Nothing Overheated In Russian Economy

Last week, the Moscow bureaus of the International Monetary Fund and the World Bank declared that Russia's economy is overheated and that the government should take immediate measures to stem inflation. The diagnosis is probably incorrect, but some of the report's recommendations still make good sense.

An economy is overheated when one of the factors of production -- labor or capital -- accumulates at an excessively high rate. In developed economies, long-term economic growth is determined by the pace of technology development and the population growth rate.

For a developing economy such as Russia's, however, overheating is virtually impossible until the amount of capital per unit of labor reaches the level of capital in the world's developed economies.

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A simple indicator that our economy is not overheating is that labor productivity is not only far below advanced countries, it is even lower in comparison with other developing countries.

Two months ago, it was Finance Minister Alexei Kudrin who used the danger of overheating to argue that state investment should be restrained. Now the IMF and the World Bank make the same plausible argument.

But the absence of overheating in the Russian economy does not mean everything is fine. Annual inflation now stands at 15 percent, which is not only higher than both last year's rate, but it exceeds what the government promised for 2008. This does not warrant extreme measures, such as price limits on individual markets, but it is a good opportunity to institute structural changes that will help to curb inflation.

Often, the idea of breaking up certain monopolies is cited as a key inflation-fighting measure. Monopolies cause high prices but not inflation. Thus, antitrust measures cannot slow the rate of inflation, but they would lead to lower prices, and this would certainly make it easier for the government to fight against inflation.

Take Moscow, for example. The reason for exorbitantly high prices in two sectors of the economy -- hotels and restaurants -- is due largely to the high degree of government involvement in those markets. First, the city government controls all the land and a large amount of rental space in its jurisdiction, which allows it to influence rental prices. Second, the city government controls regulatory bodies and the courts.

Unfortunately, we hear more talk these days about replacing Mayor Yury Luzhkov than about how his replacement should break up these monopolies, which, of course, are the real root of the problem.

Konstantin Sonin, a professor at the New Economic School/CEFIR, is a columnist for Vedomosti.