Mobilization à la russe

20.01.2014 — Analysis

A new plan has been adopted in Russia to mobilize the economy. It provides for a dramatic increase in the production of military equipment, in case of war. It also anticipates the introduction of modern production lines at companies that are part of the military-industrial complex. Experts are convinced that the new rules for allocating state defense contracts, which went into effect in 2014, will make it possible for manufacturing to modernize. But, as this columnist for RusBusinessNews has determined, this is not an easy process: the funding for equipment upgrades is shrinking and surplus capacity still exists. But here's the biggest problem: instead of modernizing outdated businesses, our domestic manufacturing potential is being destroyed.

The defense doctrine that was in effect in Russia until 2014 assumed that manufacturing capacity would be preserved in case of an all-out war. Defense-industry companies maintained surplus capacity at their own expense, which they were required to renew periodically. If the firms failed to meet the deadlines for upgrades, the state (which purchased almost no weapons or equipment in the 1990s) fined them mercilessly. This practice siphoned cash from the industry and prevented businesses from engaging in research and development work.

When in 2011 there were signs that the global economic space would be forcibly carved up once again, the Russian authorities felt that under the current circumstances, it was quality, not quantity that would be needed to resist an adversary. And so a plan to create flexible, high-tech manufacturing was announced. Russian Deputy Prime Minister Dmitry Rogozin confirms that the new mobilization plan has freed over 800 businesses from this unnecessary burden. The facilities that had been mothballed, to preserve them "just in case of nuclear war," may now be used to produce other goods. And the decision has been made to use high-power equipment to shore up the country's defense capabilities, which will allow for a dramatic increase in output in the event of an emergency.

Federal authorities ordered the governors to adopt regional mobilization plans in the next six months. At the same time, state regulation of prices was introduced on products supplied under defense contracts. There have been attempts to make the pricing procedure as transparent as possible: the government has set target prices, the profit margin has been restricted (20% of in-house costs and 1% of the expenses for the services of third-party organizations), and a maximum price for state contracts has been identified. Officials hope that the allocation of defense contracts under the new law will help accelerate equipment upgrades at defense companies, and will accordingly allow for the implementation of a new defense doctrine.

The regions have already felt the paradigm shift. According to Vladimir Kukarskikh, the executive director of the Union of Defense-Industry Companies of the Sverdlovsk region, surplus capacity is being reduced, the penalties for failure to meet the deadlines for updating mobilization capacity have been eliminated, and the profit margin for businesses is being increased. However, it was difficult for him to say whether these processes are helping to accelerate the modernization of outdated facilities: "Yes, equipment is being updated, but I have no exact data at present ... I think it's meaningless to talk about modernization without having the numbers in front of you. It's not a simple thing - state funding is being reduced for a number of companies, although I admit it's not clear to what extent. And questions remain regarding the pricing methodology. We're not satisfied with some of the provisions in the new law, and we'll discuss that at the general meeting of businesses in this industry."

Sergei Novoseltsev, the general director of Ekaterinburg's Radio Equipment Plant, OJSC, suggests that the military-industrial complex can expect another round of more stringent pricing policies - not the discretionary methods that were practiced in the days of former Defense Minister Anatoly Serdyukov, but more intelligent strategies. In this regard, he is convinced that the new law on state defense orders will not help modernization efforts. Russian radio electronics has fallen far behind its foreign competitors in recent decades, and it won't be possible to bridge that gap without massive investment. The Ministry of Defense only finances major R&D projects, so most businesses have to develop at their own expense. The established profit margin of 20% severely hamstrings them: Sergei Novoseltsev claims at that such a level of profits they can manage to do no more than repair the roofs of their facilities.

 In practice, most plants have a realistic profit margin of less than 20%. Nikolai Kozlov, the first deputy general director of Plant No. 9, OJSC, claims that the profit margin does not normally exceed 12%, because all the players in the production chain vigorously defend their own interests. That figure is sufficient for a business that produces intermediate goods (artillery) to buy new equipment. But it is much more difficult for the plants that assemble final products.

Azret Bekkiev, the general director of Sozvezdie Concern, OJSC, commented at one of the meetings of the defense-industry committee at the Russian Engineering Union, saying that businesses that assemble products for the aviation industry incur costs not only for their assembly work, but also for storage and retrieval logistics, warranty obligations, insurance, etc. And they are forced to do so for 1% of the profits, since the lion's share of the work and services (up to 75%) are produced by allied companies. It is extremely difficult for them to modernize the headquarters that produce the final products using their own profits, and targeted federal programs are unlikely to help.

Sergei Novoseltsev claims that the country's current defense capacity is still in excess of what is needed to carry out the tasks that the government assigns the defense industry. Thus the money is spread among the businesses without resulting in any noticeable technological breakthroughs. According to him, it is not possible to modernize using the targeted programs. Businesses have to use their own funds to update equipment and must train their own staff. To do this they need to become competitive, mobile, and, of course, highly profitable. The efforts of both the military-industrial complex, as well as the state, should be aimed at the creation of good-quality, highly effective products.

But this is not what we see in practice. Ural Automotive Plant (Miass, Chelyabinsk region) was established in its day to produce military trucks, but far from developing, it is obviously deteriorating: its production capabilities are diminishing, its structural divisions are being eliminated, and its design work is being devalued. This is because for two years now the plant has had virtually no state defense orders, except for the internal military forces who ordered a few dozen vehicles.

Sources from the southern Urals-based business argue that this is happening because KamAZ, OJSC has taken over all the military orders, and that company's shareholders include not only Russian manufacturing holding companies, but also foreign companies. KamAZ's management has such impressive lobbying potential - or to be more precise, financial potential - that it was possible to pull Defense Minister Sergei Shoigu over to their side.

This wouldn't matter (at the current levels of state orders, it might not actually be possible to provide work for two different plants), but the problem is that there are almost no domestic design projects at KamAZ, according to experts. Those do exist at Ural Automotive Plant, but that factory requires intensive updates. But instead of improving its own technologies, the plant's owner Oleg Deripaska is taking that business down the path traveled by KamAZ, by borrowing foreign know-how.

No one wants to pick a fight with an oligarch: Federal Security Service staffers are writing letters to Moscow, claiming that in accordance with the defense doctrine, it is not permitted to equip the army using technology that has only been licensed, but nothing is being resolved. According to forecasts, in the near future there will be facilities at the military-truck plant that either produce components or assemble foreign automobiles. So what happens if there's a war tomorrow?

Vladimir Terletsky