Sources of Growth: What Boosted Russian Economy in 2000s and What New Drivers Might Be

Dialogue Chain. Episode 5. Marek Dabrowski, Professor of the Higher School of Economics, non-resident Scholar at Bruegel, interviews Evsey Gurvich, Head of the Economic Expert Group

Dialogue Chain. Episode 5. Marek Dabrowski, Professor of the Higher School of Economics, non-resident Scholar at Bruegel interviews Evsey Gurvich, Head of the Economic Expert Group

Dabrowski: Hello, Evsey. I’ll start with what might seem a trivial question. In the early 2000s, and almost up until the 2008 crisis, the Russian economy’s growth rate was rather impressive. But then, after the crisis, the picture became less rosy. How do you understand this problem? Would it possible to achieve that growth rate again? If not, why?

Gurvich: Yes, Marek, thank you for the question. It’s an important issue, certainly, and the key is to establish what a normal growth rate looks like. If we assume that before the 2008–2009 crisis, our normal growth rate was about 7% and now growth is slower, that’s one thing…

Dabrowski: Apologies for interrupting you, but it’s clear to me that many politicians would like to believe that.

Gurvich: They did believe it; it’s not just that they wanted to. In fact, this point of view is completely wrong. During that period, we had our own estimates and we took into account estimates by organizations like the World Bank too. Of the 7% of growth back then, about 3% was generated by external factors. First, soaring oil prices. Second – people know less about this factor and pay less attention to it, but it’s important – the 2000s saw a boom in capital flows to emerging markets. I’d say it was precisely in 2007–2008 that they reached a historic high. This trend wasn’t limited to Russia, but Russia was one of its beneficiaries. Our estimates and the World Bank’s estimates show that these external temporary factors generated around 3% of growth out of 7%.

So that leaves 4%. 1.5–2% of this 4% was generated by additional capacity utilization after the crisis of the 1990s. At the beginning of this period, unemployment was above 10%. That meant workers were easy to find, and wage expectations weren’t too high either. Moreover, some mechanisms were created from scratch. For instance, mortgages.

If we take all these factors into account, we see that unused production capacity, idle capacity, workforce, and the introduction of new mechanisms gave another 1.5–2%. That leaves 2–2.5%. That was Russia’s earned growth that reflected the real state of the Russian economy.

But then what we call Russia’s resource curse came into play. By that, I mean the registered growth rate of 7% was much higher than the world average and higher than in the majority of emerging countries apart from China, while household income grew tremendously, several times faster than output did. This backfired. The government decided they had done everything necessary for economic growth, that there was no need for further reform, and that the key thing now was to control the economy, increase the proportion of it under state control, tighten the state’s grip on business, and squeeze businesses for the so-called administrative rent wherever possible. From then on their efforts shifted to controlling business instead of creating the right environment for it.

So, what’s changed? There are no positive factors, but we do have some negative ones. If we hadn’t raised the retirement age, the demographic trend would have cut growth by 0.4–0.5% each year. According to our estimates and the World Bank’s, the increased retirement age has largely (but not entirely) offset the demographic trend by adding 0.3–0.4% to the growth rate.

Dabrowski: Let’s stick with this demographic factor, shall we? It seems to me to be crucial, judging by other countries’ experience. Labour productivity growth can’t close the gap generated by the decrease in the working-age population. What are Russia’s prospects in this respect? Because as far as I can see, the offsetting effect of pension reform is also temporary.

Gurvich: True, but I think there will be no need to discuss any further increase [in the retirement age] before 2035. Perhaps between 2035 and 2040. However, firstly, we still have problems: we won’t have enough young and middle-aged workers, while after the reform we are going to have more older workers in the labour market. The research shows that these types of workers aren’t completely interchangeable. So, we still have a problem, in any case…

Dabrowski: Of a structural nature.

Gurvich: Right. We are still facing structural problems. That’s the first thing. Secondly, we have just about enough workers to facilitate growth of 1.5–2%, but if we somehow manage to achieve faster growth, above 3% of GDP, then the workforce problem is going to come to the fore again. I mean the lack of a workforce.

So, to facilitate significant economic growth, among other things, we’ll need to create a new growth model, if I could just discuss that for a minute. The growth model of the 2000s outlived its usefulness back then and is no longer working. Even if oil prices started growing the way they did in the 2000s we wouldn’t be able to bring back that golden age, that output boom.

