OPINION August 13, 2019

Doubling Growth: How To Solve The Three Problems of Productivity in Russia

Apurva Sanghi, lead economist for Russia of the World Bank Group, talks about ways to double the potential growth rate. Questions by Evsey Gurvich, head of Economic Expert Group, a leading Russian think-tank.

Gurvich: Dear Apurva, I’m really glad you agreed to share your views on Russian economic problems. I highly appreciate the analysis and the policy advice produced by your team, in particular because you put Russian problems into a broad international context. Now, to start with, what do you see as relatively strong features of the Russian economy and our bottlenecks?

Sanghi: First of all, thank you very much to you, Evsey, for having me over. It’s an absolute pleasure to be here in the hallowed halls of the Bank of Russia and I very much look forward to our conversation.

So, a Russian friend of mine told me once that this is possible only in Russia that today you wake up as an optimist and go to bed as a pessimist. But tomorrow it’s just the opposite. So, there are things that are going well and things that are not going well. On the monetary front, inflation is about a third of what it was just a few years ago. I asked my team to do this little experiment, and we calculated that if inflation trends of 2015 sustained, a bowl of borsch, soup, would have been 31 roubles instead of 18 roubles today.

Russia’s external debt to GDP ratio is the third lowest among emerging markets, and compare that to over 120% in the eurozone. And with well over half a trillion dollars, Russia now has the world’s fourth highest levels of international reserves. On the fiscal front Russia can boast fiscal surpluses across all three tiers of government: general, federal and regional. And it has a new and revamped fiscal rule that aims to end its addiction to oil. And I have to say, in all of this, luck has also played a role: the good luck in recent years of firming oil prices, recovering global economy, and good climate, which has led Russia to become the world’s largest exporter of wheat. And talking of luck, there’s this story about this talented general who was once brought to Napoleon, and Napoleon takes one look at him and says: “I don’t care if you’re talented, are you lucky?”

So, my point is that we often underestimate the importance of luck, both bad and good, in terms of outcomes, economic outcomes. Anyway, so there are all these positives, but there are a lot of pressing issues as well. And let me continue on these three fronts: monetary, external and fiscal. So, on the monetary front, what matters to a central banker is not so much inflation once it’s realised, but inflationary expectations, which in Russia still remain high and so remain to be anchored. The banking sector is heavily state dominated. State-owned banks account for over 60% of the sector’s assets. The sector is also heavily concentrated. The top five banks generated a whopping 57% of all profits. And the bail-outs of the banking sector so far have cost about 50 billion US dollars. And to put that in context: that’s about the cost of almost four Olympic Games.

On the external front, FDI, foreign direct investment, in Russia is neither very foreign nor very direct because a lot of inward FDI is either Russian investments masquerading as foreign ones or are simply reinvestments. In fact, genuine FDI, once you take reinvestments out of the equation, according to some estimates over the last three years was just 0.2% of GDP. Negligible, even lower than Venezuela. And on the fiscal front, the fiscal rule is still in its infancy. So, to entrench its credibility, Russia must avoid what I call “the honey pot syndrome”. It must resist the temptation of spending these growing oil windfalls domestically, because spending these windfalls would not only reduce what’s available for future generations and make the economy more vulnerable to oil prices again, but it also reduces the pressure to undertake deeper structural reforms. So, there are these issues, but the big question, Evsey, and I’ll stop here, is, how do you move from stability to growth? And how does Russia catch up with the rest of the world?

Gurvich: Well, what are the longer-term prospects, then, and how do you estimate, for instance, our potential growth rate?

Sanghi: So, I’m really glad you asked that question. The interesting thing is that the potential growth rate has been declining not just in Russia but the world over. It’s a global phenomenon. In fact, we at the World Bank estimated that between 2013 and 2017 the potential growth rate was lower than its longer-term average in almost 9 out of 10 advanced economies and in almost half of all emerging markets and developing economies. Now, the slowdown in potential growth in Russia is more severe because of poorer productivity growth and worse demographic outcomes. Now, coming to the estimates, our estimates of potential growth in Russia... Let me just say this: trying to estimate potential growth is like trying to observe Heisenberg’s electrons. Just as you cannot pin down an electron with complete accuracy, you cannot pin down potential growth with accuracy either. This is because potential growth is not directly observable. So, estimates vary. So, with that in mind, we estimated that during the boom years, which is 2000–2009, Russia’s potential growth in terms of average annual potential growth was almost 4%. 3.8%, to be precise. It slowed down to 1.7% between 2010 to 2017 and reached 1.5% in 2017. This was the first time that Russia’s potential growth was below the advanced economies’ average in 20 years. In the absence of reforms or inadequate implementation of reforms, potential growth would continue this gradual declining trend in the coming years.

Gurvich: These estimates do not sound too optimistic. What could be done to raise potential growth in Russia? And what effect could we expect from these measures for growth?

