Shifts on the Map

When talking about structural shifts, economists tend of speak of them in terms of supply-side shocks, which are shocks leading to an increase in costs. The first and most evident structural shift is the redirection of Russia’s foreign trade to the East and the resulting construction of the transport and logistic infrastructure. Another shift is internal changes in the country’s economy. At a session of the Bank of Russia’s Financial Congress devoted to the economic transformation of the regions, Alexander Morozov, Director of the Bank of Russia’s Research and Forecasting Department, proposed a discussion on how these processes are taking place at the regional level, which regions are benefiting and which losing out as a result of the current changes.

Refocusing of the regions

The winners are those regions that have managed to redirect their exports to the East. These are food exporters, specifically the Rostov Region and the Krasnodar and Stavropol Territories, as noted by Vladislav Onishchenko, Director General of the Agency for Transformation and Economic Development. Besides, the winners are fertiliser manufacturers and companies producing energy resources, except for gas, as it is hard to redirect pipeline gas supplies to the East. Among the territories that have been losing out are the north-western regions because of their forestry industry. This sector used to focus on the West and its refocusing on the East involves logistic difficulties. The Far East that has become the main logistic channel has been benefiting from the redirection of imports, whereas the West European part of the country has been losing out.

The beneficiaries are also regions producing construction materials, ore and fertilisers for domestic consumption and regions where the dominant industries are railway and motor transportation as they are the basis for domestic freight – these are the Urals and some Volga and Siberian regions. When the West–East and North–South transportation corridors are completely formed, the regions ‘along the axis’ of these corridors will be the winners, concludes Onishchenko.

As noted by Yekaterina Bogopolskaya, Deputy Head of the Bank of Russia’s Volga-Vyatka Main Branch, the beneficiaries of the transformation are the regions that used to have low levels of gross regional product per capita as their potential was limited because their industrial sectors were not sufficiently competitive, whereas today’s transformation has become a boost for them as a result of growing government demand for investment goods. ‘One of the examples is aircraft and ship building projects, in particular the inland navigation fleet of Nizhny Novgorod and large-tonnage vessels constructed in the Primorye Territory. Government demand has also been driving a large number of infrastructure projects to establish new foreign trade connections with Asia and projects promoting technological sovereignty – from microelectronics to heavy transport engineering,’ said Bogopolskaya.

Some enterprises have been forced to start import substitution because of foreign suppliers’ exit from the Russian market. However, as these are non-core projects for the businesses, they are unlikely to stay competitive in the future. Domestic companies are not ready to fill the niches that became vacant after global corporations’ withdrawal as this demands large investment, and large investment demands a guarantee of demand and sales. ’Businesses are wary of not being able to successfully compete with international companies when the globalisation trend resumes,’ Bogopolskaya stressed.

‘Everyone has won’

‘Everyone has won,’ Mikhail Matovnikov, Senior Managing Director of Sber and Head of bank’s Financial Analytics Centre, expressed his firm conviction. Speaking of labour resources, everyone has benefited from the situation in the form of wage rises to a greater or lesser extent. These are his conclusions based on the SberIndex aggregating multiple indicators derived from statistics on Sberbank clients. Over the past two years, the real growth of the median wage was around 15%. Moreover, it was growing faster than the average wage, though it is usually the other way round. This suggests that the poorest regions started to benefit the first as wage growth rates there were much higher than in richer regions. However, that was in 2022. In 2023, wage growth rates evened out across Russian regions, whereas varying across industries. According to Matovnikov, the highest growth rates in wages are now recorded in manufacturing, specifically about 27%, followed by IT and construction.

As a result of the two-year increase in wages, a new middle class has formed accounting for approximately 11% of the country’s population. These people tripled their incomes over the past two years. Threefold growth had happened before as well, Matovnikov added. However, it normally covered about 2% of the population and used to be typical of people hired into entry-level positions and then increasing their incomes while moving up the career ladder. Conversely, this time, wages have mostly increased among middle-aged workers, predominantly males who began with wages below the median of about 40,000 rubles, whereas their today’s incomes notably exceed the median and amount to more than 100,000 rubles, while most of them have not even changed jobs.

