What are the World Bank’s ongoing projects in Russia?
Next year we will celebrate the 30th anniversary of the World Bank's presence in the Russian Federation. We started working in the country in 1992, and since then we have provided both financial and technical assistance, helped build capacity and provided advisory services and analytics to the Russian Federation. Of course, the nature of our partnership has changed significantly over the past 30 years. Both political and economic processes have influenced it, so now we are doing something very different from what we did 30 years ago, simply because Russia has changed a lot.
Currently, our work centers on two pillars. First, continuing the financing projects that are already underway in certain areas: statistics, housing and utilities, hydrometeorology, cultural heritage preservation, including in various regions of the Russian Federation.
And the second pillar is the advisory services. In fact, this means doing research and analytical work and sharing our findings with the Russian government and the public. In this area, we have two major themes now: economic growth and competitiveness, and human capital. The first theme covers issues related to competition, public sector quality, investment climate and doing business, small and medium-sized enterprises development, green economy, agriculture, transport and digital industries. The second theme is about increasing Russia's prosperity by improving the quality of education (including higher education), about creating an integrated health system, and about social security.
Right now we are working on a new country engagement strategy for the Russian Federation.
Do you work with regional governments too?
Our main mission is fighting poverty and promoting shared prosperity. We work with federal authorities, regional authorities and even local authorities. We are well aware that there are significant differences among regions in Russia, the country is huge, and we need to work where the challenges are the greatest.
Many experts are complaining that the government of St. Petersburg faces big difficulties when it comes to a strategic vision. So, if they ask you for assistance, you won't say no?
We will be happy to engage in dialogue with any representative of the government, either federal or regional, provided that the request is in line with the World Bank's overall mission and we have the appropriate competences.
What is your opinion on how Russia has fared in the current pandemic crisis?
The global recession is the worst since World War II - we haven't seen anything like it in the last 50 years. It is therefore unlikely that we will be able to fully recover and rebuild our livelihoods in the near future. The pandemic is causing loss of life and the economic crisis could push nearly 150 million people into poverty. These scars of the pandemic will surely last and will have a long-term impact on economic trends and incomes of the population.
This is what the global picture looks like. Undoubtedly, the Russian economy has suffered too. But, perhaps, a 3.1% decline in GDP in 2020 doesn’t looks so bad compared to the losses of the global economy, which contracted by 4.3%, let alone the losses of the developed economies, where the decline reached 5.4%. Russia also outperformed commodity-exporting emerging market and developing economies which contracted by 4.8%.
So why was Russia able to survive the crisis better?
In recent years Russia has implemented very effective macro-fiscal stabilization policies, improved investment performance, accumulated significant fiscal buffers, and became less affected by volatility and instability of energy prices thanks to the National Welfare Fund and the low debt burden. All this, together with the massive clean-up of the banking sector helped Russia to come out of the crisis with minimum losses. Clearly, it took a lot of effort on the part of the government and citizens, but it was worth it.
Now the Russian government is introducing a number of countercyclical policies and tax incentives. The size of relief at 4.5% of GDP is comparable to other developing economies. This is also complemented by monetary policy efforts—the key policy rate was lowered by 200 basis points between February and July 2020. We believe all of this has helped improve macroeconomic stability.
Of course, we cannot say that the population was not affected. Unfortunately, too many people have died as a result of the pandemic or had severe cases of coronavirus. Rosstat's figures on mortality and population decline in 2020 give us an idea of the size of the losses. Real disposable income in Russia was falling from 2013 to 2017, and the present crisis interrupted a trend, albeit modest, toward higher income in 2018 - 2019. On top of that, at the end of last year, we saw a sharp increase in some basic food prices, hitting the poorest especially hard. Unemployment has also increased over the past year, reaching a maximum of 6.5% in 2020. This has primarily hit migrants and informal sector workers.
What could have been done differently? Perhaps, support to workers might have been launched a little earlier to decrease the impact of the crisis. I also think that the crisis has shown the benefits of targeted social assistance to those in need.
What risks remain relevant for Russia?
Our forecast is that the economy will gradually recover by 2.9% and 3.2% in 2021 and 2022, respectively. But there are downward risks. First of all, people may be reluctant to vaccinate, and this would slow the recovery; potential new economic sanctions would also threaten the recovery.
