Russian economy has been maturing more and more, so its growth does not depend on any reverses of market conditions and even oil prices or capital inflow or outflow, but on fundamental factors, in particular, our abilities to accelerate the national labor efficiency increase
In late January, Rosstat (Federal State Statistics Service) is publishing the preliminary GDP growth indicator for last year. It is likely to be slightly better than the previous year level of 4.3%, in particular, due to a drought that accounted for a drop of the last year indicator by about 0.3% points and added them to the last yielding year valuation. At the moment, the MED (Ministry of Economic Development) preliminary forecast is available based on the statistical data for the 11 months: 4.2 – 4.5%. The GDP development in the closing quarter of the year was quite optimistic, at least until December when, as surveys show, business anticipations considerably worsened reflecting concerns with the domestic political uncertainty and instability of the global economy.
Treacherous exports stoppage
However, albeit the final GDP growth figure is similar, its “components” were quite different last year than in 2010. Figure 1 shows that last year practically witnessed a return to the domestic demand development, both consumer and investment one, that was typical in the pre-crisis years. In quarters two to three (and, obviously, in quarter four as well), the domestic demand was maintained at a pace of over 7% driven by the growing real wages and, primarily, high rates of credit extension and a standard of personal savings that decreased more than twofold after the beginning of 2010.
The last time the domestic demand showed such development results was in quarter two 2008. However, the truth is that that the grown domestic demand rates still lagged behind the rates of 11% and more that were recorded over the period from 2003 to 2007, despite similar indicators of oil prices, at least in the first half of the year.
The only reason why the GDP finally reached the range between 4% and 5% instead of those 7% was a collapse of the export demand. Exports could grow at a pace of 1.4 times slower than imports, taking into account a higher weight of exports as compared to imports, in order to compensate a negative impact of growing imports on the GDP development. However, the physical amounts of exported gas, metal, chemical products, wood processing products, and other raw materials actually declined, in particular, against the background of the period from March to September while the index of the physical amounts of exports never attained the level existing by the end of 2010.
A decline in exports resulted in quite low growth rates of industrial production throughout the year; they even fell during August and September due to a low foreign demand primarily reflecting a recession in the Euro zone and weak Asian economies. However, an impact of industrial products oriented toward the domestic demand, i.e. cars, plastic products, footwear and leather products, furniture, and, naturally, food products stemming from good crops, did outweigh and the industrial growth in October and November resumed, although at a modest level.
First and foremost, it could be actually explained by increased consumer expenses and the investment demand as well. Output of building materials, metal structures, became effective, machines and equipment by the end of the year, in which case a significant role was played by housing construction amounts closing the pre-crisis amounts as well as government and quasi government investments: gas transportation flows, Olympic sites, and APEC summit to be held in Vladivostok.
All in all, regardless of pessimistic assessments and weak global market conditions demonstrating unsteady signs of revival, Russian industries showed a nearly 5% growth in 2011 (+3% against the 2008 level), which is good news. However, the growth rate was higher last year reaching +8.2%. But in this case, a very important role was played by export restoration (gas, metal, chemical products, wood products) accounting, in its turn, for the post-crisis restoration of industrial raw material reserves and fuel in the global economy. However, it seems impossible to maintain the current growth rates of Russian industries on the inertia basis in the mid-run. Certain “reloading” of growth drivers will be needed to make Russian industries more modern and competitive. And we will need a brief study of evolution of economic growth models and drivers for the past thirteen years to better understand them: import substituting model (1999-2000); export raw material model (2001-2004); domestic market oriented model (2005–2008); and recovering export model (2009–2010).
