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Tuesday, May 15, 2007

Pay No Attention to that Economy Behind the Curtain!

Writing in the Moscow Times, Yaroslav Lissovolik, chief economist at Deutsche Bank Russia, examines the fundamentals of the Russian economy and finds them fundamentally lacking.

Uneven development, as reflected in political polarization, geographical and ethnic diversity, the minuteness of the middle class and sectoral imbalances, is a defining feature of Russian history. Imbalances persist today and are prevalent across regions and sectors, as well as in income distribution and the comparatively minor role of small and medium enterprises.

Addressing the problem of unbalanced growth has become a top priority for the government, and this to a significant degree will determine sectoral priorities as well as the macroeconomic mix of fiscal and monetary policies in the years to come.

The imbalance among economic sectors is most obvious in Russia's excessive dependence on oil. The fuel sector -- petroleum, petroleum products and natural gas -- accounts for roughly one-quarter of gross domestic product, more than half of federal budget revenues and nearly two-thirds of total exports.

The fuel sector is also the largest recipient of foreign direct investment and accounts for more than half of stock market capitalization.

The "resource curse" looms even larger when you factor in other resource-based sectors, such as timber and metals, which together with fuel account for nearly 90 percent of total exports, leaving Russia extremely exposed to swings in global commodities markets.

Among the regions, the imbalance begins with the city of Moscow. The capital's per-capita consumption is more than twice that of any other region. It accounts for nearly one-fifth of the country's GDP; if you add the oil-rich Tyumen region, this share increases to one-third.

One reason for the discrepancy in regional development is resource distribution. According to government statistics, 54 percent of all resources are extracted in the Tyumen region, and two-thirds of resource wealth is concentrated in just three regions.

As a result, per-capital fiscal revenues in the richest regions are 10 to 20 times higher than in the poorest regions, such as Dagestan.

Inequality among people has also risen in the last few years. Income disparity, already higher than in most Central and East European countries, continues to increase. At the same time, decreases in nonpayments and inflation, along with higher pensions and public-sector wages, have made reducing poverty a realistic goal. Government statistics show that the number of people below the poverty line declined from 29 percent in 2000 to 17.6 percent in 2004.

A key to structural asymmetry in the economy is the limited role of small and medium enterprises, which in most developed economies account for more than 50 percent of total employment and GDP. In Russia, these indicators are well below 20 percent.

Finally, there is the intergenerational divide. The living standards of the elderly continue to deteriorate relative to other age groups, driven by the declining value of pensions, among other things. If in 1998 the average pension was equivalent to 40 percent of the average wage, by 2006 its value had dropped to just 30 percent.

Empirical evidence on transition economies suggests that the costs of such imbalances could be high. An International Monetary Fund study of transition economies demonstrates a direct link between greater inequality and lower GDP growth.

During the tsarist period, persistent and high income inequality contributed to political instability and killed off modernization efforts under Peter the Great and again in the late 19th and early 20th centuries. In the 1930s, sectoral imbalances were the bane of the economy, as industrialization was pursued at the expense of the agricultural and service sectors.

More recently, concerns over economic imbalances have resurfaced as the election season approaches, putting the spotlight on income and regional inequality. The government's failure to reform the social safety net, including pensions, has reinforced awareness of the unequal distribution of wealth, and the bungled reform of in-kind benefits resulted in shortages of free medicine for some of the most vulnerable members of society.

The government's drive to modernize the economy once again faces the familiar challenge of unbalanced development.

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