9 min read

Holy Macro!

Quick Hits

World food commodity prices have hit a 10-year high, harkening back to memories of the link between rising food price inflation and the Arab Spring (though today's not exactly fertile ground for the same kind of political "contagion"). Worsening harvests for major grain exporters hit particularly hard for Russia because of its diet and focus in agricultural policy to spur non-oil & gas exports. Now that annualized inflation in Russia has passed 8.1%, expect more improvised price control mechanisms to follow.

Presidents Putin and Lukashenko have agreed to 28 Union State programs and a shared military doctrine in the latest iteration of Lukashenko dancing for his money. Agreements cover crucial issues for the Belarusian economy like the pricing of natural gas. Moscow's looking at providing another $1 billion line of credit.

Russian deputy minister Aleksandr Novak, former energy minister and point man for OPEC+ negotiations, has reiterated Russia's commitment to the current OPEC+ production increase schedule citing expected declines in oil demand in 4Q 2021 and 1Q 2022 due to seasonality and the effect of continued high COVID infection rates among key consumers. The current wave of infections in China has led authorities to tell families to stockpile just in case for emergencies, squeezing consumer prices upwards and signaling a major headwind for the strength of oil demand through the end of the year while higher case counts in Europe are hitting consumption. Smaller, privately-held firms are the ones driving production increases in the Permian basin in the US at the moment and as publicly-traded companies exit shale projects, we might see drilling rise.

The Kazakh government has responded to Ukrainian president Zelensky's assertion that Russia was blocking the transit of coal from Kazakhstan to Ukraine, affirming that no full blockade is in effect but there have been limits imposed on transit and loading via Russia's rail network. There could be some deeply bureaucratic explanation since Russia's coal miners were getting the best prices in China until output ramped up there, but there's definitely intent from Russian Railways to realize the short-term political gains as well since the limitations only affect thermal coal, not coking coal.

40,735 new cases and 1,192 deaths reported today from COVID. The government backed lottery for individuals getting vaccinated with a prize worth 100,000 rubles has been extended through the end of the year. The Operational Staff is claiming that Russia's collective immunity has now reached 48%. Notice that none of the major ministries involved in the public health effort are resting on collective immunity when describing successes and failures for vaccination targets...


How to think about economic policy in Russia

One of my readers requested I write up something to explain what I think Russian economic policy ought to be since they aren't a diehard political economy or economics nerd (I'm definitely more the former than latter). At first blush, I have a pretty straigthforward set of outcomes and some ideas I think would go a long way towards generating stronger growth and much better welfare outcomes for the population in general without necessarily risking anything like an inflationary spiral. But I realized that for those less in the weeds on how economies of any stripe function, it's doubly difficult to articulate an adequate economic program for Russia because of all the political and institutional constraints that exist in practice. So instead of providing a neat package of detailed, costed ideas, I thought it would be more useful to write a short piece on how I think about economic policy and the political economy of Russia based on the problems it faces and structures it has inherited or reproduced rather than definitively assert I have the magic formula to fix things. We can't all be Anders Aslund, after all.

