Russia’s economy is going through a period of long-term stagnation. GDP growth is expected to average close to 1.5 percent over the next number of years, which is low considering Russia’s level of economic development (International Monetary Fund, World Bank). Year by year, the country will fall behind the rest of the world, which is projected to grow by more than 3 percent on average. However Russia’s economic slowdown is not new. It became apparent in 2013 when energy prices were at an all-time high. Soon after, the double shock of tumbling oil prices and economic sanctions sent Russia into a severe recession.
Russia’s economic slowdown
Since the 2015/2016 economic crisis, the Russian government has managed to refill its fiscal and monetary buffers on the back of recovering energy prices. For the last five years, economic stability has been the dominant goal of Russia’s economic policy. Pension cuts and tax increases have helped to turn Russia’s budget deficit into a surplus, but the population is paying a high toll. In early 2019, real disposable incomes of the Russian population were still 13 percent lower than in 2014. Russians are unlikely to regain their pre-crisis living standards until 2024, the year when Putin is expected to leave the Kremlin.
While it lacks drivers for growth, Russia’s economy is currently not at risk of becoming unstable. The constant flow of oil and gas dollars will remain an important pillar of Russia’s current account surplus. With a new fiscal rule implemented in 2018, the Russian government is able to compensate oil price fluctuations as long as the long-term average price remains above USD 50 (which is below forecasts) and the export volumes do not shrink. Low public and private debt as well as a hawkish Central Bank are making financial instability unlikely. Inflation is projected to stay close to 4 percent , the rate targeted by the regulator.
Russia’s GDP growth rates are limited by structural weaknesses which are unlikely to change even in the longer term. The economy’s potential for catching up is severely restricted by the institutional environment in Russia. The court system is unreliable, corruption is widespread and the bureaucracy is pervasive. Security services are eager to capture economic assets, causing a general insecurity of property rights. As a result, private investment is comparatively low, while investment undertaken by the dominant state-owned enterprises is not helping overall productivity.
Additionally, the dominance of the hydrocarbon industry impedes the development of future-proof sectors in the economy. This effect, sometimes called the “Dutch disease”, means that the natural resource industry vacuums up qualified labor and strengthens the ruble, which makes it difficult for other sectors of the economy to compete with imports and on foreign markets. The Russian oil industry will not drive growth either. Production volumes are expected to decline in the 2020s, as older fields are exhausted and new reserves are difficult to develop without Western technology.
Russia’s very peculiar demography also weighs on its growth outlook. Because of extremely low birth rates in the 1990s, the labor market currently faces a shortage of young workers, while scores of baby-boomers are entering the pension age. In sum, the number of Russians within the working age bracket has quickly fallen from 85.4 million in 2015 to 81.3 million in 2019, a trend that will only slow in the mid-2020s. Migration has compensated for some of the labor shortages, but the number of migrants drastically dropped to an all-time low in 2018, as Russia is becoming less attractive for migrant workers. While the lack of workers hurts growth, it also ensures that unemployment will not rise above 5 percent in the coming years.
Russia’s economic woes could be mitigated with the right economic policies, but most options remain rather hypothetical, because they are not compatible with the country’s political economy. Russia could invest heavily in education and healthcare to increase the productivity and longevity of its shrinking workforce. Domestic and international experts have repeatedly made this suggestion throughout Putin’s time in power. However, spending on security services and the armed forces has always had a higher priority in Russia’s budget, while Russian schools and universities are chronically underfunded. The Kremlin’s restrictive budget policy after 2014 has further hurt education spending.
The Russian leadership could also try to reduce the state’s footprint in the economy to spur competition and create more incentives for the right kind of investments. However, in the last 10 years the Russian state didn’t give up control over a single of its bigger state-owned enterprises. The reason is that privatization contradicts the interests of key personal allies of Vladimir Putin, who have turned the largest state companies into their personal realms and attempting to change that can be dangerous. When the former Minister for Economic Development Alexei Ulyukayev pushed for the privatization of Bashneft, an oil company, he faced resistance from Igor Setchin the managing director of state-owned oil giant Rosneft. A few months later, Ulyukayev was arrested in a sting operation initiated by Setchin under dubious corruption charges. Ulyukayev is now serving an 8-year sentence, while Bashneft was acquired by Rosneft without competition.
Finally, a less confrontational foreign policy would facilitate trade and investment relations with Russia’s most important economic partners in Europe. At least under Putin’s leadership, this seems highly unlikely. Moscow perceives its own aggressive policy of the last number of years as rather successful and sees itself on the winning side of the current changes in the international arena. If the Kremlin has to choose between what it interprets as Russia’s security interests and a chance for future economic development, the latter will always lose.
Three economic risks
While meager growth is the best-case scenario for Russia’s economy over the next number of years, it is by no means the worst case. The country faces three major threats which could undermine the living standards of the population and weigh on future government budget revenues.
First of all, the structure of Russia’s economy is a bet against technological change. As a resource exporter, the country is set to lose some of its wealth as the energy transition in the West and China gathers more momentum. Rapidly falling prices for energy storage, solar and wind power have made renewables competitive with Russia’s main export goods, oil and gas, in many applications. So far, international energy demand is projected to keep growing, but further technological breakthroughs could fundamentally change the demand outlook.
Even with today’s technologies, climate policies in Europe and China, e.g. a stricter carbon tax, could dampen the demand for hydrocarbons. Even if demand for fossil energy remains stable, technological change already challenges Russia within the oil and gas sector, as fracking in the U.S. and an expanding world market for liquefied natural gas bring more energy competition to Europe.
A tightening of economic sanctions on Russia is another threat for Russia’s economy in the coming years. The fundamental contradictions between Russia’s views on European security and the interests of its neighbors and Western countries can easily lead to renewed confrontation. Additional sanctions would most likely first target Russia’s public debt and state companies, further limiting Russia’s access to foreign capital. Moscow’s reaction to such sanctions, in turn, would be a further strengthening of the isolationist economic policies the Russian leadership implemented over the last years.
Finally, a fundamental risk for Russia’s economy is domestic political instability. Russia is approaching the end of a political mega-cycle, and a thorough reconfiguration of elites can be expected if the leadership changes. Personal risks for Russian elites are already on the rise, as an increasing number of arrests of acting and former ministers, business heavyweights and even foreign investors show. The struggle for power and resources in the post-Putin era could severely increase political risks, make investment less attractive and renewed capital flight more likely.
In sum, the general trends underlying Russia’s economic development point to economic stagnation, with significant risks to the downside. The scope for a change in economic or foreign policy is very limited and managing the uncertainty surrounding the end of Putin’s fourth term in 2024 will be more than enough for the Kremlin to handle. The Russian government will focus on preserving the status quo with minor corrections as long as possible. This will enable Russia’s economy to withstand some of the adversity outlined above, but at the same time rob the country of a brighter economic future in the longer term.
Photo: Steven Lee CC BY-NC-ND 2.0