Subsidies Without Reforms Are Money Down the Drain

Inflation, the exchange rate and interest rates are very closely interlinked.

Managing these three variables is extremely difficult, but there are still fundamentals on which all three depend heavily.

First, inflation can fall only if supply expands. The greater the competition, the lower the inflation.

Second, competitiveness depends on the cost of producing a good, work or service, or on its uniqueness. Cost depends on labor productivity; uniqueness depends on the development of civil society and on education. Labor productivity depends on education and transaction costs. Transaction costs, in turn, depend on a country's infrastructure and investment climate.

To raise labor productivity, we need good infrastructure, good education and a good investment climate. The investment climate depends on well-functioning laws, a good judicial system, a good tax system, high-quality supervision and sound monetary policy.

The education system depends on many factors, which deserve separate treatment.

If we build the right investment climate, invest in education and develop civil society, that will lay the foundation for growth in labor productivity and for the creation of unique products.

In mass production, it is very hard for Kazakhstan to compete with large countries such as Russia and China.

Only the right investment climate and well-educated people will allow us to find, through the market, the niches where we could be leaders, and to build a sustainable economy.

One can go into further detail, but I believe these are the areas that need to be developed.

Unfortunately, there are no reforms that deliver instant results. Any drawdown of savings and reserves will only lead to problems down the road. Any qualitative change takes time and patience.

Now, on the exchange rate and interest rates. High inflation leads to high interest rates, because in the short term interest rates are an effective mechanism for restraining inflation. High inflation also raises the cost of goods produced in the country. So if inflation is lower in another country, then, with a stable exchange rate, imported goods become cheaper in the national currency. The exchange rate of the national currency therefore acts as the adjusting variable that equalizes the prices of local and imported goods. This mechanism cannot be regulated manually; only the market can do it. What needs to change is the foundation that determines labor productivity and the ability to offer unique products.

Manual mechanisms for holding the exchange rate can also give rise to various carry trades: with a fixed exchange rate and differing interest rates, foreign counterparties will always want to earn from local interest rates, since currency risk is minimized. Of course, this works only for a time, and if the exchange rate is not floating, imbalances will build up and eventually lead to abrupt devaluations.

Kazakhstan is part of the Common Economic Space, and it is clear that economies with roughly similar structures will not complement one another but compete with one another, which is exactly what has happened. Russia has established mass production and has better-quality education, so it is very hard for us to compete with it, and that is why we see imports from Russia growing. Closing the market to Russia is difficult for us, so the only option is to make ourselves more competitive, and that can be done only by raising labor productivity and creating unique goods.

Today we are trying to solve problems with monetary measures: subsidizing interest rates and investment and providing liquidity. But in doing so we are not creating high-margin goods or unique services and works; we are mostly creating imbalances.