Wednesday, March 15, 2006

Russia's Veneer of Wealth and Economic Future

I've been reading lots on various Russian news websites about the recent Forbes wealthiest list, and the growing number of Russian billionaires. Combined with Russia sitting at the head of the G-8, Russia's increasing petroleum exports, and doubling of the Russian stock market - there is a sort of bragging and bluster among many Russians that they have arrived as an economic superpower. You can find this buzz on various Russian language blogs as well, combined with an indignation when Russia's G-8 status is questioned. There is a general sense that Russia as a great economic power isn't being given its due respect in the West.

Well ... let's examine this for a moment. Gross domestic product, purchasing power parity, per capita for the G-8 nations:
  • United States - $41,800 (2005 est.)
  • Canada - $32,800
  • Japan - $30,400
  • Germany - $29,700
  • United Kingdom - $30,900
  • Italy - $28,300
  • France - $29,900
  • Russia -$10,700
One of these things is not like the others. These figures are from the CIA World Fact Book. From other resources for 2004 GDP, I've seen Russia ranked as low as $4,000 GDP per capita, with slight variations in these figures for the other G-8 nations as well. Still, no matter your source for this data, it begs the question ... how does a nation with the 3rd largest number of billionaires, have the 53rd highest standard of living?

The critical Russian reader will become indignant and exclaim that none of these other G-8 nations have the great oil resources of Russia. Why, Russia is a petroleum colossus (as I read on a native Russians blog last night)! It is an interesting assertion; however, the US remains the 7th largest producer of petroleum, and Canada has vast reserves, particularly when considering their oil sands. So these nations are not exactly slouches when it comes to natural resources. And yet, how does a complete and utter lack of oil reserves explain the great economic success of ... Italy ... Japan ... France? The answer is - of course - that oil reserves and oil production alone will not make a country wealthy.

Further - no country has ever achieved either great economic benefits for its people, or economic super-power status from oil. Consider the case of Saudi Arabia, the largest producer of oil in the world, with the largest proven oil reserves. GDP per capita? $12,900 ... barely more than Russia, despite over 50 years of oil production.

The facts are, Russia has tremendous opportunities for growth of their economy in the future. These opportunities are reflected in their stock market growth, and the continued growth of their economy. Oil production alone will NOT give Russian citizens more wealth and opportunities, or a more secure future. As the oil model around the world demonstrates, the wealthy few that are tied to oil production make out incredibly well. But without the manufacturing and service basis to go along with oil production, the depth of wealth is rather thin. Further, these manufacturing and service expansions can only occur with the appropriate infrastructure for growth. Shipping of products via highway, rail, and air ... high speed data communication being ubiquitous throughout the nation ... a reliable and fast postal service ... all of these things enable business to function efficiently and create and sustain job and wage growth. It is no coincidence that Moscow accounts for almost 10% of the Russian population (and growing) - and a disproportionate amount of the nations wealth - currently all of these resources are found almost only in Moscow.

I won't even discuss the potential for corruption in Russia to derail economic growth - suffice to say it is a problem that must be addressed in time.

The Russian future is bright and could eventually put it on equal economic footing with Western Europe, Japan, the US, and Canada. However, Russia has not arrived yet, and all of these Western nations clamouring for Russia's raw resources is NOT for Russia's benefit. Russia would do well to remember the mercantile capitalist model - and use their resources for growth of their own industry, rather than for China and Western Europe's ultimate benefit.


Sean Guillory said...

What you say is all true. And you are right to point out that Russia's admittance to the G-8 might be unwarrented. However, it seems that the G-8 is only taken seriously by all of the member countries except for the US so its impotance might be more symbolic rather than concrete. I personally have no idea what benefits members get, except yet another forum for the rich and power ful to dicuss how they can become more rich and powerful.

That said, I think that putting Russia next to the US and Europe in terms of GDP is a bit specious. Everyone knows that their economic modernization is closer to say Brazil. But I think a better way to compare Russia's place in respect to Europe and the US is in terms of the Gini Index, which measures the degree of inequality in the distribution of family income distribution. Here is the Gini Index for 2005. From this you can see that in terms of income distribution, Russia (at 45th) is better than the US (at 29th). Now given the economic might of the US, they are in some bad company in terms of income distribution. Not only is Russia better, but so is China, Ghana, Kenya, and Pakistan. So yes while Russia's per capita is far lower than the US, I think it is important to point out that one can live on $10,000 much better in Russia than $41,000 in the US. But these are false figures in real living anyway because they are averages. When coupled with the Gini index, the concentration of wealth in the US compared to Russia is so much more that the per capita is pushed up higher than it actually is in real terms.