Foreign and domestic growth drivers
It might be noted that recovery after the 1998 and 2008 recessions and the subsequent growth in both post-crisis periods developed according to almost the same schematic, but had different phase duration. In both cases, exports were the main motor driving the growth. During the previous crisis of 1998, it did not fall as fall was associated solely with compression in sectors servicing the domestic market. On the contrary, the increased export demand mitigated significantly the recession and ensured quite fast recovery at that time. Growth with significant export contribution continued until 2004 while it continued for just the second half of 2009 and 2010 in the current period. In both cases, transition to the domestic market oriented growth took place largely as a result of growing oil prices and recovery of the crisis-affected financial infrastructure, which permitted to restore crediting. Investments, including investments in reserves that were expected to recover at a certain time period (it should be remembered that construction in progress and even its payment by the customer belongs to reserves in the national account statistics) initially played a minor role in growth renewal. Their rise was truly powerful at the phase of transition to the domestic market oriented development model.
As exports from Russia primarily consisted of raw materials and semi-finished products where possibilities to increase amounts of production are constrained, the domestic market oriented growth was faster than at the export oriented phase. As a result of a more important contribution of imports to satisfaction of the domestic demand, the structural changes underway at that time led to outstripping growth rates not only of construction, but, first and foremost, of services: primarily commerce and logistics, i.e. mainly labor intensive sectors. Therefore, fast employment expansion and labor efficiency decrease at the fast rate of real wage increase that maintained the domestic demand growth as well was a characteristic feature of the domestic market oriented growth in both cases. Foundations for gradual economic growth slowing were laid inside the model itself.
It can be emphasized that, despite common myths, there were practically no episodes of import substituting growth for the last thirteen years of our economic history. Several months in 1999 immediately following the excessively powerful ruble devaluation (from the perspective of financial misbalance corrections) in autumn and winter of 1998 can be viewed as the only case when contribution of “domestic” GDP, cleared from exports, outstripped the domestic demand growth. While the ruble exchange rate and imports were falling, the “domestic” GDP, at best, did not fall, but, as a rule, never increased compensating a decline in imports because it supplements them rather than can substitute them according to its sectorial components.
Real weakening of the ruble in the past and the current episodes did not lead to any import substituting increase in supplies of national products and services to the domestic market. On the contrary, such supplies or, otherwise, contribution of the domestic market to the GDP fell at those periods along with their share of imports and, accordingly, grew when the exchange rate strengthened as a result of expansion of logistics and commerce following it.
Naturally, potential weakening of the ruble could result in certain restructuring of the Russian economy; in particular, it could re-orient it to exports to a larger extent. However, as model estimates shows, this could happen only three to four years later during which quite a deep production decline would happen. On the contrary, strengthening of the ruble has always triggered the reverse, i.e. had a positive impact on the GDP growth so far. However, if strengthening is too long, it can also impede development of production, labor force exodus to non-commerce sectors (services and construction) that can be potentially substituted by imports and where there are fewer possibilities to improve efficiency. It is possible that we are now near such a line beyond which maintenance of the domestic market oriented model built in 2011 will be followed by declining growth rates.
A slow growth of labor efficiency and limited possibilities to engage the employed constitute the most obvious limiting factor of the current model. On the whole, it is clear that the 2005–2008 growth, once the potential of exports growth was exhausted, relied on fast development of services and construction, and low efficiency was compensated by the employed labor force growth. At present, the model is generally the same, but there is no unoccupied labor force (growth of migrants employment should not be viewed as a strategic reserve) and further growth may be hindered by the slowly growing labor efficiency. Although the number of people wishing to work grew last year, natural limits of engaging people in production have been practically reached and, if we analyze the unemployment rate based on the number of people officially registered with occupancy services, it is lower than at the pre-crisis peaks.
At the same time, labor efficiency growth determined by the trend (with smooth market situation fluctuations) is low: just about 2% per annum. Officially, it means that this is the potential GDP growth rate, i.e. it is useless trying to increase it above the existing ceiling by using ordinary cyclical stimuli, fiscal or monetary and credit ones; structural measures driving the growth potential are needed.
However, no one knows whether it is true; unlike the market economies, the Russian economy remains quite a socialist one in terms of employment responding solely by labor efficiency changes to any market situation fluctuations while employment scale corrections are quite insignificant.
