'We'll Have to Struggle for Even 1.5%-2.5% Growth'

At the latest plenary session of the XVII April International Academic Conference, participants discussed a thought-provoking new paper called The Russian Economy Before the Long Transitionby Natalia Akindinova, Yaroslav Kuzminov, and Evgeny Yasin of the Higher School of Economics. 

How the Russian Economy Is Different

Current talks on economic development focus too much on the upcoming two or three years. But according to HSE Rector Yaroslav Kuzminov, it is helpful to look at ‘where Russia is as a whole, as well as at the institutions that have been created here and will continue to function in the long-term perspective.’

As for income per capita, Russia is in the same group as several Central European countries and far ahead of China. But Russia differs substantially from former socialist countries. For example, Russia’s income inequality level is much higher than in Poland or the Czech Republic, and it creates a ‘different subjective feeling’ among the Russian population about its wealth.

What also sets Russia apart is the high level of inflation in the country. Throughout the 2000s, for example, inflation fell below 7% on just three occasions. Russia is also far behind its neighbours in terms of the country’s ability to compete on key markets. This is largely due to the large-scale nationalisation of the economy. The government’s share of the ten largest Russian companies surpassed the 80% mark in 2011. For comparison, this figure was just 11% in Germany.

In order to change the structure of the economy, stimulate economic growth, and boost wages, a ‘radical increase in the quality of public administration’ is needed. Russia must also reassess its requirements and regulations for companies, as these standards remain largely unchanged from the Soviet Union.

Additionally, the size of Russia’s grey economy fell by around 1 percentage point between 1999 and 2007, but has started growing again over the last several years. Lastly, Russian companies are losing to developed countries, as well as China, in terms of market capitalization.

High Expectations

In the 2000s, the Russian economy surpassed the Soviet economy in terms of workforce productivity and quality of life, and a large middle class took shape that according to some estimates is reaching 40%. The problem is, no mechanism was created for the public to participate personally in the formation and financing of public goods. Public goods refer to free goods or services that the government must automatically provide its citizens with. This understanding of public goods is reflected in the public’s electoral behavior, and as a result, any ideas for reform in this area spread rapidly. In addition to public goods, another inherently ‘bad’ institution is offshore capitalism.

These factors give rise to various requirements and expectations for heightened revenues within Russian business, and they are key to understanding Russia’s economic reality.

What if the new reality is that economic growth has stopped in developed countries, as was the case in Japan a quarter of a century ago? 

While in developed nations, the private sector is psychologically content with annual returns of 10%-12%, this figure is closer to 20%-30% in Russia. But these levels of returns in Russia can only be attained through either natural resources or widespread monopolies in the market.

Reaching a New Equilibrium

The current crisis is essentially the start of the Russian economy’s transition into a new equilibrium. What can be done to facilitate such a transition?

Inflation can be lowered to 3%-4%, but it is also possible to increase opportunities for businesses to receive long-term loans to boost operations.

The government is also in the position to refrain from exerting taxation pressure on businesses in the form of ‘mandatory donations.’ It’s also important to lower political and quasi-political risks. For the business sector, a psychological signal that such risks don’t exist could come from two or three years of conflicts between the state and business being resolved in favour of businesses.

It is also necessary to do away with the current system of supervision and control that has led to business losses of nearly 2% of GDP per year according to HSE estimates and up to 5% according to estimates from Opora Russia.

Where Inertia Might Lead

The most likely scenario for economic policy in the coming years revolves around the idea of inertia, experts told the Higher School of Economics in a survey. In fact, we can see this scenario unfolding now. The reserves Russia has accumulated only allow the country to go two or three years without any significant reform, but then what? What happens when Russia eats through these reserves?

The economy will face dire consequences. The construction of infrastructure and machinery will come to a halt; social programmes will diminish to levels seen in 2006; and consumer demand will plummet 15%, resulting in in the stagnation of food production, farming, and retail trade. 

Russia faces the task of transitioning from an economy of demand to an economy of supply

Above all else, it will be easy to blame the government for this, but a ‘change in the mass behaviour’ of businesses and citizens will also be necessary, Yaroslav Kuzminov believes.

It is important to create some sort of institution for long-term funds that would also accumulate the public’s savings. To do this, the political decision has to be made to increase the retirement age and to transition towards a defined contribution retirement system. It is important to understand, however, that even necessary measures like these will take time, and it will take at least 10 years to see the results of the reforms.  

Working with Your Hands

For Russia, economic growth of 2%-3% a year signifies stagnation and a drop in Russia’s share of global markets, notes Alexei Kudrin, former Finance Minister of Russia. Agreeing with many of the points presented in HSE’s paper, Kudrin added that the reserves the Russian government has become reliant on were not created as a way of allowing the country to sit by idly. One of the purposes of the reserves was to allow the government to transition into a new economic policy without cutting budgetary spending or nominal wages in a manner reminiscent of shock therapy. Lastly, a key resource, and a condition, for the Russian economy’s ability to compete is the creation of human capital and an increase in workforce productivity, Kudrin concluded. 

 

Another one of the April Conference’s guests, Mikhail Abyzov, a minister in the Russia’s cabinet, called economic growth of 2%-3% an exaggeration.

In order to change the structure of the economy, stimulate economic growth, and boost wages, a ‘radical increase in the quality of public administration’ is needed. Russia must also reassess its requirements and regulations for companies, as these standards remain largely unchanged from the Soviet Union. There are a host of provisions that still exist from the 1960s, for example, provisions that ‘fly in the face of new technologies.’  

Roadblocks to Growth

The Rector of the Russian Presidential Academy of National Economy and Public Administration (RANEPA), Vladimir Mau, suggested that we look at the ‘new reality’ from a new point of view without linking it solely to changes on the oil and natural gas market. What if the new reality is that economic growth has stopped in developed countries, as was the case in Japan a quarter of a century ago? ‘We don’t understand how long-term stagnation works or what the fundamental reasons behind it are,’ Mau noted.

Russia faces the task of transitioning from an economy of demand to an economy of supply. And amid the uncertainty that surrounds economic growth, Mau added, the aforementioned transition can be facilitated by private investments, a change in the structure of exports, a decrease in inflation and interest rates, and a change in the poverty level.

Repeating Past Mistakes

The Vice President of BP Russia, Vladimir Drebentsov, commented on a point made in the paper about Russian businesses having inflated profit expectations. According to Drebentsov, the problem is not in a certain mentality that prevails among Russian businessmen, but in the fact that these expectations are directly proportional to risk, and the risks associated with investing in Russia are very high.

In addition, he does not rule out the possibility that oil prices will return to a fairly high level. But if oil revenues return to previous levels, this might end up hurting the economy, mostly because Russia runs the risk of repeating past mistakes. Starting in 2003, unit labour costs started growing almost constantly, and no one will invest in this type of economy, Drebentsov said. ‘Everyone has gotten used to our quality of life improving much faster than the quality of our labour,’ he concluded.