Lots of security-focused analyses serving security-focused audiences in Washington, London, and Brussels are trapped by the petrostate paradigm when describing the political economy of Russia. The late Senator John McCain's 2015 quip "Russia is a gas station masquerading as a country. It's kleptocracy. It's corruption. t's a nation that's really only dependent upon oil and gas for their economy" was never strictly accurate, but it did capture the ground truth that oil & gas form the pillar of the economy's commanding heights. Oil & gas revenues provide the core of the fiscal system, command a very large share of non-defense state procurements, and offer political leverage on strategic markets. Russia, however, was never a traditional petrostate. Oil became the driving force of the Soviet economy after it had industrialized. In a normative petrostate based off Middle East cases, the oil sector dominates GDP and the oil rents are distributed across the population through generous subsidies and income support, frequently leading to a situation where oil exports priced in a national currency whose value is generally pegged to the US dollar in some form pay for loads of consumer imports, imported labor, and a relatively tenuous social contract minimizing taxation on personal incomes or consumption where possible. In the Soviet case, the oil sector exploded in size in such a manner as to begin sucking up capital that could have been productively used elsewhere. Oil exports helped pay for grain and tech imports due to mismanagement and in the wake of the Arab oil embargo, the windfall profits became a blatant means to prop up heavy industries that might have otherwise failed. Structural adjustment or an acceptance of a slower growth rate to rebalance the economy towards consumption-led light industrial investment and, eventually, services weren't options. Gorbachev's reform efforts were, in part, jammed by the collapse in oil prices and earnings his second year in office leading to a chain reaction of tradeoffs since he couldn't rely on oil exports to buy loyalty from different factions and elites. One of the biggest problems estimating the oil sector's share of the Soviet economy throughout this time period is that we lacked then and now reliable means of measuring the monetary value of outputs across the Soviet economy. Oil that was exported raised dollars that were then converted into rubles based on completely arbitrary exchange rates bearing relatively weak relationships to actual price levels. Qualitatively, it was evident the Soviet Union had become a petrostate of sorts. It was not, however, evident to what extent without a host of assumptions, chiefly based on returns on capital invested into a sector run into the ground by political figures making political choices rather than industry specialists and technocrats trying to best manage the nation's oil wealth in a sustainable fashion. Consumption and the demand side of the Soviet system were basically ignored.

Russia's explosive growth from 1999-2008 came from a mix of institutional reforms and consolidations and an oil windfall. Before the price rally from 2003-2008 massively increased federal tax revenues, output was growing rapidly thanks largely to Yukos and the adaptation of western oilfield management techniques prioritizing the maximization of shareholder value over long-term reserve management. Rising investment into production created incomes and consumption by households and firms. Rising output didn't actually drive the growth of the Russian economy by itself, though. The oil rents – the value of sales of oil above the cost of extraction that circulated to the state via taxation – had to be redistributed. Saying oil drove Russian growth is strictly true, but often obscures the real mechanism by which that happened: oil wealth was transferred from the oil sector to the state and then back to other industries. The Soviet model of using oil earnings to maintain an over-sized industrial base was resurrected, except that the industrial base had shrunk significantly in size, there were no restrictions on the flow of capital in and out of the country, and now Russians lived in a consumer culture where businesses competed for market share and they could buy imports or travel abroad freely. The collapse and Yeltsin years had forced the economy to adjust. Putin inherited the Soviet core of the commanding heights of the economy. The primary reason taxation on the population was kept low in the 2000s wasn't a recreation of petrostate politics so much as institutional weakness. Russia had already defaulted on domestic debts because of its inability to collect taxes and low rates were the easiest way to make it less painful to bring more activity out of the shadows and into contact with state organs.

Once you wrap your head around the fact that oil drove Russian growth from 1999-2013 because it lifted consumption, it becomes a lot easier to make sense of where things go wrong. Russia's fears of default and the institutional chaos of the 1990s push policymakers to obsessively seek out budget surpluses to minimize sovereign borrowing. At the same time, the country runs a consistent trade surplus which allows elites and the regime to accumulate foreign currency reserves. That makes for a bad combination in the long-run. If your budget is in surplus, what you're actually doing is drawing money that could finance investment and consumption out of the economy. That makes sense when you face a significant default risk and the economy is booming, but it doesn't make sense as a default policy preference for a fairly simple reason: when the state doesn't spend or borrow, that normally corresponds to an increase in borrowing for households and the private sector structurally if they wish to maintain spending and investment levels. A trade surplus can be a good thing, most of all because it keeps a currency strong. But a trade surplus is a reformulation of saying an economy is producing more stuff than it's consuming. In the Russian case, the fear was always that the ruble would over-appreciate in value cause of high oil prices which would wipeout domestic industries or increase the costs of subsidizing them, recreating a version of what befell Soviet industry in the 1970s and 1980s.

