Structural constraints dwarf economic growth in Russia

The Ministry of Economic Development (MED) has admitted that national economic development is facing increasingly serious problems, because GDP may have been declining. For example, the MED doesn't rule out a 0-01% decline in GDP in Q2 2014. Two quarters of falling GDP implies a technical recession.

There is nothing surprising about it – output has fallen, because the prevailing over the past twenty five years geopolitical equilibrium has been distorted.

The fact that the Russian economic status may be downgraded to "recessional" from "slow-growing" has been anticipated from the very onset of the current geopolitical crisis, and uncertainty has rather been concerning particular dates of the onset, depth and duration of a recession.

However, officially considered measures of coping with the current situation through increasing public spending seem to be insufficient, because they may lead to a temporal and insignificant recovery, but the cyclical policy alone can hardly force the recession to give way to a steady economic growth.

The foregoing conclusion is supported by the World Bank's Russia Economic Report which shows high level of capacity utilization in industry and high level of employment. The report underlines that when major infrastructure projects came to an end in 2013, the spare labor force and capacity was immediately felt in the economy, thereby making the use of the cyclical policy restrictedly efficient. It is the lack of investment keeping down the potential level of output that has a much more adverse impact on the crisis situation than the lack of measures aimed at engaging certain spare capacity and labor force in economic activity stimulating convergence of actual GDP to its potential level. The basic issues of economic growth should be addressed by eliminating the key structural constraints rather than cyclical policy methods.

Until recently, corruption and privatization slow growth rate have been the main but by far not the sole factors constraining the economic development. The result of the former was and is low probability of seeing return on investment, while the latter is inadequate effectiveness of large Russian companies. Now that these challenges have recently been topped with a credibility crisis, investment in the Russian economy has become even more scarce and borrowings more expensive.

Cyclical policy measures may therefore be nothing but a temporal supplement to the package of the reforms critical for this stage of economic development. They are required not for resuming a steady growth, but rather to make attempts to buy time which is needed to undertake structural reforms and address the key issues.

The challenge, however, is that the issue of poor investment climate which, as noted above, might have given way to the credibility crisis is unlikely to be resolved in relatively short term and might need extra time.

This extra time may be bought exactly through privatization which was promised a few years ago but extremely slow. Indeed, privatization itself needs time including the implementation of measures of increasing companies' net worth which is low amid the current crisis period. Privatization, however, can be controlled and implemented within a relatively limited term. Potentially, privatization may allow not only the budget to be replenished, but also offer hope for enhancing the effectiveness and development of privatized companies, and therefore growth in expected tax revenues.

Ivan Lyubimov, a senior researcher