The Beginning of a Lost Decade

How Russia slips into a new economic recession

In 2013, economic growth in Russia had not exceeded 1.4 percent, and hopes it may accelerate in coming years look doubtful. Russian stock exchange indicators remain at around 60–65 percent of their pre-crisis values. Why Russia, the country that during the 2000s served as an example of rapid economic development, came close to a standstill these days?

In my opinion, the very comparison of economic dynamics in recent years suggests that the crisis now evolving in Russia has nothing to do with the trends currently unfolding in the global economy. Oil, which play a crucial role in ensuring the country’s financial well-being, trades well above US $100 per barrel; financial markets continue to be flooded with money while interest rates remain low; Russia’s export revenues amount to around US $500b for each of the last three years. Therefore, the roots of the problem should be sought inside Russia—or rather in the policies of its authorities, which are pursued after President Putin’s return to the Kremlin in May, 2012. Among the most important factors explaining the current slowdown of economic growth in the country I would mention just five today.

First, in recent years Russia experienced a steady increase of both budgetary incomes and outlays at all levels. In 2013, overall budget revenues reached 37% of GDP—roughly the same amount as in Austria, and bigger almost by a third than in Poland. Tax increases happen in Russia with surprising regularity, despite the apparent feeling about its liberal tax policy, fueled by a low 13 percent income tax; the social security payments these days are as high as 30.2 percent, the corporate profit tax stays at 20 percent, and value-added tax at 18 percent. It should be noted as well that about 50 percent of federal revenues originate from customs duties, which corresponds to the level more common in the poorest African nations. Both rising taxes and employment of new tough collection measures disregard investors from starting new businesses and undermine overall investment climate in the country. No less important is the fact that big state-owned companies, such as Gazprom, Rosneft, Russian Railways and many others for many years in a row have raised tariffs on their products and services, thus making their clients increasingly uncompetitive. Thus, the first cause of the coming Russian stagnation is the growth of the state’s involvement in the economy, manifested in different forms. As a result, entrepreneurial activity slows down while the capital flight from Russia becomes a constant process (from 2009 till 2013 more than US $320b were taken out of the country predominantly by domestic investors).

Secondly, the economic growth is derailed not only by collection of excessive government revenues, but also by highly inefficient budget spendings. Back in 2010, the then President Medvedev argued that around 1 trillion rubles (US $30b) annually were unappropriately used (read—stolen) by procurement of goods and services for state needs. But even this is not the most important thing. In contrast with the case of the U.S.’ “New Deal” when the public funds helped to bring the country out of the crisis, in today’s Russia their use does not provide a similar effect. On the first glance, the amount of investment is quite ambitious, but the use of funds is either focused in the propaganda-related projects (more than US $100b has been and will be spent on the celebrations like those connected with APEC summit in Vladivostok in 2012, G20 and G8 meetings, as well as the Winter Olympics in Sochi in 2014 and the FIFA World Cup in 2018), or do not produce additional economic activity (such as modernization of the Trans-Siberian railway or construction of high-speed railway from Moscow to Kazan’—both projects are expected to take about US $50b with no chance of a break-even in less than 50 years). With a significant portion of funds stolen or lost, the majority of construction workers being migrants from former Soviet republics, and a substantial part of the equipment and materials purchased abroad, such projects are unable to give a push to the economy. So, the problems arises from the fact that the increase in tax collection slows economic growth and public investment does not accelerate it.

Thirdly, an important problem becomes the constant increase in costs. From 2001 to 2012, while the rouble/dollar exchange rate has remained relatively the same, domestic gasoline prices rose 11 times, natural gas prices—16 times, and electricity tariffs—nearly 20 times. Today, aluminum, copper and many other industrial metals are more expensive in Russia than they are traded in the world markets. Similar is the situation with construction materials. Costs of connecting new enterprises to the grid in many cases exceed estimated profits from their operations for two or three years. As a consequence, a large number of goods and services produced these days in Russia are offered at prices much higher than those existing in the Eastern Europe and in Germany. Of course, under such circumstances, neither the Russian nor the foreign entrepreneurs have a desire to invest in a country where the production factors are so overvalued. Labor costs, which in the first half of the 2000s were one of the factors of competitiveness, has grown over the past years many times—but without increasing either of the quality or the efficiency of Russian workers.

