Annual Lecture 2015 report

The BEARR Trust annual lecture, 22 June 2015

THE STATE OF THE RUSSIAN ECONOMY: HOPELESS BUT NOT POLITICALLY SERIOUS?

by Professor Philip Hanson

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“A submerging economy rather than an emerging economy” was one of the key themes of Professor Hanson’s lecture. He assessed that the Russian economy suffers from structural as well as circumstantial challenges, and would continue to grow at a lower rate than other BRIC economies.

Robert Brinkley, Chairman of The BEARR Trust, welcomed the speaker, Professor Philip Hanson, thanking him for agreeing to give the 2015 annual lecture, and also thanked the EBRD for generously hosting the event and for the Bank’s continued support for The BEARR Trust.  He thanked the BEARR Trust volunteers and trustees for their work. He mentioned the Small Grants Scheme, which this year attracted 150 bids for projects in Ukraine and nearly 50 for projects in Central Asian countries, demonstrating continued demand from small NGOs in the health and social welfare sectors in the region for support from organisations like The BEARR Trust.

Professor Hanson said that people tend to get over-excited about Russia – they are either too gloomy or too upbeat, while the reality lies somewhere in the middle. Since 1991 Russia has not explored extremes in economic policy, but has muddled through, so the outcome of the current recession in Russia, which is not as deep as the one in 2009, is likely to be a slow and sluggish recovery.  Professor Hanson said his prognosis looks ahead to 2017. His main conclusion was that the semi-stagnation of the economy would not affect the political order.

Among challenges to economic prosperity the weak rule of law is crucial. In 2015 Russian GDP would contract by 3-4% (the EBRD forecast was 4-5%). Recovery could start later in 2015 or in early 2016, though the IMF is more pessimistic. (The contraction in 2009 was 8%.) There will not be a return to the high growth rates of the early 2000s. What we see is more a submerging than an emerging economy. Russia’s share of the world economy is edging downwards, standing at about 3%, while those of China and India are rising.

At the recent St Petersburg Economic Forum President Putin suggested that the Russian economy needed to grow at the rate of 3.5% annually, but this ambition looks over-optimistic. Russian labour productivity is two fifths that of Germany, so Russia has the potential to catch up in this area, but has been failing since 2012 to close the gap.

Currently, consumption is declining. Whereas in 2009 output fell more than consumption, the reverse is now the case. Households did well in the 2000s with an average annual increase in consumption of 11%. However, unemployment is not high. Russian businesses tend to cut earnings rather than sack staff. The current dip in living standards is also affected by inflation, which was at 17% in March 2015, mainly because of the fall in the exchange rate, and the fall in the oil price has had a major effect. This graph shows consumption and GDP growth:

Russia has substantial gold and foreign-exchange reserves but they fell sharply last year, when capital outflow was even higher than in 2009. Sanctions mean there is very little funding from western banks, but this may soon be partially resumed. Russian companies with assets outside Russia can use these to pay some debts, but investment has been affected.

If the oil price holds at or above $55 a barrel things will be alright, but if it drops again or stays low for long, average annual growth of GDP could be as low as 1.5% up to 2025. The enfeebled state of the economy is the result of a perfect storm:

structural weaknesses – weak demographics resulting in a declining labour force; and the dampening effects of “Sistema”[1];

unfavourable international conditions: weakness in the Eurozone; the end of quantitative easing in Europe and the US; the rise in shale oil and its effect on oil prices.

international conflict – the Ukraine crisis: the cost to Russia of war and uncertainty, and not only as a consequence of sanctions and counter-sanctions, with costly import substitution.

Even if the Donbas becomes just a frozen conflict and sanctions peter out and if the Eurozone resumes growth, structural problems remain: the working-age population could fall to 81 million in 2020 (despite immigration from poorer neighbouring countries, which is offset by a brain drain to western economies); and the weak rule of law and protection of property rights, with widespread asset-grabbing (reiderstvo) and pressure from officials, will continue to have a negative effect. Reiderstvo is being combatted by some business associations and officials, such as the Ombudsman for Business.

One of the consequences is that entrepreneurship is weak in Russia. It comes 71st out of 73 countries assessed in the Global Entrepreneurship Monitor for the percentage of people owning their own business[2]:

  • % OWNING AN ESTABLISHED BUSINESS 2014
  • CHINA                                     14.2
  • KAZAKHSTAN                          6.2
  • RUSSIA                                     2.4 (71st/73 COUNTRIES

Who in Russia is against the rule of law?

Who benefits from the weak rule of law? The answer is big-business owners who benefit from crony relations and the bulk of the political elite, plus lower-level officials, who are in a situation of “suspended punishment” but, because of the scope they have for corrupt practices, not mutinous. If there was a free press and rule of law these groups  would feel threatened. Even “liberals” in the establishment have some incentives not to push too hard for stronger rule of law, and the general conjuncture is not favourable to reform in this sphere.

What are the possible outcomes?

A split within the elite between tycoons and siloviki (security service officials); or between big spenders such as the military and civilian sectors. There has been relative dollar impoverishment of many tycoons since sanctions and the oil price struck Russia: $73bn was lost by the main wealth holders between February and December 2014. Such people have been described as holding their wealth in Russia at the discretion of the Russian state, and are thus “Putin’s hostages”. A split is possible but not likely.

As for popular discontent, in 2013 there were signs that Putin’s popularity was becoming vulnerable to the economic situation. Then the crisis in Ukraine pushed his popularity way up. This leads to the conclusion that the current economic crisis will not change the political order, but it is nonetheless politically serious in another sense, because it provides an incentive to keep the conflict in Ukraine going.

In the Q&A, some further insights emerged: up to 2003 there was a vision of Russia becoming part of the western world, but since the Yukos affair and then in 2011 the resignation of Deputy Prime Minister and liberal reformer Kudrin, the siloviki have gained ground. Reform petered out on 2008-9, but did not go into reverse. During Medvedev’s presidency some reform occurred, but the system of tribute stifles change – too many people owe too much to too many, while rents from oil and gas are used to prop up “heritage industries” instead of closing them down and investing in new ones.