Research paper
Published 17 December 2019
Updated 9 May 2024
ISBN: 978 1 78413 361 0
How is it possible for the directors of the Russian economy to pursue an orthodox stabilization policy with a great measure of success and yet to have achieved so little to stem the growth slowdown? This paper examines the reasons for the divergence in economic management.
Lately, Russian economic growth has been below the global average. In other words, Russia’s weight in world economic activity has been edging generally downwards. Figure 2 illustrates the comparative growth performance since 2010.
A falling share of world output does not fit well with the ambition to make Russia great again. It is, moreover, a disconcerting reversal of fortune: in the 2000s Russia’s growth outpaced that of the rest of the world. Hence all the talk about a new growth strategy that will once more give Russia an increasing weight in global economic activity.
Russia’s leadership is also worried about the implications of slow growth for living standards. That was apparent from Putin’s February 2019 address to the Federal Assembly, in which he called for additional expenditure on family, housing and other benefits.22 The evidence suggests that austerity can be imposed quite brutally in the course of a short-term exercise in stabilization, but that it is not considered to be a long-term option.
As shown in Figure 3, indicators of income and consumption from 2011 are certainly weak.
The figure points to two further things. One is the problematic nature of the official statistical series of per capita real disposable income: it is not clear how this deals with the informal economy, and it may paint too gloomy a picture of household incomes. The data show a net decline from 2011 to 2018 of 2.7 per cent, while total household consumption shows a rise of 8 per cent (5.1 per cent per head). The other message from Figure 3 is that, even by the more favourable of the two indicators, gains in consumption since the start of Putin’s third presidential term have been modest: 0.7 per cent per head per year. For most of the population, this may be too slow to register as a real-life improvement.
Russia’s economic problems resemble, at a headline level, those of the world’s advanced economies: an ageing population, low investment, and sluggish productivity growth. One big difference, however, is the development level at which these problems are occurring. Russia, with its modest level of labour productivity, could be catching up rather than lagging behind, because it has a backlog of technology to make up. The ‘secular stagnation’ that some economists detect in the West23 is different in origin from the Russian variety of ‘stagnation’, and is perhaps more affordable for rich countries in so far as the population is missing out on a smaller proportion of income.
Why the Russian slowdown? It began in 2012–13, so is not solely the effect of the 2014–15 fall in oil prices. Indeed, it could be said to have started earlier, since growth in 2010–11, recovery years after the global financial crisis, was below the average level in 1999–2008.
Slower growth than before in employment and investment are part of the problem.24 Any expansion of employment is limited by the decline in the working-age population. That extends into the mid-2020s, and is partly offset by net immigration and the rise in the retirement age from 60 for men and 55 for women to 65 and 60, respectively. The reasons for the sluggish record of investment are less obvious. Inward foreign direct investment (FDI) fell in part because of sanctions, and latterly also because of a global decline in FDI. But FDI was not a large part of total fixed investment to begin with. It appears that Russian private domestic investment has been growing, in real terms, at only about 1.1 per cent per year in 2012–18, while total fixed investment fell (see Figure 4).
Weak private investment probably reflects increased uncertainty about the state of the world economy (and especially economic performance in Europe), about international political tensions, and perhaps about changing rules of the economic game in Russia as state influence expands.25
Weak investment and a declining working-age population might in principle be offset by strong growth in the productivity of labour and capital combined (i.e. total factor productivity – TFP). This has not been the case in recent years. In a working paper for the World Bank, Okawa and Sanghi estimate that TFP growth averaged 2.9 per cent annually in 2000–09, and that it was down to 1.3 per cent in 2017.26 Their baseline projection of potential output (i.e. output at full employment of capital and labour) has it edging down from 1.5 per cent in 2017 to 1.3 per cent in 2023.
Examining possible sources of acceleration, Okawa and Sanghi estimate that pension reform could add 0.3–0.4 percentage points to annual growth in 2020–28. A rise in the investment share of GDP from 23 per cent in 2017 to 34 per cent in 2028 would raise GDP by 0.6 per cent per year by 2028. A reform scenario (achieving more competition) could lead to a 0.1 per cent increase in average annual TFP growth in 2017–28, instead of the 0.2 per cent decrease projected in their baseline scenario (to 1.1 per cent growth). All of the above, plus a rise in net immigration, would by their assessment contribute to an enhanced growth rate in potential output of 3 per cent by 2028.
This would be a less rapid acceleration than Putin is calling for, but it would be a step in the right direction. What are the obstacles to such an improvement? Demographics account for the near-zero growth in employment, but what are the influences that sap investment and productivity growth?
According to Aleksei Kudrin, speaking in a personal capacity and in one of his more radical moments, Russia is in a ‘stagnation pit’, ultimately because of the lack of political competition.27 The general line of argument is that corrupt political incumbents at local, regional and national level offer protection in deals with favoured firms, creating unpredictable risks for firms without such protection (particularly asset-grabbing by insiders) and thus weakening both the confidence of potential losers and the competitive pressures on incumbents to invest and innovate. The overall result is low private investment, slow innovation, stunted development of small firms, and therefore slower growth than would otherwise be achieved.
What is meant by asset-grabbing in today’s Russia? To give a typical example, firm A conspires with law-enforcement officials to bring charges of ‘economic crime’ (say, fraud) against the main owner of firm B. A complicit judge rules that the accused must go into pre-trial detention – where conditions can be harsh, and the custody of uncertain duration. The ‘raiders’ (i.e. asset-grabbers) work on the detainee to surrender some or all of firm B to firm A and eventually he or she gives in and is released. The case does not come to trial, and the judge and the law-enforcement officials get their cut. There may or may not have been any fraud to begin with.28
There are two obvious objections to this linking of weak growth to the lack of political competition. One is that there was no political competition in the 2000s, when the Russian economy was growing quite strongly. The other is that there are countries with an apparently similar political economy, notably Kazakhstan, that have continued to grow at, or a bit above, the global average rate.
