Top of the Pops
Iron ore is insanely hot right now, with futures surging 10+% today now that the market is more confident that green demand is going to overwhelm available supply, especially since steel output in China keeps looking up. China’s approach to stimulus has reinforced that dynamic giving metals a huge tailwind, one that threatens Russia’s recovery because of the central role construction plays in state-led investment plans and the weakness of the services sector:
Rising steel prices are great for Russian producers selling for export, but domestic consumers are facing a squeeze since they’re constrained in how much more households can afford. MinPromTorg is now leading negotiations with metallurgical firms to come up with pricing formulae for contracts that’ll prevent builders from eating it too much on the price squeeze. But any reduction in the sector’s margins on domestic sales just robs them of earnings for capacity investments that other producers right now are looking at given the expectation that metals demand will trend higher for years to come. The new super-cycle means higher inflation trends and risks are here to stay and the best Moscow can come up with leaves Russian firms further behind, even if it manages to depress costs on balance sheets. Crazier still is that China is expected to start looking to reduce steel production capacity starting in June to avoid overcapacity, which may push up prices further still depending on the demand outlook in the US and Europe.
What’s going on?
In March, there was a record level of micro-loans taken out — 31 billion rubles ($417.88 million). That’s a bad sign and not evidence of strong consumer recovery, which would ideally be driven by the use of savings and more traditional sources of finance. Per one poll, 60% of microloan borrowers are paying for urgent needs using them. The volume of overdue credit card debt has hit 151.3 billion rubles ($2.04 billon) as consumer indebtedness climbs to record levels. The indicators are basically negative — if you managed to get through the crisis working from home or in and out of work with a decent salary and no medical complications or major life emergencies in your family, your spending is shooting up cause of opportunities. If not, your spending is fueled by debt to try and lock in what you can before prices and interest rates rise more and maintain living standards. These dynamics come as the UN FAO’s World Food Price Index has hit a 10-year high, eating into savings and challenging the regime’s leading economic institutions to manage the fallout. Despite an annualized slowdown in the inflation rate from 5.8% to 5.5% in April, it’s not yet seen as "sustainable” i.e. it could be a one-off or else it’s not slowing down fast enough. The argument that it’s strong demand driving these price increases only makes so much sense given how weak demand was prior to COVID and how much of the current wave of demand is debt-financed. Likelier that supply chain and commodity price stresses have accumulated, with any slowdown in inflation reflective of a stalling domestic recovery masked by the country’s exporting sectors. The relative surge in demand has probably strained firms with every incentive to minimize inventory because of how weak demand has been for a long time.
According to Viktoria Abramchenko, 90% of waste in Russia isn’t recycled and ends up in landfills, but don’t fret about the municipal waste reform. Russia’s making progress and currently at the same level of development as Mexico. Abramchenko is sticking to the the line that targets to recycle more waste for use in agriculture, industry, communal utilities, everything will be reached by 2030. LHS is blns rubles in current prices:
Recycling has been of little interest for investment into environmental protections for the last 9 years, and despite the political rhetoric that picked up in 2018-2019 in response to local protests across the country, there’s been very little pickup in spending. Abramchenko dodges criticism by reminding us that reforms only started in 2019 and they’ve just completed the first step — creating regional operators. Should it take 2+ years to setup operators when you’d expect there should have already been some working in the first place!? The fact that there’s been so little progress reflects what I like to think of as the narcissism of petty rents. Political responsibility has been kicked to local and regional authorities, but they can’t easily solve the problem since it’s not an activity that generates rents except via budget procurements and spending, both of which are capped by regional governments’ limited fiscal capacity. The failure of municipal waste reform is evidence of the desperation to find rents in a society that has entered persistent economic decline.
