Russian Economic Reform


Expert Group 1 mainly thinks that ….but there are dissenters!

Published on June 11 2011
Posted by: jeff

This Group has been discussing a general approach to formulating a new model of economic growth, taking into account the realities of the basic Russian economic structure and “current imbalances and long-term tendencies in the world economy”. A summary of an early joint report by a number of members of this Group can read here.

Jeff says that ….

(There are at least three issues in this report which some readers may want to comment on. One concerns the influence of “budget sector” size on the “economic development” of poorer countries; another concerns “modified inflation targeting” and the ruble exchange rate; and the third concerns the ruble as a “regional reserve currency”. However, there are dissenters to the general tone of this report– such as Dr. Kimelman who wants a new Russian steel industry on China’s doorstep!)

This generally good overview report presented to the Group says:  

(a)    In terms of global competitiveness, Russia is situated between rich and poor countries;

(b)   When compared to other “low-income countries”, Russia’s the international competitiveness has decreased in recent years due to a relatively high cost of labor against a back-ground of lack of progress in institutional development and in the business environment;

(c)    Russia has many advantages, particularly the size of the internal market. It also has a reasonably good education system, infrastructure, labor market efficiency, and innovation potential. However, it has poor institutions, low efficiency and lack of development in many markets (including finance), and lack of sophistication in business.  

(d)   Before the GFC, macro-economic stability was a factor to the advantage of Russia, but there has since been some re-evaluation by investors because the Crisis exposed the susceptibility of the Russian budget to large changes in oil prices;

(e)    Russia’s demographics are not good as the size of its labor force is declining. Even with rising labor productivity growth of, say, the 5% average annual rate achieved over the last decade, annual economic growth cannot exceed 4% over the next decade. In reality, it will probably be in the 3-3.5% range;   

(f)    Russia’s relatively high labor costs mean that it cannot compete in the area of large scale industrial production with developing countries, while its lack of modernization means that it cannot compete with developed countries in their market niches;

(g)    Russia has relatively high quality human capital and infrastructure compared to other developing countries, but serious efforts at institutional change are needed to take advantage of these factors.

(h)   Presence of raw material resources. This is an undoubted advantage for Russia, but is also a factor that is capable of serious negative influences on macro-economic and financial balance, promotes a rent-seeking model of social development, and may also impede institutional development.

The report continues:

“The basic macro-economic problem in Russia is the high cost of production under conditions of low technological and institutional development. It is important to develop an approach to withdraw and redistribution of natural resource rents. During 2000-5 natural resource rents were effectively removed from the economy and this allowed the economy to develop due to macro-economic stability, restrained growth in labor costs, a reasonable tax burden, and positive real interest rates. From 2006 policy moved to increasing social expenditures whilst there was little success in reducing natural resource rents. As a result, demand was stimulated. But this lead to growth in imports of goods rather than domestic production, and to higher inflation and production costs. From a macro-economic point of view such a situation is unsustainable, and Russia needs to be able to boost supply by way of:  institutional reform; more effective taxation of natural resource sector profits; restricted growth in budgetary expenditure; and lower cost of production, including taxation and the cost of corruption.” 

More specifically, the following is suggested by the report:   

(a)    Business climate need to be improved;

(b)   Fundamental institutional reorganization; including of more secure property rights, increased competition, securing the rule of law, large scale privatization and reduction in size of the non-market economy, elimination of “soft budget limits” (which support inefficient production), a more open economy, and more active measures to reduce corruption;

The report suggests reduction of government spending and taxation because, it says, examples of countries that have successfully caught-up with the “developed and industrial world” are those which have had a government budget sector smaller than in developed countries.

The report also suggests that “exchange rate policy” must be favorable for the “investment process”. This means that the ruble should be gradually be transformed into a “regional reserve currency”. Efforts to stimulate domestic production by keeping the rubles low should be replaced by “modified inflation targeting” which will permit lower interest rates and, in turn, boost investment;

Finally, the report concludes that “deep structural transformation of the social sector – particularly the pension system and public health – is needed. Efficiencies need to be increased, with increased private sector involvement”. And there is also a need for a more “open economy” in order stimulate domestic competition.

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