W. Shedd said...

Good comments Sean, and you and I had touched on this topic on your blog previously (but not directly). I guess it was inevitable that I would want to discuss it more.

But I'm not buying it. Even a casual observer of life in Russia can see that the average persons living conditions there are NOT equal to the average persons living conditions in the US. Purchasing power parity is different in both countries, depending on where money is being spent, and cost of living is obviously different in both countries. But all things being equal, the average person is doing better here - Russian friends of mine (who speak English) who immigrated to the US would never consider returning to Russia, based on standard of living alone.

I am reading through some definitions of the Gini Index (sorry to say I was not familiar with it), and basically it appears to me that all it shows - is that there is less general disparity in income distribution in higher ranked countries, than in the lower ranked countries. As an engineer, I understand enough about statistics to show that doesn't equate to a high standard of living, however. It appears to be a kind of expression of standard deviation ... from a 45 degree line. Doesn't seem to indicate if the income distribution is above or below that line of presumed fairness of income distrubution. Russia ranking slightly better than the US isn't indicative of a better standard or living or a larger middle class. Personally, I would rather see some histogram of this data, to see where the largest deviations of income distribution occur.

But I really like your comments. Personally, I think Russia is a good candidate for the G-8, based upon their economic potential. But what I object to is this false sense among Russians that they have already arrived, when I feel they have much yet to accomplish. I also feel that too many native Russians believe that economic succcess will be certain, simply because of oil reserves. I think the wealthy and powerful can easily exploit these resources and leave the average Russian eating dirt. I actually view much of Putin's policies through this filter.

W. Shedd said...

I should also add that the figures I cited were GDP, PPP - which supposedly would equalize for some of the purchasing power of different currencies, etc. I know that comparison still isn't perfect, however.

W. Shedd said... Might find this website interesting, even if not 100% applicable to the discussion.

rajeev kumar said...

What you guys don't look at is strength of Russia's fundamentals. It is spending its oil and gas revenue to rekindle the great apparatus of science and education that the Soviets created. They have also paid off their national debt and are leaving the oil money in a stablization fund for worse days. They have tripled the salaries of doctors, scientists, and teachers. College enrollements are once again surging. Oil revenue has enabled Russia to keep taxes low and healthcare, education, and pensions well funded. In fact Putin has increased spending to fight AIDS by 25 fold, while cutting the VAT to 13%. Tell me that's not investing in the future.

FDI is doubling every year. They are using their human capital to develop a knowledge based economy. Their engineering, IT, and biotech outsourcing markets are growing at 70% each year and could be larger than India's within 10 years.

And land, agricultural, and business reforms have allowed production to rise dramatically. Russia is now a net agricultural exporter. Toyotas, Fords, Chevys, Hondas, and BMWs are all manufactured in Russia to meet a growing domestic demand.

And Russia is moving up the value added chain in natural resources. It has shifted from exporting crude oil to exporting refined oil products, from timber to paper and furniture, and from non-ferrous metals to aircraft engine parts for the new Boeing Dreamliner. Unlike Saudi Arabia, Russia's people are educated enough in science and engineering to drill their own oil, provided they have a little foreigh capital and technology.

Investment is less than half that compared to China as a pecentage of GDP but Russia has almost the same annual growth rate. This means that the Bear allocates capital more efficiently than does the Dragon.

Oil wealth in Russia determines gov't revenue but will not take away from GDP growth. You are right to say that Russia cannot rely on natural resource exports to make it a world power. And evidence suggests very clearly that it is not, although it has certainly greased the skids and given the government a some leeway in this period of massive reform. In fact lower oil prices may be good because this will reduce the total value of exports, which will make the rouble cheaper against other currencies and thus make other labor intensive Russian exports more attractive.

The fundamentals of the Russian economy are phenomenal. While more reform is needed, progress has been extroardinary and the Russian economy will experience the benefits for many years. In fact by 2030, Russia's GDP is expected by many economists to surpass Germany (not per capita of course). You guys need to quit reading the papers that make it sound like the Khordokovsky blunder has triggered an economic meltdown and Putin is going to bring back the Soviet Union. Get with the times. Its not 1998. Biochemists are not on the streets selling sexual services and matryoshka dolls to make ends meet anymore.