This trend is not typical of any particular region or sector. Wages have been rising all over Russia, while government expenditures and the defence complex are not the only drivers. ‘The growth has been general: wages have been rising in food manufacturing, for instance, and not only in the defence industry. This upward trend has expanded to a vast number of people employed in industries focusing on consumer demand. We should not simplify this trend explaining it via government orders only. The first money fell there, but already leaped into the whole economy.’ Taking into account household members, nearly a fourth of the country’s population have significantly improved life quality, as noted by Matovnikov.

‘Not everyone has won’

‘I will pronounce three forbidden letters: MIC (military-industrial complex). The major beneficiaries are the regions where the defence industry is the main one. This is about half of Central Russia, almost the entire Volga region, a part of the Urals, and southern Siberia. I could have never imagined that the Novosibirsk Region would be able to restore defence production so quickly,’ stressed Natalya Zubarevich, Professor of the Lomonosov Moscow State University. All regions focusing on food manufacturing have also benefited from the situation, she believes. ‘Of course, the growth rate in manufacturing there is not 20–25% and not 58% as in the Kurgan Region, but it is yet close to 8–10%.’

Another matter is that defense enterprises have a large number of subcontractors and, accordingly, the growth has covered those sectors as well. ‘How steady are these benefits? There is a saying ‘so much beer – so many songs’. They will be benefiting for as long as the government defence order exists, since the competitiveness of this sector as an exporter is highly questionable, just as the conversion,’ Zubarevich noted.

North-western wood processors are among the losers as this industry has failed to pick up, except for furniture plywood manufactured by Russian companies to replace the products of IKEA after its withdrawal. ‘The situation is the hardest in the automobile industry,’ Zubarevich continued. ‘No matter what is said about Moskvich-6 (link in Russian), Kaluga and Kaliningrad are the victims that have not recovered yet. Considering that the sales of Chinese cars soared sixfold in 2023, I think it is obvious how fast the Russian car manufacturing sector will be recovering. The truck industry is another story as it is benefiting from the government defence order.’

Speaking of growing incomes, in the first place, it is essential to remember of the base effect, Zubarevich reminds. A modest relative rise in Moscow, if expressed in absolute ruble terms, will be more significant than the tripled growth rate in the Penza Region. Secondly, she disagrees that everyone has won. Pensioners are not among the beneficiaries: in 2023 Q3–Q4, the dynamics of real pensions were negative. Public sector employees are not among the winners either: the only indexation of their wages in 2023 could not offset the rise in inflation. Both groups make a huge percentage of the population.

Enhancing and mitigating

In order to enhance the positive shifts and mitigate the negative ones, it is crucial to promote advanced technological projects aimed at improving labour productivity and shift from industry-based aid to supporting high-achieving businesses that invest in high-performance projects, Bogopolskaya believes.

Onishchenko’s infrastructure recipe is to develop transport corridors as they have an agglomeration effect, while a reduction in transportation costs will create more opportunities in exports.

Businesses are already tackling the problem of staff shortages, which is evidenced by investment growth, and not only in manufacturing, as noted by Matovnikov referring to the statistics: ‘In terms of the nominal investment to earnings ratio in 2021, 2022 and 2023, the growth rates in consumer goods were 7.2%, 8% and 8.6%, respectively; in construction – 28%, 32% and 32%; in commodity exports – 9.2%, 10.2% and 11.3%; in intermediate goods – 6.5%, 7.2% and 8.2%; and in machine building which includes defence production, among other sectors, – 9.3%, 10.4% and 10.3%.’ This investment boom is the reason for the surprising economic growth amid staff shortages and full utilisation of production capacities, as stated by Matovnikov: ‘If not for this increase in investment, the economy would have been stagnating now. Businesses have been forced to address these issues, including through investment, as there is no other way.’ Nevertheless, a few other options do actually exist, according to Matovnikov, such as labour reserves that can be found in the low-efficiency general government sector – people are indeed transitioning from the public sector to industries offering higher wages.

‘Grooming the wish list’, which is already being done by companies, is currently the main optimisation method, Zubarevich believes. The government can also reduce the Arctic exploration programme, for example, and slow the pace of construction of the new Moscow–St Petersburg high-speed railway, which will decrease the travel time from 4 to 2.5 hours, as the multiplier effect of this project is not obvious. Zubarevich concludes that the best way to help businesses would be to remove logistic and payment bottlenecks: ‘There are simple and clear ways to achieve obvious results, whereas ascending Everest should be kept for later.’