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. Last Updated: 07/27/2016

Tackling the Problem of Economic Inequality

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U neven development, as reflected in political polarization, geographical and ethnic diversity, the minuteness of the middle class and sectoral imbalances, is a defining feature of Russian history. Imbalances persist today and are prevalent across regions and sectors, as well as in income distribution and the comparatively minor role of small and medium enterprises.

Addressing the problem of unbalanced growth has become a top priority for the government, and this to a significant degree will determine sectoral priorities as well as the macroeconomic mix of fiscal and monetary policies in the years to come.

The imbalance among economic sectors is most obvious in Russia's excessive dependence on oil. The fuel sector -- petroleum, petroleum products and natural gas -- accounts for roughly one-quarter of gross domestic product, more than half of federal budget revenues and nearly two-thirds of total exports.

The fuel sector is also the largest recipient of foreign direct investment and accounts for more than half of stock market capitalization.

The "resource curse" looms even larger when you factor in other resource-based sectors, such as timber and metals, which together with fuel account for nearly 90 percent of total exports, leaving Russia extremely exposed to swings in global commodities markets.

Among the regions, the imbalance begins with the city of Moscow. The capital's per-capita consumption is more than twice that of any other region. It accounts for nearly one-fifth of the country's GDP; if you add the oil-rich Tyumen region, this share increases to one-third.

One reason for the discrepancy in regional development is resource distribution. According to government statistics, 54 percent of all resources are extracted in the Tyumen region, and two-thirds of resource wealth is concentrated in just three regions.

As a result, per-capital fiscal revenues in the richest regions are 10 to 20 times higher than in the poorest regions, such as Dagestan.

Inequality among people has also risen in the last few years. Income disparity, already higher than in most Central and East European countries, continues to increase. At the same time, decreases in nonpayments and inflation, along with higher pensions and public-sector wages, have made reducing poverty a realistic goal. Government statistics show that the number of people below the poverty line declined from 29 percent in 2000 to 17.6 percent in 2004.

A key to structural asymmetry in the economy is the limited role of small and medium enterprises, which in most developed economies account for more than 50 percent of total employment and GDP. In Russia, these indicators are well below 20 percent.

Finally, there is the intergenerational divide. The living standards of the elderly continue to deteriorate relative to other age groups, driven by the declining value of pensions, among other things. If in 1998 the average pension was equivalent to 40 percent of the average wage, by 2006 its value had dropped to just 30 percent.

Empirical evidence on transition economies suggests that the costs of such imbalances could be high. An International Monetary Fund study of transition economies demonstrates a direct link between greater inequality and lower GDP growth.

During the tsarist period, persistent and high income inequality contributed to political instability and killed off modernization efforts under Peter the Great and again in the late 19th and early 20th centuries. In the 1930s, sectoral imbalances were the bane of the economy, as industrialization was pursued at the expense of the agricultural and service sectors.

More recently, concerns over economic imbalances have resurfaced as the election season approaches, putting the spotlight on income and regional inequality. The government's failure to reform the social safety net, including pensions, has reinforced awareness of the unequal distribution of wealth, and the bungled reform of in-kind benefits resulted in shortages of free medicine for some of the most vulnerable members of society.

The government's drive to modernize the economy once again faces the familiar challenge of unbalanced development.

The good news is that the Kremlin is clearly aware of these risks. During his state-of-the-nation address this year, President Vladimir Putin underscored the perils of the high income gap in society. Rhetoric aside, the government is actively seeking ways to overcome the imbalances that threaten the political and economic sustainability of the ongoing modernization effort.

Over the last year, the government has launched several policy initiatives aimed at bridging the inequalities in regional and sectoral development, starting with the national projects scheme, which directs resources to four high-priority sectors: education, housing, agriculture and health care.

The national projects are designed to address the income inequality gap, which is especially pronounced in terms of access to public services.

A second initiative, special economic zones, is intended to diversify regional development by creating greater economic activity outside of Moscow and the oil-rich regions.

Attempts to spread out sectoral development and to reduce dependence on the fuel sector include the creation of the Development Bank to finance large-scale industrial projects; the Russian Venture Company to finance high-risk projects in high-tech; and the Investment Fund to finance infrastructure projects such as roads and railroads.

In addition, the stabilization fund will be split next year into a reserve fund and a national welfare fund to address the problem of inequality between generations.

More generally, the country appears to be entering a period of consolidation. Some of the features of this process are familiar from East Asian models, such as the rise of so-called national champions, which are intended to create market stability and combat the mistrust of institutions left over from the 1990s.

The string of "people's IPOs" that began with Rosneft and continued with Sberbank, provided for greater public ownership of these national champions.

Macroeconomic policy is also likely to be tailored to reduce inequality. Heavy taxation of resource-based sectors of the economy is likely to continue in the medium term -- even to increase in the case of the fuel sector -- in order to promote sectoral diversification. Policymakers will continue to target inflation, which leads to greater poverty and income inequality and high mortgage rates.

Finally, the development of specific sectors is likely to be prioritized through fiscal spending and tax incentives with a view to making rapid growth consistent with reduced poverty and inequality.

The World Bank says that for governments to avoid so-called inequality traps and promote equity and growth, they must expand access to public services, develop infrastructure and invest in education.

In his state-of-the-nation speech, Putin addressed these very issues and identified new housing and infrastructure as top priorities. Rebuilding the country's infrastructure alone will not bridge the inequality gap, however. In addition to sectoral and macroeconomic policy initiatives, the government must guarantee property rights, fight corruption and ensure market fairness by curbing the power of monopolies.

Russia's priority in the years to come will be overcoming the imbalances that inhibit long-term growth. To achieve this, the government will pursue political consolidation, efforts to expand the nascent middle class and economic diversification across sectors and regions.

The sectors most likely to benefit during this new phase of economic development include banking and construction, with mortgages being the critical link; infrastructure, most notably electricity and metals; and such public service sectors as health care and education.

Long branded a country of extremes, Russia is now searching for a happy medium.

Yaroslav Lissovolik is chief economist at Deutsche Bank Russia.