Russia Growth Diagnostics (5): Uncertainty

< Part 4: Infrastructure and Human Capital

While checking for government failures, I closely follow HRV (2008), who break the failures into three groups: ex ante risks, taxation, and law enforcement. Let’s start from the first group.

Uncertainty and Investments

Ex ante risks refer to the volatility of expected returns to economic activity. Low expectations reduce investments and growth slows down. Here I discuss only the risks associated with government actions (or inactions).

We should distinguish these risks from the risks arising in particular economic activities. Acemoglu and Zilibotti (1997) developed a model in which agents are unable to invest profitably because of scarce diversification opportunities. Instead, agents choose low-risk activities, which don’t create stable growth. While this model is intended to explain the surprising economic uprising after 1800, it can also describe some modern economies. Some, but not Russia’s.

Russia has enough economic opportunities for diversification and a financial system capable of implementing it. Industry-related risks can be mitigated. Then the candidate problem is a sort of uncertainty that affects the entire economy.

How does this uncertainty affect growth? The results in the literature are sensitive to model specifications. I exemplify it with a simple regression of annual growth on volatility of growth (where I take only the period starting at the dissolution of the Soviet Union):

growth_f_volay

A strong connection appears only in the OECD sample. For control, alternative models, and more coherent coverage of the topic, I recommend Jones and Manuelli (2005).

An informative, but limited, perspective comes from investments in fixed capital: buildings, machinery, and other things that last. In an uncertain environment, we expect investments in fixed capital to fall.

gdi_gdn

The stagnation of investments continues in BRICS and G7 since 2008. For Russia, I included the private sector to indicate that not government alone supports this level (though national accounts treat state-owned enterprises as private). You can look at FDI, which fell sharply in the recent years, but hot money and parent companies in offshores make this indicator even less informative than domestic investments.

The overall stagnation is not bad (in the meantime, Greece halved investments in fixed capital to take an example of bad expectations). Yes, government spending and procurement are responsible for maintaining this level, but while speaking about uncertainty, the efficiency of spending is a separate question.

Testing Constraints

Political and social risks. Business worried about these risks right after the 2008 crash (see BEEPS 2009), but calmed down by 2013 (see that year’s BEEPS). Can worries significantly constrain growth? Declining investments would be the major channel in this case, but we saw that this channel was okay. This may change after 2014, so we’ll see.

Tax policy risk. Expectations of higher taxes are justified because one half of government revenues comes from taxes on natural resources. Commodity prices fall and government has to compensate the loss of revenue by increasing taxes on consumption and income.

Labor market risks. This is relevant mostly for households that may expect unemployment and reduce consumption in advance. Unlike the United States, where adjustments happen mostly through unemployment, the Russian economy more actively enables two other channels: working hours and real wages. These are milder forms of shocks, though at the expense of overall productivity. People pay less attention to the risk of losing the entire income and the impact on the current consumption (and growth) is small.

History of expropriation. There’re expropriation cases similar to what happens in some Latin American countries. In Russia, expropriation is limited and selective, and so is its impact on growth.

Macro uncertainty. Oil prices affect exchange rates, which, in turn, change costs in import-dependent industries, such as manufacturing. Commodity prices directly affect the revenues of exporters. The large trade flows aggravate these effects. The composition of trade implies volatility as the export side consists of commodities, half of which is oil.

Each of these five tests shows a positive result, so uncertainty hinders growth in Russia. This idea is reinforced with the difficulties of securing long-term financing (see the other post). Even if businesses have high returns or sound business plans, investors adjust these returns for the economy-wide uncertainty and reject requests for funding.

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