Dialogue Chain. Episode 2. Branko Milanovic, one of the world's leading experts in income inequality, interviews Natalya Zubarevich, MSU professor and prominent expert on the economy of Russian regions.
Milanovic: Natalia, I was, of course, very happy to have a conversation with you. I’ve known your work, but one thing that attracted a lot of my attention was your work on interregional inequality in Russia. Can you tell us a little bit about how interregional inequality changed since the end of the Soviet Union? And then I will ask you something about the past as well.
Zubarevich: During the first years of economic growth, Russian regions manifested the same trends as all the countries of catching-up development. Inequality was going up. And that is natural because, in a growth period, the regions with a competitive edge grow faster. But somewhere in the middle of the 2000s, the trend changed, and the regions started converging. Russia had the most remarkable convergence. In Kazakhstan, it was not that strong. In Ukraine, it was non-existent. And it helps us explain why the trend has changed. Recall the oil price increase, and you will see that the critical factor is the state redistribution policy. The redistributed resources (the oil rents) become larger and the mechanisms of inequality mitigation through transfers come to life. This was the case until the latest crisis. The inequality of GRP slightly increased only in 2009. While inequality in population income did not grow. The reason was the income support measures taken during the crisis of 2009. The changes began in 2015, 2016, and 2017 – a stable level of inequality or its subtle growth. The reason is also clear: in 2014, 2015, and 2016, transfers did not grow and stayed the same in rubles. There was no additional help; the mitigation mechanism did not function.
Milanovic: I had several implications of what you are saying, but one of them seems to be the following: inequality between the regions increases when the times are good. Which means when the rate of growth is good.
Zubarevich: Not exactly. When the times are good, and the oil price is low. When the oil price is high, state redistribution mechanisms come to life.
Milanovic: So in that sense, the high price of oil is being offset in the sense that all the incomes that would go to the oil producing regions are being offset by the mechanisms of redistribution.
Zubarevich: Firstly, not just high. The main word is “rising”. The price should be on the rise. Secondly, the Russian redistribution mechanism is very straightforward. There is the resource extracting tax. It amounts to quite a big part of all federal revenues. It is a purely rent tax. When the oil price was high, one region accounted for 27% of all federal tax revenues: Khanty-Mansi Autonomous Okrug. The other region, Yamalo-Nenets Autonomous Okrug, gave other 9-10%. Therefore, two oil and gas regions accounted for more than one-third of all federal tax revenues. Another tax is not the rent one, but it is very closely linked to agglomerations. It is the value-added tax. And 14-15% of federal tax revenues are received from Moscow. It is the leader in consumption, and it provides a huge amount of tax revenues for the federal budget. Thus, three Russian regions account for almost half of all federal tax revenues. Three! That is why the word “decentralization” in Russia…it is very difficult to understand how.
Milanovic: This seems to me to be a good policy because when you have, of course, regions with the increasing price of petroleum, oil, and they need to redistribute that oil rent to everybody else. So it seems to me it’s good policy but tell me what you see which is wrong in that policy.
Zubarevich: Russia is a country with tremendous, enormous inequality of regional tax base. And it is going to stay like this for a long time. As long as the oil price is high. Therefore, we should accumulate oil rents in the federal budget. It is okay. The thing is what you do next. How do you distribute these rents? We realize that it is impossible to reverse the tax policy. That is true. It is impossible. Well, we can provide regions with more excise taxes and take smaller portions of income tax revenues. But these are technicalities. Drastic change is impossible. We are going to live in a huge redistributing state for a long time. Thus, the main issue is the quality of this state. How it redistributes, what are the criteria, how transparent these policies are, whether they stimulate development or they stimulate what in Russian we call dependency culture: “Give me money! I need money!” That is why my focus is on redistributive politics. And I have got many questions about it. Firstly, it is not transparent. Secondly, many decisions are ad hoc.
Milanovic: Do we not understand the criteria? Are they not transparent?
Zubarevich: Only equalizing dotation is allocated based on a clear and transparent formula. It accounts for about 33-34% of all transfers. There exists a great balancing dotation. Its criteria are very unclear and very political. Three regions receive quite a big special balancing dotation. They are Chechnya, Crimea, Sevastopol. Secondly, the subsidies. They are allocated by ministries. There may be some criteria, but only the ministries know them. As a result, we have a very curious distribution. Where there is a lot of lobbying and non-transparent decision-making. But that is not it. There are special other budgetary transfers. I enjoy studying them.