Fourth, there is no demand for innovations since the competition between private and public enterprises will almost certainly be won by state monopolies. In Russia today, there is a narrow sector of high-tech industries (mobile communications and Internet providers for example), but it attributes only 3–4 percent to the country’s GDP, and even its rapid growth can not compensate for stagnating industrial and resource sector, which provided rapid growth from 2000 till 2008. Todays Russia produces roughly the same amount of oil and natural gas as the Russian Soviet Federative Republic did back in 1990, while both Kazakhstan and Azerbaijan exceed Soviet-time production figures by 3 to 4 times. Commodity sector, which is extremely competitive worldwide and therefore high-tech, is monopolized in Russia by state corporations and does not spend money on R&D—the result is the preservation of both production structure and its technological base, and, therefore, some extended prerequisites for further stagnation of both resource and overall economy.

Fifth, the history of recent decades shows that the most successful in the global economy are those countries which are actively involved in the global division of labor and which attract foreign investment and technology. In Russia, we now see the reverse process: the country has become virtually the only one in the world where a public company uses tens of billions of dollars for buying foreign companies operating on its territory (as it happened in the case of recent TNK-BP’s acquisition by Rosneft) and thus substitute a foreign investment by a domestic one. In addition, Russia becomes increasingly isolationist power and Putin’s foreign policy strategy is clearly aimed at limiting Western economic and political influence on the country. Meanwhile, as is well known, autarky under modern conditions almost always leads to a slowdown of growth like the one we witness in Russia today.

One may note a number of developments which are not of purely economic, but also of political and social nature, and that also undermine the confidence of investors (both domestic and foreign) in Russia’s economy. Nevertheless, the main trend looks very distinct: Russia’s economic growth these days is sacrificed to the political ambitions of the ruling elite. In order to run the country without any challenges, it waives economic growth and competitiveness. Instead of lowering of meaningless government spending and introducing some aggressive tax cuts, Kremlin increases the tax burden and focuses on the administrative measures in handling the economy, rather than on easing it for entrepreneurship. Dynamics of the last two years, during which the quarterly growth fell from 4.9 percent in the 1st quarter of 2012 to almost zero in the 4th quarter of 2013, shows that this choice is wrong. However, it will not be revised, as Putin and his aides are convinced that politics is more important than economics, and “manual control” may replace the market levers.

The result looks pretty obvious. While in Moscow the government still argues economic growth will accelerate to 3.0 percent in 2014 and to 3.4 percent in 2015, there is no reason to assume this happens. It takes from one to three years to change the trajectory of economic development—and after such a noticeable deterioration of the business climate, it is difficult to assume for its sharp improvement in the short run. Thus, it seems to me that what we all should expect is a significant deterioration in the economic situation in the country—most likely marking the beginning of a “lost decade” that will last as long as Mr. Putin remains in charge of Russia. I am not talking here about a recession or crisis; today Russia has enough means to avoid a classical recession (if necessary it may increase borrowing, cut some government spending, appropriate a share of the profits of state-owned companies) but there is no grounds to bet on growth. During 2014–2016 we might see Russian economy balancing on the brink of recession, going from a small increase into small contraction, and vice versa—but both within the statistical error. This situation is familiar to many developed countries, but quite unusual for a country that has grown at a pace of 5–8 percent annually over the previous decade. The question of how this economically “lost” decade can trigger acceleration of political process in Russia, cannot be answered today but Moscow’s claim for the status of a fast-rising power can be considered insolvent.

Vladislav Inozemtsev

Professor of Economics, Chair of the Department of International Economy at Moscow State University’s School of Public Governance.

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