Mishustin and the government further expanded the price control measures in place last week to prevent medications from exploding in price. In particular, the new decree allows the government to make use of state reserves if prices for non-food goods increase 20% or more. In the past, this approach was only applied to commodities — oil, oil products, and foodstuffs. Regional governments can now issue a request to Rosrezerv, one of the lesser known agencies created in March 2004. Rosrezerv will respond to said request by then conferring with the relevant federal ministry as to whether or not the request is appropriate to pricing conditions, and if the federal ministry approves, release resources for regional governments. The system is absolutely byzantine when you think through the market effects for non-commodity goods and recalls the Soviet planning approach to stockpile supplies when possible given the degree of militarization of the economy and political structures. If Rosrezerv is buying medications (it’s tasked with managing physical reserves of goods and emergency market operations), then it’s buying them at state-controlled prices given existing regulations in competition with the consumers who need them right now. If not, then it’s buying them when there isn’t a demand a squeeze. In theory, that should support prices and therefore investment into production. But because medication prices are controlled in a manner without some adequate compensatory mechanism to support investment since profits have to be capped and import substitution costs have to be absorbed somehow, Rosrezerv is effectively stepping in to fix a political problem for the center by making regional governments dependent without fixing anything for consumers. That is unless these operations entail some sort of logistical operations I’m not aware of, which would likely be a cross-subsidy given to RZhD.
RZhD hauled more cargo in April 2021 than it did in April 2019, a positive sign overall. The increase is small — just 0.6% in net terms and 1% including imports and transit — and registers at 6.9% against April 2020. That’s 3.59 million tons a day. What was surprising from Kommersant’s writeup was the reported drop in internal shipments of mineral construction materials, presumably the stock you’d expect if builders are trying to cover housing shortages across the regions. Add that on top of the labor shortage due to the loss of Central Asians migrant labor — construction is reportedly down 1.5-2 million workers alone — and you’d expect to see the housing price squeeze worsen since price control measures or subsidies redirected from mining firm profits can’t make up the difference. The construction pricing squeeze also doubles back into RZhD’s capacity expansion plans, which you’d think would matter more if there was really a sustained recovery taking place. For instance, plans to build a rail bypass in Saratov to reduce congestion for an estimated 55.4 billion rubles ($750.67 million). But it’s unclear how the company can actually confirm costing at this stage given the surge in commodities prices for construction and signs of bottlenecks for labor as well as physical inputs. It’s a broader problem for SOEs trying to meet politically-mandated targets this year — they have to promise budgetary discipline in an environment where prices are rising, even with the April slowdown.
COVID Status Report
8,465 new cases and 321 deaths were reported yesterday as cases have ticked up 3 days in a row. Health minister Mikhail Murashko confirms that they’ve received a sample of the Indian strain of coronavirus for study and believes that collective immunity will be achieved by September. No clarity, of course, on how many will die in the mean time. There’s not any evidence of an uptick in hospitalizations related to COVID from what I saw, which is positive. I did spot a lead from Lenta that the number of recorded cases of the Kent strain from the UK is up in Yakutia. Since the holiday from May 1-10 is over as of tomorrow, I’d expect we’d see a small uptick this week from more contact but that’s yet to be seen. The idea of using this time as a circuit breaker, akin to what Boris Johnson once touted back when the government had no clue what it was doing on COVID, might make the numbers look better initially but doesn’t change the underlying problem so long as the vaccination rate remains so slow. While every statistical adjustment factchecking official data has to be scrutinized, the latest review from the Institute for Health Metrics and Evaluation at the University of Washington estimates the COVID death toll in Russia is 5.4 times greater than official figures suggest.
Russia and the Instrumentalization of State Incapacity
If you haven’t, I highly recommend you read Yakov Feygin’s piece for Noema magazine titled “The American Fiscal State Rumbles to Life.” Aside from whole-heartedly agreeing that the pandemic has actually proven that American power has a new lease on life, it provides the kind of nuance analyzing national responses to COVID that was so sorely lacking in 2020 and still lacking this year too often. As he’s stated on Twitter, he had a lot on Russia that couldn't make the cut:
I won’t claim to know the particulars of what had to be cut — I personally agree with the claim since I find the arguments against Russia as declining power tend to have an overly-narrow understanding of power, state capacity, and cost/benefit balances for a regime incapable of sustaining domestic growth — but I think the two core insights of the piece offer a very useful way of understanding the deepening fissure points in Russia’s political system. First off:
“The successes and failures of governments around the world reveal that state capacity is largely path-dependent: the result of previous political and economic leaders’ actions and decisions. This path dependence is itself a function of where major powers are positioned in a global division of labor, wherein certain capabilities, such as financial depth or export competitiveness, are exaggerated.”