Sanghi: So, last year we put out a paper on boosting potential growth in Russia, and what we did was, we looked at four policy measures, four reform measures that are either currently underway or being considered by Russian policy makers. And what we did was, we quantified the impact of each of these reform measures on Russia’s potential growth. Now the interested viewer can read our paper; I won’t go into technical details now. So, what we found was that increases in the retirement age, for example, add about 0.4 p.p. to potential growth by the year 2028. Higher inward migration, tripling migration adds another 0.2 p.p. Higher investment brings in another 0.6 p.p. And increases in productivity, an increase in TFP growth to be more specific, adds another 0.3 p.p. Now I have to say that these numbers sound really small, decimal points, we’re talking 0.4, 0.3, 0.2… But don’t let them fool you. Because when you add them all up, they add up to an additional 1.5%. And if you recall the current level of potential growth in Russia, the growth rate is 1.5%. So, these measures can actually double potential growth to about 3% in the next 9 years. And in fact, the impact of these measures could be felt even in preceding years, so potential growth could go up to 2.5% just by the year 2024.

Gurvich: Estimated potential growth is an important characteristic that should be taken into account by decision-makers. What implications for economic policy do you see from your considerations?

Sanghi: That’s an interesting question because, if you look at the impact of what we produce on macro-fiscal policy, I would say the following: that the impediment to both actual and potential growth rate, to boosting both these growth rates, is not macro-fiscal policy per se. Sure, there are issues like we discussed on the monetary front and on the external front, on the fiscal front, but macro-fiscal policy today in Russia is pretty sound. Now, of the four reform measures that I mentioned earlier, one very interesting finding comes out. And that is that potential growth is most sensitive to changes in productivity growth, in TFP growth. So in fact, we find that there’s a one-to-one correspondence between the two. So, if TFP were to grow by 1 p.p., potential growth would also grow by 1 p.p. So the real question for policy makers is: how do you boost productivity growth in Russia?

Now, productivity has been low and declining even before the twin oil price and sanction shocks in 2014, and boosting productivity, according to us, requires speedier action in the three areas of competition, innovation, and skills. And if I may elaborate on each of these a little: on competition, Russia actually does rather well in our own World Bank Doing Business rankings. But having said that, overall competition conditions haven’t improved as rapidly. And one reason is Russia’s large state footprint. In fact, the share of the state as measured by value added, produced by the IMF, is a hefty one-third. And it’s growing, especially in energy and banking. The second area is innovation. Now, compared to OECD countries, Russia spends less than half of the OECD average on research and development, and of the little that it does spend, around 70% is public spending. So, compare that to just 24% in the case of South Korea. So, not surprising, then, that only one in ten Russian firms reports any kind of technological innovation activity, compared to between three and four firms in OECD countries.

So, the question is, how do you boost innovation? There’re no easy measures, but one good starting point could be to rebuild and repurpose Russia’s research infrastructure. Now, this was severely battered in the 1990s with the sudden decline in funding and accompanying brain drain. And I have to say, I’ve been living in Russia for three years, and there’s absolutely an abundance of very innovative talented individuals. And Russia also has a good track record in nurturing innovative companies, as exemplified by the likes of Yandex and M2M Telematics and so on and so forth. But these are islands of excellence. The overall innovation ecosystem requires growing. And, finally, the third aspect that I mentioned was skills. On skills, Russia, in terms of various global rankings, does rather well, including in our own World Bank Human Capital Index, where Russia ranks among the top 35. However, Russian students are below the OECD average when it comes to softer areas, such as social and emotional skills and collaborative problem solving. So, targeted interventions in this softer area could definitely help.

Gurvich: Do you have a message of optimism for the Russian economy?

Sanghi: Message of optimism…Well, let me say this, that we are macroeconomists. And let me complain as a macroeconomist. We sometimes get so caught up in our macrofiscal, macrofinancial indicators that we forget or we lose sight that different people feel the economy differently. Now, in the case of Russia, real disposable incomes have been declining over the last few years. The poverty rate is now at around 13%, and there is own national definition of poverty which is around 19 or so million people. But in order to continue reducing poverty, in particular halving poverty over the next 6 years, which is an important goal of the government, we estimate that growth rates would have to surge to 4.4% each year for the next 6 years. But Russia can still halve poverty even under modest growth scenarios. And we reckon that it can do so through additional redistribution, for example, through social assistance and transfer mechanisms. We also estimate that the cost of doing so is just a fraction of GDP, less than 0.4% of GDP each year. So, the message of optimism, the message of hope is…well, what could be more hopeful than knowing the fact that reducing poverty in half is well within reach of the world’s largest country?

Gurvich: Thank you, Apurva, for this comprehensive discussion. You know, Apurva, that this is a programme of relay interviews. Who would you now like to see as the next participant in this relay?

Sanghi: Evsey, I would like to talk to you, but that’s for a different day. By the way, I have to say I really like this concept of dialogue in chain. I would like to talk to Alexey Savatyugin from the Chamber of Accounts.

Gurvich: Great.

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Originally posted at https://econs.online/en/articles/video/doubling-growth-how-to-solve-the-three-problems-of/