Milanovic: Extra-budgetary?
Zubarevich: The other budgetary.
Milanovic: The other…
Zubarevich: Other. One year it is suddenly a heyday for Moscow. What is up? Why have they allocated the money? For the metro, they say. They say. Before that, it was a heyday for Saint Petersburg. They gave a lot of money. Why? For the Ring Road, they said. The key phrase is 'they said'.
Milanovic: Yes, yes. I see.
Zubarevich: We do not understand the allocation criteria for these tens of billions of rubles. That is why my main question is: “Why is this system so non-transparent?” And we have the answer to it. Because it pays for the interest groups that control this money tap and redistribute the money. And this is bad. For example, every governor spends at least ten days of the month in Moscow. He works. His vice-governors, like on a conveyor belt, go to Moscow one by one. In Russian, we call it 'rotation system'. We have 'rotation system' for those employed in primary industry, and we have governors’ 'rotation system' because the critical skill for a governor is not his ability to develop the region. The most important skill of the governor is to get money. And it gives a bad incentive.
Milanovic: This is very clear, because, of course, if the governor and his deputies have to spend most of the time trying to find ways to get the money, they, obviously, will have very little time to actually do the work of the region, and plus of that I suppose there is not even much transparency on how they would use the money. Let me ask you one more question now. You mentioned in one of your presentations that the decline or convergence of the incomes of the region often goes with slower growth, and you used the word 'zastoy' [stagnation]. So, is it something, which is the case now?
Zubarevich: Regional income inequality has been going down at the most steady pace. It has been getting less acute at the most steady pace. Firstly, this process began before the convergence of the economy. It started in 2002-2003 when the state increased public sector salaries for the first time. People that work in the public sector are more numerous in the weak regions where there is no other economy. It started the convergence. Then, the second trend is the salaries increase as per Putin’s Presidential Decree of 2012. It also facilitated the convergence because there’re many public sector employees in the weak regions. And suddenly we see no changes during the last three years and increased differentiation in 2017. A slight increase. Let me be careful here. I need two more years to analyze whether it is a trend or a fluctuation. But there was something like that in Kazakhstan when the crisis started. Let us wait. So far, we see that inequality has shrunk. But, firstly, this is the estimation of income, of personal money incomes. And, secondly, the state benefits that people receive have a significant role in this estimation. When you analyze the salaries and compare cities instead of regions, you see that Moscow keeps diverging from other cities. All the big cities in Russia converge while Moscow diverges. And this is the main reason why everything is concentrated in Moscow. Migrants, qualified jobs... That is why Moscow is not Russia. It is essential.
Milanovic: You know, we have in many countries this kind of, really, столица [capitals] becoming more and more important. Do you see the link between globalization and the growth of the big centers like Moscow?
Zubarevich: On the one hand, Moscow follows the global cities trend when it comes to development. It has a super concentration of resources, fast growth of the service economy, and a massive influx of various migrants both qualified and low-skill. The same as in other cities. But there is something called the added value. And it is called institutions. Moscow is the capital of a country with a super vertical governing system. That is why its development is influenced by two effects. The first one is the standard agglomeration effect, the effect of concentration also called the effect of scale and the effect of variety. This is how the effects work for all big cities. The second one is super concentration because of two factors. The vertical power structure, a considerable number of federal institutions where resources are accumulated, where the salaries are high and so on. Because the country is governed from the top down. And another related effect is the concentration of big businesses. Russia is the country of big business. Headquarters of big companies are located in Moscow. They try to concentrate income tax payments in their headquarters. Highly qualified jobs in business are in Moscow. Thus, there are two effects: normal and special. But, in addition, let us say that if a country had many small and medium businesses their resources would be in the regions. When the country’s economy is comprised mainly of super big and state companies, all the decision-making, everything is concentrated in Moscow. And as long as it stays this way, as long as our country remains vertically structured and super-centralized, and as long as big, huge state business prevails in Russia, Moscow will have additional, exclusive advantages for development.