This is succinctly put. States’ domestic political economy, position globally, and the operating assumptions of their leadership shaping and shaped by both prescribe certain policy choices and reactions to COVID selectively utilizing or else creating state capacity. Secondly:
“State capacity turned out to not be just one thing. Instead, it is a highly unevenly distributed set of capacities that are not only shaped by a country’s or group of countries’ history of development, but its place in the global political economy.”
I won’t relitigate what’s in the piece, but suffice to say that ‘state capacity’ is not a unitary function of a state’s strength. States can have competing capacities and deficiencies, strong safety nets but weak innovative sectors, powerful fiscal states capable of marshaling huge amounts of financial resources but deficient capabilities exporting vaccines or containing a catastrophic public health crisis and curtailing job losses. A state may be exceptionally capable of mobilizing military resources at short notice but completely unable to address the basic material needs of its population.
The self-imposed fiscal incapacity of the Russian state is a recurring theme of this newsletter, a result of the dominant economic consensus that Yegeniy Primakov was central to shepherding in the wake of the 98’ financial crisis. Fears of inflation rooted in monetary expansion are so illogically embedded into the fabric of Moscow’s governing institutions that deputy finance minister Vladimir Kolychev told Reuters that increased inflation levels this year reflect the fact that last year’s budgetary stimulus may have been too large. How the hell a finance minister can suggest this with a straight face when real incomes declined 3+% last year and 3.6% in 1Q 2021 alone is beyond me, especially given that household indebtedness is at record levels and creditworthiness continues to worsen systemically. Inflation levels in Russia track with global commodity price levels on a virtually straight line. The budget stimulus didn’t create new demand last year, it saved some existing demand (and juiced the housing market with mortgage subsidies). The appearance of inflation above acceptable levels forces the levers of power in Moscow obsessed with stability to take action, an inversion of the face of power the American fiscal state showed in this crisis. The effect is hydraulic austerity, the perpetual starvation of the economy of adequate demand levels to sustain productive investments in fear of price instability, losses of savings, and the risk of graft attendant with any and all budget spending. The refusal to liquidate a larger portion of the National Welfare Fund is part of the same logic. The regime’s economic policy approach is predicated on controlling the accumulation of capital — core to Grigoriy Yavlinsky’s critiques — and claiming it can’t spend for the public benefit because of the economically destabilizing effects, thus preserving that money for its foreign policy and personalist aims.
Underneath this fiscal incapacity are competing capacities and incapacities elsewhere that shape regime politics and the possibility of reform. I think it’s an exaggeration to claim that Russia’s economy has been fully ‘militarized’, an analytical approach adopted by more traditional Soviet-era hawks like Steven Rosefielde as early as 2005-2006, but it’s certainly the case that since the mid-2000s and Serdyukov’s appointment to the post of defense minister in 2007 in particular, Moscow focused political efforts to improve, reform, and cement the capacity of its military institutions. That entailed modernizing weapons systems, reforming recruitment and operational protocols, professionalization, and establishing a consistent and higher level of readiness to act when needed by the regime and then used in Crimea, Donbas, and Syria. This is why we see when Russia’s facing excess mortality levels closer to the famine of 1947 than anything on post-Soviet record because of its refusal to adopt stricter health measures — partially a symptom of its conviction that COVID-19 was a supply-side economic shock — the concentration of 110,000 troops on the Ukrainian border proved no problem whatsoever. Further, it speaks to a broader interest in cultivating targeted capacities to mobilize, mostly by SOEs providing electoral turnout or meeting specific economic needs including the management of foreign reserve liquidity in the banking sector during current account crunches.
