Russia needs substantial economic policy revision to reclaim glory
February 4, 2013, 7:49 am

Forecasting post-communist Russia’s economic growth has been a controversial issue. After the 1998 crisis few experts could seriously imagine that this country would exhibit astonishingly high growth rates during the following decade, enabling it to almost double the size of the economy.

Similarly, it was hard to expect that the 2008–2009 global crisis would so easily reverse Russia’s previous growth pattern. With 7.9 per cent of GDP decline in 2009 Russia fared the worst among its BRICS counterparts and most resource rich economies.

Thus, the global crisis not only substantially limited external demand for Russian exports, but also underscored internal imbalances and incoherencies of the Russian economy. The latter should be the main implication of the crisis for the future economic policy design.

There has been some good cheer in a latest PWC Report. Russia is to become Europe’s leading economy by 2030, surpassing Germany, and pushing the UK out of the top 10 by 2050, according to a new report titled Brics and Beyond released by PricewaterhouseCoopers.

A new growth trajectory, but old engines?

In 2010–2012 the Russian economy returned on the growth path, but with significantly lower dynamics than in the pre-crisis period. The average growth rate in 2010–2012 totaled 4 per cent.

The projections for 2013–2014 don’t promise acceleration. The IMF predicts growth at 3.7–3.8 per cent, similar estimates are made by the OECD. Domestic economic research NGOs are less optimistic. The Foundation “Development Center”, a leading Russian economic think-tank, expects the average 2013–2014 growth rate to be 3.2 per cent.

While Russia battles to get back on to a growth trajectory, IMF forecasts that the eurozone will stay in recession in 2013 with the currency area’s economy contracting by 0.2 per cent.

“The euro area continues to pose a large downside risk to the global outlook,” the Washington-based crisis lender said in a quarterly update of its World Economic Outlook in January.

The humble forecasts reveal that the Russian economy is still being driven by the same engines. The share of raw materials in its total exports has steadily remained over 70 per cent in 2010–2012. However, while exploiting this traditional growth determinant and natural competitive advantage, Russia is already facing infrastructure constraints.

Consequently, its contribution to the subsequent economic growth might decline in the absence of negative external demand shocks. Short-term projections by the international economic organizations reflect this inertia.

The question to be considered in whether in the long run, Russian economy is likely to run out of steam, as the prophets of doom has been forecasting? According to the OECD Economic Outlook, average GDP growth in Russia will total 3.5 per cent in 2013–2017, shrinking to 0.9 per cent in 2031–2050.

Under such scenario, other major emerging economies (Brazil, South Africa, Indonesia), to say nothing of China and India, will grow faster than Russia. This gloomy forecast also indicates that Russian economic growth will be below average world GDP dynamics, starting with 2018.

All the projections and day-to-day developments in the Russian economy make the case for a substantial economic policy revision. Throughout the 2000s the economic policy was successful, yet not so much conceptually sophisticated. To put it very simple, it was a standard Keynesian policy aimed at fueling aggregate demand.

High export revenues and public expenditures were its important ingredients. However, this policy is effective only when the economy is far from its production frontier. Now the Russian economy seems to be in the vicinity of this frontier.

The unemployment rate is slightly above 5 per cent, whereas the average capacity utilization is 65 per cent. It is well known that not accelerating inflation rate of unemployment (NAIRU) is normally around 5–6 per cent, and different empirical estimates of maximum capacity utilisation for Russia yield the range of 62–75 per cent.

So, the Russian economy is facing stagflation risks. To secure higher growth rates in the future, it is necessary to stimulate aggregate supply, i.e. entry of new firms, job creation and labor productivity. It implies pursuing more insightful policy, involving major institutional changes.

Combating excessive regulation

In this regard the general direction of future reforms announced during Putin’s electoral campaign and aimed at improving investment climate, more competitive higher education and ample technological diffusion should be endorsed.  However, there seems to be a gap between planning and implementation. For example, such important issues as pension and tax reforms have been in a stalemate over a year.

Meanwhile, the Russian economy is sliding into a trap of excessive regulation. In his recent book Andrei Shleifer, a prominent specialist in economics of regulation, emphasises that regulation should be seen as a partial substitute of resolving disputes in courts.

Even in the most advanced economies courts may fail to solve contract and tort disputes impartially and cheaply. Under such circumstances regulation emerges as an alternative which actually helps maintain the efficiency of the judicial system by preventing parties from going into courts unreasonably often.

Anyway, there should always be a balanced mix of judges and regulation. Relying primarily on regulation is insufficient, as in some cases it should be enforced. To this end, courts are indispensable.

However, in Russia the balance between judges and regulation seems to be disproportionately skewed towards the latter. The workload of courts is enormous which, ceteris paribus, has a detrimental effect on the quality of their decisions and ultimately on their credibility.

In such situation regulation is no remedy, as it can’t be adequately and timely enforced in court. It forces economic agents to look for alternative means of dispute resolution, sometimes beyond legal scope. In its turn, this involves the adoption of additional laws, as bureaucrats believe that the existing regulation has too many loopholes and should be tightened.

As a result, regulation becomes excessive as it can’t be enforced. Yet, instead of strengthening the judicial system, there remains a strong incentive to go on inflating regulation, as it gives an impression of the ongoing reforms and requires less effort.

A brief search of the website of the State Duma of the Russian Federation yields nearly 2000 new federal acts and amendments adopted annually in 2009–2012. One should also take into account that they generate a stream of by-laws, making the bias towards regulation in Russia intolerable.

The excessive regulation impedes the development of many sectors, e.g. financial markets. Despite recent changes in their regulation (anti-insider trading act, MICEX and RTS merger, inauguration of the Central Depository Trust Company, etc.) there has been no clear-cut positive trend in their development.

Such segments as mutual funds and derivates have exhibited almost no progress over the past 5 years. So, I believe, one of the main challenges the Russian economy should meet is to rebalance the role of courts and regulation. It may speed up other pending institutional reforms and eventually spur annual GDP growth rate up to the 5 per cent in the medium term which the Russian top officials have been so zealous for.

There is no denying that being the largest oil producer in the world, and with its 2011 GDP (PPP) ranking just below Germany, Russia does seem like a candidate to become Europe’s leading economy by 2030, only if embarked on the path of much needed reforms and that too fairly quickly.