Milanovic: So, if I could summarize I would see the following. And you correct me. That there’s a healthy, хорошая конвергенция [good convergence], when you have small businesses, which would be, sort of, in most of Russia, and then, of course, the small businesses would be doing relatively well, then the regions would become more similar. And there’s a sort of, not healthy convergence, where essentially the gaps are huge and then there’s some mechanism, that is not transparent, which somehow distributes that money or gives very high salaries, and there’re many, sort of, чиновники [public officials] in different parts of the country. So, then there’s, some kind of, I’m not saying artificial, but there’s a convergence which is not generated within the economic system. It’s a convergence that comes from the outside. Is this a correct reading of what you said?
Zubarevich: The convergence we see is the redistribution.
Milanovic: Redistribution.
Zubarevich: Redistribution. It is not the consequence of the fast growth of the least developed regions. It is the result of rents redistribution. And we cannot call it healthy. My suggestions are very simple. The first one is the following: while redistributing, you should not take that much from the strong regions and you should not uphold the weak ones to the point where the key thing for them is to spend the budget. No need to stimulate development! The key thing is to ask well. When you ask well, you succeed in everything.
Milanovic: You mentioned in a conversation once 'zastoy' [stagnation]. Do you think that the current period, because of the low rate of growth of the Russian economy…
Zubarevich: Not only.
Milanovic: …and, maybe, all other phenomena, we can call it 'zastoy' [stagnation]?
Zubarevich: In my point of view, 'zastoy' [stagnation] is not just a matter of economic growth dynamics or negative population income dynamics. We have had four years of negative growth. And, probably, the fifth one will be the same. For me, another 'zastoy' [stagnation] is more important...
Milanovic: Structural?
Zubarevich: No, worse.
Milanovic: Institutional?
Zubarevich: Values.
Milanovic: Right, values.
Zubarevich: People do not understand their prospects. They do not see the prospects. And it is very depressing because the current situation in Russia does not stimulate development. Many think that it is impossible to change the situation in this political and economic cycle. And we do not see the prospects. For me, 'zastoy' [stagnation] means no future. This is the scariest thing.
Milanovic: You think that 'zastoy' [stagnation] is not just the economic stagnation. 'Zastoy' [stagnation] is the lack of opportunities.
Zubarevich: Of resources, of clear prospects…
Milanovic: Prospects, right.
Zubarevich: Prospects. Of course, ordinary people care the most about income decrease. The Russian unemployment rate is not high. 20% [of the workforce] is employed in the informal economy. People care the most about income decrease. I, an expert, see a wider problem: the lack of prospects. The old instruments and the old system do not provide growth opportunities anymore. New instruments, in this political and economic situation, cannot appear. And the future holds at least four-five years of stagnation for the country. Stagnation brings depression, and depression brings brain drain. Those, who can, will leave, and those, who will stay, will not be able to. That is what scares me.
Milanovic: So, we ended, maybe, on a very pessimistic note but if the problems are institutional and structural, largely, then even the change in the price of oil and even the removal of sanctions, I suppose, would not make that much of a difference.
Zubarevich: I agree. Like, now, in this cycle, the removal of sanctions and the growth of oil prices will barely help go back to the fast growth. Because we have already used our old advantages. Dear Rector [of RANEPA Vladimir] Mau says that it is the trap of middle-income level. It is an extremely decent, academic way of explaining the institutional block. It is the institutional block. That is true. We should change our institutions. One day, this is going to happen. It is going to be very hard. It is going to be flexible: forward and back, forward and back. In my opinion, during the whole XXI century, Russia will be trying to change what we call its path dependency. I hope we will manage to do it. But it is going to be neither fast nor easy. It requires a generation shift. Values do not change fast.
Milanovic: So, the last question is, actually: whom would you like to talk next?
Zubarevich: It would be very interesting to talk to Alexandr A. Auzan [Dean of the Faculty of Economics at MSU]. He studies cultural aspects of the economy, values, and those frames stuck in our Russian heads. And this is very interesting. However, it is a bit depressing because path dependency means it is very difficult to get rid of.
Milanovic: Yeah, it is difficult to change the values.
Zubarevich: That is what I would love to talk about. How to change that stem in which we have been stuck for a long time. It is important.