now, it seems Russia is playing the latter role brilliantly. There is an enormous global demand for programmers: The US is short by nearly 600,000, and Europe – almost 500,000. In the US and in Europe, 20 or 30 years ago, it was popular to go to school to become a lawyer, doctor, financier, or manager. Engineers didn’t make much, and at that point there had been no success stories or billionaires like Bill Gates, Larry Ellison, Sergey Brin, Larry Page, and Mark Zuckerburg. Becoming an engineer was considered a poor career choice that most families couldn’t support.
By contrast, in the USSR an education in engineering was always considered highly prestigious. The principles of the Soviet education system, built in the 1930s on a foundation of pure rather than applied science, were unique: We were always taught mathematics and physics, but we were never taught how to practically apply that knowledge. On the other hand, the Anglo-Saxon system, built on case models, teaches how to act in textbook scenarios and solve textbook problems. This is good for management, which is why management culture in the West flourishes.
We were never taught in that way; recent graduates would struggle to understand how to apply the knowledge they had acquired. Many of us can recall what we were told on our first day at a company: “Forget everything you were taught.” We brought up creative people who don’t shy away from problems that are not clear-cut and are willing to identify and apply complex solutions. In management, the same situations require the same solutions. But an engineer attempts to discover new ones. Therein lies the essence of innovation: constantly seeking new solutions, which sometimes end up being better than the old ones.
This creative spirit spawned the school of Russian programming. But can we be good programmers on a larger scale? Can we create mass-produced products instead of custom-made ones? The examples are few, but they exist: Yandex, ABBYY, mail.ru, Kaspersky Lab, and Luxoft all make world-class products in high demand. A mass phenomenon has not come about, though it could have in the past decade. Today, Russia could have $30-40 billion in software exports per year. For this to happen, Russia would have to be a slightly different country, providing incentives for the development of export-oriented smart companies. Many different nations – from Canada and Switzerland to Poland, the Czech Republic, and Romania – are helping such startups by giving them benefits, grants, and administrative support.
It’s worth nothing that even among Russia’s IT leaders, only a few have gone public. Elsewhere in the world, successful companies strive for openness. If you look at the tech markets in America, Europe, China, and Japan, their tech companies are public, making not only their founders rich, but also their employees. This gives them access to capital, which is essential for contemporary technological breakthroughs: It allows companies to forego profits in the short run while getting their technology up and running. (Elon Musk of Tesla Motors and SpaceX is a great example.) But going public also has its costs. For example, as soon as Apple does anything wrong, a hundred analysts are blogging about it. Public companies are on stage, in the spotlight, and they can’t hide anything. If you release a new product or service, you have to declare it, and in two quarters you have to announce how much you sold.
Competition in the technology business, comprised of private companies, is built upon this transparency. In the past 40 to 50 years we’ve seen many attempts, in China, and even in Germany, to develop the IT market by circumventing Competition law – but it isn’t working. We went through the same thing under Soviet power, when the state lost its technology competition. The USSR produced underperforming computing machines that had bad software, despite the number of top-notch programmers!
Private companies are the main movers of the technology market. The role of the government is to ensure a level playing field for everyone. Companies should not compete for administrative resources; rather, they should compete in business performance, which in turn leads to state prosperity. Without healthy competition, the state turns from prosperous to poor, blaming its poverty on the machinations of its enemies. A level playing field includes an independent judiciary that solves conflicts in business.
More than government assistance, the market needs a specific strategy, an understanding of what the state wants in the near and distant future. Even a ten-year government strategy would enable the market to have a long-term plan and stable demand. Above all else, it would create a nurturing environment where our own Googles could emerge. We need to develop our competitive strengths, such as stimulating the growth of software exports and supporting export companies.
Only this would be profitable for the state. A typical example is India, which went from making $20 billion in software exports in the early 2000s to making about $120 billion now, and software exports have become the catalyst for advancing other technologies. It’s important to note that approximately 75% of the profits from oil exports are spent on production costs. We build roads in the North and in Siberia, settle people in oil mining districts, build cities and so on, all for the sake of producing the next barrel of oil, which offers nothing more to the economy than another barrel of oil. What’s worse, when an oil well dries up, its infrastructure becomes useless.
Whereas in IT, as in other intellectual export industries, earnings are spent primarily on salaries, which make up about 80% of every dollar made from export. And salaries spell consumption, a key driver of the economy. Salaries buy apartments, cars, and education. When there are lots of consumers, all of these local expenditures develop the economy.
That is to say, that IT export earnings per dollar in terms of salary are 5 to 6 times greater than in the oil business. This means that exported Indian software when converted to salaries is worth about $600 billion of exported oil (today we have about $350 billion). India’s economy gains more from software exports than we do from exporting oil and gas!
We should be stimulating high-tech exports, but it seems that instead the new catch-phrase has become import substitution. Conversations about reversing income tax exemptions for IT companies exporting software have resumed. And it’s obvious what’s going to happen: Canceling the benefits for social security contributions will lead to unemployment in the tech sector. A Russian programmer will cost 30% more than a Ukrainian, Indian, Polish, or Vietnamese one. These countries understand the value of high-tech exports and are in a competitive struggle to ensure such businesses thrive within their borders.
It would be naive to reverse the IT tax exemptions in the hope that budget revenues will increase as a result. Considering that in this country about 40,000 programmers contribute about $300–400 million in taxes and about $2.5 billion in export revenues, the budget would lose a significant portion of this revenue because there would be fewer employees paying taxes.
A wise strategy for Russia has been and remains developing technology exports in our strongest industries, or in those with the most potential. When you are successful in the global market, you develop a keen competence which you can apply in the domestic market. Eventually, Chinese exports spurred domestic consumption: 15 years ago, almost all their high-tech goods were being exported, and now over 50% are sold domestically. Domestic markets can be developed using international markets, but not the other way around.
Right now, the financial success of a business depends on administrative resources and government, and it remains tied to the beneficiary. If this person leaves the business, it means the business loses government assistance. Our most successful companies are the ones belonging to people with famous last names. If tomorrow that person were to sell the company and resign, the company would swiftly lose steam.
This brings us back to the issue of business transparency and the favorable rules of the game. If a company pays its employees under the table, it can’t attract money to develop, not to mention release an IPO.
Business and the nation actually want the same things: for all companies to be transparent, pay the same taxes, and have equal opportunities. Then we wouldn’t have a deficit in export-oriented large-scale technology businesses with long-term strategies that attract investments.