A different country: Russia’s economic resurgence

Lúcio Vinhas de Souza, 13 June 2008

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Russia is now once again one of the ten largest economies in the world.1 Moreover, Russia is the third largest EU trade partner and one of its essential energy suppliers. This recovery makes Russia an economic – and political – actor that we cannot ignore.

Growth recovery and macroeconomic stabilization

Russia’s 2007 GDP was worth almost $1.35 trillion. Positive and high growth has returned since 1999 (averaging 7% per year), inflation has fallen considerably, and the fiscal budget shows consistently high surpluses. As a result, Russia has fully recovered from the largely unavoidable “transition recession” (Shleifer & Treisman 2005, Vinhas de Souza & Havrylyshyn 2006) that plagued the country during the 1990s.

While the cumulative GDP recovery of Russia since the onset of “transition” still lags behind those experienced by the EU’s new member states, it is comparable to the Commonwealth of Independent States (CIS) average performance, and above the South-East Europe performance, which includes two EU candidate countries, Croatia and former Yugoslav Republic of Macedonia (see Figure 1).2

Figure 1. GDP growth rates

Source: IMF.

The CIS is arguably a better benchmark to Russia than the new member states or South East Europe, as the CIS not only shares similar structural features (larger primary sector, longer time under planned economy) with Russia, but also the lack of a EU reform “anchor”, as EU integration implied not only binding structural reforms in the new member states but also provided significant technical and financial support for the reform process. Additionally, Russia surpasses the 1999-2007 growth average of a comparator group of large emerging markets, the BRICs (Brazil, Russia, India and China). Moreover, using other macroeconomic indicators, Russia also fares similarly to the CIS aggregate in terms of inflation and above both the CIS and the new member states in terms of (post-1998) fiscal performance.

Growth drivers after the early transition

Growth in transition economies can only be properly discussed after the structural changes associated with the introduction of market mechanisms have happened. In Russia, the end of this initial adjustment period is associated with the 1998 crisis. What is behind the rather impressive performance experienced by Russia after 1998? There are many factors, from the most widely quoted, energy prices, to less recognized ones, like cumulative structural reform.

Energy Prices

Undeniably, energy prices play a very significant role in Russia’s economic performance, before, after, and during the 1998 benchmark, as they contributed to the crisis itself. In 1998, oil prices had fallen to the historically low level of $12.70 per barrel (of UK Brent). As a comparison, this is not only half the price in 1990 but also significantly below the post-war average price of $15. In contrast, by late 2000, oil prices had surpassed $28 per barrel and by May 2008 they were above $130. Gas prices followed a similar pattern.

The effects of those changes were dramatic. Exports grew from $75 billion in 1999 to almost $400 billion in 2007. The current account surplus expanded from $25 to $80 billion during the same period, while hard currency reserves increased from $8.5 billion to almost $474 billion (in May 2008 they reached almost $540 billion, making Russia the third largest holder of hard currency reserves on earth). Russian fiscal revenues’ dependency on oil export duties and profit taxes (responsible for almost half of total federal revenue) is clearly shown by the change in fiscal balance, from -6% of GDP in 1998 to almost +6% of GDP in 2007. GDP growth itself jumped from -5% in 1998 to +8% in 2007.

Nevertheless, the importance of other growth sectors in Russia should not be underestimated. The direct contribution of the energy sector to industrial growth has actually been declining since 2002 and fell below 10% by 2007. About 70% of Russian aggregate growth experienced since 1999 was not directly natural-resources-related. There has been very strong growth in industrial sectors such as the capital goods industry, especially with the recent investment boom – the period 2006-08 saw a strong take-off of investment, underpinned by strong FDI inflows, with gross capital formation soaring by almost 21% in 2007 and early 2008, up from the already high 17.5% of 2006 – and also in several services sectors. This points to the second factor, the importance of cumulative reform as a driver for growth in Russia.