Second, banks could face a deterioration in asset quality, profitability and capitalization, including from the country’s overheated mortgage market. The Bank of Russia has prolonged forbearance measures regarding provisioning for loans to small and medium-sized enterprises until mid-2021. While these measures should allow banks to accumulate more profits to increase loan-loss provisioning, they also delay recognition of unavoidable and costly losses.
The third risk is potential abrupt tightening of global financing conditions, that is, a sudden reversal of expansionary policies in a number of developed countries.
Near-term recovery will be contingent on the development of the pandemic. But longer-term prospects will depend on the country's ability to restore economic growth through diversification of the economy, reducing the state’s footprint in the economy, strengthening governance and the ability to take advantage of the changes experienced by in global value chains in the post-pandemic world.
The global transition towards green economy can play a major role. This can become a serious problem for Russia if the government does not take measures to decarbonize the economy. But at the same time, it can also offer new opportunities for innovation and job creation that would accelerate the decarbonization of the economy.
A recent World Bank report says that Russia is among global top ten improvers for progress made in health and education. However, productivity in Russia remains low and grows weakly. Why doesn’t the dynamic growth of human capital lead to economic growth and increased productivity?
We have estimates of the potential growth in Russia, assuming that labor and capital are fully employed. We made the calculations before the pandemic and this indicator was 3.8% during the period from 2000 to 2009 and it fell to 1.7% during the period from 2010 to 2017. That is, even prior to the crisis there had been a slowdown.
Indeed, the quality of human capital in Russia is high. In terms of learning outcomes of students, generalized on the basis of data from leading international research, the country is in the top ten countries, according to 2018 data. Life expectancy in the country has also increased over the past 10 years. But, clearly, more can be and should have been done. First of all, in terms of increasing male life expectancy and eliminating the causes of death - overweight, smoking and alcohol consumption. We believe that human capital is a critical asset for Russia to ensure its stability and sustainable development, which requires continuing investment in education, health, and social protection of the population.
Our recent research suggests that a decrease in productivity is associated with a decrease in total factor productivity. This trend is a global phenomenon and not Russia-specific; there is no general consensus now on why this is so. Most likely, this is due to a combination of factors.
First, market mechanisms sometimes fail: inefficient companies do not close down to free up space for more efficient ones. Because of this, new companies have no chance to enter the market and bring some innovations. The second aspect is the low level of innovation within firms. And, finally, the quality of management. Unfortunately, many companies employ the skills and competences that are more typical for the assembly-line age economy rather than the post-industrial service economy of the 21st century.
That means that it is not enough to have well-educated workers who are relatively healthy and live long—it is important that these workers are employed by a company which operates in a competitive environment and encourages its workers to maximize productivity. This can be achieved either through innovation or through management or through investment.
We often look back at the 2000s as an age of a great leap. And we ask ourselves the same question: why have everything stalled? This has a particularly dramatic effect on St. Petersburg, where in the last 10 years there have been few notable investment projects and the GRP has stopped recording double-digit growth. So, what's holding us back now?
Different periods should be compared with caution and care. In 1998, there was a major crisis and this creates an impression that it was followed by a powerful leap. But this is a low base effect. Back then, the country faced a capital outflow problem and many sectors were inefficient, especially the heavy industry and other sectors which played a large role in the economy of St. Petersburg.
Indeed, the large-scale structural changes that took place during the decade of the 2000s have led to high growth and a certain rise in productivity. So, the results do appear to be significant compared to those in the 1990s. Your city also illustrates this. In St. Petersburg, GRP grew by 160% between 2000 and 2019, while in Russia in general GRP rose on average by 99%.
But today the situation is completely different. We can see that since the 2008 crisis foreign direct investment has been declining all over the world, and developing markets, including Russia, are no exception. Competition for investment among developing countries has increased which is especially true for investment in non-commodity sectors. Investment in Russia’s commodity sectors, however, fell sharply too because commodity prices tumbled and sanctions were imposed. Given all these factors, governments now need to work much harder to attract investors. This is true for the world in general and for St. Petersburg.
And what should authorities do, how to respond properly?
