Five important facts about the Russian economy

By Michael V. Alexeev

Churchill once famously said that Russia was “a riddle, wrapped in a mystery, inside an enigma.” While this definition was based mainly on Russia’s behavior in international politics in the late 1930s, it could also apply it to Russia’s economy today. Russia is a space power that doesn’t seem to be able to produce a decent passenger car; it is a market economy with pervasive state influence, both formal and informal, in almost all areas of economic activities; it is a country with first-rate scholars and it is also rather backward in many respects. Can this riddle be solved? Many books and scholarly papers have been trying to provide an answer. What are some of the main takeaways from an analysis of this mystery?

(1) The Soviet legacy is alive.

Twenty years after the demise of the Soviet system it continues to impede Russia’s development but also provides some temporary benefits to the economy and society. The Soviet legacy can be classified into three types: physical (the old physical and human capital, and its allocation among sectors and regions), institutional (formal and informal rules, including those related to private property rights and contracting), and behavioral (the mindset of the people, including the leadership). These legacies interact and perpetuate themselves. For example, there is still a large inventory of geographically misallocated and technologically obsolete physical capital in cold areas of the country and the current system makes it worthwhile in the short run to continue exploiting the old assets and investing in their maintenance rather than scrapping them and taking advantage of new technologies in more hospitable areas. Perhaps the hardest part of the Soviet legacy to overcome is the people’s mindset that discourages initiative and risk-taking, at least in the official sector of the economy. Nonetheless, some progress has been made and there is hope that Russia will eventually rid itself of the worst features of Soviet heritage and join the club of advanced market economies.

(2) Most of the new institutions are not working too well.

Over the last 20 years, many market economy institutions have emerged. Contract law has been developed; private property rights defined; the tax system looks similar to those in developed West European countries. However, these institutions often do not function properly, mainly because of the lack of judiciary independence from the state and pervasive corruption. Russia is in the bottom 15% of the countries in terms of corruption control according to World Bank rankings. More generally, Russia lags behind most other economies in transition and even many poor countries in terms of institutional quality. The only thriving institutions are those used for natural resource rent extraction (e.g. financial infrastructure and security services).

(3) Oil and gas are still the mainstay of the economy that appears to be addicted to natural resource rents.

It is common knowledge that oil and gas represent the dominant sector of Russia’s economy. What might be less known is that the dependence on this sector has grown significantly since the turn of the century despite the apparent diversification efforts by the government. As a result, while the federal budget was in surplus at oil prices of $69/barrel just six years ago, it now requires $117/barrel prices to avoid deficits. The reliance on oil and gas rents weakens the incentives for restructuring the economy, subsidizes and perpetuates inefficient manufacturing and other sectors, and supports a bloated state bureaucracy and the military. In addition, the reliance on oil and gas exposes the economy to significant volatility due to notoriously unstable prices of these commodities.

(4) Geography and demography present major long-term challenges.

Most of the above challenges could be overcome by government policies if there is sufficient skill to diagnose the problems and determination to fix them. The problems posed by geography and demographic trends are more difficult or at least more expensive to solve. Russia is by far the largest country in the world. Moreover, much of Russia’s natural resources and a significant share of the population are located in remote areas with inhospitable climate (Soviet legacy again). Despite early expectations, there has been little migration from those areas to warmer parts of the country. Its geographical challenges are exacerbated by relatively small and rapidly ageing population that declined every year between 1993 and 2009 due to high mortality rates and low fertility. In the end, these demographic and geographic factors may prove decisive in determining the future of Russia and its economy.

(5) The economy has grown greatly since 1999.

Despite all of the challenges, Russia’s GDP per capita has approximately doubled since 1999. However, what was one of the fastest world rates of economic growth prior to the crisis of 2009 has slowed down to below 2% in the first quarter of 2013 and zero growth in June, according to preliminary data. The slowdown is partly caused by stable oil prices and thus may be temporary, but all of the challenges described above require bold policies to put Russia’s economy on a sustainable growth path less dependent on the vagaries of the world commodity prices.

Michael V. Alexeev is a Professor of Economics at Indiana University in Bloomington. His research interests include economics of institutions, public economics and economics of transition. He is the co-editor of The Oxford Handbook of the Russian Economy with Shlomo Weber.

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