As for the "energy superpower," Russia was merely asking for Ukraine to pay market prices. Russia raised gas prices on its own citizens and merely asked its neighbor to do the same. Given their refusal to curb wasteful use of gas, and their decision for political reorientation, it was only natural that Russia remove this subsidy. It has recently begun to ask Belarus and Armenia to do the same as it has pursued its own domestic energy reform. All of this said, the threat to raise prices five-fold in the middle of the coldest winter in 25 years was both cruel and bad publicity. Hey, I never said that they had their PR game down.

W. Shedd said...

I don't think anyone was saying that Russia has potential and is moving forward. The point is ... it isn't really a G8 nation NOW ... but has the potential to become one.

Sure, in 30 years Russia may have caught up with Europe, if they stay on their current path. 30 years! That was the whole point of this discussion. My opinion was that Russia was made part of the G8 not for what they are now, but for their future potential, which may or may not happen.

The fundamentals of the Russian economy are not as great as you cite, for several reasons ... inflation is high... corruption is high ... infrastructure is poor to very poor. The Russian aircraft industry is in a shambles and the current airfleet is ancient and in dire need of upgrade. Highways are essentially non-existent. Other infrastructure hallmarks of the other worlds big economies are also missing, from adequate water treatment, wastewater treatment, national high-speed communication infrastructure ... Russia basically has none of that. Investment in education is great, but it does you little good if you don't yet have the other aspects that businesses require.

I have no idea where you are getting the idea of newspapers saying the Khordokovsky blunder is causing an economic meltdown ... that is your own personal fantasy or something you read in a Russian tabloid. We hadn't mentioned it and I've never heard nor read anything like that in any newspaper.

W. Shedd said...

Oh, as for "only charging Ukraine market prices" .. if only that were true! They greatly reduced the flow of natural gas to Ukraine, essentially shutting off the flow dedicated to that country, in an attempt to force the price, rather than negotiate! Even in the worse days of OPEC in the 1970s, they kept the flow of petrol coming.

Worse still, the shut off was mostly a political blunder by Putin. While he and most of Russia were chuckling on New Years day, thinking they finally were getting some revenge on bad Ukraine ... it proved to be a major miscalculation for Russia. Most of the extremely Gazprom dependent western european nations now have to completely reevalutate their future energy needs, as regards Russia. You would be very foolish to think they are not going to heavily invest in alternatives in the future as a result.

rajeev kumar said...

You certainly do bring up some good points. I'm not saying that Russia is anywhere near our standard of living yet. And I agree that if it is a part of the G8, then certainly China, if not India ought to be as well.

But in terms of their aircraft industry being in shambles and infrastructure having fallen into disrepair since the fall of the USSR. But they are headed in the right direction. They are upgrading rails, roads, ports, airports, etc. through private investment where possible and government expenditure where it is not.

Corruption in business, government, and the military is rife on every level. The shadow economy is estimated at 40% of GDP. An extra $4 bn of funding for military equipment managed to procure all of 6 aircraft, 4 tanks, and one submarine in 2005. One must wonder where the rest went. Even with the recent action on pressing healthcare and demographic issues AIDS, alcholism, and heavy smoking will take a severe toll. Yes there are serious problems. But I do think that Russia will work them out.

An increasing maturity of the legal system is emboldening auditing agencies. And a growing middle class will surely promote greater engagement with civil society. I think that investors' memories are short and the Khordokovsky affair will be nothing more than a blemish.

As for Ukraine, I did admit that the Kremlin screwed up by doing it so suddenly at such a suspicious time. But they are now following suit on Belarus, Armenia, and their own citizens. And Ukraine was not exactly angelic either. Russia subsidized their economy and they talked about shifting their alignment. Ukraine rejected Russian demands to introduce conservation measures, happily guzzling gas at 20% of European prices. Both handled it quite clumsily really.

Given their shrinking and aging population, I'm not suggesting that they will be a superpower again. Missles aside, they were always a paper tiger anyway. But their living standards will rise, their new baby-booom will benefit them tremendously, and they will become an important advanced market economy with international leverage. It is difficult to transform and reform such a large country so quickly. And while Estonia and Czech Republic began sensible reform immediately, Russia lost precious time with that drunken buffoon Boris Yeltsin. His erratic behavior and shock therapy costed the nation trillions. But they are far from the verge of collapse. And the newfound optimism of Russia's young as well as foreign investors is not in the least bit unfounded.

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