But these ‘capacities’ generate incapacity elsewhere without a more expansive fiscal state since these institutional arrangements first developed during growth conditions driven by the oil rent windfall. This windfall wasn’t efficiently converted into expanded infrastructure or industrial policy that could sustain growth in the longer-term. Rather it provided the fiscal space to pursue military modernization during the worst of the 2008-2009 crisis irrespective of the drag it posed on civilian sectors. The focus on military-mobilization capacities useful for Putin and his closest confidantes and friends’ priorities basically leaves the rest of the country’s needs at the whims of what Vladimir Gel’man terms ‘pockets of competence’ defined by the following:
- Personal priorities of the political leadership in Moscow
- The effectiveness of policy entrepreneurs
As we’ve seen from Putin’s roundtable with business and April address, the Ministry of Finance’s thinking about the state of the recovery, and Mishustin’s mad scramble to utilize and generate mobilizational capacity to set price controls at the sector level, the state’s response to the economic crisis has been to withdraw from actively resolving it by providing adequate resources to households. The onus is now to convince private investors and firms to invest more and businesses to cooperate with the government based on its political needs. This reflects the fact that fiscal incapacity has created a permanent governance deficit — state resources that could have been used to build up more durable capabilities have been held back for personal ends or else for personal priorities within the regime. Interest groups, individuals running large firms and SOEs, and personal mandates issued to Mishustin or else regional governors and governments logically fill these gaps. Put this way, the incapacity of the Russian state outside of its core mobilizational capabilities, heavily skewed towards its military and security institutions and tools for repression, creates opportunities to rent-seek and force constant policy negotiations. These then degrade the power of the state to mobilize when needed per the priority, entrepreneur, and patronage model and force it to make more compromises when it tries to do so, lest the excessive use of its repressive capabilities turns major elite constituents against it. These contradictions worsen over time since the political logic for the regime, obsessed with controlling its purse strings, then lead it to hand over these areas of incapacity to entrepreneurs either able to provide patronage or with enough access to it already.
This is long way round to say that Putin and Putinism aren’t, in fact, as statist as they may appear to be. Their governing orthodoxies actually aren’t concerned with the development of state capacity outside of relatively narrow mobilizational bounds or else from an efficiency standpoint. The fewer resources spent to achieve results or else fewer points of contact between citizens and government officials — here’s looking at you, digitalization efforts! — the easier it is to redirect rents elsewhere. State capacity would actually pose a risk for the regime. It’d allow institutions to develop independent bases of power over time that would lead to political competition not controlled via the cabinet or presidential administration. Incapacity is politically useful since it keeps elites fighting to please the regime, whether by policy entrepreneurship or for budget resources that are kept artificially scarce. Russia’s COVID response reflects these dynamics very well. The race to create a vaccine was successful because the targeted mobilizational capabilities making use of human capital, patronage, and elite interest aligned. Getting Russians to actually get vaccinated is a different problem entirely — the state has steadily discredited its own media institutions, suffered as a result of the paranoia it stirred up over the West, and its general indifference to more restrictive public health measures and honest data during the first phases of the pandemic downplayed the severity of the crisis to a public that already has little reason to trust the state. And of course the vaccination program generated rents — people fought for preferred contracts for manufacture and distribution — and was used to try and win political points for the Kremlin with exports since domestic demand was suppressed by policy choices. Almost like the Russian economy…
The greater lesson from COVID about Russia is that the regime’s mobilizational capabilities have become so hijacked by the elite interests tasked with maintaining financial stability and those tasked with addressing the shortcomings caused by Russia’s excessively weak fiscal state that it’s ability to dictate outcomes is increasingly restricted to its repressive capabilities. I’ve noted this before, but think that the state capacity framework is probably the best way to get at the problem. Without growth, the politics of stagflation in Russia call for elites to find new ways to profit off of incapacity and create political incentives to instrumentalist incapacity to foster elite support while maintaining macroeconomic stability. Since 2013, the pool of claimants to the state’s rents has steadily grown, driven by the regime’s preference to lean into import substitution measures. They were a security measure, yes, but also a means of buying more support from a wider range of elite interests. If 2013 was the ‘peak’ of Russia’s resurgence in structural terms, 2020-2021 may prove to be when the degradation of state capacity overwhelmed its ability to maintain the system that worked post-Bolotnaya. Call it the end of “post-modern” authoritarianism or great power decline, but we need to revisit the usefulness of the ‘statist’ paradigm when describing the Russian economy and political system that has evolved since 2000. Incapacity has state-driven causes and plenty of uses. None of them benefit the public or, in the long-run, the state.
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