Characteristics of a Pro-SME Legal and Regulatory Framework and International Best Practices for Good Governance of Competitive Markets Scott Jacobs, Managing Director Jacobs and Associates Creating A Conducive Legal & Regulatory Framework for Small and Medium Enterprise Development in Russia A Policy Dialogue Workshop, St. Petersburg, Russia September 14-16,

2 SMEs will be the engine of growth in Russia in the medium-term Economic growth in Russia will depend on private sector growth fuelled by domestic entrepreneurs, mostly in the SME services sector, during the transition when large and state-owned companies are restructuring. New jobs must be created as restructuring deepens to avoid increases in unemployment, and to reduce the risk that poverty and income inequality will continue to increase in Russia.

3 The most important part of SME is the “E”: ENTERPRISE SME development depends on how well markets function in the domestic economy in creating opportunities for wealth. SMEs are like all private enterprises, big or small. They need a stable and transparent market environment to invest, create jobs, and take risks. SME-specific support policies will not work if market competition does not work.

4 Regulatory and legal frameworks are still a major constraint on growth in Russia The domestic policy environment continues to be hostile to SME start-ups, investment, and innovation. Structural and economic policy reforms have accelerated in the Russian Federation. But reforms to date have barely changed most regulatory constraints affecting private sector activity. Wider and faster reform of the regulatory framework to stimulate private sector investment and create jobs is urgent.

5 Enterprises produce wealth within well- regulated markets Creating more businesses is important But real aim of reform is to create competitive markets that reward value, re-allocate resources, and adapt to changing opportunities and risks. Changes in ownership are not enough. Poor and inadequate regulatory structures permit abuses and corruption to flourish in emerging markets, undermine investor and consumer confidence, and destroy rather than create economic value. This can be seen in utilities in Russia, where prices are increasing but service quality is not.

6 Example: Over-regulation in Russian technical standards In Russia until recently, there was mandatory certification for 60,000 Soviet-era standards, affecting about 90% of products. These rigid standards reduced innovation, created trade barriers, increased production costs, reduced product quality, and boosted corruption. Federal law no. 184-fz of December 27, 2002 on technical regulation will reduce these to transparent sectoral regulations limited to health, safety, and environmental issues. All other standards will be market-driven.

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8 The legal framework for markets (1) Market scope. The scope for private sector activity should be broad and economy-wide. State companies and monopolies should be restricted to very few areas. Property rights. Markets need a clear definition of property rights that can be exclusively enjoyed and transferred. Justice system must efficiently protect those rights. Factor inputs. Businesses require inputs – capital, labor, and land. Functioning markets are needed in all three areas.

9 The legal framework for markets (2) Market behavior. Rules for market behavior should be provided by economy-wide frameworks for competition policy and corporate governance. Market openness. Barriers to trade and investment should be eliminated, and international agreements, rules, and principles implemented. Infrastructure services. Rules-based competition in telecom, energy, and transport is needed to drive investment and improve services. Capable public sector. Reform of state organs is necessary to establish the rule of law and improve market governance capacities.

10 Five characteristics needed in Russia’s modern regulatory system  Security (legal security, respect for market principles, low risk of “sudden” regulation)  Transparency (easy access, openness, reduced corruption)  Legitimacy (must protect safety, health, environment, consumers, public interests)  Efficiency (low-cost rules, orderly and timely decisions, move swiftly to meet market needs)  Expertise (regulators must understand complex markets and technologies)

11 Reducing regulatory risk is key  Regulatory risk reduces both the quantity of investment and the value of investment.  The more uncertain and risky is the legal/administrative environment in which economic activity occurs, the more likely it is that aggressive rent seeking and short-term profit taking will replace longer-term investment in a competitive climate.

12 A multifaceted reform strategy Regulatory reform in all its aspects is needed – deregulation, re-regulation, simplification, and institution building. Actions should include: Adopt international norms of rule-based governance Eliminate barriers to entry and unnecessary regulatory costs Strengthen regulatory protections and enforcement Strengthen legal institutions that protect property rights and market competition against abuses Reduce corruption in administrative decisions and inspections Redefine the role of the state, revise its procedures and institutions, and strengthen its regulatory capacities

13 Guiding principles for good regulation: The OECD Checklist for Regulatory Quality 1. Is the problem correctly defined? 2.Is government action justified? 3. Is regulation the best form of government action? 4.Is there a legal basis for regulation? 5.What is the appropriate level (or levels) of government for this action? 6.Do the benefits of regulation justify the costs? 7.Is the distribution of effects across society transparent? 8.Is the regulation clear, consistent, comprehensible and accessible to users? 9.Have all interested parties had the opportunity to present their views? 10.How will compliance be achieved?

14 Strategies are needed to improve the varieties of business regulation… Economic regulations –Barriers to entry and exit, monopolies, pricing regulations, restrictions on hiring and firing Social regulations –Safety and health, environmental protection, workplace conditions, consumer protection, technical product standards Government formalities and red tape –Licenses, permits, approvals, certificates, inspections

15 …and the stock and flow of rules Reviewing and revising the large body of laws, rules, and formalities that have built up over years. These rules are often inefficient, outdated, and inconsistent with market principles and the role of the state in a market economy. Creating new disciplines and capacities in the machinery of government to ensure that the continuing stream of laws and regulations is drafted with understanding of market needs and impacts, and through transparent and consultative processes.

16 Regulatory problems will continue in the foreseeable future… Legal and regulatory inefficiencies and risks will be high in Russia for the foreseeable future. Some regulatory problems are purely transitional issues, normal during rapid change to a market system, but other problems are structural, due to institutional weaknesses, improper roles and structure of the state, legacies from socialism, and poor human skills.

17 …but, with the right strategy, Russia could rapidly improve its regulatory framework A sustained action program should: Start promptly and focus on concrete results, Enjoy political commitment, Adopt international benchmarks and a range of tools proven in other countries facing similar problems, Invest in institutional capacities and human resources in the public sector. Such a program is ambitious, but not unprecedented, as demonstrated by experiences in other countries.