Global Lessons For Russian Policymakers


U.S. policy on the financial crisis affects countries everywhere. However the fundamentals that determine growth rates in emerging market economies are the result of domestic policies, as several experts point out.

Russia's economy this year leapt ahead of all the European nations, becoming the fifth largest worldwide in terms of GDP. It overtook Germany, according to the World Bank's calculation of purchasing power parity, based on its gross domestic product in 2012.

Such an economy should be generating the jobs to match. But there is a debate about what those jobs are and where they should come from.

The economy racked up $3.4 trillion in GDP, largely based on energy exports. When the World Bank published its GDP by PPP ranking in July, it also ranked Russia among countries with high national income per capita; lifting it from its upper middle income ranking of the past decade.

But the economy has since contracted sharply. The International Monetary Fund expects Russia's economy to grow at 1.5 percent in 2013, its third downgrade this year after originally forecasting 3.7 percent. That's still good news for retail spending, and it is still more growth than in much of Europe.

Russia must develop its human capital, which requires structural reform in education, health and pensions.

The IMF urged the government to boost investment and said the growth rate could double next year if the global environment improves, which is a large caveat. By the way, the IMF ranks Russia's economy as the eighth biggest, in terms of the value of economic output in international trade. That puts Russia behind The U.S., China, Japan, Germany, France, the UK and Brazil, with $2 trillion GDP.

Politicians greeted the new World Bank ranking, especially as it may give Russia more clout when it accedes to the Organization for Economic Cooperation and Development (OECD) , which is planned for 2015. Experts at the OECD recommend that the country boosts labor productivity, stimulates innovation, and improves financial and tax regulation.

Employment prospects, consumer spending and consequently corporate profits depend on what happens next. Gazprom is now the second biggest global energy company (behind Saudi Arabia's ARAMCO) but the jobs market depends on business services companies, consultants, IT and communications specialists, manufacturers and engineers — along with the expansion of healthcare, schools and social services.

The preparatory meeting in July for the G20 leaders summit in St. Petersburg had suggested a continuing focus on stimulus to support the "return to a robust, job-rich growth path", in the words of the final communique.

By the actual G20 summit in September, even the Chinese economy was slowing and U.S. jobs growth had retreated (the employment participation rate fell to its lowest since the 1970s), the running dispute on the U.S. budget hoved back into view, and talk in the Eurozone turned to yet another bailout of southern Europe. In the emerging markets, falling currencies, high inflation and external imbalances began once more to trouble India, Brazil and Russia.

While the issue of Syria dominated the G20 leaders summit, politicians also managed to put some issues on the table, such as cross-border tax arrangements by international companies, which allows some of them to avoid paying any tax in countries where they make hundreds of millions of dollars in sales. But Syria largely obscured the continuing aftershocks of the financial crisis that began five years ago.

Among central bankers, the debate has been how long the rich economies can continue financial stimulus, or the creating of money, which has saved countless jobs in the banking sector, government and elsewhere. Since early summer, Federal Reserve chairman Ben Bernanke had been preparing the markets for the tapering of quantitative easing, causing Treasuries to jump and emerging market stock markets and their currencies to tumble.

On September 18th, the Federal Open market committee, which enacts Fed policy, announced it would keep printing $85 billion a month which it supposedly feeds into the economy by purchasing Treasuries and mortgage bonds. However, banks have for several years been criticised for holding onto the money to repair their balance sheets, reinvesting it not in the economy but back in the vaults of the same central banks that created the money. It has proved a mixed blessing for emerging markets, too.

At the height of QE dollars were flooding into emerging markets, causing currencies to overvalue, and forcing countries like Brazil to impose capital controls. Now the reverse is happening: money is flowing back to the US. It is clear that when the US changes its policy, it changes the environment for emerging markets, just as happened in 2007-2008.

However, the fundamentals of emerging market economies are the result of domestic policy, according to Arvind Subramanian of the Peterson Institute of International Economics, whose analysis of India has parallels for Russia.

India's growth rate of 6.5 percent since the 1970s accelerated to 8 percent a decade ago. India achieved this by maximising the use of its skilled labour, but those wages are now approaching western levels. Government regulations also mitigate against scale: as companies get bigger they face greater regulation. Subramanian says India cannot match Chinese clothing manufacturers for scale. Nor has India created the conditions for low-skilled manufacturing.

India faces familiar problems with infrastructure: ports, power supplies, roads, railways don't meet international standards, "so you don't get the private investment in manufacturing that will sustain India's next phase of growth", Subramanian wrote in a Peterson report.

The Indian government used the proceeds of the boom years on inclusive social spending plans: power, fuel and fertilizer subsidies, and underestimated how much these programs create inflation, boost imports, export capital and create deficits. Politicians wrongly assumed that the growth would create continued revenues to finance this spending. This narrative is familiar to observers of Russia.

In his white paper "Human Capital: Challenges for Russia," Vladimir Mau, Rector of the Russian Presidential Academy of National Economy and Public Administration, said that in order to pursue economic growth, "Russia must develop its human capital, which requires structural reforms in education, healthcare and pensions.

"These, in turn, must respond to major trends in service provision, including the increasing role of individual choice... and the risk that Russians will increasingly buy services abroad, rather than work to develop their own national systems."

Although the financial crisis has strained state resources, the political and social stability of societies depends upon the efficient functioning of these sectors. Russia spends 1.5 to 3 times less on education and 3 to 4 times less on healthcare as a percentage of GDP than the OECD average, Mau says.

Developing education and healthcare depends on demand, yet that demand can go elsewhere: "It is now much easier than it was 20 years ago to enrol in any university or to receive health treatment in any clinic throughout the world. This costs money, but as the economy grows, the disposable income of Russian citizens will also grow, and as experience shows, Russians are prepared to invest in themselves; in their education and healthcare.

"Of course, if those who can pay for high-quality services turn mainly to overseas suppliers, then Russia will be deprived of opportunities to improve its own services. This will limit the demand for high-quality education and healthcare and, inevitably, the supply. This is the major strategic challenge for human capital development and the principal challenge facing the overall modernisation of Russia," Mau writes.

Programs like those at Skolkovo Innovation Center certainly inspire many Russian entrepreneurs as well as a new generation of politicians. However, the economy is not yet diversified nor modernised. And the challenges go beyond the more obvious obstacles to business, like corruption and bureaucracy.

In short, the development of a service sector, both public and private, depends on demand. Middle class Russians may buy their health care abroad, but Russian doctors face a limited foreign market for their skills. Will so many Russian graduates opt to train as doctors at all?

More broadly, the jobs market like the economy requires a broad range of skills. It cannot survive on IT personnel, engineers and a streamlined banking sector.