So far as the change in trajectory over time is concerned, it appears that Russian economic growth of the 2000s was supported by other factors that have subsequently ebbed. A substantial growth accounting exercise for the boom period, estimating the contributions to growth of different factors, makes this clear (see Table 1).
|
GDP |
6.9 |
|
Fixed capital |
0.7 |
|
Capacity utilization |
1.4 |
|
Labour: hours worked |
0.7 |
|
Labour: skills |
0.2 |
|
Residual: total factor productivity |
3.7 |
Source: Entov and Lugovoy.29
There was a large element of recovery in this boom period. This shows up in capacity utilization and in hours worked. The residual will also include an element – possibly large – of productivity increases attributable to shifts in resource allocation as labour moved out of inefficient, Soviet-era manufacturing into previously underdeveloped services. That source of growth is now much reduced. Take these changes together with the levelling-off in employment and the slowdown in fixed investment, and there is ample reason for the overall deceleration. As far as ‘similar’ ex-Soviet countries are concerned, there may be other influences on their economic performance that are more favourable than they are in Russia.
The general line of argument put forward by Kudrin – and many more – has some substance. Russian economic growth did benefit from temporary favourable conditions in the 2000s, and there is evidence that the problems associated with insecure property rights have worsened.30 The need for ‘reform’ is widely accepted. But what reform or reforms would be most significant? The IMF, in its August 2019 Article IV Consultation report, summarizes needed reform areas as follows:
After exiting the recent recession, it is time to accelerate necessary reforms to improve productivity and foster new sources of growth. Long-standing weaknesses include inadequate infrastructure, a large footprint of the state, lack of competition, excessive regulations, weak protection of property rights, corruption vulnerabilities, and adverse demographic trends.31
…
To achieve significant growth dividends, reforms will need to address the long-standing problems of lack of competition in the economy, and relatedly, the large footprint of the state–both in terms of its high share in the economy and its intrusiveness into business activity.32
Infrastructure is being addressed under the Integrated Infrastructure Modernization Programme associated with the ambitious ‘national projects’ (described in the next section). Some improvements can therefore be expected in this area, albeit at high cost. Adverse demographic trends are to some extent offset by the raising of pension ages. The other reform areas highlighted by the IMF have one critical factor in common: all would be ameliorated by clear movement towards the rule of law. This would require the appointment and maintenance of judges to be made independent of the executive, and it would also require a reduction in the de facto power of the security organs – a formidable requirement politically.
Lack of competition, weak property rights and corruption would all diminish as problems if there was an independent judiciary capable of upholding the law in the face of attempts at exploitation by corrupt agents of law enforcement and regime-favoured businesspeople. This would make the large footprint of the state, in the sense of GDP share, and the mass of formal regulation less toxic.
The comparison with Kazakhstan is instructive on two other possible sources of Russia’s weak growth: rent addiction and geopolitical pretensions. The two countries have similar development levels (in terms of per capita GDP in PPP dollars33), similar fiscal dependence on oil and gas, and a similar institutional past. For what the two GDP series are worth, Kazakhstan’s recent overall growth performance is significantly better.
Kazakhstan does have demographics in its favour – in that it does not have a shrinking labour force – but this is probably not enough to account for all the difference in GDP outcomes. It is likely that Russia’s performance has been held back by a relatively large sector of uncompetitive production, as well as by its leaders’ commitment to the recovery of ‘great power’ status. (It can be assumed, here, that rule-of-law deficiencies are similar in the two countries.)
Gaddy and Ickes, and Connolly, in their work on Russia, shed some light on the first of these constraints.34 They place the Russian state at the centre of a system in which rents (earnings above normal profits) are systematically transferred from an internationally competitive sector A (mainly oil, gas and minerals) to support an internationally uncompetitive sector B (much of Soviet-legacy industry). Connolly adds a sector C, chiefly made up of services, that is outside the rent transfer system and more detached from the Russian state, and treats the financial services sector as a further division of Russia’s economic activity. The rent transfer system is dominated by the state, and dampens competition in sectors A and B. The larger sector B is, as a part of the economy as a whole, the greater the impediments to growth. While it might be speculated that Kazakhstan and Russia are systemically closely similar, Kazakhstan has a relatively smaller sector B to support. At all events, Russia’s ‘rent addiction’ (as Gaddy and Ickes call it) is part of the story of the slowdown.
The second constraint may be that Russia has a far larger geostrategic burden weighing on its progress than does Kazakhstan. Table 2 gives some indicative estimates of annual public expenditure on certain projects and commitments in some or all of the past five years:
|
Sochi Winter Olympics |
822 |
|
Bridges to Crimea |
228 |
|
Operations in Syria |
81 |
|
Subsidies to Chechnya |
30 |
Source: The Bell.35
Together, these particular commitments were equivalent to some 4.7 per cent of consolidated budget expenditure in 2014 – not a huge burden in itself, but possibly symptomatic of a larger, more general commitment of resources that tends to crowd out more productive activities. The pursuit of some of Russia’s geostrategic goals has also resulted in sanctions – another influence on economic activity that is not benign.
In summary, the social and political system impedes growth because it makes property rights insecure. A large sector B, together with Russia’s geopolitical ambitions, probably worsens the outcome. Circumstances that favoured Russian economic growth in 2000–08 no longer apply. The current trend growth rate of output seems to be between 1 and 2 per cent per year. In this context, what policies and what reforms to raise that growth rate are being implemented? And what are their chances of success?