If the economy runs a simultaneous budget surplus and a trade surplus, then an orthodox rendering of economics suggests consumption is on strong ground. If you produce more than you consume and export that surplus production, you de facto have savings circulating around the domestic economy. But this is where things go particularly wrong for Russia – that dynamic means those export earnings and "savings" tend to cluster in large state-owned or parastatal companies and elite hands rather than households while the state is running up a surplus by under-spending on public goods. You can see this play out quite evidently from growth data. Growth slows significantly from 2009-2013 because the mechanism that produced growth, especially from 2002-2008, only worked when energy rents were transferred successfully to households whose consumption then supported the expansion of the private sector and investment. Consumption drives investment for the simple reason that businesses invest to meet current and future demand. To brutalize the Keynesian framework, consumption is investment, the only question is where the productive capacity requiring investment is located based on whether a good or service is an import or not. The more unequal wealth becomes in a society, the greater the drag on growth because there is a physical limit to how many goods or services we can consume. At a certain point, the additional earnings either go into savings and financial assets or else get sunk into real estate, which generates limited productive value for the economy.

By 2012-2013, the politics of budget surpluses, fears of excessive spending and inflation, and under-investment began to weigh on consumption. After 2014, the state made the pain even worse by opting to devalue the currency – imports got more expensive – and then not providing enough stimulus for domestic production of imported goods affected to replace those imports. Things get more expensive, household incomes fall since the state reverted to austerity to avoid exposure to any sovereign debt, and since then household debt has steadily risen. The regime's "sound" macroeconomic policy makes it impossible to grow. When oil prices collapsed, the budget didn't just get cut. Taxes on households, businesses, and consumption rose as well. That further reduces the room for private capital and businesses to invest without stimulus from the state to create demand, the opposite of the approach taken in 2014-2015 and maintained since.

Long story short, Russia's problem is consumption. Growing through exports stopped working after the Global Financial Crisis and cannot work for Russia because its incomes are too high, higher than they are in China and other major Asia-Pacific exporting economies. Further, if we take the example of Germany as a developed country with a large export surplus, that surplus has largely been maintained at the expense of the incomes of households and labor's ability to demand higher wages. In other words, Germany's trade surplus (and China's) reflect under-consumption rather than a positive story about the strength of exporting industries. Had Russia been far more comfortable with deficit spending and deploying more of the 2000s windfall into long-term productivity-enhancing investments like a more expansive infrastructure program, greater increases in public health expenditure and education/educational reform, it would probably not face the constraints on growth it does today. The institutional incapacity of the Russian state is an evergreen topic, but I contend that spending can build capacity over time even if a fair chunk of the money allotted vanishes into personal bank accounts in Russia or abroad. Pair that with Russia's unwillingness to run trade deficits – a political totem of the Soviet dependence on strategic imports and the political commitment to avoid painful adjustments in monotowns and across Russia's regions – and you get a recipe for stagnation. I would never propose that depopulating Siberia and the Far East is politically palatable or a great idea despite the drag monotowns and industrial settlements create. However, I would suggest that stimulating stronger demand and public goods investment in Siberia and the Far East would go a long way towards helping sustain industries and better integrate them into the regional, national, and international economies placed nearby. Running a trade deficit with the CIS would actually have done more to lock in Russia's economic power over the region than creating the Eurasian Economic Union, but that's for another time. There are tons of other aspects to consider and this is a fairly simplistic rendering, but this is how I normally visualize Russia from a macroeconomic perspective and see how it's kneecapped its own ability to grow. Not even another oil supercycle in the 2010s could have fixed the basic problem: the system isn't designed to support consumption and consumption along with public spending on infrastructure, public goods, and redistributive policies drive investments into supply, not the accumulation of reserves, savings, or political interventions based on subsidies and supply-side measures alone.


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