Dabrowski: Right, sure. What you just said is very important. ‘New growth model’ sounds great. But what should it look like in Russia’s case, this new model?

Gurvich: You might call the 2000s growth model an extensive model. By this I mean that its main goal was to increase output to match booming demand, while all the rest was secondary. Now, the aim is to make output intensive: not to build additional plants just like the ones that already exist, but to improve labour productivity. Now, our goal is to increase the share of innovative businesses to 50%. Not everyone’s aware of this, but since 2000 (the latest data is for 2016), this proportion has stayed almost the same…

Dabrowski: It’s around 19–20%, isn’t it?

Gurvich: No, it’s about 10%. In 2000, it was 10.3%; now it’s around 9.5%, even a little bit less. At the same time, in the countries that compete with us, the proportion of innovative businesses is 20–30%. In Turkey, Poland and so on, it’s 20–30% or more, which is several times higher. So, we need to adopt new technologies. This requires new stimuli, tougher competition, and dismantled market barriers. It obviously goes without saying that property rights should be better protected. And something should be done about the public sector, because it’s a problem of ours: it caused the decrease in Russia’s baseline growth rate from 2–2.5% in the 2000s to the 1.5–2% we have now.

The public sector is getting larger. According to the Russian Presidential Academy of National Economy and Public Administration (RANEPA), its share has increased 1.5 times from about 30% in the early 2000s to about 45% now. And that…

Dabrowski: The Gaidar institute actually gives a slightly higher estimate of about 50%.

Gurvich: Well…

Dabrowski: There are fluctuations, decreases in oil prices…

Gurvich: The share reached about 50% but then decreased slightly to the approximately 45% we see today. But, generally speaking, the public sector’s share has increased 1.5 times. RANEPA papers, recent IMF studies, and other publications have shown that the public sector is less effective than the private sector. So, we have to either make the public sector more effective or else reduce its share. Or both.

So, I see three factors here. We’ve discussed demography. The second factor is public sector expansion, and the third is sanctions. I think that demography cuts growth by about 0.1%, sanctions by about 0.2%, and public sector expansion by at least 0.2%. All this leaves us with current baseline growth of 1.5–2% rather than 2–2.5%. To be honest, I can’t think of anything that could make our economy grow by 3%, let alone faster than the world average.

Dabrowski: Right. You’ve mentioned sanctions as a factor. Let’s leave the 2014/2015 sanctions and the impact they primarily had on the financial sector aside. Today, what damage do you personally think sanctions are doing to the Russian economy of today and tomorrow?

Gurvich: Well, there’s a short-term and a long-term effect. The short-term effect of sanctions primarily concerns foreign investment constraints. By that I mean that many investors now regard Russian assets as toxic. They are afraid that US and the EU regulators might sanction them for investing in Russia, and so they avoid it. That results in lower capital inflow. Foreign direct investment has suffered the most.

Then, in the longer term, access to new technologies (which are the main vehicle for higher productivity) will of course be limited. Generally speaking, foreign direct investment is the most popular and the most important source of new technologies, and it has slumped. Some types of new technology are subject to sanctions, but even inflow of technologies that are not explicitly sanctioned is going down due to fear of sanctions and higher macroeconomic risks. Foreign direct investment has decreased, and so has the inflow of new technologies. So, sanctions aren’t fatal, but they are certainly making themselves felt in the short and long term. The way we react to sanctions is also very important. Certainly, some sectors have benefitted from them. For example, in the short term, agriculture has gained from the food import ban.

Dabrowski: Kuban apples, for instance.

Gurvich: Exactly. There you go. Generally speaking, Russia’s economy and economic policy are shifting towards independence from the world economy instead of integration into it. It’s a dead-end policy: I can’t think of any successful economy that developed under autarchy regime, autonomously, in isolation from the world. Unfortunately, due to sanctions, we are decoupling from the global economy and leaving the right and promising path we were following until 2014.

Dabrowski: Thank you so much. I feel our conversation was very interesting and useful in terms of understanding key macroeconomic trends. Evsey, I was passed the relay baton of this conversation by Alexander Auzan. Who will you pass it on to?

Gurvich: I would talk to Apurva Sanghi, the World Bank's Lead Economist for Russia.

Dabrowski: Thank you.

Gurvich: Thank you, Marek.