To a large extent, solution has to do with the quality of institutions which must ensure proper effectiveness and efficiency. Russia and St. Petersburg, in particular, have made extraordinary progress in developing digital technologies. In fact, almost all aspects of government activities and interaction with citizens and businesses are now digitized. This is a tangible result and this effort should be continued. The government’s effectiveness in the fight against corruption has improved, but the result remains low compared to other governments - and this is another area of work.
This is what St. Petersburg should consider. There are three principles of working with investors that have proven to be efficient in many countries. First, promoting investment is not about choosing between domestic and foreign investment. Domestic and foreign investment should be combined and integrated into global value chains. Because that's what gives access to better management practices and new methods of products and services delivery and helps implement innovative approaches and, ultimately, earn profits. That is, global trade and investment are two sides of the same coin.
We can see that Russia's participation in global value chains varies depending on the sector, but there is plenty of room for expanding linkages between Russian companies focused on the domestic market (including small and medium-sized enterprises) and export-oriented or transnational companies.
The second principle is that global trade in services is growing faster than trade in goods. St. Petersburg, and Russia in general, should think seriously about that. Expanding trade in services - educational, tourist, legal, etc. - can also lead to the creation of quality jobs, including digital ones. And this, in turn, will increase the region’s role in value creation and will promote more active implementation of innovations. But to do this, favorable conditions must be created, people should be allowed to move from place to place to look for better job opportunities.
And finally, the third principle: investment is not a one-time event, not a one-time transaction, it is a partnership and a long-term relationship. It is not enough to attract investment, it is important to retain and link it to the operation of domestic industries in order to maximize benefits.
In the 2000s, when oil prices were high, Russia was diagnosed with the Dutch disease. Do you think it has recovered from it? Or has it contracted something else?
The considerable progress that we have been seeing in Russia's macroeconomic policies since the 2008 - 2009 crisis is obvious. And one of the key elements here is the introduction of the fiscal rule. This is a measure that has largely protected the country from volatility in commodity markets. Revenues above the cut-off price are transferred to the National Welfare Fund - a very important and effective tool to protect against the Dutch disease and similar problems. However, a full recovery from the Dutch disease requires greater diversification of the economy and further reduction of dependence on energy resources.
But, as the country achieves high income status, it is important to make efforts to avoid another problem - the middle income trap. I’m sure that Russia will be able to do this, but investment in the green economy and innovations will be required. After all, Russia has huge ore deposits, forest resources, significant technical know-how and technologies which can help not only support but lead such green transition. I think this could potentially give a huge boost to the development of the country.
One of the central pillars of the World Bank's work is reducing poverty. Could you offer any recommendations for Russia, where almost 20 million people are poor; what steps can be taken to approach this problem?
Economic growth is the most effective factor in reducing poverty. But reducing poverty requires more than growth; targeted social protection measures are necessary because this affects the dynamics of the way out of poverty. These measures also help retain and develop human capital.
For example, if a family finds itself in a difficult situation, say, in the event of job loss or health problems, this can lead to more serious consequences: alcohol or drug dependence, loss of competences and skills. This creates a vicious circle whereby poverty becomes more entrenched: people are unable to return to the job market and are trapped in this state. The value of the approaches I am talking about is that they prevent people from staying trapped in poverty.
One example of such social protection scheme is a social assistance policy aimed at fully preventing extreme poverty. This does not mean that every person in the country has a guaranteed basic income. The idea is to provide targeted assistance: we assess a person's needs and income and on the basis of this analysis we can offer certain support measures. This requires close collaboration of all responsible agencies, as well as the use of modern technologies (artificial intelligence, machine learning) so that the necessary amount of support is delivered to those who need it most and when it is needed the most. Russia is moving forward in this direction. I think we will work with the government in this area.
In many EU countries there are so-called "last-resort programs" to provide a guaranteed minimum basic income. The topic is widely discussed, with even the U.S. contemplating the introduction of such a mechanism. The advantage of such a program is that it serves as an automatic income stabilizer in the event of economic shocks because families most affected by the crisis can automatically benefit from this assistance. That is, there is no need to conduct analysis again, to determine again eligibility for support or benefits, and so on. We can see that such programs have an even greater effect per unit invested in times of crisis.
Originally published in Russian language in Business Peterburg