Declining competitiveness due to an outstripping growth of real wages as compared to labor efficiency may become an obvious obstacle for transition to the more export oriented growth. This is the result of real strengthening of the ruble. However, the IMF estimates show that, despite fast growth of the real exchange rates recorded for the last couple of years, Russia has remained competitive and the ruble has not been an over-evaluated currency as compared to other ones yet.
In the future, a stable and significant increase in the real exchange rate will not necessarily lead to any competitiveness decrease, if it relies on the labor efficiency growth and contributes to the country’s per capita GDP growth.
Significant risks for our economic growth are related to its high dependency on oil as well. Model estimates taking into account interdependency of the “domestic” GDP, exports and imports, and their dependency on oil prices attest that the GDP growth could be maintained at the level of 3%–3.5% (no possible labor efficiency-related restrictions were taken into consideration in this estimate) in the period of 2012–2016, providing that there is no unfavorable impact on the export demand of the foreign market conditions and the oil price of USD 100 per barrel is stable (the actual average price is higher in 2011 amounting to about USD 110 per barrel). Considerably worse GDP trajectories can be seen in case of any steady decrease (lasting for over a year) of oil prices to USD 50.
Finally, we should consider the net outflow of private capital as a growth obstacle that considerably strengthened last year.
Exodus or over-accumulation?
According to the Bank of Russia preliminary data, the net outflow of capital increased by over USD 50 billion last year to reach USD 84.2 billion or 4% of the GDP. Civil activists would say that capital is fleeing intolerable administrative pressure and despotism. Is that really so? In fact, if we do not consider the capital outflow balance and capital attraction from abroad, but the gross withdrawal of private capital in 2011, we could see that it even slightly dropped as compared to the average indicator for many years. Over the period from 1999 till the end of 2011, omitting crisis-affected Q4 2008, the average quarterly gross withdrawal of private capital amounted to 7% of the GDP and during the first three quarters of 2011 it totaled 6.8%. It amounted to 8.1% of the GDP by taking into account the last quarter of last year which accounted for slightly less than half of the total annual withdrawal figure. But this quarter was unique in many ways: it included quite high ruble devaluation in the beginning and generally obvious uncertainty as to the government ability to control the political situation in December. It is not surprising that even the balance of purchase of cash currency that Russian citizens sold faster than bought for the last previous years, reversed this time and purchase prevailed.
Considerable strengthening of the net private capital outflow from Russia at specific times, and not any unfavorable changes in Russia, resulted in crisis phenomena particularly on financial markets. This was the case in Q3 last year, for example, when under the conditions of a crisis of trust on the European interbank market resulting from exacerbated debt problems of several states in the Euro zone periphery, portfolio and other investments were withdrawn from the Russian market and interbank crediting of Russian banks fell by USD 12 billion in total. And this led to the ruble devaluation in the bi-currency basket by 12.7% in August and September. A similar process of withdrawing capital from the Russian market was recorded four years prior to that, namely in Q3 2007, when Western markets were affected by the first wave of the approaching financial tsunami.
As regards the future, the MED forecasts transition to the net inflow of private capital approximately starting from the second half of next year. It is difficult to understand the basis for such optimism. Given that capital inflow depends both on the Russian and global economic situation in general, where signs of strengthening investment and credit activity are not too obvious at the moment, it is unclear whether such decisive changes could be made as a result of direct foreign investments (they currently account for just 2.5% of the GDP). Furthermore, it is unclear whether the private sector of the Russian economy will need significant amounts of foreign borrowings, if there is no surplus budget and if the budget does not withdraw money from circulation.
Theoretically, it is possible that the gross capital withdrawal will drop to become lower than the average indicator recorded for many years both as a result of further deposit and cash shift to the national currency and tough control of any doubtful commercial and financial cross-border transactions performed to avoid taxes. It is difficult to make any forecasts here. At the moment, it is more likely that the considerable net capital outflow will continue, providing that the oil price will remain at the current level.