Structural Reforms

As with evaluating growth, evaluating Russia’s economic reform requires adequate benchmarks. Arguably, Russia’s reform process should be compared with clusters of countries that do not benefit from the EU external anchor. Using a rough-and-ready index of reform, the European Bank for Reconstruction and Development (EBRD)’s transition indicator, reveals several things. First, Russia again outperforms the CIS average, and its lead is increasing – Russia is reforming faster than the CIS average. Second, Russia is above the South East Europe average, which includes two EU candidate countries that raise the region’s average reform performance. Third, progress in structural reform in Russia, as measured by the transition indicator, after a hiatus in 2004-2005, started again in 2006. Fourthly, it is possible to identify the reform areas in which Russia underperforms: those are microeconomic and structural ones, arguably more difficult reform areas, Russia performs better on more traditional macro areas of reform.

This picture is roughly consistent when one uses other indicators, like the EBRD–World Bank Business Environment and Enterprise Performance Survey (BEEPS) or the World Bank “Doing Business” and “Governance Indicators”. In other words, Russia, albeit far from being a model reformer, does not necessarily fare badly when compared with adequate benchmarks. Also, the perception of an overall slowdown in reforms is not necessarily accurate. This, of course, in no way implies that additional reforms are not necessary, especially in more microeconomic and structural areas: far from it.

Have oil prices or reforms been more important for growth resumption in Russia so far? There is no precise way to assess this, as oil prices and reforms interact in complex ways. Nevertheless, using a simple “naive” regression of GDP growth rates on oil prices and the EBRD’s transition indicator (the reform indicator with the longest series available) for Russia shows that the reform variable has a considerable higher (and mostly positive) coefficient than the one associated with oil prices (albeit neither of the two variables is always significant or even positive). This outcome is robust to the use of the variables in changes or index terms and to their use in a contemporaneous or lagged format. It is also mostly robust to sample changes.

Conclusion

The impressive economic recovery in Russia since the 1990s makes Russia a nation that Europe cannot afford to ignore. When compared to relevant benchmarks (i.e., other CIS countries or the BRICs), Russia does not necessarily underperform, either in terms of growth or reforms – despite these being some of the most persistent myths concerning Russia.

As Russia’s record of macroeconomic reform is clearly more respectable, including even elements in which Russia is arguably the regional leader (like the fiscal framework), most of the remaining agenda is one of micro and structural reforms. Those additional reforms are necessary to make the impressive performance of Russia truly sustainable in the long run.

References

Ahrend, R. (2006): Russia’s Economic Expansion 1999-2005, in Vinhas de Souza, L. and Havrylyshyn, O. (eds), Return to Growth in the CIS, Springer, Germany.

Owen, D. and D. Robinson (eds) (2003): Russia Rebounds. IMF, Washington, D.C.

Rosefielde, S. (2005): Russia: An Abnormal Country, European Journal of Comparative Economics, Vol. 2, No. 1, pp. 3–16.

Shleifer, A. and Treisman, D. (2005): A Normal Country: Russia after Communism, Journal of Economic Perspectives, Vol. 19, No. 1, pp. 151–74.

Vinhas de Souza, L. (2008): Russia: A Different Country. CEPS Paperback Books Series, CEPS, Brussels.

Vinhas de Souza, L. and Havrylyshyn, O. (eds) (2006): Return to Growth in CIS Countries. Springer Verlag, Berlin.

Footnotes

1 The title of this column is a play on words with the titles of the papers by Shleifer & Treisman (2005), “A Normal Country: Russia after Communism” and Rosefielde (2005), “Russia: An Abnormal Country”, which engage in the traditional Western debate of how ‘normal’ Russia is. It also happens to be the title of my last book (Vinhas de Souza, 2008), on which this article is based.

2 The CIS is the loose association of most of the former Soviet Union republics, bar the Baltic republics that entered the EU in 2004

Topics: Development
Tags: economic performance, growth, Russia, structural reforms